IFRS Primer International GAAP Basics solution manual by Ace Test Banks

IFRS Primer International GAAP Basics

BY Wiecek & Young

1 Chapter 1 – Solutions 1-1 Define and discuss the merits of a principles-based and rules-based approach to standard setting. How do they differ? Are there any similarities? What is an objectives-based standardsetting model? How does it compare with the other two? -

Principles-based approach: - Provides a conceptual basis to follow rather than detailed rules - Built around principles/objectives, which provide guidance to accountants - Allows more room for the use of professional judgment since standards may not exist for every situation one may encounter - Broad guidelines – may be applied to many situations - Easier to manage (size and understanding) - Other

Rules-based approach: - Provides detailed rules for accountants to follow - Provides more guidance for accountants as rules/standards can normally be found for any situation - Reduces the chance for bias, therefore reducing the chance for potential litigation - Other

Differences: - Principles-based approach allows more room for professional judgment since standards are not always tailored to specific situations; professional judgment allows the chance for bias - Rules-based approach does not provide much room for professional judgment as rules exist for almost all situations and therefore provides more guidance for accountants; less chance for bias - A rules-based system may become overbearing in size as rules must be in place for all situations; the size of a principles-based system can be much more easily managed - Principles-based system has greater flexibility, especially when new situations or transactions arise; if a new situation or transaction arises under a rules-based system, a new standard/rule must be developed to account for the situation - Other

Similarities: - Although the approach taken to applying accounting standards is different, principlesbased and rules-based accounting are generally based on the same general principles and conceptual framework; therefore, the accounting results are often similar.

Objectives-based standard-setting model: - The proposed standard-setting model under U.S. GAAP - One that is neither purely rules-based nor purely principles-based - Standards are written such that there is an objective at the beginning of each - Concise statement of relevant accounting principle defined and underlies standards Solutions Manual-IFRS Primer-Chapter 1 ..

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Few if any exceptions/internal inconsistencies within the standard Supplemented by implementation guidance No bright-line tests Consistent with the conceptual framework

Similarities/differences - Takes the best of both principles- and rules-based - Like principles-based, it is anchored in the principles and conceptual framework. It is also devoid of bright-line tests – allowing use of judgment - Like the rules-based approach, it includes an appropriate amount of implementation guidance - In terms of volume of information (standards), it would likely be somewhere between the two

1-2 Go to the IASB and FASB websites and look up the project summary relating to the conceptual framework project. Identify some of the main differences between the old frameworks and the proposed framework. -

Links: - http://www.fasb.org/project/conceptual_framework.shtml - http://www.iasb.org/Current+Projects/IASB+Projects/Conceptual+Framework/Conceptu al+Framework.htm

Differences: - Although the proposed framework looks very familiar to the current U.S. GAAP framework, some differences do exist. - Some qualitative characteristics will be considered on different levels: fundamental vs. enhancing - Relevance and faithful representation are fundamental characteristics - Comparability, verifiability, timeliness, and understandability are enhancing characteristics - Other characteristics such as conservatism and reliability will be excluded from the framework. It was felt that conservatism introduced bias and that the reliability characteristic was not consistently applied. Faithful representation was felt to be more representative of the general principle. - Definitions of the elements of financial statements have also changed to provide more guidance to accountants (see “Looking Ahead” on p. 12 for proposed definitions).

1-3 Discuss the relative merits of a single set of global accounting standards. What are some of the impediments or barriers? -

Merits: - Greater comparability - Better access to global capital markets

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Better capital allocation — investors may be more willing to invest in foreign companies as they are able to make informed decisions regarding the companies’ financial position and ability to produce future cash flows Reduces an accountant’s need to learn more than one set of accounting standards (e.g., employees of Canadian-listed U.S. companies being required to reconcile to Canadian GAAP) May lead to the creation of an international accounting designation Facilitates mobility for accountants Promotes the increasingly global nature of the profession Other

Impediments/barriers - Some countries may have unique accounting needs — one set of standards may not be suitable for all countries and companies (e.g., the U.S.’s oil and gas industry). - How will the system be regulated? Currently, each country regulates its own capital markets. - Resistance to change — desire to stick with home-grown systems. This is especially true where a significant amount of funding has already gone into local country standardsetting (such as in the U.S.). - Other

1-4 Standard-setters often refer to bright-line tests. What are these and do you believe they are useful in standard setting? What are some of the drawbacks to the use of bright-lines? - Bright-line tests: Bright-line refers to the inclusion of a specific number or threshold in an accounting standard (e.g., reportable segments are identified based on whether their revenues/assets/profits/losses are greater than 10% of the total for the company) - Useful? - Can be useful in simple accounting situations, but not where the use of professional judgment would be more practicable and provide for a more useful decision - May allow for greater comparability - May allow for greater consistency in application of the standard - More objects — less judgmental - Other -

Drawbacks - IASB not in favour of bright-line test - Does not allow for use of professional judgment — every situation is different - Many accounting situations may be so complex that applying a bright-line test is far too simplistic for the situation - Puts too much emphasis on the calculation rather than the reasoning based on substance - May promote manipulation of contracts/business transactions to ensure that the brightline test is not met if the accounting implication is undesirable - Other

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4 1-5 Identify what is meant by the IASB/FASB Roadmap to IFRS. Research this on the IASB and FASB websites. What are the various components of the roadmap? What is the objective? What are some of the short-term and longer-term projects being worked on? -

IASB/FASB Roadmap to IFRS: - Released in February 2006 as a result of the October 2002 Norwalk Agreement between the IASB and FASB by which they formalized their commitment to the convergence of U.S. GAAP and IFRS. - Outlines the IASB and FASB’s plans and timeframe of convergence — both short-term and long-term projects.

Components of the roadmap - Short-term and long-term convergence projects and timeframe for project completions

Objective - Provide a timeframe for convergence efforts in the context of both the objective of removing the need for IFRS reconciliation requirements between U.S. GAAP and IFRS and the existing agendas of the FASB and the IASB. Note that the SEC has already removed the requirement for foreign filers reporting under IFRS to reconcile to U.S. GAAP.

Short-term convergence projects - IASB: borrowing costs; joint ventures - FASB: fair value option for financial instruments; investment properties; research and development; subsequent events - Both Boards: impairment; income taxes

Long-term convergence projects - Business combinations - Conceptual framework - Fair value measurement guidance - Financial statement presentation - Post-retirement benefits - Revenue recognition - Liabilities and equity - Financial instruments - Derecognition - Consolidations and special purpose entities - Intangible assets - Leases

Many of these projects have been started and/or completed. The status of deliberations is noted in the "Looking Ahead" portion of each chapter.

Solutions Manual-IFRS Primer-Chapter 1 ..

1 Chapter 2 – Solutions 2-1 Entities may present their statement of profit and loss using the nature of expense method or the function of expense method. Discuss the value of each method. - Nature of expense method: - Focuses on the type of expense itself (e.g., payroll, depreciation, etc.) - Arguably easier to prepare, especially if the accounting system is not set up by department - May evaluate performance by type of expense - Other - Function of expense method - Focuses on the nature of the activity that the expense relates to (e.g., production, distribution, etc.) - Presents the cost of sales and gross margin – may evaluate performance - May evaluate each activity separately – if expenses are out of control in one activity (e.g., administration), may be more easily brought under control. - Useful in predicting cash flows - Other 2-2 The accrual method requires that companies estimate the impact of transactions on the financial statements before the cash flows occur. This requires significant amounts of estimation. Review the assets of Rentokil Initial PLC (2007 Annual Report) and identify any assets that require estimation. Identify which estimates need to be made. - Assets requiring estimation: - Intangible assets – goodwill impairment; initial valuation of other intangible assets; depreciation (both estimated useful life and depreciation rate) - Property, plant and equipment – although initially recorded at historical cost, estimates need to be made for depreciation (both estimated useful life and depreciation rate) - Deferred tax assets – estimates made during the calculation of future taxes - Retirement benefits – significant judgment required in determining actuarial assumptions (mortality rate, payroll increases, return on plan assets, etc.), upon which defined benefit schemes are appraised - Trade and other receivables – estimated provision for impairment 2-3 Review the balance sheet for L’Oreal (2007 Annual Report). How does it present its balance sheet? Discuss, comparing to how balance sheets are currently presented in North America. - Balance sheet presentation: - Presented using the current/non-current classifications - Current/non-current classifications are in reverse liquidity order (non-current before current) – emphasizes the larger assets more.

2 - Shareholders’ equity presented before liabilities, with long-terms liabilitie coming before current. This emphasizes the way the non-current assets are financed in terms of longerterm financing. - Comparison to current presentation: - North American balance sheet also presented using current/non-current classifications - Current/non-current classifications are presented in order of liquidity (current before noncurrent). The emphasis is thus on liquidity and working capital - Liabilities presented before shareholders’ equity Note that IFRS is very flexible and encourages entities to use a format that best reflects the natures of the entity. If current/non-current labels are used, the standard provides guidance to allow consistency. 2-4 Review the accounting policy note for GlaxoSmithKline (2007 Annual Report). Identify any areas where the accounting policy choices require significant judgment or measurement uncertainty. See also the key accounting judgments and estimates note. Relate these to the underlying business. The company is a global pharmaceuticals company that specializes in research, development, manufacture, and distribution of pharmaceutical products. Thus it has significant research and development costs as well as distribution costs. - Accounting policy choices requiring significant judgment or measurement uncertainty: - Revenue recognition – revenue turnover affected by rebates, returns, etc., which must be estimated based on historical trends when revenue is recognized. The group sells through hospitals and other channels and so be affected if government funding to hospitals is cut back. - Legal & other disputes – probability of the outcome and amount of settlement A quick read of the litigation note illustrates the nature of the business and the significant business risks associated with running this type of company globally. The company is being sued by regulators and governments for its sales and promotional practices as well as customers who have suffered adverse side effects. - Pensions & other post-employment benefits – actuarial assumptions generated by management (expected mortality rates, return on plan assets, future salary increases, etc.). The entity employs a significant number of employees and provides benefits. - Property, plant & equipment – estimated useful lives and impairment tests - Goodwill – impairment tests. The entity has a significant amount of goodwill arising through acquisitions. - Other intangible assets – estimated useful lives, impairment tests, fair value of internally generated intangible assets. Since the company develops and patents drugs, significant funds are expended on intangible assets. - Impairment of non-current assets - assessment of whether the asset is overvalued - Taxation – tax issues with revenue authorities requires management to estimate amount of tax required to be paid

3 2-5 IAS 1 defines materiality. Compare the definition to the North American definition. Why is it important to relate the concept of materiality to the users? - IAS 1 materiality: - Material omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements. - U.S. GAAP materiality: - Materiality is the term used to describe the significance of financial statement information to decision makers. An item of information, or an aggregate of items, is material if it is probable that its omission or misstatement would influence or change a decision. Materiality is a matter of professional judgment in the particular circumstances. - The definitions under both IAS 1 and U.S. GAAP are virtually identical. - It is important to relate the concept of materiality to the users because materiality is assessed in the context of users. An item is considered material if its omission or misstatement could influence the decisions of the users. Therefore, one must be aware of the attributes of the users and how their decisions may be influenced by a material misstatement or omission. 2-6 Access IAS 1 (through the school’s library) and identify the level of knowledge expected of a typical user of the financial statements. Does this differ at all from knowledge required by U.S. GAAP? - Level of knowledge: - [U]sers are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence. - Difference? - No, this definition does not differ at all from knowledge required by U.S. GAAP (see below for definitions). - U.S. GAAP: U.S. GAAP presently relies on the AICPA auditing guidance for the definition and there is debate over whether this needs to be incorporated into GAAP.

2-7 Access the website(s) identified on the inside back cover of this book and prepare a concise summary of the differences that are flagged throughout the chapter material. (1) Fair presentation and compliance with IFRS - IAS 1 requires departures from the requirement to follow U.S. GAAP where departure is necessary for fair presentation.

4 (2) Statement of comprehensive income - Can be presented as a separate financial statement or in the statement of changes in equity under IFRS; under U.S. GAAP may also be presented with the income statement. (3) Extraordinary items - IAS 1 does not allow for separate presentation of extraordinary items; U.S. GAAP permits separate presentation of extraordinary items.

1 Chapter 3 – Solutions 3-1 Prepare the bottom portion of Ace Manufacturing’s statement of cash flows, along with any related disclosures required, beginning with the line “Change in cash and cash equivalents for the year.” Change in cash and cash equivalents for the year:

Cash on hand and in bank Bank overdraft Temporary investment, 60-day T bill Cash and cash equivalents Change = a decrease of $25 - $7 = $18.

2008

2007

$15 ( 8) 0 $ 7

$20 ( 0) 5 $25

Bottom of 2008 statement of cash flows: Change in cash and cash equivalents for the year Cash and cash equivalents, June 30, 2007 Cash and cash equivalents, June 30, 2008

$(18) 25 $ 7

Disclosures: - Components of cash and cash equivalents —a reconciliation to the accounts on the balance sheet similar to the schedule above. - Significant cash balances not available for use—there is $3 not available for use as it is held in a foreign country with exchange restrictions. 3-2 (a) For each asset listed, indicate whether its acquisition is an operating, investing, or a financing activity. If a choice is allowed, indicate what the choices are and explain which you would choose and why you would choose it. 1. Heavy equipment owned by a construction company

Investing

2. Income taxes receivable on overpayment by an advertising agency

Operating

3. Development costs on product X34 of a manufacturing company

Investing or operating

This transaction is an inventory transaction and therefore might be considered an operating activity, especially if the amortization period is short. Alternatively, the standard indicates that long-term development costs are included as investment activities.

2 4. Golf course acquired under a finance lease by a hospitality company

Investing and a financing activity

5. Bulldozers acquired by a heavy equipment dealer

Operating

6. Long-term portion of installment account receivable of a furniture retailer

Operating

7. Held-for-trading investment in bonds in the portfolio of a technology solutions company

Operating

8. Temporary investment in 30-day commercial paper of a major company by a department store retailer

None

The acquisition of the golf course is an investing activity; the capital lease is a financing activity

This investment is a cash equivalent.

(b) For each asset listed, indicate whether cash flows from its use and/or disposal are operating, investing, or financing cash flows. If a choice is available, explain your answer. Operating: cash flows from use – generates revenue and incurs expenses Investing: cash flows from disposal Included once cash flows from receivable are received

1. Heavy equipment owned by a construction company

Operating & Investing

2. Income taxes receivable on overpayment by an advertising agency

Operating

3. Development costs on product X34 of a manufacturing company

Investing or operating

See above.

4. Golf course acquired under a finance lease by a hospitality company

Financing

As payments are made to reduce amount owed on finance lease. As cash flows are generated from the use of the golf course. When sold, cash inflow from sale of inventory – normal course of business Inflow from receipt of cash – assuming installment account receivable is due from sale of inventory of furniture The acquisition, use and disposal of investments for trading purposes are operating flows. Any interest and gains or losses

Operating 5. Bulldozers acquired by a heavy equipment dealer

Operating

6. Long-term portion of installment account receivable of a furniture retailer

Operating

7. Held-for-trading investment in bonds in the portfolio of a technology solutions company

Operating

8. Temporary investment in 30-day commercial

Operating

3 paper of a major company by a department store retailer

on sale are considered operating flows. The investment itself is considered a cash and cash equivalent.

3-3 For each item listed (a) Identify the effect on the company’s cash and cash equivalents; and (b) Indicate how the transaction or event will be reported on the company’s statement of cash flows, if at all, and if any special disclosures are required.

1. Annual payment of $100 on a finance lease obligation, $2 of which is interest

(a) Cash outflow of $100

(b) Financing outflow of $98 Either financing or operating outflow of $2

2. Acquisition of a $100, 3%, 90day government treasury bill

None. This is considered a cash and cash equivalent item

3. Payment of $25 to a pension fund trustee

Cash outflow of $25

Operating outflow of $25

4. Cash received on the maturity of the treasury bill in item 2 above

None. The amount of cash and cash equivalents has not changed, except for any interest.

5. Annual payment of $100 on an operating lease for sales office space

Cash outflow of $100

The interest received would be an operating flow. Although interest income can be considered an investing flow as well, it is unlikely an entity would consider the return on cash and cash equivalents as anything other than an operating flow. Operating outflow of $100

6. Receipt of $10 on the sublease of excess sales office space

Cash inflow of $10

Operating inflow of $10.

7. Acquisition of the company’s treasury shares at a cost of $75

Cash outflow of $75

Financing outflow of $75

8. Conversion of convertible debt into common shares

No effect

9. Payment of $30 of a portion of long-term debt reported in current liabilities along with $3 of interest

Cash outflow of $33

No effect on cash flow statement. Disclosure required detailing conversion Financing outflow of $30 Either financing or operating outflow of $3

10. Costs incurred to repair a customer’s product under warranty—inventory supplies used $1; labor paid $4

Cash outflow of $4

Operating outflow of $4

3-4 IAS 7 Statement of Cash Flows permits a choice in how interest and dividends received and paid are classified on the statement of cash flows. For interest received, dividends received, interest paid, and dividends paid, identify two likely ways in which each might be reported. Provide a reasonable explanation for each choice. Interest Received (1) Operating: interest received enters into the determination of profit or loss; because operating activities are the principal revenue-producing activities of the entity, interest received should be included in operating activities. Also, this treatment is consistent with the returns on other investments such as those in property, plant and equipment; e.g., the cash from revenues earned and expenses incurred are operating items. (2) Investing: interest received is a return on investment rather than from the major operations of the entity. Dividends Received (1) Operating: dividends received enter into the determination of profit or loss; because operating activities are the principal revenue-producing activities of the entity, dividends received should be included in operating activities. Also, this treatment is consistent with the returns on other investments such as those in property, plant and equipment; e.g., the cash from revenues earned and expenses incurred are operating items. (2) Investing: dividends received are a return on investment rather than from the major operations of the entity. Interest Paid (1) Operating: interest paid enters into the determination of profit or loss; because operating activities are the principal revenue-producing activities of the entity, interest paid should be included in operating activities. It is an amount paid to parties outside the entity as a cost of borrowing money. (2) Financing: interest paid is a cost of obtaining financial resources. This treatment should be consistent with how dividends paid are reported as they are very similar items. Dividends Paid (1) Operating: reporting dividends paid under operating activities assists users to determine the ability of an entity to pay dividends out of operating cash flows.

5 (2) Financing: dividends paid is a cost of obtaining financial resources 3-5 Access the website(s) identified on the inside back cover of this book and prepare a concise summary of the differences that are flagged throughout the chapter material. U.S. GAAP and IFRS: Cash and cash equivalents: - Under U.S. GAAP, bank overdrafts cannot be included as part of cash for purposes of the cash flow statement. - Under IFRS, bank overdrafts can be included if they form an integral part of the entity’s cash management. Classification of interest received and paid: - Under U.S. GAAP, both interest received and paid must be classified as an operating activity (for interest expense not capitalized). - Under IFRS, a choice is permitted.

1 Chapter 4 – Solutions 4-1 Will SG report a discontinued operation on its financial statements for its year ended March 31, 2008? Explain how you determined your answer. - Yes, SG will report a discontinued operation on its financial statements for its year ended March 31, 2008. - SG’s corporate-owned restaurants represent a separate major line of business that is distinct from the franchise operation it also has. It contributes to profit and loss in a different way, and its results would have been reported separately in the financial statements from the franchised operations. - The operations and cash flows can be clearly distinguished from the rest of the entity. 4-2(a) Discuss the financial reporting issues as April 30, 2008, approaches. - The important issues are whether the building would be reported as held-for-sale and whether it meets the requirements to be considered a discontinued operation. - Held-for-sale? - Plans to sell in place – formal and detailed plan drawn up and approved by the board of directors. - The building meets some of the conditions of a held-for-sale asset – it is highly probable that will be sold and plans are not likely to change in the next year. - However, is the building available for immediate sale in its existing condition and will the sale qualify for accounting recognition within one year from the balance sheet date? While the new head office building is unlikely to be ready to move into by October 31, 2008, the sale transaction might take place before then. It seems a little premature to record this as held-for-sale at October 31, 2007. - Whether it is likely to be reported as held-for-sale really depends on whether Glassio is prepared to sell the building immediately. If yes, then the building could be classified as held-for-sale. It would be recorded on the statement of financial position at the lower of its carrying amount of $100 and fair value ($95) less costs to sell and be reported in current assets. No further depreciation is taken on the building after it is classified as held-for-sale. - If no, then it cannot be classified as held-for-sale. The asset would continue to be property, plant, and equipment, and depreciation would continue to be recognized. This is the more likely outcome. - Discontinued operation? - Ownership and occupancy of head office space is not a separate major line of business, nor does it have its own operations and cash flows that could be clearly distinguished from the rest of the entity. - The disposal would not be reported separately on the income statement as a discontinued operation. 4-2(b) Would any of the issues change if Glassio Corp. were a heavy equipment manufacturer and the building was the company’s only rental property? Explain.

2 - In this case, the issue of whether the building would be considered a discontinued operation would change. - The building would likely be a separate major line of business and have its own operations and cash flows that could be clearly distinguished from the rest of the entity. - If this were true, it would be reported separately on the income statement as a discontinued operation, as well as on the statement of financial position as held-for-sale. 4-3(a) Prepare summary income statements for Shikkiah Corp. for its year ended May 31, 2007 and 2008.

Revenue (962-43) Expenses (762-41-6+3 loss on land) Profit before tax Income tax expense Profit from continuing operations Profit/loss from discontinued operations Net Income

2008 919 -718 201 -50.3 150.7 -3.0 147.7

2007 888 -704 184 -46 138 9.7 147.7

4-3(b) Identify how the land that is in process of being expropriated will be measured and reported in the May 31, 2008, financial statements. - It appears that the land meets the conditions required to be considered held-for-sale: - Highly probable that it will be expropriated by the government – agreement to pay transfer costs and agreement on selling price - Not likely that the plans for expropriation will change over the next year - Reported on the balance sheet as held-for-sale and measured at the lower of carrying value and fair value less costs to sell ($10). A loss of $13-$10 is reported on the income statement. 4-3(c) Identify all the note disclosures that are required as a result of the events described above. - Discontinued Operation: - Revenues, expenses and pre-tax profit from operations, as well as the related income tax expense ($43 - $41 = $2 before tax, $1.5 after tax). - Loss on disposal and related income tax expense ($6 before tax loss; $4.5 after tax). - Total of the after-tax profit from operations and loss on disposal (on the income statement). - Net cash flows from operating, investing, and financing activities. - Restatement of comparative income statement to report the operating results of the discontinued operation below income from continuing operations. - Expropriated Land - Description of the land that is now held-for-sale - Reason why it is held-for sale – government expropriation - Expected date of expropriation Solutions Manual-IFRS Primer-Chapter 4 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

3 - The amount of loss on write-down to fair value ($3 loss) 4-4(a) Prepare any accounting entries AMI makes as Division X is reclassified as held-for-sale. Assuming the carrying amounts provided were determined relative to the assets’ respective IFRS: Dr. Impairment loss on assets held for sale 9 Cr. Equipment (50-45) 5 Cr. Land (40-38) 2 Cr. Miscellaneous Supplies (4-2) 2 4-4(b) Indicate how this disposal group will be reported on AMI’s statement of financial position. - The assets are reported in total in current assets ($100 + $45 + $38 + $2 = $185), described as held-for-sale, and the liabilities are reported in total in current liabilities ($65 + $3 = $68) as held-for-sale. 4-4(c) Indicate how any adjustments will be reported on the financial statements. - Any losses from asset (or liability) write-downs to the lower of carrying value and fair value less costs to sell are recorded as an impairment loss and included in profit or loss. In this case, the impairment loss relates to a discontinued operation, therefore, the $9 loss is reported in discontinued operations on the income statement. 4-5(a) Assuming JayCee Corp. prepares financial statements each June 30 and December 31, prepare all entries required to account for the equipment on June 1, 2008; June 30, 2008; December 31, 2008; June 30, 2009; and August 12, 2009. June 29 2005 Cost Est. useful life Residual value Depreciation June 1 2008 Resale value Cost to sell (10%) Carrying value Fair value less cost to sell

$100 45 units $10 $2 per unit $45 $4.50 44* 40.5**

* $100 - (28 x $2) = $44 ** $45 - ($45 x .10) = $40.50 June 1 2008 Impairment loss on asset held-for-sale Equipment held-for-sale Accumulated depreciation (100 – 44) Equipment

3.50 40.50 56.00 100.00

June 30 2008 No entry required No depreciation taken while classified as held-for-sale December 31 2008 Impairment loss on asset held-for-sale Equipment held-for-sale

2.70 2.70*

*New fair value less cost to sell $42 ($42 x .10) = $37.80 $40.50 - $37.80 = $2.70 June 30 2009 Equipment held-for-sale Gain on asset held-for-sale

6.20 6.20

Fair value less cost to sell = $50 - ($50 x .10) = $45 Carrying value = $44 $44 - 37.80 = $6.20 write-up; maximum August 12 2009 Cash (49 – 10% of 49) Equipment held-for-sale Gain on sale of asset

44.10 44.00 .10

4-5(b) Explain how any adjustments made will be reported on the income statements for each six-month period ended June 30 and December 31, 2008, and June 30 and December 31, 2009. June 30 2008: Impairment loss of $3.50 reported on statement of profit or loss from continuing operations. It is not likely that the equipment would qualify as a discontinued operation. December 31 2008: Impairment loss of $2.70 reported on statement of profit or loss from continuing operations. June 30 2009: Gain of $6.20 reported on statement of profit or loss from continuing operations. December 31, 2009: Gain on sale of asset of $0.10 reported on statement of profit or loss from continuing operations.

4-6 Access the website(s) identified on the inside back cover of this book and prepare a concise summary of the differences that are flagged throughout the chapter material. (1) Definition of discontinued operations:

5 Definition under IFRS is much more restrictive than under U.S. GAAP. Under IFRS, it is defined as “a reportable business or geographical segment or major component thereof.” Under U.S. GAAP, for example, it is defined as “a component which may be an operating segment, a reporting unit, a subsidiary, or an asset group.” (2) Disclosures for discontinued operations: Under IFRS, only post-tax income or loss is required on the face of the income statement for discontinued operations. Under U.S. GAAP, both post-tax and pre-tax income or loss are required on the face of the income statement.

1 Chapter 5 – Solutions 5-1 Contrast and compare the definitions of contingencies and contingent liabilities under both IFRS and U.S. GAAP. How does the accounting differ? Start by looking up the respective definitions under the respective standards. IFRS: (a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or (b) a present obligation that arises from past events but is not recognized because (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or (ii) the amount of the obligation cannot be measured with sufficient reliability. U.S. GAAP: requires accrual by a charge to income (and disclosure) for an estimated loss from a loss contingency if two conditions are met: (a) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and (b) the amount of loss can be reasonably estimated. Accruals for general or unspecified business risks ("reserves for general contingencies") are no longer permitted. Accounting for gain contingencies under Accounting Research Bulletin No. 50, Contingencies, remains unchanged; they are recognized when realized. Similarities or differences: - Definitions are generally the same with regards to the occurrence of a contingency. - IFRS only makes reference to a contingent liability, while U.S. GAAP implies both contingent asset and contingent liability. IFRS has a separate definition for contingent assets. - IFRS provides more guidance on what would be considered a contingency or contingent liability. - IFRS emphasis on events not wholly within the control of the entity. - IFRS – contingent assets/liabilities not recognized. Under U.S. GAAP, recognized if likely and measurable. Having said this, liabilities might get picked up under IFRS if onerous contract. 5-2 Write a short essay on the use of terms “possible” and “probable” as they relate to recognition of provisions. Do these represent “bright-line” tests? Discuss. - If the outcome of a situation is possible, a contingent liability may exist, but a provision does not exist. It does not make sense to recognize things that are only “possible.” Anything is possible. - To recognize a provision, it must be probable – there must already be an obligation in place. This allows for greater predictive value. - This is not really a bright-line test since there is no quantitative threshhold. Probable means “more likely than not,” where “more likely than not” generally means a chance greater than Solutions Manual-IFRS Primer-Chapter 5 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

2 50%. However, professional judgment is still required to determine the likelihood of a situation occurring. 5-3 Assume that each of the lawsuits is unique. Prepare the journal entries to accrue the provision. Now, assume that the three lawsuits are part of a pool of similar lawsuits. Prepare the journal entry to accrue the provision. How do the entries differ and why? Discuss. Unique lawsuits: Lawsuit A: certain at $1000 – recognized because probable and measurable. For this and the other single lawsuits, use most likely outcome but take into account probability of possible outcomes to refine estimate. For lawsuit A - $1000 is the most probable outcome. Dr. Loss on lawsuit settlement Cr. Provision for lawsuit

$1000 $1000

Lawsuit B: 80% probable – between $0 and $1000 – recognized because probable (more likely than not) and measurable – $1,000 * .50 * .80 = $400. The most likely outcome is somewhere between 0 and $1000 with no one possibility being more probable than another. Dr. Loss on lawsuit settlement Cr. Provision for lawsuit

$400 $400

Lawsuit C: between $500 and $1500 – does not appear to be probable, only possible, therefore contingent liability – disclose rather than recognize. Similar lawsuits: For a group of similar lawsuits A Same as above. Use the expected value method – assess all outcomes and assign probabilities. There is 100% probability of having to pay $1000 each. For a group of similar lawsuits B Same as above. This is a situation with a continuous range of outcomes, each as likely as the next so take the midpoint of the range multiplied by the overall likelihood of loss of lawsuit. Note that there are two uncertain items here – the outcome of the lawsuit (will they lose or not) and the measurement – how much. For a group of similar lawsuits C Same as above.

How do these entries differ and why? Discuss. The entries do not differ as noted above. For single items, you would use the most likely outcome. The standard notes further that we may take into account the probability of other outcomes to refine the estimate if the information is available. Note that this information may not be available for unique items especially where the item is a one time non-recurring event. For multiple items (for instance warranties or returns) we would consider the probabilities of the different outcomes. Where the item is part of a larger pool of similar items, it is more likely that these items would be recurring and therefore, there would be some data/evidence to support the calculations. For lawsuit A, there is a 100% likelihood of paying out $1000; therefore, the expected value and most likely outcome are the same whether individual/unique item or pool. For lawsuit B, there is an 80% likelihood of paying out $1000; therefore, it meets recognition criteria and must be estimated. Because we cannot measure the “most likely outcome” and since that information is not given, we revert back to using the same measurement technique as for the pool (large number of items with continuous range of outcomes) and use the midpoint. For lawsuit C, assume that the likelihood of payout is only possible and therefore does not meet recognition criteria.

5-4 Prepare the journal entry to accrue the provision. Similar lawsuits | risk-free rate 5% | borrowing rate 8% | paid over 5 years $1000/5= 200 per year PV 200 (5 years, 8%) = 3.99271 200(3.99271) = $598.91 Dr. Loss on lawsuit settlement Cr. Provision for lawsuit

$798.54 $798.54

4 5-5 Does the vendor have a liability at December 31, 200X? - 1/1,000,000 = 0.0001% chance that the one hamburger he sold is contaminated. - To recognize a provision for the possible contamination, it would be need to be both probable (more likely than not) and measurable. - One would assume that a 0.0001% chance of contamination is not probable – although it is possible. - No other information is given as to the potential cost of contamination – it is therefore not measurable. - It would not be recognized as a liability at December 31, 200X. - Would be considered a contingent liability, but not a provision. - Disclosure is normally required for contingent liabilities, but since it is remote no disclosure would be required. - Is there an obligating event resulting from a past transaction? What is the transaction? Is the sale of any hamburger the transaction? Because they do not know whether they sold a contaminated burger, it is difficult to say that an enforceable obligation exists even though there is an enforceable law. - See discussion on IASB website. The IASB discussed this issue at length and had mixed views. 5-6 Access the website(s) identified on the inside back cover of this book and prepare a concise summary of the differences that are flagged throughout the chapter material. (1) Best estimate & risk uncertainties: Under IFRS, provisions are measured at the best estimate to settle the obligation, which generally involves the expected value method. Under U.S. GAAP, provisions (or contingent liabilities/assets) are measured at the most probable outcome to settle the obligation; if no one item is more likely than another, use the lowest end of the range of possible amounts. (2) Present value: Under IFRS, discounting is required to estimate the amount to be accrued as a provision when the time value is material. Under U.S. GAAP, discounting is only allowed where the timing and amount of the future cash flows is fixed and determinable, unless it is specifically permitted by an accounting standard. (3) Restructuring: Under IFRS, restructuring provisions are recognized if a detailed formal plan is announced or implementation of such a plan has started. Under U.S. GAAP, restructuring provisions are recognized only when a transaction or event occurs that leaves an entity little or no discretion to avoid future transfer or use of assets to settle the liability. (4) Disclosures: Under IFRS, disclosures that may prejudice seriously the position of the entity in a dispute need not be disclosed in extremely rare cases; however, disclosure is required of the general nature of the dispute and why the details have not been disclosed. Under U.S. GAAP, disclosure is always required. Solutions Manual-IFRS Primer-Chapter 5 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

1 Chapter 6 – Solutions 6-1 Discuss the issues. - How will Foogle account for its advertising revenues? o Advertising revenues from most customers would be accounted for according to the recognition criteria for service revenues — when reliably measurable, economic benefits probable, and stage of completion and costs measurable. In other words, when services are rendered. This would be when the customer clicks on the advertisement. The company has provided the search engine and placed the advertisement. - How will Foogle account for its advertising revenue from Gunigal? - Since both agreed to advertise on each other’s website, it is similar to a barter transaction. - SIC 31 deals with barter transactions involving advertising services, as explained in the text: Barter transactions involving advertising may result in revenue recognition as long as the advertising services provided and received are different. - Since both companies appear to be similar Internet companies, earning revenues through advertising, one might argue that the advertising services provided and received are similar. - If the advertising services provided and received are similar, revenue would not be recognized. - One might also argue that as the services are different – otherwise – from a business perspective, why would both companies choose to advertise on the other’s website? If the advertising services provided and received are different, revenue can be recognized. In this case, the services rendered would be measured at the fair value of the services provided. The entity would look to similar services provided to other customers for evidence of value. The value must be supported. 6-2 Discuss the issues. -

When should Inca recognize the revenue from the December 31 sale? Considered a sale to an intermediary (wholesaler selling to retailer – goods for resale) Recognize revenue according to general revenue recognition criteria for sale of goods Have all of the revenue recognition criteria been met at December 31? 1. Has the entity transferred to the buyer the significant risks and rewards of ownership of the goods? The goods are shipped and legal title transferred. 2. Does the entity retain neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold? No — as discussed above, title and possession have passed — there is no continuing involvement. 3. Can the amount of revenue be measured reliably? Yes – the revenue is based upon an agreed upon, contracted price. 4. Is it probable that the economic benefits associated with the transaction will flow to the entity? This may not be met – see below.

5. Can the costs incurred or to be incurred in respect of the transaction be measured reliably? Yes – the furniture is completed and shipped – there are no additional costs – except perhaps those connected with #4 above (collectibility). It appears that all conditions for revenue recognition have been met with the exception of #4. The customer is new to Inca and only commenced business the previous year. There is no down payment and so the customer has nothing to lose if it backs out of the transaction. This might result in the conclusion that risks and rewards have not yet passed. As long as Inca can ensure that it will receive payment from the new customer, revenue can be recognized at December 31. If not, revenue should be recognized when it is probable that it will receive payment from the customer or when payment is received. If it is probable that Inca will receive payment at December 31, the amount recognized should be discounted using an appropriate discount/interest rate based on the riskiness of the cash flows. Since the customer is new to both Inca and the market, Inca should be aware of the credit risk associated with the customer. A credit check may be appropriate to determine an appropriate interest rate.

6-3 Prepare the journal entries to record the sale. The company uses a 50 percent mark-up policy. Use imputed rate of interest: Cash price = $95,000 Total cash flows to be paid = $100,000 Total interest = $100,000 - $95,000 = $5,000 Imputed interest rate = 95,000(1+x) = 100,000 1+x = 100,000/95,000 1+x = 1.052631579 x = 0.052631579 or 5.263% Present value factor (1 year, 5.2631579%) = 1/(1+.05263157)1 = .95 100,000 * .95 = $95,000 Cost of Goods Sold = 95,000/1.50 = 63,333.33333 Journal Entries: Dr. Accounts Receivable $100,000 Cr. Revenue Cr. Unearned Interest

$95,000 $5,000

Dr. Cost of Goods Sold Cr. Inventory

$63,333

3 6-4 Go to the FASB and IASB websites and access the minutes of the meetings where these models have been discussed. Write a short essay that explains the theoretical basis for both methods. Discuss. Measurement Model: - The amount of revenue to be recognized is determined by considering how much assets and liabilities change in a period. - The specified assets and liabilities in the model are those that arise directly from enforceable contracts with customers. - Revenue is defined as an increase in a contract asset or a decrease in a contract liability that results from the provision of goods and services to a customer. - Enter into a contract in which the underlying rights exceed the underlying obligations - Subsequently settle obligations in the contract by providing goods or services to the customer - Model is consistent with the existing definitions of revenue for both FASB and IASB, where revenue is based on increases in assets and settlements of liabilities (or a combination of both). - Instead of evaluating how much revenue has been earned, the measurement model focuses on the changes in assets and liabilities themselves to determine how much revenue to recognize. - Easier to determine whether an asset has increased or a liability has decreased rather than whether the earnings process is complete. Allocation Model: - Also known as the “customer consideration model” - An entity accounts for the contract asset or liability that arises from the rights and obligations in an enforceable contract with a customer. - As each performance obligation identified in the contract is satisfied, the resulting decrease in the contract liability or increase in the contract asset results in the recognition of revenue. - The contract rights are measured at the amount of contract consideration stated in the contract. - Using the customer consideration amount as the measurement is familiar and understandable to users due to the history of accounting transactions being measured at the transaction amount. - Users of financial statements understand what revenue in the profit and loss represents when it equals the amount of customer consideration received or receivable. 6-5 Discuss. - The issue at stake here is whether revenues can be recognized at the inception of the contract. - On the one hand, one might argue that many activities go into obtaining a contract – so these activities are significant events. When the contract is obtained, then these revenues should be recognized. - On the other hand, obtaining the contract is incidental to the real revenue-generating activity which is providing a service or product. Therefore, obtaining the contract is merely the point when the deal is struck and precedes all revenue-generating activities. Thus no revenue should be recognized. Solutions Manual-IFRS Primer-Chapter 6 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

4 - The other issue relates to measurement, e.g., if revenue should be recognized at contract inception, how do you measure it? - Other 6-6 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are.

(1) Discounting cash flows for amounts paid over time: Under IFRS, the cash flows from revenue are discounted using an imputed rate of interest when the amount due is paid over time. Under U.S. GAAP, discounting to present value is required only in limited situations. (2) Bundled sales transactions: All require separate recognition of revenue of an element of a transaction if that element has commercial substance on its own. However, IAS 18 does not provide specific criteria for making the determination of what is considered an element of a transaction. Under U.S. GAAP, for example, specific criteria must be met in order for each element to be a separate unit of accounting; at which point, revenue may be recognized for each element. (3) Recognition of revenue for sale of goods: IFRS allows revenue to be recognized only when risks and rewards of ownership have been transferred, the buyer has control of the goods, revenues can be measured reliably, and it is probable that the economic benefits will flow to the company. Under U.S. GAAP, public companies must follow more detailed guidance provided by SAB 104 Revenue Recognition, which requires that delivery has occurred (the risks and rewards of ownership have been transferred), there is persuasive evidence of the sale, the fee is fixed or determinable, and collectability is reasonably assured. (4) Illustration 6-1: In general, more specific guidance given under U.S. GAAP – especially for multiple-element sales. (5) Construction contracts: Under both IFRS and U.S. GAAP, the percentage-of-completion methods are used. However, under IFRS, if certain criteria for use of the percentage-of-completion are not met, the cost recovery method is used. If criteria for the use of the percentage-of-completion method are not met under U.S. GAAP, the completed contract method is used. The completed contract method is not permitted under IFRS. Guidance under SOP 81-1 regarding construction contracts may not be applied to non-construction contracts.

1 Chapter 7 – Solutions 7-1 Determine whether the cost of each of the items is included in the cost of inventory. Provide a brief explanation of each. 1. Hides of various leather → Yes, direct materials used in production. 2. Dyes to color the leather → Yes, used in production. Probably would be an item of indirect or variable overhead rather than a direct material. 3. Warehouse costs to store the dyed leather while drying → Yes, cost incurred during production – this warehouse cost is needed in the production process. 4. Patterns and dies used to guide the cutting of the pieces into the desired shape → Yes, used in production. The depreciation of these patterns and dies would be included in production overhead. 5. The salary of the plant manager’s administrative assistant → Yes, the cost of the plant manager’s office, including the payroll costs of the administrative assistant, is included as a factory overhead. 6. Costs of the warehouse to store finished goods → No, the cost of storing goods after production is complete is not included in the cost of inventory. 7. Underapplied factory overhead → No. This results from idle capacity or operating inefficiencies. This is charged to expense in the period. 7-2 Identify and briefly discuss the costs that are likely to be included in SC’s inventory on its year-end balance sheet. - Human resource professionals’ salaries – direct labor associated with providing the service - Administrative assistants’ salaries associated with the work performed on the client files – probably treated as indirect labor and a “production” overhead cost - Out-of-pocket costs associated with specific clients: HR professionals’ travel costs to clients’ offices, advertising costs associated with specific searches, amounts paid to candidates brought in as a result of a specific search - Supervisory salaries for those supervising employees working directly with clients or on client files - Other overhead allocated to providing these services to clients, such as rent for the space occupied by HR professionals and their administrative assistants; telecommunication costs, etc. Solutions Manual-IFRS Primer-Chapter 7 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

7-3 Identify inventory policies that would be appropriate for Kiji Appliances Ltd. to use for financial reporting purposes. - Cost would include the purchase price plus any non-refundable taxes less any volume discounts. The transportation and handling costs to bring the goods in should be added to the inventory cost as well. Some companies will expense such costs immediately because it is not cost-effective to trace such costs to individual items of inventory. - Kiji can choose a costing method of either specific cost, first-in-first-out (FIFO), or weighted-average. - For the major appliances, the specific cost method would be appropriate because they can be identified specifically by serial number; a choice between FIFO and weighted-average would have to be made for the smaller appliances as it would not likely be cost-effective to identify each specifically. Because KAL probably has an internal policy to sell the older stock first, the FIFO method would probably more closely relate to the physical flow of goods. - Report at lower of cost and net realizable value. 7-4(a) Prepare quarterly income statements for the first three quarters of KEI’s 2008 fiscal year. Report the inventory in the statements at cost, separately indicating the loss or loss recovery from adjusting inventory to the lower of cost and net realizable value.

Sales Cost of Sales* Gross Margin Inventory (Loss) or Recovery** Net Income (Loss)

March 31, 2008 $475 (164) $311 (102) $209

June 30, 2008 $210 (221) ($11) 103 $92

September 30, 2008 $500 (275) $225 4 $229

*Beginning Inventory + Purchases – Ending Inventory = Cost of Sales March 31 → 150 + 265 – 251 = 164 June 30 → 251 + 240 – 270 = 221 September 30 → 270 + 235 – 230 = 275 **Inventory (Loss) or Recovery: see part (b) for calculation 7-4(b) Assuming KEI records its LC and NRV adjustments in an allowance account, prepare the adjusting journal entries needed at March 31, June 30, and September 30, 2008. LC & NRV Allowance 5 Jan 1/08 [$150 – $145] 102 Write-down 107 Mar 31/08 [$251 – $144] Write-up

103

Write-up

3 0 Sept 30/08 [$230 – $230]

March 31: Dr. Inventory Loss Cr. LC & NRV Allowance

$102

June 30: Dr. LC & NRV Allowance Cr. Inventory Loss – Recovered

$103

September 30: Dr. LC & NRV Allowance Cr. Inventory Loss – Recovered

$102

$103

7-5 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of the differences that are flagged throughout the chapter material. (1) Exclusion of certain businesses from measurement requirements of IAS 2: Under IFRS, inventories held by producers of agricultural and forest products and mineral ores and broker-dealers of commodities are excluded from the measurement requirements of IAS 2 (measuring inventory at NRV even if above cost). Under U.S. GAAP, only precious metal inventories are excluded from the measurement requirements for inventory. (2) Inventory cost methods: Under IFRS, LIFO (last-in-first-out) is not permitted as a cost method for inventory. LIFO is permitted as a cost method for inventory under U.S. GAAP. (3) Definition of “market” Under IFRS, the lower of cost and “market” is the lower of cost and net realizable value. Under U.S. GAAP, “market” is defined as current replacement cost, as long as it falls between net realizable value and net realizable value less a normal profit margin. If replacement cost is above NRV, market is NRV. If replacement cost is less than NRV less a normal profit margin, market is NRV less a normal profit margin. (4) Reversal of inventory write-down: IFRS requires the reversal of inventory write-downs if certain criteria are met. The reversal of inventory write-downs is prohibited under U.S. GAAP.

1 Chapter 8 – Solutions 8-1 Discuss how the contract should be accounted for under the following scenarios. Prepare journal entries. (1) Reliably measurable and other recognition criteria met; therefore, recognize revenue equal to the percentage complete using costs incurred as an estimate: (250,000/1,200,000) x 1,500,000 = $312,500 Dr. Inventory Cr. Cash

250,000

Dr. Construction Expense Dr. Construction in Progress Cr. Cash Cr. Revenue

250,000 312,500

250,000

250,000 312,500

(2) Outcome is not reliably measurable; therefore, recognize revenue equal to the expenses recognized: Dr. Inventory Cr. Cash

250,000

Dr. Construction Expense Dr. Construction in Progress Cr. Cash Cr. Revenue

250,000 250,000

250,000

250,000 250,000

(3) Losses probable on the contract; therefore, recognize revenue equal to the percentage complete using costs incurred as an estimate and recognize the loss since it is probable and measurable: Losses = $300,000 Dr. Inventory Cr. Cash

250,000

Dr. Construction Expense Dr. Construction in Progress Cr. Inventory Cr. Cash Cr. Revenue

717,000 200,000*

250,000

250,000*** 250,000 417,000**

* Costs less expected loss: 500,000 – 300,000 **500,000/1,800,000 × 1,500,000 = $417,000 (500,000 includes the costs incurred to date including the inventory write-off)

2 *** Assume write off inventory since loss likely on contract (therefore no future value?). Need inventory to complete contract so cannot otherwise sell it to recover costs.

(4) Outcome not reliably measurable and costs may not be recoverable; therefore, do not recognize revenue; only recognize costs. Dr. Construction Expense Cr. Cash

250,000 250,000

May also consider writing off inventory. 8-2 Prepare the journal entries to record the revenues in the first year. Recoverable and measurable; revenue recognized is equal to the costs expensed plus the profit margin: 2,000,000 × 1.10 = $2,200,000

Dr. Construction Expense Dr. Construction in Progress Cr. Cash Cr. Revenue

2,000,000 2,200,000 2,000,000 2,200,000

8-3 Discuss whether the costs are contract costs. (1) Materials costs (some of which are still on hand) → Only those that have been used in construction would be considered contract costs. (2) Labor costs for builders → Yes, since they are directly related to the contract. (3) Salary of site supervisor → Yes, since the supervisor’s salary is directly related to the contract. (4) Salary of head office project manager → Yes, as long as he is related to this specific project. (5) Depreciation on construction machinery → Yes, as long as the machinery is used in construction and is not idle. (6) Insurance → Yes, but only the portion that is related to the specific construction contract is allocated as a contract cost. (7) Head office secretarial (for typing up the contracts and doing the accounting for the contract) Solutions Manual-IFRS Primer-Chapter 8 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

3 → Only if there are terms in the contract that specify that the customer is responsible for reimbursement of secretarial expenses.

8-4 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of the differences that are flagged throughout the chapter material. (1) Combining and segmenting construction contracts: Under IFRS, construction contracts may be, but are not required to be, combined or segmented if certain criteria are met. Under U.S. GAAP, construction contracts are combined or segmented if certain criteria are met, but criteria under U.S. GAAP differ from that under IFRS. (2) When the outcome of the contract cannot be estimated reliably: Under IFRS, would only recognize revenue to the extent of costs incurred that are recoverable. In the U.S., would use completed contract method.

1 Chapter 9 – Solutions 9-1 Discuss why the measurement model is acceptable for this type of asset but not for inventories or property, plant, and equipment. Identify other areas where fair value is used. What measurement models are supported by the framework? Discuss the issues. Hint: In researching this issue, refer to the basis for conclusions for IAS 41. The measurement model is acceptable for this type of asset because: - Biological assets increase in value as they grow and mature. - Inventory and PP&E do not increase in value; in fact, they depreciate in value over time. - Fair value changes in biological assets have a direct relationship to changes in expectations of future economic benefits to the entity. - The time lapse between the growth period and harvesting of biological assets can sometimes be extremely long (e.g., 30 years for trees). With a historical cost model, no income would be recognized until sale. However, under a fair value model, income is recognized throughout the process until harvest. Since the market for biological assets fluctuates over time, fair value would be a better measure of the assets’ worth. - Many biological assets also trade in active markets, so information regarding their market value is available. - Since market values are more reliable than cost figures, they should be used as the measurement basis for these assets. Other areas where fair value is used: - Financial instruments → available-for-sale and fair value through profit or loss (also referred to as held-for-trading) - Share-based payments - Business combinations - Property, plant, and equipment (as an option) Measurement models supported by the framework: - Historical cost – while reliable, not always relevant. - Current cost – sometimes referred to as replacement cost - Realizable value - Present value The last three are no longer seen as independent/unrelated options. In past, different countries/companies used different versions of these and so there was lack of consistency. The IASB is working towards a newer robust definition and framework for fair value that incorporates these terms. 9-2 What is the fair value hierarchy for valuing biological assets? Discuss the pros and cons of having a prescribed hierarchy. Fair value hierarchy: - If an active market exists, use the quoted market price in determining the fair value of the asset. Solutions Manual-IFRS Primer-Chapter 9 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

2 - If an active market does not exist, use market-determined prices or values (e.g., most recent market transaction price). - If market-determined prices not available, use the present value of expected net cash flows from the asset. Pros of a prescribed hierarchy: - Provides guidance to financial statement preparers who are fair-valuing biological assets - Improves consistency and comparability Cons of a prescribed hierarchy: - Standard precludes the use of PV of expected net cash flows if market-determined prices are available, even if the PV of expected net cash flows from the asset is more relevant. 9-3 Discuss whether the entity should value the crop at $100 per bushel or $90. - IAS 41.16 states that [c]ontract prices are not necessarily relevant in determining fair value, because fair value reflects the current market in which a willing buyer and seller would enter into a transaction. - The $100 reflects an estimate of the future fair value and therefore includes a time value factor. - Even though the price of the most current crop is locked in at $100 per bushel, it does not reflect fair value (because it is not the current market price). - Therefore, the entity should value the crop at its fair value of $90 per bushel, not the contract price of $100 per bushel. 9-4 Discuss how these costs should be accounted for. Hint: Review the basis for conclusion document for IAS 41. - It has been proposed that production and harvesting costs of biological assets should be expensed when incurred, while costs that increase the number of units of biological assets owned or controlled by the entity should be capitalized. - However, there is no prescribed accounting for subsequent expenditure related to biological assets due to the nature of the fair value measurement approach. 9-5 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of the differences that are flagged throughout the chapter material. (1) Measurement of biological assets: Under IFRS, biological assets are measured at fair value with gains and losses recognized in profit or loss. Under U.S. GAAP, biological assets are generally measured at historical cost. However, fair value less costs to sell is used for harvested crops and livestock held for sale. (2) Disclosures relating to biological assets: Significant amount of disclosure is required for biological assets under IFRS. No specific guidance is provided under U.S. GAAP as there is no specific standard.

1 Chapter 10 – Solutions 10-1 For each of the items listed: 10-1(a) Identify what specific costs are likely to be included in the acquisition cost. Item 1. Head office boardroom table and executive chairs

2. A landfill site

3. Wooden pallets in a warehouse 4. Forklift vehicles in a manufacturing plant 5. Stand-alone training facility for pilot training, including a flight simulator; classrooms equipped with desks, whiteboards, and electronic instructional aids

Specific Costs Purchase price Delivery charges Assembly costs (if applicable) Purchase price, transfer taxes, legal fees Costs of any work required to prepare land and make it suitable to accept refuse. Purchase price Transportation charges Purchase price Non-recoverable sales taxes Purchase price of facility, equipment, and furniture and fixtures Installation/assembly costs Delivery charges Professional fees for design

10-1(b) Explain whether any components of this asset should be given separate recognition, and why. Item 1. Head office boardroom table and executive chairs

2. A landfill site

Separate Recognition? - Boardroom table, executive chairs - Table probably has a much longer useful life than the chairs - Different parts of the landfill site (used portions vs. unused portions) - Any buildings on the site

- Building, flight simulator, desks, whiteboards, electronic instructional aids, land - All have different useful lives and rates of depreciation

10-1(c) Suggest what should be taken into consideration in determining each component’s depreciable amount and depreciation period. Solutions Manual-IFRS Primer-Chapter 10 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

2 Item 1. Head office boardroom table and executive chairs

2. A landfill site

3. Wooden pallets in a warehouse

4. Forklift vehicles in a manufacturing plant

5. Stand-alone training facility for pilot training, including a flight simulator; classrooms equipped with desks, whiteboards, and electronic instructional aids

Factors affecting depreciation - The length of time that management intends to keep the table and chairs (e.g., will they be replaced in a few years?) - Wear and tear: o What they will be used for o How often they will be used - The amount of garbage produced by the city/business/etc. relative to the size of the landfill - How long it will take to fill the landfill - Municipality’s past and proposed policies on recycling - Historical data from other municipalities - When will they be replaced/will they be replaced? - Wear and tear: o Past experience o Manufacturer’s estimates - When will they be replaced/will they be replaced? - How often parts will need to be replaced - Wear and tear: o Past experience o Manufacturer’s estimates - How often parts will need to be replaced on the flight simulator; technological obsolescence on type of instrumentation, and type of aircraft simulator is based on - When the whiteboards and desks will need to be replaced (depending on how they will be used) - The obsolescence rate of the electronic instructional aids - How long the building will be kept for

10-1(d) Suggest and explain what depreciation method might be most appropriate for each component separately identified.

3 Item 1. Head office boardroom table and executive chairs 2. A landfill site

3. Wooden pallets in a warehouse 4. Forklift vehicles in a manufacturing plant

5. Stand-alone training facility for pilot training, including a flight simulator; classrooms equipped with desks, whiteboards, and electronic instructional aids

Appropriate Depreciation Method Straight-line : will probably be used evenly over its useful life Units of production: should be depreciated based on volume of garbage dumped during the period relative to the total volume of garbage it can hold Straight-line: will probably be used evenly over its useful life Diminishing balance: depreciation on vehicles is normally much higher in earlier years than in later years as the equipment works more efficiently when it is newer. Straight-line: for building, desks, whiteboards; will be used/benefits are provided evenly over their useful lives Diminishing balance: for electronic instructional aids and flight simulator; obsolescence rate is quite high for electronics, therefore, more depreciation should be taken in the first couple of years of use. Alternatively, the flight simulator’s useful life may be in hours of usage. In this case, a units of production/activity basis may be more appropriate.

10-1(e) Identify whether the periodic depreciation is recognized as an expense on the income statement, or whether another accounting treatment is more appropriate. Explain.

Item 1. Head office boardroom table and executive chairs 2. A landfill site 3. Wooden pallets in a warehouse

4. Forklift vehicles in a manufacturing plant

5. Stand-alone training facility for pilot training, including a flight simulator; classrooms equipped with desks, whiteboards, and electronic instructional aids

Expense or other? Expense – not attributable to any other asset’s cost Expense - not attributable to any other asset’s cost Expense - not attributable to any other asset’s cost, unless the warehouse is used in an intermediate stage in production. If so, the depreciation of the pallets is a factory overhead cost that is charged to inventory. Capitalize as part of manufacturing overhead into an inventory account as it is a part of the inventory’s cost Assuming the entity’s business is charging clients for the use of the simulator and training facilities – expense - not attributable to any other asset’s cost

10-2 Discuss how the cost of the new equipment should be determined. The cost of the new equipment should include: 1. The equipment’s purchase price: the present value of the cash payments made. This will be less than the $100 invoice cost. 2. Expenditures directly attributable to bringing the asset to its required location and condition to operate as management intended. The costs of extending the building are better charged to the Building rather than the Equipment account. The costs of repairing the dropped equipment are expensed as incurred. 3. The estimate of the costs of the obligation associated with the asset’s eventual disposition that arose from its acquisition. The costs of the asset’s retirement obligation are included in the asset’s cost as they are measurable (discounted to their present value). 10-3(a) Assume you are a co-op student in the accounting department of Teyal Limited. You are asked to write a short report on what the chief accountant needs to consider in accounting for the cost of the new building and its subsequent depreciation policy. Write the report. The following items need to be addressed: - All the costs associated with the construction of the building and to bring it to its intended state – including borrowing costs - Whether the costs can be broken down into significant components to be depreciated (e.g., windows, doors, elevators, roof, flooring) and determination of costs for each component - How long the building is intended to be used for - The amount of wear and tear expected on the building – both due to its use and weatherrelated conditions, and for each of the components recognized separately. Different patterns Solutions Manual-IFRS Primer-Chapter 10 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

5 and therefore methods of depreciation might be appropriate for different components. The elevator, for example, may be recognized separately and depreciated on a declining-balance method as more of this asset’s benefits are provided in its early years than later years. 10-3(b) Assume you are a co-op student in the accounting department of Layet Corporation. If you were asked to write a report similar to the one required in part (a) above, identify in what respect it might differ, and why. - Same information except that borrowing costs cannot be capitalized as part of the building’s cost. - The report in this case would indicate that the costs of the component parts would not be available as they would under the self-construction by Teyal Limited. Therefore, Layet would likely not be able to recognize as many separate components as Teyal, and its depreciation policy would have to take into account a mix of usage and useful lives. 10-4 Prepare entries to record the recent repairs. Dr. Repairs & Maintenance Expense Dr. Building (45 + 25) Dr. Administrative Expense Cr. Cash/Accounts Payable Dr. Accumulated Depreciation Dr. Loss on Unamortized Roof Cr. Building (15/20 × $30 = 22.50)

2 70 10 82 22.50 7.50 30

10-5 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of the differences that are flagged throughout the chapter material. (1) Major repairs: Under IFRS, major repairs or overhauls are capitalized as part of the cost of the asset with the estimated cost of the part of the asset repaired or overhauled and the related accumulated depreciation removed from the accounts. Under U.S. GAAP, these costs are either expensed as incurred, deferred and amortized over the period until the next major repair, or accounted for as part of the cost of the asset. (2) Component depreciation: Under IFRS, component depreciation is required if components of an asset have differing patterns of benefit. Under U.S. GAAP, component depreciation is permitted, but it is not common. (3) Measurement after recognition: Under IFRS, an entity may choose either the cost model or the revaluation model after initial recognition. The revaluation model may be applied to an entire class of assets requiring

6 revaluation to fair value on a regular basis. Under U.S. GAAP, only the cost model may be applied after initial recognition as revaluation to fair value is not permitted. (4) Residual value: Under IFRS, the residual value of PP&E is equal to the current net selling price assuming the asset were already of the age and in the condition expected at the end of its useful life. The residual value may be increased or decreased over the life of the asset. Under U.S. GAAP, for example, the residual value is generally the discounted present value of expected proceeds on future disposal and it can only be adjusted downwards.

1 Chapter 11 – Solutions 11-1 Prepare a comparison of the fair value model of IAS 40 and the revaluation model of IAS 16. Revaluation Model (IAS 16) Initially recognized at cost. Asset measured at fair value less any subsequent accumulated deprecation and impairment losses. Gains resulting from an increase in the asset’s value upon revaluation will be recognized in other comprehensive income, accumulated in the equity account “revaluation surplus.” However, the increase shall be recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss. Losses resulting from a decrease in the asset’s value upon revaluation will be recognized in profit or loss. However, the decrease shall be recognized in other comprehensive income to the extent of any previously recognized gains existing in the revaluation surplus in respect of that asset. The fair value of property, plant, and equipment is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. The frequency of revaluations depends on the changes in fair values of the items of property, plant, and equipment being revalued. Revaluations are therefore not necessary at each reporting date, as long as the carrying value of the asset does not differ materially from the fair value that would be determined at the reporting date. Revaluation model can only be used if fair values can be reliably measured.

Fair Value Model (IAS 40) Initially recognized at cost. Asset measured at fair value – no depreciation taken while measured at fair value. Gains and losses from change in fair value are recognized in profit or loss.

The fair value of investment property is the price at which the property could be exchanged between knowledgeable, willing parties in an arm’s length transaction. Must reflect fair value at each reporting date.

If an entity has previously measured an investment property at fair value, it shall continue to measure the property at fair value until disposal or change in use, even if fair values become difficult to measure reliably.

11-2 Indicate whether the ventures described in (1) to (3) above are investment properties, and provide an explanation for your answer. Solutions Manual-IFRS Primer-Chapter 11 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

(1) Not an investment property because it does not appear that the investment portion could be sold separately or leased out under a finance lease since SC will be needing the space and no longer renting it out in the near future. Furthermore, a significant portion of the property is owner-occupied (8 out of the 10 floors). (2) Both are investment properties since they are held to earn rentals and not for production or supply of goods and services or for sale in the ordinary course of business. Furthermore, it does not appear that the services provided by SC are significant enough to declare that the property is owner-occupied and preclude recognition as an investment property, since these services are more in the nature of general maintenance services. (3) These are investment properties because SC holds the properties exclusively to earn rentals (through the minimum fixed return and 15% of operating profit). Furthermore, since SC is not involved in any significant services in the day-to-day operations of the building, this precludes recognition as an investment property. 11-3(a) Assume CI applies the cost model in accounting for its investment property. Prepare all journal entries necessary to account for the acquisition of the property in 2008 and any adjusting entries required at December 31, 2008, 2009, and 2010. Investment Property – Land (102 × 25/75) Investment Property – Building (102 × 50/75) Cash * Cost + legal fees = 100 + 2 = $102

$34 $68

Dec 31/08

Jan 1/08

Depreciation Expense Accumulated. Depreciation

Roof: ($8 - $0) ÷ 8 years Bldg: ($68 - $8 - $10) ÷ 25 years

Dec 31/09

Dec 31/10

$102

= $1/year = $2/year $3/year

Depreciation Expense Accumulated Depreciation

11-3(b) Continuing with the assumption in part (a), prepare the entry required in January 2015 when the roof is replaced at a cost of $13. Jan 2015

Investment Property – Roof (new) Cash

$13

Accumulated Depreciation – Roof (old)

$13

3 Loss on disposal of roof Investment Property – Roof (old) 2008 to 2014 = 7 years × $1/year = $7

$1 $8

11-3(c) Assume CI applies the fair value model in accounting for its investment property. Prepare all journal entries necessary to account for the acquisition of the property in 2008 and any adjusting entries required at December 31, 2008, 2009, and 2010. Jan 1 2008

Investment Property Cash * Cost + legal fees = 100 + 2 = $102

$102 $102

Dec 31 2008 Investment Property Gain on Investment Property * 104 – 102 = $2 gain

Dec 31 2009 Investment Property Gain on Investment Property * 110 – 104 = $6 gain

Dec 31 2010 Investment Property Gain on Investment Property * 111 – 110 = $1 gain

11-3(d) Continuing with the assumption in part (c), what entry would be required in January 2015 when the roof is replaced at a cost of $13? Comment on any choices that are available. Either: Jan 2015 Dec 31/15

Investment Property – Roof (new) $13 Cash Adjust property to its fair value at year end.

$13

Or: Remove the January 2015 fair value of the replaced roof from the Investment Property account (recognizing a loss) and add the cost of the new roof to the Investment Property account. At Dec. 31/15, bring the Investment Property account to its year-end fair value. 11-3(e) Compare the amounts reported on CI’s statement of financial position at December 31, 2008, 2009, and 2010, and the amounts and type of income and expenses reported on the income statements for each year under parts (a) and (c). Item Balance Sheet: Investment Property Investment Property - Land

2008(a)

2008(c)

2009(a)

104 34

2009(c)

2010(a)

2010(c)

110 34

111 34

4 Investment Property - Building Accum. Depr. - Building Total Investment Property Stmt of Profit or Loss: Gain in Value on Investment Property Depreciation expense

68 (3) 99

(3)

104

68 (6) 96

(3)

110

68 (9) 93

111

(3)

The amounts reported on the balance sheet in each year under both methods are very different. Amounts reported under the cost model are depreciated and therefore the balance in the Investment Property account continues to decrease each consecutive year. However, amounts reported under the fair value model continue to appreciate each year, with the corresponding gains reported on the statement of profit or loss. Any financial ratios based on profit or loss and long-lived assets are affected if companies use different models. 11-4 Access the websites(s) identified on the inside back cover of this book, and prepare a concise summary of what the differences are that are flagged throughout the chapter material. (1) Definition of investment property: Under IFRS, investment property is separately defined under IAS 40. Under U.S. GAAP, investment property is not separately defined and, therefore, is accounted for as held-for-use (property, plant, and equipment) or held-for-sale. (2) Recognizing an operating lease as investment property: Under IFRS, property interests held under operating leases may be accounted for as a finance lease as investment property (IAS 40) if held for investment purposes and if measured at fair value with changes in profit or loss. Otherwise, upfront payments are treated as prepayments. Under U.S. GAAP, upfront payments on property interests held under an operating lease are always treated as a prepayment. (3) Measurement after recognition: Under IFRS, investment property may be measured after recognition using either the cost model or the fair value model. Under U.S. GAAP, investment property is accounted for as property, plant, and equipment, and requires the use of the cost model only. (4) Disclosures: Since IFRS requires separate recognition for investment properties, many disclosures are required detailing information regarding the investment properties. Since investment properties are not defined under U.S. GAAP, no separate recognition is required and therefore, they fall under the regular disclosure requirements for either property, plant, and equipment or assets held-for-sale. Under IAS 40, the fair value of the investment property has to be reported, even if the cost model is used. This is not required by U.S. GAAP. Under U.S. GAAP, there is no investment property classification and, therefore, no such related disclosures as are required by IAS 40. Solutions Manual-IFRS Primer-Chapter 11 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

1 Chapter 12 – Solutions 12-1(a) Locate IAS 8 and read paragraphs 11 and 12. What do these paragraphs require? Paragraph 11 of IAS 8 requires that when no IFRS specifically applies to a transaction and a company chooses its own accounting policy, the accounting policy must be consistent with the requirements and guidance in IFRSs dealing with similar and related issues, as well as the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the framework. Paragraph 12 allows management to consider the most recent pronouncements of other standardsetting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature, and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11. 12-1(b) Briefly explain the effect of the temporary exemption from these paragraphs on entities applying IFRS 6. Temporary exemption from these paragraphs allows entities to continue to apply the accounting policies that were in place before their transition to IFRS. Since the standard for mineral resources has not yet been issued, requiring companies to potentially change their accounting policies to be consistent with the requirements and guidance in IFRSs until the standard is issued is not practicable since the accounting policies may need to be changed again after the standard is issued. Therefore, allowing entities to have temporary exemption from these paragraphs eliminates the extra cost, time, and work that would have been necessary if the accounting policies needed to be consistent with the requirements and guidance in the IFRSs. 12-2 Write a short report suitable for presentation to your class that identifies how a company’s financial statements will differ if it chooses a full cost accounting policy, instead of one that is based on successful efforts, for its exploration and evaluation activities. Identify what types of financial ratios will be affected by this choice. Successful efforts method: only costs associated with successful exploration and evaluation activities are capitalized. Full cost method: all costs associated with exploration and evaluation activities, whether successful or unsuccessful, are capitalized. Full Cost All costs – both successful and unsuccessful – will be capitalized on the balance sheet.

Since incurring costs related to unsuccessful efforts are a natural and necessary part of the exploration process to find natural resources,

Successful Efforts Only those costs associated with successful activities will be capitalized on the balance sheet; costs associated with unsuccessful activities will be expensed. Balance sheet will reflect only successful efforts and since successful exploration and evaluation activities are only those which will

2 capitalizing the full costs presents to financial statement users the total costs associated with exploration and evaluation activities. Inventories will reflect the cost of both successful and unsuccessful results as the costs of the reserves are amortized to inventory and then to the income statement over the useful life of the reserves. Income will be higher and smoother over the life of the reserves as all costs are capitalized initially and then amortized into income.

produce future benefits for the entity they fit the definition of an asset. Income statement will reflect the cost of the unsuccessful efforts as the costs are incurred. Successful costs will be reflected in inventories and then taken to the income statement as the capitalized costs are amortized. Income will fluctuate as costs of unsuccessful efforts are expensed immediately.

Financial ratios affected: - Long-term solvency and risk ratios such as debt to total assets, debt to equity, and times interest earned since total assets and net income will be higher or lower depending on the method chosen. The size of total assets will play a significant role with long-term solvency ratios. - Profitability ratios such as return on assets, return on equity, profit margin, and earnings per share since total assets and net income will be higher or lower depending on the method chosen. Size of net income will play a significant role with profitability ratios. 12-3 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Standard for exploration and evaluation of mineral resources: IFRS 6 is a standalone standard for costs associated with the exploration and evaluation activities associated with mineral resources, but is restricted to activities up to the point that technical and commercial viability is demonstrated. It permits a form of full cost accounting, but this would not be extended to the development and production phases. U.S. GAAP provides detailed guidance for all phases of activities for oil- and gas-producing entities, but not for extractive industries other than oil and gas. Companies applying U.S. GAAP do not have a choice as to whether they expense or capitalize exploration and evaluation costs – they choose either successful efforts or full cost accounting, and apply the standards identified for each. U.S. GAAP also has clear guidance on the test for recoverability under both these methods. Joint project: The comprehensive research project being undertaken by the IASB is only a “modified joint” project with the FASB. The FASB will issue an Invitation to Comment on the IASB’s Discussion Paper when it is released, and will later decide whether to add this to its project agenda.

1 Chapter 13 – Solutions 13-1 Prepare notes for a presentation to your class that address the following questions: 13-1(a) Do the carrying costs on all three assets have to be capitalized under IAS 23? (1) Not required to, but may capitalize, because the inventory produced is routine and repetitive. (2) Required to be capitalized because the inventory is not produced in large quantities and is not repetitive – it is a special order and is custom-designed by the customer. (3) If the facility is measured at cost, then they are required to be capitalized. If the facility is measured at fair value, then they are not required to be capitalized, although Alpha has a choice. 13-1(b) Are borrowing costs and interest payments the same thing? No, borrowing costs and interest payments are not the same thing. Borrowing costs may include interest costs, but they may also include other costs incurred in connection with borrowing funds. These other costs may include such costs as finance charge on finance leases and exchange differences on foreign currency borrowings that are viewed as an adjustment of interest. Furthermore, those interest costs that are included in borrowing costs are interest expenses that result from using the effective interest method. Interest payments are the actual amount paid to the lender for the acquisition of debt. Therefore, if the debt is issued at a discount or a premium, the amount paid and the amount expensed may differ depending on the effective interest rate. 13-1(c) Does the $50 advance payment on the custom-ordered machine affect the calculation of borrowing costs to be capitalized? If it does, how? Yes, the $50 advance payment will decrease the overall average expenditure in the “expenditures on the qualifying asset” part of the calculation of borrowing costs to be capitalized and ultimately the borrowing costs to be capitalized in the cost of the custom-ordered machine. 13-1(d) Explain briefly how the capitalization rate should be calculated. The capitalization rate is calculated by first determining the weighted debt outstanding that is not asset-specific. To determine the weighted debt outstanding, the principal amount of each item of debt is multiplied by the percentage of months outstanding for the year. The interest expense or borrowing cost related to each item of debt is determined. The borrowing costs for each item are summed and the sum is then divided by the total weighted debt outstanding to determine the capitalization rate. For example: If the total weighted debt outstanding = $500 and the total borrowing costs = $50, then the capitalization rate is 50/500 = .10 or 10%.

2 13-2(a) Determine the borrowing costs to be capitalized for GL’s year ended December 31, 2008. Since is does not appear that GL has any non-asset specific debt related to this construction project, the borrowing costs to be capitalized for the year ended December 31, 2008, are equal to $3 less the $2 earned on excess funds = $1. This is calculated as follows: Asset-specific borrowing (weighted): $120 * 3/12 mths = $30 Related borrowing costs = $30 * 10% = $3 Interest earned on excess funds (given) = $2 13-2(b) If GL had paid the bank a fee of $3 on September 30 to enter into the loan agreement, how would this affect your calculation in part (a), if at all? The $3 fee would be included in the cost of borrowing, by being amortized over the term of the loan. The effect therefore would be to increase the interest cost incurred above the 10% used above. 13-3(a) Calculate the capitalization rate for determining the borrowing costs to be capitalized as part of the cost of the outlets. Other debt instruments Principal Weight outstanding, Jan.31/09 Amount 8%, 8yr loan payable – $200 10/12 issued April 1, 2008 10%, 12yr bond payable – $300 12/12 issued September 25, 2003 Capitalization Rate = 43.3/466.7 = 9.3%

Weighted Debt Outstanding $166.7

Borrowing Costs $13.3

$300.0

$30.0

Total = $466.7

Total = $43.3

13-3(b) Calculate the amount of borrowing costs to be capitalized (to December 31, 2008). Date March 1, 2009 April 30, 2009 December 30, 2009

Amount $120 $150 $130 Total = $400

Weight 10/12 8/12 0/12

Average Expenditures $100 $100 $0 Total = $200

Asset-specific borrowing costs = $0 Average expenditures – total = $200 Capitalization rate = 9.3% Capitalized borrowing costs = $200 * 9.3% = $18.6

3 13-3(c) What would be the appropriate accounting treatment for the borrowing costs incurred by the company during the year if EI had issued additional common shares to finance the construction? Explain. If EI had issued additional common shares to finance the construction, the cost of issuing additional common shares would not be included in determining the borrowing costs as IAS 23 does not deal with the cost of equity. 13-4 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. (1) Borrowing costs and qualifying assets: Under IFRS, types of borrowing costs that are eligible for capitalization include interest, certain ancillary costs, and exchange differences that are regarded as an adjustment of interest. Under U.S. GAAP, types of borrowing costs generally only include interest. Under IFRS, qualifying assets do not include equity method investments but may include inventories that are routinely manufactured repetitively in large quantities if they require a substantial period of time to get ready for sale. Under U.S. GAAP, certain equity method investments are qualifying assets, but inventories that are routinely manufactured repetitively in large quantities do not qualify. (2) Investment income earned on surplus funds: IAS 23 requires that investment income earned on the temporary investment of amounts borrowed to finance a qualifying asset reduce the amount of borrowing costs capitalized. It reduces the avoidable costs. Under U.S. GAAP, interest earned on the excess funds is not deducted in determining avoidable costs. (3) Disclosure: IFRS requires the disclosure of both the amount capitalized during the period as well as the rate used to determine the capitalization amount. FAS 34 does not require the capitalization rate to be reported.

1 Chapter 14 – Solutions 14-1(a) Prepare entries to account for the acquisition of the building and receipt of the government grant on Day 1 assuming Iota presents the grant as deferred income, and then assuming Iota presents it as a reduction of the asset’s cost. Grant as deferred income: Dr. Building Cr. Cash/AP Dr. Cash Cr. Deferred Government Grant Grant as a reduction of the asset’s cost: Dr. Building Cr. Cash/AP Dr. Cash Cr. Building

500 500 100 100

14-1(b) Prepare the entry to record depreciation expense at the end of the first year of operations, as well as any other adjusting entries required under each assumption in (a) above. Grant as deferred income, assuming straight-line depreciation: Dr. Depreciation Expense $16 Dr. Deferred Government Grant 4 Cr. Accumulated Depr. – Bldg $20 or Dr. Depreciation Expense $20 Dr. Deferred Government Grant 4 Cr. Accumulated Depr. – Bldg $20 Cr. Government Grant Income 4 Grant as a reduction of the asset’s cost, assuming straight-line depreciation: Dr. Depreciation Expense $16 Cr. Accumulated Depr. – Bldg $16 14-1(c) In what respects will the statement of financial position and income statement differ under the two accounting presentations? Does it matter that they are different? Why? Statement of Financial Position: - If presented as a reduction in the asset’s cost, the amount reported as an asset will be lower. - If presented as deferred income, the amount reported for the asset will be its cost, while liabilities will increase in the amount of the grant. - It does matter which method is chosen on the statement of financial position:

2 - If the grant is presented as a reduction in the asset’s cost, financial statement users will not see the value of the asset to the entity, but the asset will be reported at the amount of consideration given up by the entity to acquire it since it will be reduced by the amount of government consideration. - If the grant is presented as deferred income, the value of the asset reported will be representative of its value to the entity. However, by reporting a deferred income it appears as though the entity has an obligation when no obligation may exist. Income Statement: - Whether the grant is presented as a reduction in the asset’s cost or as deferred income, the overall effect on the income statement will be the same under both methods since the amount of the grant is recognized in profit or loss as a reduction in the amount of depreciation over the life of the building. 14-2(a) Prepare the entry(ies) to recognize the grant repayment liability at the end of year 4 assuming Iota recognized the grant originally as deferred income. Dr. Deferred Government Grant 84 Dr. Loss on Repayment/Depreciation Expense 16 Cr. Accounts Payable To record repayment liability

100

* To recognize the cumulative amount of additional depreciation that would have been recognized in profit or loss if the grant had not been received. This is equal to the amount of depreciation that was recognized on the grant, which reduced overall depreciation recognized on the building. 14-2(b) Prepare the entry(ies) to recognize the grant repayment liability at the end of year 4 assuming Iota recognized the grant originally as a reduction of the asset’s cost. Dr. Building 100 Dr. Loss on Repayment/Depreciation Expense 16 Cr. Accumulated Depr. – Bldg. Cr. Accounts Payable To record repayment liability

16 100

* To recognize the cumulative amount of additional depreciation that would have been recognized in profit or loss if the grant had not been received. Since the grant reduced the building by $100, depreciation was only equal to $400/25 = $16/year; if the building was recorded at its original cost, depreciation would have been equal to $500/25 = $20/year. Over 4 years, depreciation was reduced by $20 – 16 = $4 * 4 years = $16.

3 14-3(a) Prepare all entries related to government assistance that Chi Corp. needs to make from July 1 to December 31, 2009, Chi’s fiscal year end. Identify any situations where there are alternatives. July 2, 2009: Dr. Cash 50 Cr. Deferred Government Grant 50 To record receipt of travel and administrative grant September, 2009: Dr. Cash 25 Cr. Other Income 25 To record receipt of training grant – reported as other income OR Dr. Cash 25 Cr. Training Expense 25 To record receipt of training grant – used to offset training expenses December 31, 2009: Dr. Government Rebate Receivable 40 Cr. Wages Expense 40 To record wage rebate receivable from the government – used to offset wages expense OR Dr. Government Rebate Receivable 40 Cr. Other Income 40 To record wage rebate receivable from the government – reported as other income

Dr. Deferred Government Grant 5 Cr. Other Income 5 To recognize portion of travel and administrative grant in profit or loss * Travel and administrative grant amortization: $50/5yrs = $10/yr * 6/12mths = $5 OR Dr. Deferred Government Grant 5 Cr. Travel & Admin. Expense 5 To recognize portion of travel and administrative grant in profit or loss

4 14-3(b) Identify the government assistance disclosures that are required for Chi’s December 31, 2009, financial statements. (1) Accounting policy applied for government grants. (2) Methods chosen for presentation in the financial statements, i.e., whether to recognize grants related to income in the statement of profit or loss as “other income” or netted against the related expenses. Disclose this for the $50 travel and administrative grant, the training expenses grant, and the wage rebate grant. (3) The nature and extent of the grants recognized in the financial statements, i.e., grants received for training expenses, travel and administrative expenses, and wage rebate that is receivable from the government. (4) Information about other forms of government assistance that Chi has benefited from, i.e., $200 government assistance given to the local college to increase the level of education in the area. (5) Information about the $50 travel and admin grant that must be repaid at a rate of $10 for each year less than five years that Chi does not operate in the area. 14-4 Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. (1) Standard for accounting for government grants: IAS 20 sets out the current standards for recognizing, measuring, and disclosing government grants and for disclosures related to other forms of government assistance. Under U.S. GAAP, no such standard exists to provide guidance for accounting for government grants.

1 Chapter 15 – Solutions 15-1 Indicate whether ZC should report a related intangible asset on its May 31, 2008, balance sheet for each expenditure described above. Explain your answer in each case. (1) This is an intangible asset. It is an identifiable, non-monetary asset, controlled by the entity and that does not have physical substance. (The computer can operate without this particular software, so the software is intangible rather than part of the computer.) It is a source of future economic benefits in the form of increased productivity. It has a useful life of one year: January 1 to December 31, 2009. (2) Not an intangible asset. IAS 38 specifically excludes the costs to train staff on new product lines, etc., from being capitalized as intangible assets. (3) Not an intangible asset. Prepayment of rent would be treated as a prepaid expense (asset), not an intangible asset. It is a service that has been paid for in advance of the service being received. At May 31, 2008, only 1 month’s rent is considered prepaid. (4) Intangible asset. It meets the definition of an intangible asset: It is identifiable (based on contractual or legal rights) and does not have physical substance. It can also be controlled by ZC, and it appears that future economic benefits will flow to the entity from the endorsement (otherwise the company would not have endorsed the sports figure). Furthermore, since ZC has paid for the endorsement, it is highly likely that its cost can be reliably measured. Therefore, ZC can recognize the endorsement as an intangible asset. (5) Not an intangible asset. According to IAS 38, advertising and promotional costs should be expensed as incurred. It cannot be classified as a prepaid asset because the service contracted for has been provided. 15-2(a) Does each intangible as described above qualify to be recognized as an intangible asset? Explain briefly. (1) Yes, recognize as an intangible asset. The license is identifiable – based on contractual and legal rights – and does not have physical substance. The rights will continue to be held by HL at very little cost. Furthermore, it can be controlled by HL, the expected future economic benefits will be realized (states that it will generate cash flows indefinitely), and since it is very marketable, the cost of the asset can likely be reliably measured. (2) Yes, recognize as an intangible asset. The non-competition covenant is separately identifiable – based on contractual rights. The contract does not have physical substance. HL has the ability to control the asset – e.g., prevent the seller from setting up another similar business or working for another competitor. Since it was paid for, the cost can likely be reliably measured. Furthermore, HL has predicted future cash flows from the agreement; as long as they are expected to be realized, the covenant can be recognized as an intangible asset. (3) Yes, recognize as an intangible asset. The medical files are separately identifiable – since HL was required to pay for them separately, this identifies that the files can be separated from the entity (through sale, transfer, etc.). Furthermore, since HL paid for the medical files, their cost is

2 likely reliably measurable. The files also do not have physical substance. Since HL has purchased the files, they have the ability to control their use. HL believes that the expected future economic benefits will be realized, but the medical files do not have an indefinite life. The files of the current names acquired will have a limited life. As new names get added and files are updated, the expenditures are related to building a new intangible that does not meet the requirements for capitalization as the cost cannot be reliably measured. Therefore, the cost of the medical files should be amortized over a finite period of time. 15-2(b) Identify the appropriate method of accounting for each intangible described above after acquisition, and explain the decisions you have made. (1) If an active market exists for these types of licenses, it could be accounted for under the revaluation model if there are market prices established and available. If not, the cost model would be used. No amortization is recognized as the asset appears to have an indefinite life. (2) It is not likely that there is an active market to determine the fair value for the noncompetition covenant. Therefore, it would be accounted for under the cost model – recorded at cost less any accumulated amortization and accumulated impairment charges. Although HL thinks the benefits will flow for at least 25 years, it is unlikely that it will benefit the entity for that long a period of time. As business conditions change, the previous owner-manager ages, etc., the agreement’s benefits are likely to expire in less than 25 years. It should be amortized over whatever period the entity determines after considering all relevant information. (3) It is not likely that there is an active market to determine the fair value of the medical files. Therefore, HL would account for the medical files under the cost model – recorded at cost less any accumulated amortization and accumulated impairment charges. The useful life of the files has to be determined for purposes of amortization. 15-3 For each cost described above, indicate whether it should be capitalized as an intangible asset or whether it should be expensed. Explain briefly. (1) Equipment: Capitalize as a tangible asset under property, plant, and equipment because of its physical substance. (2) Depreciation on equipment: Expensed over the useful life of the equipment, unless used only on projects which qualify as in the development stage. In this case, the costs could be capitalized as development costs. (3) Quality control costs during production: Since costs incurred during production, capitalize as part of the inventory cost. (4) Costs to refine, enrich, or improve existing product: Capitalize as an intangible asset as long as the six criteria for capitalizing the development costs are met. Otherwise, expense as incurred. (5) Evaluation of potential new products: Solutions Manual-IFRS Primer-Chapter 15 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

3 Expense – takes place during the research phase and according to IAS 38, expenditures on research or research activities are expensed as incurred. (6) Lab operating costs: Expense – costs to operate the lab are not directly attributable to the formula improvements. IAS 38 specifically states that overhead costs may not be capitalized as part of the cost. (7) Materials cost in pre-production pilot plant: Capitalize as an intangible asset as long as the six criteria for capitalizing the development costs are met. 15-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. (1) Recognition of development costs as internally generated intangibles: Under IFRS, development costs may be capitalized if certain criteria are met. Under U.S. GAAP, development costs must be expensed as incurred, except in certain situations where they may be capitalized (e.g., website development costs and certain costs associated with developing internal software use). (2) Advertising Costs: Under IFRS, advertising and promotional costs are expensed as incurred. Under U.S. GAAP, direct response advertising may be capitalized if it meets certain criteria. (3) Measurement after recognition: IFRS permits intangibles to be measured under the cost model or the revaluation model. However, the revaluation of intangible assets is permitted only if the intangible asset trades in an active market. Under U.S. GAAP, intangible assets may not be measured using a revaluation model. They may only be measured under the cost model. (4) Disclosure: IFRS requires more significant and specific disclosures related to each class of intangible assets than required under U.S. GAAP. In particular, IAS 38 requires disclosures for internally generated intangible assets separately from other intangible assets and for intangible assets carried at revalued amounts.

Chapter 16 – Solutions 16-1 Write a short memo to AA’s controller, identifying how he should proceed in determining whether the Remoteville assets are impaired. Memo to AA controller re: Remoteville Assets and Impairment Step 1: Determine the asset(s) or CGU to assess Because AA is required to maintain the Remoteville route and the assets that support this route as a condition of the Newalta to Oldsford route, the Remoteville assets must be assessed as part of a larger cash-generating group. In this case, the CGU is the smallest group of assets that includes the Remoteville assets and generates cash inflows that are largely independent of those from other groups of assets. This is the combination of the Newalta to Oldsford and the Oldsford to Remoteville routes. Step 2: Identifying if the CGU is impaired The CGU should be assessed for indications of impairment and should be tested for impairment only when factors suggest the assets might be impaired. The indication of impairment should encompass both external and internal sources, such as the market value of the CGU and internal reports that indicate the CGU’s performance is or will be worse than expected. Step 3: Testing for impairment AA would need to estimate the CGU’s recoverable amount, which is the higher of its fair value less costs to sell and its value in use. If either exceeds the carrying amount, the asset or CGU is not impaired. If the carrying amount is greater than the recoverable amount, an impairment loss must be recognized on the CGU. Because the Newalta to Oldsford route is so profitable, the cash flows associated with the CGU’s value in use and the fair value less costs of disposal may be greater than the carrying amount of the CGU. 16-2(a) Briefly discuss whether the assets should be assessed for impairment individually or as part of a cash-generating unit. The tools and dies and the specialized equipment have no resale value other than for scrap and thus lack a fair value that is considered representative of its value in use. Combined with the fact that they do not generate independent cash flows on their own, the assets should be grouped into a cash-generating unit. Since the general equipment has a resale value and can be used profitably in other product lines, it probably has a fair value less selling costs that is representative of its value in use and can independently generate cash flows. Thus, it could be assessed for impairment individually. 16-2(b) Assuming the assets are allocated to a CGU made up of three types of assets identified, determine whether an impairment loss needs to be recognized and, if so, in what total amount. Carrying amount of CGU: Tools and Dies ($10 - $6) Specialized Equipment ($50 - $35) General Equipment ($30 - $18) Carrying amount

$ 4 $15 $12 $31

Recoverable amount of CGU: higher of the CGU’s fair value less costs to sell and its value in use Fair value less costs to sell: $15 Present value of the net cash flows: $26 Therefore, the recoverable amount is $26. An impairment loss of $31 - $26 = $5 should be recognized as the recoverable amount is less than the carrying amount for this CGU. 16-2(c) Prepare the entry needed to record any impairment loss indicated, assuming these assets are reported in separate asset classes. Impairment Loss $5 Accumulated Impairment Losses – Tools and Dies (4/31) $0.65 Accumulated Impairment Losses – Specialized Equipment (15/31) $2.42 Accumulated Impairment Losses – General Equipment (12/31) $1.93 Note: The impairment loss is allocated to each asset in the unit on the basis of its relative carrying amount. 16-3(a) Identify the asset, cash-generating unit, or group of CGUs that FC should test for impairment. FC should use the group of CGUs, i.e., East Division and South Division and their allocated goodwill, to test for impairment. Even though each division is a CGU that would be eligible for impairment testing, the goodwill cannot be tested separately as it is fully attributable to both divisions collectively. 16-3(b) Is there an impairment loss at the end of the current year? Explain how you determined your answer. At the end of the current year there is an impairment loss of $10 that FC must recognize: Carrying amount of the group of CGUs plus allocated goodwill = $225 (75+125+25) Recoverable amount of the two divisions together = $215 Since the recoverable amount is less than the carrying amount, there is a $225 - $215 = $10 impairment loss. 16-3(c) Accounting for the impairment loss: When the recoverable amount of the group of CGUs that goodwill has been allocated to is less than the group’s carrying amount, an impairment loss is recognized. The loss is assigned in the following specific order: 1. The carrying amount of goodwill allocated to the CGU or group is reduced, and 2. Any remaining amount is allocated to each asset in the unit or group of units on the basis of its relative carrying amount.

In FC’s case, the entire impairment loss is allocated to the carrying amount of the goodwill allocated to the group, thus reduced it from $25 to $15. 16-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. (1) Indication of impairment/Identifying an asset that may be impaired: Under IFRS, the review is assessed at each reporting date. The indicators of impairment come from both external and internal sources. Under U.S. GAAP, with respect to review for impairment indicators-long lived assets, this is performed whenever events or changes in circumstance indicate that the carrying amount of the asset may not be recoverable. (2) Testing for impairment and calculation of loss: Under IFRS, a one-step approach requires that impairment loss be calculated if impairment indicators exist. The impairment loss is calculated as the amount by which the carrying amount of the asset exceeds its recoverable amount. The recoverable amount is the higher of the fair value less costs to sell and the asset or CGU’s value in use. Under U.S. GAAP, a two-step approach is applied to long-lived assets. This requires a recoverability test to be performed first (carrying amount of the asset is compared to the sum of future undiscounted cash flows generated through use and eventual disposition). If it is determined that the asset is not recoverable, an impairment loss is calculated (the amount by which the carrying amount of the asset exceeds its fair value). The adjusted carrying amount becomes the new cost basis. (3) Level of impairment testing for goodwill: Under IFRS, goodwill is assigned to a CGU or group of CGUs that is expected to benefit from the synergies of a combination. Goodwill is allocated to the lowest level in the organization that manages this asset and the CGU chosen cannot be larger than an operating segment. Under U.S. GAAP, goodwill is allocated to a reporting unit – either an operating segment or one organizational level below. (4) Calculating impairment of goodwill: Under IFRS, there is one step: compare the recoverable amount of a CGU (higher of (a) fair value less costs to sell and (b) value in-use) to carrying amount. Under U.S. GAAP, there are two steps: (1) Compare fair value of the reporting unit with its carrying amount including goodwill. If the fair value is greater than carrying amount, no impairment (skip step 2). (2) Compare “implied fair value” of goodwill, which is determined based on a hypothetical purchase price allocation, with its carrying amount, recording an impairment loss for the difference.

(5) Calculating impairment of indefinite-life intangibles: Under IFRS, an impairment loss is determined by comparing the asset’s carrying amount with its recoverable amount (i.e., higher of fair value less costs to sell and value in use). Under U.S. GAAP, an impairment loss is calculated for indefinite-life intangible assets by comparing their fair value to their carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized equal to the difference. (6) Reversing an impairment loss: Under IFRS, it is prohibited for goodwill. Other long-lived assets must be reviewed annually for reversal indicators. If appropriate, the loss may be reversed up to the newly estimated recoverable amount, not to exceed the initial carrying amount adjusted for depreciation that would have been taken to date. Under U.S. GAAP, a subsequent reversal of an impairment loss is prohibited for all assets.

Chapter 17 -- Solutions 17-1 Explain what each classification is, how the items are measured, and where the gains and losses are booked. How are impairments handled? Are reclassifications allowed subsequent to initial recognition? Why/why not? Fair Value through Profit or Loss (FVTPL): FVTPL assets are either held-for-trading (HFT) or designated as FVTPL by the entity. Instruments may be classified as HFT if they are acquired with the intent to sell or repurchase in the near term, are part of a portfolio of instruments that are managed together to maximize profits, or are derivatives. In other words, the instruments are traded for profit (“active and frequent buying and selling”). As well, once an item is classified as FVTPL, it may not be reclassified to another category, as it is always based on fair value. Similarly, instruments may not be subsequently reclassified into the FVTPL category. Financial assets are initially recognized at fair value. Transaction costs that are directly attributable to the transaction should be added to the carrying value unless the asset is classified as FVTPL. Subsequent measurements are at fair value, with gains or losses being booked to profit or loss. With respect to impairment losses, they are not applicable, as all losses are booked through profit and loss already. Held-to-Maturity Investments (HTM): HTM investments have the following characteristics: they are not derivatives and have fixed and determinable payments and fixed maturity dates. Therefore, only debt instruments that are not derivatives can be classified as HTM. HTM investments are meant to be held-to-maturity (hence the name), and the entity must demonstrate positive intent and ability to do so. These investments may be disposed of or reclassified prior to maturity only in very limited circumstances. If the entity disposes of or reclassifies more than an insignificant amount of investments prior to maturity in the current year or in the previous two years, it will not be allowed to use the HTM category going forward. As well, if it is no longer appropriate to classify an item as HTM, it is classified as AFS. It is acceptable, under the standard, to dispose of the investment under the following situations: • The investment is very close to maturity; • The entity has collected substantially all of the amounts under the terms of the debt; or • Circumstances exist that are attributable to an isolated event beyond the entity’s control, which is nonrecurring and could not have been anticipated. This restriction on reclassification exists because HTM investments are measured at amortized cost, so reclassification would potentially trigger a gain or loss and may lead to manipulation of income. Financial assets are initially recognized at fair value and transaction costs that are directly attributable to the transaction should be added to the carrying value. Subsequent measurements are at amortized cost using the effective-interest method, and gains or losses are not applicable. With respect to impairments, an entity must assess individual assets first and then, if there is no Solutions Manual-IFRS Primer-Chapter 17 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

impairment, assets in a group with similar risk. As well, an entity may subsequently reverse an impairment loss. Loans and Receivables: Loans and receivables have the following characteristics: They are non-derivative, have fixed and determinable payments, and are not quoted in an active market. Therefore, this category includes loan assets, trade receivables, and investments in debt instruments. Financial assets are initially recognized at fair value, and transaction costs that are directly attributable to the transaction should be added to the carrying value. Subsequent measurements are at amortized cost using the effective-interest method, and gains or losses are not applicable. With respect to impairments, an entity must assess individual assets first and then, if there is no impairment, assets in a group with similar risk. As well, an entity may subsequently reverse an impairment loss. Available-for-Sale Financial Assets (AFS): Available-for-sale financial assets are those that are not classified as one of the others, i.e., FVTPL, HTM, or loans and receivables. This category is therefore a default category, since instruments are presented here if they do not meet the definitions of the other categories. Financial assets are initially recognized at fair value, and transaction costs that are directly attributable to the transaction should be added to the carrying value. Subsequent measurements are at fair value, with gains or losses being booked to other comprehensive income. With respect to impairments, an entity must reclassify the loss from OCI to profit and loss. As well, the entity may also reverse the loss for debt instruments only. 17-2 Explain what a puttable instrument is and how the feature affects the accounting. The term “puttable” is a feature available to an entity that has the right to require the issuer to redeem or repay an instrument early. This feature affects the accounting as it cannot be classified as HTM since the entity would have paid extra for this right and therefore, from an economic perspective, would not have paid for the right unless it thought it might use it. With respect to debt and equity instruments, an example of a puttable instrument is shares where the holder has the right to sell them back to the company for a fixed amount. This affects the accounting because even though these are equity in terms of legal form, the substance is that there is a liability due to the contractual obligation to repay if the holder presents the shares. Therefore, they are liabilities unless certain criteria are met. 17-3 Calculate the carrying value of these notes upon initial recognition. How might these notes be classified if they are purchased by Chestnut Inc.? Financial liabilities are initially recognized at fair value. If i= 1%: PV of interest payments of $10/year: Solutions Manual-IFRS Primer-Chapter 17 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

=48.53 using the ordinary annuity formula PV of face value of $1000: = 1000/ (1.01)5 = 951.47 Therefore, the carrying value = $1000. If i= 10%: PV of interest payments of $10/year: =379.08 using the ordinary annuity formula PV of face value of $1000: = 1000/ (1.10)5 = 620.92 Therefore, the carrying value = $1000. If Chestnut Inc. were to purchase Acorn’s five-year notes, they would probably be classified as held-to-maturity as they are not derivatives and have fixed and determinable payments and fixed maturity dates. Chestnut would have to establish intent and ability to hold-to-maturity. As an alternative, the entity might choose to hold as AFS or FVTPL (if certain criteria were met – for instance, if the classification provided more relevant information). 17-4 How should these instruments be classified in the statement of financial position? Discuss, noting any alternative treatments. •

Investments in equity instruments should be classified as FVTPL if they are acquired with the intent to sell in the term or are part of a portfolio if instruments that are managed together to maximize profits. If neither of these conditions are met, these instruments would be classified as AFS.

•

Investments in marketable notes receivables would be classified as either FVTPL or HTM. Most likely they would be HTM since they have fixed and determinable payments and fixed maturity dates, but they could be FVTPL if they are acquired with the intent to sell in the term or are part of a portfolio if instruments that are managed together to maximize profits, as they are marketable.

•

Trade accounts receivables should be classified as loans and receivables as they are nonderivative, have fixed and determinable payments, and are not quoted in an active market.

•

Derivatives should be classified as held-for-trading/FVTPL.

•

Term preferred shares should be classified as FVTPL if they are acquired with the intent to sell in the term or are part of a portfolio if instruments that are managed together to maximize Solutions Manual-IFRS Primer-Chapter 17 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

profits. If neither of these conditions is met, these instruments would be classified as AFS. Alternatively, as the substance is debt, the entity may classify as HTM as long as it has the intent and ability to hold to maturity.

•

Debt issued by the entity that is repayable in a variable number of the entity’s own shares should be classified as a liability on the statement of financial position; this is because the number of shares vary depending on the amount owed and the share value and thus, the entity is locked into repaying a certain value.

•

Debt issued by the entity that is repayable in a fixed number of the entity’s own shares should be classified as part equity on the statement of financial position; this is because the number of shares is fixed depending on the amount owed and the share value here is irrelevant. Any obligation to pay interest would be treated as debt.

17-5 How should these be accounted for? How would this change if the assets were still collected by Firenze, but Firenze agreed to pay all amounts collected to Uffizi? Are there any additional criteria that must be met? This scenario is a derecognition of a financial asset; derecognition is the process of removing the receivables from the balance sheet when the contractual rights to the cash flows related to the asset expire, or the rights are transferred and certain derecognition criteria are met. When Firenze sells (transfers) the portfolio of receivables to Uffizi for $800, Firenze derecognizes the asset, which triggers a $50 loss immediately (800 - 850). As well, Uffizi initially recognizes the financial assets at $850, and will recognize a $50 gain/financing revenue. If the assets were still collected by Firenze, but Firenze agreed to pay all amounts collected to Uffizi, then further analysis should be done to see if the risks and rewards have passed. This will be discussed in greater detail in Chapter 18. 17-6 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. (1) Financial Assets at Fair Value through Profit or Loss: With respect to the option to designate any financial asset or financial liability to be measured at fair value through profit or loss, U.S. GAAP prescribes that this option is allowed at initial recognition and that the criteria in the IFRSs do not apply. Conversely, IFRS prescribes that the option is allowed if one of the three criteria – as mentioned on pages 163-164 - is met. (2) Held to Maturity Investments: With regards to the classification of financial assets as held-to- maturity, puttable debt instruments cannot be classified as held to maturity under IFRS, although no such prohibition exists under U.S. GAAP. Solutions Manual-IFRS Primer-Chapter 17 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

(3) Derecognition of a Financial Asset: Under U.S. GAAP, assets are derecognized when the transferor has surrendered control over the assets; one of the conditions is legal isolation. As well there is no partial derecognition. Under IFRS, the combination of risks and rewards and control approach is applied; this means that an entity can derecognize part of an asset, and partial derecognition is only allowed if specific criteria are complied with. Additionally, unlike U.S. GAAP, IFRS does not use an “isolation in bankruptcy” test. (4) Initial Measurement of Financial Assets and Liabilities: Under U.S. GAAP, financial instruments can be measured at fair value with changes in fair value reported through net income, except for specific ineligible financial assets and liabilities. Under IFRS, financial instruments can be measured at fair value with changes in fair value reported through net income provided that certain criteria- which are more restrictive than under U.S. GAAP - are met. (5) Subsequent Measurement of Financial Assets and Liabilities: With respect to the effective-interest method used, IFRS requires the original effective interest rate to be used throughout the life of the instrument for all financial assets and liabilities; whereas U.S. GAAP requires catch up approach, where the retrospective or prospective method of calculating the interest for amortized cost-based assets is used, depending on the type of instrument. With respect to foreign exchange differences on available-for-sale debt instruments, changes in fair value resulting from movements in exchange rates are reflected in other comprehensive income and recycled to the income statement when the instrument is sold under U.S. GAAP. Conversely, changes in fair value resulting from movements in exchange rates are reflected in the income statement as exchange differences under IFRS. (6) Fair Value Measurement Considerations: Under U.S. GAAP, fair value is based on an exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability. Under IFRS though, fair value is generally neither an exit nor an entry price, but represents the amount that an asset could be exchanged, or a liability settled between knowledgeable, willing parties in an arm’s length transaction. A significant difference is that fair value is not based on the transaction (entry) price under U.S. GAAP, but under IFRS, at the inception date, the transaction (entry) price is generally considered fair value. (7) Reclassifications: In terms of reclassification of financial instruments into or out of the trading category, it is prohibited under IFR, but is permitted and expected to be rare under U.S. GAAP.

(8) Impairment and Uncollectibility of Financial Assets: With regards to the impairment of debt and equity securities, IFRS has a focus on ‘loss events’ that provide objective evidence of impairment, while under U.S. GAAP, impairment is recognized only when the decline in fair value is other than temporary. In terms of a subsequent reversal of an impairment loss recognized in the income statement, IFRS requires this for loans and receivables, HTM and AFS debt instruments, if certain criteria are met. U.S. GAAP prohibits this subsequent reversal for HTM and AFS securities, although reversals of valuation allowances on loans are recognized in the income statement. (9) Presentation: Liabilities and Equity: U.S. GAAP specifically identifies certain instruments with characteristics of both debt and equity that must be classified as liabilities. Under IFRS, the classification of certain instruments with elements of both debt and equity focuses on the contractual obligation to deliver cash, assets, or an entity’s own shares. Economic compulsion does not constitute a contractual obligation. With respect to compound instruments, U.S. GAAP prescribes that compound financial instruments are not to be bifurcated into debt and equity, but they may be bifurcated into debt and derivative components. On the contrary, under IFRS, compound (hybrid) financial instruments are required to be split into a debt and equity component, and if applicable, a derivative component. (10) Offsetting a Financial Asset and a Financial Liability: With respect to offsetting amounts due from and owed to two different parties, IFRS requires this when and only when a legally enforceable right and the intention to settle net exist, while under U.S. GAAP, offsetting is prohibited.

Chapter 18 – Solutions 18-1 Derivatives are accounted for as follows: 1. They are recognized in the financial statements. 2. They are presented as fair value through profit and loss. 3. They are measured and remeasured at fair value with related gains/losses being booked through profit or loss. • A forward contract to buy euros This forward contract is a derivative because: ▪ The value of the forward changes with the exchange rate, which is the underlying ▪ The forward contract is priced such that there is no premium and therefore there is no initial investment ▪ The contract will be settled in the future. Under the forward contract, the company must purchase the euros or sell the contract to someone else who must settle at the end of the contract. As well, this contract would normally be priced so that the forward price equals the current spot price plus carrying costs, and the accounting would follow the three steps above since it is in fact a derivative. • A future contract to buy oil Futures are just standardized forwards, and in this case, is a contract to buy a non-financial commodity. This future contract is a derivative because: ▪ The value of the future changes with the commodity price, which is the underlying ▪ The futures contract is priced such that there is no premium and therefore there is no initial investment ▪ The contract will be settled in the future. Under the futures contract, the company must purchase the oil or sell the contract to someone else who must settle at the end of the contract. Additionally, this contract would normally be priced so that the forward price (a fixed price in the future) equals the current spot price plus carrying costs, and would be accounted for based on the three steps above since it is a derivative. Although not discussed in the chapter, futures contracts generally require a cash deposit (margin) to be deposited upfront. This is often a percentage of the value of the contract. • Options to sell shares of Franko Inc. This is a purchased put option which gives Investico the right, but not obligation, to sell Franko shares at a fixed price. This option is a derivative because: ▪ The value of the option changes with the market value of the shares of Franko Inc. and the price of the shares is the underlying ▪ The option may be settled or exercised in the future

In addition, this option is priced using options pricing models such as the Black-Scholes and binomial tree models, and would be accounted for based on the three steps mentioned above since it is indeed a derivative. • A loan commitment to lend funds to another company This loan commitment is accounted for based on whether it is or is not a derivative. Having said that, if it can be settled net in cash (or other financial assets) it is a derivative and accounted for based on the three steps noted above. If, on the other hand, this loan commitment extends a loan at below market interest rates, it is an onerous contract and should be measured at the higher of the amount determined in accordance with IAS 37 and the initial amount less amortization under IAS 18 Revenues. Finally, if this loan commitment is classified as FVTPL, it is covered by IAS 39. • A guarantee contract under which it has guaranteed the value of an asset for an unrelated company In this scenario, this is an insurance contract, not a financial guarantee, and is accounted for under IFRS 4 as long as the entity has accounted for such contracts as insurance in the past. As well, this is not a derivative; the main difference is that this insurance contract may deal with non-financial assets such as a building and machinery that are owned by the insured (assets are specific to the insured, unrelated company). As noted in the definition of a derivative, the value of a derivative varies with an underlying. The definition of an underlying excludes non-financial variables where the variable is specific to one of the parties to the contract. Depending on the specifics of the contract, insurance contracts often meet the definition of a derivative except for the fact that they usually relate to this exclusion. 18-2 Even though the asset has not been physically transferred from Feller, the transaction would be accounted for as a transfer and assessed for derecognition. This type of transaction is often referred to as a “pass-through” arrangement since the money is just passing through Feller. In this case, all of the criteria listed in the chapter are met: Feller does not need to pay anything unless it receives the cash flows from the receivables; it cannot sell the assets (assumption); and any cash flows received must be remitted to the Transferee as soon as they are received. Therefore, this is a transfer and must be further assessed to see if substantially all of the risks and rewards of ownership have been transferred. Where substantially all of the risks and rewards of ownership are transferred and there is no continuing involvement, derecognition of the receivable takes place and often a gain or loss is recognized. It is quite difficult to determine whether substantially all risks are retained or transferred, in which case Feller must determine whether it has retained control over the asset. Determining whether Feller has retained control is a matter of judgment and depends on whether it can sell the asset or not. If the transferee is able to sell the asset (without involving other parties) and without imposing any restrictions on Feller, then control has passed from Feller to the other party (transferee). Solutions Manual-IFRS Primer-Chapter 18 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

If it was determined that substantially all of the risks and rewards have been transferred, the receivables would be derecognized, and the accounting would be to remove the asset off the books and recognize a gain or loss. If the risks and rewards are substantially retained, derecognition does not occur and Feller would continue to recognize the asset in the books. 18-3 Hedges must be viewed through an economic lens as well as an accounting lens. With this is mind, Hedge Co. may enter into hedges to protect itself from economic losses or to reduce uncertainty. Since Hedge Co. has a payable in a foreign currency, there is a foreign exchange risk. If the exchange rate changes, the entity will end up paying more or less for that payable once it converts to the local currency. In order to offset that risk, Hedge Co. has entered into a forward contract to buy the foreign currency in 30 days. Thus, the entity locks in the amount of local currency that it will need to settle the payable. Therefore this would be an economic hedge. Since Hedge Co. has entered into the forward contract in order to modify its risk profile of the payable transaction, this is referred to as a hedging relationship. In this scenario, the hedged item is the payable denominated in euros. It meets the definition of a hedged item because it is a liability that (a) exposes Hedge Co. to risk of changes in fair value or future cash flows and (b) is designated as being hedged. Additionally, the hedged item is the item that is exposing Hedge Co. to some unwanted risk where Hedge Co. chooses to get rid of that risk, and it can be a liability already recognized on the balance sheet. In terms of the hedging item, this is the forward contract; it meets the definition as it is a designated derivative (for a hedge of the risk of changes in foreign currency exchange rates only) whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item. From an accounting perspective this is a fair value hedge since Hedge Co. is hedging the currency risk related to the payable, which is recognized on the balance sheet. The entity must now decide whether it would like to or needs to use special hedge accounting to ensure that the gains/losses from restating the payable offset the gains/losses from the forward contract (which, as a derivative, will be recognized in the statements and valued at fair value). The standard states that if there is a designated hedging relationship between the hedging instrument and a hedged item, then hedge accounting may be used. Normally, the forward will be recognized and measured at fair value with gains/losses booked to income (as a derivative). Because the payable is valued at cost/net realizable value/carrying value, any related gains/losses will not be reflected in the statements. Therefore, there will be a mismatch—the gains/losses on the derivative will be booked, but the gains/ losses related to changes in the value of the payable will not. Therefore, Hedge Co. may choose to use hedge accounting. If hedge accounting is used, the derivative is accounted for as usual (recognized, measured at fair value, and gains/losses recognized in profit/loss) but the payable is revalued to fair value with the gains and losses booked to income. Since the gains and losses on both the hedged and hedging items are booked through profit and loss at the same time, they are therefore matched. If the hedge accounting option is not used, only the gains or losses from the forward contract would be recognized in profit and loss. Solutions Manual-IFRS Primer-Chapter 18 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Although there is not an absolute need for hedge accounting here, this option ensures that the gains/losses from restating the payable offset the gains/losses from the forward contract. As well, unless hedge accounting is used, there will be a mismatch of gains/losses and the economic substance of the hedge (which gets rid of the volatility) is not reflected. As a side note, in order for Hedge Co. to qualify for hedge accounting, they must formalize and document the analysis regarding the existence of a hedging relationship. This involves meeting specific criteria/conditions as set out in the chapter. 18-4 In an economic hedge, the gains and losses on the hedged and hedging item are offset in the financial statements. In a perfect economic hedge, gains/losses on the item/risk hedged are offset by the gains/losses on the hedging item, to the effect that earnings are insulated from changes in value of the hedged item. Hedge accounting, on the other hand, is a special type of accounting that is optional and is an accounting policy choice for an entity. Hedge accounting may be used when the entity has economic hedges to ensure that there is no mismatch in the bookkeeping when an economic hedge exists. It may be necessary because the IFRS is currently based on a mixed measurement model (some assets and liabilities are carried at cost and some at fair value). Hedge accounting steps in to “fix” this. An important note is that not all companies use hedge accounting. Some potential reasons are as follows: ▪ There is no mismatch of gains/losses if the hedged item is measured at fair value already ▪ if the pre “hedge accounting” is such that the gains and losses do not otherwise offset each other, the entity must decide whether it wants to use the special hedge accounting to correct this or not ▪ Not all entities meet all of the hedging relationship criteria/conditions in order to qualify for hedge accounting; for example, an entity may not be able to reliably measure the effectiveness of a hedge ▪ Hedge accounting is highly complex and costly to implement 18-5: Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Derivatives: U.S. The definition of derivatives under U.S. GAAP is different (includes net settlement). Non-financial Derivatives Under U.S. GAAP documentation of ”expected use” is required. Documentation is not required under IFRS. Embedded Derivatives With respect to compound (hybrid) instruments, U.S. GAAP prescribes that compound financial instruments are not to be bifurcated into debt and equity, but they may be bifurcated into debt and derivative components. On the contrary, under IFRS, compound (hybrid) financial Solutions Manual-IFRS Primer-Chapter 18 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

instruments are required to be split into a debt and equity component, and if applicable, a derivative component. Derecognition Under U.S. GAAP, assets are derecognized when the transferor has surrendered control over the assets; one of the conditions is legal isolation. As well there is no partial derecognition. Under IFRS, the combination of risks and rewards and control approach is applied; this means that an entity can derecognize part of an asset, and partial derecognition is only allowed if specific criteria are complied with. Additionally, unlike U.S. GAAP, IFRS does not use an “isolation in bankruptcy” test. Hedging There are numerous, complex, specific differences here; however, they are beyond the scope of the book. With respect to the use of “partial term hedges” for financial items (hedge of a fair value exposure for only a part of the term of a hedged item), under IFRS this is permitted, while under U.S. GAAP, although not explicitly prohibited, these items would most probably fail the correlation requirement of FAS 133 and hence not qualify for hedge accounting. Hedge Effectiveness With regards to the topic of assuming perfect effectiveness of a hedge if critical terms match, under IFRS, this is prohibited and entity must always assess and measure effectiveness. Conversely under U.S. GAAP, this is allowed if the critical terms of the hedging instrument and the entire hedged asset or liability or hedged forecasted transaction are the same – “Matched Terms Method.” It is also allowed for hedge of interest rate risk in a debt instrument if certain conditions are met – “Shortcut Method.”

Chapter 19 – Solutions 19-1 A puttable instrument is a financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder. In theory, the put option represents an obligation on the part of the entity and is therefore presented as a financial liability; the puttable instrument meets the definition of a liability as it is a contractual obligation to deliver cash or other assets. Exception to the general treatment as a liability as prescribed in IAS 32: The standard allows an exception to the general treatment as a liability where the following conditions are met: (a) The instrument entitles the holder or another entity to a share of the entity’s net assets upon liquidation. (b) The instrument is in a class of instruments that is subordinate to all other instruments and is residual in nature (e.g., common shares). (c) All instruments in the class have the same features including the put option. (d) The instrument otherwise does not meet the definition of a liability. (e) The expected cash flows of the instrument relate to the earnings of the entity. Thus, if the instruments are otherwise common shares (legally or in economic substance) except for the put option, they may be treated as equity. Additionally, the entity must not have other instruments that would be subordinate to the puttable instruments, e.g., other common or ordinary shares. In the end, the puttable instruments must represent the residual ownership interest (residual in nature), thus meeting the definition of equity.

19-2 Kanga has a $1,000 10-year debt outstanding at 5% interest. The debt will be settled by issuing 100 common shares (fixed number of shares). Initial journal entry required: Dr. Cash Cr. Liability Cr. Equity

1000 386 614

1000 × 5% = $50 X 7.72173 = $386 This debt instrument is partly an equity instrument because the contractual obligation is settled in a fixed number of shares; as long as it is a fixed number of shares, the economic substance is that the instrument is equity. The holder of the 10-year debt will receive a fixed number of shares on settlement (versus a variable number) and therefore essentially has a residual interest in the entity. The obligation to pay interest is recorded as a liability. Solutions Manual-IFRS Primer-Chapter 19 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Debt to be settled with a variable number of shares: Dr. Cash Cr. Liability

1000 1000

If this 10-year debt can be settled in a variable number of shares. then it is more like a liability because a fixed value is needed to settle it. The entity must give whatever number of shares is needed (depending on the market value of the shares) to settle the fixed value. 19-3 The journal entries to record the five transactions, as well as explanations for the accounting treatment, are as follows: 1. Dr. Cash 5 Cr. Equity Dr. Equity 100 Cr. Liability

5 100

Since Roo is locked into purchasing a fixed amount of its own shares for cash, a financial liability exists. The liability is measured at the present value of the redemption amount and credited to a liability account. The corresponding debit is booked to equity since this is also an equity instrument (under the contract, the entity will deliver a fixed amount of cash for a fixed number of shares). 2. Dr. Cash 5 Cr. Financial Liability

The amounts in this journal entry are equal to the option premium. Since the contract is settled net in cash, the substance is that the Roo is trading for profit using its own shares as the underlying. Thus, this is more like an operating transaction than a capital transaction since Roo is not buying or selling its own shares. 3. Dr. Cash 505 Cr. Liabilities 500 Cr. Equity 5 Assume a face value of $500 for the debt. This is a compound instrument. It contains both a debt and equity component, and the equity component must be bifurcated and presented as equity upon initial recognition. The option to convert to a fixed amount of shares is, by definition, equity. The choice of settlement options is beyond the entity’s control, and so the fixed obligation to repay the debt meets the definition of a liability. The equity is separated and measured at the residual after deducting the fair value of the obligation.

4. Dr. Equity 6 Cr. Cash

This is a purchased call option as Roo is allowed, but not obligated, to buy 100 Roo common shares for $101. In this situation, Roo chose to purchase an option on its own shares for a premium. Since these are settled gross (by delivery of shares if settled), they are equity instruments and are recorded as a deduction from equity as opposed to an asset. The premium is therefore booked as a debit to equity and credit to cash. 5. Dr. Equity PV of 110 Cr. Financial Liability

PV of 110

The amount in the entry uses the present value of the forward rate. Since Roo is locked into purchasing a fixed amount of its own shares for cash, a financial liability exists. The liability is measured at the present value of the redemption amount and credited to a liability account. The corresponding debit is booked to equity since this is also an equity instrument (under the contract, the entity will deliver a fixed amount of cash for a fixed number of shares). This is due to the unique nature of a forward contract. It creates both a liability (obligation to deliver something) and an asset (right to receive something) at the same time. In this case, because the right is a right to receive the entity’s own shares, it is not an asset but rather a debit to equity. If the contract has a net settlement provision (as is often the case with forwards), the contract would be treated as a derivative. Since forwards have a zero value on inception, no journal entry would be required. 19-4: Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Objective and Scope: U.S. GAAP specifically identifies certain instruments with characteristics of both debt and equity that must be classified as liabilities. Under IFRS, the classification of certain instruments with elements of both debt and equity focuses on the contractual obligation to deliver cash, assets, or an entity’s own shares. Economic compulsion does not constitute a contractual obligation. Financial Asset: U.S. GAAP has differing definitions. IFRS includes explicit guidance on accounting for an entity’s own equity instruments. Compound Financial Instruments: With respect to compound instruments, U.S. GAAP prescribes that compound financial instruments are not to be bifurcated into debt and equity, but they may be bifurcated into debt and derivative components. On the contrary, under IFRS, compound (hybrid) financial instruments are required to be split into a debt and equity component, and if applicable, a derivative component.

Chapter 20 – Solutions 20-1 The main risks facing L’Oreal are: • •

•

Liquidity risk Market risk o Currency risk o Interest rate risk o Third party risk o Share risk Accounts receivable risk

L’Oreal appears to meet the overall objective of IFRS 7, which is to assist users in assessing the nature and extent of risks related to financial instruments. For liquidity risk, L’Oreal describes how it manages this risk and provides quantitative disclosures about its borrowings and debt, including debt by type and maturity, and comments on its confirmed credit lines. For market risk, L’Oreal describes how it manages this risk through the use of qualitative and quantitative discussion. For currency and interest rate risks, L’Oreal does a great job explaining their exposure to these risks and provides charts and numerical data on the derivatives used to minimize or hedge against these risks. With respect to share risk, L’Oreal does a sensitivity analysis surrounding changes in the share price of Sanofi-Aventis (a company in which it holds 118,227,307 shares). For accounts receivable risk, L’Oreal describes how it manages this risk and provides quantitative disclosures about its accounts receivable allowance levels. 20-2 The significant disclosures about fair values are important not only for an entity, but also for the users who require such information to make critical decisions. Through additional disclosures, the financial statements and accompanying notes can have increased transparency, comparability, and reliability. It is also very important for users to have accurate and transparent information, and to be made aware of any fair value assumptions and situations where changing assumptions will change the fair value significantly. To illustrate, an entity should disclose the following: the fair values of each class of financial assets/liabilities in such a way to allow them to be compared to carrying values and the methods and assumptions used to calculate fair value. In the scenarios when fair value disclosures are not required, because the carrying amount is a reasonable approximation of the fair value or the fair value cannot be measured reliably, the entity should disclose this information; this will assist users in making their own judgments, including the fact that fair values are not disclosed, a description of the instruments, information about the markets, information about intent to dispose of the instruments, and details about where these instruments are derecognized during the period.

Currently there is a big shift toward fair value in the global marketplace, especially in the areas of accounting and financial reporting, and it is important to keep users informed and up-to-date on how fair value, including any related assumptions, impacts their ability to make educated financial and investment decisions. 20-3 The following detail the pros and cons of mandating such detailed and voluminous disclosures under IFRS 7. Pros: • Leads to increased transparency in financial reports/statements • Can assist users in understanding the significance of financial instruments and the associated risks involved • Can assist users in making investment decisions • Can be used effectively to meet the needs of multiple stakeholders, such as creditors or investors Cons: • Cost/benefit- this is a big and time-consuming element of financial reports and can represent a large cost to the entity with regards to its preparation • An overload of disclosures can actually confuse users and complicate important decision making based on this information • Requires an increased knowledge level to decipher the disclosure content, which may not be practical for all users o For example, a basic shareholder who is not an accountant may find it very difficult to understand advanced analysis of derivatives held for currency risk hedging purposes 20-4 An entity shall disclose a sensitivity analysis for each type of market risk, including methods and assumptions used to calculate the risk and any changes from the previous period. Therefore currency, interest rate, or price risks may be subject to such analysis. In order to complete the sensitivity analysis, the following steps might be taken: 1. Identify risks. 2. Identify exposures at the balance sheet date. 3. Determine which financial statement balances might change and why. 4. Determine the appropriate level of aggregation for the analysis. 5. Calculate and present the sensitivity analysis Of the above steps, judgment is very prevalent in steps 2 through 4. Once a risk has been identified, it may take some judgment to determine an entity’s actual versus perceived exposure to that risk. There is also judgment involved in determining which balances are going to be impacted by such exposure, and how much of this information is going to presented to the user; it may be difficult or impractical for an entity to show the impacts of and exposure to a given risk. This is complicated further with respect to aggregation, as to whether this analysis is going to be done on firm wide results or segmented results for example. Solutions Manual-IFRS Primer-Chapter 20 Copyright © 2010 John Wiley & Sons Canada, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

A sensitivity analysis can be value adding to financial statements, based on user understandability and whether or not appropriate risks have been addressed and accurately presented. If a sensitivity analysis was done to show how an increase of interest rates would have impacted profits, this may be easy to understand for a user, but is essentially a ‘what if scenario’ and doesn’t truly reflect the economic reality of the transactions of an entity. This type of analysis can also be very confusing to users, especially with respect to complex derivatives, and can actually confuse their decision-making abilities (if they were to make decisions based on such information). In some cases this information adds very little value to the statements and may impact very few important investment decisions, as the information lacks usefulness and relevance. With respect to auditing, the sensitivity analysis creates a need for greater verification/assurance, and the application of audit techniques and procedures. Basic calculations such as share price fluctuations are relatively straightforward, but items such as interest rate changes with respect to derivatives or pension obligations can create added work and complexity to the audit engagement. Since the analysis is part of the statements, it must be audited, and increased engagement time can actually lead to increased costs to the reporting entity. It appears that increased costs to prepare and audit the sensitivity analyses may outweigh the potential benefits derived by users of such information. 20-5 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Classes of Financial Instruments for Financial Position and Performance: The disclosure requirements of U.S. GAAP and IFRS 7 are converged, except that IFRS 7 applies to partially derecognized assets. Hedge Accounting: The disclosure requirements of U.S. GAAP and IFRS 7 are converged, except that IFRS 7 requires less specific disclosures about hedging transactions.

Chapter 21 – Solutions 21-1 Aside from any personnel issues that arise from this situation, HC’s controller should make sure that the Braker Division uses consistent accounting policies that are aligned with the entity. In the situation presented, any accounting changes are corrections of accounting errors. That is, they resulted from the failure to use or the misuse of reliable information that was available and was expected to be used in prior years. Material errors are corrected retrospectively by adjusting all prior periods for the effects of the errors, unless it is impracticable to determine the effects on each prior period. If the adjustments can be determined for each prior period, the prior financial statements are restated to appear as if the error had never occurred, it is reported and corrected in the first financial statement issued after discovery of the error, and retained earnings , accounts receivable and inventory are adjusted for the cumulative effect to date. HC discloses the nature of the error and detailed information on each line item corrected, and the effect on EPS. A case might be made that the effects cannot be determined without having specific information about the circumstances that existed at the end of each prior period or on a cumulative basis. If so, prospective treatment could be supported on the basis of impracticability. For prospective treatment, the carrying amount of the related asset accounts would be adjusted in the current period., with disclosures explaining the error, why full retrospective treatment is impracticable, and the date from which the error has been corrected. 21-2 Scenario 1: In this first case, the capitalized product development costs that had not been adjusted or amortized and had been incorrectly coded and were missed in the annual adjustment process is a situation of a prior period error. This situation is a prior period error because it is an omission from an entity’s previously reported financial statements from failing to use reliable information that was available when those financial statements were authorized to be issued, and could reasonably be expected to have been collected and used in preparing those statements. The correcting accounting treatment to use for correcting material accounting errors is retrospective restatement in the first financial statements issued after the error is discovered. Impracticability is unlikely to be supportable in this situation. Scenario 2: In this case, the expensing of development costs appears to be appropriate for current and changed conditions and circumstances. This is not a change in accounting policy, nor a change of any sort requiring adjustment. The old method was appropriate before, and the policy now applied in appropriate now. Scenario 3: In this case, the change in accounting for development costs is a change in accounting policy. The change was made because the new approach better represents the benefits received from the development cost assets. Under IAS 8 this treatment is acceptable because the different policy will result in financial statements that provide “reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flows.” The correct accounting treatment for this voluntary change in policy is to use retroactive or retrospective application, by adjusting the opening balance of each component of equity that is Solutions Manual-IFRS Primer-Chapter 21 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

affected, along with the opening balance of other comparative amounts disclosed, for the earliest prior period presented. It should be reported as if the new policy had always been applied. 21-3 In this situation, the accountant is reversing, in 2009, an accrued liability set up in 2007. This situation would be classified as a change in accounting estimate, as an adjustment was made pertaining to the carrying amount of the liability set up in their records. This change in estimate resulted from new information regarding the lawsuit outcome. The adjustment made by the accountant should have been made prospectively, not retroactively. The carrying amount of the liability is adjusted in the period of change, i.e., 2009, and the credit recognized in the current period’s profit or loss. 21-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Accounting for prior period errors: The AcSB decided not to adopt this aspect of IAS 8 in its project to revise Section 1506. The AcSB decided to maintain convergence with U.S. GAAP on this aspect until changeover, as the U.S. does not allow an entity to be exempt from the requirement to restate prior periods for the correction of an error on grounds of impracticability.

Chapter 22 – Solutions 22-1 This event would be treated as a non-adjusting event after the reporting period because the event arose after the reporting date (the event is the refinancing). Since the debt refinancing agreement has been signed after the reporting date, the transaction would not be recognized. The maturing bonds payable would remain on the balance sheet as current liabilities, as they mature in 2009, even though the company has secured the required re-financing. Under U.S. GAAP, the refinancing would be accounted for as an adjusting event and the debt reclassified to long-term debt. 22-2 In this scenario, the customer bankruptcy is an event after the reporting period. The key is determining whether this event is an adjusting event or non-adjusting event, which involves some judgment. Since EBL had set up a bad debt provision at year-end based on the concern about the customer’s ability to pay, this would be classified as an adjusting event, as EBL can provide evidence that this condition existed at the end of the reporting period. But, it may be reasonable to assume that bad debt provisions/allowances are set up for most customers and that this was not an indication that the customer was going to go bankrupt. In this case, the event would be a non-adjusting event. In conclusion, EBL should not account for the bankruptcy as this was probably a non-adjusting event and also because the actual amount of receivable that is not to be recovered (the “write-off”) is still to be determined in the liquidity process of the customer. This could go either way and would have to be determined by the fact set. 22-3 This presents a going concern problem. Not only does the company not have sufficient cash, the bank will not extend any money and the payroll is due. Management must make a decision as to whether the entity is a going concern. Even if this determination is made after year-end, the statements would be restated if management felt that the entity was no longer a going concern. If on the other hand, management feels that it is still a going concern – perhaps there are other sources of cash – then no restatement is required. 22-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Recognition and measurement: Despite the differences in terminology, the accounting for subsequent events under SAS 1 of U.S. GAAP and IAS 10 is largely similar. The significant differences are as follows: 1) With respect to stock dividends declared after the balance sheet date, U.S. GAAP requires financial statements to be adjusted, while IFRS does not require financial statements to be adjusted. 2) With respect to short term loans refinanced with long-term loans after the balance sheet date, under U.S. GAAP, short-term loans are classified as long-term if the entity intends to refinance the loan on a long-term basis and prior to issuing the financial statements, the entity can demonstrate an ability to refinance the loan. Under IFRS, the short-term loans may qualify for disclosure, but would not result in a reclassification of the loan to long-term liabilities. Solutions Manual-IFRS Primer-Chapter 22 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Disclosure: As mentioned above, with regards to short-term loans refinanced with long-term loans after the balance sheet date, IFRS may require additional disclosure, but the refinancing would not result in a reclassification of the loan to long-term liabilities as in U.S. GAAP.

Chapter 23 – Solutions 23-1 Taxable temporary differences lead to deferred tax liabilities, while deductible temporary differences can lead to deferred tax assets. One large difference is that in addition to deductible temporary differences, deferred tax assets can arise when an entity has unused tax losses and unused tax credits that it can carry forward and deduct in the future. With deductible temporary differences, there are strict guidelines that must be followed in order for a deferred tax asset to be recognized; in contrast, this is not as essential when analyzing taxable temporary differences. In order for an entity to benefit from future reductions in tax, the deferred tax asset is only recognized if it is probable that taxable profit will be available. Thus, entities need guidelines to assess whether taxable profits are probable, and this test is laid out in IAS 12. As well, entities can still recognize deferred tax assets if it is probable that they will have enough taxable profit in a future period or there is potential for tax planning opportunities that will create taxable profit at the appropriate time. Once again IAS 12 includes guidance on what is meant by tax planning opportunities. In conclusion, IAS 12 provides much more guidance on the recognition and measurement of the tax effects derived from deductible temporary differences than for the tax effects from taxable temporary differences as entities need guidance and tests to determine whether or not to recognize deferred assets, and because deferred tax assets can be derived from more than just temporary timing differences. 23-2 An analysis of each situation follows. (1) Taxable temporary difference resulting in a deferred tax liability. The development costs have already been deducted for tax purposes, so that in the future as the entity amortizes them to expense, it will have to add them back when calculating taxable income. This will increase taxable income and future income taxes. Alternatively, as the asset’s carrying amount is recovered in the future through operations, no amount is deductible. Therefore, future tax is increased. (Tax base = $0.) (2) Taxable temporary difference resulting in a deferred tax liability. As the revenue is recognized, accounts receivable is recognized. In the year the revenue is recognized, it is deducted in calculating taxable income. As the receivable is collected, it is taxable, thus increasing future taxable incomes and future taxes. Alternatively, as the receivable is recovered, the benefits received (cash) are fully taxable as no amount is deductible in determining taxable income. (Tax base = $0.) (3) Taxable temporary difference resulting in a deferred tax liability. The transaction costs have already been deducted for tax purposes, reducing past taxable incomes. As interest expense is recognized in the accounts in the future, some part of it will not be deductible for tax purposes, so that future taxable income will be increased and more tax paid. Alternatively, the discount (contra liability or asset) has already been recognized for tax purposes. Its carrying amount is now $2 debit. No amount will be deductible in the future when the benefits are received. (Tax base of asset = $0.)

(4) Deductible temporary difference resulting in a deferred tax asset. Because the expense has exceeded the contributions in the past, taxable income has been higher than reported profit. In the future, as the net liability is settled, the entity will deduct an amount greater than the expense recognized when determining its taxes. Therefore, future taxes will be reduced. (Tax base of liability = $0.) (5) Taxable temporary difference resulting in a deferred tax liability. As the asset’s carrying value is recovered through operations, only the lower cost amount is deductible for tax purposes, meaning that a portion of the amount recovered will be taxable in the future. (Tax base = carrying amount less tax deductible amounts in the future.) 23-3(a) Year

2005

2006 2007 2008

Taxable Profit or (Loss)

= 0* + 200 (addback for depreciation) – 250(deduction for depreciation for tax purposes) = (50)

Current Year Tax Expense (Recovery)

= (20) The 50 loss gets applied to the previous 500 taxable profit from 2004, reducing the taxable profit to 450 and reducing taxes payable to 180 instead of 200. = (20) = (20) = (20)

= (50) = (50) = (50) = 0* + 200 (add back for depreciation) – 0 (deduction for depreciation for tax = 200 × 40% (tax rate) 2009 purposes as the asset does not have a tax = 80 base anymore) = 200 *Note: Profits after depreciation but before taxes= $0 (200 - 200) Aside: Taxes paid in 2004 amounted to 500 × 40% which equals $200. From 2005-2008, the entity can claim for loss carrybacks or reversal of deferred tax liabilities in the future to justify recognition of the benefit of the loss.

23-3(b) Year

2005

2006

2007

2008

2009

Temporary Difference Carrying amount = 800 (1000 less 200 depreciation) Tax base = 750 (1000 less 250 depreciation) Taxable temporary difference = 50 Carrying amount = 600 Tax base = 500 Taxable temporary difference = 100 Carrying amount = 400 Tax base = 250 Taxable temporary difference = 150 Carrying amount = 200 Tax base = 0 Taxable temporary difference = 200 Carrying amount = 0 Tax base = 0 Taxable temporary difference = 0

Balance of the Deferred Tax Item

A deferred tax liability of 20 (50 × 40%) is recognized

Deferred Tax Expense (Income) for the Year

= 20

The deferred tax liability is adjusted by 20 so that the balance is now 40 (100 × 40%)

= 20

The deferred tax liability is adjusted by 20 so that the balance is now 60 (150 × 40%)

= 20

The deferred tax liability is adjusted by 20 so that the balance is now 80 (200 × 40%)

= 20

The deferred tax liability of 80 gets reversed, so that the balance in the account is 0

= (80)

23-3(c) Partial Statements of Comprehensive Income: 2005, 2006, 2007, and 2008: Profits before depreciation expense and taxes Depreciation expense Profits before taxes Income taxes: Current tax expense (recovery) Deferred tax expense 20 Profits/ (loss) after taxes

$200 200 0 $(20) 0 $ 0

2009: Profits before depreciation expense and taxes Depreciation expense 200 Profits before taxes 0 Income taxes: Current tax expense $ 80 Deferred tax expense (80) Profits/ (loss) after taxes

$200

0 $

Note: In 2009, since the deferred tax liability is reversed, there would be a credit balance of $80 for deferred tax expense, reducing income tax expense to $0. 23-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Tax Basis: Under U.S. GAAP, the tax basis is a question of fact under the tax law. For most assets and liabilities, there is no dispute on this amount. Under IFRS, the tax basis is generally the amount deductible or taxable for tax purposes. The manner in which management intends to settle or recover the carrying amount affects the determination of tax basis. Reassessment of Unrecognized Deferred Tax Assets: Under IFRS, amounts are recognized only to the extent it is probable that they will be realized. Under U.S. GAAP, they are recognized in full but valuation allowance reduces the asset to the amount that is more likely than not to be realized. Temporary Differences and the Initial Recognition of Assets and Liabilities: Under IFRS, deferred tax is not recognized for temporary differences that arise from the initial recognition of an asset or liability in a transaction that is (a) not a business combination, and (b) does not affect accounting profit or taxable profit. Changes in this unrecognized deferred tax asset or liability are not subsequently recognized. Under U.S. GAAP, no similar exemption for non-recognition of deferred tax effects for certain assets or liabilities. Temporary Differences and Investments in Subsidiaries, Associates, and Joint Ventures Under IFRS, deferred tax is not recognized in respect of investments in subsidiaries, associates and JVs if certain conditions are met (if the reporting entity has control over the timing of the reversal of the temporary difference and it is probable that it will not reverse in the foreseeable future). Under U.S. GAAP, recognition is not required for investment in foreign subsidiary or corporate joint venture that is essentially permanent in duration, unless it appears that the difference will reverse in the foreseeable future. Deferred tax is always recognized for investments subject to significant influence.

Measurement: Current Tax Liabilities and Assets: Under U.S. GAAP, in order to measure the current tax assets and liabilities, the enacted tax rate must be used. Under IFRS, the enacted or substantively enacted tax rates as of the balance sheet date must be used. Deferred Tax Asset and Liabilities: Under U.S. GAAP, in order to measure the current tax assets and liabilities, the enacted tax rate must be used. Under IFRS, the enacted or substantively enacted tax rates as of the balance sheet date must be used. Items Recognized Outside of Profit or Loss: IFRSs use “backward tracing.” Under IFRS, the tax effects of items credited or charged directly to equity during the current year are allocated directly to equity. A deferred tax item originally recognized by a charge or credit to shareholders’ equity may change either from changes in assessments of recovery of deferred tax assets or from changes in tax rates, laws, or other measurement attributes. Consistent with the initial treatment, IAS 12 requires that the resulting change in deferred taxes also be charged or credited directly to the same element the original charge or credit was accounted for. Under U.S. GAAP, “backward tracing” is prohibited. Initial charges and credits are handled the same way as in the IFRS, but subsequent changes are allocated to continuing operations. Current and Deferred Tax Arising from Share-based Payment Transactions: Under U.S. GAAP, deferred tax is adjusted each period to reflect the amount of tax deduction received if the award were tax deductible in the current period based on the current market price of the shares. Under IFRS, deferred tax is based on the amount of compensation cost recognized in profit or loss without any adjustment for the entity’s current share price until the tax benefit is realized (i.e., intrinsic value). Classification (Presentation): Under U.S. GAAP, classification is split between current and non-current components based on the classification of the underlying asset or liability to which the deferral is related, or on the expected reversal of items not related to an asset or liability. Under IFRS, all amounts are classified as non-current in the balance sheet. Disclosures: Under IFRS, an entity is required to provide a reconciliation of the average tax rate (in all its jurisdictions) to the effective tax rate in the financial statements. Under U.S. GAAP, the statutory rate of the parent company is reconciled to the effective tax rate.

Chapter 24 – Solutions 24-1(a) In respect to Lessee Corp., the nature of this lease appears to be that of a finance lease. The main reasons supporting this classification are the facts that the lease term covers the major part of the asset’s economic life (i.e., 4 out of 6 years) and that at the beginning of the lease, the present value of the minimum lease payments covers substantially all the fair value of the leased property (i.e., the PVMLP = $25.8 * 3.48685 or $90 and the fair value = $100). In addition, the asset was manufactured according to the lessee’s specifications and it may not be appropriate for others. Therefore, the lessee will probably derive the majority of benefits this asset has to offer and the lessor will earn a return on investment in addition to a return of its investment in the leased asset. The risks and rewards of ownership appear to be transferred to the lessee. This decision is based on the limited information provided. (b) In terms of the Lessor Corp., this lease also appears to be a finance lease because the conditions identified in part (a) have been met (i.e., criteria surrounding economic life and the present value of the minimum lease payments covers most of the fair value of the equipment). The PV of the minimum lease payments for the lessor is higher than in part (a) because to the lessor, the MLPs include the unguaranteed residual as well. (For the lessor, the PVMPL = 25.8 * 3.48685 + 13 * .68301 = 98.9.) This is a recovery of about 99% of the normal selling price! At the end of the lease term, the equipment may not have general value to anyone other than the lessee, so the lessee may be able to extend the lease at a bargain price at that time. Once again, this decision is based on the limited information provided. (c) Lessee Corp: Finance Lease 2008: May 15 Equipment under Lease 90 Obligation under Lease 90 Obligation under Lease 25.8 Cash 25.8 At year-end December 31: Interest Expense 4.0 (90-25.8 =64.2 *10% *(7.5months/12months)) Interest Payable 4.0 Depreciation Expense 14.1 Acc’d Depreciation 14.1 (90/4 = 22.5) (22.5 * 7.5/12 = 14.1) 2009: May 15 Interest Expense 2.4 (90-25.8 =64.2 *10% *(4.5months/12months)) Interest Payable 2.4

May 15 Obligation under Lease 19.4 Interest Payable 6.4 (4+2.4) Cash 25.8 At year-end December 31: Interest Expense 2.8 (64.2 - 19.4 = 44.8 *10% *(7.5months/12months)) Interest Payable 2.8 Depreciation Expense 22.5 Acc’d Depreciation 22.5 (90/4 = 22.5) Operating Lease: 2008: May 15 Lease Expense 25.8 Cash

25.8

Dec. 31 Prepaid Rent 9.7 Lease Expense 9.7 (25.8 * 4.5/12) 2009: May 15 Lease Expense 25.8 Cash

25.8

Dec. 31 No entry required. (Other series of entries for the above are possible.) (d) Lessor Corp: Finance Lease 2008: May 15 Lease Receivable 116.2 (25.8*4 payments + 13 (unguaranteed residual value) Cost of Goods Sold 71.1 (80- PV of 13) Sales 90.0 (PVMLP – PV of 13) Unearned Finance Income 17.3 (Lease Received – PVMLP) Inventory 80.0 Entry to record the lease payment received Cash 25.8 Lease Receivable 25.8 Solutions Manual-IFRS Primer-Chapter 24 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

At year-end December 31: Unearned Finance Income 4.6 (116.2 – 17.3 – 25.8 = 73.1 * 10% * 7.5/12 = 4.6) Finance Income 4.6 To recognize finance income earned in the period. 2009: May 15 Unearned Finance Income 2.7 (73.1 * 10% = 7.3 – 4.6 = 2.7) Finance Income 2.7 To recognize finance income earned in the first part of 2009 (Unearned Finance Income = 17.3 – 7.3 = 10.0). May 15 Cash

25.8 Lease Receivable To record lease payment received.

25.8

At year-end December 31: Unearned Finance Income 2.3 (73.1 – 10.0 – 25.8 = 37.3 * 10% * 7.5/12 = 2.3) Finance Income 2.3 To recognize finance income earned in the period. Operating Lease: 2008: May 15 Cash 25.8 Lease Income

25.8

Dec. 31 Lease Income 9.7 (25.8 * 7.5/12 = 9.7) Unearned Lease Income 9.7 2009: May 15 Cash

25.8 Lease Income

25.8

Dec. 31 No entry needed. (Other series of entries for the above are possible.) In addition, the lessor depreciates the leased equipment under the operating lease scenario. The amount would depend on what the residual value would be at the end of the asset’s economic life. Solutions Manual-IFRS Primer-Chapter 24 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

(e)( i) Having an incremental borrowing rate of 12% does not affect any parts of (a) through (d). The incremental borrowing rate is only used by the lessee for calculating the PVMLP when the implied interest rate is unknown or cannot be reasonably determined. Since the implied interest rate is known, the IBR of 12% would not be used in this lease. (ii) If the residual amount is guaranteed by the Lessee Corp., this would affect the PVMLP, but would not change the type of lease treatment from either the perspective of the lessee or lessor. It would tend to reinforce the finance lease classification by the lessee. For part (c), finance lease, the PVMLP would go up to 98.9 (25.8 * 3.48685 + 13*0.68301 (PV of guaranteed residual)), resulting in an increased recognized leased asset and obligation of 98.9 (still lower than the FV). This would also increase each year’s interest expense which is based on the balance of the lease obligation. The depreciation charge on the lessee’s books would now be based on 98.9 - 13 = 85.9 spread over the four years. Under the operating lease for Lessee Corp., the guarantee of a residual value meets the definition of a financial liability that must be recognized and measured at fair value. As well, disclosure regarding this liability is required even if it is unlikely that any payments will have to be made. For (d), under the finance lease, the sales would go up to 98.9 and cost of goods sold would go up to 80, as the PV of the guaranteed residual is not deducted from these amounts. (iii) If the residual value is guaranteed by a party not related to the lessee, this does not affect the lease type or treatment by the lessee. With respect to the lessor for part (d) and assuming the guarantor is not related to the lessor, under the finance lease, the sales would go up to 98.9 and cost of goods sold would go up to 80, as the PV of the guaranteed residual is not being deducted. (iv) If the Lessee Corp. had an option to purchase the leased asset for $4 on May 14, 2012, this would be seen as a bargain purchase option (BPO) as its FV at that time is estimated to be $13. This condition leads to a clearer decision that this is a finance lease, but since other conditions already exist, this new information does not affect the type of lease. The same applies for the type of lease from the perspective of the lessor. For (c) the PVMLP would be increased to reflect the present value of the payment required to exercise the BPO (would increase to 25.8 * 3.48685 + 4 * 0.68301 which equals 92.7). This amount would be recognized as the leased asset and obligation. This increase also increases each year’s interest expense which is based on the balance of the lease obligation. The depreciation expense will now be based on 92.7 minus whatever the residual value is expected to be at the end of its 6 year economic life, depreciated over 6 years. For (d) the lessor includes the BPO in calculating the lease payments receivable amount and the present value of the BPO in determining the net investment in the lease and excludes the residual value numbers. This lease would not be classified as an operating lease. The sales and cost of goods sold amounts would not be reduced by the PV of the residual value. (v) In this case, the new information acts as additional support for classifying this lease as a finance lease for both the lessee and lessor. With respect to (c) and (d), there should be no Solutions Manual-IFRS Primer-Chapter 24 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

changes to the entries; this is due to the fact that at the end of the lease, the lessor is trying to sell the equipment to the lessee for its estimated residual value of 13, which appears to not be a bargain for the lessee. Therefore, it is not reasonably assured that the lessee would exercise this option, therefore not impacting any of the lease amounts for the lessee and lessor when compared to the entries in (c) and (d). 24-2 The following shows a decision chart to accompany IAS 17: SALE LEASEBACK (SELLER-LESSEE)

LEASEBACK IS AN OPERATING LEASE

LEASEBACK IS A FINANCE LEASE (1)

DEFER ANY PROFIT ON THE SALE AND AMORTIZE TO INCOME OVER TERM OF THE LEASE

SALE MADE AT FAIR VALUE: PROFIT OR LOSS IS RECOGNIZED IMMEDIATELY (2)

SALE AMOUNT LESS THAN FAIR VALUE: (3)

SALE AMOUNT GREATER THAN FAIR VALUE: THE EXCESS OVER FV IS DEFERRED AND AMORTIZED OVER THE PERIOD THE ASSET IS EXPECTED TO BE USED (4)

WITHOUT LOWER THAN FAIR VALUE LEASE PAYMENTS, LOSS IS RECOGNIZED IMMEDIATELY

IF FUTURE LEASE PAYMENTS ARE LOWER TO COMPENSATE FOR LOWER SELLING PRICE, LOSS IS DEFERRED AND AMORTIZED ON THE SAME BASIS AS THE LEASE PAYMENTS

Under situation 1, the treatment is reasonable as it is not appropriate to recognize a gain as a result of a financing transaction. Under situation 2, the treatment is reasonable as the risks and rewards have been transferred to the buyer-lessor and because the transaction is considered to be a normal sale. Under situation 3, the risks and rewards have been transferred. Recognizing the loss immediately is reasonable treatment when there is no future “compensation” for the lower than FV selling price. If the future lease payments are reduced to compensate for the lower than FV selling price it is reasonable to defer recognition of the loss as it will be recovered through the lower rental payments. Under situation 4, the excess over fair value is deferred and amortized over the period of asset use, which is fair treatment as it matches benefits with use. 24-3(a) Yearly rent expense: Total cost: $2 + $10/month for (48 – 4) months = $442 Solutions Manual-IFRS Primer-Chapter 24 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Recognize on a straight-line basis: $442 ÷ 4 years = $110.5 per year or $9.2 per month (b) Journal entries: Prepaid Rent 2 Cash

Months 1 and 2, same entry: Rent Expense 9.2 Prepaid Rent .8 Cash 10 The result is that the monthly rent expense of $9.2 is the expense for each and every month, including the last 4 months. The lease payments are recognized as rent expense over the term of the lease on a systematic basis that relates to the time pattern of the benefits received, usually on a straight-line basis. This principle is applied even if the lease payments themselves are not uniform amounts. In Jamal Corp.’s case, the pattern of benefits received is on a monthly basis. At the end of Month 44, the balance in the Prepaid Rent account is $2 + (44 × $0.8) = $37.2. There is no rent payable in months 45 to 48; therefore, the prepaid amount is recognized over the remaining months at $37.2 ÷ 4 = $9.3 per month (without the rounding error, this would be $9.2 per month, exactly as each and every other month in the lease). Entry for each of months 45, 46, 47, and 48: Rent Expense 9.3 Prepaid Rent 9.3 24-4(a) Lor Ltd’s entries: June 30, 2008: Lease Receivable 640 (6 payments*100 + 40 residual) COGS 450 Sales 524.50 Unearned Finance Income 115.50 Inventory 450 Cash

112 Lease Receivable Unearned Maintenance Fee

December 31, 2008: Unearned Finance Income Finance Income

100 12

17 ((net investment of 524.5 – 100 payment) * 8%) 17 (0.5 for half a year; assumes 8% return per annum)

Unearned Maintenance Fee 6 ($12 × 6/12) Maintenance expense 6 June 30, 2009: Cash 112 Lease Receivable Unearned Maintenance Fee

100 12

Assumption is that Lor prepares adjusting entries only at December 31 each year. Gross investment at December 31, 2008: =640 – 100 (payment) =540 Net investment at December 31, 2008: = gross investment less unearned finance income =540 – (115.5 -17) =540 – 98.5 =441.5 Profit or loss reported at year ended Dec 31, 2008: Gross profit on sale: 74.5 (524.5 - 450) Maintenance expense: 6 cr. against maintenance expense incurred Finance income: 17 (b) Lor Ltd’s entries: June 30, 2008: Lease Receivable 640 (6 payments *100 + 40 residual) COGS 425 (450 - PV of 40 unguaranteed residual) Sales 499.5 (524.5- PV of 40 unguaranteed residual) Unearned Finance Income 115.5 Inventory 450 All remaining entries are exactly the same as in part (a). The profit or loss recognized is exactly the same. To compare (a) and (b) with respect to guaranteed versus unguaranteed residuals, in terms of the lessor’s amounts and entries, only sales revenue and cost of goods sold are reported differently; therefore, gross investment, unearned finance income, and gross profit are unaffected. The difference comes from the fact that a guaranteed residual value can be considered part of sales revenue because the lessor knows that the entire amount will be realized. Conversely, there is less certainty that any unguaranteed residual will be realized. Therefore, sales and cost of goods sold are only recognized for the portion of the asset that is sure to be realized. However, the gross profit on sale is unaffected. Solutions Manual-IFRS Primer-Chapter 24 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

(c) Incremental initial direct costs incurred by Lor Ltd. (a dealer-lessor) to negotiate and arrange the lease are recognized as an expense in the period the sale is recognized. Therefore, it would expense the $10 of negotiating costs on June 30, 2008, and no further entries would need to be made. 24-5 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Classification of leases: Under IFRS, leases are classified as finance or operating leases based on whether the risks and rewards associated with ownership are transferred to the lessee. U.S. GAAP is similar except that it uses the term “capital” instead of finance lease, and lessors subclassify capital leases as salestype or direct financing. IAS 17 does not do this. The U.S. standard uses more specific rules and “bright-lines” rather than setting out principles as does IAS 17. Lease of land and building together: IAS 17 indicates that the land and building elements of a lease are considered separately for evaluating all indicators for the type of lease, unless the land value is immaterial. U.S. GAAP requires a lease for land and building that transfers ownership or contains a bargain purchase option to be classified as a capital lease, regardless of the relative value of the land. For evaluating other classification criteria, the land is considered separately only if the land at inception represents 25% or more of the total fair value of the lease. Sale and leaseback: Under IAS 17, a gain or loss on a sale and leaseback that is an operating leaseback is recognized immediately, subject to adjustment is the sales price differs from fair value. Under U.S. GAAP, if the seller gives up only a minor part of the right to use the asset, the gain or loss is deferred and amortized over the lease term. If more than a minor portion is given up, then part or all of the gain may be recognized depending on the amount relinquished.

Chapter 25 – Solutions 25-1(a) Short-Term Employee Benefits: Short-term employee benefits are benefits other than termination benefits that are due to be settled within 12 months after the end of the period in which the related service is rendered by the employee. Post-Employment Benefits: Post-employment benefit plans are formal or informal arrangements to provide employee benefits (other than termination benefits) after employment that cover retirement pension benefits and other benefits such as post-employment life insurance. Other Long-Term Benefits: These benefits are provided by entities and are not all due within a year after the end of the period in which employees earn them. Those that accrue with service such as long-term disability benefits paid 12 months or more after the period in which it was earned have characteristics similar to post-employment benefit plans. Termination Benefits: Termination benefits are employee benefits payable that result either from an entity’s decision to end an individual’s employment before the normal retirement date or an employee’s decision to accept voluntary termination in exchange for those benefits. Because there are no future benefits accruing to the entity from employee service after termination, the entire cost is expensed when the entity is committed to the plan as explained above. If termination benefits are due beyond 12 months from the balance sheet date, the entity discounts them using the same discount rate as determined for defined benefit post-employment plans. (b) When benefit obligations are met in the short term, the entity recognizes the undiscounted amount of benefits expected to be paid as a liability and an associated cost. If the benefit accrues with service, the expense and liability are accrued as well. If the benefit does not accrue, the liability and expense are both recognized in full when an obligating event occurs. Because the entity does not receive any benefit while the employee is on leave, the expense is recognized in full before the benefits are paid. Short term and termination benefits are recognized only when measurable. Longer-term benefits require the use of estimates, but this is preferable to not recognizing the expense and obligation as they accrue.

25-2 Pension worksheet: Employer Financial Statements Expense

Opening balance Past service costs Current service cost Interest expense Employer contributions Benefits paid Amortization of past service costs Expected return on assets Actuarial loss on DBO Actuarial loss on Plan Assets Subtotal Total

Cash

Pension Financial Statements

Defined benefit liability (16)

Plan assets 64

Defined Benefit Obligation (80) (8)

(9)

8.8

(8.8) (11)

Unrecognized Amounts in Employer F/S Past Unamortized service actuarial costs (gains)/losses

11 (4)

(5)

(6)

(1)

(4)

16.8

(11)

Supporting Calculation: Interest: Opening DBO 80 +PSC 8 88 *10% Interest cost = 8.8

(5.8) (21.8)

(102.8)

(past service costs are granted early in the year) . (discount rate)

(a) DBO and plan asset reconciliations are in the worksheet above (b) Pension benefit expense is $16.8 as determined in the above worksheet (c) Pension benefit liability: = (16) + expense of (16.8) – contribution of 11 = (21.8) as above

(d) An option available to the entity is to recognize all actuarial gains and losses in other comprehensive income in the period they occur and take them directly to retained earnings. This option does not impact any of the amounts in the worksheet above, except that the 5 of unamortized actuarial losses would be presented in OCI, instead of being off-balance sheet. (e) Adjusted pension worksheet: Employer Financial Statements Expense

Opening balance Past service costs Current service cost Interest expense Employer contributions Benefits paid Net return on plan assets Actuarial loss on DBO Subtotal Total

Cash

Defined benefit liability (16)

Pension Financial Statements Plan Defined assets benefit obligation 64 (80)

(8)

(9)

8.8

(8.8) (11)

11 (4) 2

(2) 1 24.8

(1) (11)

(13.8) (29.8)

(102.8)

Some of the tentative decisions of the Discussion Paper are the following: • All changes in the value of plan assets and the post-employment benefit obligation should be recognized when incurred (therefore, actuarial gains and losses and pasts service costs are all recognized immediately in expense). • There is no need to separate out the expected return on plan assets and recognize an actuarial gain or loss (in the spreadsheet, this is presented as net return on plan assets). • Unvested past service costs should be recognized immediately when a plan is amended. Impacts on (a) and (b): There would be no change to the total amounts of the plan asset or pension benefit obligation. There would be a change to pension expense due to the 5 of losses being recognized and the immediate recognition of past service costs; the expense would then be 24.8 instead of 16.8. In addition, the liability reported on the statement of financial position is equal to the funded status of the plan, i.e., 29.8 net obligation.

25-3 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Post Employment Benefit Plans: Multi-employer Plan With respect to a multi-employer plan that is a defined benefit plan, IFRS prescribes that this plan should be accounted for as a defined benefit plan if the required information is available (otherwise, as a defined contribution plan). U.S. GAAP, on the contrary, accounts for the plan as a defined contribution plan. Present Value of a Defined Benefit Obligation: With respect to the actuarial method used to determine the present value of an entity’s defined benefit obligation for a specific period, U.S. GAAP prescribes that different methods are required dependent on the characteristics of the benefit calculation of the plan. On the contrary, IFRS prescribes that the projected unit credit actuarial method is required an all cases as it sees each period of service as giving rise to an additional unit of benefit entitlement and measures each unit separately to build up the final obligation. Plan Assets: Under IFRS, plan assets are recognized at fair value at the balance sheet date. Under U.S. GAAP, defined benefit plan assets are valued at “market-related” value (either FV or a calculated value that smoothes the short-term effect of market fluctuations over five years) as of the B/S date. Actuarial Gains and Losses: With respect to recycling in profit or loss of actuarial gains and losses previously recognized in equity, under IFRS, this is not permitted. Under U.S. GAAP though, subsequently these amounts will be reclassified from other comprehensive income and recognized in profit or loss as components of net periodic benefit cost. Option to Recognize all Actuarial Gains and Losses in Other Comprehensive Income: With respect to recognizing actuarial gains and losses directly in equity when they arise, under IFRS, this is permitted, while under U.S. GAAP this is required. Past Service Costs: With regards to the recognition of past service cost related to benefits that have vested, IFRS prescribes that they be recognized immediately in expense and in the balance sheet account, while under U.S. GAAP, they are generally amortized to expense over the remaining service period or life expectancy. With respect to the presentation of past service costs under IFRS, they are presented as an offset or increase to the defined benefit obligation, while under U.S. GAAP, they are presented within other comprehensive income with unrecognized actuarial gains and losses. Recognition and Measurement: Defined Benefit Liability Under U.S. GAAP, effective for fiscal years ending after December 15, 2007, an entity must recognize in its balance sheet the over-/underfunded status as the difference between the fair Solutions Manual-IFRS Primer-Chapter 25 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

value of the plan assets and the benefit obligation (the PBO for pension plans). Under IFRS, an entity must recognize a liability in the balance sheet equal to the present value of the defined benefit obligation plus or minus any actuarial gains or losses not yet recognized, minus unrecognized prior service costs, minus the fair value of any plan assets. That is, some portion of the funded status remains off-balance sheet. Presentation of the Benefit Liability or Asset: Under U.S. GAAP, no portion of a plan asset can be classified as current, and the current portion of the net postretirement liability is the amount expected to be paid in the next 12 months. Under IFRS and IAS 19, balance sheet classification is not addressed. Recognition of Termination Benefits: With respect to termination benefits under IFRS, there is no distinction between “special” and other termination benefits. Termination benefits are recognized when the employer is demonstrably committed to pay. Conversely, U.S. GAAP recognizes special (one-time) termination benefits generally when they are communicated to employees unless employees will render service beyond a “minimum retention period”, in which case the liability is recognized ratably over the future service period. U.S. GAAP also recognizes contractual termination benefits when it is probable that employees will be entitled and the amount can be reasonably estimated and it recognizes voluntary termination benefits when the employee accepts the offer.

Chapter 26 – Solutions 26-1 The following indicates whether the event is or is not a related-party transaction. • Sold inventory to a subsidiary. This is a related-party transaction, as RL is related to the subsidiary through its control of the subsidiary. This transaction would be disclosed separately in the notes of RL and would be presented in the financials as revenue and cost of goods sold. •

Purchased land from the CEO’s wife. This is a related-party transaction since the wife is a close member of the family of the CEO and the CEO is a member of the key management personnel of RL. This transaction would be disclosed separately in the notes and would be included in the balance sheet and statement of cash flows (investing section).

•

Borrowed funds from the bank. This is not a related-party transaction, since none of the criteria as set out in IAS 24 has been met. The borrowed funds would be reflected in the financials as part of the cash account and loan payable (current or non-current presentation) that would be recognized.

•

Guaranteed loans for its subsidiary. This is a related-party transaction because RL and the subsidiary are related, as RL controls the subsidiary. This transaction would be disclosed separately for the subsidiary. Accounting for financial guarantees was covered in Chapter 18. Depending on the nature of the guarantee and the specific case facts, the guarantee may also be recognized in the financial statements.

•

Paid its top management salary and bonuses. This is a related-party transaction since top management includes the key management personnel who have the authority and responsibility for planning, directing, and controlling the activities of RL. This transaction is part of the required disclosures as set out in IAS 24.

•

Paid pension amounts to its former president. This is a not a related-party transaction since the former president is not currently part of the key management personnel of the entity and is thus not related anymore. This transaction would be represented in the financials by an expense and a payable recognition or cash reduction. If the former president was also a shareholder then, depending on the percentage of shares owned, this might qualify as a related-party transaction.

26-2 The following describes the pros and cons of GAAP and IFRS approaches to related-party transactions. U.S. GAAP Approach: Pros: • Provides guidance on measurement, so that entities can accurately present the impacts of related-party transactions in the financial statements, leading to transparent financial statements for users Solutions Manual-IFRS Primer-Chapter 26 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

• •

Sets out criteria and guidance so that entities will have multiple options for remeasurement based on their specific situation Increased comparability between entities, as there is less judgment involved and less variability in the remeasurement options used

Cons: • Lack of flexibility in measurement options if, for example, only three are available and the default category does not reflect the economic substance/reality of the entity’s specific transaction(s) IFRS Approach: Pros: • Extensive disclosure requirements, which help users to understand the impact that the related-party transactions have on the company’s performance and financial position • Movement toward more transparent reports (at least with respect to the notes section) • Allows for flexibility of measurement options, as the standard does not prescribe specific conditions or criteria Cons: • Does not provide measurement or recognition criteria, which is essentially lack of support to entities following this standard • Does not provide guidance on any resulting gains or losses from related-party transactions • Results in increased judgment and responsibility for those preparing the financial statements, as they will have to decide on how to account for a related-party transaction; each entity could have a different approach/option that is used 26-3 In this scenario, A Limited entered into a joint venture agreement with B Limited. Together, they formed AB Inc., an entity that will be jointly controlled by A and B. A and B are thus venturers that jointly control AB. Since A has joint control over AB, A and AB are related. Similarly, B has joint control over AB, and thus B and AB are related parties. Although both of these relationships exist in this joint venture, A and B are not otherwise related parties as their relationship does not meet the criteria set out in IAS 24. 26-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Management Compensation: Under U.S. GAAP, an entity is not required to disclose the compensation of key management personnel, although under IFRS, this compensation must be disclosed. The disclosure requirements under IFRS are similar to those required under SEC.

Chapter 27 – Solutions 27-1 If EPS calculations were based on comprehensive income, this may alter the EPS figures reported. Comprehensive income includes all changes in equity during a period except for the changes that result from investments by owners and distributions to owners. It therefore includes all revenues, gains, expenses, and losses reported in net income and, in addition, gains and losses that bypass net income but affect shareholders’ equity. These items that bypass the income statement are recorded in other comprehensive income. Comprehensive income is equal to net income plus other comprehensive income. This alternative would be all-encompassing as comprehensive income may eventually be recognized as the true bottom line on the income statement. Although this would be the “true” EPS number, it may not represent the actual profit or loss attributable to ordinary equity holders; the number may be skewed due to various items in OCI, such as unrealized holding gains and losses on certain securities. Unrealized amounts, for example, do not represent profit available to the shareholders; an unrealized gain that inflates OCI is not accessible by the ordinary shareholders and could not be used in dividend decisions. Using comprehensive income may in fact skew the reliable information that financial statements try and present, thus impacting investment decisions. 27-2 The calculation of the weighted average number of common shares is as follows: 1000 shares * 12/12 = 1000

(ordinary shares as of the start of the year)

100 shares * 6/12

= 50

15 shares * 3/12

= (3.75)

(shares issued in business combination are assumed to be issued on the acquisition date, i.e., June 30). (retired shares as of September 30)

= 1046.25 shares Note: Contingently issuable shares are not included here as all conditions are not met (i.e., sustained earning levels over a 2 year period haven’t been reached). 27-3 The calculation of BEPS and DEPS is as follows: Notes: • • • • • •

Profits = 10,000 1100 of cumulative dividends for the preferred shares that was not declared is deducted from earnings, as they are owed regardless. Non-cumulative dividends of 700 that are declared are not included in the EPS calculation as they relate to a financial liability and not a non-cumulative preferred share. Purchased put options are not included as they are “in the money” (EPSL can sell shares at $12 when worth $10) and anti-dilutive, The issued call options need to be included in DEPS since they are “in the money” to the holder (holder can buy for $7 and worth $10). The convertible debt needs to be analyzed once BEPS is calculated. Solutions Manual-IFRS Primer-Chapter 27 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

BEPS: = 10,000- 1,100 / 1046.25 shares = 8.51 DEPS: 1. Identify potential ordinary shares • Convertible debt • Written call options • Contingently issuable shares 2. Assume that all potential ordinary shares will be converted/exercised at the beginning of the period 3. Calculate the incremental impact of conversion/exercise • Convertible debt: $1000 avoided interest divided by 150 ordinary shares = 6.67 and therefore potentially dilutive since it is less than BEPS • Options: $0 impact on numerator divided by 100 additional shares = dilutive • With the calls, the shares added to the denominator = cash from the exercise of the options divided by the share’s market price, as it is assumed that the cash is used to buy back shares in the open market to reduce the dilutive impact of the exercise • Contingently issuable shares dilutive - 0 impact on numerator and increase denominator by 10. Even though the contingency period is still outstanding, the test was met as at year-end so include in calculation. 4. Rank from most dilutive to least dilutive • Options are most dilutive, contingently issuable shares are next and then the convertible debt is least dilutive 5. Calculate interim DEPS

BEPS Options Subtotal Contingently issuable shares Convertible debt Subtotal

Income available to ordinary shareholders $8900 0 8900

Weighted average ordinary shares

EPS

1046.25 100 1146.25

$8.39 7.76

8900 1000 9900

1156.25 150 1306.25

7.70 7.58

6. DEPS should be the lowest number if profits exist. Therefore, DEPS = $7.58. Solutions Manual-IFRS Primer-Chapter 27 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

27-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Calculation of year-to-date (YTD) diluted EPS: Under IFRS, an entity would apply the treasury stock method on a YTD basis, that is, do not average the individual interim period calculations. Under U.S. GAAP, an entity would average the individual interim period incremental shares. Contracts that may be settled in ordinary shares or cash: With respect to contracts that may be settled in ordinary shares or in cash, at the issuer’s option, IFRS assumes always that the contracts will be settled in shares. Under U.S. GAAP, there is a presumption that such contracts will be settled in shares unless evidence is provided to the contrary. Presentation: With respect to the disclosures of earnings per share (EPS), under IFRS, an entity would disclose basic and diluted income from continuing operations per share and net profit or loss per share. Under U.S. GAAP, an entity would disclose basic and diluted income from continuing operations, discontinued operations, extraordinary items, cumulative effect of a change in accounting policy, and net profit or loss per share.

Chapter 28 – Solutions 28-1 The following examines both the discrete and integral approaches for dealing with interim financial reporting. Discrete approach: • Effectively deals with revenues received that are of a cyclical, seasonal or occasional nature • Effectively deals with costs that are uneven throughout the fiscal year • Supports many of the transactions and entries incurred by an entity such as provisions or bonuses • Presents financials that are accurate and reliable based on the fact that the assets, liabilities, income and expenses meet the definitions set out in various IFRS as at the end of the interim period Integral approach: • Each period is not treated as distinct or self-standing, but as a part of the larger timeframe; therefore, financial reporting can be seen as more of a continuous process • Leads to more comparable statements as it prepared in the same manner as the annual report and because each period is not isolated • Effectively deals with employer taxes and taxes that are based on a 12-month period • Provide support for continual revision of year-to-date estimates The IFRS takes the discrete approach with regards to interim financial reporting, with some exceptions, in which the integral approach is used. The discrete approach is taken because it reflects the reality of the business and its elements. Financial statement items such as revenues are only recognized when they occur or are earned, and costs that do not meet the definition of an asset are not treated as such in the interim period. This approach accurately and reliably reflects items that are true and that meet the definitions set out in IFRS; for example, an asset reported is an actual asset, and not just a cost that was improperly capitalized. Although the discrete approach is the dominant approach, the integral view is effective with large business elements and transactions, such as taxes and year-to-date estimates. 28-2 In the first scenario, the lawsuits are examples of contingent liabilities. There are two issues here: Firstly, do the lawsuits meet the definition of a contingent liability as at the end of the interim period as only information at that date is used to make the decision; this is complicated by the fact that Interim Inc. has not discussed the status with its lawyers (the lawyers will be able to clarify whether these lawsuits are likely and measureable). Secondly, are the legal papers acceptable evidence for interim reporting and are they comprehensive enough to be used in creating a reasonable estimate of the legal liability; the lack of legal consultation, which is the best evidence for support of estimates, could lead to irrelevant or unreliable estimates in the interim financial statements. Solutions Manual-IFRS Primer-Chapter 28 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

In the second scenario regarding a pension plan, the issue surrounds estimates used in the interim financial statements. In order to be reliable and relevant, the estimates surrounding the pension obligation should be supported by the best evidence; in this case, it would be measured by an actuary. What complicates the estimate is that an actuarial evaluation has taken place 6 months prior; therefore, acceptable evidence required for interim reporting would be an extrapolation of the prior year end valuation. In the third scenario, a planned overhaul transaction is expected in the third quarter. Under the discrete approach, the accounting treatment is as follows: do not accrue unless a legal or constructive obligation exists. Since a contract has not been signed with the external engineers, no liability or cost will be reported in the interim financials. 28-3 In preparing its first quarter financials, Green and Green Accountants must determine which approach they are following: discrete, integral or a combination of the two. If the discrete approach is being followed according to IAS 34, no smoothing of costs is allowed, and the entity would only recognize the training costs incurred in the first quarter. If the integral approach is taken and the first quarter is seen as part of the annual period, it might make sense to allocate costs to each period, as they would benefit from the training in future quarters. Since IFRS supports the view that each period is viewed as a discrete period with some exceptions, Green and Green Accountants should follow the discrete approach as prescribed in IAS 34. Regardless of the approach taken, training costs are recognized when incurred, which is in the first quarter of the fiscal year. 28-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Same Accounting Policies as Annual: With respect to interim reporting – revenue and expense recognition, IFRS views the interim period as a discrete reporting period (with certain exceptions), while U.S. GAAP views the interim period as an integral part of an annual period (with certain exceptions).

Chapter 29 – Solutions 29-1 The following lists some of the arguments for and against full recognition (based on the IFRS 2 Basis for Conclusion document). Arguments for non-recognition: • No cash impact • Not a real expense as no cash outlay as noted above and no cost to the entity • More like an opportunity cost • Difficult to measure • Entity is not party to the transaction • Employees do not provide service • Inconsistent with the definition of expense • EPS is hit twice • Adverse economic consequences • Other Arguments for recognition • In substance a form of compensation or remuneration • Based on economic substance (not legal form) • Measurable using finance tools such as options pricing and other models which have become more generally accepted • Other 29-2 The following discusses the various measurement options, including which are the primary and which are the default ones. Equity-Settled Share-Based Payment Transactions: The transaction is primarily measured at the fair value of the goods or services received. If the fair value cannot be reliably measured, then the default measurement would be the fair value of the equity instrument. Since there is a rebuttable presumption that the fair value of the goods and services may be reliably measured, in most cases, the fair value of the equity instruments would not be used. Using the fair value of the equity instrument does have merit in situations where the transaction involves employees rendering services, as it may be too difficult to measure the services; this is true if the equity instruments are given to the employee as part of the compensation package for services normally rendered as an employee. Cash-Settled Share-Based Payment Transactions: In a transaction that will eventually be settled in cash, a liability is recognized and the transaction is measured at the fair value of the liability at the measurement date (grant date or the date that the entity receives the goods/services). For transactions involving options/share appreciation rights (SARs), the fair value of the liability is measured at the fair value of the options/SAR. Share-Based Payment Transactions with Cash Alternatives: Where there is a choice (at the option of the entity or counterparty) to settle transactions in either cash or equity, the type of instrument must first be determined and then the measurement options Solutions Manual-IFRS Primer-Chapter 29 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

would follow. If a liability exists, the instrument would be valued at the fair value of the liability. If there is no liability, the equity-settled options would be applicable, and the primary option would be the fair value of the good/services unless it is not reliably estimable, in which case the fair value of the equity instrument would be the default option. A compound instrument would be bifurcated with the liability portion being measured/allocated first. For transactions where the fair value is based on the equity instrument, fair values would be based on market values. If these are not available, valuation techniques would be used (using as much market-based inputs as possible). Finally, if fair value is not determinable, the intrinsic value would be used. 29-3 With respect to SARs, the rights allow the employee to be paid the excess of the market value of a share over a certain base price, and the excess may be paid in cash or in shares. The accounting, as prescribed under IFRS 2, may be inconsistent with IAS 32 in cases where the SAR may be settled in shares (according to the terms of the SAR). Under IFRS 2, if the SAR is to be settled with shares, it is accounted for as equity and is categorized as an equity-settled share-based transaction (whether the number of shares is fixed or variable). As an equity-settled share-based transaction, the SAR would be accounted for under IFRS 2 as follows: • Measured at the fair value of the SAR at the grant date, • Credited to equity, and • Not subsequently remeasured after vesting date. Conversely, under IAS 32, if the number of shares is variable, the instrument would be accounted for at least partially as a liability. Even though the amount can be repaid with shares, the number of shares varies, depending on the amount owed and the share value. The entity is therefore locked into repaying a certain value and this is a liability. The difference exists mainly due to the classification debate of debt versus equity. IFRS 2 prescribes that the settlement in shares is classified as equity, while IAS 32 would classify this transaction as a liability based on the fact that the entity owes a certain amount that is to be paid with a variable number of shares based on fluctuating share values. In this case, the difference should be allowed to remain and each IAS/IFRS should have priority over one another based on the type of transaction. For example, in this scenario we are dealing with share-based payments, and thus an entity should look to the guidance of IFRS 2, not IAS 32. If this scenario was dealing with recognizing financial instruments, an entity would look to IAS 32. The IASB concluded that this was part of the larger issue of defining liabilities versus equities and would be studied further with the project on financial instruments. 29-4 The journal entries for year 1 are as follows. Plan 1: Stock Options Dr. Expense 20 Cr. Equity – stock options

At the end of the first year, Hannibal Limited would recognize only an expense of $20 ($60 fair value/3 years since the instruments vest over three years). The transaction is measured based on the fair value of the options at the grant date. Subsequently, the entity may adjust the numbers but only for forfeitures (number of share/options). At the end of three years, the transaction reflects only the number of instruments actually issued/settled. For instance, at the end of year 2, if Hannibal assumes that only 80% of the employees will stay, the expense in the second year will be $60 * 80% * 2/3 years = 32. Since it has already recognized $20, it would recognize only $12 as expense in year 2.

Plan 2: SARs At the end of the year, the SARs are measured at the fair value of the SAR, i.e., $2000. Since the SARs vest over five years, only one-fifth would be booked. The following entry would be booked at the grant date: Dr. Expense 400 Cr. Liability

400

At the end of subsequent years, the liability would continue to be remeasured to reflect the fair value of the SARs, and the difference would be expensed over the remaining period of four years. 29-5: Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Objective and scope: Under U.S. GAAP, the determination of whether the counterparty is an employee or a shareholder depends on whether certain criteria are met per AICPA Accounting Interpretation 1 of Opinion 25. Equity-settled share-based payment transactions: Under IFRS, the fair value of a transaction should be based on the value of the goods or services received, and only on the fair value of the equity instruments if the fair value of the goods and services cannot be reliably determined. Under U.S. GAAP, either the fair value of (1) the goods or services received, or (2) the equity instruments, is used to value the transaction, based on whichever is more reliable. Determining the fair value of equity instruments granted (2): First, with regards to the date for measuring share-based payments to non-employees, IFRS prescribes that the measurement date is the date the entity obtains the goods or the counterparty renders the services and there is no performance commitment concept. Conversely, U.S. GAAP uses the earlier of counterparty's commitment to perform (where a sufficiently large disincentive for nonperformance exists) or actual performance.

Second, IFRS requires consideration of volatility in measuring stock compensation even for shares that are not traded. U.S. GAAP allows the option to exclude if not measurable. Treatment of vesting condition: With respect to share-based payments with graded vesting features, under IFRS, the charge is recognized on an accelerated basis to reflect the vesting as it occurs. Under U.S. GAAP, an accounting policy choice exists for awards with a service condition only to either: (a) amortize the entire grant on a straight-line basis over the longest vesting period, or (b) recognize a charge similar to IFRS. Modifications to the terms and conditions: With respect to modification of an award by change in performance condition (improbable to probable), under IFRS, an expense is determined based on the grant date fair value. Under U.S. GAAP, the expense determined is based on fair value at the modification date. Cash-settled share-based payment transactions: With respect to the balance sheet classification of share-based payment arrangements, IFRS focuses on whether the award can be cash-settled, while U.S. GAAP has more detailed requirements that may result in more share-based arrangements being classified as liabilities. Share-based payment transactions in which the terms of the agreement provide the counterparty with a choice of settlement: With respect to equity repurchase features at employee’s election, IFRS prescribes that the liability classification is required. Conversely, U.S. GAAP does not require the liability classification if the employee bears the risks and rewards of equity ownership for at least six months from the date the equity is issued or vests.

Chapter 30 – Solutions 30-1 DL should account for its investment in Company A by using the equity method. This method should be used as DL appears to have significant influence over A; the ability to significantly influence the strategic decisions of A without control is illustrated by the fact that DL has two top executives on A’s board of directors, and the relationship established between the two companies when DL helped A through cash flow problems associated with a recent expansion. DL is required to clearly demonstrate that significant influence exists because its equity interest is less than 20%. For its investment in Company B, DL should use the equity method only if it does, in fact, have the power to take part in the financial and operating policy decisions of Company B. While DL does have a 40% equity interest, the remaining 60% is owned by a single shareholder on whom Company B’s board and management are probably very dependent. DL may, in fact, have no influence at all. More information is needed about the decision-making at Company B before the appropriate method of accounting can be determined. Again, if it is determined that significant influence does not exist, DL is required to demonstrate why this is so. Finally, with the information provided, it appears that DL probably exerts significant influence over Company C. It holds between 20% and 50% of C’s equity interest (voting power) and the remaining shareholders have not combined to control or otherwise influence C’s board. Additional information may be necessary to ensure this is the case. 30-2(a) The following shows a T account of LC’s investment in Gnome Ltd., at year-end, December 31, 2008. Investment in Gnome Ltd. (associate) Dr.

100

Dr.

Cr.

Balance of 105 **See entries below: Entries at acquisition: Investment in associate- Gnome Ltd. 100 Cash

100

This 100 investment carrying amount is composed of three amounts: 1. 25% of the associate’s net book value (75) 2. 25% of the associates fair value differences (25% * (land of 12 + patent of 60) =18) 3. Goodwill of 7 (100 - 75 – 18)

Entries made throughout the year: Investment in associate 10 (40 profit * 25% share that LC is entitled to) Investment income 10 Investment income 3* Investment in associate 3 * To amortize the fair value differences that exist as the underlying assets are realized. $60 patent/ 5 year useful life = $12 of amortization x 25% share.

Cash

4 (25% share of Gnome’s declared and paid dividend) Investment in associate 4

Investment in associate 2* Other comprehensive income 2 * 25% * 8 of unrealized holding gain reported in OCI. To the extent that Gnome recognizes changes in its net assets through OCI, LC also adjusts the investment account and its OCI for its 25% share.

(b) Referring to the above entries, the investment income that LC reports in profit or loss for 2008 is $7 (i.e., 10 - 3). This amount consists of a 25% stake in Gnome Ltd.’s profits and an amortization amount in respect of fair value differences (as the fair value of the net identifiable assets differs from their carrying amounts in Gnome’s accounts). (c) The balance in the investment account of 105 represents four amounts: (1) 25% of Gnome’s book value/carrying amount of its net assets: 25% * (300 + 40 + 8 – 16)

= 83

(2) 25% of the land’s unrealized fair value difference: 25% * 12

= 3

(3) 25% of the patent’s unrealized fair value difference: 25% * (60 – 12)

= 12

(4) LC’s share of Gnome’s unrecorded goodwill

= 7 105

30-3 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Significant Influence: Under U.S. GAAP, FAS 159 gives entities the option to account for their equity method investments at fair value. When the fair value option is not elected for use, the equity method of accounting is required. Conversely, IAS 18 requires investors to use the equity method of accounting for investments in associates. The only exception allowed is that when separate financial statements are presented by a parent or investor, investments in associates can be accounted for at either cost or fair value.

Application of the Equity Method: After Acquisition: Different reporting dates of the investor and associate: Under U.S. GAAP, the reporting date difference generally should not be more than three months. As well, the entity must disclose effects of any significant intervening transactions, and may adjust for such transactions. Conversely, IFRS requires that the associate’s financial statements used must be dated no more than three months from the investor’s reporting date, and they are adjusted for significant transactions and events that occurred in the intervening period before the equity method is applied. Different accounting policies of the investor and associate: Under U.S. GAAP, the SEC staff does not require the policies to be conformed provided that policies are in accordance with U.S. GAAP. In contrast, IFRS requires that the associate’s accounting policies for similar transactions and events be the same as those of the investor. Otherwise, the associate’s policies are conformed to the investor’s policies before its financial statements are used in applying the equity method.

Chapter 31 – Solutions 31-1(a) Option1: In this option Hype Ltd. would now have 60 shares outstanding, 40 of which are owned by its original shareholders and 20 of which are held by Tense Ltd.’s original shareholders. Since Hype Ltd. has a majority of the shares outstanding, it can elect the majority of the members of its board of directors, thus being identified as the acquirer. Option 2: Under Option 2, the combined net assets of both Hype Ltd. and Tense Ltd. are owned by a new entity, HT Corp. While HT Corp. is the legal acquirer, HT Corp. is not the acquirer under IFRS 3. HT has 45 shares outstanding, 30 (67%) of which are held by Hype shareholders (either indirectly through their ownership of Hype or directly if Hype distributes its shares of HT to Hype Ltd. shareholders) and 15 (33%) of which are held by the original Tense shareholders. The original Hype shareholders as a group control the combined assets and therefore Hype Ltd. is the acquirer for accounting purposes. (b) It is essential that an acquirer be identified in order to account for each business combination, so that the acquisition method is correctly applied. Specifically, the acquirer’s net assets, except for the new investment, continue to be accounted for at their existing carrying amounts, whereas the net assets of the acquired company are remeasured to and reported at their fair values at the acquisition date. Identifying the correct acquirer ensures that the net assets of the appropriate party to the combination are remeasured. (c) Goodwill - Option 1: $1500 Fair value of consideration transferred (20 new shares issued * 250 average market price) Less: fair value of the net identifiable assets (400 + 3400 - 300)

5,000 3,500 1,500

Goodwill - Option 2: $1500 Fair value of consideration transferred (FV of HT Corp. shares is not determinable; use FV of shares received, i.e., 40 shares @ $125)

Less: fair value of the net identifiable assets (400 + 3400 – 300)

5,000 3,500 1,500

31-2 Hype acquires 60% of Tense’s 40 shares (i.e., 24 shares) by issuing 12 new shares worth 3000 ($250*12 shares). Tense shares not acquired = 16, worth 2000 (16 shares*$125). Goodwill calculations for Option 1: i) If non-controlling interest is measured at fair value: Fair value of consideration transferred 3000 + fair value of non-controlling interest 2000 - fair value of the identifiable net assets (3500) Goodwill 1500

ii) If non-controlling interest is measured at its proportionate share of the fair value of only the net identifiable assets: Fair value of consideration transferred 3000 + non-controlling interest (40% * 3500) 1400 - fair value of the identifiable net assets (3500) Goodwill 900 31-3 Definitions of the following terms are provided as follows: (a) Reverse acquisition: When identifying an acquirer in a business combination when shares are exchanged, the acquirer is usually the entity that issues its equity interests, but sometimes so many new shares are issued for the business acquired that control of the combined assets ends up with the shareholders of the entity “acquired.” (b) Goodwill: In general, it is excess of the fair value of an entity over the fair value of its identifiable net assets. (c) Control: The power of an investor to govern the financial and operating policies of an investee and through this obtain benefits from the investee’s activities. (d) Identifiable net assets: The net assets (i.e., assets less liabilities) that have a separate and identifiable value that can be recognized for accounting purposes. Alternatively, they are all the assets less liabilities except for goodwill. 31-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Combinations of entities under common control: This topic is outside the scope of IFRS 3. Under U.S. GAAP, a method similar to the pooling of interests method is required. That is, the receiving entity accounts for common control transactions based on the carrying amounts in the consolidated financial statements of the parent at the date of the transfer and comparative financial statements are revised. Identifying the acquirer: Although both IFRS and U.S. GAAP identify an acquirer based on control, they are not harmonized on what constitutes “control.” The IFRS is based on the concept of the power to control and considers potential voting rights and the notion of “de facto control.” Under U.S. GAAP, the focus is on controlling financial interests and potential voting rights are not considered. Recognition and measurement of identifiable assets, liabilities, and non-controlling interest: IFRS 3 requires the acquirer to recognize all of the acquiree’s identifiable assets, liabilities, and contingent liabilities at their fair values at the acquisition date. As well, a choice is permitted by the IFRS for the measurement of any non-controlling interest in the acquiree; it is measured at either its fair value including its share of goodwill or at its proportionate share of the fair value of the acquiree’s identifiable net assets (excluding goodwill). Under the new U.S. GAAP for converged standards, non-controlling interest is measured at fair value, including goodwill. The choice permitted by the IFRS is not reflected in the U.S. standards.

Non-controlling interest: See above under “Recognition and measurement of identifiable assets, liabilities, and noncontrolling interest.”

Chapter 32 – Solutions 32-1 In this scenario, Bay Company is the parent of Chase Company, as it controls this other entity. This is based on the fact that Bay owns 75% of the voting shares of Chase and thus can govern Chase’s financial and operating policies and, through this, is able to obtain benefits from its activities. Chase is the subsidiary in this scenario, as it is an entity controlled by the parent Bay. 32-2 From the information provided, the following are some of the major adjustments and eliminations that appear to be required: - Investment in bonds and Bonds payable - Interest income and Interest expense - Rental income and Rental expense - Management fee income and Management fee expense - Sales and Cost of sales (intercompany sales and purchases) - Intercompany unrealized profits remaining in Shove’s inventory and related inventory amounts in cost of sales - Dividends receivable and Dividends payable - Investment income (or Dividend income) - Recognition of any fair value differences and goodwill - Amortization/depreciation/elimination of any fair value differences realized; goodwill impaired Further, the carrying amount of Push’s investment in Shove is eliminated, as is Push’s portion of the equity accounts of Shove. The interest of the non-controlling shareholders in Shove’s profit and other items of comprehensive income is determined, i.e., the other 35% stake in Shove. The interest of the non-controlling shareholders in Shove’s net assets is determined. This amount is based on the fair value of the non-controlling interest established when Shove was acquired, adjusted for its share of the changes in equity since acquisition. 32-3 Group Consolidated Statement of Comprehensive Income Year ended December 31, 2008 Group Profits before adjustments: Adjustments: Less: Dividend recognized in investment income (0.8 * $10 dividend) Less: Amortization of fair value differences assigned to building Group Profit Other Comprehensive Income Comprehensive Income

150 8 2

(10) 140 5 145

Profit attributable To Prompt Co. shareholders: 100 + 80% (50) – 80% (10) – 80% (2) To non-controlling interest: 20% (50) – 20% (2)

Comprehensive income attributable To Prompt Co. shareholders: 130.4 + 80% (5) To non-controlling interest: 9.6 + 20% (5)

130.4 9.6 140.0

134.4 10.6 145.0

32-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Who Presents Consolidated Financial Statements: Under U.S. GAAP, the preparation of consolidated financial statements is required by all parent entities, while under IFRS this is generally required, but there is a limited exemption; a parent is excluded from this requirement only if all of the following conditions are met: i) it is a wholly owned subsidiary or a partially owned subsidiary of another entity whose other owners have been informed and do not object to the non-consolidation, ii) it does not have and is not in the process of having any debt or equity instruments that are publicly traded, and iii) its ultimate or an intermediate parent prepares consolidated financial statements for public use that comply with IFRSs. Consolidation Procedures: Under IFRS, all entities being consolidated must apply the same accounting policies before being consolidated, or their policies would have to be conformed. Under U.S. GAAP, an exception is permitted for subsidiaries in a specialized industry. They are permitted to retain their specialized accounting policies in consolidation. With respect to different reporting dates of the parent and subsidiaries, both IFRS and U.S. GAAP require that the reporting date of the parent and subsidiary cannot be more than three months. However, under IFRS, the effects of significant events occurring between the reporting dates are adjusted for in the financial statements, whereas under U.S. GAAP, the parent must disclose the effects of any significant intervening transactions (the parent may adjust for such transactions).

Chapter 33 – Solutions 33-1(a) The following lists the strengths and weaknesses of the proportionate consolidation and equity methods: Strengths of the proportionate consolidation method: • Reflects the “substance and economic reality of a venturer’s interest in a jointly controlled entity” • Reflects the “control over the venturer’s share of the future economic benefits” • Reports the type of assets and liabilities and the extent of the risks the venturer has taken on in its ownership of the jointly controlled entity, thereby providing useful information to financial statement readers Weaknesses of the proportionate consolidation method: • Adds together jointly controlled assets and liabilities with elements that are under the direct control of the venturer’s management • Assets are defined as economic resources controlled by the entity – the assets reported are not controlled by the venturer Strengths of the equity method: • Supports the belief that joint control is more similar to having significant influence than having control • Ease of accounting particularly about the issue whether an entity has the legal rights to offset assets and liabilities Weaknesses of the equity method: • Lack of transparency, as the investment reported in the statements does not tell the user the type of assets and liabilities and the extent of the risks the venturer has taken on in its ownership of the jointly controlled entity • The extent of liabilities is not reported (due to netting against assets). An investment account may have a balance of $100, but a situation where this is represented by A of $200 and L of $100 is very different from one in which there are A of $101 and L of $1 as far as relative risk is concerned. (b) The Exposure Draft ED 9 Joint Arrangements will correct the weakness of the proportionate consolidation method mentioned above, as the proportionate consolidation method would not be an acceptable accounting method for interests in a joint venture. Instead, the equity method will be applied, along with considerable disclosure about the extent of assets and liabilities of an entity’s joint ventures, also correcting a weakness of the equity method. 33-2 In an investment in a jointly controlled operation, instead of setting up a separate entity to conduct joint activities, a venturer may enter into an agreement with one or more venturers to produce, market, and distribute a specific product. Since this form attempts to take advantage of the resources and abilities of the individual venturers, they may agree to use their own assets, incur their own expenses and liabilities, etc. The joint venture agreement sets out how the revenue from the sale of the product worked on together is shared and how any shareable costs

are allocated to the venturers. Additionally, the venturer does not have to prepare any investment-related adjustments. Similarly, in an investment in jointly controlled assets, no legal or other entity is formed separately from the venturers themselves. Under this form of joint venture, each venturer has control over its share of future economic benefits through its share of the asset. Therefore, each party to the agreement takes a share of the output from the asset and pays an agreed share of the costs incurred to operate it. The accounting for this form of joint venture is similar to that of a jointly controlled operation; the assets and liabilities are reported separately on the statement of financial position according to their nature, not as an investment, and the income from the asset and expenses incurred are reported on the operating statement. Unlike a joint venture that is a jointly controlled operation or assets, a jointly controlled entity controls the assets of the joint venture, incurs the liabilities and expenses, and earns income. Each venturer usually has an ownership interest in the venture and is entitled to a share of its profits or output. When the jointly controlled entity is organized, the individual venturers contribute cash or other assets in return for an ownership interest. These contributions are recognized in each venturer’s accounting records as an investment in the joint venture; this investment is accounted for using either of the equity or proportionate consolidation methods, which is not required when accounting for an interest in a jointly controlled operation or asset. An investor in a joint venture: Is a party to the venture but does not have joint control. If an investor has an equity interest in a joint venture but it not a party to the joint control agreement, the investor applies the equity method prescribed in IAS 28 Investments in Associates assuming it has significant influence in the joint venture. Otherwise, it applies IAS 39 Financial Instruments: Recognition and Measurement. 33-3(a) ABC Joint Venture’s ownership is as follows: Able’s ownership (equity) interest in ABC Joint Venture is 25%. (Cost of $500 = $20 for 1% * 25%) Bain’s ownership (equity) interest in ABC Joint Venture is 15%. (Cost of $300 = $20 for 1% * 15%) Cohn’s ownership (equity) interest in ABC Joint Venture is 60%. (Cost of $1200 = $20 for 1% * 60%) With respect to control of ABC, each party has 1/3 control as prescribed in the joint control arrangement, assuming that this arrangement is contractual. This means that regardless of actual ownership rights, the strategic financial and operating decisions, by contract, require unanimous consent of the venturers. Otherwise, if the arrangement is not contractual, Cohn would have control of ABC based on its 60% voting power.

(b) Equity Method: ABC’s profit recognized by each venturer is as follows: Able: $40 Bain: $24.6 Cohn: $76.8 Supporting calculations: Unrealized Inventory Profit of A- 100 × 40% = $40 B- 90 × 40% = $36 C- 180 × 40% = $72

Company to Eliminate

Gross Profit to Eliminate

25% 15% 60%

10 5.4 43.2

Able: 25% * 200 profit of ABC Less: unrealized profit to eliminate Profit to recognize

50 10 40

15% * 200 profit of ABC Less: unrealized profit to eliminate Profit to recognize

30.0 5.4 24.6

60% * 200 profit of ABC Less: unrealized profit to eliminate Profit to recognize

120.0 43.2 76.8

Bain:

Cohn:

Note: Dividends are not included in these calculations using the equity method, as they require just an adjustment to the investment account and do not impact investment income. Proportionate Consolidation: Because the standard dealing with transactions between a venturer and a joint venture can be applied using either proportionate consolidation or the equity method, the amount of the eliminations will be identical, as will the amount of profit or loss recognized by the venturer. (c) The equity basis T account of Cohn’s investment is as follows: Investment in ABC Joint Venture Dr 1200 Dr 120 Cr 43.2 Cr 30 Balance $1,246.8 Dr

Supporting entries for Year 1: Dr. Investment in ABC Joint Venture 1200 ($20 per 1% interest * 60% interest) Cr. Cash 1200 To account for the initial investment in ABC. Dr. Investment in ABC Joint Venture 120 (60% share * $200 profit) Cr. Investment income 120 To account for Cohn’s share of ABC‘s profits. Dr. Investment income 43.2 Cr. Investment in ABC Joint Venture 43.2 To adjust the investment account for the inventory that remains in Cohn’s assets, as Cohn must sell the inventory to an independent party to recognize its share of the profit. Dr. Cash 30 (60% share * $50 dividend paid) Cr. Investment in ABC Joint Venture 30 To account for Cohn’s share of the dividend paid by ABC. 33-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Financial Statements of a Venturer: IFRS provides venturers with a choice of methods to account for their investment in a jointly controlled entity. A joint venturer is required to apply proportionate consolidation or the equity method of accounting for its investment in a jointly controlled entity unless it is exempt from having to use these methods. Conversely, investments in joint ventures are generally accounted for using the equity method (except in construction, oil, and gas industries) as prescribed under U.S. GAAP.

Chapter 34 – Solutions 34-1 Segmented information that is presented using a different basis than that of the rest of the annual financial statements can be either a good or bad thing. For each reportable segment, the entity must present the profit or loss figures and total assets, while supplementary info is disclosed where it is regularly presented to the CODM. Even though this involves judgment, it adheres to the general principle that if the CODM thinks the info (such as liabilities or revenues) is important for decision-making, it should be presented to the external users. Therefore, the CODM is essentially accountable/responsible to the users and can help in making the segmented information more transparent. As well, if not all info has to be presented, this may reduce the time and costs incurred by the entity when preparing its segmented information. On the flip side, a different presentation basis can lead to lack of transparency and can mislead users. If the CODM, for example, decides not to present liabilities for the segments, this may limit the usefulness of the reconciliation between the reportable segments and the financial statement numbers. Additionally, since IFRS 8 asks for basic information to be presented for each reportable segment, this lacks transparency, as many important numbers and transactions are left out, for example, income tax expense or investment in associates or joint ventures. Thus, users may lack complete information for sound decision-making. 34-2 To determine whether these are operating segments, consider the following: Subsidiary A: • Engages in the business activity of manufacturing car parts; from this it earns $100 in revenues. • Cannot determine whether the operating results are reviewed by senior management for resource allocation and performance evaluation. • Assuming the combined information regarding assets is just for subsidiaries A and B, it is deduced that A has $1700 in assets. Although the revenues and assets are available separate information, this may not constitute complete financial information. Subsidiary B: • Engages in the business activity of engineering consulting; from this it earns $800 in revenues ($900 less $100). • Cannot determine whether the operating results are reviewed by senior management for resource allocation and performance evaluation. • For B, there is separate, available information for assets and revenue; this information may not constitute complete financial information. As all three criteria need to be met to be an operating segment, neither A nor B are operating segments as criteria number two is missing. As well, criteria three is lacking completeness since assets and revenues may not constitute an entire segment.

34-3 With respect to all of the separately disclosed segments in Siemens’ financial statements, they meet the definition of an operating segment based on the fact that each segment engages in business activities from which it may earn revenues and incur expenses; such examples include asset management and technical maintenance. From the paragraphs presented, each segment is not technically an operating segment of Siemens unless the operating results of each segment are reviewed by senior management for resource allocation and performance evaluation, and separate information is available. In order for an operating segment to be reported separately in the financial statements, the segment must exceed a size test; in this test, the segment must meet at least one of the three criteria as set out in the quantitative thresholds section of IFRS 8. Additionally, once management has identified the reporting segments (determined by the size test), they assess whether additional segments shall be reported. For this test, if the total external revenues for the reportable segments are less than 75% of the entity’s revenues, the entity identifies additional reportable segments. Once the entity has identified sufficient reportable segments to meet the 75% threshold, the rest of the non-reportable segments are added together under “other operating segments” and disclosed. 34-4 To determine whether these divisions should be presented as operating segments, consider the following: R&D Division: -Business activity from which it earns revenues: research and development -Could be construed as a function that does not earn revenues from a specific business itself as it supports other divisions such as the drug and equipment division -A counter point would be that, even if the revenues are not external, it could be an operating segment if the included revenues and expenses relate to transactions with other components of the same entity, such as divisions 1 through 4 Division 1: -Business activity from which it earns revenues: generic drug production Division 2: -Business activity from which it earns revenues: website development Division 3; -Business activity from which it earns revenues: medical equipment manufacturing Division 4: -Business activity from which it earns revenues: runs a small medical center Each of these divisions appears to meet criteria one of an operating segment. Once again, each division would be classified as an operating segment if the other two criteria are met: The operating results of each segment are reviewed by senior management for resource allocation and performance evaluation, and separate information is available.

With respect to being reportable, divisions 1 through 4 lack the revenue and asset criteria under the size test, as their assets and reported revenues are less than 10% of the combined figures. Criteria two of the size test cannot be verified as profit or loss figures are not present. Conversely, the R&D division meets the revenue size criteria (60% is greater than the 10% threshold) and is thus reportable. Consequently, Litton Limited’s management would have to assess whether additional segments should be reported. Since the total revenues are less than 75% of the entity’s revenues (60% and this figure is assumed to be a percentage of total external revenues), Litton identifies additional reportable segments, i.e., divisions 1-4. Once Litton has identified sufficient reportable segments to meet the 75% threshold, i.e., by adding in 3 segments with 5% revenues, for example, the rest of the non-reportable segments are added together under “other operating segments” and disclosed. 34-5 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Operating Segments: With respect to the ‘matrix’ form of organization – identification of segments, IFRS prescribes that operating segments are identified on the basis of the core principle. Under U.S. GAAP, operating segments are identified based on products and services. Information about Profit or Loss, Assets and Liabilities: With respect to the disclosure of non-current assets attributable to segments, IFRS prescribes that this disclosure includes intangible assets, while under U.S. GAAP, the disclosure excludes intangible assets. Measurement: With regards to the disclosure of measure of liabilities, under IFRS, this is required, while under U.S. GAAP this not required, even if they are reported to the CODM. Reconciliations: U.S. GAAP and IFRS 8 are converged, except that IFRSs do not recognize extraordinary items.

Chapter 35 – Solutions 35-1 The following presents the pros and cons of Foreign Company Limited determining whether its functional currency should be in U.S. dollars, Canadian dollars, or Mexican pesos. U.S. Dollars: Pros: • Sales – a substantial amount of business is conducted in the United States and most customers are American • Financing currency – the entity uses the U.S. capital market to obtain funding • Regulatory environment – entity issues shares on the NYSE, which is regulated by the U.S. SEC Cons: • Lack of labor and raw materials market, unless the U.S. currency influences labor and raw material prices Canadian Dollars: Pros: • Regulatory environment – entity issues shares on the TSX, which is regulated by the OSC (Canadian) • FCL headquarters are located in Canada • Main bank account is with a Canadian bank Cons: • Lack of sales market, which is a priority factor in determining functional currency Mexican Pesos: Pros: • Labor and raw materials – employees and suppliers at the Mexican manufacturing plant are paid in pesos Cons: • Lack of main priority factors, e.g., sales markets, regulatory and competitive environment In the end, this would be a judgment call! 35-2 A functional currency is the currency of the primary economic environment in which the entity operates, while a presentation currency is the currency in which the financial statements are presented. In this context, an entity’s functional and presentation currency may be the same. Following IAS 21, an entity must first identify its functional currency and any other currencies are then relative to the functional currency. In determining its functional currency, an entity would look to various factors such as sales and its current operating currency. In some instances it is not so clear-cut and management must use their judgment; in this situation, management of

an entity would give priority to the following factors: sales markets, the regulatory and competitive environment, and labor and raw materials markets. Although there is some judgment/options for an entity to determine its functional currency initially, once the functional currency is identified, it is not changed unless the underlying business or economic environment changes. With respect to the presentation of financial statements, an entity may choose to present its financials in a functional currency or a foreign currency, which is a currency other than the functional currency of an entity. 35-3 The accounting treatment for each transaction is as follows: 1. When the foreign operation is reporting in a different functional currency than the parent, the step-two translation is not required; the balances are already in the functional currency (even though it is a different functional currency than the parent). Since the presentation currency is U.S. dollars for Lactose, the receivable must be translated to the spot rate at reporting dates since it is a monetary asset. The related gains/losses may be booked to other comprehensive income if the receivable is treated as part of the investment; this would appear to be the case since Lactose does not intend to collect the money in the foreseeable future. 2. Dr. Receivable110 Cr. Sales

110

The exchange rate on the date the transaction occurred would be used: $1 FCU = $1.1. At year-end, the receivable, as a monetary item that is denominated in a foreign currency would be translated at the year-end spot exchange rate as follows: Dr. Receivable40 Cr. Gain on forex

3. Dr. Investment in subsidiary, at cost Cr. Cash/Equity/Payable The foreign subsidiary has functional currency of FCU. Therefore the FCUs must get translated into U.S. dollars (Lactose’s presentation currency). Any investment income or dividend entries would need to be translated into U.S. dollars at the rate on the date the transaction occurred. Since this is a non-monetary item, it is measured in terms of historical cost in the foreign currency – at the historical exchange rate. When consolidated, the investment would be eliminated and any gains/losses on translation to the presentation currency would be booked to other comprehensive income. 4. Since the subsidiary uses the same functional currency as the parent (Lactose Limited) and because the functional currency is the same as the presentation currency, steps 2 and 3 prescribed by IAS 21 do not have to be completed (step 2 is skipped because the items do not have to be translated into the functional currency and step 3 is skipped as no further translation is required). However, any transactions that are not in U.S. dollars

would have to be translated at the transaction date and any remaining monetary assets/liabilities translated at the spot rate at reporting dates. 5. With respect to the long term liability (loan), it must be converted from the foreign currency into the functional currency. This monetary item would be translated at the year end spot exchange rate with gains/losses being booked to income.

35-4 In the case of translating a foreign operation, goodwill and fair value increments arising from business combinations are treated as assets of the foreign operation. The standard requires that goodwill and fair value increments be “pushed down” to the level of the functional currency. Since the functional currency is the same as the parent and the goodwill is a non-monetary asset, it is translated at the historical rate. Note that this would be different if the subsidiary had a different functional currency than the parent. In the latter case, the goodwill would be translated at the closing rate at the reporting date. The fair value increment would be translated as part of the building. Since the building is being accounted for using the revaluation method, the exchange rate in effect at the date of the revaluation would be used. Note that if the building were accounted for at amortized cost, the historical rate would be used. Note further that if the functional currency of the subsidiary was different, the closing rate would be used. According to IAS 21, if the inventory was written down to net realizable value of 90 FCU (as inventory is carried at the lower of cost and net realizable value), it would be translated at the rate in effect when the net realizable value was determined. In terms of carrying value, in the final statements, the lower of cost and net realizable value prevails. Therefore, the test has to be done based on the translated values. In this case, to determine whether a write-down is needed in the translated statements, the inventory cost would be translated at the historic rate and the net realizable value at the current exchange rate. The two balances would then be compared and the lower one reported in the statements. Cost of 100 * $0.9 = 90 NRV of 90 * $1.1 = 99 Therefore, the inventory would be reported in the statements at $90. 35-5 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Summary of the approach: U.S. GAAP considers whether a foreign subsidiary is integrated or self-sustaining. The IAS does not use these labels although the analysis criteria and the end result is essentially the same. IAS 21 takes a functional currency approach.

Reporting at the ends of subsequent reporting periods: IAS 21 requires that non-monetary items measured at fair value be translated at the date when the fair value was determined rather than the balance sheet date. U.S. GAAP generally deals with non-monetary asset measured at market (versus fair value). Translation to the presentation currency: With respect to the functional currency of foreign operations in a hyperinflationary economy, IFRS prescribes that the local functional currency financial statements (current and prior period) are indexed using a general price index and then translated to the reporting currency at the current date. Under U.S. GAAP, the local functional currency financial statements are remeasured as if the functional currency was the reporting currency (USD in the case of a U.S. parent) with resulting exchange differences recognized in income. Translation of a foreign operation: With regards to the consolidation of foreign operations, under IFRS, the method of consolidation is not specified and as a result, either the direct or the step-by-step method is used. Under the direct method, each entity within the consolidated group is directly consolidated into the ultimate parent without regard to any intermediate parent. Under U.S. GAAP, the step-by-step method is used whereby each entity is consolidated into its intermediate parent until the ultimate parent has consolidated the financial statements of all the entities below it. Disposal or partial disposal of a foreign operation: With respect to foreign currency translation reserves, accounting for dividends considered to be returns of investment, under IFRS, are accounted for as a disposal of part of the foreign investment and the relevant part of the reserve is recycled to the income statement. Under U.S. GAAP, there is no recycling of the reserve to the income statement, as no recognition is made when there is a partial return of investment to the parent. Disclosure: Differing disclosures are required under IFRS and U.S. GAAP.

Chapter 36 – Solutions 36-1(a) The statement of changes in net assets available for benefits is similar to an income statement prepared by a business. (b) The similarities between the statements are as follows: • • • •

Investment income, such as interest and dividends, and other income is presented Administrative expense and other expenses are presented Income taxes are presented Profits and losses on disposals of investments and changes in the value of the investments are presented

The statement of changes in net assets available for benefits differs from the income statement as follows: • • • •

It presents employer and employee contribution into the benefit plan It shows the benefits paid or payable (classified by type) It presents the transfers to and from other benefit plans An income statement may present income from discontinued operations, extraordinary events, and earnings per share

36-2 The controversial issue that results in permitting a variety of formats of the statement of net assets available for benefits is whether the actuarial present value of the promised benefits meets the definition of a liability of the entity that is the benefit plan. Some believe that comparing the actuarial present value of the promised retirement benefits to the plan assets is not valid and that actuaries do not take this approach in assessing the adequacy of plan assets. These issues are compounded by different views of how the obligation should be measured – based on current salary levels or based on future/projected salary levels. 36-3(a) Financial statements in countries with hyperinflation need to be restated from functional currency into current currency units to account for the currency’s significant decline in purchasing power. If not restated, non-monetary assets held for any length of time tend to “disappear.” For example, assume that an entity purchases equipment on Day 1, Year 1 for 10 FCUs (foreign currency units) in a country that experiences 100% inflation in each of the next 5 years. If no adjustment is made for changes in the value of the FCU (and ignoring depreciation), the cost of the equipment reported at the end of year 5 is still $10. However, if the price of this equipment changed with the general level of inflation, it would now take 320 FCUs to represent the same cost (i.e., 10 × 2 × 2 × 2 × 2 × 2). (b) For example, an entity has a statement of financial position with 2 items on it: $1 of cash and $1 of current accounts payable as of Jan 1, 2008. As well, during 2008 inflation is running at 100% per year. At the end of 2008, assume a pen that used to cost $1 now costs $2, so that same $1 that used to buy 1 pen now only buys 1/2 of a pen, representing a loss in purchasing power. On the contrary, the $1 of accounts payable that this entity is obligated to pay can still be settled for $1 (instead of $2). Thus, the entity benefits/gains from owing money in times of inflation as it can repay debt with currency that is worth only half of what it was previously. The person

receiving this $1 suffers the purchasing power loss as they can take that $1 and only buy 1/2 of an item that previously cost $1 (such as a pen), as the good has doubled in cost because of hyperinflation. (c) At the end of Year 3: Equipment on the company’s unadjusted financial statements: Equipment 100 Accumulated Depreciation 30 Carrying amount 70 Equipment on the company’s price-level adjusted financial statements: Equipment 300 Accumulated Amortization 90 Carrying amount* 210 *Assuming < recoverable amount

This equipment is a non-monetary asset carried at amortized cost and is restated using the change in price level from the acquisition date to the end of the current period. In this case, prices in Inflationland tripled. 36-4 Access the website (s) identified on the inside back cover of this book, and prepare a concise summary of what the differences that are flagged throughout the chapter material are. Part 1: Objective and Scope: With respect to rights and obligations under insurance contracts, IFRS 4 addresses recognition and measurement in only a limited way; it is an interim standard pending completion of a comprehensive project. IFRS applies to all insurance contracts, regardless of the type of entity that issued the contract. Under U.S. GAAP, several comprehensive pronouncements and other comprehensive industry accounting guides have been published, and they apply only to insurance companies. IFRS 4 also deals with financial instruments with discretionary participation features. Under U.S. GAAP, this term is not used. Instead, U.S. GAAP addresses similar items in accounting for dividends to policyholders. IFRS 4 requires the unbundling of a deposit element from some insurance contract and accounts for the deposit element as a financial instrument. Under U.S. GAAP, there is no broad unbundling requirement. With respect to derivatives embedded in insurance contracts, IFRS requires that an embedded derivative whose characteristics and risks are not closely related to the host contract but whose value is interdependent with the value of the insurance contract need not be separated out and accounted for as a derivative. U.S. GAAP prescribes that an embedded derivative with characteristics and risks not closely related to the host contract must be accounted for separately.

Recognition and Measurement: Temporary Exemption from Other IFRSs: In the U.S., insurance companies must apply the accounting policies specified in the specific literature ,whereas under IFRS 4 entities are permitted, in general, to continue with their existing policies related to insurance contracts. Under IFRS 4, a liability adequacy test is required, and “shadow accounting” for insurance liabilities is permitted. Under U.S. GAAP, a form of premium adequacy test is required (that meets the minimum requirement of the liability adequacy test), and the use of “shadow accounting” is required. Part 3: Restatement of Financial Statements: With respect to adjusting financial statements of an entity that operates in a hyperinflationary economy, IFRS requires an entity to adjust using a general price level index before translation. Conversely, U.S. GAAP prescribes that the financial statements be adjusted as if the reporting currency of the parent was the entity’s functional currency.

Chapter 37 – Solutions 37-1 The basic philosophy of IFRS1 is to provide relief from the difficult task of conversion from national GAAP and to provide guidance to entities on how to transition over to IFRSs. The overall objective of this IFRS is to ensure that transparency is achieved, that costs do not exceed the benefits, and to provide a suitable starting point for conversion. In terms of the first-time adoption of IFRS, two exemptions are necessary: the exemptions from other IFRSs (exceptions based on cost/benefit) and the exemptions from the general principle of retrospective application (prohibitions to prevent the undue use of hindsight). With respect to cost/benefit, it will be very difficult and time-consuming to go back and collect the information needed to apply IFRSs. Therefore, the standard allows some relief and has articulated several exceptions to the retrospective application principle. Additionally, because hindsight is 20/20, bias might be introduced when applying the standards retrospectively. Since this is difficult to apply in practice, several specific prohibitions have been articulated in the standards. Essentially, these exemptions are meant to provide some relief from the difficult task of transitioning to IFRSs. The entity may also use this opportunity for a fresh start, e.g., if it has made some decisions in the past that are proving to be unwieldy from a cost-benefit perspective. 37-2 The exemption that relates to fixed assets is the “fair value or revaluation as deemed cost.” Under this exemption Yodel has the option to measure an item of property, plant, and equipment at fair value at the date of transition; this fair value may then be deemed to be the asset cost at the date of transition. The option allows an entity to come up with a suitable starting value without having to go back in time to recreate a value based on historical cost. Without this exemption, the fixed assets would continue to be accounted for at historical cost. As well, if Yodel makes this election to use fair value, it does not mean that it has to continue to use fair value as a measurement base. After determining the starting point, Yodel would then decide how the asset will be valued going forward under IFRSs, which is a policy choice. If Yodel chooses the revaluation model under IAS 16, the cumulative revaluation surplus is booked to a separate component of equity. The entity may also be affected by the exemption relating to borrowing costs depending on how the assets were financed. This exemption allows the entity to apply the transitional provisions in IAS 23 (normally the individual transitional provisions in the various standards would not be applied). 37-3 The following discusses exceptions to retrospective application of other IFRSs, as well as prospective treatments of IFRSs. Derecognition of financial assets and financial liabilities: The derecognition provisions in IAS 39 must be applied prospectively for transactions occurring on or after January 1, 2004. Financial instruments that have already been derecognized prior to that would not be re-recognized. This helps an entity who may not have the information required to retrospectively apply. The entity is allowed to apply the derecognition provisions from IAS 39 Solutions Manual-IFRS Primer-Chapter 37 Copyright © 2010 John Wiley & Sons, Inc. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

retrospectively only if sufficient information is and was available at the time of initially accounting for the transaction. Hedge accounting: Hedging relationships (under a previous GAAP) that do not qualify as such under IFRS should not be recognized on transition and the entity may not retrospectively designate hedges. This prevents the use of hindsight. Estimates: The entity may not use hindsight for estimates and any subsequent information regarding estimates would be dealt with under IAS 10 Events after the Reporting Period. Assets classified as held for sale and discontinued operations: IFRS 5 is to be applied retrospectively. The exemption incorporated in IFRS 1 is not available to entities with transition dates after January 1, 2005. Non-controlling interests: The entity applies certain requirements from IAS 27 prospectively from the date of transition unless the entity elects to apply IFRS 3 and IAS 21 retrospectively, in which case it must also apply IAS 27 retrospectively. This helps entities who may not have the resources to recreate the information needed to account for the business combinations retrospectively. Fair value measurement of financial assets or financial liabilities: Under this exemption, the entity may apply the guidance regarding valuation techniques in IAS 39 on a prospective basis to transactions entered into after January 1, 2004, or after October 25, 2002. Therefore, the practice of only restrictively recognizing “day 1 profits” may be applied prospectively. IFRS 1 requires retrospective application since this will allow users to have greater comparability. However, deviations from this application are allowed because of two concepts: cost/benefit and hindsight. For an entity, it may be too difficult and time-consuming to go back and collect the information needed to apply IFRSs, or the information may never have been captured by the entity’s pre-transition accounting information system. As well, bias might be introduced when applying IFRSs retrospectively; thus, only information that was available at the time may be used for estimates. In the end, these deviations allow an entity to smoothly transition to IFRS. 37-4 The financial statements of Hene Limited should reflect IFRSs as at the end of the first reporting period, which is defined as the period in which the entity first presents its IFRS statements. In the U.S., in general, this would be 2011 (with the balance sheet date December 31, 2011, for entities with a calendar year-end). The full set of statements, including comparatives and the opening balance sheet, is prepared on the basis of December 31, 2011 IFRSs. Therefore, 2011 is the first IFRS reporting period for Hene Limited.

As a side note, Hene Limited has already prepared some form of IFRS financial statements. But do these statements qualify as the first IFRS statements? Because the information was not issued to the public (only issued for consolidation) and since the entity did not have an explicit and unreserved statement that the financial statements were in accordance with IFRS, the prior statements would not be considered to be the first IFRS statements and 2011 would be the first IFRS reporting period.