Solution Manual & Test Bank For Applying IFRS Standards, 4th Edition by Ace Test Banks

Solution Manual & Test Bank For Applying IFRS Standards, 4th Edition

richard@qwconsultancy.com

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Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Nila Latimer and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Applying IFRS Standards 4e Solutions Manual

Chapter 1 The IASB and its Conceptual Framework Discussion Questions 1.

Describe the standard-setting process of the IASB.

The standard setting process of the IASB for issuing IFRSs has six stages. The six stages are: 1. Setting the agenda. The IASB considers the relevance and reliability of the information that could be provided, the existing guidance (if any), the potential for enhanced convergence of accounting practice and the quality of the standard to be developed and any resource constraints. 2. Planning the project. The IASB decides whether it should undertake the project by itself or jointly with another standard setter such as the Financial Accounting Standards Board (FASB). 3. Developing and publishing the discussion paper. The IASB may issue a discussion paper; however, this is not mandatory. 4. Developing and publishing the exposure draft (ED). The IASB must issue an ED. This is a mandatory step. 5. Developing and publishing the standard. The IASB may re-expose an ED, particularly where there are major changes since the ED was first released in stage 4. 6. Procedures involving consultation and evaluation after an IFRS has been issued. The IASB may hold regular meetings with interested parties, including other standardsetting bodies, to help understand unanticipated issues related to the practical implementation and potential impact of the IFRS. They also carry out post-implementation reviews of each new IFRS. The IASB has full discretion over its technical agenda and over the assignment of projects, potentially to national standard setters. In preparing the IFRSs, the IASB has complete responsibility for all technical matters including the preparation and issuance of standards and exposure drafts, including any dissenting opinions on these, as well as final approval of interpretations developed by the IFRS Interpretations Committee. IASB meetings are normally held every month and last between three and five days. The meetings are open to the public. Interested parties can attend the meetings in person, or may listen and view the meeting via the IASB webcast. Subsequent to each meeting, the decisions are summarised in the form of a publication called IASB Update which is available on the IASB website.

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Chapter 1: The IASB and its Conceptual Framework

Identify the potential benefits of a globally accepted set of accounting standards.

Potential benefits of a globally accepted set of accounting standards include: Using a principles based approach which allows more scope for the use of professional judgement when the principles are applied to specific situations. Greater comparability between financial reports of different entities and countries if they are prepared using an internationally recognized and accepted basis of accounting. Reduction in the cost of financial statement preparation if restatement of financial statements for other jurisdictions is no longer required Greater mobility of staff as staff trained in IFRS will be more readily able to move between foreign subsidiaries without the need for retraining in financial statement preparation.

Outline the fundamental qualitative characteristics of financial reporting information to be considered when preparing general-purpose financial statements. This requires a discussion of the qualitative characteristics mentioned in figure 1.2 in learning objective 4, namely relevance, reliability, comparability and understandability.

Discuss the importance of the going concern assumption to the practice of accounting. The going concern assumption is important in that all measures of performance and financial position, and all classifications in a statement of financial position (current and non-current) implicitly assume that the entity is going to continue. Furthermore, valuation of assets on the basis of cost is sometimes justified on the grounds of the going concern assumption. The accrual basis assumption is made in the preparation of general-purpose financial reports. Under this assumption, the effects of all transactions and other events are recognised in the accounting records when they occur, rather than when cash or its equivalent is received or paid. Financial reports prepared on the accrual basis inform readers not only of past transactions involving the receipt and payment of cash but also of obligations to pay cash in the future and of amounts owing to the entity in the form of receivables. It is argued that the accrual basis therefore provides better information for users in their decision-making processes.

Discuss the essential characteristics of an asset as described in the Conceptual Framework. Discussion of essential characteristics of asset: • • •

resource must contain future economic benefits control, requiring a capacity to benefit from the asset in the pursuit of the entity’s objectives, and an ability to deny or regulate the access of others to those benefits. past event, giving rise to the entity’s control over future economic benefits

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Non-essential characteristics: • • •

purchased at a cost tangibility exchangeability

With the proposed definition of an asset, namely “An asset of an entity is a present economic resource to which, through an enforceable right or other means, the entity has access or can limit the access of others,” there will be less focus on “future economic benefits” and more on “present resource”; and less on “control”, with more on the existence of enforceable rights to limit access of others.

Discuss the essential characteristics of a liability as contained in the Conceptual Framework. A liability is defined in the current Framework as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’. Important aspects of this definition: • A legal debt constitutes a liability, but a liability is not restricted to being a legal debt. Its essential characteristic is the existence of a present obligation, being a duty or responsibility of the entity to act or perform in a certain way. A present obligation may arise as a legal obligation and also as an obligation imposed by custom or normal business practices (referred to as a ‘constructive’ obligation). For example, an entity may decide as a matter of normal business policy to rectify faults in its products even after the warranty period has expired. Hence, the amounts that are expected to be spent in respect of goods already sold are liabilities. • A present obligation needs to be distinguished from a future commitment. A decision by management to buy an asset in the future does not give rise to a present obligation. • A liability must result in the giving up of resources embodying economic benefits which requires settlement in the future. The entity has little, if any, discretion in avoiding this sacrifice. This settlement in the future may be required on demand, at a specified date, or on the occurrence of a specified event. • A liability is that it must have resulted from a past event. For example, wages to be paid to staff for work they will do in the future is not a liability as there is no past event and no present obligation. The IASB and FASB have proposed to change the definition of a liability by focusing on a liability as an enforceable “economic obligation” rather than an expected future sacrifice of economic benefits. Furthermore, the reference to past events is to be replaced by a focus on the present. The essential attributes of an enforceable obligation include the involvement of a separate party and the existence of a mechanism that is capable of forcing an entity to take a specified course of action.

Discuss the difference, if any, between income, revenue and gains. The Framework defines income as “increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” This definition of income is linked to the definitions of assets and liabilities. The definition

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is wide in its scope, in that income in the form of inflows or enhancements of assets can arise from the provision of goods or services, the investment in or lending to another entity, the holding and disposing of assets, and the receipt of contributions such as grants and donations. To qualify as income, the inflows or enhancements of assets must have the effect of increasing the equity, excluding capital contributions by owners. Income can exist as well through a reduction in liabilities that increase the entity’s equity. An example of a liability reduction is if a liability of the entity is ‘forgiven’. Income arises as a result of that forgiveness, unless the forgiveness of the debt constitutes a contribution by equity holders. Under the current Framework, income encompasses both revenue and gains. A more complete definition of revenue arises in accounting standard IAS 18 Revenue as follows: “the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.” Revenue therefore represents income which has arisen from ‘the ordinary activities of an entity’. On the other hand, gains represent income which does not necessarily arise from the ordinary activities of the entity, e.g. gains on the disposal of non-current assets or on the revaluation of marketable securities. Gains are usually disclosed in the income statement net of any related expenses, whereas revenues are reported at a gross amount. Revenues arise from the “ordinary activities” of the entity and gains may or may not be from ordinary activities. What “ordinary activities” means in any particular context is unclear; hence the distinction between revenues and gains is unclear. Would we be better off abandoning the distinction?

Distinguish between the financial and physical concepts of capital and their implications for the measurement of profit. Under the financial capital concept, capital is synonymous with the net assets or equity of the entity, measured either in terms of the actual amount of dollars by subtracting the total of liabilities from assets, or in terms of the purchasing power of the dollar amount recorded as equity. Profit exists only after the entity has maintained its capital, measured as either the dollar value of equity at the beginning of the period, or the purchasing power of those dollars in the equity at the beginning of the period. Under the physical capital concept, capital is seen not so much as the equity recorded by the entity but as the operating capability of the entity’s assets. Profit exists only after the entity has set aside enough capital to maintain the operating capability of its assets.

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Exercises Exercise 1.1

MEASURING INVENTORIES OF GOLD AND SILVER

IAS 2 Inventories allows producers of gold and silver to measure inventories of those commodities at selling price, even before they have sold it, which means a profit is recognised at production. In nearly all other industries, however, profit is recognised only when the inventories are sold to outside customers. What concept(s) in the Conceptual Framework might the IASB have looked to with regard to accounting for gold and silver production? a. Unlike other ordinary goods, there is a ready liquid market with quoted prices, minimal transaction costs, minimal selling effort, minimal after-costs, and immediate cash settlement. b. Under the Conceptual Framework, an item that meets the definition of an asset, liability, income, or expense should be recognised if:

•

it is probable that any future economic benefit associated with the item will flow to or from the entity; and

•

the item has a cost or value that can be measured with reliability.

The IASB concluded that because of the nature of the market in which gold and silver are bought and sold, the conditions for income recognition are met at the time of production.

Exercise 1.2

RECOGNISING A LOSS FROM A LAWSUIT

The law in your community requires store owners to shovel snow and ice from the pavement (sidewalk) in front of their shops. You failed to do that. A pedestrian slipped and fell, resulting in serious and costly injury. The pedestrian has sued you. Your attorney says that while he will vigorously defend you in the lawsuit, you should expect to lose $25 000 to cover the injured party’s costs. A court decision, however, is not expected for at least a year. What aspects of the Conceptual Framework might help you in deciding the appropriate accounting for this situation? a. The definition of liability can help decide the accounting treatment of the situation. Under the Conceptual Framework a liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. In this case, the past event is the fall and injury to the pedestrian. b. Present obligation depends on the probability of payment. The attorney has advised that a $25 000 loss is probable. Therefore appropriate accounting involves recognising a liability for the probable payment. An expense would also be recognised. c. Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities. In this case, the expense arises at the time the pedestrian is injured because a liability has also arisen at that time.

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Exercise 1.3

NEED FOR THE CONCEPTUAL FRAMEWORK VS. INTERPRETATIONS

Applying the Conceptual Framework is subjective and requires judgement. Would the IASB be better off to abandon the Conceptual Framework entirely and, instead, rely on a very active interpretations committee that develops detailed guidance in response to requests from constituents? a. No. The fact that the Conceptual Framework involves judgement does not mean that it should be abandoned. b. The guidance developed by the interpretations committee would be ad hoc – that is, developed case by case without the foundation of the Conceptual Framework to look to. The standards themselves would suffer from the same problem if there were no Conceptual Framework. c.

The Conceptual Framework provides guidance and direction to the standard setters, and therefore will lead to consistency among the standards.

d. But it is a set of concepts. It provides a boundary for the exercise of judgement by the standard setter and the interpretive body.

Exercise 1.4

ASSESSING PROBABILITIES IN ACCOUNTING RECOGNITION

The Conceptual Framework defines an asset as a resource from which future economic benefits are expected to flow. Expected is something less than a sure thing – it involves some degree of probability. At the same time, the Conceptual Framework establishes, as a criterion for recognising an asset that “it is probable that any future economic benefit associated with the item will flow to or from the enterprise.” Again, an assessment of probability is required. Is there a redundancy, or possibly some type of inconsistency, in including the notion of probability in both the asset definition and recognition criteria? It is not an inconsistency to include the notion of probability both in the definition of an asset and in the recognition criteria. However, it may be a redundancy.

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Exercise 1.5

PURCHASE ORDERS

An airline places a non-cancellable order for a new airplane with one of the major commercial aircraft manufacturers at a fixed price, delivery in 30 months, payment in full to be made at delivery. (a) Under the Conceptual Framework, do you think the airline should recognise any asset or liability at the time it places the order? (b) One year later, the price of this airplane model has risen by 5%, but our airline had locked in a fixed, lower price. Under the Conceptual Framework, do you think the airline should recognise any asset (and gain) at the time when the price of the airplane rises? If the price fell by 5%, instead of rising, do you think the airline should recognise a liability (and loss) under the Conceptual Framework? (a) Under the Conceptual Framework, the airline should not recognise any asset or liability at the time it place the order, because the transaction has not taken place. Accounting recognises purchase transactions when delivery takes place, and title passes. At this point the airline, and not the manufacturer, has assumed the risks and rewards of owning the airplane. Nonetheless, the airline has made an important and irrevocable commitment. Generally, major capital spending commitments are disclosed in the notes to the financial statements. (b) The airline is better off for having locked in the price than if it had not done so. Conversely, if the price had fallen, it would be worse off for having signed the non-cancellable fixed price order. Nonetheless, under current accounting standards, such gains and losses are not recognised. Accounting treats commitments to purchase financial assets differently from commitments to purchase property. If the airline had agreed to purchase a foreign currency at a fixed price for delivery at a future date, and the exchange rate goes up or down, it is required to recognise a gain or loss.

Exercise 1.6

DEFINITIONS OF ELEMENTS AND RECOGNITION CRITERIA

Explain how you would account for the following items, justifying your answer by reference to the Conceptual Framework’s definitions and recognition criteria: (a) A trinket of sentimental value only. (b) You are guarantor for your friend’s bank loan: (i) You have no reason to believe your friend will default on the loan. (ii) As your friend is in serious financial difficulties, you think it likely that he will default on the loan. (c) You receive 1000 shares in X Ltd, trading at $4 each, as a gift from a grateful client. (d) The panoramic view of the coast from your café’s windows, which you are convinced attracts customers to your café. (e) The court has ordered your firm to repair the environmental damage it caused to the local river system. You have no idea how much this repair work will cost.

(a)

Trinket of sentimental value • Fails the para 49(a) asset definition as it does not constitute future economic benefits, defined in para 53 as the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. • Recognition criteria are irrelevant, as there is no asset to recognise.

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Chapter 1: The IASB and its Conceptual Framework

(b)

(c)

Guarantor for friend’s loan (i)

Friend unlikely to default on his loan • Meets the para 49(b) liability definition: (1) present obligation – legal obligation via the guarantor contract; (2) past event – signing the guarantor contract; (3) settlement involving outflow of economic benefits – payment of the guarantee. • Fails probability recognition criterion, as it is not likely that you will be required to pay on the guarantee. Hence, no liability can be recognised. However, note disclosure of the guarantee may be warranted (para 88).

(ii)

Friend likely to default on his loan • Again, meets the liability definition as per (i) above. • Meets both recognition criteria – probable that outflow of economic benefits will be required, and settlement amount can be reliably measured (amount owing). Hence, a liability should be recognised. • Also meets the expense definition and recognition criteria. Definition: (1) decrease in economic benefits in the form of a liability increase – you now owe the amount of your friend’s loan; (2) during period – the liability increase arose during period; (3) results in equity decrease – if liabilities increase and assets do not change, equity decreases. Recognition criteria: The decrease in future economic benefits has arisen, as you now owe the amount of your friend’s loan. The bank can advise exactly how much your friend owes and so it can be reliably measured.

Receipt of 1000 shares in X Ltd, trading at $4 each, as a gift from a grateful client. • •

•

The receipt of the shares meets the asset definition: (1) represent FEBs (via future sales or dividend stream); (2) controlled by you (only you can benefit from either selling them or receiving dividends); (3) past event (their receipt). They also meet the asset recognition criteria: probable that FEBs will eventuate (via sale or dividend stream); and the shares have a value (they are trading at $4 each) that can be reliably measured (this value can be verified via stock exchange etc.). The shares also meet the income definition and recognition criteria. Definition: (1) increase in EBs in the form of an asset increase – you now own the shares; (2) during period – the shares were received during period; (3) results in equity increase – if assets increase and liabilities do not change, equity increases. Recognition criteria: The increase in FEBs has arisen, as you now own the shares (asset). The shares’ value is known and so can be reliably measured.

(d)

Café’s panoramic view • The view fails the definition as the entity does not control the FEBs that are expected to flow from the view – the entity cannot deny or regulate access by others to the view. • Recognition criteria are irrelevant, as there is no asset to recognise.

(e)

Court order to repair environmental damage caused to the local river system. You have no idea how much this repair work will cost. • The court order meets the liability definition: (1) present obligation – legal obligation; (2) past event – order has been made; (3) settlement will involve outflow of EBs – future payment for repair of damage. • Fails reliable measurement recognition criterion, as you have no idea as yet how much the repair work will cost. Hence, no liability can be recognised. However, note disclosure of the court order may be warranted (para 88). • However, if you know a minimum amount that you will have to pay, then the reliable measurement criterion is met for this amount. The probability criterion is met as it is certain (given that you have been ordered by the court) that you will have to pay the repair cost. Again, note disclosure may still be warranted advising that the cost may be well in excess of this amount.

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Exercise 1.7

ASSETS

Lampeter Cosmetics has spent $220 000 this year on a project to develop a new range of chemical-free cosmetics. As yet it is too early for Lampeter Cosmetics’ management to be able to predict whether this project will prove to be commercially successful. Explain whether Lampeter Cosmetics should recognise this expenditure as an asset, justifying your answer by reference to the Conceptual Framework asset definition and recognition criteria. •

The Conceptual Framework defines an asset as a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

•

The expenditure of developing a new line of chemical-free cosmetics meets this definition as: (1) it represents future economic benefits via sale of the new line of cosmetics; (2) the benefits are controlled, as Lampeter Cosmetics will enjoy the economic benefits flowing from the new line; and (3) there is a past event, as Lampeter Cosmetics has already spent the $220 000.

•

Under the Conceptual Framework an asset is recognised only when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be reliably measured.

•

The expenditure fails the probability criterion, as it is not yet possible to predict whether the project will prove to be commercially relevant.

•

Accordingly, Lampeter Cosmetics cannot (yet) recognise the expenditure as an asset.

Exercise 1.8

ASSET DEFINITION AND RECOGNITION

On 28 May 2013 $20 000 cash was stolen from Ming Lee Ltd’s night safe. Explain how Ming Lee should account for this event, justifying your answer by reference to relevant Conceptual Framework definitions and recognition criteria. •

The Conceptual Framework defines expenses as decreases in economic benefits during the period in the form of asset decreases or liability increases that result in decreases in equity, other than those relating to distributions to owners.

•

The theft of the $20 000 cash satisfies the expense definition as: o It is a decrease in economic benefits during the period, as cash (economic benefits) has decreased; o The decrease in economic benefits is in the form of an asset decrease, as cash (an asset) has decreased; and o It has resulted in a decrease in equity, as assets have decreased and liabilities have not changed.

•

In accordance with the Conceptual Framework an expense must be recognised when: o A decrease in economic benefits related to an asset increase or a liability decrease has arisen; and o The decrease can be reliably measured.

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•

The theft of the cash satisfies both recognition criteria as: o The decrease in economic benefits related to an asset decrease (a decrease in cash) has occurred; and o The decrease can be reliably measured, as the amount of cash lost is known (i.e. $20 000).

•

Accordingly, an expense (Dr) and asset decrease (Cr) of $20 000 must be recognised.

Exercise 1.9

RELEVANT INFORMATION FOR AN INVESTMENT COMPANY

A year ago you bought shares of stock in an investment company. The investment company, in turn, buys, holds, and sells shares of business enterprises. You want to use the financial statements of the investment company to assess its performance over the past year. a. What financial information about the investment company’s holdings would be most relevant to you? b. The investment company earns profits from appreciation of its investment securities and from dividends received. How would the concepts of recognition in the Conceptual Framework apply here? a. The performance of an investment company results from income earned on its investments (dividends and interest) and changes in the fair values of its investments while they are held. I would like to know: •

Fair values of the securities that the investment company holds

•

How those fair values changed during the year. It would not matter much to me whether the investment company actually sold the investments (in which case they would have to replace them with other investments) or held on to the investments. Either way, the fair value changes represent gains and losses to the investment company and, therefore, to me as an investor in the investment company.

•

How the fair value changes of investments managed by this investment company compared to changes in similar investments in the market as a whole.

•

Turnover of the portfolio, and related transaction costs such as commissions.

•

Interest and dividends earned.

•

Information about risks in the portfolio.

•

Income taxes are usually based on only those fair value changes that have been “confirmed” by a sale transaction. If that is the case with this investment company, I might want to know how the fair value changes were split between “realised” (relating to investments that have been sold) and “unrealised” (relating to investments that are still held). In many countries, investment companies that distribute their earnings rapidly to the investors do not themselves pay taxes – only the investors pay the taxes on realised gains and dividend and interest income.

b. Under the Framework, an item that meets the definition of an asset, liability, income, or expense should be recognised if: (a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and (b) the item has a cost or value that can be measured with reliability. With respect to income, the Framework states that income is recognised in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. Appreciation of the fair value of investment securities does represent an increase in an asset. For an

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investment company, it is an important component of performance. As to dividends, when the investment company’s right to receive payment is established, it can recognise dividends as revenue. Because fair value changes and dividends are different in nature, they would be reported separately.

Exercise 1.10

FINANCIAL STATEMENTS OF A REAL ESTATE INVESTOR

An entity purchases a rental property for $10 000 000 as an investment. The building is fully rented, and is in a prosperous area. At the end of the current year, the enterprise hires an appraiser who reports that the fair value of the building is “$15 000 000 plus or minus ten per cent”. Depreciating the building over 50 years would reduce the carrying amount to $9 800 000. a. What are the relevance and reliability accounting considerations in deciding how to measure the building in the entity’s financial statements? b. Does the Conceptual Framework lead clearly to measuring it at $15 000 000? Or at $9 800 000? Or at some other amount? a. Is the fair value relevant to stakeholders’ decisions? Whether the stakeholders care about the fair value of the building should be considered. Relevance •

Information in financial statements is relevant when it influences the economic decisions of users. It can do that both by (a) helping them evaluate past, present, or future events relating to an enterprise and by (b) confirming or correcting past evaluations they have made.

•

Materiality is a component of relevance. Information is material if its omission or misstatement could influence the economic decisions of users.

•

Timeliness is another component of relevance. To be useful, information must be provided to users within the time period in which it is most likely to bear on their decisions.

Reliability •

Information in financial statements is reliable if it is free from material error and bias and can be depended upon by users to represent events and transactions faithfully. Information is not reliable when it is purposely designed to influence users' decisions in a particular direction.

•

There is sometimes a trade-off between relevance and reliability - and judgement is required to provide the appropriate balance.

•

Reliability is affected by the use of estimates and by uncertainties associated with items recognised and measured in financial statements. These uncertainties are dealt with, in part, by disclosure and, in part, by exercising prudence in preparing financial statements. Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. However, prudence can only be exercised within the context of the other qualitative characteristics in the Conceptual Framework, particularly relevance and the faithful representation of transactions in financial statements. Prudence does not justify deliberate overstatement of liabilities or expenses or deliberate understatement of assets or income, because the financial statements would not be neutral and, therefore, not have the quality of reliability.

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Analysis •

The fair value of the property is relevant to the investors in the enterprise. The enterprise – and therefore its owners – are better off because the value of the property has gone up. Better off means that their wealth increased.

•

Is the fair value reported by the appraiser reliable? Certainly, appraisals involve judgements, and different valuation methods and different assumptions can generate different valuations. The objectivity and other qualifications of the appraiser should be considered. The Conceptual Framework acknowledges that accounting information can be reliable even if it is not precise. The appraiser acknowledged that there is a potential for error of plus or minus 10%. That does not mean that the value information is not reliable.

b. The Conceptual Framework does not include concepts or principles for selecting which measurement basis should be used for particular elements of financial statements or in particular circumstances. The qualitative characteristics do provide some guidance, particularly the characteristics of relevance and reliability.

Exercise 1.11

MEANING OF ‘DECISION USEFUL’

What is meant when we say that accounting information should be ‘decision-useful’? Provide examples. a. The Conceptual Framework identifies the principal classes of users of general purpose financial statements as: •

present and potential investors,

•

lenders,

•

suppliers and other trade creditors,

•

employees,

•

customers,

•

governments and their agencies; and

•

the general public.

b. All of these categories of users rely on financial statements to help them in making various kinds of economic and public policy decisions. Investors need to decide whether to buy, sell, or hold shares. Lenders need to decide whether to lend and at what price. Suppliers need to decide whether to extend credit. Employees need to make rational career decisions. And so on. Information is decision-useful if it helps these people make their decisions. c.

Because investors are providers of risk capital to the enterprise, financial statements that meet their needs will also meet most of the general financial information needs of the other classes of users. Common to all of these user groups is their interest in the ability of an enterprise to generate cash and cash equivalents and of the timing and certainty of those future cash flows. Therefore, the Conceptual Framework regards investors as the primary, overriding user group.

d. The Conceptual Framework notes that financial statements cannot provide all the information that users may need to make economic decisions. For one thing, financial statements show the financial effects of past events and transactions, whereas the decisions that most users of financial statements have to make relate to the future. Further, financial statements provide only a limited amount of the non-financial information needed by users of financial statements.

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e. Financial statements cannot meet all of the diverse information needs of these user groups. However, there are information needs that are common to all users, and general purpose financial statements focus on meeting those needs. f.

While the concepts in the Conceptual Framework are likely to lead to information that is useful to the management of a business enterprise in running the business, the Conceptual Framework does not purport to address their information needs. The same can be said for the Standards and Interpretations themselves.

Exercise 1.12 PERFORMANCE OF A BUSINESS ENTITY A financial analyst says: “I advise my clients to invest for the long term. Buy good stocks and hang on to them. Therefore I am interested in a company’s long-term earning power. Accounting standards that result in earnings volatility obscure longterm earning power. Accounting should report earning power by deferring and amortising costs and revenues.” How does the Conceptual Framework relate to this analyst’s view of financial statements? a. Accounting standards should help provide relevant and reliable financial information. b. Companies that operate in risky business environments or that enter into risky kinds of transactions are likely to experience real ups and downs in their performance. In such cases, volatility of reported earnings results from the real transactions and activities of the company. c.

In other words, the statement of comprehensive income reflects the underlying risks. It is not the role of financial accounting and reporting to try to smooth the company’s earnings by, say, deferring profits in good years and deferring expenses in bad years. The amounts reported in the financial statements would not be reliable because they do not reflect real phenomena.

Exercise 1.13 GOING CONCERN What measurement principles might be most appropriate for a company that has ceased to be a going concern (e.g. it is unable to renew loans and is planning to sell major assets needed for existing operations in order to repay creditors)? a. Net realisable value is an asset’s selling price or a liability’s settlement amount less disposal or settlement costs. If a company ceases to be a going concern, that means it is either being wound up or sold. b. Either way, the relevant measurements to users of financial statements would be the net realisable value of the company’s net assets.

Exercise 1.14 DEFINITIONS AND RECOGNITION CRITERIA Explain how you would account for the following items, justifying your answer by reference to the definitions and recognition criteria in the Conceptual Framework. Also state, where appropriate, which ledger accounts should be debited and credited. (a) (i) (ii) (b) (c)

Your firm has been sued for negligence – likely you will lose the case. Your firm has been sued for negligence – likely you will win the case. Obsolete plant now retired from use. Receipt of a donation of $10 000.

1.14

Chapter 1: The IASB and its Conceptual Framework

(a) (i) Your firm has been sued for negligence – likely you will lose the case. • The liability definition (para 49(b)) is met as all 3 characteristics are present. o Past event: The act of negligence or the act of being sued. o Present obligation: Para 60 states that an obligation is a duty or responsibility to act or perform in a certain way. The key question here is whether there is a present obligation. Does the lawsuit create a present obligation? Or will the obligation only arise when a court decision against you is handed down? The definition requires the existence of a present, not a future, obligation (para 61). I believe that the lawsuit (arising from being sued) gives rise to a present obligation. o Settlement involves the outflow of economic benefits: If a present obligation is accepted as existing, its settlement will involve the outflow of economic benefits, namely cash. • The liability recognition criteria (para 91) are met, as it is probable that an outflow of economic benefits (cash) will result from settling the liability, and the amount ($20 000 minimum) can be reliably measured. • Therefore, at this stage a liability of $20 000 must be recognised. If the damages firm up to another amount as the case progresses, the amount must be adjusted. • The expense definition (para 70(b)) is met as all 3 characteristics are present. o Decrease in economic benefits during the period: The loss of at least $20 000 represents a decrease in economic benefits and you were sued during the period. o In the form of a liability increase: See above liability discussion – you now owe $20 000 minimum. o Results in a decrease in equity: If liabilities increase and assets remain unchanged, equity decreases. • The expense recognition criteria (para 94) are met, as the decrease in economic benefits has arisen, as you now owe $20 000 minimum, and the amount ($20 000 minimum) can be reliably measured. • Therefore, at this stage an expense of $20 000 must also be recognised. If the damages firm up to another amount as the case progresses, the amount must be adjusted accordingly. • Note that in this case the recognition of a liability has resulted in the simultaneous recognition of an expense (paras 91 and 98). (a)(ii)

Your firm has been sued for negligence – likely you will win the case. • The liability definition (para 49(b)) is met as all 3 characteristics are present. See discussion in (b) (i) above. • However, the liability probability recognition criterion (para 91) is failed, as it is not probable that an outflow of economic benefits will result from settling the liability. As you are likely to win the case, it is unlikely that you will have to pay damages. • Therefore, the liability cannot be recognised. However, if material, the lawsuit should be disclosed in the notes.

(b)

Obsolete plant now retired from use. • The asset definition is failed as the plant no longer represents future economic benefits (para 49(a)). • The plant must now be written off from the accounts. • Recognition criteria are thus irrelevant, as there is no asset to recognise.

(c)

Donation of $10 000 cheque. • The asset definition (para 49(a)) is met as all 3 characteristics are present. o Past event: The receipt or clearance of the cheque. o Flow of future economic benefits: The cheque represents an inflow of $10 000 cash into your firm. o Control over the future economic benefits: Your firm will benefit from this $10 000 cash inflow and can deny or regulate the access of others to this cash inflow.

1.15

Applying IFRS Standards 4e Solutions Manual

• • •

The asset recognition criteria (para 89) are met, as it is probable (actually, it is certain) that an inflow of economic benefits (cash) will flow to the entity, and the amount ($10 000) can be reliably measured as it is known. Therefore, an asset of $10 000 must be recognised. The income definition (para 70(a)) is met as all 3 characteristics are present. o Increase in economic benefits during the period: The inflow of $10 000 cash represents an increase in economic benefits, and you received and cleared the cheque during this period. o In the form of an asset increase: See above asset discussion – you now have additional cash of $10 000. o Results in an increase in equity: If assets increase and liabilities remain unchanged, equity increases. The income recognition criteria (para 92) are met, as the increase in economic benefits has arisen (as you now have additional cash), and the amount ($10 000) is known. Therefore, income of $10 000 must also be recognised. Note that in this case the recognition of an asset has resulted in the simultaneous recognition of income (paras 84 and 92).

Exercise 1.15 DEFINITIONS AND RECOGNITION CRITERIA Glasgow Accounting Services has just invoiced one of its clients $3600 for accounting services provided to the client. Explain how Glasgow Accounting Services should recognise this event, justifying your answer by reference to relevant Conceptual Framework definitions and recognition criteria •

The Conceptual Framework defines an asset as a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

•

Invoicing the client gives rise to an asset as all 3 characteristics are present: o Flow of future economic benefits: The invoice represents a future cash inflow to the firm; o Control: The firm has control over the economic benefits via its contractual right to the future cash inflow; and o Past event: The issuing of the invoice or the provision of the services for which the invoice was issued.

•

Under the Conceptual Framework an asset must be recognised when it is probable that the future economic benefits will flow to the entity, and the asset has a cost or value that can be reliably measured.

•

These recognition criteria are met as: o It is more than 50% likely (probably certain) that the firm will receive the cash (otherwise it would not have provided the services); and o The value ($3600) can be reliably measured as it is known.

•

Therefore, an asset (receivable) of $3600 must be recognised.

•

The Conceptual Framework defines income as increases in economic benefits during the period in the form of inflows or enhancements of assets or decreases in liabilities that result in increases in equity, other than those relating to owners’ contributions. Invoicing gives rise to income as all 3 characteristics are present: o Increase in economic benefits during the period: The right to a future cash inflow arose during the period; o Increase in assets or decrease in liabilities: The increase is in the form of an asset increase as the receivable meets the asset definition and recognition criteria; and

•

1.16

Chapter 1: The IASB and its Conceptual Framework

Increase in equity: As assets have increased and liabilities have not changed, equity has increased.

•

Under the Conceptual Framework income must be recognised when an increase in future economic benefits, related to an asset increase or liability decrease, has arisen that can be measured reliably.

•

These recognition criteria are met as: o The asset increase has arisen (on issue of the invoice); and o The increase ($3600) can be reliably measured as it is known.

•

Therefore, income (fee revenue) of $3600 must be recognised.

1.17

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 1 The IASB and its Conceptual Framework

CHAPTER 1 The IASB and its Conceptual Framework

Learning Objectives 1.1 Describe the organisational structure of the key players in setting International Financial Reporting Standards (IFRSs) 1.2

Describe the purpose of a conceptual framework – who uses it and why

1.3 Explain the qualitative characteristics that make information in financial statements useful 1.4

Discuss the going concern assumption underlying the preparation of financial statements

1.5 Define the basic elements in financial statements – assets, liabilities, equity, income and expenses 1.6

Explain the principles for recognising the elements of financial statements

1.7 Distinguish between alternative bases for measuring the elements of financial statements 1.8

Outline concepts of capital.

1.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

Which of the following statements is INCORRECT? Learning Objective 1.1 Describe the organisational structure of the key players in setting IFRSs: *a. The International Accounting Standards Board was replaced by the International Standards Committee in 2001. b. The International Accounting Standards Board is funded by the IASC Foundation. c. The responsibility for issuing International Financial Reporting Standards lies with the International Accounting Standards Board. d. Members of the International Accounting Standards Board are appointed by the IFRS Foundation.

Which of the following bodies report to the IFRS Foundation? Learning Objective 1.1 Describe the organisational structure of the key players in setting IFRSs: a. The IASB and AASB b. The IASB, AASB and the IFRS Advisory Council c. The IASB and the FASB *d. The IASB and the IFRS Advisory Council

Which of the following statements is INCORRECT? Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why a. The Framework identifies the qualitative characteristics that make information in financial statements useful. *b. The Framework defines principles for accounting recognition, measurement and disclosure. c. The Framework defines the objective of financial statements. d. The Framework defines the basic elements of financial statements and the concepts for recognizing and measuring them in financial statements.

1.2

Chapter 1 The IASB and its Conceptual Framework

Which of the following statements is CORRECT? Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why *a. IAS 8 Accounting Policies, Changes in Accounting Estimates, and Errors requires that The Framework be followed in the absence of a specific standard or interpretation. b. IAS 8 Accounting Policies, Changes in Accounting Estimates, and Errors recommends, but does not require The Framework to be followed in the absence of a specific standard or interpretation. c. The Framework is used solely by the IASB when considering new accounting issues. d. The Framework is non-binding guidance which does not have to be followed by preparers of financial statements.

The Framework focuses on: Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why a. privately owned business entities only. *b. business entities only, including private and state owned business entities. c. business entities, although the concepts may be applied to other types of entities, such as not-for profit entities. d. all types of entities, including business entities, government and not-for profit entities.

General Purpose Financial Statements: Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why a. are only necessary for users who do not have the power to obtain information in addition to that contained within the General Purpose Financial Statement. b. provide all the information that users may need to make economic decisions. c. focus on disclosing information relevant to assessing the ability of an entity to generate future cash flows. *d. meet the information needs that are common to all users.

1.3

Test Bank to accompany Applying IFRS Standards 4e

Which of the following statements is INCORRECT in relation to the preparation of financial statements? Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why a. General Purpose Financial Statements must be prepared in accordance with accounting standards. b. General Purpose Financial Statements are reports intended to meet the information needs common to users who are unable to command the preparation of reports tailored so as to specifically meet all their information needs. *c. The sole objective of a General Purpose Financial Statement is to serve an economic decision making objective. d. The objective of a General Purpose Financial Statement is to provide information useful to users for making and evaluating decisions about the allocation of scarce resources.

Which of the following statements is INCORRECT? Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why a. Information about the variability of profits helps in forecasting future cash flows from an entity’s existing resources. *b. Performance of an entity is determined solely through examination of the Statement of Profit or Loss and Other Comprehensive Income of an entity. c. An entity’s Statement of Cash Flows provides insight into changes in assets and liability balances during an accounting period. d. The Statement of Financial Position presents information relating to economic resources, the financial structure of an entity, liquidity and solvency and capacity to adapt to changes in an entity’s environment.

The purpose of the notes to the financial statements is to: Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why a. explain any resources and obligations not recognised in the Statement of Financial Position b. provide information meeting the disclosure requirements under national laws or regulations. c. disclose risks and uncertainties affecting the entity. *d. all of the above.

1.4

Chapter 1 The IASB and its Conceptual Framework

10.

Which category of user is most likely to be interested primarily in the Statement of Profit or Loss and Other Comprehensive Income of an entity? Learning Objective 1.2 Describe the purpose of a conceptual framework – who uses it and why a. suppliers and trade creditors *b. shareholders c. employees d. lending institutions

11.

The qualitative qualitative characteristics that make information in financial statements useful to investors identified within The Framework are: Learning Objective 1.3 Explain the qualitative characteristics that make information in financial statements useful a. Relevance, faithful representation, timeliness and comparability b. Relevance and faithful representation *c. Relevance, faithful representation, comparability, verifiability, timeliness and understandability d. Comparability, verifiability, timeliness and understandability

12.

Information that is able to confirm or correct past evaluations that have been made by users of financial information is an example of information that satisfies which of the following characteristics of financial information identified in The Framework? Learning Objective 1.3 Explain the qualitative characteristics that make information in financial statements useful a. Understandability *b. Relevance c. Verifiability d. Comparability

13.

An asset is defined in the conceptual framework as: Learning Objective 1.3 Explain the qualitative characteristics that make information in financial statements useful concepts in the IASB Framework. a. a resource controlled by the entity as a result of past events b. a resource controlled by the entity as a result of future events and from which possible future economic benefits may flow to the entity. c. a resource controlled by the entity from which future economic benefits are expected to flow to the entity. *d. a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

1.5

Test Bank to accompany Applying IFRS Standards 4e

14.

A liability is defined in conceptual framework as: Learning Objective 1.3 Explain the qualitative characteristics that make information in financial statements useful concepts in the IASB Framework. a. possible obligation of the entity, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. b. a possible obligation of the entity expected to arise from future events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. *c. a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. d. a present obligation of the entity arising from past events, the settlement of which is expected to result in an inflow to the entity of resources embodying economic benefits.

15.

The fundamental qualitative characteristics that make financial information useful for decision-making are: Learning Objective 1.3 Explain the qualitative characteristics that make information in financial statements useful.

comparability relevance understandability faithful representation a. I; b. II; c. III; *d. IV.

16.

II Yes Yes No No

III No No No No

IV No Yes No Yes

The enhancing qualitative characteristics that make financial information useful for decision-making are: Learning Objective 1.3 Explain the qualitative characteristics that make information in financial statements useful.

comparability verifiability timeliness understandability *a. I; b. II; c. III; d. IV.

17.

I Yes Yes Yes Yes

II Yes Yes No No

III No No No No

IV No Yes No Yes

The going concern assumption underlying the preparation of financial statements is also know as: Learning Objective 1.4 Discuss the going concern assumption underlying the preparation of financial statements

1.6

Chapter 1 The IASB and its Conceptual Framework

*a. b. c. d. 18.

the continuity assumption the matching principle the prudence principle the historical cost measurement basis

If management intends to liquidate the entity’s operations, financial statements are prepared on the basis of Learning Objective 1.4 Discuss the going concern assumption underlying the preparation of financial statements a. b. *c. d.

Historical cost Historical cost with a note that the entity is about to liquidate Expected liquidation values Financial statements do not have to be prepared.

19.

The IASB conceptual framework for financial reporting describes the basic concepts that underlie financial statements and defines: Learning Objective 1.5 Define the basic elements in financial statements – assets, liabilities, equity, income and expenses. a. the principles for measurement; b. disclosure principles; *c. the elements of financial statements d. accounting recognition criteria.

20.

Which of the following income and expense items is NOT recorded initially directly in equity? Learning Objective 1.5 Define the basic elements in financial statements – assets, liabilities, equity, income and expenses *a. The impairment of goodwill in accordance with IAS 36 Impairment of Assets, where the entity is confident that the factors giving rise to the impairment will reverse in a future period. b. An increase in the fair values of land & buildings, where the revaluation method is used to account for land & buildings in accordance with IAS 16 Property, Plant and Equipment. c. Foreign currency translation adjustments arising on the translation of a foreign operations financial statements from their functional currency in accordance with IAS 21 The Effects of Changes in Foreign Exchange Rates. d. None of the above.

21.

Which of the following statements in relation to income is true? Learning Objective 1.6 Explain the principles for recognising the elements of financial statements *a. Gains are normally reported separately from revenue in the Statement of Profit or Loss and Other Comprehensive Income due to the different probabilities attached to that type of income. b. The Framework requires that all items of income are reported on a net basis. c. Gains and revenue are different in nature and therefore are recognised as separate elements of the financial statements per The Framework.

1.7

Test Bank to accompany Applying IFRS Standards 4e

The Framework defines income as an increase in economic benefits which results in an increase in equity.

22.

Which of the following statements is INCORRECT in relation to the recognition criteria for elements of the financial statements? Learning Objective 1.6 Explain the principles for recognising the elements of financial statements a. Assets are recognised when it is probable that future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. b. Because equity is the arithmetic difference between assets and liabilities, a separate recognition criteria for equity is not needed in The Framework. c. Liabilities are recognised when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which settlement will take place can be measured reliably. *d. Income is recognised when an increase in future economic benefits related to a decrease in an asset or an increase in a liability that has arisen can be measured reliably.

23.

In relation to the concept of recognition of an item in the financial statements: Learning Objective 1.6 Explain the principles for recognising the elements of financial statements a. Items of equity must satisfy both the probability and measurement criteria before they can be recognised. b. Assets can only be recognised where there is a high probability of future economic benefits flowing to the entity. c. Expenses are recognised when a decrease in a future economic benefit related to an increase in an asset or a decrease in a liability has arisen that can be measured reliably. *d. For items to qualify for recognition in the financial statements as liabilities or income they must first satisfy the definition of an element, and then meet both the probability and measurement requirements in relation to recognition.

24.

In accordance with the conceptual framework, income is recognised in the statement of profit or loss and other comprehensive income when: Learning Objective 1.6 Explain the principles for recognising the elements of financial statements. a. an decrease in future economic benefits relating to an decrease in an asset or an increase in a liability can be measured reliably. *b. an increase in future economic benefits relating to an increase in an asset or a decrease in a liability can be measured reliably. c. an increase in future economic benefits relating to an increase in an asset can be measured reliably. d. an increase in future economic benefits relating to an decrease in an asset or an increase in a liability can be measured reliably.

25.

Expenses are recognised in the statement of profit or loss and other comprehensive

1.8

Chapter 1 The IASB and its Conceptual Framework

income when: Learning Objective 1.6 Explain the principles for recognising the elements of financial statements. a. increase in future economic benefits related to a increase in an asset or an increase in a liability can be measured reliably. *b. a decrease in future economic benefits related to a decrease in an asset or an increase in a liability can be measured reliably. c. a decrease in future economic benefits related to a decrease in an asset or a decrease in a liability can be measured reliably. d. none of the options are correct.

26.

In relation to measurement of the elements of financial statements Learning Objective 1.7 Distinguish between alternative bases for measuring the elements of financial statements *a. The Framework acknowledges that a variety of measurement bases are used to different degrees and in varying combinations in financial statements. b. The Framework includes detailed concepts and principles for selecting which measurement basis should be used for particular elements of financial statements. c. Net realisable value is the preferred basis for measurement of assets. d. The Framework adopts a mixed attribute accounting model

27.

The measurement method most commonly used in the preparation of financial statements is: Learning Objective 1.7 Distinguish between alternative bases for measuring the elements of financial statements: a. present value; b. current cost; c. realisable value; *d. historical cost.

1.9

Exercises Exercise 1.9 ★

Exercise 1.10 ★

Exercise 1.11 ★

Exercise 1.12 ★

Exercise 1.13 ★

Exercise 1.14 ★

Exercise 1.15 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

RELEVANT INFORMATION FOR AN INVESTMENT COMPANY

A year ago you bought shares of stock in an investment company. The investment company in turn buys, holds and sells shares of business enterprises. You want to use the financial statements of the investment company to assess its performance over the past year. (a) What financial information about the investment company’s holdings would be most relevant to you? (b) The investment company earns profits from appreciation of its investment securities and from dividends received. How would the concepts of recognition in the Conceptual Framework apply here? FINANCIAL STATEMENTS OF A REAL ESTATE INVESTOR

An entity purchases a rental property for $10 000 000 as an investment. The building is fully rented and is in a prosperous area. At the end of the current year, the entity hires an appraiser who reports that the fair value of the building is $15 000 000 plus or minus 10%. Depreciating the building over 50 years would reduce the carrying amount to $9 800 000. (a) What are the relevance and faithful representation considerations in deciding how to measure the building in the entity’s ﬁnancial statements? (b) Does the Conceptual Framework lead to measuring the building at $15 000 000? Or at $9 800 000? Or at some other amount? MEANING OF ‘DECISION USEFUL’

What is meant by saying that accounting information should be ‘decision useful’? Provide examples.

PERFORMANCE OF A BUSINESS ENTITY

A ﬁnancial analyst says: ‘I advise my clients to invest for the long term. Buy good stocks and hang onto them. Therefore, I am interested in a company’s long-term earning power. Accounting standards that result in earnings volatility obscure long-term earning power. Accounting should report earning power by deferring and amortising costs and revenues.’ How does the Conceptual Framework relate to this analyst’s view of ﬁnancial statements? GOING CONCERN

What measurement principles might be most appropriate for a company that has ceased to be a going concern (e.g. it is unable to renew loans and is planning to sell major assets needed for existing operations in order to repay creditors)? DEFINITIONS AND RECOGNITION CRITERIA

Explain how you would account for the following items, justifying your answer by reference to the definitions and recognition criteria in the Conceptual Framework. Also state, where appropriate, which ledger accounts should be debited and credited. (a) (i) Your firm has been sued for negligence — likely you will lose the case. (ii) Your firm has been sued for negligence — likely you will win the case. (b) Obsolete plant now retired from use. (c) Receipt of a donation of $10 000. DEFINITIONS AND RECOGNITION CRITERIA

Glasgow Accounting Services has just invoiced one of its clients $3600 for accounting services provided to the client. Explain how Glasgow Accounting Services should recognise this event, justifying your answer by reference to relevant Conceptual Framework deﬁnitions and recognition criteria.

CHAPTER 1 The IASB and its Conceptual Framework

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised by Gilad Livne

John Wiley & Sons, Ltd, 2016

Chapter 2: Owners’ equity: share capital and reserves

Chapter 2 – Owners’ equity: share capital and reserves Discussion Questions 1.

Discuss the nature of a reserve. How do reserves differ from the other main components of equity? Under international accounting standards there are 2 forms of equity: - contributed equity: inflows from equity contributors (e.g., share capital and share premium) reserves See para 4.20 of the IASB’s Conceptual Framework (2010). Reserves arise as a result of increases in equity other than from contributions from equity participants. They may arise from various actions: - earnings of profits [retained earnings] - increases in the fair value of assets [asset revaluation surplus] Unlike share capital, reserves are not created via cash flows into the entity. Dividends may be paid out of reserves, but not out of capital.

A company announces a final dividend at the end of the financial year. Discuss whether a dividend payable should be recognised. Note paras. 12 and 13 of IAS 10. Note also IFRIC 17 “Distributions of Non-cash Assets to Owners” (effective 1 July 2009): A dividend payable should be recognised when the dividend is appropriately authorised and is no longer at the discretion of the entity. If a dividend is not declared at end of reporting period, no liability is recognised. If a liability is declared after end of reporting period, a liability is recognised only if the dividends are appropriately authorised and no longer at the discretion of the entity. For example, if the payment of dividends requires the approval of shareholders at a forthcoming AGM, then they are still at the discretion of the entity and no liability is raised. The reason for this treatment is that no present obligation exists while an entity still has discretion in relation to payment.

2.1

Solutions Manual to accompany Applying IFRS 4e

The telecommunications industry in a particular country has been a part of the public sector. As a part of its privatisation agenda, the government decided to establish a limited liability company called Telecom Plus, with the issue of 10 million $3 shares. These shares were to be offered to the citizens of the country. The terms of issue were such that investors had to pay $2 on application and the other $1 per share would be called at a later time. Discuss: (a) The nature of the limited liability company, and in particular the financial obligations of acquirers of shares in the company. (b) The journal entries that would be required if applications were received for 11 million shares. The answer to this question may depend on local jurisdictional arrangements. In general: The nature of a limited liability company is such that shareholders’ liability is limited to the issue price of a share. If the shares are issued at par value, the liability is limited to payment of that par value per share. If shares are issued at a given price, the limitation is to that price. The journal entries are – assuming that applications were received for 10 million shares: Cash

Dr Cr

Share capital (Issue of shares)

20 000 000 20 000 000

Alternatively, the following entries can also be used:

Cash Trust Application (Receipt of application money)

Dr Cr

20 000 000

Application Share capital (Issue of shares)

Dr Cr

20 000 000

Dr Cr

20 000 000

Cash Cash trust (Transfer from cash trust on issue of shares)

20 000 000

Why would a company wish to buy back its own shares? Discuss. Companies may undertake a buy-back of shares: -

to increase the worth per share of the remaining outstanding shares. However, this would happen only when the purchase price is below the market price of the shares. When the buy-back is at the market price, there will be no effect of the worth of the remaining shares outstanding. as a part of management of the capital structure in terms of gearing. efficiently manage surplus funds, rather than pay a dividend. Form a tax perspective. This is the case when capital gain tax is lower than tax on dividends.

A company has a share capital consisting of 100 000 shares issued at $2 per share, and 50 000 shares issued at $3 per share. Discuss the effects on the accounts if: (a) The company buys back 20 000 shares at $4 per share (b) The company buys back 20 000 shares at $2.50 per share

2.2

Chapter 2: Owners’ equity: share capital and reserves

At date of buyback, the company has issued 150 000 shares and has a total share capital of $350 000. Having issued the shares, the issue price is irrelevant. (a)

If the company buys back 20 000 shares at $4 per share, the company will record a cash receipt of $80 000. Which equity accounts it adjusts is the decision of management, but typically treasury shares account will be used. There is no requirement that share capital be reduced, unless the shares are cancelled.

(b)

The answer is the same if the shares are bought back at $2.50 per share.

A company has a share capital consisting of 100 000 shares having a par value of $1 per share and issued at a premium of $1 per share, and 50 000 shares issued at $2 par and $1 premium. Discuss the effects on the accounts if: (a) The company buys back 20 000 shares at $4 per share (b) The company buys back 20 000 shares at $2.50 share The share capital consists of: 100 000 $1 shares issued at a $1 premium 50 000 $2 shares issued at a $1 premium

$200 000 $150 000

(a) $80 000 is used and hence treasury shares account (a contra equity account) will be debited by this amount. (b) $50 000 is used and hence treasury shares account (a contra equity account) will be debited by this amount.

What is a rights issue? Distinguish between a tradeable and a non-tradeable issue. A rights issue is an issue of shares with the terms of issue giving existing shareholders the right to an additional number of shares in proportion to their current shareholding, i.e. the shares are offered on a pro rata basis. For example, each shareholder may be entitled to one share for every two currently held. Tradeable: existing shareholders may - accept the offer i.e. exercise the rights. - sell all or part of their rights to the new shares to another party. - do nothing i.e. reject the offer. Non-tradeable: existing shareholders may: - do nothing i.e. reject the offer. - accept the offer.

What is a private placement of shares? Outline its advantages and disadvantages. A private placement is where a company places the shares with specific investors rather than invite applications for the new issue of shares. Advantages [see text]: - speed - price - direction - prospectus Disadvantages; - dilution of current shareholders’ interests. - where shares are placed at a discount.

2.3

Solutions Manual to accompany Applying IFRS 4e

Discuss whether it is necessary to distinguish between the different components of equity rather than just having a single number for shareholders’ equity. The question is whether an investor would prefer to invest in Company A or Company B assuming the net assets of the company are the same: Company A

Company B

$100 000 30 000 40 000 170 000

$20 000 60 000 90 000 170 000

Share capital General reserve Retained earnings

In general the composition of equity is irrelevant. Composition may be relevant where local laws place restrictions on what can be done with particular equity accounts e.g. if dividends may be paid only out of profits.

10.

For what reasons may a company make an appropriation of its retained earnings? Appropriations from retained earnings are made for: - dividends, cash or shares - transfer to other reserves May also like to consider how increases in retained earnings occur: - earning of profit - transfers from reserves - recognition of actuarial gains and losses under IFRS 4 [note here that in all other cases amounts recognised directly in equity are taken to reserve accounts rather than to retained earnings]

Exercises Exercise 2.1

RESERVES AND DIVIDENDS

Prepare journal entries to record the following unrelated transactions of a public company: (a) payment of interim dividend of €30 000 (b) transfer of €52 000 from the asset revaluation surplus to the general reserve (c) transfer of €34 000 from the general reserve to retained earnings (d) payment of 240 000 bonus shares, fully paid, at €2 per share from the general reserve.

(a)

(b)

(c)

Dividend paid Cash (Payment of dividend)

Dr Cr

30 000

Asset revaluation reserve General reserve (Transfer between reserves)

Dr Cr

52 000

General reserve Retained earnings (Transfer between reserves)

Dr Cr

34 000

30 000

52 000

34 000

2.4

Chapter 2: Owners’ equity: share capital and reserves

(d)

General reserve Share capital (Bonus issue: 240 000 shares at €2 each)

Exercise 2.2

Dr Cr

480 000 480 000

RIGHTS ISSUE

(a) If 80% of the rights were exercised by the due date, provide journal entries made by Property Ltd in relation to the rights issue and the eventual share issue. (b) If the rights issue was not underwritten and any unexercised rights lapsed, what would be the required journal entries? PROPERTY LTD (a) The net effect can be recorded in a single entry: Cash

990 000

Share capital

990 000

Alternatively, the process can be fully recorded as: 15/2 to 15/3

Cash

Dr Cr

800 000

Application – rights issue Receivable from underwriter Share capital (Issue of shares)

Dr Dr Cr

800 000 200 000

Share capital Cash (Costs of share issue)

Dr Cr

10 000

Dr Cr

200 000

Application – rights issue (Money received on applications for rights issue: 160 000 x $5) 15/3

800 000

1 000 000

10 000

Sometime later: Cash Receivable from underwriter (Money received from underwriter)

200 000

(b) The net effect can be recorded in a single entry: Cash

790 000

Share capital

790 000

Alternatively, the process can be fully recorded as: 15/2 to 15/3

Cash Application – rights issue (Money received on applications for rights issue)

15/3

Application – rights issue

Dr Cr

800 000

2.5

Solutions Manual to accompany Applying IFRS 4e

Share capital (Issue of shares)

Share capital Cash (Costs of share issue)

Dr Cr

Exercise 2.3

800 000

10 000 10 000

SHARE ISSUE, OPTIONS

Prepare the journal entries in the records of Jordan Ltd in relation to the equity transactions in 2016. JORDAN LTD 25/3

Cash Equity (temporary account) (Applications for shares and options)

Dr Cr

760 000 7650 000

Note: The cash is typically placed in a special account until shares are issued. Then it is transferred to an ordinary bank account. 2/4

31/12

Equity (temp. acct.) Share capital (Issue of shares)

Dr Cr

600 000

Equity (temp. acct.) Cash (Refund to unsuccessful applicants)

Dr Cr

150 000

Equity (temp. acct.) Cash Share capital (Issue of shares on issue of options)

Dr Dr Cr

9 000 63 000

Equity (temp. acct) Reserves (Transfer of lapsed options)

Dr Cr

1 000

Note: share capital.

600 000

150 000

72 000

1 000

the choice of reserve for the £1 000 for lapsed options could have be included in

2.6

Chapter 2: Owners’ equity: share capital and reserves

Exercise 2.4

ISSUE OF ORDINARY AND PREFERENCE SHARES

Prepare journal entries and ledger accounts to record the following transactions for Kahuna Ltd: KAHUNA LTD

2016 01/4

NO ENTRY

10/4

Cash

15/4

Equity (temp. acct.) Share capital – ordinary (Issue of 100 000 shares at €1.50 each)

Dr Cr

150 000

Equity (temp. acct.) Receivable from underwriter Share capital – preference (Issue of 100 000 shares at €2 each)

Dr Dr Cr

170 000 30 000

Equity (temp. acct.) Cash (Refund to unsuccessful applicants: 40 000 x €1.50)

Dr Cr

60 000

Share capital – preference Share capital – ordinary Cash Receivable from Underwriter (Costs of underwriting and receipt of application monies due from underwriter)

Dr Dr Dr Cr

4 000 500 25 500

Dr 380 000 Equity(temporary account) Cr 380 000 (Applications for ordinary and preference shares: 140 000 x €1.50 + 85 000 x €2) Note: The cash is typically placed in a special account until shares are issued. Then it is transferred to an ordinary bank account.

20/4

150 000

200 000

60 000

30 000

2.7

Solutions Manual to accompany Applying IFRS 4e

Exercise 2.5

SHARE ISSUE, OPTIONS

Prepare general journal entries to record the above transactions. BORON LTD GENERAL JOURNAL ENTRIES DATE

DETAILS

25/07/15

Other receivables (preference shareholders) Share capital – preference (50 000 shares x $1.00)

Dr Cr

50 000

Cash Other receivables (preference shareholders) (50 000 – 7 500 = 42 500 shares x $1.00)

Dr Cr

42 500

Share capital – preference (7 500 x $3.00) Call – preference (7 500 x $1.00) Capital redemption reserve (7 500 x $2.00)

Dr Cr Cr

22 500

Cash Equity (temporary account) (40 000 x $3.00)

Dr Cr

120 000

Equity (temporary account) Share capital – B ordinary (30 000 shares x $3.00)

Dr Cr

90 000

Equity (temporary account) Other payables (10 000 applications x $3.00)

Dr Cr

30 000

Share capital B Ordinary Cash (Share issue costs) Cash Share capital – A ordinary (15 000 shares x $4.50)

Dr Cr

5 200

Dr Cr

67 500

Options Share capital – A ordinary (15 000 x $0.56) Reserves (5 000 x $0.56)

Dr Cr Cr

11 200

31/08/15

07/09/15

30/11/15

01/12/15

5/12/15

30/04/16

50 000

42 500

7 500 15 000

120 000

90 000

30 000

5 200

67 500

8 400 2 800

Note: the choice of the specific reserve account is unspecified.

2.8

Chapter 2: Owners’ equity: share capital and reserves

Exercise 2.6

BUY-BACK OF SHARES

(a) Prepare the journal entries to account for the buy-back. Explain the reasons for the entries made. (b) Assume that the buy-back price per share was equal to 70p per share. Prepare journal entries to record the buy-back, and explain your answer. (c) Assume that, instead of the share capital shown above, Victor Ltd had issued 1 million shares at a par value of £1 and a share premium of £3 per share. Rework your answers to (a) assuming the repurchased shares were subsequently cancelled (ignore costs of buy-back scheme). VICTOR LTD General Journal (a)

Treasury shares Dr 2 243 500 Cash Cr (Repurchase of 400 000 ordinary shares at $5.60 under a buy-back scheme plus $3 500 costs)

2 243 500

(b)

(c)

Treasury shares Cash (Repurchase of 400 000 ordinary shares at $0.70 under a buy-back scheme)

Dr Cr

283 500

Treasury shares Cash

Dr Cr

560 000

Dr Dr Dr

260 000 100 000 300 000

283 500

560 000

(Repurchase of 400 000 ordinary shares at $5.60 under a buy-back scheme) General reserve Share capital Share premium reserve

Treasury shares Cr Capital redemption reserve Cr (Cancellation of 100 000 ordinary shares under a buy-back scheme plus costs)

560 000 100 000

2.9

Solutions Manual to accompany Applying IFRS 4e

Exercise 2.7

SHARES, OPTIONS, DIVIDENDS AND RESERVE TRANSFERS

(a) Prepare general journal entries to record the above transactions. (b) Prepare the equity section of the statement of financial position as at 30 June 2016. MONDEGREEN INC. (a) 2015 15/9

Retained earnings Cash (Payment of preference dividend)

Dr Cr

4 500

Retained earnings Cash (Payment of dividend of 16c per share on 400 000 A shares)

Dr Cr

64 000

‘Retained earnings Cash (Payment of dividend of 60% x 16c per share on 300 000 B shares)

Dr Cr

28 800

4 500

64 000

28 800

30/11

Cash Dr 114 00 Receivable – underwriter Dr 35 00 Share capital – Ordinary A Cr 149 000 (Issue of 80 000 shares at $1.90 each, 20 000 of which issued to underwriter less a commission of $3 000)

10/12

Cash

Dr Cr

35 000

Retained earnings General reserve (Transfer between reserves)

Dr Cr

35 000

Cash Options reserve*

Dr Dr

126 000 21 000

Receivable – underwriter (Payment from underwriter net of costs)

35 000

2016

28/2

35 000

Share capital – Ordinary C Cr 147 000 (Exercise of 35 000 options, out of 40 000, and issue of 70 000 ordinary C shares) * Note: the issue price of lapsed options may be taken to any equity account, or left in an options “reserve” account. Legal and taxation implications must be considered.

30/4

31/5

Other receivables (Call – Ordinary B) Share capital – Ordinary B (Call of 80c per share on 300 000 shares)

Dr Cr

240 000

Cash

Dr Cr

228 000 228 000

Other receivables (Call – Ordinary B) (Receipt of 80c call on 285 000 shares)

240 000

18/6 Treasury shares

12 000

2.10

Chapter 2: Owners’ equity: share capital and reserves

26/6

Other receivables (Call – Ordinary B)Cr (Transfer of unpaid amount on Ordinary B to Treasury)

12 000

Cash

27 000

Other payables Cr 15 000 Treasury shares 12 000 (Reissue of 15 000 Ordinary B shares for $27 000 and establishing a liability for shares to be repaid at $1 each) 27/6

Other payables B Cash (Refund to holders of forfeited shares)

Dr Cr

15 000

15 000 15 000

30/6 Until authorised, the declared dividend cannot be recognised.

(b) MONDEGREEN INC. Shareholders’ Equity Share capital: Ordinary A shares: 480 000 shares fully paid Ordinary B shares: 300 000 shares fully paid Ordinary C shares: 70 000 fully paid Preference shares: 50 000 fully paid General reserve Options reserve Retained earnings Total shareholders’ equity

$949 0001 600 0002 147 000 75 000 1 771 000 35 000 3 000 283 0003 $2 092 000

1 $800 000 + $149 000 2 $360 000 + $240 000 3 $318 000 - $35 000

2.11

Solutions Manual to accompany Applying IFRS 4e

Exercise 2.8

DIVIDENDS, SHARE ISSUES, SHARE BUY-BACK, OPTIONS AND MOVEMENTS IN RESERVES

(a) Prepare the general journal entries to record the above transactions. (b) Prepare the statement of changes in equity for Hide Ltd for the year ended 31 December 2016. HIDE LTD 2016 15/2

Dividend payable Cash (Payment of dividend)

Dr Cr

25 000

Cash

Dr Cr

550 000

Dr Cr

825 000

Share capital Dr Cash Cr (Share issue costs: 10%[€550 000 + €825 000])

137 500

Dividend paid Cash (Interim dividend paid)

Dr Cr

20 000

Land

Dr Cr Cr

30 000

Dr Cr

55 000

Treasury shares Dr Cash Cr (Repurchase of 5 000 shares at €56 per share)

280 000

General reserve Dr Share capital Cr (Bonus issue of 6 500 shares at $30 each: No. of shares = 5%[110 000 + + 25 000 – 5 000])

195 000

Share capital Cash (Share issue costs: 10% x €195 000)

Dr Cr

19 500

Cash

Dr Cr

20 000

25 000

20 June 20/6

Share capital (Transfer on issue of shares)

Cash Share capital (Placement of shares: 15 000 x €55)

25/6

30/6

Deferred tax liability Asset revaluation reserve (Revaluation of land) 1/7

Retained earnings Provision for insurance (Adjustment on early adoption of IFRS 4)

550 000

825 000

137 500

20 000

9 000 21 000

55 000

22/7

16/11

1/12

Options

280 000

195 000

19 500

20 000

2.12

Chapter 2: Owners’ equity: share capital and reserves

(Issue of options: 100 000 x 20c) 31/12

Retained earnings Dividend payable (Final dividend)

Dr Cr

30 000

Retained earnings General reserve (Transfer between reserves)

Dr Cr

40 000

Asset revaluation reserve Retained earnings (Transfer between reserves)

Dr Cr

30 000

Profit and Loss Summary

150 000

Retained earnings

30 000

40 000

30 000

150 000

(Closing entry) Statement of Changes in Equity for year ended 31 December 2016

Comprehensive income for the period

€171 0001

Share capital: Balance at 1 January 2016 – 110 000 shares Share issues: 25 000 shares

€3 590 000 1 237 500

Bonus issue: 6 500 shares Balance at 31 December 2016 – 141 500 shares

175 500 €5 003 000

Treasury shares Balance at 1 January 2016 – 000 shares Repurchase of shares: 5 000 shares Balance at 31 December 2016 – 5 000 shares

€0 (280 000) (280 000)

Retained earnings: Balance at 1 January 2016 Profit for the period Transfer from asset revaluation surplus Dividends declared and paid Early adoption of IFRS 4

€750 000 150 000 30 000 (50 000) (55 000)

Transfer to general reserve Balance at 31 December 2016

(40 000) €785 000

Asset revaluation reserve Balance at 1 January 2016 Increase – revaluation of land Transfer to retained earnings Balance at 31 December 2016

€180 000 21 000 (30 000) €171 000

General reserve: Balance at 1 January 2016 Bonus issue of shares Transfer from retained earnings Balance at 31 December 2016

€240 000 (175 500) 40 000 €104 500

2.13

Solutions Manual to accompany Applying IFRS 4e

Options: Balance at 1 January 2016 Options issued Balance at 31 December 2016

€0 20 000 €20 000 €150 000 21 000 €171 000

1 Profit for the year

Asset revaluation

Statement of Financial Position (extract) 2016 Share capital €5 003 000 Treasury shares (280 000) Options 20 000 General reserve 104 500 Asset revaluation reserve 171 000 Retained earnings 785 000 €5 803 500

Exercise 2.9

2015 €3 590 000 0 0 240 000 180 000 750 000 €4 760 000

DIVIDENDS, SHARE-ISSUES, OPTIONS, RESERVE TRANSFERS

(a) Prepare general journal entries and closing entries to record the above transactions and events. (b) Prepare reconciliations for the following general accounts for the period 30 June 2016 to 30 June 2019: • Share capital (Ordinary ‘A’) • Share capital (Ordinary ‘B’) • Share capital (Preference). MERCURY PLC (a) 2016 30/09

31/10

JOURNAL ENTRIES

Retained earnings Cash ([Ord A: 120 000 x 10p = 12 000] + [Ord B: 150 000 x 10p x 105/180 = 8 750] + [Pref: 100 000 x 8% = 8 000])

Dr Cr

28 750

Cash Equity (options) (Issuing 50 000 options as 80p each)

Dr Cr

40 000

Other receivables (call on Ordinary B) Calls in advance Share cap (Ordinary B) (Ord B call: 150 000 x 50p)

Dr Dr Cr

60 000 15 000

28 750

NO ENTRY

30/11

2017 15/01

40 000

75 000

2.14

Chapter 2: Owners’ equity: share capital and reserves

15/02

20/04

Cash Other receivables (Call on Ordinary B) (Call monies received: 75 000 – 15 000)

Dr Cr

60 000

Share capital (Preference) Dr Reatined earnings Dr Cash Cr (Buyback of 50 000 pref shares @ £1.10/share)

50 000 5 000

General reserve Retained earnings (Transfer from general reserve)

Dr Cr

20 000

P&L summary

44 000

Retained earnings (Retaining profit for the year)

60 000

55 000

30/06

20 000

44 000

30/09

Retained earnings Dr 31 000 Cash Cr 31 000 (Payment of final dividend: Ord A+B: (150 000 + 120 000) x 10p = £27 000; Pref dividend: £50 000 x 8% = £4 000)

15/12

Retained earnings Cash ([Ord A: 120 000 x 5p = 6 000] [Ord B: 150 000 x 5p = 7 500])

2018 31/1 28/02

15/03

30/06

30/11

Dr Cr

13 500

Other receivables (Rights on Ordinary B) Share capital (Ordinary B) (120 000/5 = 24 000 Ord B shares issued - rights issue at £1.50 per share)

Dr Cr

36 000

Cash Other receivables (Ord B) (Receipt of monies under rights issue)

Dr Cr

36 000

P&L summary

56,000

Retained earnings (Retaining profit for the year)

13 500

NO ENTRY

36 000

56000

General reserve Dr Share capital (Ordinary A) Cr Share capital (Ordinary B) Cr Share capital (Preference) Cr (1-for-10 bonus issue: [Ord A: 120 000/10 x £1.20 = 14 400] [Ord B: {150 000+24 000}/10 x £1.60 = 27 840] [Pref: 50 000/10 x £1.15 = 5 750])

47 990

Equity (options) Other receivables (options on Ord A)

40 000 28 000

Dr Dr

14 400 27 840 5 750

2.15

Solutions Manual to accompany Applying IFRS 4e

Share capital (Ordinary A)

68 000

(Exercise of 40 000 options at 70p each and transferring £40 000 received on 30 November 2016 into share capital of Ordinary A)

20/12

2019 10/01

Cash Other receivables (options on Ordinary A) (Receipt of monies under option issue)

Dr Cr

28 000

Retained earnings Dr Cash Cr ([Ord A: {120 000 + 12 000 + 40 000} x 5p = 8 600] [Ord B: {150 + 24 + 17 400} x 5p = 9 570])

18 170

P&L summary Retained earnings

48 000

28 000

18 170

30/06 Dr Cr

48 000

(Retaining profit for the year)

(b)

Reconciliations SHARE CAPITAL (ORDINARY ‘A’)

Balance 30 June 2016 Balance 30 June 2017 Bonus issue Balance 30 June 2018 Shares issued (exercise of options) Balance 30 June 2019

132 000 132 000 14 400 146 400 68 000 214 400

SHARE CAPITAL (ORDINARY ‘B’) Balance 30 June 2016 Call issue Balance 30 June 2017 Bonus and rights issues Balance 30 June 2018 Balance 30 June 2019

105 000 75 000 180 000 63 840 243 840 243 840

SHARE CAPITAL (PREFERENCE)

Balance 30 June 2016 Cancellation Balance 30 June 2017 Bonus and rights issues Balance 30 June 2018 Balance 30 June 2019

100 000 (50 000) 50 000 5 750 50 750 50 750

2.16

Chapter 2: Owners’ equity: share capital and reserves

Exercise 2.10

DIVIDENDS

Determine how much each class of shares should receive under the following situations: (a) the preference shares are non-cumulative and non-participating (b) the preference shares are cumulative and non-participating (c) the preference shares are cumulative and participating. Assume that the participation agreement requires that the ordinary shareholders receive the same percentage of dividend as the preference shareholders, and that any balance of dividends to be paid is shared in proportion to the issued share capital of each class. INDIA LTD (a)

Preference shares Ordinary shares

$20 000 = $200 000 x 10% $80 000 = $100 000 - 20 000

(b)

Preference share Ordinary shares

$60 000 = 3 x $200 000 x 10% $40 000 = $100 000 - 60 000

(c)

Preference shares Ordinary shares

$70 000 $30 000

Baseline ordinary dividend is 10% x 40 000 x $5 = $20 000. Hence, after paying preferred dividend of $60 000 and ordinary dividend of $20 000 the remaining $20 000 is split equally.

Exercise 2.11

DIVIDENDS, CALLS ON SHARES AND BONUS ISSUE

(a) Prepare the journal entries to give effect to the above events. (b) Prepare the equity section of the statement of financial position at 31 December 2015. JAPAN LTD General Journal (a) 2015 June 25

July 10

Dividend paid Cash (Interim dividend of 10c per share on 600 000 fully paid shares and 5c per share on 400 000 partly paid shares)

Dr Cr

80 000

Other receivables Share capital (Final call on 400 000 shares at 50c)

Dr Cr

200 000

Cash Other receivables (Cash received on call)

Dr Cr

200 000

General reserve

100 000

80 000

200 000

September 15

200 000

2.17

Solutions Manual to accompany Applying IFRS 4e

December 31

Share capital (1-10 bonus issue on 1 000 000 shares from general reserve)

Profit and loss summary

Retained earnings

100 000

60 000 60 000

Since the dividend has not been approved, there is no need to recognise a liability. (b) JAPAN LTD Statement of Financial Position [extract] (as at 31 December 2015) Share capital: (1 100 000 shares fully paid) General reserve Plant maintenance reserve Retained earnings

Exercise 2.12

$1 100 000 100 000 50 000 __60 000 $1 310 000

RIGHTS ISSUE, PLACEMENT OF SHARES

Prepare the general journal entries to record the above transactions. IRAQ LTD 31/3

Cash

Dr Cr

200 000

Share capital Cash (Share issue costs)

Dr Cr

5 000

Cash

Dr Cr

20 000

Share capital (Exercise of 100 000 rights at $2 each)

30/6

Share capital (Placement of 10 000 shares at $2)

Exercise 2.13

200 000

5 000

20 000

ISSUE OF OPTION AND SHARES, FORFEITURE OF SHARES

Pass the necessary entries to record the following transactions for Nepal Ltd. NEPAL LTD 2015 01/7

NO ENTRY

21/7

Cash

Dr Equity (temporary account)

310 000 Cr

310 000

2.18

Chapter 2: Owners’ equity: share capital and reserves

(Applications for ordinary and preference shares: 120 000 x $2.00 + 35 000 x $2.00) 31/7

Equity (temp. acct.) Share capital – ordinary (Issue of 100 000 shares at $2.00 each)

Dr Cr

200 000 200 000

Equity (temp. acct.) Dr 70 000 Receivable from underwriter Dr 30 000 Share capital – preference Cr 100 000 (Issue of 35 000 preference shares at $2 each to the public, and 15 000 preference shares at $2 to underwriter) 14/8

1/12

Share capital – preference Share capital – ordinary Cash Receivable from underwriter (Costs of underwriting and receipt of application monies due from underwriter)

Dr Dr Dr Cr

3 250 3 250 23 500 30 000

No entry

2016 1/6

10/6

15/6

Cash Share capital - ordinary

Dr Cr

108 000 108 000

(Exercise of 40 000 options at $2.7 each and issuing 40 000 shares) Cash Dr 95 000 Share capital - ordinary Cr 95 000 ($95 000 received from call on 100 000 ordinary shares for $1 each; only $95 000 received) Share capital - ordinary Capital redemption reserve

Dr Cr

10 000 10 000

Cancellation of 5 000 ordinary shares at $2 each.

Exercise 2.14

RIGHTS ISSUE, CALL ON SHARES, ISSUE OF OPTIONS

Prepare journal entries to record the above transactions in the records of Syria Ltd. SYRIA LTD General Journal 2014 Nov 30

Cash Share capital - B Ordinary (Allotment of 8 000 B ordinary shares at a price of $2.25 under a 1 for 5 rights issue)

2015 Jan 16

Other receivables (A Ordinary Shareholders) Share Capital - A Ordinary (Call of 75c per share on 120 000 A Ordinary shares)

Dr Cr

18 000

90 000

18 000

90 000

2.19

Solutions Manual to accompany Applying IFRS 4e

Jan 31

Cash

Dr Cr

82 500

Share Capital - A Ordinary Dr Other receivables Cr Capital redemption reserve Cr (Cancellation of 10 000 A ordinary shares, called to $1.50, paid to 75c)

15 000

Other receivables (Cash received on call: 110 000 x 75c) Feb 5

Mar 17-31 Cash

7 500 7 500

Dr Cr

21 000

Cash Dr Equity Dr Share capital - A Ordinary* Cr (Allotment of 25 000 A ordinary shares at $1.78 on exercise of 25 000 options)

44 500 15 000

Equity – options (Issuing 35 000 options for $0.60 each)

Dec 31

82 500

21 000

59 500

* Note: the issue price of lapsed options may be taken to any equity account, or left in any “reserve” account (as is the case in this solution). Legal and taxation implications must be considered. Share Capital – A Ordinary Cash (Payment of share issue costs)

Exercise 2.15

Dr Cr

2 000 2 000

SHARE ISSUE, OPTIONS, STATEMENT OF CHANGES IN EQUITY

(a) Prepare general journal entries, including any closing entries required, to record the above transactions. (Narrations are not required, but show all workings.) (b) Prepare a statement of changes in equity for the year ended 30 June 2014. (c) Taiwan Ltd has recognised a ‘Forfeited shares reserve’ as part of equity. Explain how and why such a reserve would be created. TAIWAN LTD

(a) – General Journal Entries

DATE

DETAILS

20/09/13

Retained earnings Dividend payable (120 000 x 6c = $7 200)

Dr Cr

7 200

Dividend payable Cash

Dr Cr

7 200

27/09/13

7 200

2.20

Chapter 2: Owners’ equity: share capital and reserves

31/10/13

05/11/13

Cash Equity (temporary account) (50 000 x $2.00)

Dr Cr

100 000

Equity (temp. acct.) Share capital General reserve

Dr Cr Cr

100 000

Share capital Cash (Share issue costs)

Dr Cr

2 500

Dividend declared Dividend payable ([120 000 + 40 000] x 3c)

Dr Cr

4 800

Dividend payable Cash

Dr Cr

4 800

Cash Share capital (80 000 x $2.90)

Dr Cr

232 000

Other receivables (for options) Share capital (65 000 x $3.00)

Dr Cr

195 000

Options reserve Share capital (Exercise of 65 000 options at $0.50 each)

Dr Cr

32 500

Cash Other receivables

Dr Cr

195 000

Retained earnings General reserve

Dr Cr

30 000

Profit and loss summary

Dr Cr Cr Cr

69 420

100 000

80 000 20 000

(Issuing 40 000 shares at $2.00 each and returning $20 000 over subscription)

15/11/13

31/12/13

01/02/14

28/04/14

02/06/14

21/06/14

30/06/14

Retained earnings (Closing entry to retain current year’s profit)

2500

4 800

232 000

195 000

32 500

195 000

30 000

69 420

2.21

Solutions Manual to accompany Applying IFRS 4e

(b) Taiwan Ltd Statement of Changes in Equity for the year ended 30 June 2014 Comprehensive income for the period

$69 420

Movements of changes in equity during the period ending 30 June 2014 were:

Share capital

30 June 2013 Dividends Shares issued Transfer between reserves Comprehensive income 30 June 2014

300 000

40 000

30 000

537 000

(32 500)

20 000 30 000

837 000

Options reserve

7 500

General reserve

80 000

Capital redemption reserve 2 000

2 000

Retained earnings 75 000 (12 000)

Total

(30 000)

447 000 (12 000) 524 500 0

69 420

102 420

1 028 920

(c) Taiwan Ltd has recognised a “Capital Redemption Reserve” as part of equity. Explain how and why such a reserve would be created. When shares are cancelled, creditor protection rules in many countries require maintenance of capital. Upon cancellation retained profits (or other reserves) are reduced and capital redemption reserve is established.

2.22

Chapter 2: Owners’ equity: share capital and reserves

Exercise 2.16

SHARE ISSUES, OPTIONS, RIGHTS ISSUES, DIVIDENDS, RESERVE TRANSFERS

(a) Prepare general journal entries to record the transactions relating to share issues and options for the year ending 30 June 2014. (b) Prepare general journal entries, including any closing entries required, to record the transactions relating to dividends and reserve transfers for the year ended 30 June 2014. (c) If the company’s constitution required all dividends to be approved by the shareholders at the annual general meeting before they could be paid, explain how and why your recording of the dividend payment on 29 September 2013 would change. Assume shareholder approval was granted on 20 September 2013.

YEMEN LTD (a) GENERAL JOURNAL ENTRIES DATE

DETAILS

01/09/13

Other receivables (Applications: preference shares) Receivable from underwriter Share capital - preference (280 000/2 = 140 000 x $2.80; receivable from underwrite: $2.80 x40 000/2)

10/09/13

21/09/13

02/04/13

Dr Dr Cr

336000 56 000

Share capital - preference Cash Receivable from underwriter (40 000/2 = 20 000 shares x $2.80 - $5 000 share issue costs)

Dr Dr Cr

5 000 51 000

Cash Other receivables

Dr Cr

336 000

Cash Equity (Options) (80 000 x $0.10)

Dr Cr

8 000

392000

56 000

336000

8 000

(b) 29/09/13

02/01/13

30/06/13

Dividend payable Cash (280 000 x 10c)

Dr Cr

28 000

General reserve Share capital – ordinary (280 000/4 = 70 000 x $3.00)

Dr Cr

210 000

General reserve Retained earnings

Dr Cr

30 000

Retained earnings Dividends payable (Ordinary: (280 000 + 70 000) x 8c = $28 000 Preference: $392 000 x 5% = $19 600)

Dr Cr

47 600

28 000

210 000

30 000

47 600

2.23

Solutions Manual to accompany Applying IFRS 4e

Retained earnings

Dr Cr

36 000

Profit and loss summary

(c)

36 000

IAS 10 mandates that no liability can be raised for dividend declared prior to end of reporting period if shareholder approval is required. As a consequence, no recognition of the dividend would have occurred in the prior period. When the approval is obtained a liability (dividend payable) is established, and then is closed when the dividend is paid.

Exercise 2.17

OPTIONS, SHARES, DIVIDENDS, RESERVES

Provide journal entries in relation to: (a) issue of shares on exercise of options, and related transfers to/from reserves (b) issue of shares to public (c) dividends (d) movements in general reserve. Note: None of the entries should contain the account Retained Earnings. PHILIPPINES LTD DATE (a)

(b)

(c)

(d)

DETAILS Cash Share capital (50 000 x $3.00)

Dr Cr

Options Share capital (50 000 x 0.40) General reserve (10 000 x 0.40)

Dr Cr Cr

24 000

Cash Share capital (80 000 x $2.90)

Dr Cr

252 000

Share capital Cash (Share issue costs)

Dr Cr

2 500

Retained earnings Dividend payable

Dr Cr

8 000

Reatined earnings Cash

Dr Cr

4 000

Transfer to general reserve General reserve

Dr Cr

30 000

General reserve Share capital

Dr Cr

80 000

Dr 150 000

Cr 150 000

20 000 4 000

252 000

2500

8 000

4 000

30 000

80 000

2.24

Chapter 2: Owners’ equity: share capital and reserves

Exercise 2.18

DIVIDENDS, SHARE ISSUES, FORFEITURE OF SHARES

(a) Prepare general journal entries and closing entries to record the above transactions. (b) Prepare the statement of changes in equity for the period 30 June 2012 to 30 June 2013. MALAYSIA LTD 1.

JOURNAL ENTRIES

02/08/11

15/08/11

Final dividend declared Final dividend payable

Dr 11 000 Cr

Final dividend payable Cash

Dr Cr

01/10/11

NO ENTRY

31/10/11

Cash Other creditors (Application - Ordinary) (75 000 x 35c)

02/11/11

11 000 11 000

26 250 26 250

Other creditors (Application - Ordinary) Dr 21 000 Other receivables (Allotment – Ordinary) Dr 21 000 Share capital – Ordinary Cr (60 000 shares issued at 70c per share with 50c per share on call) Share capital Cash (Share issue costs)

30/11/11

Dr Cr

11 000

Dr Cr

1 500

Cash Dr Other receivables (Allotment – Ordinary)Cr

21 000 21 000

42 000

1 500

(Alternatively, if the balance of $5 250 in other creditors is used. Can record: 30/11/11

Cash Dr Other creditors Dr Other receivables (Allotment – Ordinary) Cr

05/01/12

Retained earnings Cash ([100 000 x 5c = 5 000] + [60 000 x 5c x 70/120 = 1 750])

Dr Cr

6 750

Other receivables (Call – Ordinary) Share capital – Ordinary (60 000 x 50c)

Dr Cr

30 000

Cash Other receivables (Call – Ordinary)

Dr Cr

28 500

31/01/12

28/02/12

15 750 5 250 21 000)

6 750

30 000

28 500

20/03/12

Share capital – Ordinary Dr 3 600 Other receivables (Call – Ordinary) Cr 1 500 Capital redemption (reserve Cr 2 100 Cancellation of 3 000 shares at $1.20 each for which 70c was paid each)

31/03/12

Other receivables (options – Ordinary)

13 200

2.25

Solutions Manual to accompany Applying IFRS 4e

Share capital – Ord (12 000 x $1.10)

Options Share capital – Ordinary

Dr Cr

13 200

6 000 6 000

(Capital: 12 000 x 50c Options reserve remaining balance: 1 500 = 3 000 x 50c) 30/04/12

31/05/12

30/06/12

Cash Other receivables (options – Ordinary)

13 200 13 200

General reserve Dr Share capital – Ordinary Cr Share capital – Preference Cr (Ord: [100 000 + 60 000 – 3 000 + 12 000]/4 x $1.20 Pref: 50 000/4 x $1.20)

65 700

P&L summary

29 460

Retained earnings

Dr Cr

50 700 15 000

29 460

Statement of changes in equity

30-Jun-12

Preference shares 5%

Ordinary shares

Options

60 000

112 390

7 500

General Reserve

Capital redemption reserve

123 100

Dividends Transfer between reserves

15 000

Retained earnings

Total

136 340

439 330

(17 750)

50 700

65 700

Share issue

70 500

Share cancellation

(2 100)

Exercise of options

19 200

2 100

13 200

Comprehensive income 30-Jun-13

75 000

250 690

(6 000) 1 500

123 100

2 100

29 460

148 050

600 440

2.26

Testbank to accompany

Applying ® IFRS Standards 4e Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 2: Owners’ equity: share capital and reserves

CHAPTER 2 Owners’ equity: share capital and reserves

Learning Objectives 2.1 Describe the essence of the equity section in the statement of financial position 2.2 Describe in general terms what a for-profit company is 2.3 Outline the key features of the corporate structure 2.4 Discuss the different forms of share capital 2.5 Account for the issue of both no-par and par value shares 2.6 Account for share placements, rights issues, options, and bonus issues 2.7 Discuss the rationale behind and accounting treatment of share buy-backs 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends 2.9 Prepare note disclosures in relation to equity, as well as a statement of changes in equity.

2.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

For-profit companies may be Learning Objective 2.2 Describe in general terms what a for-profit company is I Unlimited II Listed III Limited by guarantee IV No-liability a. b. c. *d.

II and III only; I, II and III only; II, III and IV only; I, II, III and IV.

Which of the following statements is incorrect? Learning Objective 2.3 Outline the key features of the corporate structure a. Each share in a company carries a right to share in the assets on the liquidation of the company; *b. Each share in a company carries a right to share proportionately in all new share issues of a company; c. A share represents an ownership right in a company; d. Each share in a company carries a right to vote for directors of the company.

In respect to the issue of shares by a company, what is an IPO? Learning Objective 2.5 Account for the issue of both no-par and par value shares a. Investment in Preference and Ordinary shares; *b. Initial Public Offering of shares; c. Investment Prospectus for an issue of Options; d. Instruments Providing Options to ordinary shareholders.

When a public share issue is made, the offer comes from: Learning Objective 2.5 Account for the issue of both no-par and par value shares a. the company issuing the shares; b. the relevant oversight body once it has reviewed the prospectus documentation; c. the broker handing the share issue for the company; *d. the applicant.

2.2

Chapter 2: Owners’ equity: share capital and reserves

ABC Ltd was registered as a corporation on 1 July 2016. On 4 July 2016, ABC Ltd issued a prospectus offering 100 000 ordinary shares at an issue price of £2.50 each, payable £1.50 on application and £1.00 on allotment. Application closed on 1 August 2016 with the company having received applications for 110 000 shares. The shares were allotted on 15 August 2016, with the over-subscription amount being refunded to unsuccessful applicants. All allotment monies were received by 31 August 2016. Following the allotment the balance in the Share Capital account would be: Learning Objective 2.5 Account for the issue of both no-par and par value shares a. £100 000 Credit; *b. £250 000 Credit; c. £100 000 Debit; d. £250 000 Debit.

Use the following information to answer questions 6 to 8. A company’s capital consists of 50 000 ordinary shares issued at £2 and paid to £1 per share. On 1 September, a first call of 50c was made on the ordinary shares. By 30 September, the call money received amounted to £22 500. No further payments were received, and on 31 October, the shares on which calls were outstanding were forfeited. On 15 November, the forfeited shares were reissued as paid to £1.50 for a payment of £1 per share. The appropriate cash amount from the reissue was received on 19 November. Costs of reissue amounted to £2 000. The company’s constitution provided for any surplus on resale, after satisfaction of unpaid calls, accrued interest and costs, to be returned to the shareholders whose shares were forfeited.

The entry to record the forfeiture of shares is: Learning Objective 2.5 Account for the issue of both no-par and par value shares *a. Share capital Dr 7 500 First Call – Ordinary shares Cr 2 500 Forfeited shares Cr 5 000 b.

Share capital First call – Ordinary shares Forfeited shares

Dr Cr Cr

7 500

Share capital Forfeited shares

Dr Cr

5 000

Forfeited shares Share capital

Dr Cr

2 500

5 000 2 500

5 000

2 500

2.3

Test Bank to accompany Applying IFRS Standards 4e

The entry to record the reissue of forfeited shares is: Learning Objective 2.5 Account for the issue of both no-par and par value shares *a. Cash Dr 5 000 Forfeited shares Dr 2 500 Share capital – Ordinary Cr 7 500 b.

Cash Forfeited shares Share capital – Ordinary

Dr Dr Cr

2 500 2 500

Cash Share capital – Ordinary

Dr Cr

5 000

Share capital Forfeited shares

Dr Cr

7 500

5 000

7 500

The amount of the surplus payable to the shareholders whose shares were forfeited is: Learning Objective 2.5 Account for the issue of both no-par and par value shares a. £5000; *b. £500; c. £2500; d £3000.

If the balance in a forfeited shares account is refundable to the owners of those shares, then the forfeited shares account is classified as a component of: Learning Objective 2.5 Account for the issue of both no-par and par value shares a. income; *b. liabilities; c. equity; d. expense.

10.

The appropriate account to record any excess proceeds received and retained (not refunded) by a company from an oversubscription to a share offer application, is the: Learning Objective 2.5 Account for the issue of both no-par and par value shares a. Share issue costs account; b. Forfeited Shares account; c. Share capital account; *d. Calls in advance account.

2.4

Chapter 2: Owners’ equity: share capital and reserves

11.

Which of the following journal entries demonstrates the appropriate accounting treatment for share issue costs? Learning Objective 2.5 Account for the issue of both no-par and par value shares a. Dr Deferred asset Cr Cash; b. Dr Cash Cr Deferred asset; *c. Dr Share capital Cr Cash; d. Dr Cash Cr Share capital.

12.

The bonus issue of shares has the following impact on the equity of a company; Learning Objective 2.6 Account for share placements, rights issues, options, and bonus issues a. total equity increases; b. total equity decreases; *c. one equity account increases and another equity account decreases by an equal amount; d. only the amount of issued share capital changes.

13.

A company issued share option is an instrument that gives the holder the right but not the obligation to: Learning Objective 2.6 Account for share placements, rights issues, options, and bonus issues *a. buy a certain number of shares in the company by a specified date at a stated price; b. sell a certain number of shares in the company by a specified date at a stated price; c. receive a certain dividend declared by the company by a specified date; d. receive a bonus issue of shares in a proportion as notified by the company.

14.

Valdez Limited issued 10 000 share options to subscribe for ordinary shares. The exercise price on the options was $3 per share. If all options were exercised on due date the following journal entry would be recorded: Learning Objective 2.6 Account for share placements, rights issues, options, and bonus issues a. Share capital - Ordinary Dr 30 000 Cash Cr 30 000 b.

*d.

Share options – Ordinary Share capital - Ordinary

Dr Cr

30 000

Share options reserve Cash

Dr Cr

30 000

Cash Share capital - Ordinary

Dr Cr

30 000

2.5

Test Bank to accompany Applying IFRS Standards 4e

15.

Which of the following is not a reason that companies may undertake a share buy-back? Learning Objective 2.7 Discuss the rationale behind and accounting treatment of share buy-backs *a. as a defence against a hostile takeover; b. to manage the capital structure; c. to increase the worth per share of the remaining shares; d. as a way to efficiently manage surplus funds.

16.

In relation to an asset revaluation surplus, an entity Learning Objective 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends a. is not able to use this surplus for the payment of future dividends; *b. is able to use this surplus for the payment of future dividends; c. is not able to transfer this surplus to any other reserve account; d. can transfer the surplus to current period profit or loss when the asset is disposed

of.

17.

The balance in the retained earnings account is affected by the transfer to that account of: Learning Objective 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends I Issued share capital II Dividends paid or provided for III Transfers to or from other reserve accounts IV Changes in accounting policies and errors a. b. *c. d.

18.

II and III only; I, II and III only; II, III and IV only; I, II, III and IV.

Dividends declared after the balance date but before the financial statements are authorised for issue: Learning Objective 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends a. meet the criteria for recognition as a liability; b. satisfy the criteria for recognition as an expense; c. are recognised in the Statement of Financial Position as they meet the definition of equity; *d. do not meet the IAS 37 criteria of a present obligation.

2.6

Chapter 2: Owners’ equity: share capital and reserves

19.

IAS 1 Presentation of Financial Statements requires the following items to appear on the face of the Statement of Changes in Equity Learning Objective 2.9 Prepare note disclosures in relation to equity, as well as a statement of changes in equity I The net amount of cash from the issue of any securities during the period II The cumulative effect of changes in accounting policy and the correction of errors III Each item of income or expenses that are required to be recognised directly in equity IV Profit or loss for the period. a. *b. c. d.

I, II, III and IV; II, III and IV only; I, III and IV only; II and IV only.

20.

Laws in relation to share buy-backs are primarily designed to protect the interests of the company’s: Learning Objective 2.7 Discuss the rationale behind and accounting treatment of share buy-backs a. shareholders; *b. creditors; c. directors; d. option holders.

21.

Accounting for share buy-backs is prescribed by Learning Objective 2.7 Discuss the rationale behind and accounting treatment of share buy-backs a. an IFRS; b. an IFRIC interpretation; c. an IAS; *d. generally accepted accounting practices.

22.

Whether a dividend is paid by a company depends on the decisions made by the: Learning Objective 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends a. creditors of the company; b. International Accounting Standards Board; c. auditors of the company; *d. directors of the company.

2.7

Test Bank to accompany Applying IFRS Standards 4e

23.

Gains or losses that arise as a result of translating foreign currency denominated operations into the reporting currency are recognised in income: Learning Objective 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends a. in the reporting period in which they arise; *b. only when the interest in the foreign operation is sold; c. only if they are material items; d. only when they are settled in cash.

24.

Gains and losses on available-for-sale financial assets are recognised directly in equity until the financial asset is derecognised. At this time the cumulative gain or loss previously recognised is: Learning Objective 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends *a. recognised in profit and loss; b. transferred to a revaluation reserve account in equity; c. charged against a provision for gains and losses account; d. set-off against the relevant financial asset.

25.

Retained earnings are a component of Learning Objective 2.8 Outline the nature of reserves and account for movements in retained earnings, including dividends a. Contributed equity; *b. Reserves; c. Other equity; d. Comprehensive income.

26.

IAS 1 requires that a reconciliation between the carrying amount of each class of contributed equity capital and each reserve at the beginning and end of each period be disclosed in: Learning Objective 2.9 Prepare note disclosures in relation to equity, as well as a statement of changes in equity a. the Statement of Changes in Equity only; b. the notes only; *c. either the Statement of Changes in Equity or the notes; d. Statement of Comprehensive Income.

2.8

Chapter 2: Owners’ equity: share capital and reserves

27.

Which of the following does not appear in the Statement of Changes in Equity? Learning Objective 2.9 Prepare note disclosures in relation to equity, as well as a statement of changes in equity *a. The non-controlling interest share of equity; b. Dividends declared but not yet paid at year end; c. Appropriations from retained earnings; d. The payment of a bonus dividend from a reserve.

28.

In relation to share capital, IAS 1 does not require disclosure in the financial report of: Learning Objective 2.9 Prepare note disclosures in relation to equity, as well as a statement of changes in equity a. the number of shares on issue at the end of the year; *b. the amount of any over or under subscription of new share issues during the year; c. restrictions on dividends payable to certain classes of shareholders; d. the total dollar value of share capital at the end of the year.

29.

IAS 1 requires that information in relation to dividends paid or declared during the year be disclosed in: Learning Objective 2.9 Prepare note disclosures in relation to equity, as well as a statement of changes in equity a. the Statement of Changes in Equity only; b. the notes only; *c. either the Statement of Changes in Equity or the notes; d. the Statement of Comprehensive Income.

2.9

Exercises Exercise 2.10 ★

Exercise 2.11 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

DIVIDENDS

India Ltd’s share capital currently consists of 40 000 ordinary shares issued with a par value of $5 per share, and 20 000 10% preference shares issued at $10 each. In relation to the preference shares, dividends have not been paid for the 2 years prior to the current year. The company plans to pay out $100 000 in dividends in the current period, meeting all past obligations (where applicable) to shareholders. Determine how much each class of shares should receive under the following situations: (a) the preference shares are non-cumulative and non-participating (b) the preference shares are cumulative and non-participating (c) the preference shares are cumulative and participating. Assume that the participation agreement requires that the ordinary shareholders receive the same percentage of dividend as the preference shareholders, and that any balance of dividends to be paid is shared in proportion to the issued share capital of each class. DIVIDENDS, CALLS ON SHARES AND BONUS ISSUE

The equity of Japan Ltd at 1 January 2015 was as follows: Share capital 600 000 shares fully paid 400 000 shares issued for $1 and paid to 50c General reserve Plant maintenance reserve Retained earnings Total owners’ equity

$600 000 200 000

$ 800 000 200 000 50 000 80 000 $1 130 000

The following events occurred during the year: June 25

Interim dividend of 10c per share paid, with partly paid shares receiving a proportionate dividend.

July 10

Call of 50c per share on the partly paid shares.

July 31

Collection of call money.

Sept. 16

Bonus share issue of one share for each 10 shares held, at $1 per share, allocated from general reserve.

Dec. 31

Directors announce that a dividend of 20c per share will be paid in September 2016, subject to approval at the February annual general meeting. The company earned a profit of $60 000.

Required

(a) Prepare the journal entries to give effect to the above events. (b) Prepare the equity section of the statement of ﬁnancial position at 31 December 2015. Exercise 2.12 ★★

RIGHTS ISSUE, PLACEMENT OF SHARES

The shareholders’ equity of Iraq Ltd on 1 January 2014 was: Share capital — 200 000 shares fully paid General reserve Retained earnings

$400 000 200 000 100 000

The following transactions occurred during the year ended 31 December 2014: 1. On 1 February 2014, a tradable one-for-two rights issue was made to existing shareholders. The issue price was $2 per share, payable in full on application. The issue was underwritten for a commission of $5000. The issue closed fully subscribed on 31 March, with holders of 40 000 shares having transferred their rights. The underwriting commission was paid on 5 March. 2. On 30 June 2014, 10 000 shares were privately placed with Asian Investments Ltd at $2 per share. Required

Prepare the general journal entries to record the above transactions. CHAPTER 2 Owners’ equity: share capital and reserves

Exercise 2.13

ISSUE OF OPTION AND SHARES, FORFEITURE OF SHARES

★★ Pass the necessary entries to record the following transactions for Nepal Ltd: 2015 July 1

Exercise 2.14

A prospectus was issued inviting applications for 100 000 ordinary shares at an issue price of $3, with $2 payable on application and the balance payable on 10 June 2016. The prospectus also offered 50 000 10% preference shares at $2, fully payable on application. The issue was underwritten at a commission of $6500, allocated equally between the classes of shares.

July 21

Applications closed with the ordinary share issue oversubscribed by 20 000 and the preference shares undersubscribed by 15 000.

July 31

All shares were allotted, and application money refunded to unsuccessful applicants for ordinary shares.

Aug. 14

The underwriter paid amounts owing less commission.

Dec. 1

The directors resolved to give each ordinary shareholder, free of charge, one option for every two shares held. The options are exercisable prior to 1 June 2016 and allow each holder to acquire one ordinary share at an exercise price of $2.70. Options not exercised prior to that date lapse.

2016 June 1

The holders of 40 000 options elected to exercise those options and 40 000 shares were issued.

June 10

The balance payable on the ordinary shares was received from holders of 95 000 ordinary shares.

June 15

The shares on which call money was not received were cancelled.

RIGHTS ISSUE, CALL ON SHARES, ISSUE OF OPTIONS

★★ The share capital of Syria Ltd on 30 June 2014 was: 120 000 ‘A’ ordinary shares issued at $1.50, paid to 75c 50 000 ‘B’ ordinary shares issued at $2.00, fully paid 100 000 9% preference shares issued at $1, paid to 80c

$ 90 000 100 000 80 000 $270 000

The following transactions occurred during 2014 and 2015: 2014 Nov. 1 Nov. 30 2015 Jan. 16

The company makes a one-for-five rights offer to its ‘B’ ordinary shareholders. The rights are tradable, and allow holders to obtain ‘B’ ordinary shares for $2.25 per share, payable in full on application. The holders of 40 000 ‘B’ ordinary shares accept the rights offer by the expiry date. The shares are duly allotted. A call of 75c per share is made on all ‘A’ ordinary shares. All call money except that owed by the holder of 10 000 shares is received by 31 January.

Feb. 5

Shares on which calls are unpaid are cancelled.

Mar. 17

To assist with cash flow difficulties, the company issued a prospectus inviting offers for 50 000 options to acquire ‘A’ ordinary shares at an issue price of 60c per option, payable in full on application. Each option, exercisable prior to 31 December 2015, allows the holder to acquire one ‘A’ ordinary share for $1.78.

Mar. 31

Offers had been received for 35 000 options and these were duly allotted.

Dec. 31

The holders of 25 000 options had exercised their options, with money paid on exercise, and 25 000 ‘A’ ordinary shares were issued. The remaining options lapsed. Costs of issuing the shares amounted to $2000.

Required

Prepare journal entries to record the above transactions in the records of Syria Ltd. 2

PART 2 Elements

Exercise 2.15

SHARE ISSUE, OPTIONS, STATEMENT OF CHANGES IN EQUITY

★★★

On 30 June 2013, the equity accounts of Taiwan Ltd consisted of: 120 000 ordinary shares, issued at $2.50 each, fully paid Options reserve (80 000 at 50c each)* General reserve Capital redemption reserve Retained earnings

$300 000 40 000 30 000 2 000 75 000

* The options were exercisable between 1 May 2014 and 31 May 2014. Each option allowed the holder to buy one ordinary share for $3 each.

Additional information The following transactions and events occurred during the year ended 30 June 2014: • The final 6c per share dividend for the year ended 30 June 2013 was paid on 27 September 2013. Shareholder approval to pay the dividend had been obtained at the annual general meeting on 20 September. • On 1 October, the directors issued a prospectus offering 40 000 ordinary shares at an issue price of $2.80, payable $2 on application and 80c as a future call. The closing date for application was 31 October 2013. The share issue was underwritten by Support Stockbrokers for a fee of $2500, payable on 15 November 2013. • By 31 October 2013, applications for 50 000 shares had been received. • On 5 November 2013, the directors allotted the shares pro rata, with applicants receiving 80% of their requested shares. The company’s constitution allows excess application monies to be retained (in the general reserve) and used to offset future calls payable. • On 15 November 2013, the underwriting fee was paid. • On 31 December 2013, the directors announced an interim dividend of 3c per share payable in cash on 1 February. • To raise funds for expansion, the directors sold a parcel of 80 000 ordinary shares to a pension fund on 28 April 2014 at an issue price of $2.90 per share. • By 31 May 2014, the holders of 65 000 options had indicated that they wished to purchase shares. On 2 June 2014, 65 000 ordinary shares were issued with monies being payable by 21 June. Options not exercised duly lapsed. • All outstanding monies were received with respect to shares issued to option holders. • Profit for the year was $69 420. On 30 June 2014, the directors decided to: – transfer $30 000 to the general reserve – declare a final 5c per share dividend. Shareholder approval for this dividend will be sought at the annual general meeting in September 2014. Required

Exercise 2.16 ★★★

SHARE ISSUES, OPTIONS, RIGHTS ISSUES, DIVIDENDS, RESERVE TRANSFERS

The equity of Yemen Ltd on 30 June 2013 (end of the reporting period) consisted of: 280 000 ordinary shares, issued at $2.40 each General reserve Retained earnings

$672 000 290 000 53 780

Additional information The following transactions and events relating to share issues and options occurred during the year ended 30 June 2014: • On 1 August 2013, a rights offer (offering 5% preference shares at an issue price of $2.80 per share) was made to existing shareholders on the basis of one preference share for every two ordinary shares held. Shares were payable in full on allotment and rights were renounceable. The issue was underwritten for a fee of $5000. CHAPTER 2 Owners’ equity: share capital and reserves

• The rights offer closed undersubscribed on 31 August 2013, and rights in respect of 40 000 ordinary shares were transferred to the underwriter. On 1 September 2013, the shares were allotted. The underwriter paid for its allotment of shares, net of its fee, on 10 September 2013. All other monies were received by 21 September 2013. • On 1 March 2014, the directors offered for sale 100 000 options at 10c each. Each option gave the holder the right to purchase one ordinary share for $2.80 each. Options were exercisable between 1 April 2015 and 30 June 2015. The option offer closed with 80 000 applications being received. Options were duly allotted on 2 April 2014. The following transactions and events relating to dividends and reserve transfers occurred during the year ended 30 June 2014: • On 29 September 2013, the ﬁnal dividend of 10c per share for the year ended 30 June 2013 was paid. The dividend had been declared on 28 June 2013. Shareholder approval is not required for a declaration of dividends. • On 2 January 2014, the directors declared and paid an ordinary interim share dividend of one ordinary share, valued at $3, for every four ordinary shares held. The dividend was funded from the general reserve. • On 30 June 2014, the directors transferred $30 000 from the general reserve to retained earnings, declaring the 5% preference dividend as well as a ﬁnal ordinary dividend of 8c per share. The loss for the year ended 30 June 2014 was $36 000. Required

Exercise 2.17

OPTIONS, SHARES, DIVIDENDS, RESERVES

★★★ The statement of changes in equity for Philippines Ltd for the year ended 30 June 2015 is as follows:

PHILIPPINES LTD Statement of Changes in Equity for the year ended 30 June 2015 Profit for the year Other comprehensive income Total comprehensive income for the year Movements in equity during the year ended 30 June 2015 were: Share capital Balance at 1 July 2014 Issue of 40 000 ordinary shares @ $2.00 Share issue costs: public issue Issue of 80 000 ordinary shares @ $2.90 to public Issue of 50 000 ordinary shares @ $3.00 on exercise of options costing 40c Balance at 30 June 2015 Options Balance at 1 July 2014 Transfer to share capital on exercise Transfer to general reserve on lapse Balance at 30 June 2015 General reserve Balance at 1 July 2014 Bonus issue of shares Transfer from options reserve Transfer from retained earnings Balance at 30 June 2015

PART 2 Elements

$ 69 420 0 $ 69 420

$300 000 80 000 (2 500) 232 000 170 000 $759 500 $ 24 000 (20 000) (4 000) $ 0 $110 000 (80 000) 4 000 30 000 $ 64 000

Retained earnings Balance at 1 July 2014 Dividends declared and approved Interim dividends paid Transfer to general reserve Profit for the period Balance at 30 June 2015

$ 75 000 (8 000) (4 000) (30 000) 69 420 $102 420

Required

DIVIDENDS, SHARE ISSUES, FORFEITURE OF SHARES

On 30 June 2012 the equity of Malaysia Ltd was as follows: 50 000 5% cumulative preference shares, issued at $1.20, fully paid 100 000 ordinary shares, issued at $1.15, fully paid, less 2 610 issue cost Options (15 000 @ 50c) General reserve Retained earnings

$ 60 000 112 390 7 500 123 100 136 340

Each option entitles the holder to acquire 1 ordinary share at a price of $1.10 per share, exercisable by 31 March 2013. Any options not exercised by this date will lapse. The books are balanced 6-monthly. The following events occurred during the year ended 30 June 2013: 2012 Aug. 2 & 15

The final 8c per share ordinary dividend and the final preference dividend, both declared on 30 June 2012, were paid in cash. Shareholder approval is required for payment of dividends and was obtained at the annual general meeting of 2 August.

Oct. 1

A prospectus was issued offering 60 000 ordinary shares at an issue price of $1.20 per share, payable 35c on application, 35c on allotment and 50c on a first and final call. The closing date for applications was 31 October 2012. The issue was underwritten at a commission of $1500.

Oct. 31

Applications were received for 75 000 shares by this date.

Nov. 2

The directors allotted 4 shares for every 5 applied for, with allotment monies due by 30 November 2012. In accordance with the constitution, surplus application monies were kept as an advance on future calls and allotment monies, but subject to refund at applicants’ discretion. The underwriting commission was paid.

Nov. 30

All allotment monies owing were received by this date.

2013 Jan. 5

An interim 5c per share ordinary dividend was paid in cash.

Jan. 31

The first and final call was made, with monies due by 28 February 2013.

Feb. 28

$28 500 call monies were received by this date.

Mar. 20

The shares on which the call was unpaid were cancelled against capital redemption reserve. The company is entitled to keep any balance arising from forfeiture of shares.

Mar. 31

12 000 shares were allotted as a result of 12 000 options having been exercised, with allotment monies due by 30 April 2013.

CHAPTER 2 Owners’ equity: share capital and reserves

April 30

All allotment monies were received by this date.

May 31

A 1-for-4 bonus issue was made from the general reserve, with the shares valued at $1.20 each.

June 30

A 10c per share final dividend was declared, payable on 15 August 2013. Net profit for the year ended 30 June 2013 was $29 460.

Required

(a) Prepare general journal entries and closing entries to record the above transactions. (b) Prepare the statement of changes in equity for the period 30 June 2012 to 30 June 2013.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 3: Fair value measurement

Chapter 3 – Fair value measurement Discussion Questions 1.

Name three current accounting standards that permit or require the use of fair values.

IFRS 3 Business combinations para 32 IFRS 9 Financial instruments para 4.1 IAS 16 Property, plant and equipment, para 31 IAS 38 Intangibles para 33, 75 IAS 40 Investment property para 30 IAS 41 Agriculture para 13

What are the main objectives of IFRS 13

The main objectives are: to define fair value to establish a framework for measuring fair value to require disclosures about fair value measurement (IFRS 13, para 1)

What are the key elements of the definition of ‘fair value’? -

current exit price: to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date

How does the proposed definition of fair value differ from that used in current accounting standards?

The definitions are the same in terms of: assumes an hypothetical transaction the transaction is orderly market participants is the same as knowledgeable willing parties in an arm’s length transaction The new definition: specifies that an entity is selling the asset, not buying clarifies that a liability is to be transferred specifies the need for a measurement date

How does entry price differ from exit price?

An entry price is one that would be paid to buy an asset or received to incur a liability. An exit price is one that would be received to sell an asset or paid to transfer a liability. They are expected to be the same IF they relate to the same asset or liability on the same date in the same form in the same market. This is probably only true in an active market.

3.1

Solutions Manual to accompany Applying IFRS Standards 4e 6.

Is the reporting entity a market participant?

No. Assumptions made by market participants are not those made by the entity itself. The fair value is not entity-specific.

Does the measurement of fair value take into account transport costs and transactions costs? Explain.

Transaction costs are the incremental direct costs to sell an asset or transfer a liability, while transport costs are the costs necessarily incurred to transfer an asset to its most advantageous market. The measurement of fair value requires both costs to be taken into consideration in the determination of the most advantageous market. However, only transport costs are used in the calculation of the fair value number. Transaction costs are entity-specific, transport costs are not; they relate to the asset itself. See Illustrative example 3.1.

What are the key steps in determining a fair value measure?

An entity has to determine: 1. the particular asset or liability that is the subject of the measurement (consistent with its unit of account). 2. for a non-financial asset, the valuation premise that is appropriate for the measurement (consistently with its highest and best use). 3. the principal (or most advantageous market) for the asset or liability. 4. the valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use in pricing the asset or liability and the level of the fair value hierarchy within which the inputs are categorised.

Explain the difference between the current use of an asset and the highest and best use of that asset.

The current use is how the reporting entity is currently using an asset. The highest and best use is based on how market participants will use the asset. An example of where the two may differ is where land is currently used as a site for a factory, but the land could be used for residential purposes. The current use is industrial while the highest and best use could be either industrial or residential.

10.

Explain the difference between the in-combination valuation premise and the stand-alone valuation premise.

In-combination valuation premise: A basis used to determine the fair value of an asset that provides maximum value to market participants principally through its use in combination with other assets and liabilities as a group (as installed or otherwise configured for use). Stand-alone valuation premise: A basis used to determine the fair value of an asset that provides maximum value to market participants principally on a stand-alone basis. The highest and best use of an asset establishes the valuation premise used to measure the fair value of that asset.

3.2

Chapter 3: Fair value measurement 11.

What is the difference between the principal market for an asset or liability and its most advantageous market?

Appendix A to IFRS 13 contains the following definitions: Most advantageous market: The market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after considering transaction costs and transport costs. Principal market: The market with the greatest volume and level of activity for the asset or liability. Because there may be buyers and sellers who are willing to pay high prices and deal outside the principal market, the most advantageous market may not be the principal market. However, an entity may assume that the principal market is the most advantageous market provided that the entity can access the principal market.

12.

What valuation techniques are available to measure fair value?

the market approach: prices generated by market transaction the cost approach: prices based on amounts required to replace the service capacity of an asset. the income approach: prices generated by considering future cash flows or future income and expenses

13.

Explain the fair value hierarchy.

The fair value hierarchy is a hierarchy of inputs into the fair value measurement. The inputs are the assumptions that market participants make when using a valuation technique in pricing an asset or liability. The inputs are classified as observable or unobservable. The fair value hierarchy gives the highest priority to observable inputs and the lowest to unobservable inputs. The hierarchy does NOT prioritise the valuation techniques, just the inputs to those techniques. The fair value hierarchy prioritises inputs into 3 levels – Level 1, 2 and 3 – see the answer to RQ 14 for information on these levels. The hierarchy is also used in the disclosure process as a fair value measure is classified in its entirety based on the lowest level input that is significant to the entire measurement.

14.

Explain the different levels of fair value inputs.

Level 1 inputs are quoted prices in active markets for identical assets or liabilities. The inputs are observable. The markets must be active. The assets/liabilities must be identical. Level 2 inputs are inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly as prices or indirectly as derived from prices. The inputs are observable. The inputs are based on market prices or other market data such as interest rate curves. Level 3 inputs are inputs for the asset or liability that are not based on observable market data. The inputs are unobservable. The information may include entity-specific data. © John Wiley and Sons, Ltd, 2016

3.3

Solutions Manual to accompany Applying IFRS Standards 4e

15.

How does the measurement of the fair value of a liability differ from that of an asset?

The highest and best use does not apply to liabilities. There will generally be no observable price for the transfer of a liability. The measurement of the liability is based on the same methodology that the counterparty would use to measure the fair value of the corresponding asset. Non-performance risk is taken into consideration in the measurement of the fair value of a liability.

3.4

Chapter 3: Fair value measurement

Exercises Exercise 3.1

VALUATION PREMISE FOR MEASUREMENT OF FAIR VALUE

Discuss how you would measure these fair values. 1. Determine the asset or liability that is the subject of measurement: In this case, there are 2 assets that could be measured at fair value, namely land and factory. An alternative would be to consider the land and the factory as a single asset. 2. Determine the valuation premise consistent with the highest and best use The land could be sold for residential purposes for an estimated €1m. Given the cost to demolish the existing factory of €100 000, the land could be sold for residential purposes for €900 000. Measuring fair value in this fashion assumes a specific use and is based on an in-exchange valuation premise as the land is considered on a stand-alone basis. The land and factory could also be sold as a package for use by market participants in conjunction with other assets. The factory has been depreciated by the reporting entity to half its original cost. Given the cost to build a new factory is €780 000, a depreciated replacement cost of the existing factory could be said to be €390 000. However as the factory could presumably be viably built on a cheaper block of land i.e. one not usable for residential purposes, it is unlikely that there is a market for the land and the factory on an in-use basis. A market participant would be forced to pay the €900 000 for the factory and the land given the alternative use of the land for residential purposes. 3. Determine the most advantageous market for the assets The most advantageous market would appear to be the selling of the property for residential purposes. 4. Determine the valuation technique The market approach would be the appropriate valuation technique given that there are observable market inputs in relation to the selling prices of similar properties. The land has a fair value based on market prices for similar properties of €900 000. The factory has a zero fair value as a separate asset. Example 3.5 of the Illustrative Examples considers a similar situation to this case. The highest and best use of the land is determined by comparing: (i) the value of the land as a vacant block for residential purposes which would include the factory at a zero fair value, and (ii) the value of the land as currently developed for industrial use which would include the factory as an ongoing asset. The highest and best use is the higher of these two values. If (i) is chosen, then the factory has a zero fair value and no subsequent depreciation would be determined. If (ii) is chosen, then it would be necessary to determine the fair value of the land separate from the fair value of the factory in order to depreciate the factory. It could be argued that that the fair value of the factory equals the difference between the fair value of the land for residential purposes and the fair value of the combined assets.

3.5

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 3.2

HIGHEST AND BEST USE

Discuss the process of determining this fair value 1. Determine the asset or liability that is the subject of measurement: In this case, the asset is the right to use the temperature-revealing device. 2. Determine the valuation premise consistent with the highest and best use To measure the fair value of the asset at initial recognition, the highest and best use of the asset is determined on the basis of its use by market participants. There are a number of possible uses for the asset: (a) BGW Ltd could continue to develop the device for use with bottles – how the device could be used with wine bottles has yet to be specifically determined. BGW Ltd believes its employees have the skills to be able to investigate this possibility. The fair value measured would then be based on an in-use valuation premise and would be based on the price that would be received in a current transaction to sell the device to market participants, assuming that there are other wine makers, or even soft drink companies that would be able to use the device in conjunction with their bottling activities. (b) BGW Ltd could decide to cease development of the device in relation to its applicability to use with bottles. In valuing the asset, the assumption is then that other market participants would also lock up the device based upon a defensive competitive strategy, reducing the risk that competitors could achieve a significant marketing edge and so substantially increase market share. The appropriate assumption is then an in-use valuation premise. (c) BGW Ltd could consider that the highest and best use of the asset is to cease development of the project as other market participants would also cease development if they acquired the asset. This may be the case where market participants do not consider that the device will eventually be able to be used with bottles and so the device will not provide a market rate of return if completed. The fair value would be measured using an in-exchange valuation premise in this scenario. The fair value would be determined by considering what market participants would pay for the rights to use the device for bottles if BGW Ltd sold this asset to them. 3. Determine the principal (or most advantageous market) for the assets The most advantageous market would be determined by considering the three scenarios in part 2 above and taking into account the transport and transaction costs. 4. Determine the valuation technique This asset is a unique asset. There are no similar assets on the market. Hence a market valuation approach is not applicable. An income valuation approach could be used based on the expected extra cash flows that could be derived from sales once the device has proved to be successful. Given that the device still has to be proved to be useful in relation to bottles, this requires a great deal of judgement. The cost approach would require the determination of the costs required to develop a similar device and have the rights to its use. This would be difficult for BGW Ltd to be able to calculate with any reliability. It is expected that the income valuation approach would be the most applicable method. In deciding to pay Solar-Blue € 7 100 000 for the rights to use the device, it is assumed that BGW Ltd would have investigated the possible effects on its profits and market share if its competitors had acquired the device from Solar-Blue.

3.6

Chapter 3: Fair value measurement Exercise 3.3

CHARACTERISTIC OF AN ASSET

Outline any provisions in IFRS 13 that relate to consideration of restrictions on the measurement of fair value of assets, and how the situation described above the restrictions would affect the measurement of the fair value of the property by MedSea. The relevant paragraphs of IFRS 13 are: 11, 20, 28(b) as well as BC46 and BC100 A definition of these paragraphs is given in the relevant sections for IFRS 13 Note that the adjustment for a restriction is not a level 1 input, and if the adjustment is significant, the fair value measure would be categorised at a lower level of the fair value hierarchy. The asset considered in this case is the house and the land. There are no restrictions on the house but there are restrictions on the land. There are 2 restrictions on the land: - the trees cannot be cut down until Mr Merman dies; and - there is a gas pipeline across one corner of the land. The restriction on the cutting down of the trees is enforceable on MedSea but not on any subsequent buyers of the property. Because the restriction is specific to MedSea and not to other market participants the restriction is not considered in measuring the fair value of the property – fair value measurement is not entity-specific. Therefore the fair value of the land is based on the higher of its fair value as the grounds of the current property, ie on an in-use valuation premise – and its fair value in exchange to market participants ie on an in-exchange valuation premise, considering the use of the property as a residential building site. The restriction on the property in relation to the felling of the trees is not a consideration in this measurement process. The restriction in relation to the gas pipeline is a condition specific to the asset itself in the same way as the condition or location of an asset is specific to an asset. This restriction is transferred to subsequent buyers of the property, the market participants. Measurement of the fair value of the property must then take into consideration the existence of the restriction and the effect on the valuation of the property. For example, if a building cannot be built over the pipeline as the gas authorities may need access to the pipeline, then this restricts the size of any building that could be built on the property. This affects the value of the land regardless of whether an in-use or an inexchange valuation premise is applied.

Exercise 3.4

ASSETS WITHOUT AN ACTIVE MARKET

Discuss the issues associated with fair value accounting for assets without an active market. Paragraph 62 of IFRS 13 proposes 3 possible valuation techniques: - the market approach - the cost approach, and - the income approach In using these techniques the reporting entity will make assumptions or provide inputs into the valuation model. The inputs are classified as being one of two types: - observable, and - unobservable These inputs are prioritised into 3 levels: Levels 1, 2 and 3. Only Level 1 and level 2 inputs relate to information obtained from markets. Level 3 inputs are not based on observable market data. In the quotation from Chasan the question is whether fair values based on unobservable inputs should be allowed. Questions relate to: - the reliability of the fair value numbers - the cost of generating such numbers - the relevance and understandability of these numbers: will users of financial reports treat all fair values the same regardless of the level of inputs? Past experience with entities such as Enron do not inspire confidence in the use of fair value numbers based on unobservable inputs. © John Wiley and Sons, Ltd, 2016

3.7

Solutions Manual to accompany Applying IFRS Standards 4e

The quotation from Nusbaum states that investors have to get used to an imperfect world. The standard-setters have tried to get users used to such a world by requiring entities to disclose the assumptions underlying the fair values disclosed. Whether this will allow users to be able to deal with volatility and to assess the effects of unobservable inputs is yet unknown.

Exercise 3.5

EXIT PRICES AS FAIR VALUE FOR CLASSES OF ASSETS

Discuss the use of entity-specific information in the generation of fair value numbers under IFRS 13 The measurement of fair values under IFRS 13 is based on a hypothetical transaction between the reporting entity and market participants. The assumptions used as inputs into the valuation process are those made by the market participants, not those made by the entity itself. Hence the fair value under IFRS 13 is not an entity-specific measure. However, even though this is the intent of the standard-setters, the question is whether in practice fair value measures will not be based on entity-specific information: - a reporting entity is not required to identify specific market participants, so any assumptions made will not relate to the circumstances facing any entity currently operating in practice. - In an endeavour to make the inputs more reliable, an entity may rely on information generated within itself rather than less reliable, hypothetical information concerning some non-existent market participant. - If the market participant buyer steps into the shoes of the entity that holds those specialised assets, then potentially the market participant is assumed to be the same as the reporting entity and entity-specific factors are used in the valuation. - Where an income valuation approach is used, and a net present value method applied, it is hard to see that entities will not insert the entity-specific information into the present value calculations. - Similarly where level 3 unobservable inputs are used, non-market data is not readily available for in-use assets carried by other entities. - Simple cost-benefit considerations will encourage an entity to use in-house data rather than model what a market participant might hypothetically do.

Exercise 3.6

MEASUREMENT OF FAIR VALUE

Discuss how IFRS 13 attempts to overcome these issues when providing information to users of financial reports. Paragraph 91 of IFRS 13 states that the key principle of disclosure is that an entity will disclose information that enables users of the financial statements to assess the methods and inputs to develop these measurements as well as to enable users to see the effect on profit or loss or other comprehensive income where unobservable inputs are used. If fair values are only used in a small number of cases, then it is possible that users of financial statements may be able to see what is occurring. However if a large number of an entity’s assets are measured at fair value, the extent of the detail may be such as to make the information not understandable. Para 93(e) specifically addresses disclosures where level 3 inputs are used in the measurement of fair value. In particular the effects on comprehensive income are addressed. Disclosure of information concerning valuation methods and inputs – such as required by paragraph 93(d) should assist in understanding the level of objective and subjective information. As the measurement of fair value is based on a hypothetical transaction, there is always going to be information based on “hypothetical calculations”. © John Wiley and Sons, Ltd, 2016

3.8

Chapter 3: Fair value measurement What are “real” market processes? As the measures of fair value are based on hypothetical transactions, no measures of fair value are based on real market transactions. However, the methods used and the inputs used have differing market measures in them. By disclosing the methods and inputs used, users of financial reports are made aware of these differences and can then assess for themselves the reliability and relevance of the information to them in making their decisions. The distinction between realised and unrealised gains is not based on IFRS 13 but rather on the underlying standard that is applied in the measurement of specific assets. For example, with property, plant and equipment, under the valuation model where fair value is measured, the application of IAS 16 requires the valuation increment to be recognised in other comprehensive income (an unrealised gain) rather than in profit or loss (only for realised gains). However for financial assets, some movements in fair value, although unrealised, may be recognised in profit or loss.

Exercise 3.7

MANAGEMENT BIAS ON FAIR VALUE MEASUREMENT

Compare the potential for management bias when making market-based or entity specific assumptions. The measurement of fair values under IFRS 13 is based on a hypothetical transaction between the reporting entity and market participants. Being hypothetical this allows management to decide the constraints and the determinants of that transaction. The assumptions used as inputs into the valuation process are those made by the market participants, not those made by the entity itself. Hence the fair value under IFRS 13 is not supposed to be an entity-specific measure. However, even though this is the intent of the standard-setters, the question is whether in practice fair value measures will not be based on entity-specific information: - a reporting entity is not required to identify specific market participants, so any assumptions made will not relate to the circumstances facing any entity currently operating in practice. - In an endeavour to make the inputs more reliable, an entity may rely on information generated within itself rather than less reliable, hypothetical information concerning some non-existent market participant. - If the market participant buyer steps into the shoes of the entity that holds those specialised assets, then potentially the market participant is assumed to be the same as the reporting entity and entity-specific factors are used in the valuation. - Where an income valuation approach is used, and a net present value method applied, it is hard to see that entities will not insert the entity-specific information into the present value calculations. - Similarly where level 3 unobservable inputs are used, non-market data is not readily available for in-use assets carried by other entities. - Simple cost-benefit considerations will encourage an entity to use in-house data rather than model what a market participant might hypothetically do. Under these circumstances, management bias could potentially enter into the determination of the fair value.

Exercise 3.8

IN-COMBINATION’ VALUATION PREMISE

Discuss how the various valuation approaches may be applied in the determination of the fair value of the computer program The computer program would provide the best value to market participants through its use with other assets as the program works with other assets in the manufacturing process. Hence, the in-use valuation premise is appropriate for this asset while the highest and best use for the asset is its current use within the manufacturing process.

3.9

Solutions Manual to accompany Applying IFRS Standards 4e The market valuation approach would not be applicable if the software program is unique. Use of the market valuation approach would require the existence of comparable software assets. The income approach could be applied with a present value technique being used. The cash flows used in this technique would be based on the income stream expected to result from the use of the computer program over its economic life. This may be determined by considering what market participants would pay as a licence fee to be able to use the computer program in their businesses. The cost approach could also be used. This approach would require the estimation of what it would cost currently to construct a substitute computer program that would perform the same tasks as the program being valued. A difficulty in this process could arise if some of the components of the program are unique and difficult to replicate by another market participant.

Exercise 3.9

REQUIREMENT FOR A STANDARD

Discuss why such a standard was considered necessary. The definition of fair value prior to the issue of IFRS 13 was as follows: Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable willing parties in an arm’s length transaction. Paragraph BC30 provides three reasons for the change in the definition: 1. the current definition does not specify whether an entity is buying or selling the asset. It is then uncertain whether fair value is an exit [selling] price or an entry [buying] price. The proposed definition requires the use of an exit price. 2. in the current definition, it is unclear what is meant by “settling” a liability. Who are the knowledgeable parties? Does this mean the creditor, or other parties? The proposed definition requires measurement by reference to the transfer of a liability to a party who may not be the creditor. 3. there is no explicit statement in the current definition whether the exchange or settlement takes place at the measurement date or at some other date. The proposed definition specifies that the fair value is the price at the measurement date.

Exercise 3.10

DEFINITION OF FAIR VALUE

Outline the key characteristics of this definition and explain the effects of the inclusion of each characteristic in the definition The key characteristics of the definition of ‘fair value’ for IFRS 13 are: 1. a current exit price: A definition is given in Appendix A for IFRS 13 The price is based on expectations about the future cash flows to be generated by an asset or used to pay or transfer a liability. The cash flows for an asset can be generated from use of the asset or sale of the asset. The price may be different from an entry price. The effect of this characteristic, for an asset, is that the price is a selling price not a buying price. © John Wiley and Sons, Ltd, 2016

3.10

Chapter 3: Fair value measurement 2. an orderly transaction: A definition is given in Appendix A for IFRS 13 The transaction is a hypothetical one. The transaction occurs in current markets, in particular in markets where orderly transactions occur. Market transactions in cases of liquidation sales or fire sales are not relevant markets. This characteristic affects the choice of markets to be observed. 3. between market participants: A definition is given in Appendix A for IFRS 13 The phrase “knowledgeable, willing parties in an arm’s length transaction” has the same meaning. The assumptions made in the valuation process are those made by the market participants, not those made by the reporting entity. There is no need to identify specific market participants – the emphasis is on the characteristics of the participants. The fair value measure is not entity-specific. The market participants are assumed to have the other assets to combine with the asset being valued where an in-use valuation premise is applied. 4. at the measurement date: Fair value is measured at a specific point of time taking into consideration the conditions and restrictions in relation to an asset and a liability at that date.

Exercise 3.11

EXIT PRICES AS FAIR VALUE

Discuss whether Benston’s criticisms of FAS 157 are applicable to IFRS 13 Benston raises 2 issues: 1. Although fair value is defined as an exit price, use of entry prices in level 2 inputs and determination of values using level 3 inputs will mean that fair values are not always really exit prices. Where the valuation relies on an in-use valuation premise, the fair value may be determined by calculating the cost of constructing an item of plant and equipment. Also if an income valuation approach is used, there may be no market measures at all as the NPV calculation could be based on unobservable market data. This also raises questions in terms of the fair value being entity-specific versus that of market participants. Where unobservable data such as income stream is used, the numbers used in that calculation will generally be based on those coming from an entity’s own data. This is firstly because a reporting entity has no access to other entity’s internal data, and secondly because the asset being valued may not currently be being used by other entities. 2. In some cases, the exit price will be zero. Does this affect relevance of information? A classic case of this is the land on which there is currently a factory but, because of rising residential prices, the highest and best use of the land is for residential purposes. For unique assets (those that are special tools for the entity), are there circumstances where there are no other market participants? Or must the valuer assume that other market participants have the relevant other assets to use with the asset being valued? This seems to stretch the hypothetical transaction very thinly.

3.11

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 3.12

FAIR VALUE OF WORK-IN-PROGRESS

Discuss the statement made by Benston. The comment that “the exit price of raw materials will almost always be less than the price at which they were purchased and the exit value of partially finished goods probably is zero or negative” is not true. This comment assumes that an in-exchange valuation premise is used. If that were the case then the current selling price of such items may be small. However, where an in-use valuation premise is used, the exit value is determined based on what a market participant would pay for these items assuming the items are used by that participant in conjunction with other assets held by the market participant. The exit price for raw material would then not be significantly different from what the reporting entity paid, assuming no market changes in the short term. Similarly with the special purpose non-current assets such as a large blast furnace used by a smelting company. This asset may not be able to be removed once placed into the reporting entity’s factory. As such its disposable – or in-exchange – value would be scrap value only. However, assuming a market participant had the same combination of other assets and requires a blast furnace to complete the grouping of assets to get a factory into operation, the fair value is not zero. The fair value would be based on the cost of obtaining such a blast furnace for incorporation into the factory’s operations.

Exercise 3.13

FAIR VALUE HIERARCHY

Discuss the differences between the various levels in the hierarchy and whether prices produced under all levels should be described as ‘fair values’. There are 3 valuation approaches into which inputs or assumptions are made. The inputs are classified as observable and unobservable. The inputs are placed in a fair value hierarchy [note that the valuation techniques are not put into a hierarchy, just the inputs to those techniques]. Note: 1. The inputs are prioritised into 3 levels – Levels 1,2 and 3. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Note the references to active markets and the need for identical items. Level 2 inputs are inputs other than quoted market prices in level 1 that are observable for the asset or liability, either directly as prices or indirectly being derived from prices. These inputs are observable and may be inputs from information other than prices such as interest rate curves. Adjustments may have to be made to these prices based on condition of the assets. Level 3 inputs are not based on observable market data. These are unobservable inputs. This information may sometimes be based on entity-specific data adjusted for factors concerning market participants. 2. The fair value hierarchy gives the highest priority to quoted market prices in active markets for identical assets and liabilities [level 1] and lowest priority to unobservable inputs [level 3]. 3. The availability of inputs and their relative subjectivity affect the selection of the valuation technique. 4. The fair value measure is categorised in its entirety at the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement. © John Wiley and Sons, Ltd, 2016

3.12

Chapter 3: Fair value measurement

Questions about whether prices determined using level 3 inputs should be called fair values are based on issues about - the reliability of the fair value numbers - the cost of generating such numbers - the relevance and understandability of these numbers: will users of financial reports treat all fair values the same regardless of the level of inputs? Past experience with entities such as Enron do not inspire confidence in the use of fair value numbers based on unobservable inputs. Whether disclosure will assist in overcome these problems is an issue on which there is still on-going debate. The standard-setters believe that disclosure will assist in the interpretation of the fair value numbers.

Exercise 3.14

HIGHEST AND BEST USE

Discuss the issues associated with measuring the fair value of a site currently used for production but which also can be redeveloped for retail purposes. This quotation raises questions about the utility of fair value information about assets that are held for use rather than exchange. With IFRS 13 the standard-setters have been concerned with how to measure fair value rather than when to require fair value measures. In the example of the land on which a factory is built but for which there is a higher and better use in terms of residential property, the question of whether the factory should have a fair value of zero may be of concern. It could be argued that measuring the factory at zero would not provide decision-useful information when an entity is using that factory in its operations. In particular users may want to see a depreciation component determined so that they could assess the economic resources consumed in the generation of cash flows process. In other words, it could be argued that the use of fair value in this circumstance does not provide the most decision-useful information. However on the other hand, recording the factory at a zero amount alerts the users of the report that there are alternative uses for the land and factory.

3.13

Testbank to accompany

Applying ® IFRS Standards 4e Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 3: Fair value measurement

CHAPTER 3 Fair value measurement

Learning Objectives 3.1 Explain the need for an accounting standard on fair value measurement 3.2 Understand the key characteristics of the term ‘fair value’ 3.3 Explain the steps in determining the fair value of non-financial assets 3.4 Understand how to measure the fair value of liabilities 3.5 Explain how to measure the fair value of an entity’s own equity instruments 3.6 Discuss issues relating to the measurement of the fair value of financial instruments 3.7 Prepare the disclosures required by IFRS 13 Fair Value Measurement 3.8 Discuss the issues associated with the measurement and use of fair values.

3.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

Which of the following is not one of the key reasons given by the IASB for a standard on fair value measurement? Learning Objective 3.1 Explain the need for an accounting standard on fair value measurement a. to establish a single source of guidance for all fair value measurements required or permitted by IFRSs to reduce complexity and improve consistency in their application; b. to clarify the definition of fair value and related guidance in order to communicate the measurement objective more clearly; *c. to require the use of fair value when accounting for all non-financial assets; d. to enhance disclosures about fair value to enable users of financial statements to assess the extent to which fair value is used and to inform them about the inputs used to derive those fair values.

Which of the following documents issued alongside IFRS 13 do not form an integral part of the standard? I II III IV

Basis for Conclusions Illustrative Examples Appendix A: Defined terms Appendix B: Application guidance

Learning Objective 3.1 Explain the need for an accounting standard on fair value measurement *a. I and II; b. II and III; c. III and IV; d. I and IV.

Which of the following is the definition of fair value per IFRS 13? Learning Objective 3.2 Understand the key characteristics of the term ‘fair value’ a. The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction; *b. The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; c. The price that would be received to sell an asset or paid to transfer a liability; d. A transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (eg a forced liquidation or distress sale).

3.2

Chapter 3: Fair value measurement

At which date is fair value determined? Learning Objective 3.2 Understand the key characteristics of the term ‘fair value’ *a. the measurement date; b. the settlement date; c. the transaction date; d. the exchange date.

When determining the fair value of an asset its fair value is based on its: Learning Objective 3.2 Understand the key characteristics of the term ‘fair value’ a. Current use; b. Proposed use; *c. Highest and best use; d. Value in use.

Which of the following is not a valuation technique prescribed by IFRS 13? Learning Objective 3.3 Explain the steps in determining the fair value of non-financial assets *a. the fair value approach; b. the income approach; c. the cost approach; d. the market approach.

The market with the greatest volume and level of activity for the asset or liability is defined as the: Learning Objective 3.3 Explain the steps in determining the fair value of non-financial assets a. active market; *b. principal market; c. liquid market; d. most advantageous market.

Valuation techniques that convert future amounts to a single current amount and determines the fair value on the basis of the value indicated by current market expectations about those future amounts is an example of: Learning Objective 3.3 Explain the steps in determining the fair value of non-financial assets a. the fair value approach; *b. the income approach; c. the cost approach; d. the market approach.

3.3

Test Bank to accompany Applying IFRS Standards 4e

Unobservable inputs for the asset or liability are an example of: Learning Objective 3.3 Explain the steps in determining the fair value of non-financial assets a. a Level 1 input; b. a Level 2 input; *c. a Level 3 input; d. a Level 4 input.

10.

Which of the following is not an example of a level 2 input? Learning Objective 3 Explain the steps in determining the fair value of non-financial assets *a. a financial forecast of cash flow or earnings; b. quoted prices for identical or similar assets or liabilities in markets that are not active; c. inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves, volatilities, prepayment speeds, and credit risks; d. inputs that are derived from or corroborated by observable market data by correlation or other means.

11.

Trademarks would be measured primarily using which type of inputs? Learning Objective 3.3 Explain the steps in determining the fair value of non-financial assets a. Level 1 inputs; b. Level 2 inputs; *c. Level 3 inputs; d. Level 4 inputs.

12.

Which of the following steps in not relevant when valuing liabilities? Learning Objective 3.4 Understand how to measure the fair value of liabilities a. the particular liability that is the subject of the measurement; *b. the valuation premise that is appropriate for the measurement; c. the principal (or most advantageous) market for the liability; d. the valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability and the level of the fair value hierarchy within which the inputs are categorised.

13.

When measuring the fair value of a liability, which of the following is assumed? Learning Objective 3.4 Understand how to measure the fair value of liabilities a. the liability is settled by the holder; *b. the liability will be settled by the market participant; c. the liability will not be settled; d. the liability is settled with the counterparty on measurement date.

3.4

Chapter 3: Fair value measurement

14.

Where a liability is held as a corresponding asset by another entity the fair value of the liability is determined by: Learning Objective 3.4 Understand how to measure the fair value of liabilities a. applying a present value technique to measure the liability; b. applying the cost approach to valuing the liability; *c. measuring the fair value of the corresponding asset; d. determining the amount required to settle the present obligation.

15.

In which circumstance will it be necessary to determine the fair value of an entity’s own equity instruments? Learning Objective 3.5 Explain how to measure the fair value of an entity’s own equity instruments a. where the entity is preparing for listing; *b. where the entity undertakes a business combination and issues its own equity instruments in exchange for a business; c. where the entity undertakes a share buy-back; d. where there is a change in the shareholding of the entity.

16.

Which of the following is not assumed when measuring the fair value of an equity instrument? Learning Objective 3.5 Explain how to measure the fair value of an entity’s own equity instruments a. The market participant transferee will take on the rights and responsibilities associated with the instrument; *b. An entity’s own equity instruments are transferred to a market participant at transfer date; c. An entity’s own equity instrument would remain outstanding; d. The instrument would not be cancelled or otherwise extinguished on the measurement date.

17.

Where a market has both a bid and an ask process, the price used in measuring fair value is: Learning Objective 3.6 Discuss issues relating to the measurement of the fair value of financial instruments a. the bid price; b. the ask price; c. the bid-ask spread; *d. the most representative price for the transaction.

3.5

Test Bank to accompany Applying IFRS Standards 4e

18.

An entity holding both financial assets and liabilities is allowed to offset and determine fair value on the net position as long as: I they hold a net long position II they hold a net short position III they have a documented risk management strategy IV the manage the group of net financial assets and liabilities on a net exposure basis V. transactions are conducted in an orderly market Learning Objective 3.6 Discuss issues relating to the measurement of the fair value of financial instruments a. I and III; b. II and IV; *c. III and IV; d. II and V.

19.

Which of the following disclosures are not required under IFRS 13? Learning Objective 3.7 Prepare the disclosures required by IFRS 13 Fair Value Measurement a. the valuation techniques used to measure fair value; b. the inputs used to measure fair value; c. the level of the fair value hierarchy within which the fair value measurements are categorised; *d. quantitative information about all unobservable inputs used in the fair value measurement.

20.

Which of the following does Whittington (2008) see as a main feature of the fair value view? Learning Objective 3.8 Discuss the issues associated with the measurement and use of fair values. a. Stewardship, defined as accountability to present shareholders, is a distinct objective, ranking equally with decision usefulness; *b. Reliability is less important and is better replaced by representational faithfulness, which implies a greater concern for capturing economic substance, and less with statistical accuracy; c. Present shareholders of the holding company have a special status as users of financial statements; d. Future cash flows may be endogenous: feedback from shareholders and markets in response to accounting reports may influence management decisions.

21.

Which are the two most common measures used by IFRS? Learning Objective 3.1 Explain the need for an accounting standard on fair value measurement.

3.6

Chapter 3: Fair value measurement

a. b. *c. d.

fair value less costs to sell and cost; value in use and cost; cost and fair value; net realisable value and fair value.

22.

Which of the following is the definition of exit price per IFRS 13? Learning Objective 3.2 Understand the key characteristics of the term ‘fair value’. a. A transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (e.g. a forced liquidation or distress sale); b. The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction; c. The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; *d. The price that would be received to sell an asset or paid to transfer a liability.

23.

Which of the following is not a characteristic of a market participant under IFRS 13? Learning Objective 3.2 Understand the key characteristics of the term ‘fair value’. a. Buyers and sellers that are able to enter into a transaction for the asset or liability; b. Buyers and sellers that are willing to enter into a transaction for the asset or liability; *c. Buyers and sellers that are dependent on each other; d. Buyers and sellers that are knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information.

24.

Which of the following is an indication of an active market? Learning Objective 3.3 Explain the steps in determining the fair value of non-financial assets. a. there are few recent transactions; b. price quotations vary substantially over time; c. price quotations vary substantially among market-makers; *d. price quotations are based on current market information.

25.

Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date are an example of: Learning Objective 3.3 Explain the steps in determining the fair value of non-financial assets. a. a Level 2 input; *b. a Level 1 input; c. a Level 3 input; d. a Level 4 input.

3.7

Test Bank to accompany Applying IFRS Standards 4e

26.

Non-performance risk refers to the risk that: Learning Objective 3.4 Understand how to measure the fair value of liabilities. a. a market participant will not fulfil an obligation; *b. the holder of the liability will not fulfil an obligation; c. the counterparty will not fill an obligation; d. the holder of a corresponding asset will not fulfil an obligation.

27.

Which of the following is an example of a liability where there is no corresponding asset? Learning Objective 3.4 Understand how to measure the fair value of liabilities *a. a provision for decommissioning; b. a debenture issued by a listed company; c. a loan owing to a financial institution; d. a provision for warranties.

28.

In measuring an equity instrument at fair value the objective is to estimate an exit price at measurement date from the perspective of: Learning Objective 3.5 Explain how to measure the fair value of an entity’s own equity instruments. a. the issuer of the equity instrument; b. the party to whom the instrument will be transferred; c. the party who intends to repurchase the instrument; *d. a market participant who holds the instrument as an asset.

29.

The fair value of an equity instrument is based on determining a/an _________ price which may relate to the price paid for an entity to repurchase its shares. Learning Objective 3.5 Explain how to measure the fair value of an entity’s own equity instruments. a. transfer; b. settlement; c. entry; *d. exit.

30.

Which of the following disclosure are required under IFRS 13? Learning Objective 3.7 Prepare the disclosures required by IFRS 13 Fair Value Measurement. a. the valuation techniques used to measure fair value b. the level of the fair value hierarchy within which the fair value measurements are categorised c. quantitative information about the significant unobservable inputs used in the fair value measurement *d. all of the options are correct.

3.8

Exercises Exercise 3.8 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

IN-COMBINATION VALUATION PREMISE

Mega Ltd acquired a business that used a large number of assets that worked in combination to produce a product saleable in offshore markets. One feature of the assets of the business is that it includes a computer program that enables the inputs to the manufacturing process to be transferred in a predetermined routine to the assets that work together to produce the output. In measuring the fair value of the computer program, management of Mega Ltd determined that the valuation premise was ‘in-combination’ as the program worked together with other assets in the business. Required

Discuss how the various valuation approaches may be applied in the determination of the fair value of the computer program. Exercise 3.9 ★

REQUIREMENT FOR A STANDARD

Measurement at fair value has been available in accounting standards for a long period of time. However, it was only in 2011 that the IASB issued IFRS 13 Fair Value Measurement, providing an accounting standard in relation to fair value measurement. Required

Discuss why such a standard was considered necessary. Exercise 3.10 ★

DEFINITION OF FAIR VALUE

IFRS 13 provides a deﬁnition of ‘fair value’. Required

Outline the key characteristics of this deﬁnition and explain the effects of the inclusion of each characteristic in the deﬁnition. Exercise 3.11 ★

EXIT PRICES AS FAIR VALUE

Benston (2008) issued the following statement: Although the FASB has specified that fair values should be exit prices, many of the illustrative examples involve calculations of value-in-use or entrance values. This inconsistent application of the prescription of FAS 157 appears due to two factors. One is that the price another firm might pay for an asset depends on the value of the asset to that firm, its value in use. The other is perhaps the realization that when there is no potential purchaser, exit values would be zero or even negative if the firm would have to pay to dispose of an asset. The balance sheet would be decimated.

Required

Discuss whether Benston’s criticisms of FAS 157 are applicable to IFRS 13. Exercise 3.12 ★

FAIR VALUE OF WORK-IN-PROGRESS

In relation to fair value measurement, the following statement was made by Benston (2008): Since the exit price of raw materials will almost always be less than the price at which they were purchased and the exit value of partially finished goods probably is zero or negative, companies using the . . . definition of fair value would have to record a substantial expense. . . . The situation is likely to be more drastic for fixed assets, particularly for special-purpose assets that have no value to other parties.

Required

Discuss the statement made by Benston. Exercise 3.13 ★

FAIR VALUE HIERARCHY

IFRS 13 proposes a fair value hierarchy. Required

Discuss the differences between the various levels in the hierarchy and whether prices produced under all levels should be described as ‘fair values’.

CHAPTER 3 Fair value measurement

Exercise 3.14

HIGHEST AND BEST USE

★ Royal Dutch Shell (2009) stated: 5.2. In practical terms, however, we doubt that an asset measured on any other basis than its intended use will provide more useful information to readers . . . the fact that, say, a site used for production would have a higher market value if it were redeveloped for retail purposes, is not relevant if the entity is not engaged in retail or, more obviously, needs the site in order to carry out its production operations. 5.3. The risk here is that the fair value measure, as redeﬁned, results in irrelevant information.

Required

Discuss the issues associated with measuring the fair value of a site currently used for production, but which also can be redeveloped for retail purposes.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ruth Picker and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 4: Revenue from contracts with customers

Chapter 4 - Revenue from contracts with customers Discussion Questions 1. What are the main accounting issues associated with the recognition of revenue and how does IFRS 15 address those? <await solution> 2. Why might it be necessary to combine individual contracts? Give two examples of these and discuss how IFRS 15 applies to such transactions. <await solution> 3. Compare and contrast the revenue recognition criteria for the sale of goods with those for the rendering of services. Revenue from the sale of goods can be recognised when the following conditions have been satisfied: (IAS 18 paragraph 14) (a) The entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) The amount can be reliably estimated (d) It is probable that the economic benefits associated with the transaction will flow to the entity; and (e) The costs incurred or to be incurred in respect of the transaction can be measured reliably. On the other hand, the revenue from a service transaction can be recognised when all of the following conditions are satisfied: (IAS 18 paragraph 20) (a) The amount of revenue can be measured reliably; (b) It is probable that the economic benefits associated with the transaction will flow to the entity; (c) The stage of completion of the transaction at the end of the reporting period can be measured reliably; and (d) The costs incurred for the transaction and the costs to complete the transaction can be measured reliably. Only paragraphs (a), (b) and (d) of the recognition criteria for the sale of services are the same as those for the sale of goods (paragraphs (c) and (d). Of these, (a) and (b) for services [and (c) and (d) for goods] repeat the recognition criteria set out in the Objective paragraph of IAS 18.

4.1

Solutions Manual to accompany Applying IFRS Standards 4e

4. Explain the disclosure objectives and general requirements of IFRS 15. <await solution>

4.2

Chapter 4: Revenue from contracts with customers

Exercises Exercise 4.1

DEFINITIONS, SCOPE

State whether each of the following is true or false: 1. 2. 3. 4. 5. 6.

‘Income’ means the same as ‘revenue’.” ‘Gains’ are always recognised net under IFRSs. ‘Revenue’ must always be in respect of an entity’s ordinary operations ‘Gains’ must always be outside of an entity’s ordinary operations. ‘Deferred revenue’ meets the definition of a liability under the Conceptual Framework. Services provided under a construction contract are accounted for under IFRS 15.

1. 2. 3. 4. 5. 6.

False False True False False False. IAS 11 applies

Exercise 4.2

MEASUREMENT

State whether each of the following is true or false: 1. Revenue is measured at the fair value of the consideration given by the seller. 2. Revenue is measured at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 3. If payment for the goods or services is deferred, the fair value of the consideration will be less than the nominal amount of the cash receivable. 4. A swap or exchange for goods or services of a similar nature and value generates revenue. 5. Collectability of amounts due from customers is a measurement issue, not a recognition issue. 1. False. Revenue is measured at the fair value of the consideration received or receivable by the seller. 2. True. 3. True. 4. False. 5. True.

Exercise 4.3

REVENUE RECOGNITION – SALE OF GOODS

In each of the following situations, state at which date, if any, revenue will be recognised: 1. A contract for the sale of goods is entered into on 1 May 2016. The goods are delivered on 15 May 2016. The buyer pays for the goods on 30 May 2016. The contract contains a clause that entitles the buyer to rescind the purchase at any time. This is in addition to normal warranty conditions. 2. A contract for the sale of goods is entered into on 1 May 2016. The goods are delivered on 15 May 2016. The buyer pays for the goods on 30 May 2016. The contract contains a clause that entitles the buyer to return the goods up until 30 June 2016 if the goods do not perform according to their specification.

4.3

Solutions Manual to accompany Applying IFRS Standards 4e 3. A contract for the sale of goods is entered into on 1 May 2016. The goods are delivered on 15 May 2016. The contract contains a clause that states that the buyer shall only pay for those goods that it sells to a third party for the period ended 31 August 2016. Any goods not sold to a third party by that date will be returned to the seller. 4. Retail goods are sold with normal provisions allowing the customer to return the goods if the goods do not perform satisfactorily. The goods are invoiced on 1 May 2016 and the customer pays cash for them on that date.

1. No revenue is recognised because the customer has the right to rescind the purchase at any time – beyond normal warranty conditions. The cash is recorded on receipt with the credit being recorded as a borrowing. 2. Revenue is recognised on 30 June 2016.This is the date at which the seller has no further performance obligations. 3. Revenue is recognised only at the dates the buyer on-sells the goods to a third party. 4. Revenue is recognised on 1 May 2016. The right of return is a normal warranty clause and is included in determining the measurement of the revenue.

Exercise 4.4

MULTIPLE-ELEMENT ARRANGEMENT

Required Prepare the journal entries to record this transaction in accordance with IFRS 15 for the year ended 30 June 2016, assuming Company A applies the relative fair value approach. Show all workings.

Connection fee Access fee Troubleshooting Total

Fair value of each component if sold separately 5 000 12 000 23 000 40 000

At inception of the agreement: DR Cash CR Revenue – connection fee CR Deferred revenue – access CR Deferred revenue – troubleshooting

Allocation of fair value to total consideration

Allocated amount

5 000/40 000 x 35 000 12 000/40 000 x 35 000 23 000/40 000 x 35 000

4 375 10 500 20 125 35 000

35 000 4 375 10 500 20 125

The deferred revenue for each of the undelivered elements (i.e. the ongoing access and on-call troubleshooting) will be recognised when those services are delivered. Because these are available to Customer B continuously over the period of the agreement the revenue should be recognised in accordance with IFRS 15 – i.e. on a straight-line basis. Since this agreement is for 1 year Company A would record the following over the year ended 30 June 2016: DR DR CR

Deferred revenue – access Deferred revenue – troubleshooting Revenue

10 500 20 125

30 625

4.4

Chapter 4: Revenue from contracts with customers Exercise 4.5

REVENUE RECOGNITION – RENDERING OF SERVICES

In each of the following situations, state at which date(s), if any, revenue will be recognised: 1. A contract for the rendering of services is entered into on 1 May 2016. The services are delivered on 15 May 2016. The buyer pays for the services on 30 May 2016. 2. A contract for the rendering of services is entered into on 1 May 2016. The services are delivered continuously over a 1-year period commencing on 15 May 2016. The buyer pays for all the services on 30 May 2016. 3. A contract for the rendering of services is entered into on 1 May 2016. The services are delivered continuously over a 1-year period commencing on 15 May 2016. The buyer pays for the services on a monthly basis, commencing on 15 May 2016. 4. Company A is an insurance agent and provides insurance advisory services to Customer B. Company A receives a commission from Insurance Company I when Company A places Customer B’s insurance policy with Insurance Company I, on 1 April 2016. Company A has no further obligation to provide services to Customer B. 5. Company A is an insurance agent and provides insurance advisory services to Customer B. Company A receives a commission from Insurance Company I when Company A places Customer B’s insurance policy with Insurance Company I, on 1 April 2016. Company A is required to provide ongoing services to Customer B until 1 April 2017. Additional amounts are charged for these services. All amounts are at market rates. 6. Company A receives a non-refundable upfront fee from Customer B for investment advice, on 1 March 2016. Under the agreement with Customer B Company A must provide ongoing management services until 1 March 2017. An additional amount is charged for these services. The upfront fee is higher than the market rate for equivalent initial investment advice services.

1. Revenue is recognised on 15 May 2016. 2. Revenue is recognised on a straight-line basis over the year commencing 15 May 2016. The upfront payment is deferred and recognised as revenue over this period. 3. Revenue is recognised on a straight-line basis over the year commencing 15 May 2016. 4. Revenue is recognised on 1 April 2016. 5. Commission revenue is recognised on 1 April 2016. Revenue for the ongoing services is recognised as those services are provided over the year commencing 1 April 2016. 6. The upfront fee should be allocated between revenue for initial investment advice (based on the fair value of an equivalent fee for such advice) and ongoing management services. The part attributable to ongoing services should be deferred and recognised as revenue over the period 1 March 2016 – 1 March 2017. The part attributable to initial investment advice may or may not be recognised immediately depending on whether there is any link to the ongoing services.

4.5

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 4.6

DEFINITIONS

State which of the following meets the definition of ‘revenue’ under IFRS 15 for Company Z, a retailer of toys. Give reasons for your answer: 7. 8. 9. 10. 11.

1. Sales tax collected on behalf of the taxing authority. 2. Gain on the sale of an investment property. 3. Amounts receivable from customers who have purchased toys. 4. Gain on the sale of equity securities held as investments. 5. Revaluation increment on the revaluation of operating properties under IAS 16.

1. 2. 3. 4. 5.

No. No. Yes. No. No.

This is an agency relationship. This is not ordinary operations. This falls within ordinary operations. This is outside of the scope of IFRS 15. This is not ordinary operations.

Exercise 4.7

RECOGNITION

What is an ‘executory contract’? How does this affect the dates on which revenue is recognised under the Conceptual Framework?

An executory contract (also known as an agreement equally proportionately unperformed) is one where neither party to the contract has performed their obligations. In the case of such agreements no asset or liability exists under the Conceptual Framework. Only when the seller performs its obligation under the contract (usually at the delivery date) is it entitled to receive payment. It has an asset and revenue under the Conceptual Framework at that date.

Exercise 4.8

MEASUREMENT – DATES FOR RECOGNITION

Company R sells plastic bottles. Wholesale customers that purchase more than 10 000 bottles per month are entitled to a discount of 6% on their purchases. On 1 March 2014 Customer P ordered 10 crates of bottles from Company R. Each crate contains 2000 bottles. The normal selling price per crate is $400. Company R delivered the 10 crates on 15 March 2014. Customer P paid for the goods on 15 April 2014. The end of Company R’s reporting period is 30 June. Required Prepare the journal entries to record this transaction by Company R for the year ended 30 June 2014.

10 crates x $400 per crate = $4000 Customer P is entitled to the discount because total bottles purchased = 20 000 Discount = $4000 x 6% = $240 Therefore the amount, net of the discount is $3760. This is the amount to be recognised as revenue in accordance with IFRS 15. 1 March 2014: No entry (date of order)

4.6

Chapter 4: Revenue from contracts with customers

15 March 2014 DR Receivable 3760 CR Revenue 3760 (to record the receivable and revenue at the date of delivery) 15 April 2014 DR Cash 3760 CR Receivable 3760 (to record the cash received and recovery of the receivable)

Exercise 4.9

Revenue Recognition – Rendering of Services

Required Calculate the revenue to be recognised by Company Z for the year ended 30 June 2014 and prepare the journal entries to record the transactions described. Assume all of Company Z’s costs are paid for in cash.

Total costs incurred to date: Less: Costs in respect of services not yet performed: Total

490 000 ($360 000 + $130 000) 85 000 ($60 000 + $25 000) 405 000 (a)

Total estimated costs Percentage Complete

670 000 (b) 60.448% [(a) / (b)]

Total estimated revenue under the agreement

860 000 (c)

Revenue to be recognised at 30 June 2014

519 851 [60.448% x (c)]

Journal Entries DR Expenses 490 000 CR Cash 490 000 (to record expenses for costs incurred up to 30 June 2014) If Company Z could sustain an argument that the $85 000 costs incurred in respect of services yet to be delivered could be deferred until those services are delivered then it could capitalise those costs as follows: DR Deferred expenses 85 000 CR Expenses 85 000 (to record deferral of expenses related to future revenue) DR Receivable from Customer S 519 851 CR Revenue 519 851 (to record revenue in accordance with the % completion method) DR Cash CR Receivable from Customer S (to record payments made by Customer S)

500 000 500 000

Profit on the contract as at 30 June 2014 assuming expenses of $85,000 are deferred: Revenue 519 851 Less expenses 405 000 Profit 114 851

4.7

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 4.10

AGENT VS. PRINCIPAL QUESTION

Discuss how an entity would determine whether it acts as an agent or principal in sales transactions. In your answer, discuss the distinguishing features between an agency versus principal relationship and the consequences for revenue recognition.

In an agency relationship, amounts collected on behalf of the principal are not gross inflows flowing to the agent and thus do not meet the definition of revenue. Rather, the revenue is the amount of commission received or receivable by the agent. In practice this is addressed by identifying who bears the risks and rewards of the goods or services to be provided. The party bearing the majority of the risks and rewards would usually be the principal in the transaction and would recognise revenue gross. Factors to consider include: • who is responsible for product or service faults; • who bears any warranty obligations; and, • who takes ultimate responsibility for performance of the goods.

Exercise 4.11

TELECOMMUNICATIONS MULTIPLE-ELEMENT ARRANGEMENT

Required Discuss the revenue recognition issues that arise out of the transactions described (a) for Company A and (b) for the distributor. Ignore discounting.

(a) Company A Handset cost Sale to distributor Loss on handset

$100 $ 80 $ 20

12-month contract $50 x 12 Less 12% commission Net amount

$600 $ 72 $528

24-month contract $40 x 24 Less 15% commission Net amount

$960 $144 $816

Company A regards the handset sale to the distributor as a separate transaction as it does not regard the distributor as its agent for the handset. Therefore it must recognise the loss on the handset immediately and cannot defer the cost as part of either the 12-month or the 24-month contracts. DR CR

Cash/Receivable Revenue

DR CR

Cost of sales Inventory

100

The fact that the sale is for 50% less than fair value raises the question of the amount of revenue to be recorded. IFRS 15 requires revenue to be measured at the fair value of the consideration received/receivable. Even though the fair value of the handset is $160, the amount receivable from the distributor is $80 – therefore this is the amount to be recognised as revenue. [Note to lecturers: in coming up with its revenue model, the IASB considered and decided against the pure fair value

4.8

Chapter 4: Revenue from contracts with customers method for measuring revenue. They decided that the consideration received for the transaction would be the most practical approach to implement]. On the 12-month contract, Company A records the gross amount received from the customer as revenue over the period of the contract (because the distributor is its agent) and records the commission as a cost of sale; i.e.: DR CR

Cash/Receivable Deferred revenue

600

DR CR

Deferred revenue Revenue

600

DR CR

600

Commission expense Cash/Payable

72 72

The revenue would be initially recorded as deferred revenue and released to income on a straight-line basis in accordance with IFRS 15 because Company A has an obligation to provide access to its network over the 12-month period. On the 24-month contract Company A records the gross amount received from the customer as revenue over the period of the contract (because the distributor is its agent) and records the commission as a cost of sale; i.e.: DR CR

Cash/Receivable Deferred revenue

960

DR CR

Deferred revenue Revenue

960

DR CR

Commission expense Cash/Payable

144

960

144

The revenue would be initially recorded as deferred revenue and released to income on a straight-line basis in accordance with IFRS 15 because Company A has an obligation to provide access to its network over the 24-month period. (b) Distributor 12-month contract Commission Handset ($160 x 60%) Total amount Less: Cost of handset Profit No Contract Commission Handset Total amount Less: Cost of handset Profit

$72 $96 $168 $80 $88

24-month contract Commission Handset ($160 x 50%) Total amount Less: Cost of handset Profit

$144 $80 $224 $80 $144

$160 $160 $80 $80

The distributor acts for Company A as an agent for the service contract, and thus recognises as revenue its commission received. It acts as principal for the handset, and thus recognises as revenue the amount received from the customer, with the cost of the handset recognised as an expense. The commission is recognised immediately unless there is an actual or implicit performance obligation to the customer for the duration of the contract, and that obligation is linked to the service contract. The distributor has an obligation to replace the handset if it fails but this would generally be considered a

4.9

Solutions Manual to accompany Applying IFRS Standards 4e normal warranty obligation. This obligation is linked to the handset, not to the service contract. Any customer problems with access to the network or calls etc. would be met by Company A who is the principal in respect of the service contract. Thus the distributor should recognise all its commission upfront and include any warranty obligation in its measurement of the revenue from the handset. Example journal entries – 12-month contract DR Cash/Receivable CR Revenue (to record commission revenue)

DR CR

Cash/Receivable Revenue

DR Cost of sales CR Inventory (to record handset revenue and cost of sale)

4.10

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 4 Revenue from contracts with customers

CHAPTER 4 Revenue from contracts with customers

Learning Objectives 4.1 Understand the background to the issuance of IFRS 15 4.2 Identify the types of contracts that are within the scope of IFRS 15 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 4.4 Understand how to account for contract related costs 4.5 Identify other significant application issues associated with IFRS 15 4.6 Explain the presentation and disclosure requirements of IFRS 15.

4.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

Which of the following is a reason why the IASB and FASB jointly developed a revenue standard? I.

remove inconsistencies and weaknesses in the current revenue recognition literature; II. provide a more robust framework for addressing revenue recognition issues; III. improve comparability of revenue recognition practices across the various industries, entities, jurisdictions and capital markets; IV. provide a single reference point in order to reduce the volume of the relevant standards and interpretations that entities will need to refer to; V. provide more useful information to users through enhanced-disclosure requirements. Learning Objective 4.1 Understand the background to the issuance of IFRS 15 a. b. c. *d.

I, II only II, III and IV only I, III and IV only I, II, III, IV and V

Which of the following are excluded from the scope of IFRS 15? I II III IV

the initial recognition of agricultural produce insurance contracts within the scope of IFRS 4 Insurance Contracts the extraction of mineral ores lease agreements

Learning Objective 4.2 Identify the types of contracts that are within the scope of IFRS 15 a. I, II only b. II, III and IV only c. I, III and IV only *d. I, II, III and IV

4.2

Chapter 4 Revenue from contracts with customers

Which of the following contracts with customers to provide goods or services in the ordinary course of business are included within the scope of IFRS 15? I II III

lease contracts accounted for under IAS 17 Leases; insurance contracts accounted for under IFRS 4 Insurance Contracts; financial instruments and other contractual rights or obligations accounted for under IFRS 9 Financial Instruments or IAS 39 Financial Instruments: Recognition and Measurement, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint Ventures non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers.

Learning Objective 4.2 Identify the types of contracts that are within the scope of IFRS 15 a. I., II. and III. b. III. only c. I., II. and IV. *d. None of the above

According to IFRS 15, an entity will recognise revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to a customer, which requires entities to apply a five-step model as follows: Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 a. 1. Identify the contract(s) with a customer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Recognise revenue when (or as) the entity satisfies a performance obligation 5. Allocate the transaction price to the performance obligations in the contract b.

1. Identify the performance obligations in the contract 2. Identify the customer 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations in the contract 5. Recognise revenue when (or as) the entity satisfies a performance obligation

*c.

1. Identify the contract(s) with a customer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations in the contract 5. Recognise revenue when (or as) the entity satisfies a performance obligation

None of the above

4.3

Test Bank to accompany Applying IFRS Standards 4e

In which circumstances arrangements with customers are contracts within the scope of IFRS 15? I.

the contract might be approved by all parties in writing, or in accordance with other customary business practices, II. the parties are committed to carrying out their respective obligations; III. the entity cannot identify the rights of each party with regard to the goods or services that are to be transferred under the contract; IV. the entity cannot identify the payment terms for the goods or services to be transferred; V. the entity has completed performing all of its obligations under the contract and has received all, or substantially all, of the consideration promised by the customer. Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 a. I., II. and III. b. II. and V. c. I., II. and IV. *d. None of the above

According to IFRS 15, which method should be used to estimate the stand-alone selling prices? I. II. III.

Adjusted market assessment approach. Expected cost plus a margin approach. Residual approach, in limited circumstances.

Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 *a. I., II. and III. b. I. and II. c. II. and III. d. None of the above

4.4

Chapter 4 Revenue from contracts with customers

Blue Marine Limited sells boats and provides mooring facilities for its customers. Blue Marine sells the boats for €60,000 each and provides mooring facilities for €10,000 per year. Blue Marine sells these goods and services separately; therefore, they are distinct and accounted for as separate performance obligations. Blue Marine enters into a contract to sell a boat and one year of mooring services to a customer for €65,000. Blue Marine Limited will allocate the transaction price of €65,000 to the performance obligations as follows:

Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 Boat Mooring services a. €65,000 Nil b. Nil €65,000 c. €55,000 €10,000 *d. €55,714 €9,286

Seller enters into a contract with a customer to sell Products A, B and C for a total transaction price of £100,000. Seller regularly sells Product A for £25,000 and Product B for £45,000 on a stand-alone basis. Product C is a new product that has not been sold previously, has no established price, and is not sold by competitors in the market. Products A and B are not regularly sold together at a discounted price. Product C is delivered on 1 March, and Products A and B are delivered on 1 April. How should Seller determine the stand-alone selling price of Product C? Seller can use the residual approach to estimate the stand-alone selling price of Product C, because Seller has not previously sold or established a price for Product C. II. Prior to using the residual approach, Seller should assess whether any other observable data exists to estimate the stand-alone selling price. For example, although Product C is a new product, Seller might be able to estimate a stand-alone selling price through other methods, such as using expected cost plus a margin. III. Seller has observable evidence that Products A and B sell for £25,000 and £45,000 respectively, for a total of £70,000. The residual approach results in an estimated stand-alone selling price of £30,000 for Product C (£100,000 total transaction price less £70,000). I.

Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 *a. I., II. and III. b. I. and II. c. II. and III. d. None of the above

According to IFRS 15, the methods for recognising revenue on arrangements involving the transfer of goods or services over time are: I. II.

Output methods Residual method

4.5

Test Bank to accompany Applying IFRS Standards 4e

III. Input methods IV. Adjusted assessment method

Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 a. I., II. and III. b. I. and IV. *c. I. and III. d. II., III. and IV.

10.

Construction Co lays railroad track and enters into a contract with Railroad to replace a stretch of track for a fixed fee of €100,000. All work in process is the property of Railroad. Construction Co has replaced 75 units of track out of 100 total units of track to be replaced by year end. The effort required of Construction Co is consistent across each of the 100 units of track to be replaced. Construction Co determines that the performance obligation is satisfied over time, as Railroad controls the work in process asset being created. Construction Co should recognise revenue totalling:

Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 a. €100,000. *b. €75,000 c. €25,000 d. €175,000

4.6

Chapter 4 Revenue from contracts with customers

11.

In 2016 Contractor enters into a contract with Government to build an aircraft carrier for a fixed price of €4 billion. The contract contains a single performance obligation that is satisfied over time. Additional contract characteristics are: • •

Total estimated contract costs are €3.6 billion, excluding costs related to wasted labour and materials. Costs incurred in year one are €740m, including €20m of wasted labour and materials.

Contractor concludes that the performance obligation is satisfied over time, because Government controls the aircraft carrier as it is created. Contractor also concludes that an input method using costs incurred relative to total cost expected to be incurred is an appropriate measure of progress towards satisfying the performance obligation. How much revenue and cost should Contractor recognise as of the end of 2016? Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 Revenue Cost *a. €800m €740m b. €800m €760m c. €800m €720m d. €760m €740m

12.

Equipment Dealer enters into a contract to deliver construction equipment to Landscaping Inc. Equipment Dealer operates in a country where it is common to retain title to construction equipment and other heavy machinery as protection against non-payment by a buyer. Equipment Dealer’s normal practice is to retain title to the equipment until the buyer pays for it in full. Retaining title enables Equipment Dealer to more easily recover the equipment if the buyer defaults on payment. Equipment Dealer concludes that there is one performance obligation in the contract that is satisfied at a point in time when control transfers. Landscaping Inc has the ability to use the equipment and move it between various work locations once it is delivered. Normal payment and credit terms apply. When should Equipment Dealer recognise revenue for the sale of the equipment?

Learning Objective 4.3 Apply the five-step model for measuring and recognising revenue under IFRS 15 a. when entering the contract *b. upon delivery c. when full payment is made d. none of the above

13.

Biotech licenses intellectual property (IP) to an early-stage drug compound to Pharma. Biotech also provides research and development (R&D) services as part of the arrangement. Biotech is the only vendor able to provide the R&D services based on its specialised knowledge of the technology.

4.7

Test Bank to accompany Applying IFRS Standards 4e

How is this arrangement defined? Learning Objective 4.5 Identify other significant application issues associated with IFRS 15 a. licence b. distinct licence *c. non distinct licence d. patent

14.

Software Co provides a perpetual software licence to Engineer. Software Co will also install the software as part of the arrangement. Software Co offers the software licence to its customers with or without installation services, and Engineer could select a different vendor for installation. The installation does not result in significant customisation or modification of the software. How is this arrangement defined?

Learning Objective 4.5 Identify other significant application issues associated with IFRS 15 a. patent *b. distinct licence c. non distinct licence d. trademark

15.

Web Co operates a website selling used books. Web Co enters into a contract with Bookstore, a used bookshop, to sell books sold by Bookstore. The terms and conditions of the contract include: • • • • • •

Web Co will transport the books sold to the end customer. Web Co does not take possession of the books sold to the customers; however, the customer returns the books to Web Co if they are dissatisfied. Web Co has the right to return books to Bookstore without penalty if they are returned by the customer. Web Co will invoice the customer for the sale. Web Co earns a fixed margin on the books sold, and has no flexibility in establishing the sales price of the book. Bookstore retains credit risk for sales to the customer.

Web Co should recognise revenue on the transfer of the books to the customer: Learning Objective 4.5 Identify other significant application issues associated with IFRS 15 a. on a gross basis *b. on a net basis c. on a gross basis as Bookstore retains all credit risk d. on a net basis as Web Co does not set the sales price

4.8

Chapter 4 Revenue from contracts with customers

16.

Travel Co negotiates with major airlines to obtain access to airline tickets at reduced rates, and it sells the tickets to its customers through its website. Travel Co contracts with the airlines to buy a specific number of tickets at agreed rates and must pay for those tickets regardless of whether it is able to resell them. Customers visiting Travel Co’s website search Travel Co’s inventory of tickets, and Travel Co has latitude to set the prices for the tickets that it sells to its customers. Customers pay for airline tickets using credit cards, and Travel Co is the merchant of record. Credit card charges are pre-authorised; however, Travel Co incurs occasional losses as a result of disputed charges. Travel Co is responsible for delivering the ticket to the customer. Travel Co will also assist the customer in resolving complaints with the service provided by the airlines. The airline is responsible for fulfilling all other obligations associated with the ticket, including the air travel and related services (that is, the flight), and remedies for service dissatisfaction. Travel Co should recognise revenue:

Learning Objective 4.5 Identify other significant application issues associated with IFRS 15 a. for the ticket price agreed with the airlines *b. for the fee charged to customers on a gross basis c. for the fee charged to customers net of the amounts paid to the airlines d. for the fee charged to customers net of credit card charges

17.

Data Co enters into a two-year contract with a customer to build a data centre in exchange for consideration of €1m. Data Co incurs incremental costs to obtain the contract and costs to fulfil the contract that are recognised as assets and amortised over the expected period of benefit. The economy subsequently deteriorates, and the parties agree to renegotiate the pricing in the contract, resulting in a modification of the contract terms. The remaining amount of consideration to which Data Co expects to be entitled is €650,000. The carrying value of the asset recognised for contract costs is €600,000. An expected cost of €150,000 would be required to complete the data centre. How should Data Co account for the asset after the contract modification?

Learning Objective 4.5 Identify other significant application issues associated with IFRS 15 *a. Data Co should recognise an impairment loss of C100,000. b. Data Co should record the contract asset for €1m. c. The carrying value of the asset recognised for contract cost should be €500,000 (€650,000 less €150,000). d. Data Co should recognise an impairment loss of €150,000.

4.9

Test Bank to accompany Applying IFRS Standards 4e

18.

On 1 January 2016, Producer enters into a contract to deliver a product to Customer on 31 March 2016. The contract is non-cancellable and requires Customer to make an advance payment of €5,000 on 1 February 2016. Customer does not pay the consideration until 1 March. How should Producer reflect the transaction in the statement of financial position?

Learning Objective 4.5 Identify other significant application issues associated with IFRS 15 a. 1 February 2016 Dr Trade Receivables €5,000 Cr Contract Liability €5,000 31 March 2016 Dr Contract Liability Cr Revenue *b.

€5,000 €5,000

1 February 2016 Dr Trade Receivables Cr Contract Liability

€5,000 €5,000

1 March 2016 Dr Cash Cr Trade Receivables

€5,000

31 March 2016 Dr Contract Liability Cr Revenue

€5,000

1 January 2016 Dr Trade Receivables Cr Contract Liability

€5,000 €5,000

1 February 2016 Dr Cash Cr Trade Receivables

€5,000

31 March 2016 Dr Contract Liability Cr Revenue

€5,000

d. None of the above

4.10

Chapter 4 Revenue from contracts with customers

19.

Which of the following disclosure are required by IFRS 15? Total income, allocated between revenue and other gains qualitative and quantitative information about contracts with customers qualitative and quantitative information about any assets recognised from the costs to obtain or fulfil a contract with a customer IV. the opening and closing balances of receivables, contract assets and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed I. II. III.

Learning Objective 4.6 Explain the presentation and disclosure requirements of IFRS 15 a. I and II only *b. II, III and IV only c. I, II and III only d. I, II, III and IV

4.11

Online Exercises for Chapter 4 Revenue from contracts with customers

Applying IFRS® Standards 4e Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Online Exercises for Chapter 4 Revenue from contracts with customers STAR RATING ★ BASIC ★ ★ MODERATE ★ ★ ★ DIFFICULT

Exercise 4.6

DEFINITIONS

★ State which of the following meets the definition of ‘revenue’ under IAS 18 for Company Z, a retailer of toys. Give reasons for your answer: 1.

Sales tax collected on behalf of the taxing authority.

Gain on the sale of an investment property.

Amounts receivable from customers who have purchased toys.

Gain on the sale of equity securities held as investments.

Revaluation increase on the revaluation of operating properties under IAS 16.

Exercise 4.7

RECOGNITION

★ What is an ‘executory contract’? How does this affect the dates on which revenue is recognised under the Conceptual Framework?

Exercise 4.8

MEASUREMENT – DATES FOR RECOGNITION

★★ Company R sells plastic bottles. Wholesale customers that purchase more than 10 000 bottles per month are entitled to a discount of 6% on their purchases. On 1 March 2014, Customer P ordered 10 crates of bottles from Company R. Each crate contains 2000 bottles. The normal selling price per crate is

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Online exercises to accompany Applying IFRS Standards 4e

$400. Company R delivered the 10 crates on 15 March 2014. Customer P paid for the goods on 15 April 2014. The end of Company R’s reporting period is 30 June. Required Prepare the journal entries to record this transaction by Company R for the year ended 30 June 2014.

Exercise 4.9

REVENUE RECOGNITION – RENDERING OF SERVICES

★★ On 1 February 2014, Company Z entered into an agreement with Customer S to develop a new database system (both hardware and software) for Customer S. The agreement states that the total consideration to be paid for the system will be $860 000. Company Z expects that its total costs for the system will be $670 000. As the end of its reporting period, 30 June 2014, Company Z had incurred labour costs of $130 000 and materials costs of $360 000. Of the materials costs, $60 000 is in respect of materials that have not yet been used on the system. Of the labour costs, $25 000 is an advance payment to a subcontractor who had not performed his work on the project as at 30 June 2014. As at 30 June 2014, Customer S had made progress payments to Company Z of $500 000. Company Z has determined that IAS 11 does not apply to this transaction and calculates the percentage of completion using paragraph 24(c) of IAS 18. Required Calculate the revenue to be recognised by Company Z for the year ended 30 June 2014 and prepare the journal entries to record the transactions described. Assume all of Company Z’s costs are paid for in cash.

Exercise 4.10 AGENT VS. PRINCIPAL QUESTION ★★ Discuss how an entity would determine whether it acts as an agent or principal in sales transactions. In your answer, discuss the distinguishing features between an agency versus principal relationship and the consequences for revenue recognition.

Exercise 4.11 TELECOMMUNICATIONS MULTIPLE-ELEMENT ARRANGEMENT ★★★ Company A is a telecommunications company that offers a variety of services to its customers including fixed-line telephone services, mobile phone services and Internet services. It uses numerous distributors to sell its mobile phone services. Customers purchase a phone handset from the distributor and at the same time can sign up to a contract with Company A for a period of 12 months or 24 months for the provision of network access for a fixed fee. Calls are charged separately if they exceed a certain limit per month. If the customer enters into a 12-month contract, the handset is sold to them for 40% less than the quoted market price. If the customer enters into a 24-month contract, the handset is sold to them for 50% less than the quoted market price. The distributor earns a commission from Company A based on a John Wiley & Sons, Ltd 2016

Online Exercises for Chapter 4 Revenue from contracts with customers

percentage of the consideration for each contract entered into — 12% for a 12-month contract and 15% for a 24-month contract. Company A sells its handsets to its distributors at 50% less than fair value on the basis that the distributor will use the handset to entice customers to enter into the contracts with Company A. If the customer has any problems with the handset during or after the period of the contract (up to a maximum of 2 years), the customer has recourse to the distributor who must replace the handset at its own cost. In the case of a handset manufactured by Company A, the distributor will source the handset from Company A, who will sell it to the distributor at 50% less than fair value. The distributor sells handsets to customers even if they don’t sign up to any services agreement with Company A. In such cases, the customers are charged the market price for the handsets. The distributor also sells other handsets (i.e. not only those of Company A). Company A has determined that the distributor is acting as its agent in respect of the service contracts but not in respect of its handsets.

Additional information Handset cost to Company A

$100

Handset fair value

$160

12-month contract, price charged to customers

$50 per month, all paid upfront

24-month contract, price charged to customers

$40 per month, all paid upfront

Required Discuss the revenue recognition issues that arise out of the transactions described (a) for Company A and (b) for the distributor. Ignore discounting.

John Wiley & Sons, Ltd 2016

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ruth Picker and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 5: Provisions, contingent liabilities and contingent assets

Chapter 5: Provisions, contingent liabilities and contingent assets Discussion Questions 1.

How is present value related to the concept of a liability?

IAS 37 (para 42) requires that the risks and uncertainties surrounding the events and circumstances should be taken into account in reaching the best estimate of a provision. IAS 37 requires provisions to be discounted to present value where the effect of discounting is material (paragraph 45). The discount rate used must be a pre-tax rate that reflects the time value of money and the risks specific to the liability. To avoid double-counting, where the estimates of future cash flows have been adjusted for risk then the discount rate should not also reflect the particular risk (paragraph 47). In practical terms it is often difficult to determine reliably a liability-specific discount rate. Usually entities use a rate available for a liability with similar terms and conditions or, if a similar liability is not available, a risk-free rate for a liability with the same term (for example a government bond 1 with a five-year term may be used as the basis for a company’s specific liability with a five-year term) and this rate is then adjusted for the risks pertaining to the liability in question.

Define (a) a contingency and (b) a contingent liability.

A “contingency” is not defined in IAS 37. In plain English a contingency is an unforseen event that may or may not happen. IAS 37 defines a “contingent liability” at paragraph 10. It has two limbs to the definition: (a) a possible obligation that arises from past events; or (b) a present obligation (liability) that fails the recognition criteria. The definition at paragraph 10 is: “(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 recognised 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.” Refer to section 5.5 of the text for discussion about why part (a) of the definition is potentially misleading.

What are the characteristics of a provision?

The characteristics of a provision are that it is a liability where there is uncertainty as to either the timing of settlement or the amount to be settled. When measuring a provision, the amount to be recognised should be the best estimate of the consideration required to settle the present obligation at the end of the reporting period. The fact that it is difficult to measure a provision and that estimates have to be used does not mean that the provision is not reliably measurable.

Assumed to be risk-free, although this may not always be the case.

5.1

Solutions Manual to accompany Applying IFRS Standards 4e

Define a constructive obligation.

One of the essential characteristics of a liability is that there must be a present obligation arising from past events. A present obligation exists only where the entity has no realistic alternative but to make the sacrifice of economic benefits to settle the obligation. A present obligation includes a constructive obligation. A constructive obligation is defined in IAS 37 as “an obligation that derives from an entity’s actions where: (a) By an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and (b) As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.”

What is the key characteristic of a present obligation?

The key characteristic of a present obligation is if the entity has no realistic alternative but to make the sacrifice of economic benefits to settle the obligation. This may be the case for example, if an entity makes a public announcement that it will match dollar for dollar the financial assistance provided by other entities to bushfire victims, and because of custom and moral obligations, there is no realistic alternative but to provide the financial assistance. In rare cases it may not be clear whether there is a present obligation. In such cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the reporting date (IAS 37, para 15)

What are the recognition criteria for provisions?

The recognition criteria for provisions are contained in IAS 37 (paragraph 14). A provision should be recognised when: (a) an entity has a present obligation (legal or constructive) as a result of a past event; (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation.

At what point would a contingent liability become a provision?

Contingent liabilities need to be continually assessed to determine whether or not they have become actual liabilities. This is done by considering whether the recognition criteria for liabilities have been met. If it becomes probable that an outflow of economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognised in the financial statements in the period in which the change in probability occurs. 8.

Compare and contrast the requirements of IFRS 3 and IAS 37 in respect of restructuring provisions and contingent liabilities.

See Table 5.2 in the text.

5.2

Chapter 5: Provisions, contingent liabilities and contingent assets

Table 5.2 summarises the similarities and differences between IFRS 3 and IAS 37. TABLE 5.2 Similarities and differences between IFRS 3 and IAS 37 IAS 37

IFRS 3

Contingent liabilities — part (a) of the definition of a contingent liability

Possible liabilities are not recognised by the entity

Possible liabilities are not recognised by the acquirer

Same

Contingent liabilities — part (b) of the definition of a contingent liability

A present obligation that fails either of the recognition criteria must not be recognised by the entity

A present obligation whose fair value can be reliably measured must be recognised by the acquirer

Different

Contingent consideration

Contingent consideration is not specifically addressed, but applying the definition of a contingent liability would likely result in no amount being recognised by the entity

Contingent consideration must be recognised by the acquirer at its acquisitiondate fair value

Different

Restructuring provisions

A restructuring provision is recognised by the entity only if the criteria in IAS 37 are met

A restructuring provision is recognised by the acquiree only if the criteria in IAS 37 are met

Same

Same/Different

5.3

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 5.1

RECOGNISING A PROVISION

When should liabilities for each of the following items be recorded in the accounts of the business entity? (a) Acquisition of goods by purchase on credit (b) Salaries (c) Annual bonus paid to management (d) Dividends (a) When the goods are delivered (the obligating event for the purchaser is the receipt of the goods) (b) When the services are rendered (the obligating event for the employer is when the employees deliver their services) (c) When the conditions for receiving the bonus are met and the amount can be reliably measured. See also IAS 19 paras 17–22. (d) When the dividends are declared (appropriately authorised and no longer at the discretion of the entity). See also IAS 10 paras 12 and 13.

Exercise 5.2

RECOGNISING A PROVISION

Should company A provide for the costs of the staff training at the end of the reporting period?

The question here is whether a present obligation as a result of a past obligating event exists. There is no obligation because no obligating event (retraining) has taken place. Therefore, no provision is recognised.

Exercise 5.3

RECOGNISING A PROVISION

Should company B recognise a liability for damages in its financial statements at 30 June 2016? How should it deal with the information it receives two weeks after the financial statements are published?

At 30 June 2016 Present obligation as a result of a past obligating event – On the basis of the evidence available when the financial statements were approved, there is no obligation as a result of past events because, according to legal advice, Company B does not have a present obligation. Even if Company B did have a present obligation, the recognition criterion of probability of outflow of resources is not met. Conclusion – No provision is recognised. The matter is disclosed as a contingent liability (either a possible liability or a present obligation that fails the recognition criteria) unless the probability of any outflow is regarded as remote. Once company B becomes aware of the new information: Present obligation as a result of a past obligating event – On the basis of the evidence available, there is a present obligation. An outflow of resources embodying economic benefits in settlement – Probable.

5.4

Chapter 5: Provisions, contingent liabilities and contingent assets

Conclusion – A provision should be recognised for the best estimate of the amount to settle the obligation. However, company B has already issued its financial statements. The fact that the expected damages are material to the reported profit means that company B, being a listed company, will be most likely to have a continuous disclosure obligation to disclose the new information. Depending on the laws of its jurisdiction it may have to rescind the financial statements and issue new ones, updating the disclosures about the contingent liability and recognising the provision as required by paragraphs 19 and 20 of IAS 10 Events After the Reporting Period.

Exercise 5.4

DISTINGUISHING BETWEEN CONTINGENT LIABILITIES

LIABILITIES,

PROVISIONS

AND

Identify whether each of the following would be a liability, a provision or a contingent liability, or none of the above, in the financial statements of company A as at the end of the reporting period of 30 June 2016. Assume that company A’s financial statements are authorised for issue on 24 August 2016. (a) An amount of $35 000 owing to company Z for services rendered during May 2016. (b) Long-service leave, estimated to be $500 000, owing to employees in respect of past services. (c) Costs of $26 000 estimated to be incurred for relocating employee D from company A’s head office location to another city. The staff member will physically relocate during July 2016. (d) Provision of $50 000 for overhaul of a machine. The overhaul is needed every five years and the machine was five years old as at 30 June 2016. (e) Damages awarded against Company A resulting from a court case decided on 26 June 2016. The judge has announced that the amount of damages will be set at a future date, expected to be in September 2016. Company A has received advice from its lawyers that the amount of the damages could be anything between $20 000 and $7 million.

(a) Liability. This event falls within the reporting period and the amount and timing are certain. (b) Provision – the amount and timing are uncertain: it is unclear how long employees will continue to serve in company A’s employ and this affects whether or not they become eligible for long service leave. (c) No provision or liability – the amount is a future cost. (d) No provision or liability – no present obligation to overhaul the machine – company A could decide to sell the machine or not repair it. (e) This is a present obligation and the obligating event has occurred, therefore it is a liability; however the amount cannot be reliably measured as the estimated range is too great. Therefore this should be disclosed as a contingent liability, being a liability that fails the recognition criterion of reliable measurement.

5.5

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 5.5

RECOGNISING A PROVISION

In each of the following scenarios, explain whether or not company G would be required to recognise a provision. (a) As a result of its plastics operations, company G has contaminated the land on which it operates. There is no legal requirement to clean up the land and company G has no record of cleaning up land that it has contaminated. (b) As a result of its plastics operations, company G has contaminated the land on which it operates. There is a legal requirement to clean up the land. (c) As a result of its plastics operations, company G has contaminated the land on which it operates. There is no legal requirement to clean up the land, but company G has a long record of cleaning up land that it has contaminated. (a) No present obligation – no provision. (b) Present obligation – contamination of the land is the past event therefore a provision should be recognised. (c) There is a constructive obligation – construed from company G’s past actions; therefore a provision should be recognised.

Exercise 5.6

CALCULATION OF A PROVISION

Calculate the provision for relocation costs for company A’s financial statements as at 30 June 2013. Assume that IAS 37 applies to this provision and that the effect of discounting is immaterial. Company A relocated employee R from company A’s head office location to another city. Employee R moved to the other city during May 2013. As at 30 June 2013 (company A’s reporting date) the costs were estimated to be $40 000. An analysis of the costs and the amounts to be included as part of a provision, is as follows: Note that the obligating event is the relocation of the employee, which occurred before 30 June 2013. Costs for shipping goods good have been shipped before 30 June 2013) Airfare employee flew in May 2013) Temporary accommodation costs (May and June) Temporary accommodation costs (July and August) Reimbursement for lease break costs (paid in July; lease was terminated in May) Reimbursement for cost-of-living increases (for the period 15 May 2013-15 May 2014)

$3 000

Include

(assume

6 000

Include

(assume

8 000 9 000

Include Exclude - Future costs 2 000 Include; obligating event occurred in May 2013 12 000 Include $2 000 for May and June 2013; remainder are future costs

Total amount provided should therefore be $21 000 ($3000 + $6000 + $8000 + $2000 + $2000).

5.6

Chapter 5: Provisions, contingent liabilities and contingent assets

Exercise 5.7

COMPREHENSIVE PROBLEM

Prepare the relevant extracts from the financial statements (including the notes) of ChubbyChocs as at 30 June 2015, in compliance with IAS 37 and related International Financial Reporting Standards. Include comparative figures where required. Show all working separately. Perform your workings in the following order: (a) Calculate the warranty provision as at 30 June 2014. This should agree with the financial statements provided in the question. (b) Calculate the warranty provision as at 30 June 2015. (c) Calculate the movement in the warranty provision for the year. (d) Calculate the prospective change in depreciation required as a result of the shortened useful life of the conveyer belt. (e) Determine whether the unpaid amount owing as a result of the peanut allergy case is a liability or a provision. (f) Determine whether the receipt of damages for the negligent advice meets the definition of an asset or a contingent asset. (g) Determine whether the bank guarantee meets the definition of a provision or a contingent liability. (Ignore IAS 39 in this regard.) (h) Prepare the financial statement disclosures. Workings (a) + (80% x 0) + (15% x 1 000 000) + (5% x 6 000 000)

= = =

$0 $150 000 $300 000 $450 000

Timing: FY 2015: + 150 000 + (40% x 300 000)

$150 000 $120 000 $270 000 (current portion)

FY 2016: + (60% x 300,000 discounted at 6% [for 2 years]) = 180 000/1.12 $160 715 (non-current portion) Therefore total provision = 270 000 + 160 715 = $430 715 (b) + (85% x 0) + (12% x 1 000 000) + ( 3% x 5 000 000)

$0 $120 000 $150 000 $270 000

Timing: FY 2016: + 120 000 + (20% x 150 000)

$120 000 $ 30 000 $150 000

FY 2017: + (80% X 150 000 discounted at 6% [for 2 years]) = 120 000/1.12 $107 143 Therefore total new provision = 150 000 + 107 143 =

$257 143

5.7

Solutions Manual to accompany Applying IFRS Standards 4e

(c) Opening balance Plus: Increase in the provision Less: Amounts used during the year Less: Unused amounts reversed during the year

$430 715 $257 143 (200 000) ( 70 000)

Plus: Increase in discounted amount arising from the passage of time

$19 285

Closing balance

$437 143

Proof: New provision: Balance of provision from FY 2015 payable in FY 2016

[270 000 expected to be paid in FY 2015, 200 000 was actually paid] [180 000 – 160 715]

$257 143 $180 000 $437 143

Non-current portion = $107 143 (d) Conveyer Belt overhaul The expected overhaul is not a provision as ChubbyChocs has no present obligation to conduct the overhaul. Rather, it is evidence that the conveyer belt’s useful life has been shortened. The change in the depreciation rate must be accounted for prospectively in accordance with IAS 16 paragraph 61 as follows: Conveyer belt Original cost Accumulated depreciation Carrying amount

As at 30 June 2014 200 000 60 000 140 000

As at 30 June 2015 200 000 80 000 120 000

The following adjustment should be made: Original expected life Expired life at 30 June 2015 New expected life Therefore, remaining life at 30 June 2015 Therefore, deprecation rate should have been Carrying amount at 30 June 2015 should have been Therefore, additional depreciation required for 2015 Calculations for disclosure of plant & equipment: Excluding conveyer (10 yr life) Cost 1 800 000 Accumulated 720 000 depreciation to 30 June 2012 Carrying amount 1 080 000

10 years 4 years 5 years (4 years old at 30 June 2015, approx. 1 year left) 1 year 20%, i.e. 40 000 per annum [200 000 – (4 x 40 000)] = 40 000 80 000 (120 000 – 40 000)

Conveyer (5 yr life) 200 000 160 000

Total

40 000

1 120 000

2 000 000 880 000

5.8

Chapter 5: Provisions, contingent liabilities and contingent assets

(e) The unpaid amount of $700 000 ($1 500 000 - $800 000 already paid) owing as a result of the peanut allergy case, should be included as part of trade and other payables as there is no uncertainty regarding timing or amount of settlement and hence it is not a provision.

(f) The receipt of damages for the negligent advice about the conveyer belt meets the definition of a contingent asset because the case has been found in favour of ChubbyChocs as at the reporting (thus it is a possible asset) and the amount to be received is dependent on the outcome of future events not wholly within the control of ChubbyChocs (the hearing for damages). The contingent asset should be disclosed because the receipt of damages is probable. Note that the receipt of damages is not a reimbursement relating to a provision – the overhaul of the conveyer belt is not accounted for as a provision.

(g) ChubbyChocs’ guarantee of the loan made by BankSweet to CCC Ltd would be disclosed as a contingent liability rather than recorded as a provision because CCC was in a strong financial position at 30 June 2015 and therefore whilst ChubbyChocs has a present obligation under the guarantee, it is not probable that an outflow of economic benefits will be required to settle the obligation.

(h) Extracts from Financial Statements of ChubbyChocs Limited as at 30 June 2015 30 June 2015 $ CURRENT LIABILITIES Trade & other payables Provisions Provision for warranties (Note x) NON-CURRENT LIABILITIES Provision for warranties (Note x) NON-CURRENT ASSETS Plant and equipment (Note y) At cost Accumulated depreciation Carrying amount

30 June 2014 $

Reference

IAS 1 para.54 IAS 1 para.54

700 000

XXX

330 000

270 000

IAS 1 para. 54, IAS 37, para.84

160 715

IAS 1, para 54 IAS 1 para.54, IAS 37, para.84

2 000 000

IAS 1 para.54 IAS 1, para 54, IAS 16 para 73 (d)

880 000 1 120 000

600 000 1 400 000

107 143

Note x: Provision for warranties ChubbyChocs provides for expected amounts payable under warranties for products sold during the financial year. The portion of the warranty provision that is expected to be settled more than 1 year after the end of the reporting period is classified as a non-current provision. Assumptions used in calculating the warranty are based on past history and experience and include the percentage of products having minor defects vs. those having major defects, the expected costs of rectifying those defects and the expected timing of settlement.

IAS 37 para 85

Reconciliation of warranty provision:

5.9

Solutions Manual to accompany Applying IFRS Standards 4e

Opening balance

430 715

Plus: Additional provision made in the current year

257 143

Less: Amounts used during the year

(200 000)

Less: Unused amounts reversed during the year

(70 000)

IAS 37 para. 84. No comparatives required. As above

As above

Plus: Increase in discounted amount arising from the passage of time

As above 19 285

Closing balance

437 143

Note y: Plant and equipment Plant and equipment is measured at cost. Depreciation is calculated on a straight line basis. Useful lives of the assets vary from 5 years to 10 years.

As above

IAS 16 para 73 Reconciliation not required as all the available information is disclosed on the face of the end of reporting period.

Note 36: Contingent liabilities and contingent assets During the year ChubbyChocs signed an agreement with BankSweet to the effect that ChubbyChocs would guarantee a loan made by BankSweet to ChubbyChocs’ subsidiary, CCC Ltd. CCC’s loan with BankSweet was $3 200 000 as at 30 June 2015. CCC was in a strong financial position at 30 June 2015 and accordingly ChubbyChocs believes that it is not probable that the guarantee will be called (IAS 37 para. 86). ChubbyChocs commenced litigation against one of its advisers for negligent advice in relation to the installation of certain plant and equipment. In April 2015 the court found in favour of ChubbyChocs. The hearing for damages had not been scheduled as at the date these financial statements were authorised for issue. ChubbyChocs estimates that it will receive approximately $425 000, based on advice from their lawyers (IAS 37 para. 89).

5.10

Chapter 5: Provisions, contingent liabilities and contingent assets

Exercise 5.8

RECOGNISING A PROVISION — MEASUREMENT

Explain how a borrowing cost could arise as part of the measurement of a provision. Illustrate your explanation with a simple example. Where discounting is used, the carrying amount of a provision increases in each period to reflect the passage of time. This increase is recognised as borrowing cost. This is similar to the way finance lease liabilities are accounted for under IAS 17 Leases. Refer to Illustrative Example 5.4 in the text, which shows how the interest (borrowing cost) is calculated and provides the journal entries.

Exercise 5.9

RESTRUCTURING COSTS

Which of the following costs, if any, are restructuring costs? (a) The costs of employees (salaries and benefits) to be incurred after operations cease and that are associated with the closing of the division (b) The costs of leasing the factory space occupied by the division for the year after the date of acquisition (c) The costs of modifying the division’s purchasing system to make it consistent with that of the acquirer’s (a) Yes – they are directly attributable to the restructuring and are not associated with the ongoing activities of the entity (b) No – they relate to the ongoing activities of the entity (c) No – they relate to the ongoing activities of the entity

Exercise 5.10

RESTRUCTURING COSTS

Are these costs restructuring costs? These employees will be part of Company Z’s ongoing activities. The costs of retraining and relocating those employees are not restructuring costs because they are costs associated with the ongoing activities of the entity. The costs of the advertising and branding of new stationery etc. to promote the new company image are not restructuring costs because they relate to the ongoing activities of the entity. In addition, they are costs that the acquirer will incur and thus are not permitted to be recognised as part of the acquisition accounting under IAS 37 or IFRS 3.

Exercise 5.11

CONTINGENT LIABILITIES – DISCLOSURE

How should company A disclose this event in its financial statements as at 31 December 2014? A customer filed a lawsuit against the company in December 2014, for costs and damages allegedly incurred as a result of the failure of an electrical product. The company is confident that it will successfully defend the case, however the company’s lawyers have advised that expected costs and damages would be about $500 000 in the event that the company is unsuccessful in defending the case. (Paragraph 86 of IAS 37 requires disclosure of each class of contingent liability unless the possibility of an outflow in settlement is remote, which is not the case here. However, paragraph 86 also requires that the estimate of the financial effect be measured under paragraphs 36 – 52: that is, the amount is a ‘best estimate’ of the expenditure required to settle the obligation, rather than the amount claimed by the customer).

5.11

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 5.12

RISK AND PRESENT VALUE OF CASH FLOWS

Using examples, explain how a liability-specific discount rate could cause the amount calculated for a provision to be lower when the risk associated with that provision is high. How could this problem be averted in practice?

The higher the discount rate used, the lower the present value of cash flows will be. Therefore using a higher discount rate to reflect higher risk creates a lower provision – a counter-intuitive outcome. Consider $100 to be paid in five years’ time. If the risk associated with this anticipated cash flow is considered to be high, a discount rate of (say) 10% p.a. might be used; if the risk associated with the cash flow is lower, a lower discount rate (say 5% p.a.) might be chosen. $100 in 5 years discounted at 10% p.a. $100 in 5 years discounted at 5% p.a.

PV (0.62092) PV (0.78352)

$62.09 $78.35

However, when adjusting a discount rate for a provision, the risk-adjusted rate should actually be LOWER than the risk-free rate. This outcome may seem surprising, because the experience of most borrowers is that lenders will charge a higher rate of interest on loans that are assessed to be a higher risk to the lender. However, in the case of a provision, a lower rate reflects the elimination of the possibility of the actual cost being higher (i.e. the cost is capped at a certain amount above which it will not go) whereas in the case of a loan the lender requires a premium to compensate it for the risk of not recovering the full value of the loan (i.e. the lender’s asset is set at a floor below which it will not go). In other words, the discount rate for the asset (in this case the loan held by the lender) is increased to reflect the risk of recovering less and the discount rate for a provision is reduced to reflect the risk of paying more. A simpler way to factor in risk would be to use it in assessing the probability of outcomes for purposes of calculating expected future cash outflows, and use the risk-free rate to discount the cash flows.

See Illustrative Example 5.2.

Exercise 5.13

MEASURING A RESTRUCTURING PROVISION

Calculate the amount of the restructuring provision recognised in Company T’s financial statements as at 30 June 2014, in accordance with IAS 37.

Factory Z was shut down on 31 May 2014. An offer of $4 million has been received for factory Z, however there was no binding sales agreement: this is not relevant – the binding sale agreement test in paragraph 78 of IAS 37 applies to the sale of an operation. In this case the factory has already been shut down and thus the implementation of the restructuring has virtually been completed. The 100 employees who have been retrenched have left and their accumulated entitlements have been paid, however an amount of $76 000, representing a portion of the three months’ wages for the retrenched employees, has still not been paid. This amount is included in the restructuring provision as the implementation of the restructuring has commenced and the amount represents a present obligation. Costs of $23 000 are expected to be incurred in transferring the 20 employees to their new work in factory X. The transfer will occur on 14 July 2014. This item is not included as the costs relate to ongoing operations.

5.12

Chapter 5: Provisions, contingent liabilities and contingent assets

Four of the five head-office staff have been retrenched; they have left and their accumulated entitlements, including the three months’ wages, have been paid. However one employee, Jerry Perry, remains on to complete administrative tasks relating to the closure of factory Z and the transfer of staff to factory X. Jerry is expected to stay until 31 July 2014. Jerry’s salary for July will be $4000 and his retrenchment package will be $13 000, all of which will be paid on the day he leaves. Jerry estimated that he will spend 60% of his time administering the closure of factory Z, 30% of his time administering the transfer of staff to factory X and the remaining 10% on general administration. The amount to be recognised as a provision is (60% x $4000) + $13 000 = $15 400. The 30% of his salary that relates to ongoing operations and the 10% that relates to general administration cannot be included. The Company has a present obligation for the retrenchment pay so that amount is included. Therefore the total provision is = $76 000 + $15 400 = $91 400.

Exercise 5.14

RESTRUCTURING PROVISIONS ON ACQUISITION

Should Company A create a provision for restructuring as part of its acquisition accounting entries? Explain your answer. How would your answer change if all the circumstances are the same as those above except that Company A decided that, instead of closing a division of Company B, it would close down one of its own facilities? Part (a) Answer is no – under both IAS 37 and IFRS 3 the acquirer cannot recognise the provision if it is not already recognised as a liability of the acquiree. Part (b) – In this situation, although the closing of the facility only arises because of the proposed acquisition, whether or not a present obligation exists would need to be considered in accordance with the requirements for an internal restructuring under IAS 37 as opposed to a restructuring recognised as part of an acquisition. This is because the IFRS 3 requirements relating to restructuring provisions recognised as part of an acquisition, relate only to assets and liabilities of the acquiree. Since the intended closure relates to an operation of the acquirer, a restructuring provision cannot be raised in the books of the acquiree and cannot be considered as part of a restructuring recognised as part of an acquisition.

5.13

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 5 Provisions, contingent liabilities and contingent assets

CHAPTER 5 Provisions, contingent liabilities and contingent assets Learning Objectives 5.1

Describe the background to IAS 37

5.2

Identify which items are included within the scope of the standard

5.3

Outline the concept of a provision

5.4

Discuss how to distinguish provisions from other liabilities

5.5

Outline the concept of a contingent liability

5.6

Describe how to distinguish a provision from a contingent liability

5.7

Explain when a provision should be recognised

5.8

Explain how a provision, once recognised, should be measured

5.9

Apply the definitions, recognition and measurement criteria for provisions and contingent liabilities to practical situations

5.10

Outline the concept of a contingent asset

5.11

Describe the disclosure requirements for provisions, contingent liabilities and contingent assets

5.12

Compare the requirements of IFRS 3 regarding contingent liabilities with those of IAS 37

5.13

Explain the expected future developments for IAS 37.

5.1

Testbank to accompany Applying IFRS Standards 4e Multiple Choice Questions

Provisions in relation to which of the following balances are within the scope of IAS 37? Learning Objective 5.2 Identify which items are included within the scope of the standard *a. warranties b. employee benefits c. financial instruments d. operating leases

The uncertainty that exists in relation to provisions is one of: Learning Objective 5.3 Outline the concept of a provision a. timing b. amount c. timing and amount *d. timing or amount

Which of the following is an example of a provision falling within the scope of IAS 37? Learning Objective 5.4 Discuss how to distinguish provisions from other liabilities a. accruals *b. onerous contracts c. employee benefits d. future operating losses

An event that gives rise to a present obligation, but which cannot be measured with sufficient reliability is an example of a: Learning Objective 5.5 Outline the concept of a contingent liability a. liability b. accrual c. provision *d. contingent liability

Entity A has provided a bank guarantee to a bank in relation to a loan provided to entity B. Entity B is solvent and shows no signs of defaulting on the loan. The treatment of the bank guarantee in the records of entity A is to: Learning Objective 5.6 Describe how to distinguish a provision from a contingent liability a. recognise a liability b. recognise a provision *c. recognise a contingent liability d. do nothing

5.2

Chapter 5 Provisions, contingent liabilities and contingent assets

Provisions shall be recognised when: I II III IV

an entity has a present obligation it is possible that an outflow of resources will be required to settle the obligation the amount of the obligation can be reliably estimated there has been a past event

Learning Objective 5.7 Explain when a provision should be recognised a. I, II and III b. II, III and IV *c. I, III and IV d. I, II and IV

Liabilities which fail the recognition criteria and where the possibility of an outflow is remote should: Learning Objective 5.7 Explain when a provision should be recognised a. be recognised as an accrual b. be recognised as a provision c. be recognised as a contingent liability *d. not be recognised in the financial statement at all

JayJay Limited estimated that the future cash outflows relating to settlement of warranty obligations would be as follows: In 1 year $40 000 In 2 years $50 000 In 3 years $60 000. A government rate for bonds with similar terms is 6%. What is the present value of the total expected future cash outflow? Learning Objective 5.8 Explain how a provision, once recognised, should be measured *a. $132 563; b. $140 510; c. $150 000; d. $159 000.

According to IAS 37, when providing for the future, a future event such as the clean-up of a contaminated site, gains and other cash inflows that are expected to arise on the sale of asset related to the clean-up, must be treated as follows: Learning Objective 5.8 Explain how a provision, once recognised, should be measured a. set-off against the provision for the clean-up; *b. measured separately of the provision; c. recognised directly in equity in the period in which the cash inflows arose; d. recognised as a deferred asset.

5.3

Testbank to accompany Applying IFRS Standards 4e 10.

Purcell Limited is a manufacturer of swimming pools and provides its customers with warranties at the time of sale. The warranty applies for three years from the date of sale. Past experience shows that there will be some claims under the warranties. The appropriate treatment of this item under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, is to: Learning Objective 5.8 Explain how a provision, once recognised, should be measured a. disclose in the notes, but do not recognise in the financial statements; *b. recognise the best estimate of costs as a provision; c. charge the costs directly to profit or loss in the period in which the economic outflows occur; d. transfer the expected amount of the warranty from retained earnings to a special reserve account in equity.

11.

A railway company is required, under law, to overhaul its rail-tracks every three years as a safety measure. The appropriate treatment of this event for the purposes of preparing financial statements is: Learning Objective 5.9 Apply the definitions, recognition and measurement criteria for provisions and contingent liabilities to practical situations a. recognise as a provision for future maintenance costs; *b. estimate the future maintenance costs and charge as depreciation over the next three years; c. disclose in the notes as a contingent liability, but do not recognise; d. estimate the future cash outflows and discount to determine the amount to be recognised as a deferred liability.

12.

The following is statement made in IAS 37: ‘a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it’. This statement provides a definition of: Learning Objective 5.9 Apply the definitions, recognition and measurement criteria for provisions and contingent liabilities to practical situations *a. an onerous contract; b. a deferred liability; c. a future operating loss; d. a present obligation.

5.4

Chapter 5 Provisions, contingent liabilities and contingent assets

13.

McCann Limited announced its plans for a major restructuring of its operations. Under IAS 37, the entity is able to: Learning Objective 5.9 Apply the definitions, recognition and measurement criteria for provisions and contingent liabilities to practical situations a. capitalise all direct and indirect restructuring costs; b. set up a provision for the best estimate of all restructuring costs; *c. provide only for restructuring costs that are directly and necessarily caused by the restructuring; d. provide for restructuring costs that are associated with the ongoing activities of the entity.

14.

According to IAS 37, the appropriate accounting treatment for future operating losses is to: Learning Objective 5.9 Apply the definitions, recognition and measurement criteria for provisions and contingent liabilities to practical situations a. determine a reasonable estimate of the cost and provide for the future liability; b. determine the cost and charge it directly against retained earnings; *c. not recognise such items in the financial statements; d. measure on the basis of estimated future cash flows.

15.

The following statement, contained in IAS 37, defines: ‘a possible asset 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’ Learning Objective 5.10 Outline the concept of a contingent asset a. a deferred liability; b. a contingent liability; c. a deferred asset; *d. a contingent asset.

16.

At balance sheet date, Raschella Limited was awaiting the final details of a court case for damages awarded in its favour. The amount and possible receipt of damages is unknown and will not be decided until the court sits again in several months’ time. How is this event dealt with in the preparation of the financial statements? Learning Objective 5.10 Outline the concept of a contingent asset a. do not recognise or disclose in the financial statements as the possibility of receiving damages is remote; b. recognise as an asset in the financial statements as the receipt of damages is probable; *c. disclose in the notes to the financial statements as it is possible that the entity will receive the damages and the court decision is out of its control; d. recognise as a deferred asset in the statement of financial position and re-classify as a non-current asset when the court decision is known.

5.5

Testbank to accompany Applying IFRS Standards 4e 17.

According to IAS 37, the appropriate treatment for a contingent asset in the financial statements of an entity is: Learning Objective 5.10 Outline the concept of a contingent asset *a. disclosure of information in the notes, but do not recognise in the financial statements; b. recognition in the financial statements, and note disclosure; c. recognition in the financial statements, but no further disclosure in the notes; d. do not recognise in the financial statements, and do not disclose in the notes.

18.

In respect to a contingent liability, IAS 37 requires disclosure of Learning Objective 5.11 Describe the disclosure requirements for provisions, contingent liabilities and contingent assets a. any increase in the contingent liability during the period; *b. an estimate of its financial effect; c. the carrying amount at the beginning and end of the period; d. an indication of the uncertainties about the amount or timing of expected outflows.

19.

For each class of provision, an entity is required by IAS 37 to disclose the following information: I II III IV V

The carrying amount at the beginning and end of the period. Amounts incurred and charged against the provision during the period. Comparative information. Unused amounts reversed during the period. Additional provisions made during the period.

Learning Objective 5.11 Describe the disclosure requirements for provisions, contingent liabilities and contingent assets *a. I, II, IV and V only; b. I, II, and III only; c. II, III and IV only; d. I, III, IV and V only.

20.

The June 2005 Exposure Draft issued in relation to proposed changes to IAS 37: Learning Objective 5.13 Explain the expected future developments for IAS 37 a. will be issued as a standard applicable for reporting periods ending on or after 1 June 2014 b. has been withdrawn by the IASB *c. is still under consideration by the IASB d. is already applicable

5.6

Chapter 5 Provisions, contingent liabilities and contingent assets

21.

Which of the following is not within the scope of IAS 37? Learning Objective 5.2 Identify which items are included within the scope of the standard. a. The treatment of future operating losses b. The treatment of contingent assets *c. The treatment of restructuring provisions arising from a business combination d. The treatment of onerous contracts

22.

An example of where an entity has a present obligation is: Learning Objective 5.3 Outline the concept of a provision. *a. a public announcement made by an entity’s management to undertake restructuring. b. a recommendation from the HR manager to the Board as to the level of bonuses to be paid at year end. c. a historical pattern of performing a major overhaul of machinery every two years. d. the declaration of a dividend by directors which is required to be ratified at a meeting of shareholders

23.

Which of the following statements is correct? Learning Objective 5.3 Outline the concept of a provision. a. A present obligation is an example of a legal obligation. b. A legal obligation is an example of a constructive obligation. c. A constructive obligation is an example of an equitable obligation. *d. An equitable obligation is an example of a present obligation.

24.

Which of the following statements is correct? Learning Objective 5.4 Discuss how to distinguish provisions from other liabilities. *a. a provision is a class of liabilities b. a contingent liability is a class of liabilities c. a provision is a class of contingent liabilities d. contingent liabilities and provisions are classes of liabilities

25.

A contingent liability is defined as a: possible obligation that arises from past events possible obligation whose existence will be confirmed by the occurrence of an uncertain future event

III

Yes

Learning Objective 5.5 Outline the concept of a contingent liability. *a. I; b. II; c. III; d. IV.

5.7

Testbank to accompany Applying IFRS Standards 4e 26.

Contingent liabilities are: Learning Objective 5.6 Describe how to distinguish a provision from a contingent liability. a. recognised in the financial statements unless the possibility of an outflow in settlement is remote. *b. recognised in the notes to the financial statements unless the possibility of an outflow in settlement is remote. c. recognised in the notes to the financial statements because the possibility of an outflow in settlement is remote. d. not recognised in the notes to the financial statements because the possibility of an outflow in settlement is remote.

27.

An entity sells goods under warranty and past experience shows that minor defects account for 10% of sales and major defects account for 2% of sales. If all minor defects were repaired the warranty cost would be €300 000, and if all major defects were repaired the warranty cost would be €800 000. The expected value of the warranty cost is: Learning Objective 5.8 explain how a provision, once recognised, should be measured. a. €0; b. €22 000; *c. €46 000; d. €86 000.

28.

The costs under an onerous contract are measured using which valuation method? Learning Objective 5.9 Apply the definitions, recognition and measurement criteria for provisions and contingent liabilities to practical situations. a. the lower of cost or net market value; *b. the lower of the cost of fulfilling the contract and the penalties arising from failure to fulfil the contract; c. the present value method using a risk-free discount rate; d. the unavoidable costs of meeting the obligations discounted by reference to market yields at reporting date.

29.

Entities are not required to disclose which of the following in relation to provisions? Learning Objective 5.11 Describe the disclosure requirements for provisions, contingent liabilities and contingent assets. a. carrying amounts of provisions at the beginning of the period b. amounts used during the period c. the effect of any change in the discount rate used *d. comparatives

5.8

Chapter 5 Provisions, contingent liabilities and contingent assets

30.

The June 2005 exposure draft issued in relation to IAS 37 proposed changes to: I II III IV

the name of the standard recognition and measurement criteria the definition of contingencies the method of disclosure for provisions

Learning Objective 5.13 Explain the expected future developments for IAS 37. *a. I, II and III b. II, III and IV c. I, III and IV d. I, II and IV

5.9

Exercises Exercise 5.8 ★

Exercise 5.9 ★★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

RECOGNISING A PROVISION — MEASUREMENT

Explain how a borrowing cost could arise as part of the measurement of a provision. Illustrate your explanation with a simple example. RESTRUCTURING COSTS

A division of an acquired entity will be closed and activities discontinued. The division will operate for 1 year after the date of acquisition, after which all divisional employees will be retrenched except for the retention of some employees to ﬁnalise closure of the division. Required

Which of the following costs, if any, are restructuring costs? (a) The costs of employees (salaries and beneﬁts) to be incurred after operations cease and that are associated with the closing of the division. (b) The costs of leasing the factory space occupied by the division for the year after the date of acquisition. (c) The costs of modifying the division’s purchasing system to make it consistent with that of the acquirer’s. Exercise 5.10 ★★

RESTRUCTURING COSTS

Company Z acquires Company Y. The restructuring plan, which satisﬁes the criteria for the existence of a present obligation under IAS 37 and IFRS 3, includes an advertising program to promote the new company image. The restructuring plan also includes costs to retrain and relocate existing employees of the acquired entity. Required

Are these costs restructuring costs? Exercise 5.11 ★★

CONTINGENT LIABILITIES — DISCLOSURE

A customer ﬁled a lawsuit against Company A in December 2014, for costs and damages allegedly incurred as a result of the failure of one of Company A’s electrical products. The amount claimed was $3 million. Company A’s lawyers have advised that the amount claimed is extortionate and that Company A has a good chance of winning the case. However, the lawyers have also advised that, if Company A loses the case, its expected costs and damages would be about $500 000. Required

How should Company A disclose this event in its ﬁnancial statements as at 31 December 2014? Exercise 5.12 ★★

Exercise 5.13

RISK AND PRESENT VALUE OF CASH FLOWS

Using examples, explain how a liability-speciﬁc discount rate could cause the amount calculated for a provision to be lower when the risk associated with that provision is high. How could this problem be averted in practice? MEASURING A RESTRUCTURING PROVISION

★★ Company T’s directors decided on 3 May 2014 to restructure the company’s operations as follows: • Factory Z would be closed down and put on the market for sale. • 100 employees working in factory Z would be retrenched on 31 May 2014, and would be paid their accumulated entitlements plus 3 months’ wages. • The remaining 20 employees working in factory Z would be transferred to factory X, which would continue operating. • Five head-ofﬁce staff would be retrenched on 30 June 2014, and would be paid their accumulated entitlements plus 3 months’ wages. As at the end of Company T’s reporting period, 30 June 2014, the following transactions and events had occurred: • Factory Z was shut down on 31 May 2014. An offer of $4 million had been received for factory Z but there was no binding sales agreement. • The 100 retrenched employees had left and their accumulated entitlements had been paid. However, an amount of $76 000, representing a portion of the 3 months’ wages for the retrenched employees, had still not been paid.

CHAPTER 5 Provisions, contingent liabilities and contingent assets

• Costs of $23 000 were expected to be incurred in transferring the 20 employees to their new work in factory X. The transfer is planned for 14 July 2014. • Four of the ﬁve head-ofﬁce staff who have been retrenched have had their accumulated entitlements paid, including the 3 months’ wages. However, one employee, Jerry Perry, remains in order to complete administrative tasks relating to the closure of factory Z and the transfer of staff to factory X. Jerry is expected to stay until 31 July 2014. His salary for July will be $4000 and his retrenchment package will be $13 000, all of which will be paid on the day he leaves. He estimates that he would spend 60% of his time administering the closure of factory Z, 30% on administering the transfer of staff to factory X, and the remaining 10% on general administration. Required

Calculate the amount of the restructuring provision recognised in Company T’s ﬁnancial statements as at 30 June 2014, in accordance with IAS 37. Exercise 5.14

RESTRUCTURING PROVISIONS ON ACQUISITION

★★★ Company A acquires Company B, effective 1 March 2014. At the date of acquisition, Company A intends to close a division of Company B. As at the date of acquisition, management has developed and the board has approved the main features of the restructuring plan and, based on available information, best estimates of the costs have been made. As at the date of acquisition, a public announcement of Company A’s intentions has been made and relevant parties have been informed of the planned closure. Within a week of the acquisition being effected, management commences the process of informing unions, lessors, institutional investors and other key shareholders of the broad characteristics of its restructuring program. A detailed plan for the restructuring is developed within 3 months and implemented soon thereafter. Required

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised by David Kolitz

John Wiley & Sons, Ltd, 2016

Solutions Manual to accompany Applying IFRS Standards 4e

Chapter 6 - Income taxes Discussion Questions 1.

What is the main principle of tax-effect accounting as outlined in IAS 12?

As the objective paragraph of IAS 12 points out, ‘the principal issue in accounting for income taxes is how to account for the current and future tax consequences of: (a) the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an enterprise’s statement of financial position; and (b) transactions and other events of the current period that are recognised in an enterprise’s financial statements. IAS 12 adopts the philosophy that, as a general rule, the tax consequences of transactions that occur during a period should be ‘recognised as income or an expense in the net profit or loss for the period’ irrespective of when those tax effects will occur. A transaction may have two tax ‘effects’: 1. 2.

Tax payable on profit earned for the year may be reduced or increased because the transaction is not taxable or deductible in the current year. Future tax payable may be reduced or increased when that transaction becomes taxable or deductible.

If only current tax payable is recorded as an expense the profit for the current year is understated or overstated by the amount of tax (benefit) to be paid or received in future years. Similarly, in the years that the tax or benefit on these transactions is paid or received income tax expense will include amounts relating to prior periods and therefore be understated or overstated. To illustrate, consider an entity with accrued interest of £12 000 at balance date. Assuming accrued interest is deductible only when paid, taxable profit will be £12 000 greater than accounting profit, resulting in £3600 extra tax being paid (assuming a 30% tax rate). In the next accounting period, the tax deduction for interest paid results in a taxable profit that is £12 000 lower than the accounting profit. This tax benefit reduces the current tax expense by £3600 although the transaction occurred in the prior year. To ensure that the tax effect (expense or benefit) of a transaction is recorded in the appropriate period, IAS 12 requires income tax expense to reflect all tax effects of transactions entered into during the year regardless of when the effects occur.

Explain the meaning of a temporary difference as it relates to deferred tax calculations and give three examples.

Temporary differences between accounting profit and taxable profit arise when revenues and expenses are recognised in different periods from those in which such revenues and expenses are treated as taxable income and allowable deductions. Differences that result in the entity paying more tax in the future, for example when interest is received, are known as taxable temporary differences. Differences that result in the entity recovering tax via additional deductible expenses in the future, for example when accrued expenses are paid, are known as deductible temporary differences

Explain how accounting profit and taxable profit differ and how each is treated when accounting for income taxes.

Accounting profit is defined in IAS 12, paragraph 5, as ‘net profit or loss for a period before deducting tax expense’, net profit or loss Being the excess (or deficiency) of revenues less expenses for that period. Such revenues and expenses would be determined and recognised in accordance with accounting standards and the conceptual Framework. Taxable profit is defined in the same paragraph as ‘the profit for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable’. Taxable

6.1

Chapter 6 Income Taxes

profit is the excess of taxable income over taxation deductions allowable against that income. Thus, accounting profit and taxable profit – because they are determined by different principles and rules - are unlikely to be the same figure in any one period. Income tax expense cannot be determined by simply multiplying the accounting profit by the applicable taxation rate. Instead, accounting for income taxes involves identifying and accounting for the differences between accounting profit and taxable profit. These differences arise from a number of common transactions and may be either permanent or temporary in nature.

In tax-effect accounting, creation of temporary differences between the carrying amount and the tax base for assets and liabilities leads to the establishment of deferred tax assets and liabilities in the accounting records. List examples of temporary differences that create: (a) deferred tax assets (b) deferred tax liabilities.

Examples include: Deferred tax assets

Deferred tax liabilities

Provisions Accrued expenses Prepaid revenue Accounting depreciation > Taxation Tax losses

Accrued revenue Prepaid expenses Expenses capitalised and amortised Accounting depreciation < Taxation

6.2

Solutions Manual to accompany Applying IFRS Standards 4e

In IAS 12 criteria are established for the recognition of a deferred tax asset and a deferred tax liability. Identify these criteria and discuss any differences between those criteria for assets and those for liabilities.

Deferred tax liabilities must be recognised for all taxable temporary differences. A liability is recognised when, and only when, it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably (Framework, paragraph 91). There is no need to explicitly consider the recognition criteria for a deferred tax liability, as it is always probable that resources will flow from the entity to pay the tax associated with taxable temporary difference. Deferred tax assets must be recognised for all deductible temporary differences and from the carry forward of tax losses but only to the extent that is it probable that future taxable profits will be available against which the temporary differences can be utilised. An asset is recognised when it is probable that the future economic benefits will flow to the enterprise and the asset has a cost or value that can be measured reliably (Framework, paragraph 89). The Framework, paragraph 85, states that the concept of probability refers to the degree of uncertainty that the future economic benefits associated the asset will flow to the entity. This probability must be assessed using the best evidence available when the financial statements are prepared. The reversal of deductible temporary differences results in deductions against taxable profits of future periods. However, economic benefits in the form of reductions in tax payments will flow to the enterprise only if it earns sufficient taxable profits against which the deductions can be offset. Therefore, an enterprise recognises deferred tax assets only when it is probable that taxable profits will be available against which the deductible temporary differences can be utilised (IAS 12, paragraph 27).

6.3

Chapter 6 Income Taxes

Exercises Exercise 6.1

TAX EFFECTS OF A TEMPORARY DIFFERENCE

Assuming that no equipment is purchased or sold during the years ended 30 June 2014 and 30 June 2015, calculate: (a) the accounting expense and tax deduction for each year (b) the impact of depreciation on the taxable profit for each year (c) the movement in the temporary difference balance for each year. Protea Ltd

Year ended 30 June 2014 Current tax effect: (a) (a) (b)

Accounting depreciation expense Taxation depreciation deduction Impact on taxable profit

£ 75 000 (300 000 x 25%) (60 000) (300 000 x 20%) 15 000

Movement in temporary difference (c)

Temporary difference at 30 June 2013 Temporary difference at 30 June 2014 Movement

45 000 (120 000 – 75 000) 60 000 (60 000 – 0) 15 000 (Arising)

Year ended 30 June 2015 Current tax effect: £ (a) (a) (b)

Accounting depreciation expense Taxation depreciation deduction Impact on taxable profit

0 (is fully written down) (60 000) (300 000 x 20%) (48 000)

Movement in temporary difference (c)

Temporary difference at 30 June 2014 Temporary difference at 30 June 2015 Movement

60 000 (60 000 – 0) 0 (0 – 0) (60 000) (Reversing)

6.4

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 6.2 1. 2.

CALCULATION OF CURRENT TAX

Calculate the current tax liability for the year ended 30 June 2014, and prepare the adjusting journal entry. Explain your treatment of rent items in your answer to requirement 1.

1. Thistle Ltd Current Tax Worksheet (for year ended 30 June 2014) £ Accounting profit Add: Donations to political parties (non-deductible) Depreciation expense – Machinery Rent received Annual leave expense

5 000 15 000 10 000 5 600

Deduct: Rent revenue Annual leave paid Depreciation of machinery for tax Taxable profit Current liability @ 30%

12 000 6 500 18 750

£ 40 000

35 600 75 600

(37 250) 38 350 £11 505

Adjusting journal entry 30 June 2014 Income Tax Expense (current) Current Tax Liability (Being recognition of current tax liability)

Dr Cr

11 505 11 505

2. Rent is recognised as income by Thistle Ltd as it is earned, but will not be taxable income until the cash is received. In the current year only £10 000 of the £12 000 rental income earned has been received and thus, an adjustment is required to remove £2000 from the accounting profit when calculating the company’s tax liability for the current year. In the worksheet this is accomplished by adding all rent received in cash to accounting profit and deducting all rent income recognised. This difference will create a deferred tax liability of £600 (£2000 x 30%) which will be recognised via the deferred tax worksheet. When the cash is received next year the company will add £2000 rent to the accounting profit, pay the £600 tax and reverse the tax liability.

6.5

Chapter 6 Income Taxes

Exercise 6.3

CALCULATION OF DEFERRED TAX

Prepare a deferred tax worksheet to identify the temporary differences arising in respect of the assets and liabilities in the statement of financial position, and to calculate the balance of the deferred tax liability and deferred tax asset accounts at 30 June 2014. Assume the opening balance of the deferred tax accounts was £0. Orchid Ltd Deferred Tax Worksheet as at 30 June 2014 Carrying Amount

Assets Receivables Machines Liabilities Interest Payable Total temporary differences Excluded differences Temporary differences Deferred tax liability Deferred tax asset Beginning balances Movement during year Adjustment

Future Taxable Amount £

Future Deductible Amount £

Tax Base

23 000 75 000

(0) (75 000)

2 000 50 000

25 000 50 000

1 000

(1 000)

Taxable Temporary Differences

25 000

Deductible Temporary Differences £ 2 000

25 000

1 000 3 000

25 000

3 000

7 500 900

(0)

7 500 Cr

900 Dr

6.6

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 6.4

CURRENT AND DEFERRED TAX

1. Determine the balance of any current and deferred tax assets and liabilities for Myrtle Ltd as at 30 June 2013. 2. Prepare any necessary journal entries. MYRTLE LTD Current Tax Worksheet (for year ended 30 June 2013) £ Accounting profit Add: Entertainment expense (non-deductible) Depreciation – buildings (non-deductible) Depreciation – plant Insurance expense Development expenditure Doubtful debts expense Annual leave expense

1 700 7 600 22 500 4 200 15 000 4 100 46 000

Deduct: Royalty revenue (tax exempt) Bad debts written off Annual leave paid Insurance paid Depreciation – plant (tax) Gain – Sale of buildings (non-assessable) Taxable income Add back exempt income

£ 256 700

101 100 357 800

8 000 3 500 52 000 3 700 30 000 5 000

Tax loss recouped Taxable profit Tax payable @ 30% Less quarterly tax paid Current tax liability

(102 200) 255 600 8 000 263 600 (12 500) 251 100 75 330 (53 500) 21 830

Workings: Depreciation of plant for tax purposes: £150 000 x 20% = £30 000. Accumulated depreciation for tax purposes is £30 000 x 3 = £90 000.

The entry to recognise current tax is: Income Tax Expense (current) Current Tax Liability Deferred Tax Asset

Dr Cr Cr

25 580 21 830 3 750

6.7

Chapter 6 Income Taxes

MYRTLE LTD Deferred tax worksheet (for year ended 30 June 2013) Carrying Amount £ Relevant Assets Receivables Prepaid insurance Buildings Plant Development expenditure Relevant Liabilities Annual leave Total Temporary Differences Exempt differences Temporary Differences Deferred tax liability Deferred tax asset Beginning balances Movements during the year Adjustment

Future Taxable Amount £

Future Deductible Amount £

Tax Base

17 400 4 500

0 (4 500)

4 100 0

21 500 0

110 500 82 500 0

(110 500) (82 500) (0)

0 60 000 15 000

10 000

(10 000)

Taxable Temporary Differences £

Deductible Temporary Differences £

4 100 -

4 500 110 500 22 500

15 000

10 000 137 500

29 100

110 500 27 000

29 100

8 100 8 730 (27 270)

*(5 850)

(19 170) Dr

(2 880) Dr

* (£9 600 – 3 750 (tax loss recouped) = £5 850)

The entry to adjust deferred tax accounts is: Deferred Tax Liability Deferred Tax Asset Income Tax expense

Dr Dr Cr

19 170 2 880 22 050

6.8

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 6.5 CALCULATION OF CURRENT TAX LIABILITY AND ADJUSTING JOURNAL ENTRY Prepare a worksheet to calculate taxable profit and the company’s current tax liability as at 30 June 2014, and prepare the end of reporting period adjustment journal.

Violet Ltd Current Tax Worksheet (for year ended 30 June 2014) £ Accounting profit Add: Bad debts expense Depreciation – plant Annual leave expense Entertainment costs (non-deductible) Depreciation – buildings (non-deductible) Rent received (tax)

6 000 5 000 3 000 1 800 800 3 500

Deduct: Government grant (non-taxable) Rent revenue Bad debts written off Depreciation – plant (tax) Annual leave paid Taxable profit Current tax liability (30%) The entry to recognise current tax is: Income Tax Expense (current) Current Tax Liability

1 000 3 000 4 500 7 500 2 000

Dr Cr

£ 60 000

20 100 80 100

(18 000) 62 100 18 630

18 630 18 630

Workings:

Debts written off Closing balance

Leave paid Closing balance

Rent revenue Closing balance

Allowance for Doubtful Debts £ 4 500 Opening balance 5 500 Expense 10 000 Provision for Annual Leave £ 2 000 4 000 6 000

Rent received in advance £ 3 000 2 500 5 500

£ 4 000 6 000 10 000

Opening balance Expense

£ 3 000 3 000 6 000

Opening balance Cash receipts

£ 2 000 3 500 5 500

6.9

Chapter 6 Income Taxes

Exercise 6.6

CREATION AND REVERSAL OF TEMPORARY DIFFERENCES

The following are all independent situations. Prepare the journal entries for deferred tax on the creation or reversal of any temporary differences. Explain in each case the nature of the temporary difference. Assume a tax rate of 30%. 1. The entity has an allowance for doubtful debts of £10 000 at the end of the current year relating to accounts receivable of £125 000. The prior year balances for these accounts were £8500 and £97 500 respectively. During the current year, debts worth £9250 were written off as uncollectable. 2. The entity sold a vehicle at the end of the current year for £15 000. The vehicle cost £100 000 when purchased 3 years ago, and had a carrying amount of £25 000 when sold. The taxation depreciation rate for equipment of this type is 33%. 3. The entity has recognised an interest receivable asset with a beginning balance of £17 000 and an ending balance of £19 500 for the current year. During the year, interest of £127 000 was received in cash. 4. At the end of the current year, the entity has recognised a liability of £4000 in respect of outstanding fines for non-compliance with safety legislation. Such fines are not tax-deductible. 1.

Doubtful debts are recognised as an accounting expense when the likelihood of receiving a debt is doubtful, whereas for tax purposes the deduction will only be allowed when the debt is written out of the books as bad. The differential accounting treatment creates a temporary tax difference when the allowance for doubtful debts is raised. The difference is reversed when the debts are written off as bad. Therefore, in this situation, the current year doubtful debts expense of £10 000 will not be an allowable deduction against taxable income and must be added back to accounting profit when income tax expense is being determined. On the other hand, the debts of £9250 written off during the current year will be deductible. £8500 of these debts were expensed in the prior year. Last year, the carrying amount of accounts receivable would have been £8500 lower than the tax base giving rise to a deferred tax asset of £2550 (£8 500 x 30%). The deferred tax asset will reverse this year, but a new deferred tax asset of £3 000 will be created due to allowance for doubtful debts of £10 000 raised in the current period giving rise to a net increase to the deferred tax asset of £450 (£3000 - £2550). The adjusting journal entry required will be: Deferred tax asset Income Tax expense

Dr Cr

450 450

The accounting treatment for depreciation as per IAS 16 is to allocate the depreciable amount on a systematic basis over the asset’s useful life. The tax treatment is normally based on a standard set of rates supplied by the taxing authority and often different to the accounting depreciation rates. On sale of the vehicle IAS 16 requires an entity to measure and report the difference between the proceeds on sale and the carrying amount of the asset at the date of sale as a gain/loss on sale. In this case, the accounting loss is £10 000 (£15 000 - £25 000). For taxation purposes, the difference between the proceeds and the carrying amount determined using tax deprecation rates will be taxable/deductible. The tax gain is £15 000 (£15 000 – 0) as the asset is fully depreciated for tax purposes. The net difference of £25 000 must be added to accounting profit to derive taxable profit resulting in £7500 more tax being paid in the current year. This payment represents the reversal of a taxable temporary difference of £25 000 which has accumulated over the past three years when the carrying amount of the asset exceeded its tax base due to the depreciation rate differentials. A total deferred tax liability of £7500 would have been recorded and must now be removed via the following journal entry: Deferred tax liability

7 500

6.10

Solutions Manual to accompany Applying IFRS Standards 4e

Income Tax expense

7 500

Interest income is recognised for accounting purposes when earned but is taxed when it is received in cash. In the current year, £127 000 cash was received representing £17 000 owing from last year and £110 000 earned this year. Accounting income for the current year is £129 500 (£110 000 received and £19 500 receivable). In the prior year a taxable temporary difference of £17 000 was created by the recognition of the interest receivable (tax base £0). A deferred tax liability of £5100 (£17 000 x 30%) would have been recognised. This tax difference has reversed with the receipt of the cash. The additional tax will be paid this year. However, a new temporary difference has been created by the recognition of this year’s interest receivable requiring a deferred tax liability of £5850 (£19 500 x 30%) to be recognised. A net adjustment of £750 (£5850 - £5100) is required as follows: Income tax expense Deferred tax liability

Dr Cr

750 750

As the fines are non-deductible for taxation purposes no temporary difference can exist with respect to the liability. The fines expense recorded in the current year will be added back to accounting profit; taxable profit will exceed accounting profit by £4000; and tax of £1200 will be paid. This additional tax is a permanent difference.

Exercise 6.7

CREATION AND REVERSAL OF TEMPORARY DIFFERENCE

For each of the years ended 30 June 2012, 2013 and 2014, calculate the carrying amount and the tax base of the asset and determine the appropriate deferred tax entry. Explain your answer. Rose Ltd Workings Cost Depreciation (12) Carrying amount (12) Depreciation (13) Carrying amount (13) Depreciation (14) Carrying amount (14) Proceeds on sale Gain on sale

Accounting 25 000 (5 000) 20 000 (5 000) 15 000 (7 500) 7 500 (15 000) 7 500

Taxation 25 000 (3 750) 21 250 (3 750) 17 500 (3 750) 13 750 (15 000) 1 250

6.11

Chapter 6 Income Taxes

Rose Ltd Calculation of deferred tax (extract) as at 30 June 2012 Carrying Future Future Tax Base Amount Taxable Deductible Amount Amount £ £ £ £ Equipment

20 000

(20 000)

21 250

Taxable Temporary Differences £

Deductible Temporary Differences £

21 250

1 250

The differential in depreciation rates has created a deductible temporary difference of £1250. Rose Ltd will receive these deductions at the end of the asset’s useful life when taxation deductions exist but the equipment is fully depreciated for accounting purposes. A deferred tax asset must be created as follows: Deferred tax asset Income Tax expense

Dr Cr

375 375

Rose Ltd Calculation of deferred tax (extract) as at 30 June 2013 Carrying Future Future Tax Base Amount Taxable Deductible Amount Amount £ £ £ £ Equipment

15 000

(15 000)

17 500

Taxable Temporary Differences £

Deductible Temporary Differences £

17 500

2 500

The deductible temporary difference has increased to £2500 (representing two year’s depreciation differentials). A deferred tax asset for £375 already exists so this year’s adjustment will add a further £375 as follows: Deferred tax asset Income Tax expense

Dr Cr

375 375

Rose Ltd Calculation of deferred tax (extract) as at 30 June 2014 Carrying Future Future Tax Base Amount Taxable Deductible Amount Amount £ £ £ £ Equipment

(0)

Taxable Temporary Differences £

Deductible Temporary Differences £

As the asset has been sold the temporary difference will reverse. In the current tax worksheet there will be two differences impacting on taxable profit: difference between the accounting gain on sale £7500 and the taxable gain £1250 will reduce taxable profit by £6250 difference between accounting depreciation expense £7500 and tax deductible depreciation £3750 will increase taxable profit by £3750.

6.12

Solutions Manual to accompany Applying IFRS Standards 4e

The net decrease of £2500 will result in £750 less tax being paid in the current year. This benefit represents the reversal of the deferred tax asset. The adjusting journal entry will be:

Income tax expense Deferred tax asset

Exercise 6.8

Dr Cr

750 750

CALCULATION OF DEFERRED TAX, AND ADJUSTMENT ENTRY

1. Calculate the temporary differences for Bulb Ltd as at 30 June 2013. Justify your classification of each difference as either a deductible temporary difference or a taxable temporary difference. 2. Prepare the journal entry to record deferred tax for the year ended 30 June 2013 assuming no deferred items had been raised in prior years. Bulb Ltd Deferred Tax Worksheet as at 30 June 2013 Carrying Amount

Assets Receivables (1) Motor Vehicle (2) Liabilities Provision for warranty (3) Deposits in advance (4) Total temporary differences Exempt differences Temporary differences Deferred tax liability Deferred tax asset Beginning balances Movement during year Adjustment

Future Taxable Amount £

Future Deductible Amount £

Tax Base

Taxable Temporary Differences

40 000

Deductible Temporary Differences £

150 000 165 000

(0) (165 000)

25 000 125 000

175 000 125 000

12 000

(12 000)

12 000

15 000

(0)

15 000

25 000

40 000

52 000

40 000

52 000

12 000 15 600

(0)

12 000 Cr

15 600 Dr

6.13

Chapter 6 Income Taxes

Explanations: 1.

Receivables. The carrying amount is £25 000 less than the tax base due to the allowance for doubtful debts. This reduction will only occur for taxation purposes when the debts actually go bad and are written off in the books. Thus, a deductible temporary difference exists for which a deferred tax asset will be raised.

Motor vehicle. The tax base for motor vehicle is less than the carrying amount because the asset is being depreciated faster for taxation purposes than for accounting. Thus, the company will be paying less tax in the early years of the asset’s useful life due to the extra deduction for depreciation. When the asset is written off for tax purposes the accounting expense will not be deductible and more tax will be payable. Thus, a deferred tax liability is created. The journal entry to record deferred tax is: Deferred tax asset Deferred tax liability Income tax (deferred)

Dr Cr Cr

15 600 12 000 3 600

Provision for warranty. The carrying amount of the liability is £12 000 greater than the tax base of nil. Expenditure on warranty claims will only be deductible when they are paid. Hence the carrying amount represents future deductions for which a deferred tax asset should be raised.

Deposits in advance. The deposits have been deferred for accounting purposes and will be recognised as income when the goods or services relating to the deposit have been provided in a future accounting period(s). For tax purposes, the money is taxable on receipt. As the money has been received and the tax paid then when the income is recorded as accounting profit no tax will be payable. The prepayment of tax creates a deductible temporary difference and a deferred tax asset.

Exercise 6.9

CALCULATION OF CURRENT TAX

Required 1. Use a current tax worksheet to calculate the current tax liability for the year ended 30 June 2015. Prepare the adjusting journal entry. 2. Explain the future tax effect of the adjustment made in part 1 for rent received/revenue. 1. Daisy Ltd Current Tax Worksheet (for year ended 30 June 2015) £ Accounting profit Add: Entertainment expense (non-deductible) Depreciation – vehicles Rent received (taxable income) Deduct: Rent revenue Depreciation – vehicle (tax) Taxable profit Current tax liability (30%)

2 000 17 000 3 000

2 500 25 500

£ 100 000

22 000 122 000

28 000 94 000 28 200

6.14

Solutions Manual to accompany Applying IFRS Standards 4e

The entry to recognise current tax is: Income Tax Expense (current) Current Tax Liability

Dr Cr

28 200 28 200

2. In part 1, an additional £500 (£3000 – 2500) was added to accounting profit to determine taxable profit for the year resulting in an increase in current tax liability of £150 (£500 x 30%). This adjustment creates a deductible temporary difference which will reverse next year when accounting profit will be £500 greater than taxable profit but no additional tax will be payable.

Exercise 6.10

CALCULATION OF MOVEMENTS IN DEFERRED TAX ACCOUNTS

Prepare a worksheet to calculate the end of reporting period adjustment to deferred tax asset and liability accounts as at 30 June 2014, and show the necessary journal entry. Acacia Ltd Deferred tax worksheet as at 30 June 2014 Future Future Taxable Deductible Amount Amount £ £

Carrying Amount £ Relevant Assets Receivables Plant Relevant Liabilities Prov for LSL Unearned Rent Total Temporary Differences Excluded differences Temporary Differences Deferred tax liability Deferred tax asset Beginning balances Movements during the year Adjustment

Tax Base

445 000 240 000

(0) (240 000)

55 000 110 000

500 000 110 000

60 000 25 000

0 (25 000)

(60 000) 0

0 0

Taxable Temporary Differences £

Deductible Temporary Differences £ 55 000

130 000

60 000 25 000 130 000

140 000

130 000

140 000

39 000 42 000 (38 100)

(40 500)

900 Cr

1 500 Dr

The entry to adjust deferred tax accounts is: Deferred Tax Asset Deferred Tax Liability Income Tax expense

Dr Cr Cr

1 500 900 600

6.15

Chapter 6 Income Taxes

Exercise 6.11

CURRENT AND DEFERRED TAX WITH TAX RATE CHANGE

1. Prepare the journal entry to account for the change in the income tax rate in September 2012. 2. Prepare the worksheets and journal entries to calculate and record the current tax liability, and any movements in deferred tax assets and liabilities in accordance with IAS 12, for the year ended 30 June 2014. Fennel Ltd 1. Change in tax rate Adjusting journal entry: Deferred Tax Liability Deferred Tax Asset Income Tax Expense (being recognition of change of tax rate)

Dr Cr Cr

18 000 7 400 10 600

Working Opening balance Adjustment for change in tax rate: (40-30)/40

DTA £29 600 (7 400) 22 200

DTL £72 000 (18 000) 54 000

2. Current Tax Worksheet (for year ended 30 June 2013) Accounting profit Add: Impairment - goodwill Amortisation – development expenditure Depreciation - buildings Depreciation - plant Warranty expense Doubtful debts expense Long service leave expense Deduct: Exempt income Bad debts written off Warranty repairs paid Development costs – additional deduction Development costs paid Depreciation - plant (tax) Taxable profit Current tax liability @ 30%

£920 000 £20 000 64 000 29 000 70 000 20 000 15 000 8 000

226 000 1 146 000

126 000 14 000 22 000 30 000 120 000 105 000

(417 000) 729 000 £218 700

6.16

Solutions Manual to accompany Applying IFRS Standards 4e

2 - WORKINGS

1. Research and development costs:

1/07/12

Opening balance Costs paid

Development Costs £ 200 000 120 000 30/06/13 320 000

£ Closing balance

320 000 320 000

Additional deduction for development costs is 25% of £120 000 = £30 000

2. Doubtful debts expense can be found by reconstructing the allowance for doubtful debts account, given that the balance of the account increased by £1000 over the year:

30/06/13 30/06/13

Debts written off Closing balance

Allowance for Doubtful Debts £ 14 000 1/07/12 Opening balance 13 000 30/06/13 Doubtful debts 27 000

£ 12 000 15 000 27 000

3. To calculate warranty expense

30/06/13 30/06/13

Warranty costs Closing balance

Provision for Warranty £ 22 000 1/07/12 32 000 30/06/13 54 000

£ 34 000 20 000 54 000

Opening balance Warranty expense

Carrying Amount £ Relevant Assets Receivables Plant Buildings Development Costs Relevant Liabilities Provision for Warranty Provision for Long service leave Total Temporary Differences

Fennel Ltd Deferred tax worksheet as at 30 June 2013 Future Future Taxable Deductible Amount Amount £ £

Tax Base

Taxable Temporary Differences

95 000 701 000 176 000

Deductible Temporary Differences £

222 000 410 000 701 000 176 000

(0) (410 000) (701 000) (176 000)

13 000 315 000 0 0

235 000 315 000 0 0

13 000

32 000

(32 000)

32 000

36 000

(36 000)

36 000

972 000

81 000

6.17

Chapter 6 Income Taxes

Exempt differences Temporary differences Deferred tax liability Deferred tax asset Beginning balances Movement during year Adjustment

(701 000)

271 000

81 000

81 300 24 300 (72 000)

(29 600)

*18 000

*7 400

27 300 Cr

2 100 Dr

(* Tax rate change September 08) The entries for income tax, current and deferred, are: Income Tax Expense (current) Current Tax Liability Income Tax Expense (deferred) Deferred Tax Asset Deferred Tax Liability

Dr Cr

218 700

Dr Dr Cr

25 200 2 100

218 700

27 300

Exercise 6.12 RECOGNITION OF DEFERRED TAX ASSETS Required 1. Discuss the factors that Tulip Ltd should consider in determining the amount (if any) to be recognised for deferred tax assets at 30 June 2013. 2. Calculate the amount (if any) to be recognised for deferred tax assets at 30 June 2013. Justify your answer.

1. Tulip Ltd IAS 12, paragraph 24 states that deferred tax assets shall be recognised for all deductible temporary differences (DTD) ‘to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilised’. The same recognition criteria apply to deferred tax assets arising from carry forward tax losses (paragraph 34). In determining whether it can recognise deferred tax assets with respect to: Tax losses of £12 500, and Deductible temporary differences of £17 000 Tulip Ltd will need to consider the following factors. a)Taxable profit against which tax losses and DTDs can be utilised will be available if taxable temporary differences (TTD) reverse in the same period as the deductions are available. Thus, the extent and period of reversal of TTDs will need to be considered.

6.18

Solutions Manual to accompany Applying IFRS Standards 4e

b)If insufficient TTDs exist to recoup the DTDs and tax losses Tulip Ltd will need to consider if the company will earn sufficient taxable profit in the period of reversal against with the deductions can be made. c) IAS 12, paragraph 35 states that the existence of unused tax losses is strong evidence that future taxable profit may not be available. Tulip Ltd will need to examine the cause of the loss to determine whether it is due to factors which are unlikely to recur. 2. As Tulip Ltd has incurred a tax loss in the current year deferred tax assets can only be recognised to the extent that TTDs exist and will reverse in the same period as the DTDs and tax losses, and to the extent that convincing evidence exists that future taxable profits will be made. An analysis of the temporary differences at 30 June 2013 reveals: Existing Reversal 2013 2014 DTD 17 000 14 500 TTD 11 500 11 500

Reversal 2015 2 500 -

As there is no indication that the losses incurred in 2013 are a ‘one-off’ Tulip Ltd can only recognise a DTA of £3450 (£11 500 x 30%) representing the deductions which can be made against taxable profit arising in 2014 from the reversal of taxable temporary differences. The DTA of £5250 raised in the prior year will need to be written down to £3450.

Exercise 6.13

CURRENT AND DEFERRED TAX

1. Determine the balance of any current and deferred tax assets and liabilities for Lily Ltd as at 30 June 2013, using appropriate worksheets. Show all workings. 2. Prepare any necessary journal entries. 1. Lily Ltd Current Tax Worksheet for year ended 30 June 2013 Accounting profit Add: Entertainment expense (non-deductible) Depreciation – motor vehicle Depreciation – equipment Doubtful debts expense Annual leave expense Carrying amount – equipment Rent received (tax) Deduct: Royalty revenue (non-assessable) Rent revenue Depreciation of equipment for tax Bad debts written off Annual leave paid Carrying amount – equipment (tax) Taxable profit

£18 500 £1 500 4 500 20 000 2 300 5 000 18 000 15 600 5 000 16 000 15 000 1 800 6 500 21 000

66 900

(65 300) 20 100

6.19

Chapter 6 Income Taxes

Current tax liability @ 30%

£6 030

1 - Workings: 1. Sale of equipment: Accounting 30 000 12 000 18 000 19 000 1 000

Cost Accumulated depreciation Carrying amount Proceeds on sale Gain (loss)

Taxation 30 000 *9 000 21 000 19 000 (2 000)

* £30 000 x 15% x 2 years 2. Annual Leave paid

30/06/12 30/06/12

Leave paid Closing balance

Provision for Annual Leave £ 6 500 1/07/11 4 500 30/06/12 11 000

£ 6 000 5 000 11 000

Opening balance Expense

3. Bad Debts written off

30/06/12 30/06/12

Allowance for Doubtful Debts £ Bad debts written off 1 800 1/07/11 Opening balance Closing balance 3 000 30/06/12 Expense 4 800

£ 2 500 2 300 4 800

4. Rent revenue received

1/07/11 30/06/12

Opening balance Rent Revenue

Rent Receivable £ 2 400 30/06/12 16 000 30/06/12 18 400

£ 15 600 2 800 18 400

Rent received Closing balance

5. Equipment carrying amount for taxation £100 000 (cost) x 15% x 3 years = £45 000 accumulated depreciation. Carrying amount is then 100 000 – 45 000 = £55 000

Carrying Amount £ Relevant Assets Receivables Rent

9 000 2 800

Lily Ltd Deferred Tax Worksheet as at 30 June 2013 Future Future Tax Base Taxable Deductible Amount Amount £ £ £

(0) (2 800)

3 000 0

12 000 0

Taxable Temporary Differences £

Deductible Temporary Differences £

3 000 2 800

6.20

Solutions Manual to accompany Applying IFRS Standards 4e

receivable Motor vehicle Equipment Relevant Liabilities Annual leave provision Total Temporary differences Exempt differences Temporary differences Deferred tax liability Deferred tax asset Beginning balances Movement during year Adjustment

2 250 40 000

(2 250) (40 000)

0 55 000

4 500

(4 500)

2 250

15 000

4 500

5 050

22 500

5 050

22 500

1 515 6 750 (2 745)

(6 450)

(1 230) Dr

300 Dr

2. The entries for income tax, current and deferred, are: Income Tax Expense (current) Current Tax Liability

Dr Cr

6 030

Deferred Tax Liability Deferred Tax Asset Income Tax Expense (deferred)

Dr Dr Cr

1 230 300

6 030

1 530

6.21

Chapter 6 Income Taxes

Exercise 6.14

DISCLOSURES

The following taxation worksheets relate to Mint Ltd’s taxation adjustments for the years ending 30 June 2013 and 30 June 2014. Using these worksheets, prepare appropriate notes to the financial statements for 30 June 2014 in accordance with IAS 12 disclosure requirements. Mint Ltd Notes to the financial statements 30 June 2014 Notes

Note 5- Income tax Major components of income tax expense Current tax expense Deferred tax from origination and reversal of temporary differences Reduction in opening balances of deferred taxes resulting from a reduction in the tax rate Income tax expense Reconciliation of income tax to prima facie tax on pre-tax profit: The prima facie tax on profit differs from the income tax provided in the accounts as follows: Pre-tax profit Prima facie tax Tax effect of non-deductible expenses Depreciation – Buildings Legal fees Entertainment Political donations Penalty Tax effect of additional deduction 25% of research and development expenditure Reduction in opening deferred taxes resulting from reduction in tax rate Tax effect of net movements in items giving rise to: Deferred tax assets Deferred tax liabilities Current tax expense

2014 £

2013 £

648 599

822 145

125 598

69 405

774 197

(8 780) 882 770

1 900 591 665 207

2 042 686 714 940

58 800 30 450 33 460 3 780 -

37 800 27 720 30 380 3 430 7 280

(10 500)

(8 750)

781 197

(8 780) 804 020

20 300 (152 898) 648 599

83 195 (65 070) 822 145

The applicable tax rate is the national corporate income tax rate of 35% (2005: 35%).

Mint Ltd Notes to the financial statements 30 June 2014 Notes

2014 £

2013 £

Note 5- Income tax (continued) Deferred tax assets and liabilities The following items have given rise to

6.22

Solutions Manual to accompany Applying IFRS Standards 4e

Deferred tax assets: Allowance for doubtful debts Employee entitlements Interest payable Total deferred tax assets

56 210 330 820 2 450 389 480

43 050 323 680 2 450 369 180

The following items have given rise to deferred tax liabilities: Prepayments Plant and equipment Consumable supplies Intangible asset Research and development Interest receivable Total deferred tax liabilities Offset deferred tax asset against liability Net deferred tax liability

28 193 494 375 57 575 35 000 28 000 2 800 645 943 (389 480) 256 463

25 305 374 500 41 440 52 500 6 300 500 045 (369 180) 130 865

(Note: The amount of the deferred tax income or expense recognised in the income statement for the current year is apparent from the changes in the amounts recognised in the statement of financial position. Thus, the disclosure required by paragraph 81(g) is not necessary here.)

6.23

Chapter 6 Income Taxes

Exercise 6.15

PAYMENT OF INCOME TAX AND AMENDED ASSESSMENT

Prepare all journal entries necessary to record the taxation transactions for the period to 31 December 2013. Dover Ltd Journal Entries 28 October 2012 Income tax expense Cash (First quarterly tax instalment)

Dr Cr

13 200

28 January 2013 Income tax expense Cash (Second quarterly tax instalment)

Dr Cr

11 600

28 April 2013 Income tax expense Cash (Third quarterly tax instalment)

Dr Cr

15 200

30 June 2013 Income tax expense Current Tax Liability (Recognise current tax liability for the year)

Dr Cr

17 500

28 July 2013 Current Tax Liability Cash (Pay fourth tax instalment)

Dr Cr

17 500

1 November 2013 Income tax expense Deferred Tax Liability Current Tax Liability (Recognition of amended assessment)

Dr Dr Cr

450 1 500

Dr Cr

1 950

31 December 2013 Current Tax Liability Cash (Pay additional tax liability)

13 200

11 600

15 200

17 500

1 950

6.24

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 6.16 1.

Current and deferred tax with prior year losses

Prepare the worksheets and journal entries to calculate and record the current tax liability and the movements in deferred tax accounts for the year ended 30 June 2013. Justify your treatment of the interest revenue in the current tax worksheet. Explain how and why this leads to the deferred tax consequence shown in the deferred tax worksheet.

1. Gardenia Ltd Current Tax Worksheet for year ended 30 June 2013 Accounting profit Add: Entertainment expense (non-deductible) Depreciation of plant Rent expense Doubtful debts expense Long service leave expense Interest received (assessable for tax) Deduct: Interest revenue Government grant (exempt) Bad debts written off Rent paid Long service leave paid Tax depreciation - plant[220 000 x 10%] Taxable income Add back exempt income

£175 900 £3 900 33 000 22 800 4 200 7 000 10 000

80 900 256 800

11 000 3 600 2 400 23 200 4 000 22 000

Less recoupment of tax loss Taxable profit Current tax liability @ 30%

(66 200) 190 600 3 600 194 200 (15 000) 179 200 £53 760

PART 1 - WORKINGS

30/06/13 30/06/13

01/07/12

Closing balance Debts written off

Leave paid Closing balance

Opening balance

Allowance for Doubtful Debts £ 5 000 01/07/12 Opening balance 2 400 30/06/13 Expense 7 400

£ 3 200 4 200 7 400

Provision for Long Service Leave £ 4 000 01/07/12 Opening balance 64 000 30/06/13 Expense 68 000

£ 61 000 7 000 68 000

Prepaid Rent £ 2 400 30/06/13

Rent expense

£ 22 800

6.25

Chapter 6 Income Taxes

30/06/13

01/07/12 30/06/13

Rent paid

23 200 30/06/13 25 600

Opening balance Interest revenue

Interest Receivable £ 0 30/06/13 11 000 30/06/13 11 000

Closing balance

2 800 25 600

£ 1 000 10 000 11 000

Closing balance Interest received

Plant – carrying amount for taxation purposes Cost Accumulated depreciation Carrying amount

220 000 66 000 154 000

Accounting accumulated depreciation = £99 000 which at £33 000 per annum is 3 years therefore tax accumulated depreciation is 3 x £22 000.

Carrying Amount £ Relevant Assets Receivables Interest receivable Plant Prepaid rent Relevant Liabilities Provision for long service Temporary differences Deferred tax liability Deferred tax asset Beginning balances Movement during year Adjustment

Gardenia Ltd Deferred Tax Worksheet as at 30 June 2013 Future Future Tax Base Taxable Deductible Amount Amount £ £ £

Taxable Temporary Differences £

78 000 1 000

(0) (1 000)

5 000 0

83 000 0

1 000

121 000 2 800

(121 000) (2 800)

154 000 0

2 800

64 000

(64 000)

Deductible Temporary Differences £

5 000

33 000

64 000

3 800 1 140

102 000

30 600 (720)

(25 860)*

420 Cr

4 740 Dr

* net of tax loss of £4500 recouped via current worksheet

The entries for income tax, current and deferred, are:

6.26

Solutions Manual to accompany Applying IFRS Standards 4e

Income Tax Expense (current) Current Tax Liability Deferred tax asset (tax losses)

Dr Cr Cr

58 260

Deferred Tax Asset (deferral) Deferred Tax Liability Income Tax expense

Dr Cr Cr

4 740

53 760 4 500

420 4 320

2. Interest is recorded as revenue for accounting purposes as it is earned but is only taxable when the cash is received. In this situation £1000 of interest income has not been received and has been recognised as a receivable at end of reporting period. In calculating the current tax liability this £1000 was deducted from accounting profit as not taxable. Accordingly, the current tax liability for the year does not include tax of £300 with respect to the interest receivable. This tax will be paid in the next financial year when the cash is received. A deferred tax liability of £300 has been raised to reflect this future tax payment.

6.27

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 6 Income Taxes

CHAPTER 6 Income taxes Learning Objectives 6.1 6.2

Understand the nature of income tax Understand differences in accounting treatments and taxation treatments for a range of transactions 6.3 Explain the concept of tax-effect accounting 6.4 Calculate and account for current taxation expense 6.5 Discuss the recognition requirements for current tax 6.6 Account for the payment of tax 6.7 Explain the nature of and accounting for tax losses 6.8 Calculate and account for movements in deferred taxation accounts 6.9 Apply the recognition criteria for deferred tax items 6.10 Account for changes in tax rates 6.11 Account for amendments to prior year taxes and identify other issues 6.12 Explain the presentation requirements of IAS 12 6.13 Implement the disclosure requirements of IAS 12.

6.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1.

Generally, when considering the differences between the accounting treatment and the income tax treatment of a particular item the accounting treatment is based on: Learning Objective 6.1 Understand the nature of income tax a. cash flows; b. cash flows adjusted for depreciation charges; *c. accrual accounting and is subject to the requirements of accounting standards; d. the income tax legislation.

The following information relates to Godfrey Limited for the year ended 30 June 2016: Accounting profit before income tax (after all expenses have been included) £300 000 Fines and penalties (not tax deductible) 20 000 Depreciation of plant (accounting) 40 000 Depreciation of plant (tax) 100 000 Long-service leave expense (not a tax deduction until the leave is paid) 8 000 Income tax rate 30% On the basis of this information the current tax liability is: Learning Objective 6.4 calculate and account for current taxation expense a. £74 400; b. £78 000; *c. £80 400; d. £99 600.

Differences between the carrying amounts of an entity’s net assets determined under accounting standards, and the tax bases of those net assets, are described as: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts *a. temporary differences; b. permanent differences; c. tax losses; d. the current income tax liability.

A taxable temporary difference is expected to lead to the payment of: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts a. more tax in the future and gives rise to a deferred tax asset; b. less tax in the future and gives rise to a deferred tax asset; *c. more tax in the future and gives rise to a deferred tax liability; d. less tax in the future and gives rise to a deferred tax liability.

6.2

Chapter 6: Income taxes

A deductible temporary difference is expected to lead to the payment of: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts a. more tax in the future and gives rise to a deferred tax asset; *b. less tax in the future and gives rise to a deferred tax asset; c. more tax in the future and gives rise to a deferred tax liability; d. less tax in the future and gives rise to a deferred tax liability.

CTT Limited has an asset which cost $300 with related accumulated depreciation of $100. The accumulated depreciation for tax purposes is $180 and the company tax rate is 30%. The tax base of this asset is: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts *a. $120; b. $220; c. $80; d. $20.

At what point in time are deferred tax accounting adjustments recorded? Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts a. As each transaction arises or is incurred; b. As the cash flows from each transaction occur; c. At the end of each month; *d. At the reporting date.

Under IAS 12 Incomes Taxes, deferred tax assets and liabilities are measured at the tax rates that: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts a. applied at the beginning of the reporting period; b. at the end of the reporting period; c. at the rates that prevail at the reporting date; *d. are expected to apply when the asset is realised or the liability is settled.

D’Silva Limited has a product warranty liability amounting to $10 000. The product warranty costs are not tax deductible until paid out to customers. The company tax rate is 30%. The company has: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts *a. a deductible temporary difference of $10 000; b. an taxable temporary difference of $10 000; c. a tax base of $10 000; d. a future deductible amount of $0.

6.3

Test Bank to accompany Applying IFRS Standards 4e

10.

The following information was extracted from the financial records of Pamakari Limited: Equipment purchased on 1 July 2015 for $100 000 (accounting depreciation 10% straight line tax depreciation 20% straight line). If the company tax rate is 30%, the deferred tax item that will be recorded by Pamakari Limited at 30 June 2016 is: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts a. debit Deferred tax asset $3000; b. credit Deferred tax asset $3000; c. debit Deferred tax liability $3000; *d. credit Deferred tax liability $3000.

11.

Malarky Limited accrued €30 000 for employees’ long service leave in the year ended 30 June 2016. This item will not be tax deductible until it is paid in approximately 10 years’ time. If the company tax rate is 30%, Malarky Limited must record the following tax effect adjustment at the reporting date: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts *a. debit Deferred tax asset €9000; b. debit Deferred tax liability €9000; c. credit Deferred tax asset €9000; d. credit Deferred tax liability €9000.

Use the information below to answer questions 12 and 13. A company commenced business on 1 July 2014. On 30 June 2015, an extract of the statement of financial position prepared for internal purposes, but excluding the effect of income tax, disclosed the following information: Assets Cash Inventory Plant Accumulated depreciation

£40 000 100 000 300 000 (30 000)

Liabilities Trade payables Long service leave

£80 000 5 000

Additional information: 1.

The plant was acquired on 1 July 2014. Depreciation for accounting purposes was 10% (straight-line method), while 15% (straight-line) was used for tax purposes.

The tax rate is 30%.

Using the following worksheet, determine the deferred tax asset and deferred tax liability.

6.4

Chapter 6: Income taxes

Carrying amount

Future taxable amount

Future deductibl e amount

Tax base

Taxable temporary differences

Deductible temporary differences

Assets Cash Inventory Plant Liabilities Trade payables Long-service leave

Deferred tax liability Deferred tax asset

12.

The deferred tax liability is: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts a. £1500; *b. £4500; c. £15 000; d. £34 500.

13.

The deferred tax asset is: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts *a. £1500; b. £4500; c. £5000; d. £25 500.

14.

In jurisdictions where the impairment of goodwill is not tax deductible, IAS 12 Income Taxes: Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts *a. does not permit the application of deferred tax accounting to goodwill; b. allows the recognition of a deferred tax item in relation to goodwill; c. requires that any deferred tax items in relation to goodwill be recognised directly in equity; d. requires that any deferred tax items for goodwill be capitalised in the carrying amount of goodwill.

15.

On 1 April 2015, the company rate of income tax was changed from 35% to 30%. At the previous reporting date (30 June 2014) Montgomery Limited had the following tax balances: ➢ Deferred tax assets

$26 250

6.5

Test Bank to accompany Applying IFRS Standards 4e

➢ Deferred tax liabilities

$21 000

What is the impact of the tax rate change on income tax expense? Learning Objective 6.10 Account for changes in tax rates *a. increase $750; b. decrease $750; c. increase $875; d. decrease $875. 16.

Balchin Limited had the following deferred tax balances at reporting date: ➢ Deferred tax assets ➢ Deferred tax liabilities

€12 000 €30 000

Effective from the first day of the next financial period, the company rate of income tax was reduced from 40% to 30%. The adjustment to income tax expense to recognise the impact of the tax rate change is: Learning Objective 6.10 Account for changes in tax rates a. DR €6000; b. DR €4500; c. CR €6000; *d. CR €4500.

17.

Tax losses can be viewed as providing: Learning Objective 6.7 Explain the nature of and accounting for tax losses a. taxable temporary differences, and therefore a current tax liability; b. taxable temporary differences, and therefore a current tax refund; *c. deductible temporary differences, and therefore a deferred tax asset; d. deductible temporary differences, and therefore deferred tax liabilities.

18.

The tax expense related to profit or loss of the period is required to be presented: Learning Objective 6.12 Explain the presentation requirements of IAS 12. a. on the face of the statement of financial position; *b. on the face of the statement of profit or loss and other comprehensive income; c. in the statement of cash flows; d. in the statement of changes in equity.

19.

Unless a company has a legal right of set-off, IAS 12 Income Taxes, requires disclosure of all of the following information for deferred tax in the statement of financial position: I The amount of deferred tax assets recognised II The amount of the deferred tax liabilities recognised III The net amount of the deferred tax assets and liabilities recognised IV The amount of the deferred tax asset relating to tax losses Learning Objective 6.12 Explain the presentation requirements of IAS 12 *a. I, II and IV only; b. I, II and III only; c. III and IV only; d. IV only.

6.6

Chapter 6: Income taxes

20.

During the year ended 30 June 2015 Barry Ltd, pays quarterly tax instalments as follows: €4000 on 28 October 2014 €11 000 on 28 February 2015 €12 000 on 28 April 2015 On 30 June 2015, Barry Ltd determines its total current tax liability for the year to be €33 000. The final tax instalment for the year will be: Learning Objective 6.6 Account for the payment of tax a. a refund of €2000; *b. a payment of €6000; c. a payment of €12 000; d. a payment of €33 000.

21.

According to IAS 12, current tax for current and prior periods shall, to the extent unpaid, be recognised as a: Learning Objective 6.5 Discuss the recognition requirements for current tax a. Note to the financial statements; b. Contingent liability; *c. Liability; d. Expense.

22.

The tax effect method of accounting for a company’s income tax is based on an assumption that: Learning Objective 6.3 Explain the concept of tax-effect accounting a. income tax expense is equal to income tax payable; b. an accounting balance sheet and a tax balance sheet are the same; c. a tax balance sheet is prepared according to accounting standards; *d. income tax expense is not equal to current tax liability.

23.

Current tax consequences of business operations give rise to: Learning Objective 6.2 Understand differences in accounting treatments and taxation treatments for a range of transactions a. a deferred liability for income tax payable; *b. a current liability for income tax payable; c. a non-current liability for taxes payable; d. a contingent liability for taxes payable.

When assessing the probability that a deferred tax asset from a tax loss can be recognised an entity should consider: Learning Objective 6.9 Apply the recognition criteria for deferred tax items a. whether the unused tax losses result from identifiable causes which are likely to recur; *b. whether tax planning opportunities are available to the entity that will create sufficient future taxable profits to recover the tax losses; c. whether it is guaranteed that the entity will have future taxable profits before the tax losses expire; d. whether the entity has sufficient deductible temporary differences which will result in taxable amounts in future so that the tax losses can be used.

6.7

Test Bank to accompany Applying IFRS Standards 4e

25.

Which of the following disclosures are optional under IAS 12? Learning Objective 6.13 Implement the disclosure requirements of IAS 12 a. the major components of income tax expense; b. the aggregate current tax or deferred tax that arises relating to items that are charged or credited directly to equity; c. the amount of deductible temporary differences and unused tax losses, for which no deferred tax asset is recognised in the statement of financial position; *d. a numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis of calculating the applicable tax rate.

26.

If a taxation authority amends a company’s assessment, the company should: Learning Objective 6.11 Account for amendments to prior year taxes and identify other issues a. Debit income tax expense if more tax needs to be paid; b. Credit income tax expense if less tax needs to be paid; *c. Analyse the reason for the adjustment and consider whether both current and deferred tax are affected; d. Treat the adjustment as a prior period adjustment.

27.

Carry-forward tax losses create: Learning Objective 6.7 Explain the nature of and accounting for tax losses a. a deductible temporary difference and therefore a deferred tax asset in that the company will pay more tax on future taxable profits; b. a taxable temporary difference and therefore a deferred tax asset in that the company will pay less tax on future taxable profits; c. a deductible temporary difference and therefore a deferred tax liability in that the company will pay more tax on future taxable profits; *d. a deductible temporary difference and therefore a deferred tax asset in that the company will pay less tax on future taxable profits.

28.

To the extent that tax payable exists and has NOT yet been paid, a company will recognise: Learning Objective 6.2 Understand differences in accounting treatments and taxation treatments for a range of transactions a. current tax asset; b. non-current asset; c. non-current liability; *d. current tax liability.

29.

Beta Limited has an accounting profit before tax of €200 000. All of the following items have been included in the accounting profit: depreciation of equipment €30 000 (tax deductible depreciation is €20 000); entertainment expenses €15 000 (non-deductible for tax purposes); Long service leave expense provided €6000 (no employee took long service leave during the year). The tax rate is 30%. The amount of current tax liability is: Learning Objective 6.4 Calculate and account for current taxation expense a. €81 300; b. €50 700; *c. €69 300;

6.8

Chapter 6: Income taxes

30.

€38 700.

ABC Limited has an asset with a carrying value of €50 000. The tax base of this asset is €40 000. The tax rate is 30%. As a result, which of the following deferred tax items does Roland Limited have? Learning Objective 6.8 Calculate and account for movements in deferred taxation accounts a. A deferred tax asset of €10 000; *b. A deferred tax liability of €3000; c. A deferred tax liability of €10 000; d. A deferred tax asset of €3000.

6.9

Exercises Exercise 6.9 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

CALCULATION OF CURRENT TAX

Daisy Ltd recorded an accounting proﬁt before tax of £100 000 for the year ended 30 June 2015. Included in the accounting proﬁt were the following items of revenue and expense.

£ 2 000 1 7 000 2 500

Entertainment expenses (non-deductible) Depreciation — vehicles (10%) Rent revenue For tax purposes the following applied: Depreciation rate — vehicles Rent received Income tax rate

15% £ 3 000 30%

Required

1. Use a current tax worksheet to calculate the current tax liability for the year ended 30 June 2015. Prepare the adjusting journal entry. 2. Explain the future tax effect of the adjustment made in part 1 for rent received/revenue.

Exercise 6.10

CALCULATION OF MOVEMENTS IN DEFERRED TAX ACCOUNTS

★ The statements of ﬁnancial position of Acacia Ltd at 30 June 2014 showed the following net assets:

Assets Cash Inventory Receivables Allowance for doubtful debts Plant Accumulated depreciation Deferred tax asset Liabilities Accounts payable Provision for long-service leave Rent received in advance Deferred tax liability

2014

2013

80 000 170 000 500 000 (55 000) 500 000 (260 000) ?

85 000 155 000 480 000 (40 000) 500 000 (210 000) 40 500

290 000 60 000 25 000 ?

260 000 45 000 20 000 38 100

Additional information (a) Accumulated depreciation of plant for tax purposes was £315 000 at 30 June 2013, and depreciation for tax purposes for the year ended 30 June 2014 amounted to £75 000. (b) The tax rate is 30%. Required

Prepare a worksheet to calculate the end of reporting period adjustment to deferred tax asset and liability accounts as at 30 June 2014, and show the necessary journal entry.

Exercise 6.11

CURRENT AND DEFERRED TAX WITH TAX RATE CHANGE

★★ You have been asked by the accountant of Fennel Ltd to prepare the tax-effect accounting adjustments for the year ended 30 June 2014. Investigations revealed the following information: (a) In September 2012, the government reduced the company tax rate from 40 cents to 30 cents in the pound, effective from 1 July 2013. (b) The proﬁt for the year ended 30 June 2014 was £920 000. CHAPTER 6 Income taxes

2013

Accounts receivable Allowance for doubtful debts Inventory Land Buildings Accumulated depreciation — buildings Plant Accumulated depreciation — plant (accounting)

£ 235 000 (13 000) 250 000 100 000 800 000 (99 000) 600 000 £(190 000)

£ 200 000 (12 000) 220 000 100 000 800 000 (70 000) 600 000 £(120 000)

Development expenditure — costs incurred — accumulated amortization Deferred tax asset Goodwill (net) Accounts payable Deferred tax liability Provision for long-service leave Provision for warranty claims

320 000 (144 000) ? — 170 000 ? 36 000 32 000

200 000 (80 000) 29 600 20 000 150 000 72 000 28 000 34 000

(d) The company is entitled to claim a tax deduction of 125% for development expenditure in the year of expenditure. The company has adopted the accounting policy of capitalising and then amortising the expenditure over ﬁve years. (e) Revenue for the year included: Non-taxable income £126 000 (f) Expenses brought to account included: Depreciation — buildings £ 29 000 Depreciation — plant 70 000 Impairment — goodwill (non-deductible) 20 000 Amortisation — development expenditure 64 000 (g) Accumulated depreciation on plant for tax purposes was £180 000 on 30 June 2013, and £285 000 on 30 June 2014. (h) Bad debts of £14 000 were written off during the year, and warranty repairs to the value of £22 000 were carried out. There was no tax deduction for long-service leave in the current year. (i) Buildings are depreciated in the accounting records but no deduction is allowed for tax purposes. Required

Exercise 6.12

RECOGNITION OF DEFERRED TAX ASSETS

★★ Tulip Ltd incurred an accounting loss of £7560 for the year ended 30 June 2013. The current tax calcu-

lation determined that the company had incurred a tax loss of £12 500. Taxation legislation allows such losses to be carried forward and offset against future taxable proﬁts. The company had the following temporary differences:

Deductible temporary differences: Accounts receivable Plant and equipment Taxable temporary differences: Interest receivable Prepaid insurance

30 June 2013

30 June 2012

Expected period of reversal

£12 000 5 000

£10 000 7 500

2014 2014/2015 equally

1 500 10 000

2 500 20 000

2014 2014

At 30 June 2012, Tulip Ltd had recognised a deferred tax liability of £6750 and a deferred tax asset of £5250 with respect to temporary differences existing at that date. No adjustment has yet been made for temporary differences existing at 30 June 2013. 2

PART 2 Elements

Required

1. Discuss the factors that Tulip Ltd should consider in determining the amount (if any) to be recognised for deferred tax assets at 30 June 2013. 2. Calculate the amount (if any) to be recognised for deferred tax assets at 30 June 2013. Justify your answer.

Exercise 6.13 ★★

CURRENT AND DEFERRED TAX

The accounting proﬁt before tax for the year ended 30 June 2013 for Lily Ltd amounted to £18 500 and included: £ 4 500 20 000 16 000 5 000 2 300 1 500 19 000 18 000 5 000

Depreciation — motor vehicle (25%) Depreciation — equipment (20%) Rent revenue Royalty revenue (non-taxable) Doubtful debts expense Entertainment expense (non-deductible) Proceeds on sale of equipment Carrying amount of equipment sold Annual leave expense

The draft statement of ﬁnancial position at 30 June 2013 contained the following assets and liabilities:

Assets Cash Receivables Allowance for doubtful debts Inventory Rent receivable Motor vehicle Accumulated depreciation — motor vehicle Equipment Accumulated depreciation — equipment Deferred tax asset Liabilities Accounts payable Provision for annual leave Current tax liability Deferred tax liability

2013

2012

£ 11 500 12 000 (3 000) 19 000 2 800 18 000 (15 750) 100 000 (60 000) ?

£ 9 500 14 000 (2 500) 21 500 2 400 18 000 (11 250) 130 000 (52 000) 6 450 136 100

15 655 4 500 ? ?

21 500 6 000 7 600 2 745 37 845

Additional information (a) The company can claim a deduction of £15 000 (15%) for depreciation on equipment, but the motor vehicle is fully depreciated for tax purposes. (b) The equipment sold during the year had been purchased for £30 000 2 years before the date of sale. (c) The company tax rate is 30%. Required

Exercise 6.14 ★★

DISCLOSURES

The following taxation worksheets relate to Mint Ltd's taxation adjustments for the years ending 30 June 2013 and 30 June 2014. Using these worksheets, prepare appropriate notes to the ﬁnancial statements for 30 June 2014 in accordance with IAS 12 disclosure requirements. CHAPTER 6 Income taxes

MINT LTD Current Tax Worksheet for the year ended 30 June 2013 Accounting profit before tax Add: Depreciation building — non-deductible Entertainment expense — non-deductible Legal expense — non-deductible Political donations — non-deductible Penalty — non-deductible Doubtful debts expense Depreciation expense — equipment Depreciation expense — furniture and fittings Depreciation expense — motor vehicles Annual leave expense Insurance expense Long-service leave expense Amortisation — patent Rent expense Interest expense Supplies expense Carrying amount of equipment sold Interest received for tax purposes

£2 042 686 £108 000 86 800 £ 79 200 9 900 20 800 123 000 120 000 720 000 160 000 680 000 254 200 22 000 100 000 309 600 28 000 404 800 550 000 187 550

3 963 850 6 006 536

Deduct: Interest revenue Political donations deductible Carrying amount of equipment sold — taxation Debts written off Depreciation — equipment (taxation) Depreciation — furniture and fittings (taxation) Depreciation — motor vehicles (taxation) Annual leave paid Interest paid Insurance paid Development expenditure — additional deduction Amortisation — patent (taxation) Supplies purchased Rent paid Taxable income Taxable profit

(3 657 550) 2 348 986

Total tax payable (35%)

822 145

Less: Tax already paid

(546 271)

Current tax liability

186 050 100 400 000 92 300 150 000 960 000 200 000 495 000 28 000 256 400 25 000 150 000 402 200 312 500

PART 2 Elements

£ 275 874

MINT LTD Deferred Tax Worksheet as at 30 June 2013 Carrying amount Relevant assets Accounts receivable (net) Interest receivable Consumable supplies Prepaid insurance Prepaid rent Building Furniture and fittings Motor vehicles Equipment Patent Relevant liabilities Interest payable Provision for long-service leave Provision for annual leave

£2 406 000 18 000 118 400 59 400 12 900 3 492 000 3 470 000 520 000 240 000 200 000 7 000 220 800 704 000

Future taxable amount £

Future deductible amount

Taxable temporary differences

Tax base

0 (18 000) (118 400) (59 400) (12 900) (3 492 000) (3 470 000) (520 000) (240 000) (200 000)

£ 123 000 0 0 0 0 0 2 560 000 450 000 150 000 50 000

£2 259 000 0 0 0 0 2 560 000 450 000 150 000 50 000

0 0 0

(7 000) (220 800) (704 000)

0 0 0

Deductible temporary differences £ 123 000

18 000 118 400 59 400 12 900 3 492 000 910 000 70 000 90 000 150 000 7 000 220 800 704 000

Temporary differences Excluded differences

4 920 700 3 492 000

1 054 800 _

Net temporary differences

1 428 700

1 054 800

500 045

Deferred tax liability (35%) Deferred tax asset (35%) Beginning balances Movement during year (tax rate)

369 180 (326 840) 40 855

(397 080) 49 635 £ 152 600

Adjustment

Credit

83 195 Debit

MINT LTD Current Tax Worksheet for the year ended 30 June 2014 Accounting profit before tax Add: Depreciation building — non-deductible Entertainment expense — non-deductible Legal expense — non-deductible Political donations — non-deductible Amortisation — development expenditure Doubtful debts expense Depreciation expense — equipment Depreciation expense — furniture and fittings Depreciation expense — motor vehicles Annual leave expense Insurance expense Long-service leave expense Amortisation — patent Rent expense Supplies expense Carrying amount of equipment sold Interest received for tax purposes

£ 1 900 591 £ 168 000 95 600 87 000 10 900 40 000 160 600 135 000 963 750 160 000 652 000 £ 276 300 48 400 100 000 356 400 458 300 90 000 140 650

£ 3 942 900 5 843 491 (continued)

CHAPTER 6 Income taxes

Deduct: Interest revenue Political donations — deductible Carrying amount of equipment sold — taxation Debts written off Depreciation — equipment (taxation) Depreciation — furniture and fittings (taxation) Depreciation — motor vehicles (taxation) Annual leave paid Insurance paid Research and development paid (125%) Amortisation — patent (taxation) Supplies purchased Rent paid

150 650 100 37 500 123 000 168 750 1 285 000 200 000 680 000 282 600 150 000 50 000 504 400 358 350

(3 990 350) 1 853 141

Taxable income Taxable profit Total tax payable (35%)

648 599

Less: Tax already paid

(475 000)

Current tax liability

173 599

MINT LTD Deferred Tax Worksheet as at 30 June 2014

Relevant assets Accounts receivable (net) Interest receivable Consumable supplies Prepaid insurance Prepaid rent Building Furniture and fittings Motor vehicles Equipment Patent Development expenditure Relevant liabilities Interest payable Provision for long-service leave Provision for annual leave Temporary differences Excluded differences

Carrying amount

Assessable amount

Deductible amount

Tax base

Taxable temporary differences

£2 588 400 8 000 164 500 65 700 14 850 6 424 000 3 406 250 360 000 465 000 100 000 80 000

0 (8 000) (164 500) (65 700) (14 850) (6 424 000) (3 406 250) (360 000) (465 000) (100 000) (80 000)

£ 160 600 0 0 0 0 0 2 175 000 250 000 393 750 0 0

£2 749 000 0 0 0 0 0 2 175 000 250 000 393 750 0 0

£8 000 164 500 65 700 14 850 6 424 000 1 231 250 110 000 71 250 100 000 80 000

0 0 0

(7 000) (269 200) (676 000)

0 0 0

7 000 269 200 676 000

Deductible temporary differences £ 160 600

8 269 550 (6 424 000)

7 000 269 200 676 000 1 112 800 —

Net temporary differences

1 845 550

1 112 800

Deferred tax liability (35%) Deferred tax asset (35%) Beginning balances Movement during year

645 943

Adjustment

PART 2 Elements

(500 045)

389 480 (369 180)

145 898

20 300

Credit

Debit

Exercise 6.15 ★★

PAYMENT OF INCOME TAX AND AMENDED ASSESSMENT

Dover Ltd calculated its current tax liability at 30 June 2013 to be £57 500. This tax was paid in instalments as shown in the following table. 28 October 2012 28 January 2013 28 April 2013 28 July 2013

£13 200 11 600 15 200 17 500

On 1 November 2013, an amended assessment notice was received from the taxing authority. It disallowed a donation for £1500 claimed as a deduction, and amended the taxation depreciation rate used for vehicles from 50% to 30%. The accounting depreciation rate is 25%. As a result, further tax of £1950 was paid on 31 December 2013. The company tax rate is 30%. Required

Prepare all journal entries necessary to record the taxation transactions for the period to 31 December 2013.

Exercise 6.16 ★★★

CURRENT AND DEFERRED TAX WITH PRIOR YEAR LOSSES

The accounting proﬁt before tax of Gardenia Ltd was £175 900. It included the following revenue and expense items: Government grant (non-taxable) Interest revenue Long-service leave expense Doubtful debts expense Depreciation — plant (15% p.a., straight-line) Rent expense Entertainment expense (non-deductible)

£3 600 11 000 7 000 4 200 33 000 22 800 3 900

The draft statement of ﬁnancial position as at 30 June 2013 included the following assets and liabilities:

Cash Accounts receviable Allowance for doubtful debts Inventory Interest receivable Prepaid rent Plant Accumulated depreciation — plant Deferred tax asset Accounts payable Provision for long-service leave Deferred tax liability

2013

2012

£ 9 000 83 000 (5 000) 67 100 1 000 2 800 220 000 (99 000) ? 71 200 64 000 ?

£ 7 500 76 800 (3 200) 58 300 — 2 400 220 000 (66 000) 30 360 73 600 61 000 720

Additional information (a) The tax depreciation rate for plant is 10% p.a., straight-line. (b) The tax rate is 30%. (c) The company has £15 000 in tax losses carried forward from the previous year. A deferred tax asset was recognised for these losses. Taxation legislation allows such losses to be offset against future taxable proﬁt. Required

1. Prepare the worksheets and journal entries to calculate and record the current tax liability and the movements in deferred tax accounts for the year ended 30 June 2013. 2. Justify your treatment of the interest revenue in the current tax worksheet. Explain how and why this leads to the deferred tax consequence shown in the deferred tax worksheet. CHAPTER 6 Income taxes

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ruth Picker and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 7: Financial instruments

Chapter 7 – Financial instruments DISCUSSION QUESTIONS 1.

Discuss the concept of ‘equity risk’ and how it is useful in determining whether a financial instrument is a financial liability or an equity instrument of the issuer.

Equity risk refers to the extent to which holders of a financial instrument are exposed to losing their investment in that financial instrument. Equity risk-takers take the risk of not receiving any return on their investment (e.g. dividends may or may not be paid) and also take the risk of not receiving back the amount they invested. They are entitled only to periodic returns once all the obligations of the company have been paid, and they are entitled only to the residual left over in the company on winding up after all liabilities have been repaid. Equity risk-takers differ from debt investors who are entitled to periodic returns and can demand that their funds invested be returned. Debt investors bear credit risk and liquidity risk, but not equity risk. The concept is useful in determining whether or not a financial instrument is a liability or an equity instrument of the issuer because it assists in determining the substance of the parties’ rights and obligations under the financial instrument.

Does IAS 32 contain a clear hierarchy to be used in determining whether a financial instrument is a financial liability or an equity instrument of the issuer? Explain your answer.

No – IAS 32 does not contain a clear hierarchy to be used in determining whether a financial instrument is a financial liability or an equity instrument of the issuer. The various rules need to be read together and it is not clear which ones take precedence. Sometimes the rules and guidance contradict each other. For example, the substance of a financial instrument may appear to be a liability (e.g. there may be escalating ‘dividend’ payments if certain events occur, such that one would always expect the issuer to pay the dividend even if it is not strictly legally required to, but the strict wording of paragraph 16 overrides this by requiring a contractual obligation to pay dividends.)

7.1

Solutions Manual to accompany Applying IFRS Standards 4e

IAS 39 applies a ‘rights and obligations approach’ to the recognition of financial instruments. Discuss.

IAS 39 applies to contracts equally proportionately unperformed (where both parties to the contract have equal unperformed rights and obligations) unless they are specifically scoped out. Traditionally, contracts equally proportionately unperformed have not been accounted for. Common examples of such contracts are normal purchase and sale agreements such as the purchase of a machine. A purchaser does not usually account for the right to receive a machine and the corresponding obligation to pay for it at the date of making a purchase order. Similarly, the supplier does not usually account for the right to receive payment for the machine and a corresponding obligation to deliver it, at the date of receiving the purchase order. Both parties commence recognition at the date of delivery, which is the date at which the equally unperformed rights and obligations are performed. IAS 39 requires accounting on a rights and obligations basis unless the contracts giving rise to those rights and obligations are scoped out of the standard. Hence the scoping out of normal purchases and sales of non-financial items. However, as soon as the contract becomes something other than normal, with terms that embody financial assets and liabilities, a rights and obligations approach is required. IAS 39, paragraph 14, states that “an entity shall recognise a financial asset or a financial liability on its statement of financial position when, and only when, the entity becomes a party to the contractual provisions of the instrument”. AG 35 provides other examples of applying the recognition criteria, as follows: “Unconditional receivables and payables are recognised as assets or liabilities when the entity becomes a party to the contract and, as a consequence, has a legal right to receive or a legal obligation to pay cash”. Normal trade accounts receivable and trade accounts payable would fall into this category. “Assets to be acquired and liabilities to be incurred under a firm commitment to purchase or sell goods or services are generally not recognised until at least one of the parties has performed under the agreement”. However, this is subject to the rules set out in the scope paragraph of IAS 39. Thus, if a firm commitment to buy or sell non-financial items is within the scope of IAS 39 its net fair value is recognised as an asset or liability on the commitment date. “A forward contract within the scope of the standard is also recognised as an asset or liability on the commitment date”.

Explain what an economic hedge is. Will hedge accounting always result in the same outcome as an economic hedge?

Entities enter into hedge arrangements for economic reasons; to protect themselves from financial risks such as currency risk, market price risk, interest rate risk and so on. Hedge accounting generally results in a closer matching of the statement of financial position effect with the profit or loss effect and protects the statement of comprehensive income from volatility caused by changes in fair value from period to period. Hedge accounting under IAS 39 will not always result in the same outcome as an economic hedge because the rules in IAS 39 are very prescriptive so that in order to qualify for hedge accounting, entities need to meet strict specified criteria. If these criteria are not met then hedge accounting cannot be applied even if the hedge works from an economic perspective.

7.2

Chapter 7: Financial instruments

Identify the main criticisms of accounting for financial instruments that emerged during the financial crisis. To what extent had the IASB addressed these by the end of 2011?

The main criticisms were: 1. The complexity of the standards 2. Difficulties in determining fair values in illiquid or inactive markets 3. Delayed recognition of impairment losses 4. Off-balance sheet entities By the end of 2011 the IASB had addressed (2) by the issuance of IFRS 13 Fair Value Measurement, which specifically addresses how to determine fair value in inactive or illiquid markets. It had also addressed (4) by the issuance of the revised standards on consolidation (IAS 27 and IFRS 12). It had partially addressed (1) and (3) by the issuance of IFRS 9; however IFRS 9 was still not complete and the final rules on hedging and impairment had not been issued. The complexity surrounding liability versus equity distinction had also not been addressed.

7.3

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises  Exercise 7.1

SCOPE OF IAS 32

Which of the following is a financial instrument (i.e. a financial asset, financial liability, or equity instrument in another entity) within the scope of IAS 32? Give reasons for your answer. (a) Cash (b) Investment in a debt instrument (c) Investment in a subsidiary (d) Provision for restoration of a mine site (e) Buildings owned by the reporting entity (f) Forward contract entered into by a bread manufacturer to buy wheat (g) Forward contract entered into by a gold producer to hedge the future sales of gold (h) General sales tax payable (a) Cash – within the scope of IAS 32; it is a financial asset (b) Investment in a debt instrument - within the scope of IAS 32; it is a financial asset (c) Investment in a subsidiary – outside the scope of IAS 32; specifically excluded (d) Provision for restoration of a mine site – outside the scope of IAS 32; it is not a contractual obligation (e) Buildings owned by the reporting entity - outside the scope of IAS 32; it is a non-financial asset (f) Forward contract entered into by a bread manufacturer to buy wheat - outside the scope of IAS 32; it is a contract to purchase a non-financial asset (g) Forward contract entered into by a gold producer to hedge the future sales of gold – within the scope of IAS 32 (h) General sales tax payable – outside the scope of IAS 32; this is a statutory obligation rather than a contractual obligation

 Exercise 7.2

SCOPE OF IAS 39

Which of the following is a financial instrument (that is. a financial asset, financial liability, or equity instrument in another entity) within the scope of IAS 39? Give reasons for your answer. (a) Provision for employee benefits (b) Deferred revenue

7.4

Chapter 7: Financial instruments

(c) Prepayments (d) Forward exchange contract (e) 3% investment in private company (f) A percentage interest in an unincorporated joint venture (g) A non-controlling interest in a partnership (h) A non-controlling interest in a discretionary trust (i) An investment in associate (j) A forward purchase contract for wheat to be used by the entity to make flour (k) As for part (j), but the entity regularly settles the contracts net in cash or takes delivery of the underlying wheat and sells it shortly after making a dealer’s margin (l) Leases (m) Trade receivables

(a) Outside the scope of IAS 39. Specifically scoped out in the application paragraph, as it comes under IAS 19. (b) Outside the scope of IAS 39. It is a contractual obligation to deliver services, not cash or other financial assets (c) Outside scope. Represents contractual right to receive services. Prepayments are service potential, not a right to receive cash. (d) Within the scope of IAS 39. It is a contract to simultaneously receive and deliver cash, therefore contains a financial asset and financial liability. It fits the definition of a derivative. (e) Within the scope of IAS 39. It is an equity instrument in another entity. (f) Outside the scope of IAS 39. Specifically excluded from IAS 39; falls under IAS 31 Joint Ventures. (g) Within the scope of IAS 39 It is an equity instrument in another entity. (Assumes that it is not within IAS 28, Associates). (h) Within the scope of IAS 39. It is an equity instrument in another entity. (Assumes that it is not within IAS 28, Associates). (i) Outside the scope of IAS 39. Specifically excluded from IAS 39: falls under IAS 28. (j) Outside the scope of IAS 39. Even though contracts such as these may fit the definition of derivative, they are specifically excluded by virtue of the ‘normal purchase, sale or usage requirements’ exemption. (k) Within the scope of IAS 39. It fits the definition of a derivative. It does not qualify for above exemption. Most commodity broker/traders are within the scope of IAS 39. (l) Outside the scope of IAS 39. Even though it fits the definition of ‘contractual obligation to deliver cash’ it is specifically scoped out of IAS 39 and into IAS 17 Leases. Lease receivables are still subject to IAS 39 de-recognition requirements. (m) Within the scope of IAS 39. Contractual right to receive cash.

7.5

Solutions Manual to accompany Applying IFRS Standards 4e

 Exercise 7.3

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS (1)

Determine whether this financial instrument should be classified as a financial liability or equity instrument of Company A. Give reasons for your answer. This financial instrument should be classified as a financial liability as it is a non-derivative that provides for the issue of a variable number of shares that will always equal the amount of the obligation. There is no equity risk for the holder.  Exercise 7.4

CATEGORISING COMMON FINANCIAL INSTRUMENTS UNDER IAS 32

Categorise each of the following common financial instruments as financial assets, financial liabilities or equity instruments – of the issuer or the holder, as specified. (a) Loans receivable (holder) (b) Loans payable (issuer) (c) Ordinary shares of the issuer (d) The holder’s investment in the ordinary shares in part (c) (e) Redeemable preference shares of the issuer, redeemable at any time at the option of the holder (f) The holder’s investment in the preference shares in part (e) (a) Loans receivable (holder) – financial asset. (b) Loans payable (issuer) – financial liability. (c) Ordinary shares of the issuer – equity instrument. (d) The holder’s investment in the ordinary shares in (c) – financial asset. (e) Redeemable preference shares of the issuer, redeemable at any time at the option of the holder – financial liability of the issuer because it has a contractual obligation to redeem the shares. (f) The holder’s investment in the preference shares in (e) – financial asset.

 Exercise 7.5

FINANCIAL INSTRUMENTS CATEGORIES AND MEASUREMENT

Identify which of the four categories specified in IAS 39 each of the following items belongs to in the books of company H, the holder. Also identify how each item will be measured. (a) Forward exchange contract

7.6

Chapter 7: Financial instruments

(b) 5-year government bond paying interest of 5% (c) Trade accounts receivable (d) Trade accounts payable (e) Mandatory converting notes paying interest of 6% (the notes must convert to a variable number of ordinary shares at the expiration of their term) (f) Investment in a portfolio of listed shares held for capital growth (g) Investment in a portfolio of listed shares held for short-term gains (h) As in part (e), except that in the previous year company H sold the majority of its held-to-maturity investments to company Z. (i) Borrowings of $1 million, carrying a variable interest rate (a) Forward exchange contract – fair value through profit or loss. (b) 5-year government bond paying interest of 5% - held-to-maturity investment, measured at amortised cost. (c) Trade accounts receivable – loans and receivables, measured at amortised cost. (d) Trade accounts payable – financial liabilities, measured at amortised cost (e) Mandatory converting notes paying interest of 6%. The notes must convert to a variable number of ordinary shares at the expiration of their term - held-tomaturity investment, measured at amortised cost. (f) Investment in a portfolio of listed shares held for capital growth – available-for-sale investment, measured at fair value with changes in fair value through equity. (g) Investment in a portfolio of listed shares held for short-term gains – held-for-trading; at fair value through profit or loss. (h) As in (e) except that in the prior year Company H sold the majority of its held-to-maturity investments to Company Z. Cannot be classified as held-tomaturity, classified as available-for-sale, measured at fair value with changes in fair value through equity. (i) Borrowing of $1 000 000, carrying a variable interest rate – financial liability, measured at amortised cost.

 Exercise 7.6

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer. This financial instrument should be classified as a financial liability as it is a non-derivative that provides for the issue of a variable number of shares that will always equal the amount of the obligation. There is no equity risk for the holder.

7.7

Solutions Manual to accompany Applying IFRS Standards 4e

 Exercise 7.7

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer. This is a compound instrument. The issuer has a contractual obligation to pay interest and to redeem the principal (redemption is at the holder’s option). Therefore the liability component is the present value of the interest and principal discounted at 7%. The conversion option is an equity instrument because the number of shares is fixed. The equity option is measured as the residual.

7.8

Chapter 7: Financial instruments

 Exercise 7.8

AMORTISED COST, JOURNAL ENTRIES

Prepare the journal entries to record this transaction on initial recognition and throughout the life of the bond in the books of company B. 0 488 000 Journal 1 Dr Cash 488 000 1 -30 000 Cr Bond - liability 500 000 2 -30 000 Dr Bond - liability 12 000 3 -30 000 4 -30 000 5 -530 000 Journal 2 Dr Interest expense 32 104 Cr Bond - liability 2 104 6.579% effective rate Cr Cash 30 000 opening cash flows effective closing Journal 3 Dr Interest expense 32 243 488 000 488 000 Cr Bond - liability 2 243 488 000 -30 000 32 104 490 104 Cr Cash 30 000 490 104 -30 000 32 243 492 347 492 347 -30 000 32 390 494 737 Journal 4 Dr Interest expense 32 390 494 737 -30 000 32 548 497 285 Cr Bond - liability 2 390 497 285 -530 000 32 715 0 Cr Cash 30 000 Journal 5

Journal 6

Dr Interest expense Cr Bond - liability Cr Cash

32 548

Dr Interest expense Dr Bond - liability Cr Cash

32 715 497 285

2 548 30 000

530 000

7.9

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 7.9

EMBEDDED DERIVATIVES

Identify which of the following embedded derivatives must be separated from the relevant host contract. In each case, state also how the host contract and the embedded derivative should be measured in the books of the holder. Assume that the host instrument is not measured at fair value through profit or loss. (a) An equity conversion feature embedded in a convertible debt instrument (b) An embedded derivative in an interest-bearing host debt instrument, where the embedded derivative derives its value from an underlying interest rate index and can change the amount of interest that would otherwise be paid on the host debt instrument (c) An embedded cap (upper limit) on the interest rate on a host debt instrument, where the cap is at or above the market rate of interest when the debt instrument is issued (d) As in part (c), except that the cap is below the market rate of interest (a) An equity conversion feature embedded in a convertible debt instrument – must be separated because the characteristics and risks of the equity feature are not closely related to the debt host contract. The convertible debt instrument in the books of the holder is classified as an available-for-sale investment, measured at fair value through equity; the embedded derivative is separated and measured at fair value through profit or loss. (b) An embedded derivative in an interest-bearing host debt instrument, where the embedded derivative derives its value from an underlying interest rate index and can change the amount of interest that would otherwise be paid on the host debt instrument – must NOT be separated because the characteristics and risks of the derivative are closely related to the debt host contract. The host debt instrument is most likely classified as an availablefor-sale investment, measured at fair value through equity; the embedded derivative is not separately measured but rather is included in the measurement of the fair value of the host contract. (c) An embedded cap (upper limit) on the interest rate on a host debt instrument, where the cap is at or above the market rate of interest when the debt instrument is issued - must NOT be separated because the characteristics and risks of the derivative are closely related to the debt host contract. The host debt instrument is most likely classified as an available-for-sale investment, measured at fair value through equity; the embedded derivative is not separately measured but rather is included in the measurement of the fair value of the host contract. (d) As in c) except that the cap is below the market rate of interest - must be separated because the characteristics and risks of the derivative are not closely related to the debt host contract. This is because the interest rate in the cap is below the market interest rate. The host debt instrument in the books of the holder is classified as an available-for-sale investment, measured at fair value through equity; the embedded derivative is separated and measured at fair value through profit or loss.

7.10

Chapter 7: Financial instruments

 Exercise 7.10

CLASSIFICATION OF REVENUES AND EXPENSES

Classify the following items as statement of comprehensive income/statement of changes in equity. (a) Dividends paid on non-redeemable preference shares (b) Dividends paid on preference shares redeemable at the holder’s option (c) Interest paid on a five-year, fixed interest note (d) Interest paid on a convertible note classified as a compound instrument (a) Dividends paid on non-redeemable preference shares – preference shares will be classified as equity instruments therefore dividends will be classified as a distribution to equity holders in the statement of changes in equity. (b) Dividends paid on preference shares redeemable at the holder’s option – preference shares will be classified as financial liabilities therefore “dividends” will be classified as interest expense in the statement of comprehensive income. (c) Interest paid on a 5 year, fixed interest note - note will be classified as a financial liability therefore interest will be classified as interest expense in the statement of comprehensive income. (d) Interest paid on a convertible note classified as a compound instrument – the interest will need to be split into its component parts – that part relating to the financial liability will be classified as interest (statement of comprehensive income) and that part relating to the equity component will be classified as a distribution to equity holders (statement of changes in equity).  Exercise 7.11

IMPAIRMENT

State whether each of the following statements is true or false: (a) Financial assets measured ‘at fair value through profit or loss’ must be tested annually for impairment. (b) A reversal of an impairment loss on a held-to-maturity investment is recognised in profit and loss. (c) A reversal of an impairment loss on an available-for-sale investment in a debt instrument is not permitted. (d) A reversal of an impairment loss on an available-for-sale investment in an equity instrument is not permitted. (a) False – the impairment rules do not apply to such instruments. (b) True – a reversal should only occur if there is objective evidence of an event after the impairment occurred; such a reversal is recognised in profit or loss. (c) False – reversals of an impairment loss on debt instruments are permitted: reversals for equity instruments are not permitted. (d) True – reversals are only permitted for debt instruments.

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Solutions Manual to accompany Applying IFRS Standards 4e

 Exercise 7.12

HEDGING

State whether each of the following statements is true or false. (a) In any hedge relationship there needs to be a hedged item and a hedging instrument. (b) A hedging instrument must always be a derivative. (c) A cash flow hedge locks in a reporting entity’s future cash flows. (d) A forecast transaction is an uncommitted but anticipated future transaction. (e) In order to qualify for hedge accounting there must be formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge. (f) The documentation and designation in (e) may occur at any time. (a) (b) (c) (d) (e) (f)

True. False – it must be a derivative unless it is hedging foreign currency exchange risk, in which case it can be a non-derivative. True – a cash flow hedge is a hedge of the exposure to variability in cash flows. True – a forecast transaction is an uncommitted but anticipated future transaction (IAS 39 paragraph 9). True. False – the documentation must occur at the inception of the hedge.

 Exercise 7.13

CATEGORISING COMMON FINANCIAL INSTRUMENTS UNDER IAS 39

Categorise each of the following common financial instruments in one of the four categories specified in IAS 39. Assume that the entity does not elect the ‘at fair value through profit or loss category’. (a) Loans receivable (holder) (b) Loans payable (issuer) (c) Ordinary shares of the issuer (d) The holder’s investment in the ordinary shares in part (c) (e) Redeemable preference shares of the issuer, redeemable at any time at the option of the holder (f) The holder’s investment in the preference shares in part (e) (a) Loans receivable (holder) – financial asset – loans and receivables (b) Loans payable (issuer) – financial liability – financial liability (c) Ordinary shares of the issuer – equity instrument of the issuer– categorisation not applicable (scoped out of IAS 39)

7.12

Chapter 7: Financial instruments

(d) The holder’s investment in the ordinary shares in (c) – financial asset, available-for-sale investment (e) Redeemable preference shares of the issuer, redeemable at any time at the option of the holder – financial liability of the issuer because it has a contractual obligation to redeem the shares, categorised as a financial liability (f) The holder’s investment in the preference shares in (e) – financial asset – available-for-sale. This cannot be classified as held-to-maturity because the holder is able to redeem the shares at any time.  Exercise 7.14

OFFSETTING A FINANCIAL ASSET AND A FINANCIAL LIABILITY

In each of the situations below, state whether the financial asset and financial liability must be offset in the books of Company A as at 30 June 2016, and explain why. (a) Company A owes company B $500 000 due on 30 June 2017. Company B owes company A $300 000 due on 30 June 2017. A legal right of setoff between the two companies is documented in writing, and the parties have indicated their intent to settle the amounts on a net basis. (b) Company A owes company B $500 000 due on 30 June 2017. Company B owes company A $300 000 due on 31 March 2017. A legal right of setoff between the two companies is documented in writing, and the parties have indicated their intent to settle the amounts on a net basis whenever possible. (c) Company A owes company B $500 000, due on 30 June 2017. Company C owes company A $300 000 due on 30 June 2017. (d) Company A owes company B $500 000, due on 30 June 2017. Company C owes company A $500 000 due on 30 June 2017. A legal right of setoff between the three companies is documented in writing, and the parties have indicated their intent to settle the amounts on a net basis. (e) Company A owes company B $500 000, due on 30 June 2017. Company A has plant and equipment with a fair value of $500 000 that it pledges to Company B as collateral for the debt. (a) Yes – set-off required. Legal right of set-off exists and parties intend to settle net. Amounts can be settled net as they are due on the same dates. (b) No – amounts cannot be offset. Although a legal right of set-off exists and parties intend to settle net, the amounts cannot be settled net as they are not due on the same dates. (c) No – no legal right of set-off. The amounts are not between the same counterparties. (d) Yes – legal right of set-off documented between the three parties, amounts due on the same dates, intent and ability to settle net. (e) No – no legal right of set-off. Specifically prohibited.

7.13

Solutions Manual to accompany Applying IFRS Standards 4e

 Exercise 7.15

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer. This is a compound financial instrument. The issuer has a contractual obligation to pay interest for 5 years. The issuer does not have a contractual obligation to repay the principal since redemption is at the issuer’s option. This is so, even though both options would result in the holder getting their money back (via cash or settlement in a variable number of the issuer’s shares). The point is that the issuer does not have a contractual obligation to redeem the shares at all. There is no conversion option. Therefore the liability component is the present value of the interest discounted at 7%. The residual is the equity component. The classification of the instrument does not alter until the first 5 years have passed. If, after 5 years the notes have not been redeemed then they will be likely be reclassified as a liability as they will carry a new market interest rate and do not appear to have conversion or redemption clauses. Perpetual notes carrying market interest rates are in substance liabilities because the notes will be ultimately repaid through the interest payments.  Exercise 7.16

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer. This instrument is a financial liability. The issuer has a contractual obligation to pay dividends (they are cumulative) and to redeem the shares on maturity (holder’s option). Cumulative dividends on their own are not enough to cause liability classification but since the shares are redeemable this causes primary liability classification.  Exercise 7.17

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer. This is an equity instrument. The issuer does not have a contractual obligation to either redeem the shares or to pay dividends. This is so even though the substance of the instrument, when considering all its terms and the circumstances of its issue, indicate that it is a liability.

7.14

Chapter 7: Financial instruments

 Exercise 7.18

ACCOUNTING FOR A COMPOUND FINANCIAL INSTRUMENT

Prepare the journal entries to account for this transaction for each year of its term under each of the following circumstances. (a) The holders exercise their conversion option at the expiration of the note’s term. (b) The holders do not exercise their option and the note is repaid at the end of its term. (c) The holders exercise their option at the end of year 2.

7.15

Solutions Manual to accompany Applying IFRS Standards 4e

(a) Journal 1 Dr Cr

Cash Liability

Equity

Journal 2 Dr Cr Cr

Interest expense

1848122

1 848 122

1 2

-120000 -120000

151 878

-2120000

2 000 000

166 331 (1 848 122 x 9%) 46 331 (166 331 – 120 000) 120 000 (2 000 000 x 6%)

Liability Cash

9.000% effective rate opening

Journal 3 Dr Cr Cr Journal 4 Dr

(b) Journal 1

Interest expense

Dr Cr

Liability Cash

Equity

Dr Cash

50 501 (1 894 453 x 9%) 120 000

Dr Interest expense Cr Liability

effective

-120 000 -120 000

166 331 170 501

1 894 453 1 944 954

1 944 954

-2 120 000

175 046

closing 1 848 122

175 046 (1 944 954 x 9%) 1 944 954 120 000 2 000 000

2 000 000

Cr Liability Cr Equity

Journal 2

1 848 122 1 894 453

170 501 (1 894 453 x 9%)

Liability Cash Interest expense

cash flows 1 848 122

1 848 122 151 878

0 1

1 848 122 -120 000

2 3

-120 000 -2 120 000

166 331 46 331

Cr Cash

9.000% effective rate

120 000 opening

cash flows

effective

closing

7.16

Chapter 7: Financial instruments

Journal 3

Dr Interest expense

170 501

Cr Liability Cr Cash Journal 4

Dr Interest expense

50 501 120 000

Dr Liability Cr Cash

1 944 954

Dr Cash

2 000 000

Dr Interest expense Cr Bond - liability

166 331 170 501

1 894 453 1 944 954

1 944 954

-2 120 000

175 046

1 848 122 151 878

1 848 122

0 1

1848122 -120000

2 3

-120000 -2120000

166 331 46 331

9.000% effective rate

120 000 170 501 50 501

Cr Cash Dr Liability Cr Equity

-120 000 -120 000

2 120 000

Cr Cash Journal 3

1 848 122

175 046

Cr Liability Cr Equity

Journal 2

1 848 122 1 894 453

120 000

opening

cash flows

1 848 122

1 848 122 -120 000

effective 166 331

1 848 122 1 894 453

closing

1 894 453 1 944 954

-120 000 -2 120 000

170 501 175 046

1 944 954 0

1 944 954 1 944 954

OR Dr Interest expense

55 046

6-17

Solutions Manual to accompany Applying IFRS Standards 4e

Dr Liability

1 944 954

Cr Equity

2 000 000

7.18

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 7 Financial Instruments

CHAPTER 7 Financial Instruments Learning Objectives 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 7.12 7.13 7.14

describe the background to the development of accounting standards on financial instruments define a financial instrument outline and apply the definitions of financial assets and financial liabilities distinguish between equity instruments and financial liabilities explain the concept of a compound financial instrument determine the classification of revenues and expenses arising from financial instruments describe the scope of IFRS 9 explain the concept of an embedded derivative distinguish between the categories of financial instruments specified in IFRS 9 apply the recognition criteria for financial instruments understand and apply the measurement criteria for each category of financial instrument determine when financial assets and financial liabilities may be offset outline the rules of hedge accounting set out in IFRS 9 and be able to apply the rules to simple common cash flow and fair value hedges describe the main disclosure requirements of IFRS 7.

7.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

When first issued, IAS 39 was: Learning Objective 7.1 Describe the background to the development of accounting standards on financial instruments *a. More rule-based than other AASB standards b. Less rule-based than other AASB standards c. Wider in scope that other AASB standards d. Narrower in scope that other AASB standards

Which of the following is NOT an example of a derivative financial instrument? Learning Objective 7.4 Explain the concept of a derivative a. A forward exchange contract *b. A commercial bill contract c. A futures contract d. An option contract

Company A issues preference shares to Company B, the terms of which entitle party B to redeem the preference shares for cash if Company A’s revenues fall below a specified level. From Company A’s perspective the preference shares are: Learning Objective 7.4 Distinguish between equity instruments and financial liabilities a. an equity instrument *b. a financial liability c. a compound financial instrument d. a financial asset

Which of the following items is classified as a financial asset? Learning Objective 7.3 Outline and apply the definitions of financial assets and financial liabilities a. ordinary shares of the issuer; b. loans payable (owed by the borrower); *c. accounts receivable; d. inventory.

All of the following would be regarded as financial instruments except: Learning Objective 7.2 Define a financial instrument a. bank overdraft; b. notes payable; c. cash; *d. equipment.

7.3

Chapter 7 Financial Instruments

Which of the following items are regarded as a financial liability? Learning Objective 7.3 Outline and apply the definitions of financial assets and financial liabilities a. ordinary shares held in another entity; *b. a contract that is a non-derivative for which the entity is obliged to deliver a variable number of its own equity instruments; c. a contractual right to exchange under potentially favourable conditions, an option to purchase shares below the market price; d. the right of a depositor to obtain cash from a financial institution with which it has deposited cash.

Which of the following are regarded as financial instruments: I II III IV V

Deposits held by a financial institution; Ordinary shares; Raw materials inventories; Property, plant and equipment. Accounts receivable and accounts payable.

Learning Objective 7.2 Define a financial instrument a. I, II, IV and V only; b. II, III and IV only; *c. I, II and V only; d. I, IV and V only.

Company A issued convertible notes 3 years ago and accounted for them as a compound financial instrument. Complete the following: At the end of the three year period the portion of the (1) component that relates to the notes which have been converted (2) . Learning Objective 7.5 Explain the concept of a compound financial instrument (1) (2) a. equity is transferred to profit & loss b. liability remains as a liability *c. liability is transferred to equity d. liability is transferred to profit & loss

7.4

Test Bank to accompany Applying IFRS Standards 4e

Company A has convertible notes on issue. These notes are convertible to ordinary shares of the Company after 3 years. The distributions made to the note holders by Company A are classified by Company A as follows: Learning Objective 7.5 Explain the concept of a compound financial instrument a. interest expense. b. dividends distributed. *c. a portion representing interest expense and a portion representing dividends distributed d. indeterminable based on the information provided.

10.

Which of the following events provide objective evidence that a financial asset has been impaired: I A default in interest payments. II The borrower enters into bankruptcy. III Significant financial difficulty of the issuer. IV The downgrade of an entity’s credit rating. Learning Objective 7.11 understand and apply the measurement criteria for each category of financial instrument *a. I, II and III only; b. II, III and IV only; c. I, III and IV only; d. II and IV only.

11.

IFRS 9 requires that on initial recognition financial liabilities must be measured at: Learning Objective 7.11 understand and apply the measurement criteria for each category of financial instrument a. fair value; *b. fair value minus transaction costs; c. fair value plus transaction costs; d. discounted future net cash flows.

12.

The formal documentation of a hedging relationship must include identification of:

The hedging instrument The hedged item The nature of the risk being hedged How the entity will assess hedge effectiveness

I II No No No Yes No Yes Yes No

III IV Yes Yes Yes No Yes Yes Yes No

Learning Objective 7.13 Outline the rules of hedge accounting set out in IFRS 9 and be able to apply the rules to simple common cash flow and fair value hedges a. I; b. II; *c. III; d. IV.

7.5

Chapter 7 Financial Instruments

13.

To be regarded as ‘highly effective’ in achieving offsetting changes in fair value or cash flows, actual hedge results must be in the range: Learning Objective 7.13 Outline the rules of hedge accounting set out in IFRS 9 and be able to apply the rules to simple common cash flow and fair value hedges a. 70% - 100%; *b. 80% - 125%; c. 90% - 100%; d. 20% - 50%.

14.

Whitnall Limited lost $150 on a hedging instrument and had a corresponding gain on the hedged item of $100. The effectiveness range for the associated transactions is: Learning Objective 7.13 Outline the rules of hedge accounting set out in IFRS 9 and be able to apply the rules to simple common cash flow and fair value hedges a. 100% - 150%; b. 20% - 30%; c. 0% - 15%; *d. 66% - 150%.

15.

The degree to which changes in the fair value or cash flows of a hedge item that are attributable to a hedge risk are offset by the changes in the fair value or cash flows of a hedging instrument, describes: Learning Objective 7.13 Outline the rules of hedge accounting set out in IFRS 9 and be able to apply the rules to simple common cash flow and fair value hedges a. transaction exposure; b. hedge ineffectiveness; *c. hedge effectiveness; d. transaction variability.

16.

When accounting for a cash flow hedge, IFRS 9 requires that hedge ineffectiveness is: Learning Objective 7.13 Outline the rules of hedge accounting set out in IFRS 9 and be able to apply the rules to simple common cash flow and fair value hedges *a. recorded in profit or loss; b. separately recorded in equity; c. recorded separately as a financial liability; d. capitalised as a deferred asset.

7.6

Test Bank to accompany Applying IFRS Standards 4e

17.

The definition of a derivative requires which of the following characteristics to be met? I

its value must change in response to a change in an underlying variable such as a specified interest rate, price or foreign exchange rate. II it must be settled on a net basis III it must require no initial net investment or an additional net investment that is smaller than would be required for other types of contracts with similar responses to changes in market factors. IV it is to be settled at a future date Learning Objective 7.8 explain the concept of an embedded derivative a. I, II and III *b. I, III and IV c. I, II and IV d. II, III and IV

18.

Callas Corporation Limited buys an option that entitles it to purchase 2000 shares in Maria Limited at $5 per share at any time in the next 3 months. The derivative financial instrument in this transaction is the: Learning Objective 7.8 explain the concept of an embedded derivative a. shares in Callas Corporation Limited; b. shares in Maria Limited; c. price of the shares in Maria Limited after 3 months have elapsed; *d. option priced at $5.

19.

The classification of a financial instrument on the Statement of Financial Position of an entity is governed by the principle of: Learning Objective 7.4 Distinguish between equity instruments and financial liabilities a. legal form; b. net present value; *c. substance over form; d. forfeiture.

20.

The appropriate accounting treatment for incremental costs directly attributable to an equity transaction that would otherwise have been avoided is to: Learning Objective 7.6 determine the classification of revenues and expenses arising from financial instruments *a. deduct from equity, net of tax; b. add to equity, net of tax; c. expense in the period incurred; d. defer as a contingent asset.

7.7

Chapter 7 Financial Instruments

21.

When an entity has a legally enforceable right to set off the recognised amounts of a financial asset and financial liability and it intends to settle on a net basis, it: Learning Objective 7.12 determine when financial assets and financial liabilities may be offset a. can write off both the asset and the liability; *b. may offset the financial asset and liability; c. is not entitled to offset the asset and liability; d. need not present the asset, the liability or the net amount in its financial statements.

22.

The risk that one party to a financial instrument will fail to discharge an obligation and cause the other party to incur a financial loss is referred to as: Learning Objective 7.14 describe the main disclosure requirements of IFRS 7 a. interest rate risk; b. liquidity risk; c. market risk; *d. credit risk.

23.

Which of the following is within the scope of IFRS 9? Learning Objective 7.7 describe the scope of IFRS 9 a. a lease obligation *b. a lease renewal option within a lease agreement c. a financial guarantee contract d. an investment in a joint venture.

7.8

Online Exercises for Chapter 7 Financial instruments

Applying IFRS® Standards 4e Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Online exercises for Chapter 7 Financial instruments

STAR RATING ★ BASIC ★ ★ MODERATE ★ ★ ★ DIFFICULT

 Exercise 7.10

CLASSIFICATION OF REVENUES AND EXPENSES

 Exercise 7.11

IMPAIRMENT

 Exercise 7.12

HEDGING

John Wiley & Sons, Ltd 2016

Online exercises to accompany Applying IFRS Standards

(e) In order to qualify for hedge accounting there must be formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge. (f) The documentation and designation in (e) may occur at any time.

 Exercise 7.13

CATEGORISING COMMON FINANCIAL INSTRUMENTS UNDER IAS 39

 Exercise 7.14

OFFSETTING A FINANCIAL ASSET AND A FINANCIAL LIABILITY

 Exercise 7.15

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Company A issues 100 000 $1 redeemable convertible notes. The notes pay interest at 5%. They convert at any time at the option of the holder into 100 000 ordinary shares. The notes are redeemable at the option of the issuer for cash after 5 years. If after 5 years the notes have not

John Wiley & Sons, Ltd 2016

Online Exercises for Chapter 7 Financial instruments

been redeemed or converted, they cease to carry interest. Market rates for similar notes without the conversion option are 7%. Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer.

 Exercise 7.16

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Company A issues 100 000 $1 redeemable convertible notes. The notes pay interest at 5%. The notes are redeemable after 5 years at the option of the issuer for cash or for a variable number of shares (calculated according to a formula). If after 5 years the notes have not been redeemed or converted, they continue to carry interest at a new market rate to be determined at the expiration of the 5 years. Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer.

 Exercise 7.17

DISTINGUISHING FINANCIAL LIABILITIES FROM EQUITY INSTRUMENTS

Company A issues redeemable preference shares with a fixed maturity date. The shares are redeemable only on maturity at the option of the holder. The shares carry a cumulative 6% dividend. Determine whether this financial instrument should be classified as a financial liability or equity instrument of company A. Give reasons for your answer.

 Exercise 7.18

ACCOUNTING FOR A COMPOUND FINANCIAL INSTRUMENT

The facts from example 4 of figure 7.3 are repeated below: Company A issues 2000 convertible notes on 1 July 2012. The notes have a 3-year term and are issued at par with a face value of €1000 per note, giving total proceeds at the date of issue of €2 million. The notes pay interest at 6% annually in arrears. The holder of each note is entitled to convert the note into 250 ordinary shares of Company A at any time up to maturity. When the notes are issued, the prevailing market interest rate for similar debt (similar term, similar credit status of issuer and similar cash flows) without conversion options is 9%. This rate is higher than the convertible note’s rate because the holder of the convertible note is prepared to accept a lower interest rate given the implicit value of its conversion option. The issuer calculates the contractual cash flows using the market interest rate (9%) to work out the value of the holder’s option, as follows:

John Wiley & Sons, Ltd 2016

Online exercises to accompany Applying IFRS Standards

Proceeds of the note issue

John Wiley & Sons, Ltd 2016

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Nila Latimer and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 8: Share-based payment

Chapter 8: Share-based payment Discussion Questions 1.

Why do standard setters formulate rules on the measurement and recognition of share-based payment transactions?

Prior to the introduction of IFRS 2 Share-based payment, there was no requirement to recognise the cost of compensation payments to employees and transactions for the acquisition of goods and services from others in the financial statement. This situation can be criticised as reducing the transparency and reliability of financial statements. Standard setters have argued that recognising the cost of share-based payments in the financial statements of entities improves the relevance, reliability and comparability of that financial information and helps users of financial information to understand better the economic transactions affecting an enterprise and supports resource allocation decisions.

What is the difference between equity-settled and cash-settled share-based payment transactions?

Equity-settled share-based payment transactions arise when an entity receives goods or services as consideration for its own equity instruments (including shares and share options). Cash-settled share-based payment transactions arise when an entity acquires goods or receives services by incurring liabilities (debt) for amounts based on the value of its own equities. Other share-based payment transactions may arise in which the entity receives or acquires goods or services and either the entity or the supplier has the choice of whether the transaction is settled in cash or equity instruments.

What is the different accounting treatment for instruments classified as debt and those classified as equity?

Instruments classified as debt (liabilities) are accounted for by recognising an increase in an expense (or asset) and a corresponding increase in debt (a liability). The fair value of such liabilities determines the measurement of the transaction. Additionally, the debt (liability) must be remeasured at each reporting date and at settlement date. Instruments classified as equity are accounted for by recognising an increase in an expense (or asset) and a corresponding increase in equity. The fair value of the goods or services received is measured at the grant date fair value of the goods or services received and it is not subsequently remeasured. If the fair value of the goods or services received cannot be measured reliably, the transaction amount is determined indirectly by reference to the fair value of the equity instruments granted.

8.2

Applying IFRS Standards 4e Solutions Manual 4.

Outline the accounting treatment for the recognition of an equity-settled share-based payment transaction.

Equity settled share-based payment transactions are recognised as an increase in the goods or services received and a corresponding increase in equity measured at the grant date at the fair value of the goods or services received, or it the fair value of the equity instruments granted.

Explain when a counterparty’s entitlement to receive equity instruments of an entity vests.

A counterparty’s entitlement to receive equity instruments of an entity vest when the vesting conditions are met. These are typically service criteria ie: the employee remaining employed by the entity for a specified period of time and performance conditions such as the entity achieving a specified growth in profit or a specified increase in the entity’s share price.

What are the minimum factors required under IFRS 2 to be taken into account in option pricing models?

Appendix B of IFRS 2 supplies a list of factors that all option pricing models take into account as a minimum. These include: a. the exercise price of the option b. the life of the option c. the current price of the underlying shares d. the expected volatility of the share price e. the dividends expected on the shares f. the risk-free interest rate for the life of the option. Appendix B also contains a discussion of the valuation issues in the context of applying options pricing models. The student should refer to the discussion in IFRS 2 Appendix B. In brief, the following important matters are discussed in Appendix B. Expected volatility – is a measure of the amount by which a price is expected to fluctuate during a period. Volatility is typically expressed in annualised terms, for example, daily or monthly price observations. Often a range of reasonable expectations about future volatility can be determined, and if so, an expected value should be calculated by weighting each amount within the range by its associated probability of occurrence. Expectations about the future are generally based on experience, modified if the future is reasonably expected to differ from the past. There may be cases where historical patterns may not be the best indicator of reasonable expectations for the future, for instance where a significant business segment has been acquired or disposed of. Whether dividends should be taken into account depends on the counterparty’s entitlement to those dividends. Generally assumptions about dividends are to be based on publicly available information. The risk-free interest rate is the implied yield currently available on zero-coupon government issues of the country in whose currency the exercise price is expressed, with a remaining term equal to the expected term of the option being valued.

8.3

Chapter 8: Share-based payment 7.

Distinguish between vesting and non-vesting conditions.

Vesting conditions comprise service and performance conditions only. Other features of share-based payment transactions are not regarded as vesting conditions. Whether or not a condition is a vesting condition or a non-vesting condition is illustrated in the following flowchart. Does the condition determine whether the entity receives the services that entitle the counter-party to the share-based payment? NO Non-vesting condition

YES Does the condition require only a specified period of service to be completed? NO Performance condition

YES Service condition

Explain what the ‘retesting’ of share options means.

Retesting (or repricing) of share options occurs when an entity chooses to modify the terms and conditions on which it granted equity instruments. For example, it might change (reprice/retest) the exercise price of share options previously granted to employees at prices that were higher than the current price of the entity’s shares. It might accelerate the vesting of share options to make the options more favourable to employees; or it might remove or alter a performance condition. If the exercise price of options is modified, the fair value of the options changes. A reduction in the exercise price would increase the fair value of share options. Irrespective of any modifications to the terms and conditions on which equity instruments are granted, paragraph 27 of IFRS 2 requires the services received, measured at the grant-date fair value of the equity instruments, to be recognised unless those equity instruments do not vest. Although some companies provide for retesting to allow for the potential volatility of earnings and the cyclical nature of the market, many companies limit the retesting opportunities and others do not allow retesting at all.

8.4

Applying IFRS Standards 4e Solutions Manual 9.

Explain the measurement approach for cash-settled share-based payment transactions.

If a share-based payment is settled in cash, the general principle employed in IFRS 2 is that the goods or services received and the liability incurred are measured at the fair value of the liability (IFRS 2 paragraph 10). The fair value of the liability must be remeasured at the end of each reporting period and at the date of settlement, and any changes in fair value are recognised in profit or loss (IFRS 2 paragraph 30).

10. (a) (b) (c)

Are the following statements true or false? Goods or services received in a share-based payment transaction must be recognised when they are received. Historical volatility provides the best basis for forming reasonable expectations of the future price of share options. Share appreciation rights entitle the holder to a future equity instrument based on the profitability of the issuer.

(a) True (b) False (c) False

8.5

Chapter 8: Share-based payment

Exercises Exercise 8.1

SCOPE OF IFRS 2

Which of the following is a share-based payment transaction within the scope of IFRS 2? Give reasons for your answer. (a) Goods acquired from a supplier by incurring a liability based on the market price of the goods (b) An invoiced amount for professional advice provided to an entity, charged at an hourly rate, and to be settled in cash (c) Services provided by an employee to be settled in equity instruments of the entity (d) Supply of goods in return for cash or equity instruments at the discretion of the supplier (e) Dividend payment to employees who are holders of an entity’s shares

(a) IFRS 2 does not include such transactions as share-based payment transactions within the scope as outlined in IFRS 2 paragraph 2: however, if the liability for the goods were based on the market price of the entity’s equity, the transaction would be considered a share-based payment transaction. (b) This is not a share-based payment transaction as the entity does not receive services as consideration by incurring liabilities for amounts based on the price of its own equity instruments. (c) This is a share-based payment transaction as specified by IFRS 2 paragraph 2(a), that is, it is a transaction in which the entity receives goods or services as consideration for equity instruments of the entity. (d) This is a share-based payment transaction as specified by IFRS 2 paragraph 2(c), that is, it is a transaction in which the entity receives goods and the terms of the arrangement provide the supplier with a choice of whether to settle in cash or equity instruments of the entity. (e) This is not a share-based payment transaction. Paragraph 4 of IFRS 2 excludes transactions with employees (or other parties) in the employees’ capacity as a holder of equity instruments of the entity.

8.6

Applying IFRS Standards 4e Solutions Manual

Exercise 8.2

EQUITY-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

Prepare a schedule setting out the annual and cumulative remuneration expense to be recognised by Park Ltd for services rendered as consideration for the share options granted.

Year

Calculation

(20 x 250 options x 90% x $14) x 1/3 years (20 x 250 options x 90% x $14) x 2/3 years) – $21 000 (20 x 250 options x 90% x $14) – $42 000

2 3

Exercise 8.3

Remuneration expense for period $ 21 000

Cumulative remuneration expense $ 21 000

21 000 21 000

42 000 63 000

ACCOUNTING FOR A GRANT WHERE THE NUMBER OF EQUITY INSTRUMENTS EXPECTED TO VEST VARIES

Prepare a schedule setting out the annual and cumulative remuneration expense for year 1.

Year

Calculation

(80 x 200 options x 78%) x $12 x 1/3 years

Exercise 8.4

Remuneration expense for period $ 49 920

Cumulative remuneration expense $ 49 920

ACCOUNTING FOR A GRANT OF SHARE OPTIONS WHERE THE EXERCISE PRICE VARIES

Prepare a schedule setting out the annual remuneration expense to be recognised by Whistler Ltd and the cumulative remuneration expense for 2015. Year

Calculation

2015

3000 options x $22 x 1/3 years

Remuneration expense for period $ 22 000

Cumulative remuneration expense $ 22 000

8.7

Chapter 8: Share-based payment Exercise 8.5

ACCOUNTING FOR A GRANT WITH A MARKET CONDITION

Calculate the annual and cumulative remuneration expense to be recognised by Bay Ltd for 2016. Year

Calculation

2016 10 000 options x $14 x 1/3 years Source: Adapted from AASB2, IG13

Exercise 8.6

Remuneration expense for period $ 46 667

Cumulative remuneration expense $ 46 667

SHARE-BASED PAYMENT WITH A NON-VESTING CONDITION

Prepare the necessary journal entry or entries to recognise this arrangement at the end of the first year. Expense $ $ Year 1 Salary $3000 x 1 x .90 Dr 2700 (Contribution to plan) $3000 x 1 x .10 Dr 300 (Share-based payment) Dr

Exercise 8.7

Cash $

Liability Equity $

Cr (2700) Cr (300) 200

Cr (200)

ACCOUNTING FOR CASH-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

Required Prepare a schedule setting out the expense and liability that Abernethy Ltd must recognise at the end of each of the first three years.

Year

Calculation

(10-3) employees x 1000 SARs x $4.40 x 1/3 years (10-3) employees x 1000 SARs x $5.50 x 2/3 years -$10 267

Expense $

Liability $

10 267

15 400

25 667

Expense $

Liability $

30 600

Year

Calculation

(10-3-4) employees x 1000 SARs x $10.20 – $25 667

4 933

4 employees x 1000 SARs x $9.00

36 000

8.8

Applying IFRS Standards 4e Solutions Manual

Exercise 8.8

RECOGNITION PRINCIPLES

Is this a share-based payment transaction? Should Zebra Ltd recognise the acquisition cost as an asset or an expense? Explain.

This is a share-based payment transaction. IFRS 2 paragraph recognises the acquisition of goods by incurring liabilities to the supplier of those goods for amounts that are based on the share price of the entity’s shares, a share-based payment transactions. The Crowd Control Equipment should be recognised as an asset and progressively recognised as an expense according to the pattern of usage of the economic benefits.

Exercise 8.9

CATEGORISING

Should the entity recognise the cost of these services as a liability or a component of equity? Explain.

This is share-based payment transaction. IFRS 2 paragraph 2 recognises the acquisition of goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the share price of the entity’s shares, as share-based payment transactions.

8.9

Chapter 8: Share-based payment Exercise 8.10 CASH-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

Measure the value of this transaction and prepare an appropriate journal entry to recognise it. Amount of the liability for inventory received, measured by direct reference to the entity’s own shares is $47 500 (5000 shares x $9.50). An appropriate journal entry to recognise this share-based payment transaction is: Dr Inventory (asset) 47 500 Cr Accounts payable (liability) 47 500 (Recognition of a cash-settled share-based payment transaction in which the amount for the fair value of goods received is measured by reference to the entity’s own shares).

Exercise 8.11

MODIFICATIONS TO EQUITY-SETTLED SHARE BASED PAYMENT TRANSACTIONS

Prepare a schedule setting out the remuneration expense to be recognised at the end of years 1 and 2.

Eight employees left during year 1, and Iona Ltd estimates that a further nine employees will depart during year 2. By the end of year 1, the company’s share price has dropped and it decides to reprice the share options. The repriced share options will vest at the end of year two. At the date of repricing Iona Ltd estimates the fair value of each of the original share options is $7 and the fair value of each repriced share option is $10. The incremental value is $3 per share option and this amount is recognised over the remaining one year of the vesting period along with the remuneration expense based on the original option value of $12. Year

Calculation

(120-17) employees x 50 options x $12 x 1/2 years

Year

Calculation

([120-17] employees x 50 options) x ($12 + $3) - $30 900

Remuneration expense for period $

Cumulative remuneration expense $

30 900

Remuneration expense for period $

Cumulative remuneration expense $

46 350

77 250

8.10

Applying IFRS Standards 4e Solutions Manual

Exercise 8.12

DISCLOSURE

Prepare an appropriate memorandum outlining the disclosures that will need to be made in Bentley Ltd’s financial statement following the adoption of IFRS 2.

Memorandum to XXX According to the requirements of IFRS 2 Share-based Payment, the financial statements for the next reporting period must include sufficient disclosure in respect to the share option plan operated on behalf of employees to enable users of the financial statements to understand the nature and extent of share-based payment arrangements that existed during the year; to understand how the fair value of goods or services received or the fair value of share options granted during the year was determined; and to understand the effect of share-based payment transactions on the profit or loss for the period and on financial position. The additional disclosures Bentley Ltd will need to make in order to satisfy the requirements of IFRS 2 are the following: IFRS 2 paragraph 45(a) A description of the share plan including the general terms and conditions, vesting requirements, maximum term of options granted and method of settlement. IFRS 2 paragraph 45(b) The number and weighted average exercise prices of share options for each of the following groups+ (i) outstanding at the beginning of the period; (ii) granted during the period; (iii) forfeited during the period; (iv) exercised during the period; (v) expired during the period; (vi) outstanding at the end of the period; and (vii) exercisable at the end of the period. IFRS 2 paragraph 45(c) For share options exercised during the period, the weighted average share price at the date of exercise (or is exercised regularly throughout the period, the weighted average share price during the year). IFRS 2 paragraph 45(d) For share options outstanding at the end of the period, the range of exercise prices and weighted average remaining contractual life. If the range of exercise prices is wide, these options will need to be divided into ranges that are meaningful for an assessment of the number and timing of additional shares that may be issued and the cash that may be received on the exercise of the options. IFRS 2 paragraph 47(a) For share options granted during the period, the weighted average fair value of those options at the measurement date and information on how that fair value was measured including: (i) the options pricing model used and the inputs to that model, including the weighted average share price, exercise price, expected volatility, option life, expected dividends, risk-free interest rate, and any other inputs; (ii) how expected volatility was determined, including the extent to which expected volatility was based on historical volatility; (iii) whether and how any other features of the option were incorporated into the measurement of fair value.

8.11

Chapter 8: Share-based payment IFRS 2 paragraph 47(c) For arrangements that were modified during the period: (i) an explanation of the modifications (ii) the incremental fair value granted as a result; and (iii) information on how the incremental fair value was measured. IFRS 2 paragraph 51 The total expense recognised for the period that did not qualify for recognition as assets. Although it does not appear that employees have a settlement choice under this plan, if they do, then separate disclosure of the portion of the expense accounted for as equity-settled share-based payments must be made, and for any liabilities arising the total carrying amount at the end of the period, and the total intrinsic value at the end of the period for which the employees’ right to cash had vested by the end of the period. IFRS 2 paragraph 52 Any such other information as is necessary to enable the users understand the nature and extent of sharebased payments, how the fair value of equity instruments granted was determined, and the effect of the transactions on profit or loss and financial position.

Exercise 8.13

APPLICATION OF THE INTRINSIC VALUE METHOD

Calculate the annual and cumulative remuneration expense to be recognised by Atlas Ltd for each of the three years.

At the end of year 1, three employees have left and the company estimated that a further three employees will leave during years 2 and 3. Hence, only 88% of the share options are expected to vest. Year

Calculation

(50 x 2000 options x 88%) x $53-$50) x 1/3 years

Remuneration expense for period $

Cumulative remuneration expense $

88 000

Two employees left during year 2, and one further employee was expected to leave during year three hence the company estimate of the number of share options expected to vest remained at 88%. Year

Calculation

(50 x 2000 options x 88% x [$55-$50] x 2/3 years) - $88 000 (44 x 2000 options x [$65–$50]) – $293 333

Remuneration expense for period $

Cumulative remuneration expense $

205 333 1 026 667

293 333 1 320 000

8.12

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 8 Share-based payment

CHAPTER 8 Share-based payment

Learning Objectives 8.1 Explain the objective and scope of IFRS 2 8.2 Distinguish between cash-settled and equity-settled share-based payment transactions 8.3 Demonstrate how equity-settled and cash settled share-based payment transactions are recognised 8.4 Explain how equity-settled share-based payment transactions are measured 8.5 Explain the concept of vesting through differentiating between vesting and non-vesting conditions 8.6 Explain the concept of a share option reload feature 8.7 Explain how modifications to granted equity instruments are treated 8.8 Demonstrate how cash-settled share-based payment transactions are measured 8.9 Describe and apply the disclosure requirements of IFRS 2.

8.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1.

Which of the following is NOT within the scope of IFRS 2? Learning Objective 8.1 Explain the objective and scope of IFRS 2 *a. Transactions in which the entity receives or acquires goods or services as part of the net assets acquired in a business combination to which IFRS 3 Business Combinations applies. b. Equity instruments granted to employees of the acquiree in a business combination in their capacity as an employee. c. Cancellation, replacement or other modification of share-based payment arrangements because of a business combination. d. Cancellation, replacement or other modification of share-based payment arrangements because of other equity restructuring.

A share–based payment transaction in which the entity acquires goods or services by incurring liabilities to the supplier for amounts that are based on the value of the entity’s shares or other equity instruments of the entity is classified in IFRS 2 as: Learning Objective 8.2 Distinguish between cash-settled and equity-settled share-based payment transactions a. an equity-settled share-based payment transaction *b. a cash-settled share-based payment transaction c. a liability-settled share-based payment transaction d. an “other” share-based payment transaction

A share–based payment transaction in which the entity receives goods or services as consideration for equity instruments of the entity is classified in IFRS 2 Share-based Payment as Learning Objective 8.2 Distinguish between cash-settled and equity-settled share-based payment transactions *a. an equity-settled share-based payment transaction b. a cash-settled share-based payment transaction c. a liability-settled share-based payment transaction d. an “other” share-based payment transaction

Reload features are accounted for as follows: Learning Objective 8.6 Explain the concept of a share option reload feature a. included in the fair value of the initial options granted at measurement date *b. separately from the initial options granted c. as a market condition d. as a modification to the initial terms and conditions of the initial options granted

8.3

Chapter 8 Share-based payment

On 1 July 2015 Pepper Limited granted 500 share options to each of its 100 employees. Each grant is conditional on the employee working for the company for the next two years. The fair value of each option is estimated to be €3.00. Pepper estimates that 8% of its employees will leave during the two year period and therefore forfeit their rights to the share options. During the year ended 30 June 2016 five employees left. At this time the company revised its estimate of total employee departures over the full two-year period to 10%. During the year ended 30 June 2017 a further 4 employees left. The amount to be recognised as an expense by Pepper for the year ended 30 June 2016 is: Learning Objective 8.5 Explain the concept of vesting through differentiating between vesting and non-vesting conditions *a. €67 500 b. €69 000 c. €71 250 d. €135 000

On 1 July 2013, Leo Limited granted 250 options to each of its 50 employees. The options are conditional on the employees remaining with the company for the 2 year vesting period. The options have a fair value of €10 at vesting date. In addition, the shares will vest as follows: • On 30 June 2014 if the company’s earnings have increased by more than 15% • On 30 June 2015 if the company’s earnings have increased by more than 12% averaged across the 2 year period At 30 June 2014 Leo’s earnings have increased by 12% and 3 employees have left. The company expects that earnings will continue to increase at a similar rate during the year to 30 June 2015 and that the shares will vest at that time. It also expects that a further 4 employees will leave during the year. The remuneration expense for the year ended 30 June 2014 for Leo is: Learning Objective 8.5 Explain the concept of vesting through differentiating between vesting and non-vesting conditions a. €35 833 *b. €53 750 c. €58 750 d. €117 500

8.4

Test Bank to accompany Applying IFRS Standards 4e

Which of the following statements in relation to modifications to the terms and conditions on which equity instruments were granted as part of an employee share scheme is correct? Learning Objective 8.7 Explain how modifications to granted equity instruments are treated a. a reduction in the exercise price of options will reduce the fair value of the share options b. a reduction in a performance hurdle relating to profitability targets will reduce the fair value of the options *c. a shortening of the vesting period will increase the fair value of the share options. d. an increase in the number of equity instruments granted is not an example of a modification

On 1 July 2013 Diamond Ltd granted 800 share options with an exercise price of €35 to the CFO, conditional on the CFO remaining in employment with the company until 30 June 2016. The exercise price will drop to €30 if Diamond’s earnings increase by an average of 8% per year over the three year period. On 1 July 2013 the estimated fair value of the share options with an exercise price of €35 is €10 per option, and if the exercise price is €30, the estimated fair value of the options is €12 per option. During the year ended 30 June 2014 Diamond’s earnings increased by 10% and they are expected to continue to increase at this rate over the next two years. During the year ended 30 June 2015 Diamond’s earnings increased by 5% and Diamond management expected that the earnings target would be achieved. During the year ended 30 June 2016 Diamond’s earnings increased by 11%. When calculating the remuneration expense to be recognised for the year ended 30 June 2015 which of the following dollar values should be included in the calculation? Learning Objective 8.5 Explain the concept of vesting through differentiating between vesting and non-vesting conditions *a. €10 b. €12 c. €30 d. €35

8.5

Chapter 8 Share-based payment

The following information relates to questions 9 and 10 On 1 July 2013 Fantasy Ltd granted 200 options to each of its 100 employees. The share options will vest on 30 June 2015 if the employees remain employed with the company on that date. The share options have a life of four years. The exercise price is $5, which is also Fantasy’s share price at the grant date. Fantasy is unable to reliably estimate the fair value of the share options at the grant date. Fantasy’s share price and the number of options exercised are set out below. Share options may only be exercised at year end. Year ended 30 June 2014 30 June 2015 30 June 2016 30 June 2017 9. is:

Share price at year end $6 $7 $8 $9

Number of options exercised at year end 7 800 10 000

The cumulative remuneration expense to be recognised by Fantasy as at 30 June 2015 Learning Objective 8.6 Explain the concept of a share option reload feature a. $7800 b. $17 800 *c. $35 600 d. $124 600

10.

The formula to calculate the remuneration expense for the year ended 30 June 2016 is: Learning Objective 8.6 Explain the concept of a share option reload feature a. 7800 x ($8-$7) b. 7800 x $8 c. (7800 + 10 000) x ($8-$5) *d. (7800 + 10 000) x ($8-$7)

8.6

Test Bank to accompany Applying IFRS Standards 4e

The following information relates to questions 11 to 13 On 1 July 2013 Watson Pty Ltd granted 100 share appreciation rights (SARS) to each of its 50 employees, conditional on the employee not leaving the company in the next three years. The company estimates the fair value of the SARS at the end of each year in which a liability exists as shown in the table below. The intrinsic values of the SARS at the date of exercise at 30 June 2016, 2017 and 2018 are also shown. All SARS held by employees at 30 June 2016 vest. Year ended 30 June 2014 30 June 2015 30 June 2016 30 June 2017 30 June 2018

Fair value $14.40 $15.50 $18.20 $21.40

Intrinsic value

$15.00 $20.00 $25.00

By 30 June 2016 nine employees have left and 15 employees have exercised their SARS.

11.

The amount recognised as an expense for the year ended 30 June 2016 is: Learning Objective 8.8 Demonstrate how cash-settled share-based payment transactions are measured a. $5987 b. $22 500 *c. $28 487 d. $47 320

12.

The liability recorded at 30 June 2015 is: Learning Objective 8.8 Demonstrate how cash-settled share-based payment transactions are measured a. $19 680 b. $21 653 *c. $41 333 d. $47 320

13.

This is an example of: Learning Objective 8.8 Demonstrate how cash-settled share-based payment transactions are measured a. an equity-settled share-based payment transaction *b. a cash-settled share-based payment transaction c. a share-based payment transaction where the counterparty has the settlement choice d. a share-based payment transaction where the entity has the settlement choice

8.7

Chapter 8 Share-based payment

The following information relates to questions 14 to 16 Viola Ltd has granted each of its 10 senior executives a choice between receiving a cash payment equivalent to 1000 shares or receiving 1200 share. The grant is conditional on the completion of three years’ service with the company. If the share alternative is chosen, the shares must be held for two years after vesting date. At grant date the company’s share price is £25 per share. At the end of years 1, 2 and 3 the share price is £27, £28 and £30 respectively. The company does not expect to pay dividends in the next three years. After taking into account the effect of post-vesting transfer restrictions the company estimates the grant-date fair value of the share alternative is £24 per share. 14.

What is the fair value of the cash alternative? Learning Objective 8.8 Demonstrate how cash-settled share-based payment transactions are measured a. £240 000 *b. £250 000 c. £288 000 d. £300 000

15.

What is the fair value of the equity alternative? Learning Objective 8.8 Demonstrate how cash-settled share-based payment transactions are measured a. £240 000 b. £250 000 *c. £288 000 d. £300 000

16.

What is the liability component at the end of year 1? Learning Objective 8.8 Demonstrate how cash-settled share-based payment transactions are measured a. £83 333 *b. £90 000 c. £100 000 d. £108 000

8.8

Test Bank to accompany Applying IFRS Standards 4e

17.

On 1 July 2014 Luca Ltd grants 200 options to each of its 75 employees conditional on the employee remaining in service over the next two years. The fair value of each option is estimated to be $7. Luca estimates that 8 employees will leave over the two year vesting period. By 30 June 2015 four employees have left and the entity estimates that a further five employees will leave over the next year. On 30 June 2015 Luca decided to reprice its share options, due to a fall in its share price over the last 12 months. The repriced share options will vest on 30 June 2016. At the date of repricing Luca estimates that the fair value of each original option is $1.50 and the fair value of each repriced option is $3. During the year ended 30 June 2016 four employees left. The remuneration expense for the year ended 30 June 2015 is: Learning Objective 8.7 Explain how modifications to granted equity instruments are treated *a. $34 650 b. $35 175 c. $46 200 d. $46 900

18.

In a share based payment transaction where the entity has settlement choice: Learning Objective 8.8 Demonstrate how cash-settled share-based payment transactions are measured a. where a present obligation does not exist the entity has a choice of classification as an equity or cash settled share based payment transaction. *b. the entity has a present obligation to settle in cash where it has a past practice or stated policy of settling in cash c. the entity must settle in equity unless there is no commercial substance to the transaction. d. if an entity elects to settle in cash the settlement is accounted for as an expense.

19.

Which of the following statements in relation to disclosures required under IFRS 2 Share-based Payment is NOT correct? Learning Objective 8.9 Describe and apply the disclosure requirements of IFRS 2 a. For arrangements that were modified during the year, the incremental fair value granted as a result. b. The weighted average price at the date of exercise for options exercised during the period. c. A description of the plan, including the general terms and conditions, vesting requirements, maximum term of options granted and method of settlement must be disclosed. *d. For liabilities arising from share-based payment transactions, the total intrinsic value at the end of the period for liabilities where the counter party’s right had not yet vested.

8.9

Chapter 8 Share-based payment

20.

21.

Salt Limited grants 1000 share options to each of its 100 employees. Each grant is conditional on the employee working for the company for the next two years. The fair value of each option is estimated to be €5.00 at grant date and €7.50 at vesting date. The amount to be recognised as an expense by Salt in year 2 is: Learning Objective 8.4 Explain how equity-settled share-based payment transactions are measured: *a. €250 000 b. €375 000 c. €500 000 d. €750 000

22.

Pepper Limited grants 500 share options to each of its 30 employees. Each grant is conditional on the employee working for the company for the next three years. The fair value of each option is estimated to be €5.00 at grant date and €7.50 at vesting date. The amount to be recognised as an expense by Pepper in year 2 is: Learning Objective 8.4 Explain how equity-settled share-based payment transactions are measured: *a. €25 000 b. €37 500 c. €50 000 d. €75 000

23.

In situations where an option-pricing model is required to be used to determine the fair value of equity instruments granted IFRS 2 Share-based Payment: Learning Objective 8.4 Explain how equity-settled share-based payment transactions are measured: a. requires expected dividends to be taken into account when measuring the shares or options granted. *b. allows the entity to choose the option-pricing model it wishes to use, but contains a number of factors that the option-pricing model selected must take into account as a minimum. c. requires the use of a binominal option-pricing model. d. requires the use of the Black-Scholes-Merton formula.

8.10

Test Bank to accompany Applying IFRS Standards 4e

24.

On 1 July 2013, Nelson Pty Ltd granted 250 options to each of its 50 employees. The options are conditional on the employees remaining with the company for the 3 year vesting period. The options have a fair value of €7.50 at vesting date. In addition, the shares will vest as follows: o On 30 June 2014 if the company’s earnings have increased by more than 12% o On 30 June 2015 if the company’s earnings have increased by more than 10% averaged across the 2 year period o On 30 June 2016 if the company’s earnings have increased by more than 8% averaged across the 3 year period At 30 June 2014 Nelson’s earnings have increased by 11% and 3 employees have left. The company expects that earnings will continue to increase at a similar rate during the year to 30 June 2015 and that the shares will vest at that time. It also expects that a further 4 employees will leave during the year. The remuneration expense for the year ended 30 June 2014 for Nelson is: Learning Objective 8.5 Explain the concept of vesting through differentiating between vesting and non-vesting conditions a. €26 875.00 b. €29 375.00 *c. €40 312.50 d. €88 125.00

25.

On 1 July 2013 Pearl Pty Ltd granted 800 share options with an exercise price of €35 to the CFO, conditional on the CFO remaining in employment with the company until 30 June 2016. The fair value of Pearl’s shares at that time was assessed to be €40. The exercise price will drop to €30 if Pearl’s earnings increase by an average of 8% per year over the three year period. On 1 July 2013 the estimated fair value of the share options with an exercise price of €35 is €10 per option, and if the exercise price is €30, the estimated fair value of the options is €12 per option. During the year ended 30 June 2014 Pearl’s earnings increased by 10% and they are expected to continue to increase at this rate over the next two years. During the year ended 30 June 2015 Pearl’s earnings increased by 9% and Pearl management continued to expect that the earnings target would be achieved. During the year ended 30 June 2016 Pearl’s earnings increased by only 2%. At 30 June 2016 the share price is €23. The remuneration expense to be recognised for the year ended 30 June 2014 is: Learning Objective 8.5 Explain the concept of vesting through differentiating between vesting and non-vesting conditions: a. €2667 *b. €3200 c. €8000 d. €9600

8.11

Chapter 8 Share-based payment

26.

27.

On 1 July 2013 Pearl Pty Ltd granted 800 share options with an exercise price of $35 to the CFO, conditional on the CFO remaining in employment with the company until 30 June 2016. The fair value of Pearl’s shares at that time was assessed to be $40. The exercise price will drop to $30 if Pearl’s earnings increase by an average of 8% per year over the three year period. On 1 July 2013 the estimated fair value of the share options with an exercise price of $35 is $10 per option, and if the exercise price is $30, the estimated fair value of the options is $12 per option. During the year ended 30 June 2014 Pearl’s earnings increased by 10% and they are expected to continue to increase at this rate over the next two years. During the year ended 30 June 2015 Pearl’s earnings increased by 9% and Pearl management continued to expect that the earnings target would be achieved. During the year ended 30 June 2016 Pearl’s earnings increased by only 2%. At 30 June 2016 the share price is $23. Assuming that the CFO decides NOT to exercise his options at 30 June 2016, the following entry would be recorded: Learning Objective 8.6 Explain the concept of a share option reload feature: a. DR Wages expense CR Options issued (equity) b.

Options issued (equity) CR Lapsed options reserve

Options issued (equity) CR Retained earnings

*d.

Options issued (equity) CR Wages expense

In relation to equity instruments granted by an entity where the entity makes modifications to the terms and conditions attaching to the grant, Learning Objective 8.7 Explain how modifications to granted equity instruments are treated: a. the incremental fair value is measured as the difference between the fair value of the modified instrument, estimated at the date of modification and that of the original equity instrument, estimated at the date of original granting. b. if the modification occurs during the vesting period the incremental fair value is recognised immediately. c. terms or conditions may not be modified in a manner that is not beneficial to the employee. *d. where the exercise price of options is modified, the fair value of the options changes.

8.12

Test Bank to accompany Applying IFRS Standards 4e

28.

29.

On 1 July 2013 Poggio Ltd grants 300 options to each of its 100 employees conditional on the employee remaining in service over the next three years. The fair value of each option is estimated to be $12. Poggio estimates that 15 employees will leave over the three year vesting period. By 30 June 2014 four employees have left and the entity estimates that a further ten employees will leave over the next two years. On 30 June 2014 Poggio decided to reprice its share options, due to a fall in its share price over the last 12 months. The repriced share options will vest on 30 June 2016. At the date of repricing Poggio estimates that the fair value of each original option is $3 and the fair value of each repriced option is $5. During the year ended 30 June 2015 a further 6 employees leave and Poggio estimates that another 3 employees will leave during the year ended 30 June 2016. During the year ended 30 June 2016 four employees left. The entry at 30 June 2015 to account for the share based payment transaction is: Learning Objective 8.7 Explain how modifications to granted equity instruments are treated: a. DR Wages expense CR Liability to employee *b.

Wages expense CR Options issued (equity)

Wages expense CR Share capital

Wages expense CR Cash

Which of the following statements in relation to disclosures required under IFRS 2 is not correct? Learning Objective 8.9 Describe and apply the disclosure requirements of IFRS 2: a. Option pricing models used in valuing share options must be identified. b. The number and weighted average exercise price of share options outstanding at the beginning and end of each period must be disclosed. c. Information about share-based payment arrangements that are substantially the same may be aggregated. *d. The total expense arising from share-based payment transactions in which the services qualified for recognition as an asset must be disclosed.

8.13

Exercises Exercise 8.8 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

RECOGNITION PRINCIPLES

Zebra Ltd, a listed company, organises major sporting events. It acquires crowd control equipment in return for a liability for an amount based on the price of 1000 of its own shares. Required

Is this a share-based payment transaction? Should Zebra Ltd recognise the acquisition cost as an asset or an expense? Explain.

Exercise 8.9 ★

CATEGORISING

An entity grants 10 000 shares to a senior manager in return for services rendered. Required

Should the entity recognise the cost of these services as a liability or a component of equity? Explain.

Exercise 8.10 ★

CASH-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

An entity receives inventory from a counterparty in exchange for a liability based on the price of 5000 of the entity’s own shares. At the date of receiving the inventory, the entity’s shares have a market value of $9.50 each. Required

Measure the value of this transaction and prepare an appropriate journal entry to recognise it.

Exercise 8.11 ★★

MODIFICATIONS TO EQUITY-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

At the beginning of year 1, Iona Ltd grants 50 share options to each of its 120 employees, conditional on the employee remaining in the employ of Iona Ltd over the next 2 years. The company estimates that the fair value of the options on grant date is $12. On the basis of a weighted average probability, Iona Ltd estimates that 15% of its employees will leave during the vesting period. At the end of year 1 eight employees have left, and Iona Ltd estimates that a further nine will leave during year 2. By the end of year 1 the company’s share price has dropped, and it decides to reprice the share options. It estimates that the fair value of the original share options is $7 and the fair value of the repriced share options is $10. Nine employees leave during year 2. Required

Prepare a schedule setting out the remuneration expense to be recognised at the end of years 1 and 2.

Exercise 8.12

DISCLOSURE

★★ Bentley Ltd operates a share option plan for its ofﬁcers, employees and consultants for up to 10% of its outstanding shares. Under this plan, the exercise price of each option equals the closing market price of the shares on the day before the grant. Each option has a term of 5 years and vests one-third on each of the 3 years following grant date. Before this ﬁnancial period, Bentley Ltd has accounted for its share option plan on settlement date and no expense has been recognised. Required

Prepare an appropriate memorandum outlining the disclosures that will need to be made in Bentley Ltd’s ﬁnancial statement following the adoption of IFRS 2.

Exercise 8.13

APPLICATION OF THE INTRINSIC VALUE METHOD

★★ At the beginning of 2016, Atlas Ltd grants 2000 share options to each of its 50 most senior executives. The share options have a life of 5 years and will vest at the end of year 3 if the executives remain in service until then. The exercise price is $50 and Atlas Ltd’s share price is also $50 at the grant date. As the company’s share options have characteristics signiﬁcantly different from those of other traded share options, the use of option-pricing models will not provide a reliable measure of fair value at grant date. CHAPTER 8 Share-based payment

The company’s share price during years 1–3 is shown below.

Year

Share price at yearend

Estimated number of executives departing in each year

Number of executives remaining at year-end

Number of share options exercised at year-end

1 2 3

53 55 65

3 2 1

46 44 43

0 0 0

Required

Calculate the annual and cumulative remuneration expense to be recognised by Atlas Ltd for each of the 3 years.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ruth Picker, revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Solutions Manual to accompany Applying IFRS Standards 4e

Chapter 9 – Inventories Discussion Questions 1.

Define ‘cost’ as applied to the valuation of inventory.

The cost of inventories is the aggregate of: • The costs of purchase • The costs of conversion • Other costs to bring the inventories to their present location and condition. Discuss each type of cost with appropriate examples.

What is meant by the term ‘net realisable value’? Is this the same as fair value? If not, why not?

Net realisable value is the net amount that an enterprise expects to realise from the sale of inventory in the ordinary course of business and is defined in IAS 2 paragraph 6 as: the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. As such, net realisable value is specific to an individual enterprise and is not necessarily equal to fair value less costs to sell. Fair value is defined as ‘the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction’ (IAS 2, paragraph 6).

In what circumstances must assumptions be made in order to assign a cost to inventory items when they are sold?

One of the major problems in accounting for inventory is assigning the cost of acquiring inventory between those items sold during the year and those items still on hand at the reporting date. Ideally, costs should be individually identified for each inventory item however, this is only practical for entities whose inventory consists of a small number of easily identifiable items such as art galleries or manufacturers of specialised equipment. Where a specific cost cannot be identified because of the nature of the item sold then some method has to be adopted to estimate that cost. This process is known as “assigning” cost. Most inventory items fall into this category, for example, identical items of food and clothing and bulk items like oil and minerals. How can you measure the cost of a tonne of wheat when it is extracted from a stockpile consisting of millions of tonnes acquired at different prices over the accounting period? There are many method of assigning a cost to inventory items sold but IAS 2 paragraph 25 restricts entities to a choice between two methods – FIFO and weighted average.

9.1

Chapter 9: Inventories

Compare and contrast the impact on the reported profit and asset value for an accounting period of the first-in, first-out method and the weighted average method.

The key issue for discussion in this question is the relevance and reliability of financial information produced under each method. FIFO values the asset at the latest price and includes the earliest purchases in inventory and thus in times of rising prices may defer losses to the next accounting period and may overstate assets. Weighted average ‘smooths’ the impact of price rises across income and asset values but may mask problems with obsolescence.

Why is the lower of cost and net realisable value rule used in the accounting standard? Is it permissible to revalue inventory upwards? If so, when?

Net realisable value is the net amount that an enterprise expects to realise from the sale of inventory in the ordinary course of business. Where net realisable value is lower than cost the inventory item must be written down. The rationale for this measurement rule is stated in IAS 2 paragraph 28, ‘assets should not be carried in excess of amounts expected to be realised from their sale or use’. Inventory cannot be revalued upwards unless there has been a previous write down. If the circumstances that previously caused inventories to be written down below cost change, or if a new assessment confirms that net realisable value has increased the amount of a previous write down can be reversed (subject to an upper limit of the original write down). This could occur if an item of inventory written down to net realisable value because of falling sales prices, is still on hand at the end of a subsequent period and its selling price has recovered. Under no circumstances can inventory be valued beyond its original cost.

What impact do the terms of trade have on the determination of the quantity and value of inventory on hand where goods are in transit at the end of the reporting period?

Accounting for goods in transit at end of reporting period will depend upon the terms of trade. Where goods are purchased on an FOB shipping basis the goods belong to the purchaser from the time they are shipped, and should be included in inventory/accounts payable at reporting date. If goods are purchased on FOB destination terms no adjustment will be required as the goods still legally belong to the supplier. If goods are sold on FOB destination terms then they belong to the enterprise until they arrive at the customer’s premises. If the sale has been recorded in the current year it will need to be derecognised.

9.2

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 9.1

CONSIGNMENT OF INVENTORY

Arendal Ltd reported in a recent financial statement that approximately $12 million of merchandise was received on consignment. Should the company recognise this amount on its statement of financial position? Explain. Under a consignment arrangement, an agent (the consignee) may agree to sell goods on behalf of the consignor on a commission basis. The transfer of goods to the consignee is not a legal sale/purchase transaction. Legal ownership remains with the consignor until the agent sells the goods to a third party. Steps must be taken to ensure that goods held on consignment are not included in the physical count. Equally, goods owned by the enterprise that are held by consignees must be added to the physical count. Thus, Arendal Ltd will not report the consignment merchandise as inventory on its statement of financial position.

Exercise 9.2

SELECTION OF COST ASSUMPTION

Under what circumstances would each of the following inventory cost methods be appropriate? (a) Specific identification (b) Last-in, first-out (c) Average cost (d) First-in, first-out (e) Retail inventory (a) Specific identification should always be used where it is possible to clearly identify the cost of the item sold. (b) Last-in-first-out – this method is prohibited under IAS 2. (c) Average cost is best used where prices are subject to considerable variation or have a consistent rising trend. Using the FIFO method in this situation means that inventory is always valued at the highest price. Additionally, average cost is particularly suited to inventory where homogenous products are mixed together, like iron ore or spring water. (d) First-in-first-out - many proponents of the FIFO method argue that this method best reflects the physical movement of inventory, particularly perishable goods or those subject to changes in fashion or rapid obsolescence. (e) Retail inventory is not a method of assigning cost but a method of measuring cost used by the retail industry where inventory comprises large numbers of rapidly changing items with similar margins where other methods of measuring cost are not practicable.

9.3

Chapter 9: Inventories

Exercise 9.3

DETERMINING INVENTORY COST AND COST OF GOODS SOLD (PERIODIC)

What was the cost of sales for the year ended 31 December 2013? What is the cost of ending inventory using the weighted average costing method?

Correct answers to multiple choice questions are: 1.

(b)

See working A

(a)

See Working B

Workings: A.

Cost of Sales Opening inventory Purchases Purchase returns Goods available for sale Closing inventory Cost of Sales

25 000 160 000 (1 400) 183 600 35 000 148 600

Weighted average cost Opening inventory Purchases Total cost of inventory ÷ total units = Cost per unit Closing inventory

$ 250 1 734 $1 984 79 $25.00 $625.00

Exercise 9.4

(240 + 1 014 + 480)

(rounded to nearest $) (25 units x $25.00)

ASSIGNMENT OF COST (PERIODIC AND PERPETUAL)

1. If Malmo Ltd uses the perpetual inventory system with the moving average cost flow method, the 18 April sale would be costed at what unit cost? 2. If Malmo Ltd uses the periodic inventory system with the FIFO cost flow method, what would be the cost of sales for April? 3. If Malmo Ltd uses the perpetual inventory system with the FIFO cost flow method, the 21 April sale return (relating to the 18 April sale) would be costed at what unit cost? 4. If Malmo Ltd uses the periodic method with the weighted average cost flow method, what would be the value of closing inventory at 30 April 2011? (Round average cost to the nearest cent.) Correct answers to the multiple choice questions are: 1.

(c)

This is the alternative answer which is mathematically correct as per the workings below. Workings for Question 1

9.4

Solutions Manual to accompany Applying IFRS Standards 4e

Date Apr 01 04 07 10 13 18 21 29

No.

Purchases Unit Total Cost

90 100

$8.40 $8.60

$756.00 $860.00

(20)

$8.60

($172.00)

170 2.

1 444.00

No.

Sales Unit Cost

Total

8.46

423.00

70 (5) 40 155

8.44 8.44 8.44

590.80 (42.20) 337.60 1 309.20

No. 20 110 210 160 140 70 75 35

Balance Unit Total Cost $8.00 $160.00 8.33 916.00 8.46 1 776.00 8.46 1 353.00 8.44 1 181.00 8.44 590.20 8.44 623.40 8.44 285.00

(a)

The FIFO method of assigning cost assumes that the earliest purchases are sold first meaning that the closing inventory is valued at the latest purchase price, which in this question is $8.60. Under the periodic system, the cost of goods sold expense is assumed to be equal to the difference between the total value of goods available for sale and the total value of goods still on hand.

Workings for Question 2 Cost of Sales Opening inventory Purchases (net of returns) Goods available for sale Closing Inventory* Cost of Sales

160.00 1 444.00 1 604.00 301.00 $1 303.00

* 35 units x 8.60 (latest purchase price)

(b)

The first-in, first-out method also assumes that the last goods sold are the first goods returned. Thus, the five items returned would be costed at the last price of $8.60. This assures that inventory is always valued at the lasted purchase price. Workings for Question 3

No.

Purchases Unit Total Cost

Apr 01 04

$8.40

$756.00

100

$8.60

$860.00

Date

10 13 18

(20)

$8.60

No.

Sales Unit Cost

Total

20 30

8.00 8.40

160.00 252.00

60 10

8.40 8.60

504.80 86.00

($172.00)

No. 20 20 90 20 90 100 60 100 60 80 70

Balance Unit Total Cost $8.00 $160.00 8.00 160.00 8.40 756.00 8.00 160.00 8.40 756.00 8.60 860.00 8.40 504.00 8.60 860.00 8.40 504.00 8.60 688.00 8.60 602.00

9.5

Chapter 9: Inventories

21 29 170

1 444.00

(5) 40 155

8.60 8.60

(43.00) 344.00 1 303.00

75 35

8.60 8.60

645.00 301.00

(a)

Under the periodic system the weighted average is calculated by dividing the total number of units available for sale during the year by the total cost of those units. This average cost is then used to value inventory on hand in order to calculate cost of goods sold. Workings for Question 4 Weighted Average Unit Cost: Total cost =

Unit cost = = Closing inventory =

Opening inventory 160.00 Purchases (net of returns) 1 444.00 Goods available for sale 1 604.00 $1 604.00/190 units $8.44 $295.40 (35 x $8.44)

9.6

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 9.5

END-OF-PERIOD ADJUSTMENTS

1. Prepare any adjusting journal entries required on 30 June 2013. 2. Prepare the trading section of the statement of profit or loss and other comprehensive income for the year ended 30 June 2013. Part 1 Workings: Reconciliation Inventory account balance Add goods in transit

$ 194 400 1 200 195 600 195 600

Physical count NRV Test Inventory at cost Inventory at net realisable value Write down required

195 600 194 740 860

Uppsala Ltd Journal entries Year ended 30 June 2013 30 June 2013 Sales Dr Accounts Receivable Cr (reverse sale incorrectly recorded in June)

1 320

Inventory Cost of Sales (amendment for goods in transit)

Dr Cr

1 200

Inventory write down expense Inventory (write down to net realisable value)

Dr Cr

860

1 320

1 200

860

Part 2

Date 2013 30/06 30/06

Details

30/06

Balance b/d

Balance b/d Cost of Sales GJ

INVENTORY ACCOUNT Ref $ Date 2013 194 400 30/06 1 200 30/06 195 600 195 600

Details

Ref

Inventory write down GJ Balance c/d

860 194 740 195 600

Note: the question requires students to complete the inventory account for the year but there is insufficient information for this to be done.

9.7

Chapter 9: Inventories

Part 3 UPPSALA LTD Statement of Comprehensive Income (Extract) for the year ended 30 June 2013 $ Sales revenue Less: Sales returns Net sales Less: Cost of Sales Gross profit

$ 630 450 6 410 624 040 467 440 156 600

Note: Inventory shortage and write down expenses would be shown as other expenses (selling).

Exercise 9.6

APPLYING THE LOWER OF COST AND NRV RULE

Calculate the value of inventory on hand at 30 June 2013 in accordance with the requirements of IAS 2. (NRV = estimated selling price less cost of completion and disposal) Item

A1458 A1965 B6730 DO943 G8123 W2167

Qty

600 815 749 98 156 1 492

Cost per unit $ 2.30 3.40 7.34 1.23 3.56 6.12

Total Cost $ 1 380.00 2 771.00 5 498.66 120.54 555.36 9 131.04

NRV per unit $ 3.26 2.95 9.05 0.88 5.03 7.30

Total NRV

Lower

$ 1 956.00 2 404.25 6 778.45 86.24 784.68 10 891.60

Cost NRV Cost NRV Cost Cost

Adjust $ 366.75 34.30 -

Therefore, inventory on hand would be: Inventory (at cost) Inventory (at NRV) Total inventory

$16 565.06 2 490.49 $19 055.55

9.8

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 9.7

END-OF-REPORTING-PERIOD ADJUSTMENTS

Adjust and reconcile the inventory control ledger account balance to the physical account (adjusted as necessary). Balance of inventory control account. $ Unadjusted balance 248 265 Purchase return not recorded (1 200) Damaged goods written off (595) Goods in transit 1 500 Error in posting May purchases 3 600 Adjusted balance (cost) 251 570 Reconcile to physical count

Physical count Goods in transit Less consignment stock Returned goods not included Adjusted count Control account balance

$ 256 100 1 500 (7 600) 1 570 251 570 251 570

9.9

Chapter 9: Inventories

Exercise 9.8

ALLOCATING COST (WEIGHTED AVERAGE), REPORTING GROSS PROFIT AND APPLYING THE NRV RULE

1. Calculate the cost of inventory on hand at 31 March 2014 and the cost of sales for the month of March. (Round the average unit cost to the nearest cent, and round the total cost amounts to the nearest dollar.)

No. units

Purchases Unit Total Cost Cost

No. units

COS Unit Cost

Total Cost

Date

Details

01/03

Inventory balance

01/03

Sales

300

82.33

24 699

03/03

Sales return

(5)

(82.33)

(412)

09/03

Purchases

91.00

10/03

Purchase

96.00

15/03

Sales

17/03

Purchase return

22/03

Sales

26/03

Purchase

29/03

No entry*

91.00

32355

82.33

7 656

82.33

8 068

5 005

153

85.44

13 073

7 296

229

88.95

20 369

143

88.95

12 719

142

88.93

12 628

88.93

7 292

98.00

154

93.17

14 348

88.95

88.93

5 336

7 056

19 266

•

7 650

(91.00)

60 72

Balance Unit Total Cost Cost 82.33

86 (1)

No. unit s 393

37 273

154

14 348

The damaged goods returned would not be placed back into stock

2. Show the Inventory general ledger control account (in T-format) as it would appear at 31 March 2014.

Date 2014 01/03 31/03 30/03

Details

01/04

Balance b/d

Balance b/d Cost of Sales A/c payable

INVENTORY CONTROL Ref Date $ Details 2014 32 35530 17/03 A/c Payable GJ 412 31/03 Cost of Sales PJ 19 35790 31/03 Balance c/d 52 122 14 34862

Ref

GJ SJ

91 37 685 14 348 52 122

9.10

Solutions Manual to accompany Applying IFRS Standards 4e

3. Calculate the gross profit on sales for the month of March 2014. Gross profit for the month of March 2014 Sales revenue Less sales returns Net sales revenue Less Cost of Sales* Gross profit

$55 110 850 54 260 37 091 $17 169

* The damaged bikes returned on 29 March would require the following journal entry to be recorded: 31 March 2014 Inventory losses and write downs Cost of Sales (damaged inventory written off)

Dr Cr

182 182

9.11

Chapter 9: Inventories

Exercise 9.9

1. 2. 3. 4.

ALLOCATING COST (FIFO), REPORTING GROSS PROFIT AND APPLYING THE NRV RULE

Calculate the cost of inventory on hand at 31 March 2013 and the cost of sales for the month of March. Show the Inventory general ledger control account (in T-format) as it would appear at 31 March 2013. Calculate the gross profit on sales for the month of March 2013. IAS 2 requires inventories to be measured at the lower of cost and net realisable value. Identify three reasons why the net realisable value of the bicycles on hand at 31 March 2013 may be below their cost. If the net realisable value is below cost, what action should Stockholm Ltd take?

Part 1 – Calculate the cost of inventory on hand and cost of sales (FIFO)

No. units

Purchases Unit Total Cost Cost

No. units

COS Unit Cost

Total Cost

No. units 350 43

Balance Unit Total Cost Cost 82.00 28 700 85.00 3 655

Date 01/03

Details Inventory balance

01/03

Sales

300

82.00

24 600

50 43

82.00 85.00

4 100 3 655

03/03

Sales return

(5)

(82.00)

(410)

82.00

4 510

85.00

3 655

09/03

Purchases

91.00

5 005

55 43 55

82.00 85.00 91.00

4 510 3 655 5 005

10/03

Purchase

96.00

7 296

55 43 55 76

82.00 85.00 91.00 96.00

4 510 3 655 5 005 7 296

15/03

Sales

12 55 76

85.00 91.00 96.00

1 020 5 005 7 296

17/03

Purchase return

85.00

1 020

54 76

91.00 96.00

4 914 7 296

6 76

91.00 96.00

546 7 296

6 76 72

91.00 96.00 98.00

546 7 296 7 056

22/03

Sales

26/03

Purchase

29/03

No entry*

55 31

(1)

91.00

98.00

85.00 91.00

1 020 4 368

7 056

19 266

•

4 510 2 635

(91.00)

12 48 72

82.00 85.00

36 723

154

14 898

The damaged goods returned would not be placed back into stock

9.12

Solutions Manual to accompany Applying IFRS Standards 4e

Part 2 – Show the general ledger inventory account at 31 March 2013

Date 2013 01/03 31/03 30/03

Details

31/03

Balance b/d

INVENTORY CONTROL Ref Date $ Details 2013 32 355.30 17/03 A/c Payable GJ 410 31/03 Cost of Sales PJ 19 357.90 31/03 Balance c/d 52 12220 14 898.62

Balance b/d Cost of Sales A/c payable

Ref

GJ SJ

91 37 133 14 898 52 122

Part 3 Gross profit for the month of March 2013 Sales revenue Less sales returns Net sales revenue Less Cost of Sales* Gross profit

$55 110 850 54 260 36 541 $17 719

* The damaged bikes returned on 29 March would require the following journal entry to be recorded: 31 March 2013 Inventory losses and write downs Cost of Sales (damaged inventory written off)

Dr Cr

182 182

Part 4 Reasons why net realisable value may decline below cost included: • Inventories are damaged • Inventories are wholly or partially obsolete • Selling prices have declined below cost • A decision taken by the entity to sell products for the time being at a loss as part of an overall marketing strategy • Miscalculation or errors in purchasing.

Part 5 If the net realisable value of the bikes falls to $92.00 the inventory value should be reduced to $14 168 (154 bikes at $92.00 each) by passing the following entry: 31 March 2013 Inventory write-down Inventory (write down to net realisable value)

Dr Cr

730 730

9.13

Chapter 9: Inventories

Exercise 9.10 ASSIGNING COST AND END-OF-PERIOD ADJUSTMENTS 1. Calculate the number of units in inventory and the FIFO unit cost for baked beans and plain flour as at 30 June 2013 (show all workings). 2. Calculate the total dollar amount of the inventory for baked beans and plain flour, applying the lower of cost and net realisable rule on an item-by-item basis. Prepare any necessary journal entries (show all workings). Calculation of inventory (FIFO) Baked Beans Qty 350 200 470 (350) (200) (180) 50 340 14 326

Price 19.60 19.50 19.70 19.60 19.50 19.70 19.70 19.70 19.70 19.70

Value 6 860 3 900 9 259 (6 860) (3 900) (3 546) 985 6 698 (276) 6 422

Price 38.40 38.45 38.45 39.00 38 40 38.45 38.45 38.45 39.00

Damaged goods Goods in transit Physical count

Qty 625 150 200 240 (625) (150) (175) 25 240 265 (10) (240) 15

Value 24 000 5 768 7 690 9 360 (24 000) (5 768) (6 729) 961 9 360 10 321 (384) (9 360) 577

Baked Beans Plain Flour

Qty 326 15

Cost $6 421 577 $6 998

Opening balance Purchase 10 June Purchase 19 June Sales

Sales returns Perpetual balance Inventory shortage Physical count

Plain Flour Opening balance Purchase 03 June Purchase 15 June Purchase 29 June Sales

Perpetual balance

38.45 39.00 38.45

Part 2 Inventory NRV $9 454 577

Lower Cost Cost

Journal entries 30 June 2013 Inventory losses Inventory (Baked Beans) (write off missing inventory)

Dr Cr

275.80

Inventory losses Inventory (Plain Flour) (write off damaged cases)

Dr Cr

384.50

Accounts Payable Inventory (Plain Flour) (goods in transit – FOB destination)

Dr Cr

9 360.00

275.80

384.50

9 360.00

9.14

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 9.11

STATEMENT OF FINANCIAL POSITION CLASSIFICATION

Where, if at all, should the following items be classified on a statement of financial position? (a) Goods out on approval to customers (b) Goods in transit that were recently purchased FOB destination (c) Land held by a real estate firm for sale (d) Raw materials (e) Goods received on consignment (f) Stationery supplies (a)

As these goods are still owned by the entity they would be classified as inventory (current asset).

(b)

These goods still legally belong to the supplier and would not be recognised by the entity.

(c)

Key issue here is ownership – is the real estate firm merely offering the land for sale on behalf of the owner in which case the land would not be an asset of the real estate firm. Alternatively, if the land is owned by the real estate firm, and they sell land as part of their ordinary activities, the land would be recorded as inventory (current asset).

(d)

Raw materials would be included in inventory (current asset).

(e)

Goods received on consignment would not legally belong to the consignee and would not be recognised.

(f)

Stationery supplies would be classified as ‘other’ current assets unless the entity sells stationery or uses stationery as part of a production process in which case the supplies would be part of inventory.

Exercise 9.12

DISCLOSURES RELATING TO INVENTORY

What additional disclosures might be necessary to present the inventory fairly? IAS 2, paragraph 36 requires Jokela Ltd to disclose the following information about inventory (if appropriate): • the accounting policies adopted in measuring inventories, including the cost formula used. • The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity • The carrying amount of inventories carried at fair value less costs to sell • The amount of inventories recognised as an expense during the period • The amount of any write-down of inventories recognised as an expense in the period in accordance with paragraph 34 • The amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as an expense in accordance with paragraph 34 • The circumstance or events that led to the reversal of a write-down of inventories in accordance with paragraph 34 • The carrying amount of inventories pledged as security for liabilities.

9.15

Chapter 9: Inventories

Exercise 9.13

RECORDING INVENTORY TRANSACTIONS

Prepare journal entries for March 2014, using the pro-forma journals provided. Journal entries for March 2014

Date 2014 01/03 15/03

Capital S Stvanger

23/03

Sales

Cash Receipts Journal Ref Cash Disc all

Account

Chq

2014 08/03 14/03 21/03 30/03

Purchases B Askoy N Kurikka Salary expense

003 004 005 006

Date 2014 02/03 12/03 22/03

A/c rec

Other

16 000 1 176

1 300 18 476

__ 24

1 300 1 300

_____ 1 200

_____ 16 000

Cash Payments Journal Ref Other A/c pay

Purch

Cash

Disc. Rec.

✓

Date

Sales

16 000

860 ✓ ✓ 1 400 1 400

4 800 2 000 _____ 6 800

Purchases Journal Account Terms B Askoy N Kurikka B Kimito

1 200

___ 860

Ref

96 40 ___ 136

Amount

✓ ✓ ✓

2/15, n/30 2/10, n/30 2/15, n/30

860 4 704 1 960 1 400 8 924

4 800 2 000 2 400 9 200

Date 2014 05/03 21/03

Account S Stavanger Alesund Ltd

Sales Journal Terms

Ref

Amount

✓ ✓

2/10, n/30 2/10, n/30

1 200 1 600 2 800

Date 2014 01/03

25/03

GENERAL JOURNAL Account Ref

Office equipment Capital (Office equipment contributed by owner) Accounts payable/B Kimito Purchase returns (Return of defective goods)

10 000 10 000 ✓

600 600

9.16

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 9.14 1.

ASSIGNING COST (PERPETUAL)

Using this information, assume that Arvika uses the FIFO cost flow method and that the sales returns relate to the 20 August sales. The sales return should be costed back into inventory at what unit cost? Assuming that Arvika uses the moving average cost flow method, the 12 August sales should be costed at what unit cost?

(d)

See Working A

(a)

See Working B

FIFO assumes sales returns are valued at the latest purchase price. August 20 sales = 10 x $4.20 + 20 x $4.30 + 10 x $4.60 = $172.00 August 28 return = 3 x $4.60 = $13.80

Moving average calculations: 1 August Opening balance 7 August Purchase (10 x $4.20) 10 August Purchase (20 x $4.30)

Exercise 9.15 1.

20 x $4.00 = 80.00 30 x $4.06 = 122. 00 (122/30 = $4.06) 50 x $4.16 = 208.00 (208/50 = $4.16)

END-OF-PERIOD ADJUSTMENTS

Based on the above information, calculate the amount that should appear for inventory on Brunnsberg Pty Ltd’s statement of financial position at 31 December 2013. Prepare any journal entries necessary to adjust the Inventory general ledger account to the amount calculated in requirement 1.

Part 1 Inventory Balance at 31 December 2013 $ 441 000 38 000 51 000 $530 000

Physical count Consignment stock not owned by Brunnsberg Ltd Goods in transit still owned by Brunnsberg Ltd Goods in transit owned by customer Goods in transit still owned by supplier Goods in transit owned by Brunnsberg Ltd Adjusted inventory balance

(a) (b) (c) (d) (e)

Part 2 Brunnsberg Ltd Journal entries Year ended 31 December 2013 31 December 2013 Inventory Dr Cost of Sales Cr (goods in transit sold FOB destination) Inventory Dr Accounts Payable Cr (goods in transit purchased FOB shipping)

38 000 38 000

51 000 51 000

9.17

Chapter 9: Inventories

Exercise 9.16

ASSIGNING COST AND REPORTING GROSS PROFIT USING DIFFERENT COST METHODS

Calculate the cost of inventory on hand at 30 September 2013 and the cost of sales for the year ended 30 September 2013, using: (a) the FIFO cost method (b) the moving average cost method (round the average unit costs to the nearest cent, and round the total cost amounts to the nearest dollar). Prepare the trading section of the statement of profit or loss and other comprehensive income for the year ended 30 September 2013, using: (a) the FIFO cost method (b) the moving average cost method.

9.18

Solutions Manual to accompany Applying IFRS Standards 4e

Part 1 – Calculate the cost of inventory on hand and cost of sales (a)

Date 01/10

Details Inventory balance

06/10

Purchases

05/11

Sales

FIFO Method

No. units

600

Purchases Unit Total Cost Cost

14.10

No. units

COS Unit Cost

Total Cost

8 460

1 600 400

14.00 14.10

22 400 5 640

No. units 1 600

Balance Unit Cost 14.00

Total Cost 22 400

1 600 600

14.00 14.10

22 400 8 460

200

14.10

2 820

19/12

Purchases

2 200

14.70

32 340

200 2 200

14.10 14.70

2 820 32 340

24/12

Purchase return

(160)

14.70

(2 352)

200

14.10

2 820

2 040

14.70

29 988

840

14.70

12 348

840

14.70

12 348

16 800

15.00

252 000

10/01

22/03

31/04

Sales

Purchases

200 1 200 16 800

15.00

14.10 14.70

2 820 17 640

252 000

Sales

840 2 760

14.70 15.00

12 348 41 400

14 040

15.00

210 600

04/05

Sales return

(40)

15.00

(600)

14 080

15.00

211 200

04/06

Sales

7 000

15.00

105 000

7 080

15.00

106 200

06/08

Purchases

7 080 1 000

15.00 16.00

106 200 16 000

27/09

Sales

880 1 000

15.00 16.00

13 200 16 000

1 000

16.00

16 000

6 200

15.00

306 448

93 000

299 648

9.19

Chapter 9: Inventories

Part 1 – Calculate the cost of inventory on hand and cost of sales (b)

Moving average cost method

No. units

Purchases Unit Total Cost Cost

No. units

COS Unit Cost

Total Cost

No. Units 1 600

Balance Unit Cost 14.00

Total Cost 22 400

2 200

14.02

30860

200

14 02

2820

Date 01/10

Details Inventory balance

06/10

Purchases

05/11

Sales

19/12

Purchases

2 200

14.35

32 340

2 400

14 65

35160

24/12

Purchase return

(160)

14.35

(2 352)

2 240

14.65

32 808

10/01

Sales

840

14.65

12 298

22/03

Purchases

17 640

14.98

264 298

31/04

Sales

3 600

14.98

53 928

14 040

14.98

210 370

04/05

Sales return

(40)

14.98

(599)

14 080

14.98

210 370

04/06

Sales

7 000

14.98

104 860

7 080

14.98

106 109

06/08

Purchases

8 080

15.11

122 109

27/09

Sales

1 880

15.11

28 427

600

14.10

8 460 2 000

1 400 16 800

1 000

15.00

16.00

14.02

14.65

28 040

20 510

252 000

16 000 6 200

15.11

306 448

93 682 300 421

Part 2 LILLEHAMMER TRADING Income statement (extract) For the year ended 31 December 2013 FIFO

Sales Revenue Less: Sales returns Net sales Less: Cost of sales Gross profit

$ 366 280 1 060 365 220 300 748 $ 64 472

Moving average $ 366 280 1 060 365 220 300 421 $ 64 799

9.20

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 9.17

END-OF-YEAR ADJUSTMENTS

Prepare any journal entries necessary on 30 June 2013 to correct any errors and to adjust inventory. Workings Recorded Balance $ 221 020 2 400 -2 730 (6 300) 2 650 $217 200

Balance prior to adjustment Less consignment stock incorrectly counted Add goods in transit Add sale incorrectly recorded, FOB destination Add unrecorded purchase Less unrecorded sale Less damages goods write-off not processed

Physical Count $ 220200 (6 600) 1 200 2 400 $217 200

Johnkoping Fashions General Journal 2013 June 30 Sales Revenue Accounts receivable (Iceland Pty Ltd) (Correction – sale recorded in error)

Dr Cr

3 900

Inventory Cost of sales (Correction – sale recorded in error)

Dr Cr

2 400

Inventory Accounts payable (Finn Handbags) (Correction – unrecorded purchase)

Dr Cr

2 730

Accounts receivable (Viking Boutique) Sales revenue (Correction – unrecorded sale)

Dr Cr

9 600

Cost of sales Inventory (Correction – unrecorded sale)

Dr Cr

6 300

Inventory losses and write-downs Inventory (Damaged inventory written off)

Dr Cr

2 650

3 900

2 400

2 730

9 600

6 300

2 650

9.21

Chapter 9: Inventories

Exercise 9.18

ASSIGNMENT OF COST

For the inventory item (wall plaques), calculate October’s cost of sales expense and the cost of inventory on hand at 31 October 2013. Round all figures to the nearest cent.

Date 2012 01/10

Inventory record – Wall Plaques Purchases No. Unit Total Details units Cost Cost Inventory balance

04/10

Purchase

08/10

Sale

6.50

No. units

COS Unit Cost

Total Cost

325.00 45 15

6.40 6.50

288.00 97.50

No. units 45

Balance Unit Total Cost Cost 6.40 288.00

45 50

6.40 6.50

288.00 325.00

6.50

227.50

11/10

Purchase

6.60

462.00

35 70

6.50 6.60

227.50 462.00

14/10

Purchase return

(10)

6.60

(66.00)

6.50

227.50

19/10

Sale

24/10

Sale return

28/10

Purchase

6.70

35 35

6.50 6.60

227.50 231.00

6.60

165.00

(5)

6.60

(33.00)

6.60

165.00

268.00 989.00

Exercise 9.19

811.00

END-OF-REPORTING-PERIOD RECONCILIATION AND NRV

1. Reconcile the Inventory control ledger account balance with the physical count figure (adjust both figures as necessary). 2. Prepare any journal entries necessary to achieve the reconciliation. Part 1

Calculate the balance of the inventory control account at 30 June 2013. $ Unadjusted balance 193 700 Damaged goods written off (220) Goods in transit 590 Adjust for stolen goods (160) Adjusted balance (cost) 193 910 Reconcile to physical count Physical count Posters not counted Goods in transit not counted Consignment stock Item incorrectly included Adjusted count Control account balance

$ 189 650 420 590 4 200 (950) 193 910 193 910

9.22

Solutions Manual to accompany Applying IFRS Standards 4e

Part 2 Journal details DATE 30/06/13

Exercise 9.20

DETAILS Inventory Accounts Payable Damaged inventory expense Inventory Inventory shortage expense Inventory

Dr 590

Cr 590

220 220 160 160

END-OF-REPORTING-PERIOD RECONCILIATION AND NRV

Explain what is meant by the term ‘net realisable value’ and detail the action C Bligh must take in respect to the wall barometers. Net realisable value is defined by IAS 2 as “the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale”. In other words, it is an assessment of the future benefits embodied in the inventory item – what we can get from selling the item. With the wall barometers, the expected benefits of selling the items $540 ($90 x 6) is less than the cost of $900 ($150 x 6) so the barometers must be written down to $540 to avoid overstating the value of the asset. The journal entry required is: 30/6/13 Write-down to NRV expense Inventory

Exercise 9.21

1. 2.

Dr Cr

360 360

ALLOCATING COST (MOVING AVERAGE), ADJUSTMENTS AND WRITE-DOWNS TO NRV

END-OF-PERIOD

Prepare the perpetual inventory records for June 2014. Prepare the inventory control and accounts payable control general ledger accounts (in T-format) for the month of June 2014. Prepare any general journal entries necessary to correct the Inventory control general ledger account balance as at 30 June 2014. (Narrations are not required, but show all workings.) Do not adjust the perpetual inventory records prepared in Part A. 1. What does the term ‘net realisable value’ mean? 2. What sources of evidence could Mario examine to determine net realisable value? 3. What action should Mario take as at 30 June 2014 with respect to these net realisable values? Why?

9.23

Chapter 9: Inventories

Part A – Perpetual Inventory records Pool Filters DATE No. 01/06/14 01/06/14 05/06/14 09/06/14 18/06/14 20/06/14 23/06/14 24/06/14 28/06/14

PURCHASES Unit Cost Total

12 (3)

236.70 (236.70)

238.10

No.

SALES Unit Cost

Total

1 18 (2)

232.50 232.50 (232.50)

232.50 4 185.00 (465.00)

15 5

233.58 233.58

3 503.70 1 167.90

COGS:

$8624.10

SALES Unit Cost

Total

493.80

490.37

1 961.48

COGS:

$2 455.28

N o. 43 42 24 26 38 35 20 15 30

2 840.40 (710.10)

3 571.50 5 701.80

BALANCE Unit Cost Total 232.50 232.50 232.50 232.50 233.83 233.58 233.58 233.58 235.84

9 997.50 9 765.00 5 580.00 6 045.00 8 885.40 8 175.30 4 671.60 3 503.70 7 075.20

Pool Pumps DATE No. 01/06/14 01/06/14 04/06/14 17/06/14 18/06/14 24/06/14 26/06/14

PURCHASES Unit Cost Total

5 3

476.10 491.30

2 380.50 1 473.90

2 (1)

491.30 (476.10)

982.60 (476.10) 4 360.90

N o.

No.

BALANCE Unit Cost Total

21 20 25 28 24 26 25

493.80 493.80 490.26 490.37 490.37 490.44 491.02

10 369.80 9 876.00 12 256.50 13 730.40 11 768.92 12 751.52 12 275.42

LEDGER ACCOUNTS

Date 2014 31/05 09/06 30/06

Details

01/07

Balance b/d

Date 2014 20/06 30/06

Details

Balance b/d C.O.S. A/c payable

Inventory Cash & disc Balance c/d

INVENTORY CONTROL Ref Date $ Details 2014 20 367.30 20/06 A/c payable GJ 465.00 26/06 A/c receivable PJ 11 248.90 30/06 C.O.S. ________ Balance c/d 32 081.20 19 350.62

ACCOUNTS PAYABLE CONTROL Ref Date $ Details 2014 GJ 710.10 31/05 Balance b/d CPJ 15 562.30 30/06 Inventory 2 950.10 19 222 .50 01/07 Balance b/d

Ref

GJ GJ SJ

710.10 476.10 11 544.38 19 350.62 32 081.20

Ref

7 973.60 11 248.90 _______ 19 222.50 2 950.10

9.24

Solutions Manual to accompany Applying IFRS Standards 4e

Part B General Journal Entries

30/06/14

Accounts payable Inventory (being removal of purchase not yet completed)

Dr Cr

3 571.50

Inventory shortage expense Inventory (being write off of missing pool filter)

Dr Cr

235.84

Sales returns and allowances Accounts receivable (being sales return)

Dr Cr

550.00

Inventory Cost of Sales (being return of one pool pump)

Dr Cr

490.37

3 571.50

235.84

550.00

490.37

Part C 1.

Net realisable value is defined by IAS 2 as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

Mario should examine the following sources of evidence to determine net realisable value: • expected selling price • estimated costs of completion (if any), and • estimated selling costs. These estimates take into consideration fluctuations of price or cost occurring after balance date to the extent that such events confirm conditions existing at balance date. The purpose for which inventory is held should be taken into accounts when reviewing net realisable values. For example, the net realisable value of inventory held to satisfy firm sales or service contracts is based on the contract price. If the sales contracts are for less than the inventory quantities held, the net realisable value of the excess is based on general selling prices. Estimated selling costs include all costs likely to be incurred in securing and filling customer orders such as advertising costs, sales personnel salaries and operating costs, and costs of storing and shipping finished goods.

IAS 2 requires that inventory must be carried at the lower of cost and net realisable value and that this rule be applied to each individual inventory item. As the NRV of the pool filters is less than their average cost Mario should write down the pool filter stock. No adjustment is required to the cost of pool pumps.

9.25

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Test Bank to accompany Applying IFRS Standards 4e

Chapter 9 Inventories Learning Objectives: 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9

Discuss the nature of inventories Explain how to measure inventories Explain what is included in the cost of inventory Account for inventory transactions using both the periodic and the perpetual methods Explain and apply end-of-period procedures for inventory under both periodic and perpetual methods Explain why cost flow assumptions are required and apply both FIFO and weighted average cost formulas Explain the net realisable value basis of measurement and account for adjustments to net realisable value Identify the amounts to be recognised as inventory expenses Implement the disclosure requirements of IAS 2.

9.1

Chapter 9: Inventories

Multiple Choice

All of the following are common classifications for the disclosure of inventories in a set of financial statements:

Raw materials Finished goods Work in progress Assets held for resale

I Yes Yes No No

II III IV Yes No No Yes Yes Yes Yes Yes No Yes No Yes

Learning Objective 9.1 Discuss the nature of inventories a. I; *b. II; c. III; d. IV.

Commodity broker traders are able to measure their inventories at: Learning Objective 9.2 Explain how to measure inventories a. replacement cost; b. nominal cost; *c. fair value less costs of disposal; d. current cost.

IAS 2 prohibits which of the following from being included in the cost of inventory? Learning Objective 9.3 Explain what is included in the cost of inventory a. trade discounts received; *b. freight (where the terms of sale are FOB destination); c. production overheads; d. import duties.

IAS 2 allows which of the following to be capitalised into the cost of inventory? Learning Objective 9.3 Explain what is included in the cost of inventory a. storage costs for finished goods; b. selling costs; *c. normal wastage costs; d. administrative overheads.

9.2

Test Bank to accompany Applying IFRS Standards 4e

Which of the following statements is correct? Learning Objective 9.4 Account for inventory transactions using both the periodic and the perpetual methods a. the periodic method of accounting for inventory will always result in a higher closing inventory balance than the perpetual method; b. the periodic method of accounting for inventory will always result in a lower closing inventory balance than the perpetual method; *c. closing inventory will always be the same under the periodic and perpetual methods; d. the relationship between the closing inventory balance under the periodic and perpetual methods will depend on whether the FIFO or weighted average method is used to value inventory.

Stock take discrepancies between a count sheet and recorded quantities in the ledger may arise due to: I II III IV

Theft of stock during the year Stock purchased under FOB destination terms being in transit at period end A consignee including consignment stock in their physical count Sales returns not being processed into the ledger

Learning Objective 9.5 Explain and apply end-of-period procedures for inventory under both periodic and perpetual methods a. I, II and III; b. II, III and IV; *c. I, III and IV; d. I, II and IV.

Duo Ltd uses a periodic inventory system and rounds the average unit cost to the nearest dollar. The following data relates to Duo Ltd for the year ended 30 June 2016: Opening inventory January purchases July purchases October purchases Ending inventory

15 units @ average cost of €25 each 10 units @ €24 each 25 units @ €26 each 20 units @ €24 each 20 units

The cost of ending inventory at 30 June 2016 using the weighted average cost method (rounded to the nearest euro) is: Learning Objective 9.6 Explain why cost flow assumptions are required and apply both FIFO and weighted average cost formulas a. €459; b. €465; *c. €499; d. €483. The weighted average inventory costing method is particularly suitable to inventory where: Learning Objective 9.6 Explain why cost flow assumptions are required and apply both FIFO and weighted average cost formulas a. dissimilar products are stored in separate locations; b. the entity carries stocks of raw materials, work-in-progress and finished goods;

9.3

Chapter 9: Inventories

c. *d.

goods have distinct use-by dates and the goods produced first must be sold earliest; homogeneous products are mixed together.

When an inventory costing formula is changed, the change is required to be applied: Learning Objective 9.6 Explain why cost flow assumptions are required and apply both FIFO and weighted average cost formulas a. prospectively and the adjustment taken through the current profit or loss; *b. retrospectively and the adjustment taken through the opening balance of retained earnings; c. prospectively and the current period adjustment recognised directly in equity; d. retrospectively and the adjustment recognised as an extraordinary gain or loss.

10.

The measurement rule for inventories, mandated by IAS 2 Inventories, is: Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value a. lower of fair value and selling price; *b. lower of cost and net realisable value; c. higher of initial cost and realisable value; d. higher of completion costs and replacement costs.

11.

‘Net realisable value’ of inventory is defined as the net amount that an entity expects to realise from the sale of the inventory: Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value *a. in the ordinary course of operations less estimated costs of completion and costs necessary to make the sale; b. plus the estimated costs of completion plus the estimated costs necessary to make the sale; c. in a forced sale; d. plus the estimated costs of completion.

9.4

Test Bank to accompany Applying IFRS Standards 4e

12.

Net realisable value of inventories may fall below cost for a number of reasons including: I II III IV

Product obsolescence Physical deterioration of inventories An increase in the expected replacement costs of the inventory An increase in the estimated costs of completion

Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value *a. I, II and IV only; b. I, III and IV only; c. II, III and IV only; d. I and II only.

13.

When determining the net realisable value of inventory, estimates must be made of the following: I II III IV

Estimated costs of completion (if any) Expected replacement cost Expected selling price Estimated selling costs

Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value a. I, II, III and IV; b. I, II and III only; c. II and IV only; *d. I, III and IV only.

14.

IAS 2 Inventories requires that when inventories are written down to net realisable value, they are written-down: Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value a. on a class-by-class basis; b. on the basis of industry segment; *c. on an item-by-item basis; d. according to geographical segment within the entity.

9.5

Chapter 9: Inventories

15.

Ming Limited had the following items of inventory at reporting date: Item Refrigerators Stoves

Quantity 10 20

Cost/unit £ 100 80

NRV/unit £ 95 85

The adjustment necessary at reporting date is: Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value a. DR Inventory £50; b. DR Inventory £100; *c. CR Inventory £50; d. CR Inventory £0.

16.

If the selling price of inventory that has been written down to net realisable value in a prior period, subsequently recovers, the: Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value *a. previous amount of the write-down can be reversed; b. carrying amount of the inventory cannot be adjusted; c. value adjustment can be recognised immediately in equity; d. adjustment must be recognised in a ‘provision for future inventory write-downs’ account.

17.

Where the net realisable value of inventory falls below cost, IAS 2 Inventories, requires that: Learning Objective 9.7 Explain the net realisable value basis of measurement and account for adjustments to net realisable value a. the inventory continue to be carried in the Statement of Financial Position at cost; *b. the inventory be written down to net realisable value; c. no adjustment be made, but the difference between net realisable value and cost be disclosed in the notes to the financial statements; d. the difference be added to the carrying amount of the inventory.

18.

Under IAS 2 Inventories, items of inventory that are used by business entity as components in a self-constructed property asset are required to be: Learning Objective 9.8 Identify the amounts to be recognised as inventory expenses a. aggregated into the ‘cost of sales’ expense in the period in which the items are used; b. expensed directly into equity in the period in which the items are used; *c. capitalised and depreciated; d. added to a ‘property construction’ provision account.

9.6

Test Bank to accompany Applying IFRS Standards 4e

19.

IAS 2 requires separate disclosure of: Learning Objective 9.9 Implement the disclosure requirements of IAS 2. a. where there has been abnormal wastage which has been expensed; *b. details of inventory pledged as security for loans; c. interest costs which have been capitalised into the cost of inventory; d. details of key terms of purchase.

20.

IAS 2 applies to the accounting for: Learning Objective 9.1 Discuss the nature of inventories a. work in progress under construction contracts; b. financial instruments; c. biological assets; *d. materials consumed in the manufacture of knitting machines for sale.

21.

When an entity’s operating cycle is not clearly identifiable it is assumed to be: Learning Objective 9.1 Discuss the nature of inventories a. three months; b. six months; c. nine months; *d. 12 months.

22.

Where inventories in an industry are measured by reference to historical cost which of the following measurement rules applies subsequent to initial measurement? Learning Objective 9.2 Explain how to measure inventories a. historical cost; b. discounted cash flow; *c. lower of cost and net realisable value; d. replacement cost.

23.

Taxes may be included in the costs of inventory unless they are: Learning Objective 9.3 Explain what is included in the cost of inventory a. levied on the entity by a foreign government; b. in respect to the raw materials component of manufactured inventory; *c. recoverable by the entity from the taxing authority; d. in the nature of import duties.

9.7

Chapter 9: Inventories

24.

The terms ‘2/7’ appearing on an invoice for the sale/purchase of inventory means that the buyer: Learning Objective 9.3 Explain what is included in the cost of inventory *a. will receive a 2% discount if paid within 7 days of the invoice date; b. will receive a 7% discount if paid within 2 days of the invoice date; c. has 7 days from the invoice date to pay or will be charged a 2% surcharge; d. has 2 days from the invoice date to pay or will be charged a 7% surcharge.

25.

Under the periodic inventory approach the cost of sales during a period is determined as follows: Learning Objective 9.4 Account for inventory transactions using both the periodic and the perpetual methods *a. beginning inventory + net purchases – ending inventory; b. beginning inventory – net purchases – ending inventory; c. opening inventory + net purchases + closing inventory; d. opening inventory – net purchases + closing inventory.

26.

Which of the following is an appropriate journal entry to recognise inventory items that have been lost? Learning Objective 9.5 Explain and apply end-of-period procedures for inventory under both periodic and perpetual methods a. DR Inventory(asset) CR Provision for inventory losses (liability); *b. DR Inventory losses (expense) CR Inventory (asset); c. DR Cost of sales (expense) CR Inventory (asset); d. DR Provision for Inventory losses (liability) CR Inventory (asset).

27.

Under the periodic inventory approach an appropriate journal entry to measure closing inventory is: Learning Objective 9.5 Explain and apply end-of-period procedures for inventory under both periodic and perpetual methods: a. DR Opening inventory (cost of sales expense) CR Inventory (asset); b. DR Purchases (expense) CR Inventory (asset); *c. DR Inventory (asset) CR Closing inventory (cost of sales expense); d. DR Purchases returns (cost of sales expense) CR Inventory (asset).

9.8

Test Bank to accompany Applying IFRS Standards 4e

28.

Which of the following is not recognised as an expense in accordance with IAS 2? Learning Objective 9.8 Identify the amounts to be recognised as inventory expenses a. Cost of sales; b. Write-downs of inventories to net realisable value; c. Reversal of write downs to net realisable value; *d. Inventory items used by an entity as components in self-constructed property, plant or equipment.

29.

IAS 2 requires disclosure of the following:

I II III IV

Details of reversals of prior year write-downs Separate disclosure of the carrying amount of inventories carried at cost and those carried at net realisable value The accounting policy adopted by the entity in relation to inventory valuation The carrying amount of inventory by class Learning Objective 9.9 Implement the disclosure requirements of IAS 2 a. II and III only; b. I, II and III only; c. II, III and IV only; *d. I, II, III and IV.

9.9

Exercises Exercise 9.11 ★

Exercise 9.12

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

STATEMENT OF FINANCIAL POSITION CLASSIFICATION

Where, if at all, should the following items be classified on a statement of financial position? (a) Goods out on approval to customers (b) Goods in transit that were recently purchased FOB destination (c) Land held by a real estate firm for sale (d) Raw materials (e) Goods received on consignment (f) Stationery supplies DISCLOSURES RELATING TO INVENTORY

★ Jokela Pty Ltd reported inventory in its statement of ﬁnancial position as follows: Inventories

$11 247 900

What additional disclosures might be necessary to present the inventory fairly? Exercise 9.13

RECORDING INVENTORY TRANSACTIONS

★ Henry Halmstad began business on 1 March 2014. Henry balances the books at month-end and uses the periodic inventory system. Henry’s transactions for March 2014 are detailed below.

March 1

Henry invested $16 000 cash and $10 000 ofﬁce equipment into the business.

Purchased merchandise from B Askoy on account for $4800 on terms of 2/15, n/30.

Sold merchandise to S Stavanger on account for $1200 on terms of 2/10, n/30.

Purchased merchandise for cash, $860 on cheque no. 003.

Purchased merchandise from N Kurikka on account for $2000 on terms of 2/10, n/30.

Paid B Askoy for 2 March purchase on cheque no. 004.

Received $1176 from S Stavanger in payment of the account.

Sold merchandise to Alesund Ltd on account for $1600 on terms of 2/10, n/30.

Paid N Kurikka for 12 March purchase on cheque no. 005.

Purchased merchandise from B Kimito on account for $2400 on terms of 2/15, n/30.

Sold merchandise for $1300 cash.

Returned defective merchandise that cost $600 to B Kimito.

Paid salaries of $1400 on cheque no. 006.

Required

Prepare journal entries for March 2014, using the pro-forma journals provided. Cash Receipts Journal Date

Account

Ref.

Cash

Disc. all.

Sales

A/c rec.

Other

CHAPTER 9 Inventories

Cash Payments Journal Date

Account

Ch.

Ref.

Other

A/c pay.

Purch.

Cash

Disc. rec.

Purchases Journal Date

Account

Terms

Ref.

Amount

Ref.

Amount

Sales Journal Date

Account

Terms

Sales Journal Date

PART 2 Elements

Account

Ref.

Exercise 9.14 ★

ASSIGNING COST (PERPETUAL)

Select the correct answer. Show any workings required and provide reasons to justify your choice. Arvika uses the perpetual inventory method. Arvika’s inventory transactions for August 2014 were as follows: No.

Unit cost

Total cost

Beginning inventory

$4.00

$80.00

Purchases

$4.20

$42.00

Purchases

$4.30

$86.00

Sales

Purchases

$4.60

$92.00

Sales

Sales returns

Aug. 1

1. Using this information, assume that Arvika uses the FIFO cost ﬂow method and that the sales returns relate to the 20 August sales. The sales return should be costed back into inventory at what unit cost? (a) $4.00 (c) $4.30 (b) $4.20 (d) $4.60 2. Assuming that Arvika uses the moving average cost ﬂow method, the 12 August sales should be costed at what unit cost? (a) $4.16 (c) $4.06 (b) $4.07 (d) $4.00 Exercise 9.15

END-OF-PERIOD ADJUSTMENTS

★★ A physical count of inventory at 31 December 2013 revealed that Brunnsberg Pty Ltd had inventory on hand at that date with a cost of $441 000. Brunnsberg Pty Ltd uses the periodic method to record inventory transactions. Inventory at 1 January 2013 was $397 000. The annual audit identiﬁed that the following items were excluded from this amount: • Merchandise of $61 000 is held by Brunnsberg Pty Ltd on consignment. The consignor is Angelholm Ltd. • Merchandise costing $38 000 was shipped by Brunnsberg Pty Ltd FOB destination to a customer on 31 December 2013. The customer was expected to receive the goods on 6 January 2014. • Merchandise costing $46 000 was shipped by Brunnsberg Pty Ltd FOB shipping to a customer on 29 December 2013. The customer was scheduled to receive the goods on 2 January 2014. • Merchandise costing $83 000 shipped by a vendor FOB destination on 31 December 2013 was received by Brunnsberg Pty Ltd on 4 January 2014. • Merchandise costing $51 000 purchased FOB shipping was shipped by the supplier on 31 December 2013 and received by Brunnsberg Pty Ltd on 5 January 2014. Required

1. Based on the above information, calculate the amount that should appear for inventory on Brunnsberg Pty Ltd’s statement of ﬁnancial position at 31 December 2013. 2. Prepare any journal entries necessary to adjust the inventory general ledger account to the amount calculated in requirement 1. Exercise 9.16 ★★

ASSIGNING COST AND REPORTING GROSS PROFIT USING DIFFERENT COST METHODS

The following information has been extracted from the records of Lillehammer Trading about one of its products. Lillehammer Trading uses the perpetual inventory system and its reporting period ends on 30 September.

No. of units

Unit cost $

Total cost $

1 600

14.00

22 400

600

14.10

8 460

2013 01/10

Beginning balance

06/10

Purchased

05/11

Sold @ $24.00 per unit

2 000

CHAPTER 9 Inventories

19/12

Purchased

2 200

14.70

32 340

24/12

Purchase returns

160

14.70

2 352

10/01

Sold @ $24.20 per unit

1 400

22/03

Purchased

16 800

15.00

252 000

30/04

Sold @ $26.50 per unit

3 600

04/05

Sales returns @ $26.50 per unit

04/06

Sold @ $27.00 per unit

7 000

06/08

Purchased

1 000

16.00

16 000

27/09

Sold @ $30.00 per unit

6 200

Required

1. Calculate the cost of inventory on hand at 30 September 2013 and the cost of sales for the year ended 30 September 2013, using: (a) the FIFO cost method (b) the moving average cost method (round the average unit costs to the nearest cent, and round the total cost amounts to the nearest dollar). 2. Prepare the trading section of the statement of proﬁt or loss and other comprehensive income for the year ended 30 September 2013, using: (a) the FIFO cost method (b) the moving average cost method. Exercise 9.17

END-OF-YEAR ADJUSTMENTS

★★ The inventory control account balance of Johnkoping Fashions at 30 June 2013 was $221 020 using the perpetual inventory method. A physical count conducted on that day found inventory on hand worth $220 200. Net realisable value for each inventory item held for sale exceeded cost. An investigation of the discrepancy revealed the following: • Goods worth $6600 held on consignment for Swede Accessories had been included in the physical count. • Goods costing $1200 were purchased on credit from Vetlanda Ltd on 27 June 2013 on FOB shipping terms. The goods were shipped on 28 June 2013 but, as they had not arrived by 30 June 2013, were not included in the physical count. The purchase invoice was received and processed on 30 June 2013 • Goods costing $2400 were sold on credit to Iceland Pty Ltd for $3900 on 28 June 2013 on FOB destination terms. The goods were still in transit on 30 June 2013. The sales invoice was raised and processed on 29 June 2013. • Goods costing $2730 were purchased on credit (FOB destination) from Finn Handbags on 28 June 2013. The goods were received on 29 June 2013 and included in the physical count. The purchase invoice was received on 2 July 2013. • On 30 June 2013, Johnkoping Fashions sold goods costing $6300 on credit (FOB shipping) terms to Viking Boutique for $9600. The goods were dispatched from the warehouse on 30 June 2013 but the sales invoice had not been raised at that date. • Damaged inventory items valued at $2650 were discovered during the physical count. These items were still recorded on 30 June 2013 but were omitted from the physical count records pending their write-off. Required

Prepare any journal entries necessary on 30 June 2013 to correct any errors and to adjust inventory. Exercise 9.18

Note: Exercises 9.18, 9.19 and 9.20 concern the same entity, Sweden Emporium, because they have been designed ★★★ so that they can be combined to form a single comprehensive problem. ASSIGNMENT OF COST

PART 2 Elements

The following information lists the transactions during October 2013 for one item of inventory (wall plaques): Date

Detail

Oct. 1 4 8 11 14 19 24 28

Opening balance Purchase Sale Purchase Purchase return Sale Sale return (on 19 Oct. sale) Purchase

Number

Unit cost

45 50 60 70 10 70 5 40

6.40 6.50 6.60 6.60

6.70

Required

For the inventory item (wall plaques), calculate October’s cost of sales expense and the cost of inventory on hand at 31 October 2013. Round all ﬁgures to the nearest cent. Exercise 9.19 ★★★

END-OF-REPORTING-PERIOD RECONCILIATION AND NRV

Sweden Emporium is a gift shop situated in a small fishing village. The business carries a range of merchandise that it accounts for under the perpetual inventory method. Cost is assigned using the FIFO cost flow method. All purchases are on FOB shipping terms, with 30 days’ credit. The end of the reporting period is 30 June. A physical count of inventory at 30 June 2014 found inventory worth $189 650. The inventory control ledger account at that date had a balance of $193 700. Investigations of the discrepancy between these two figures revealed the following: • An unopened carton containing posters worth $420 had not been included in the count. • Seven large conch shells were found to be damaged beyond repair and were not recorded in the count. The shells, worth $220, are still recorded in the inventory records. • Goods costing $590 were ordered on 27 June 2014 and delivered to the transport company by the supplier on 29 June. As the goods were in transit on 30 June, they were not included in the count. The purchase was recorded when the goods arrived at the shop on 2 July 2014. • Sweden Emporium has a number of paintings on display in local restaurants on a consignment basis. The paintings are worth $4200 and were not included in the count. • A brass telescope had been sold for $1200 on 30 June. As the telescope was still in the shop awaiting collection by the owner, it was included in the count. The telescope cost $950. • Five missing dolphin statues worth $160 could not be located and are presumed to have been stolen from the shop. Required

1. Reconcile the Inventory control ledger account balance with the physical count ﬁgure (adjust both ﬁgures as necessary). 2. Prepare any journal entries necessary to achieve the reconciliation. Exercise 9.20 ★★★

END-OF-REPORTING-PERIOD RECONCILIATION AND NRV

Explain what is meant by the term ‘net realisable value’ and detail the action C Bligh must take in respect to the wall barometers. Exercise 9.21 ★★★

ALOCATING COST (MOVING AVERAGE), END-OF-PERIOD ADJUSTMENTS AND WRITE-DOWNS TO NRV

Part A Mario Gothenburg uses the perpetual inventory method and special journals, balances the books at month-end and uses control accounts and subsidiary ledgers for all accounts receivable and accounts payable. All sales and purchases are made on 2/10, n/30, FOB destination terms. The moving average method is used to assign cost to inventory items. CHAPTER 9 Inventories

The information below has been extracted from Mario’s books and records for May and June 2014. $ Inventory control ledger account balance at 31 May Accounts payable control ledger account balance at 31 May Inventory purchases on credit during June Cash paid to trade creditors during June Discount received during June Inventory sales on credit during June Inventory ledger card balances at 1 June: Pool filters 43 @ $232.50 Pool pumps 21 @ $493.80 The credit inventory purchases during June comprised the following: June 4 5 pool pumps @ $476.10 each 17 3 pool pumps @ $491.30 each 18 12 pool filters @ $236.70 each 24 2 pool pumps @ $491.30 each 29 15 pool filters @ $238.10 each The credit inventory sales during June comprised the following: June 1 1 pool pump @ $520 and 1 pool filter @ $300 5 18 pool filters @ $300 each 18 4 pool pumps @ $550 each 23 15 pool filters @ $330 each 28 5 pool filters @ $330 each

20 367.30 7 973.60 11 248.90 15 123.40 438.90 15 020.00 9 997.50 10 369.80 20 367.30 2 380.50 1 473.90 2 840.40 982.60 3 571.50 11 248.90 820 5 400 2 200 4 950 1 650 15 020

Other movements in inventory during June were: June 9 2 pool filters, sold 5 June (not paid for) were returned by the customer 20 3 pool filters purchased 18 June (not paid for) were returned to the supplier 26 1 pool pump, purchased 4 June (paid for) was returned to the supplier Required

1. Prepare the perpetual inventory records for June 2014. 2. Prepare the inventory control and accounts payable control general ledger accounts (in T-format) for the month of June 2014. Part B At 30 June 2014, Mario conducted a physical stocktake that found 14 pool ﬁlters and 26 pool pumps on hand. An investigation of discrepancies between the inventory card balances and the physical count showed that the 15 pool ﬁlters purchased on 29 June 2014 were still in transit from the supplier’s factory on 30 June 2014, and one pool pump, sold on 18 June, had been returned by a customer on 30 June. No adjustment has been made in the books for the sales return. The customer had not paid for the returned pump. Required

Prepare any general journal entries necessary to correct the Inventory control general ledger account balance as at 30 June 2014. (Narrations are not required, but show all workings.) Do not adjust the perpetual inventory records prepared in Part A. Part C On 30 June 2014, Mario determined that his inventory items have the following net realisable values: Pool filters Pool pumps

$232 each $546 each

Required

1. What does the term ‘net realisable value’ mean? 2. What sources of evidence could Mario examine to determine net realisable value? 3. What action should Mario take as at 30 June 2014 with respect to these net realisable values? Why?

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Janice Loftus

John Wiley & Sons, Ltd, 2016

Solutions Manual to accompany Applying IFRS Standards 4e

Chapter 10: Employee benefits Discussion Questions 1.

What is a paid absence? Provide an example.

Refer to section 10.4.4. Compensated absence refers to an employee entitlement to be paid during certain absences. Examples include sick leave and annual recreational leave.

What is the difference between accumulating and non-accumulating sick leave? How does the recognition of accumulating sick leave differ from the recognition of non-accumulating sick leave?

Refer to section 10.4.4. Accumulating sick leave may be carried forward to a future period if the employee has not taken the leave in the current period. A liability must be recognised for accumulating sick leave when the employee renders services that increase the entitlement. The liability is measured as the amount that the entity expects to pay. If the leave is non-vesting, the amount recognised is affected by the probability that the leave will be taken. Non-accumulating sick leave may not be carried forward to a future period. Accordingly, no liability is recognised for non-accumulating sick leave. It is recognised as an expense when the employee takes paid sick leave.

What is the difference between vesting and non-vesting sick leave? How does the recognition and measurement of vesting sick leave differ from the recognition and measurement of non-vesting sick leave?

Refer to section 10.4.4. If sick leave is vesting, the employee is entitled to cash settlement for unused leave. If sick leave is non-vesting, the employee has no entitlement to cash settlement of unused leave. The employer recognises a liability for accumulating sick leave, measured as the undiscounted amount expected to be paid. The entity will have good reason to expect that all vested accumulating sick leave will be paid. However, if sick leave is not vesting, the liability is measured as the proportion of accumulated sick leave that the entity expects to be taken by its employees. That is, the measurement of the provision for sick leave is affected by the probability that employees will take paid sick leave.

Explain how a defined contribution pension plan differs from a defined benefit pension plan.

Refer to section 10.5. Under a defined contribution pension plan the employer pays fixed contributions into a fund. Employees’ benefits are a function of the level of contributions paid and the return achieved by the fund on the investment of plan assets. The employer has no obligation to make further payments if the fund is unable to pay all the benefits accruing to members for past service. In a defined-benefit pension plan, the benefits received by members on retirement are determined by a formula reflecting their years of service and level of remuneration, rather than the performance of the fund. The employer has an obligation to pay further contributions if the fund is unable to pay members’ benefits.

During October 2008 there was a sudden global decline in the price of equity securities and credit securities. Many pension funds made negative returns on investments during this period. How would this event affect the wealth of employees and employers? Consider both defined benefit and defined contribution pension funds in your answer to this question. © John Wiley and Sons, Ltd, 2016

10.2

Chapter 10: Employee benefits Refer to section 10.5. In a defined contribution fund the employees bear the risk of low or negative returns on the investment of plan assets. This is because the benefits paid on retirement are a function of the level of contributions and the return achieved on plan assets. Thus, the employer is not directly affected by the poor performance of the defined contribution pension fund because it has no obligation for additional contributions if the pension fund is unable to pay benefits to members on retirement. Members of defined benefit plans would not be affected by the negative returns achieved by the fund. Their benefits are defined in terms of their years of service and level of remuneration, rather than by the performance of the fund. The employer has an obligation for the excess of the defined benefit over the plan assets.

Explain how an entity should account for its contribution to a defined contribution pension plan in accordance with IAS 19.

Refer to section 10.6. Contributions payable to defined contribution funds are recognised as expenses in the period that the employee renders services, unless another standard permits the cost of employment benefits to be allocated to the carrying amount of an asset, such as inventory. If the amount paid to the defined contribution fund by the entity during the year is less than the amount payable in relation to services rendered by employees, a liability for unpaid contributions must be recognised. The liability is measured at the undiscounted amount payable unless it is due more than 12 months after the end of the period, in which case it is discounted.

Compare the off-balance sheet approach to accounting for a defined benefit postemployment plan with the net capitalisation approach adopted by IAS 19. Can these approaches be explained by different underlying views as to whether a deficit or surplus in the fund meets the definition of a liability or asset of the sponsoring employer?

Refer to section 10.7. Under the net capitalisation method, the entity recognises an asset (liability) for the surplus (deficit) of the fair value of plan assets over the present value of the defined benefits. Under the offbalance sheet method, assets and liabilities arising from surpluses and deficits in the pension plan are not recognised. IAS 19 takes the view that the surplus or deficit of the defined benefit pension plan is an asset or liability of the sponsoring entity. In the case of a surplus it represents future savings in contributions, while a deficit reflects the obligation to provide addition contributions to enable the pension plan to meet its pension obligations to members. In contrast, the off-balance sheet approach reflects the view that the surplus or deficit of the defined benefit pension plan is not an asset or liability of the sponsoring entity. Advocates of this view argue that there is an absence of control over a surplus because the employer cannot access or use it to further its own objective. Similarly, advocates of the off-balance sheet approach argue that the employer does not have a present obligation to make good a deficit unless required to do so by the trustee of the pension plan, and that deficits, like surpluses will simply reverse over time. 8. In relation to defined benefit post-employment plans, paragraph 56 of IAS 19 states, “…the entity is, in substance, underwriting the actuarial and investment risks associated with the plan’. Evaluate whether the requirements for the recognition and measurement of the net defined benefit liability reflect the underlying assumptions about the entity’s risks. The economic substance of the entity’s exposure may be considered as the net surplus or deficit of the fund. The net capitalisation approach captures the underlying risk of the plan as the excess of the present value of the defined benefit obligation over the fair value of the plan assets. However, an alternative view is that the surplus or deficit of the defined benefit post-employment plan does not reflect the entity’s exposure to the defined benefit post-employment plan because the retirement benefits are not immediately due and payable. The measurement of the defined benefit obligation includes benefits that have not yet vested. Although an obligation arises as services are provided, there is uncertainty as to the amount that will be required to settle the obligation in subsequent periods.

10.3

Solutions Manual to accompany Applying IFRS Standards 4e 9.

Identify and discuss the assumptions involved in the measurement of a provision for long service leave. Assess the consistency of these requirements with the fundamental qualitative characteristics of financial information prescribed by the Conceptual Framework.

Refer to section 10.8. Accounting for long service leave requires estimation of when the leave will be taken, projected salary levels and the proportion of employees who will continue in the entity’s employment long enough to become entitled to long service leave. It is necessary to estimate when employees will take long service leave, which may be any time after they become entitled. The estimation of the timing of when leave will be taken affects estimates of projected salaries and wages and the discounting of the defined benefit. The estimation of projected salary levels may be affected by inflation as well as promotion. The likelihood of promotion may differ among different categories of employees, such as engineers, graduate trainees and unskilled workers. The proportion of employees who will become entitled to long service leave may vary from one location to another, and is usually considered to be increasing with the period of past employment. Employees who are approaching entitlement are less likely to leave before their long service leave vests, as the loss of long service leave entitlement would be viewed as a cost of changing employment. The extensive use of estimates in the measurement of the provision for long service leave may be cause to question the reliability of the measurement and whether the qualitative characteristic of faithful representation is satisfied. The uncertainty of the measurement and timing of settlement is reflected in the classification of this type of liability as a provision (refer chapter 5 of the text). Further, addition disclosures may be made and indeed required when there is estimation uncertainty resulting from the use of assumption in measuring assets and liabilities. (refer section 16.6.2 of this text).

10. Explain the projected unit credit method of measuring and recognising an obligation for longterm employee benefits. Illustrate your answer with an example. Refer sections 10.7.1 and 10.8. Under the projected unit credit method the obligation for long-term employee benefits is measured by calculating the present value of the expected future payments that will result from employee services provided to date. For example, if employees will be entitled to 13 weeks of long service leave after 10 years of employment, 30% of the amount expected to be paid in the future is recognised for employees who have provided three years of service.

10.4

Chapter 10: Employee benefits 11.

The board of directors of City Scooters Ltd met in December 2016 and decided to close down a branch of the company’s operations when the lease expired in the following August. The chief financial officer advised that termination benefits of €2.0 million are likely to be paid. Should the company recognise a liability for termination benefits in its financial statements for the year ended 31 December 2016? Justify your judgement with reference to the requirements of IAS 19.

Refer section 10.9. A liability for termination benefits should be recognised when the entity has become demonstrably committed. There is evidence that City Scooters Ltd had a detailed plan at 31 December 2016 because the location and timing of implementation had been identified. It is likely that the function and approximate number of affected employees had been determined as these factors ought to have formed part of the basis of the chief financial officer’s estimation of the amount of termination benefits payable. However, it seems unlikely that City Scooters Ltd has no reasonable possibility of withdrawing. Although the lease is due to expire in the following August, there is no indication that it could not be renewed. Further, there does not appear to have been any communication of the plan to affected parties. It seems that at 31 December 2016 the board of directors of City Scooters Ltd were still able continue to operate the branch if they chose to do so. Accordingly, City Scooters Ltd should not recognise a liability for termination benefits in its financial statements for the year ended 31 December 2016.

10.5

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 10.1

ACCOUNTING FOR SICK LEAVE

Calculate the employee benefits expense for sick leave during the year and the amount that should be recognised as a liability, if any, for sick leave at the end of the year. Employee benefits for sick leave during the year: 150 days x $140 per day = $210 000 Ontario Ltd should not recognise a liability for sick leave because it is non-cumulative.

Exercise 10.2

ACCOUNTING FOR ANNUAL LEAVE

Calculate the amount of annual leave that should be accrued for each employee.

Employee

Wage / day £160 £125 £150 £100

Chand Kim Smith Zhou

Exercise 10.3

Change in AL entitlement 6+20-15 3+20-16 2+20-13 4+20-17

AL 31/12/16 in days 11 7 9 7

AL accrual (col. 2 x col. 4) £ 1 760 875 1 350 700

ACCOUNTING FOR PROFIT-SHARING ARRANGEMENTS

Prepare a journal entry to record Schwarzwald GmbH’s liability for employee benefits arising from the profit-sharing arrangement at the end of the reporting period. 95% x 1% x €70 000 000 = €665 000 31 Dec

Wages and Salaries Expense Provision for Employee Benefits (Accrual of employee benefits arising from profit-sharing arrangements)

Dr Cr

665 000 665 000

10.6

Chapter 10: Employee benefits

Exercise 10.4

ACCOUNTING FOR DEFINED CONTRIBUTION PENSION PLANS

Prepare all journal entries required during 2016 for Southern Inc.’s payment of, and liability for, pension plan contributions. Pension payable $700 000 Contributions paid $600 000 ($50 000 x 12) Pension liability $100 000 Each month the following entry would be made: Pension Expenses Bank (Pension contribution for the month)

Dr Cr

50 000 50 000

Alternatively, students might present a summarised journal entry for the year as follows: 31 December Pension Expenses Dr 600 000 Bank Cr (Pension contribution for 2016) 31 December

Pension Expenses Pension Liability

Exercise 10.5

Dr Cr

600 000

100 000 100 000

ACCOUNTING FOR THE PAYROLL AND ACCRUAL OF WAGES AND SALARIES

1. Prepare all journal entries to account for the August payroll and all payments relating to employee benefits during August. 2. Prepare a journal entry to accrue wages for the remaining days in August not included in the final August payroll. Use the same level of remuneration as per the final payroll for August. (1). 3 August

10 August

11 August

15 August

21 August

Accrued Payroll Bank (Payment of July health insurance payroll deductions)

Dr Cr

20 000

Accrued Payroll Bank (Payment of July payroll deductions for union fees)

Dr Cr

6 500

Wages and Salaries Expense Accrued Payroll (Payroll for fortnight ended 7/8)

Dr Cr

700 000

Accrued Payroll Bank (Payment of net wages & salaries)

Dr Cr

553 230

Accrued Payroll Bank (Payment of employee income tax withheld in July)

Dr Cr

250 000

Accrued Payroll

Dr © John Wiley and Sons, Ltd, 2016

20 000

6 500

700 000

553 230

250 000

4 000 10.7

Solutions Manual to accompany Applying IFRS Standards 4e

24 August

25 August

(2). 31 August

Bank (Payment of July payroll deductions for charity donations)

4 000

Wages and Salaries Expense Accrued Payroll (Payroll for fortnight ended 21/8)

Dr Cr

600 000

Accrued Payroll Bank (Payment of net wages & salaries)

Dr Cr

471 270

Wages and Salaries Expense Accrued Wages and Salaries (Accrual of wages and salaries for 6 business days Mon 24-28 Aug, 31 Aug

Dr Cr

360 000

600 000

471 270

360 000

Daily wages £600 000/10 days = £60 000; 6 days x £60 000 per day = £360 000

Exercise 10.6

ACCOUNTING FOR SICK LEAVE

Calculate the employee benefits expense for sick leave for the year and the amount that should be recognised as a liability for sick leave at 31 December 2016, assuming that sick leave entitlements are: (a) non-accumulating (b) accumulating and non-vesting (c) accumulating and vesting. a) Non-accumulating sick leave is recognised when the leave is taken. Employee category

Base pay /day

Supervisors Operators

£ 100.00 80.00

Leave taken in 2016 Days 20 400

Employee benefits

Provision for Sick Leave

£ 2 000 32 000 $34 000

£ Nil Nil Nil

Workings for Provision for sick leave: There is no opening balance of sick leave, even if accumulating, because all employees commenced in the current year.

Category Supervisors Operators

Wage /day £ 100 80

Current Service Days 30 500

Days Clos Accum. taken Term. bal. 31 Dec Days Days Days £ 20 3 7 700 400 60 40 3200 c) 3900

Exp. To Provision be Used non-vesting % 90 70 b)

£ 630 2240 2870

Accumulating sick leave is recognised when the employee provides a service and the liability is measured as the nominal amount (if short-term) that is expected to be paid for sick leave arising from services already provided. b) Employee benefits expense: © John Wiley and Sons, Ltd, 2016

10.8

Chapter 10: Employee benefits = leave taken during the period + increase in the provision for sick leave = £34 000 + £2870 = £36 870 Amount of liability = £2870 c) If the accumulating sick leave is vesting, all unused entitlement is expected to be paid. Employee benefits expense: = leave taken during the period + increase in the provision for sick leave = £34 000 +£3900 = £37 900 Amount of liability = £3900

Exercise 10.7

1. 2. 3.

4. 5.

ACCOUNTING FOR DEFINED BENEFIT PENSION PLANS

Determine the surplus or deficit of the plan at 31 December 2016. Determine the net defined benefit asset or liability at 31 December 2016. Calculate the net interest and distinguish between the interest expense component of the defined benefit obligation and the interest income component of the change in the fair value of plan assets for 2016. Determine the amount to be recognised in profit or loss in relation to the defined benefit pension plan for 2016. Determine the amount to be recognised in other comprehensive income in relation to the defined benefit pension plan for the year ended 31 December 2016.

1. $1 200 000 deficit Present value of the defined benefit obligation 31 December 2016 Fair value of plan assets 31 December 2016 Deficit of the fund at 31 December 2016

$7 200 000 6 000 000 $1 200 000

2. The net defined benefit liability at 31 December 2016 is $1,200,000, being the deficit of the plan. 3. Net interest = $100 000 Interest expense component of the defined benefit obligation = $6 000 000 x 10% =$600 000 Interest income component of the change in fair value of plan assets = $5 000 000 x 10% = $500 000 4. $500 000 Net interest Service cost Pension expense

$100 000 400 000 $500 000

5. The actuarial loss of $300 000 is recognised in other comprehensive income.

Exercise 10.8

ACCOUNTING FOR DEFINED BENEFIT PENSION PLANS

For each of the following scenarios, determine (i) the surplus or deficit in the defined benefit pension plan and (ii) the net defined benefit liability or asset that should be recognised by the sponsoring employer in accordance with IAS 19:

Present value of DBO (a) (b) (c) (d)

$1 300 000 $1 550 000 $2 000 000 $2 400 000

Fair value of plan assets $1 000 000 $1 200 000 $2 200 000 $2 500 000

Asset ceiling

(i) Deficit or surplus

$Nil $Nil $100 000 $250 000

$300 000 Deficit $350 000 Deficit $200 000 Surplus $100 000 Surplus

(ii) Net defined benefit asset / liability $300 000 liability $350 000 liability $100 000 asset $100 000 asset 10.9

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 10.9

ACCOUNTING FOR LONG SERVICE LEAVE

Prepare the journal entry to account for Geranium Ltd’s provision for long service leave at 31 December 2016.

31/12/2016

Long Service Leave Expense Provision for Long Service Leave (Increase in provision for long service leave)

Dr Cr

20 830 20 830

Workings Step 1 Estimate the number of employees who are expected to become eligible for long service leave: Years of service 1 2 3 4

% expected to become entitled 20% 30% 50% 60%

Total No. of Employees 60 50 30 10

Step 1 12 15 15 6

Step 2 Estimate the projected salaries. = salary x (1 + inflation rate)n Years of service 1 2 3 4

From Step 1 Employees 12 15 15 6

Current salary € 27 000 27 000 27 000 27 000

Inflation rate 0.01 0.01 0.01 0.01

Period until LSL vests Years 9 8 7 6

Projected salary € 354 354 438 557 434 215 171 966

Step 3 Determine the accumulated benefit. = Years of employment x weeks of paid leave x projected salaries Years required for LSL 52 Years of service 1 2 3 4

Projected salary € 354 354 438 557 434 215 171 966

Unit credit

LSL weeks /52

0.1 0.2 0.3 0.4

0.25 0.25 0.25 0.25

Accumulated benefit € 8 859 21 928 32 566 17 197

10.10

Chapter 10: Employee benefits Step 4 Measure the present value of the accumulated benefit. = accumulated benefit (1 + i)n Years of service 1 2 3 4

Accumulated benefit € 8 859 21 928 32 566 17 197

Discount factor 0.424098 0.501866 0.547034 0.596267

Present value € 3 757 11 005 17 814 10 254 42 830

The increase in the provision for long service leave can be calculated as €42 830 less the opening balance, €22 000, because there have been no long service leave payments during the year. Thus the long service leave expense for the year ended 31 December 2016 is €20 830.

Exercise 10.10 1. 2. 3. 4. 5. 6.

ACCOUNTING FOR DEFINED BENEFIT PENSION PLANS

Determine the surplus or deficit of Lily Ltd’s defined benefit plan at 31 December 2016. Determine the net defined benefit asset or liability that should be recognised by Lily Ltd at 31 December 2016. Calculate the net interest for 2016. Calculate the actuarial gain or loss for the defined benefit obligation for 2016. Calculate the return on plan assets, excluding any amount recognised in net interest, for 2016. Present a reconciliation of the opening balance to the closing balance of the net defined benefit liability (asset), showing separate reconciliations for plan assets and the present value of the defined benefit obligation. Prepare a summary journal entry to account for the defined benefit pension plan in the books of Lily Ltd for the year ended 31 December 2016.

1. Deficit of the fund = $702 500 Present value of the defined benefit obligation 31 December 2016 Fair value of plan assets 31 December 2016 Deficit of the fund at 31 December 2016 $

$10 750 000 10 047 500 702 500

2. The net defined benefit liability at 31 December 2016 is $702 500, being the deficit of the fund. 3. Net interest = $45 000 Workings Interest expense component of the defined benefit obligation = $10 000 000 x 9% =$900 000 Interest income component of the change in fair value of plan assets = $9 500 000 x 9% = $855 000 4. Actuarial gain on remeasurement of the defined benefit obligation = $100 000 Workings Closing present value of defined benefit obligation (DBO) = Opening DBO + interest cost + current service costs- benefits paid +(-) actuarial loss (gain) $10 750 000 = $10 000 000 + $900 000 + $1 150 000 - $1 200 000 +/- actuarial loss (gain) Solving for actuarial gain arising on remeasurement of DBO: $10 750 000 - $10 000 000 - $900 000 - $1 150 000 + 1 200 000 = - $100 000 actuarial gain 5. Return on plan assets (excluding amount recognised in net interest) = $107 500 Workings Fair value of plan assets at 31 Dec 2015 $ 9 500 000 © John Wiley and Sons, Ltd, 2016

10.11

Solutions Manual to accompany Applying IFRS Standards 4e + Interest income + Contributions received by the fund - Benefits paid to members

855 000 1 000 000 (1 200 000) 10 155 000 Loss on plan assets excluding interest (107 500) Fair value of plan assets at 31 December 2016 $10 047 500

6. Reconciliation Net defined benefit liability $ Balance 31 Dec 2015 Interest @ 9% Current service cost Contributions received by the plan Benefits paid by the plan Loss on plan assets excluding interest recognised Actuarial gain on remeasurement of DBO Balance 31 December 2016

500 000

Defined benefit obligation $ 10 000 000 900 000 1 150 000 (1 200 000)

702 500

(100 000) 10 750 000

Plan assets $

9 500 000 855 000 1 000 000 (1 200 000) (107 500) 10 047 500

7. Summary journal entry

31/12/2016

Pension Expense (P/L) Pension Expense (OCI) Bank Net Pension liability

Dr Dr Cr Cr

1 195 000 7 500 1 000 000 202 500

(Pension expense and contributions for the year)

Workings Profit or Loss

Balance 31 Dec 2015 Net interest Service cost Contributions paid to the plan Loss on plan assets (ex. interest) Actuarial gain on DBO Journal entry Balance 31 December 2016

Other comprehensive income

Bank

Net DBL(A)

500 000 Cr 45 000 Dr 1 150 000 Dr 1 000 000 Cr

1 195 000 Dr

107 500 Dr 100 000 Cr 7 500 Dr

1 000 000 Cr

202 500 Cr 702 500 Cr

10.12

Chapter 10: Employee benefits Exercise 10.11

ACCOUNTING FOR THE PAYROLL

1. Prepare all journal entries to record the July payroll, the payment of July salaries and the remittance of deductions. 2. Calculate the balance of the Accrued Payroll account at the end of July. 1. 6 July

7 July

15 Aug

Wages and Salaries Expense Accrued Payroll (Payroll for July)

Dr Cr

500 000

Accrued Payroll Bank (Payment of net salaries for July)

Dr Cr

365 000

Accrued Payroll Bank (Payment of health insurance payroll deductions)

Dr Cr

10 000

Accrued Payroll Bank (Payment of payroll deductions for withheld income tax)

Dr Cr

125 000

500 000

365 000

10 000

125 000

2. €135 000 credit (€500 000 - €365 000), as all June payroll deductions would have been remitted during July the balance of the payroll at 31 July comprises the amounts deducted from July wages and salaries.

Exercise 10.12

ACCRUAL OF WAGES AND SALARIES

Prepare a journal entry to accrue the weekly payroll as at 30 June. Wages and salaries must be accrued for four business days after Friday 24 June: Monday 27 June – Thursday 30 June. 4/5 x £125 000 = £100 000 30 June

Wages and Salaries Expense Accrued Wages and Salaries (Accrual of payroll for business days 27–30 June)

Exercise 10.13

Dr Cr

100 000 100 000

ACCOUNTING FOR SICK LEAVE

Prepare a journal entry to recognised Huang Ltd’s liability, if any, for sick leave at 31 December 2016. 60% x (100 x 5 – 300) x $150 = $18 000 31 Dec

Wages and Salaries Expense Provision for Sick Leave (Accrual of sick leave)

Dr Cr

18 000 18 000

10.13

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 10.14

ACCOUNTING FOR LONG SERVICE LEAVE

Prepare all journal entries in relation to long service leave for the year ended 31 December 2016. £ £ Defined obligation 31/12/16 150 000 Obligation B/fwd 140 000 Less LSL paid (25 000) 115 000 Required increase/LSL 35 000 expense During 2016

Provision for Long Service Leave Bank (Long service leave paid)

Dr Cr

25 000

31 Dec 2016

Long Service Leave Expense

35 000

Provision for Long Service Leave (Increase in Liability for LSL)

EXERCISE 10.15

25000

35 000

ACCOUNTING FOR ANNUAL LEAVE

Prepare journal entries to account for the liability for annual leave at 31 December 2016. 31 Dec 2016

Wages and Salaries Expense

Provision for Annual Leave (Accrual annual leave)

284 000 284 000

Workings Category Managers Sales staff Office workers Other Liability 31 December Balance of provision Accrual

Opening Closing Pay/day balance Increase AL taken balance Liability € Days Days Days Days € 440 100 200 260 40 17 600 220 150 600 630 120 26 400 110 120 400 387 133 14 630 100 60 200 240 20 2 000 60 630 Cr 223 370 Dr 284 000

Closing balance of annual leave accumulation (in days): = Opening balance + accumulation during the year – Annual leave taken e.g. Managers: 100 + 200 – 260 = 40 days Provision = Days accumulated at the end of the period x basic pay rate e.g. Managers: 40 days x $440 per day = €17 600

10.14

Chapter 10: Employee benefits

Exercise 10.16

ACCOUNTING FOR DEFINED BENEFIT PENSION PLANS

Which of the following items in relation to a defined benefit fund are recognised in (i) profit or loss and (ii) other comprehensive income in accordance with IAS 19? i) recognised in profit or loss (a) current service cost (b) past service cost incurred during the period (c) net interest ii) recognised in other comprehensive income (d) return on plan assets excluding amounts recognised in net interest (f) current period actuarial gains in relation to the defined benefit obligation (g) current period actuarial losses in relation to the defined benefit obligation Note that (e) is not recognised in profit or loss or other comprehensive income because payments to members are transactions of the pension plan, and not transactions of the sponsoring entity (employer). Contributions paid to the plan (j) are accounted for as an increase (decrease) in the pension asset (liability). Items (h) and (i) should be ignored because actuarial gains and losses only arise in relation to the defined benefit obligation.

10.15

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 10.17

ACCOUNTING FOR SICK LEAVE

1. Prepare journal entries to account for the liability for sick leave at 31 December 2016. 2. State how much of the provision should be classified as a non-current liability. (1) 31 Dec 2016

Wages and Salaries Expense

Provision for Sick Leave (Accrual of employee benefits for sick leave)

49 655 49 655

Workings Category Managers Consultants Clerical staff

Daily wage £ 450 300 100

Op bal Days 120 110 80

Current service 50 100 100

Taken or Lapsed 10 90 70

Clos. bal days 160 120 110

Accumulated Benefit £ 72 000 36 000 11 000

Closing balance of sick leave accumulation (in days): = Opening balance + entitlement for service during the year – sick leave taken/lapsed e.g. Managers: 120 + 50 – 10 = 160 days

Managers Consultants Clerks

Accum. Benefit 72 000 36 000 11 000

Amount of Sick Leave Expected to be Taken Within 1 Year 1 Year Later 2 Years Later % £ % £ % £ 20 14 400 10 7 200 5 3 600 75 27 000 10 3 600 0 0 65 7 150 9 990 0 0 48 550 11 790 3 600

Provision for long service leave Current - due within one year after balance date (undiscounted) Non-current Due one year later, discounted at 7% = £11 790 = (1 + .07) Due 2 years later, discounted at 8%

£3600 (1 + 0.08)2 Total provision for sick leave at 31 December 2016 Amount per trial balance Accrual

£48 550 £11 019

£ 3 086 £62 655 Cr 13 000 Cr £49 655

(2) Non-current component of Provision for Sick Leave = £11 019 + £3 086 = £14 105

10.16

Chapter 10: Employee benefits Exercise 10.18

ACCOUNTING FOR BONUSES AND DEFINED CONTRIBUTION PENSION PLANS

1. Prepare the journal entry to record the contribution to the pension plan for 2016. 2. Prepare a journal entry to record the liability, if any, arising from the bonus plan at 31 December 2016. 3. Prepare a journal entry to account for the pension asset or liability, if any, at 31 December 2016. 1. 31/12/16

2. 31/12/16

Contribution Expenses Bank (Payment of contribution to pension plan)

Dr Cr

45 000

Wages and Salaries Expense Accrued Managerial Bonuses (Accrual of managerial bonuses)

Dr Cr

410 000

45 000

410 000

Workings Calculation of bonuses expected to be paid for the year ended 31 Dec 2016 Salary of manager considering leaving Other managerial salaries

3. 31 Dec 2016

Bonus payable $ 80 000 370 000 450 000

Pension Expense

Pension Liability (Accrual of managerial bonuses)

Probability used % 50 100%

Expected payment $ 40 000 370 000 410 000

85 000 85 000

Workings Total wages and salaries expense for 2016 excluding bonuses Less accrual 31 December 2016 not paid in 2016 Add accrual 31 December 2015 paid in 2016 Wages and salaries paid during 2016 Managerial bonuses for 2015 paid during 2016 Total wages, salaries and bonuses paid during 2016 Pension contribution – 10% x $12 850 000 Contributions paid $100 000 x 12 Contributions payable

$ 12 500 000 (300 000) 250 000 12 450 000 400 000 12 850 000 1 285 000 (1 200 000) 85 000

10.17

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 10.19

ACCOUNTING FOR LONG SERVICE LEAVE

Prepare the journal entry to account for Bluebell plc’s provision for long service leave at 31 December 2016 in relation to the non-managerial employees of the company’s debt collection business.

31 Dec 2016

Long Service Leave Expense

Provision for Long Service Leave (Increase in provision for long service leave)

150 735 150 735

Workings Step 1 Estimate the number of employees who are expected to become eligible for long service leave: Years of service 1 2 3 4 5

% expected to become entitled 20% 26% 35% 50% 65%

Total No. of Employees 100 85 40 32 25

Step 1 20 22.1 14 16 16.25

Step 2 Estimate the projected salaries. = salary x (1 + inflation rate)n Years of service

From Step 1

1 2 3 4 5

20 22.1 14 16 16.25

Current salary £ 40 000 42 000 44 000 46 500 49 600

Inflation rate

Period until LSL vests

0.05 0.05 0.05 0.05 0.05

9 8 7 6 5

Projected salary £ 1 241 063 1 371 374 866 774 997 031 1 028 683

Step 3 Determine the accumulated benefit. = Years of employment x weeks of paid leave x projected salaries Years required for LSL 52 Years of service 1 2 3 4 5

Projected salary £ 1 241 063 1 371 374 866 774 997 031 1 028 683

Unit credit

LSL weeks /52

0.1 0.2 0.3 0.4 0.5

0.25 0.25 0.25 0.25 0.25

Accumulated benefit £ 31 027 68 569 65 008 99 703 128 585

10.18

Chapter 10: Employee benefits Step 4 Measure the present value of the accumulated benefit. = accumulated benefit (1 + i)n Years of service 1 2 3 4 5

Accumulated benefit £ 31 027 68 569 65 008 99 703 128 585

Discount factor 0.591898 0.627412 0.710681 0.746215 0.783526

Present value £ 18 364 43 021 46 200 74 400 100 750 282 735

The amount by which the provision for long service should be increased can be calculated as the present value of the accumulated benefit at 31 December 2016 less the opening balance of the provision for long service leave because there have been no long service leave payments during the year: £282 735 - £132 000 = £150 735

Exercise 10.20 1. 2. 3. 4.

ACCOUNTING FOR DEFINED BENEFIT PENSION PLANS

Determine the surplus or deficit of Maple Ltd’s defined benefit plan at 31 December 2016. Determine the net defined benefit asset or liability that should be recognised by Maple Ltd at 31 December 2016. Calculate the net interest and the return on plan assets for 2016. Present a reconciliation of the opening balance to the closing balance of the net defined benefit liability (asset), showing separate reconciliations for plan assets and the present value of the defined benefit obligation. Prepare a summary journal entry to account for the defined benefit pension plan in the books of Maple Ltd for the year ended 31 December 2016.

1. Deficit of the fund = $2 870 000 Present value of the defined benefit obligation 31 December 2016 $23 000 000 Fair value of plan assets 31 December 2016 20 130 000 Deficit of the fund at 31 December 2016 $ 2 870 000 2. The net defined benefit liability at 31 December 2016 is $2 870 000, being the deficit of the fund. 3. Net interest = $300 000 Workings Interest expense component of the defined benefit obligation: Defined benefit obligation brought forward $20 000 000 Past service cost 2 000 000 $22 000 000 x 10% = $2 200 000 Interest income component: $19 000 000 x 10% = $1 900 000 Return on plan assets Fair value of plan assets 31 Dec. 2016 $20 130 000 Less: Opening balance 19 000 000 Interest income 1 900 000 Contributions paid to the plan 1 000 000 Benefits paid by the plan (2 100 000) 19 800 000 Return on plan assets ex. Interest income $ 330 000 © John Wiley and Sons, Ltd, 2016

10.19

Solutions Manual to accompany Applying IFRS Standards 4e

4. Reconciliation Net defined benefit liability $ 1 000 000

Balance 31 Dec. 2015 Past service cost Revised balance Interest @ 10% Current service cost Contributions paid to the plan Benefits paid by the plan Return on plan assets excluding interest recognised * Actuarial loss on remeasurement of DBO Balance 31 Dec. 2016

Defined benefit obligation $ 20 000 000 2 000 000 22 000 000 2 200 000 800 000 (2 100 000)

2 870 000

100 000 23 000 000

Plan assets $

19 000 000

1 900 000 1 000 000 (2 100 000) 330 000 20 130 000

5. Summary journal entry 31 Dec. 2016

Pension Expense (P/L)

3 100 000

Pension Income (OCI) Bank Net Pension liability

Cr Cr Cr

230 000 1 000 000 1 870 000

Other comprehensive income

Bank

(Pension expense and contributions for the year)

Workings Profit or Loss

Balance 31 December 2015 Past service cost Net interest Service cost Contributions paid to the fund Gain on plan assets (ex. interest) Actuarial loss on DBO Journal entry Balance 31 December 2016

Net DBL(A)

1 000 000 Cr 2 000 000 Dr 300 000 Dr 800 000 Dr 1 000 000 Cr

3 100 000 Dr

330 000 Cr 100 000 Dr 230 000 Cr

1 000 000 Cr

1 870 000 Cr 2 870 000 Cr

10.20

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 10 Employee benefits

CHAPTER 10 Employee benefits

Learning Objectives 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9

Outline the principles applied in accounting for employee benefits Discuss the scope and purpose of IAS 19 Discuss the definition of employee benefits Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave Compare defined benefit and defined contribution post-employment benefit plans Prepare entries to account for expenses, assets and liabilities arising from defined contribution post-employment plans Prepare entries to record expenses, assets and liabilities arising from defined benefit post-employment benefit plans Explain how to measure and record other long-term liabilities for employment benefits, such as long service leave Explain when a liability should be recognised for termination benefits and how it should be measured.

10.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1.

Which of the following types of employee benefits are required to be measured at their nominal value? Learning Objective 10.1 Outline the principles applied in accounting for employee benefits a. long service leave b. defined benefit post-employment benefits *c. accumulating non-vesting sick leave d. defined contribution employment benefits

Which of the following types of employee benefits are required to be measured at the present value of expected future cash flows? Learning Objective 10.1 Outline the principles applied in accounting for employee benefits a. annual leave b. accumulating non-vesting sick leave c. maternity leave *d. long service leave

Employee benefits can arise from which of the following? I workplace agreements between an entity and its employees II enterprise bargaining agreements between an entity and the relevant employee union III government legislation IV specific industry arrangements Learning Objective 10.2 Discuss the scope and purpose of IAS 19 a. I and II only b. II, III and IV only c. I, II and III only *d. I, II, III and IV

An enterprise bargaining agreement results from an entity entering into an agreement with: Learning Objective 10.2 Discuss the scope and purpose of IAS 19 a. its employees b. the government c. the relevant industry body *d. the relevant employee union

10.2

Chapter 10 Employee benefits

Employee benefits can be allocated to assets: Learning Objective 10.3 Discuss the definition of employee benefits a. only if it relates to the cost of an internally generated intangible b. where the entity is certain the future economic benefits will flow to it *c. in accordance with the requirements of other accounting standards d. where they meet the definition of an asset under the Conceptual Framework

IAS 19 defines employee benefits as: Learning Objective 10.3 Discuss the definition of employee benefits a. any cash consideration given by an entity to employees or their authorised representatives in exchange for services rendered by the employee b. all forms of consideration given by an entity to employees or their authorised representatives in exchange for services rendered by the employee *c. all forms of consideration given by an entity in exchange for service rendered by employees d. all forms of consideration given by an entity to employees or their authorised representatives

Which if the following is NOT an example of a short-term employee benefit? Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave a. wages and salaries *b. termination payments c. bonuses and profit-sharing arrangements d. short-term compensated benefits

Salary sacrificing refers to: Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave a. an employer withholding a portion of an employee’s salary or wages for substandard performance b. an employee not receiving a portion of their salary and wages due to the fact that pre-determined performance targets have not been met c. an employee foregoing some of their salary because leave entitlements such as sick leave have been exceeded *d. an employee electing to forego some of their salary or wages in return for other non-cash benefits

10.3

Test Bank to accompany Applying IFRS Standards 4e

IAS 19 requires short-term employee benefits to be measured at: Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave a. future value *b. nominal value c. present value d. fair value

10.

ABC Ltd employs 5 staff. Each staff member is entitled to 20 days annual leave per annum. Leave loading of 17.5% is paid when the leave is taken. On 31 December 2016 Joan Rivers left the company and was paid out her untaken leave entitlements. Joan had 12 days leave owing at 1 July 2016 and took 4 days leave between 1 July and 31 December 2016. Her salary at the time of her departure was $140 000. There are 260 work days in a year. On 1 July each year all employees receive a 3% wage rise. There are no other wage rises given during the year. The gross entitlement owing to Joan Rivers on 31 December 2016 was: Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave a. $17 715 b. $9692 c. $5061 *d. $11 388

11.

Carpenter Ltd has 6 employees, who are each paid $750 per week for a 5 day working week. Each employee is entitled to 8 days accumulating non-vesting sick leave per year. At 1 July 2016 the accumulated untaken leave was 14 days in total. During the year ended 30 June 2017 a total of 50 days sick leave was taken, of which 12 days were unpaid leave. Of the accumulated untaken leave at 30 June 2017 it is estimated that 75% of it will be taken during the following year. The balance of the provision for sick leave at 30 June 2017 is: Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave a. $1350 b. $3600 *c. $2700 d. NIL, as the leave is non-vesting

10.4

Chapter 10 Employee benefits

12.

Pirate Ltd employs 5 staff. Each staff member is entitled to 20 days annual leave per annum. Leave loading of 17.5% is paid when the leave is taken. At 1 July 2016 the balance in the provision for annual leave account was $20 303. Details of each employees leave entitlement at 30 June 2017 are as follows: Employee

Salary

Jo Bird Bill Brown Ben Fit Greg Horn Lou Hamilton

$65 000 $70 000 $85 000 $62 500 $90 000

Days owing @ 1/7/13 17 5 24 3 9

Days taken during year 22 12 18 15 26

There are 260 work days in a year. On 1 July each year all employees receive a 5% wage rise. There are no other wage rises given during the year. The closing balance in the provision for annual leave account at 30 June 2017 is: Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave a. $18 712 b. $19 647 *c. $23 086 d. $27 221

13.

An entity is required to recognise a liability for short-term compensated absences that are: Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave *a. accumulating and vesting b. non-accumulating and vesting c. non-accumulating and non-vesting d. all of the above

10.5

Test Bank to accompany Applying IFRS Standards 4e

14.

Pirate Ltd employs 5 staff. Each staff member is entitled to 20 days annual leave per annum. Leave loading of 17.5% is paid when the leave is taken. At 1 July 2015 the balance in the provision for annual leave account was €20 303. Details of each employees leave entitlement at 30 June 2016 are as follows: Employee

Salary

Jo Bird Bill Brown Ben Fit Greg Horn Lou Hamilton

€65 000 €70 000 €85 000 €62 500 €90 000

Days owing @ 1/7/13 17 5 24 3 9

Days taken during year 22 12 18 15 26

There are 260 work days in a year. On 1 July each year all employees receive a 5% wage rise. There are no other wage rises given during the year. Annual leave payments made during the year were debited against the provision account. The total debit against the annual leave account during the year in relation to leave taken was: Learning Objective 10.4 Prepare journal entries to account for short-term liabilities for employee benefits, such as wages and salaries, sick leave and annual leave a. €27 221 b. €28 654 *c. €33 585 d. €33 668

15.

The key difference between defined benefit and defined contributions post-employment plans is that: Learning Objective 10.5 Compare defined benefit and defined contribution postemployment benefit plans a. the employee bears the risk in a defined benefit plan, whereas the employer bears the risk in a defined contribution plan b. the fund bears the risk in a defined benefit plan, whereas the employee bears the risk in a defined contribution plan *c. the employer bears the risk in a defined benefit plan, whereas the employee bears the risk in a defined contribution plan d. the employer bears the risk in a defined benefit plan, whereas the fund bears the risk in a defined contribution plan

10.6

Chapter 10 Employee benefits

16.

Benefits paid to members of a defined contribution post-employment fund are based on: I the level of contributions made to the fund II remuneration levels while employed III number of years in service IV investment returns generated by the fund Learning Objective 10.5 Compare defined benefit and defined contribution postemployment benefit plans a. I and II only b. II and III only c. III and IV only *d. I and IV only

17.

IAS 19 does NOT prescribe the accounting treatment for: Learning Objective 10.6 Prepare entries to account for expenses, assets and liabilities arising from defined contribution post-employment plans a. contributions to defined contribution post-employment benefit funds *b. contributions received by a defined contribution post-employment benefit fund c. assets arising from defined benefit post-employment benefit plans from the perspective of the employer d. liabilities arising from defined benefit post-employment benefit plans from the perspective of the employer

18.

If the amount paid to the defined contribution fund by an entity during the year is less than the amount payable in relation to service provided by employees, the entity must recognise; Learning Objective 10.6 Prepare entries to account for expenses, assets and liabilities arising from defined contribution post-employment plans a. an asset for the unpaid contributions *b a liability for the unpaid contributions c. an expense for the unpaid contributions d. a gain for the unpaid contributions

19.

An increase in the present value of a defined benefit obligation resulting from employee service in the current period is referred to as: Learning Objective 10.7 Prepare entries to record expenses, assets and liabilities arising from defined benefit post-employment benefit plans *a. the current service cost b. the past service cost c. the interest cost d. an actuarial gain or loss

10.7

Test Bank to accompany Applying IFRS Standards 4e

20.

Benefits paid to members of a defined benefit post-employment fund are based on: I the level of employer contributions made to the fund II remuneration levels while employed III number of years in service IV investment returns generated by the fund Learning Objective 10.7 Prepare entries to record expenses, assets and liabilities arising from defined benefit post-employment benefit plans a. I and II only *b. II and III only c. III and IV only d. I and IV only

21.

Actuarial gains or losses can arise from: I employee service provided in the current period II the unwinding of the discount applied to the obligation III changes to actuarial assumptions IV experience adjustments Learning Objective 10.7 Prepare entries to record expenses, assets and liabilities arising from defined benefit post-employment benefit plans a. I and II b. II and III *c. III and IV d. I and IV

22.

The key steps involved in accounting by the employer for a defined benefit postemployment fund in accordance with IAS 19 include: Learning Objective 10.7 Prepare entries to record expenses, assets and liabilities arising from defined benefit post-employment benefit plans a. determining the deficit or surplus of the fund b. determining the amount of the net defined benefit liability (asset) c determining the amounts to be recognised in profit or loss for current service cost, any past service cost and net interest expense (income) on the net defined benefit liability (asset) *d. all of the options are correct

23.

The nominal value of an accumulated benefit for long service leave is calculated as (Years of employment/Years required for LSL) x (weeks of paid leave/52) x ______? Learning Objective 10.8 Explain how to measure and record other long-term liabilities for employment benefits, such as long service leave a. current salaries b. projected salaries x (1+inflation rate)n c. current salaries / (1+inflation rate)n *d. projected salaries

10.8

Chapter 10 Employee benefits

24.

Determining an entity’s liability for long service leave requires estimation of: Learning Objective 10.8 Explain how to measure and record other long-term liabilities for employment benefits, such as long service leave a. when the leave will be taken b. projected salary levels c. proportion of employees who will become entitled to the leave *d. all of the above.

25.

IAS 19 requires an entity to record a liability for long service leave: Learning Objective 10.8 Explain how to measure and record other long-term liabilities for employment benefits, such as long service leave a. once the employee becomes presently entitled to the leave *b. as the employee provides service to the entity c. when the leave is taken by the employee d. in a consistent manner from year to year

26.

IAS 19 adopts which method to determining long service leave obligations? Learning Objective 10.8 Explain how to measure and record other long-term liabilities for employment benefits, such as long service leave a. units of production method b. the actuarial method c. the bi-nominal method *d. projected unit credit method

27.

Which of the following do NOT fall within the definition of a termination benefit? Learning Objective 10.9 Explain when a liability should be recognised for termination benefits and how it should be measured *a. employee resignation b. voluntary redundancy accepted by an employee c. termination of employment before the normal retirement date due to company insolvency d. termination of employment before the normal retirement date due to poor performance

28.

Which of the following obligations do NOT arise from past services provided by an employee? Learning Objective 10.9 Explain when a liability should be recognised for termination benefits and how it should be measured a. short-term compensated absences *b. termination benefits c. other long-term employee benefits d. post-employment benefits

10.9

Test Bank to accompany Applying IFRS Standards 4e

29.

An entity is able to record a provision for termination benefits when it: Learning Objective 10.9 Explain when a liability should be recognised for termination benefits and how it should be measured a. has a detailed formal plan b. has a definite intention of terminating employment c. has received Board approval for the termination benefits *d. can no longer withdraw the offer of the benefits

30.

The offer to pay termination benefits can no longer be withdrawn when the entity has communicated to affected employees a plan of termination that meets which of the following criteria? Learning Objective 10.9 Explain when a liability should be recognised for termination benefits and how it should be measured a. actions required to complete the plan indicate that significant changes to the plan are unlikely b. the plan identifies the location, function or job classification, the number of employees whose services are to be terminated, and the expected completion date c. the plan establishes the termination benefits payable in sufficient detail to enable employees to determine the type and amount of benefits they will receive *d. all of the above

10.10

Exercises Exercise 10.11 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

ACCOUNTING FOR THE PAYROLL

Giovanni SpA pays its employees on a monthly basis. The payroll is processed on the 6th day of the month and payable on the 7th day of the month. Gross salaries for July were €500 000, from which €125 000 was deducted in tax. All of Giovanni SpA’s salaries are accounted for as expenses. Deductions for health insurance were €10 000. Payments for health insurance and employee withheld income taxes are due on the 15th day of the following month. Required

1. Prepare all journal entries to record the July payroll, the payment of July salaries and the remittance of deductions. 2. Calculate the balance of the Accrued Payroll account at the end of July.

Exercise 10.12 ★

ACCRUAL OF WAGES AND SALARIES

London plc has a weekly payroll of £125 000. The last payroll processed before the end of the interim reporting period was for the week ended Friday 24 June. Employees do not work during weekends. Required

Prepare a journal entry to accrue the weekly payroll as at 30 June.

Exercise 10.13

ACCOUNTING FOR SICK LEAVE

★ Huang Ltd has 100 employees who each earn a gross wage of $150 per day. In an attempt to reduce absenteeism, Huang Ltd modiﬁed its employee contracts to provide all employees with entitlement to 5 days of non-vesting, accumulating sick leave per annum, effective from 1 January 2016. Under the previous workplace agreement, all sick leave was non-cumulative. During the year ended 31 December 2016, 300 days of paid sick leave were taken by employees. It is estimated that 60% of unused sick leave will be taken during the year ended 31 December 2017 and that 40% will not be taken at all. Required

Prepare a journal entry to recognised Huang Ltd’s liability, if any, for sick leave at 31 December 2016.

Exercise 10.14 ★

ACCOUNTING FOR LONG SERVICE LEAVE

Victoria plc provides long service leave entitlement of 13 weeks of paid leave after 10 years of continuous employment. The provision for long service leave had a credit balance of £140 000 at 31 December 2015. During the year ended 31 December 2016, long service leave of £25 000 was paid. At the end of the year, the present value of the deﬁned beneﬁt obligation for long service leave was £150 000. Required

Prepare all journal entries in relation to long service leave for the year ended 31 December 2016.

Exercise 10.15

ACCOUNTING FOR ANNUAL LEAVE

★ Tulip nv provides 4 weeks (20 days) of accumulating vested annual leave for each year of service. The company policy is that annual leave must be taken within 6 months of the end of the period in which it accrues. Annual leave is paid at the base salary rate (which excludes commissions, bonuses and overtime). The following summary data is derived from Tulip nv’s payroll records for the year ended 31 December 2016. Base pay rates have increased during the year. The amounts shown are applicable at 31 December 2016. Annual leave

Employee category Managers Sales staff Office workers Other

Base pay/day €

Balance b/d 1 January 2016 days

Accumulated during year days

Taken during year days

440 220 110 100

100 150 120 60

200 600 400 200

260 630 387 240

CHAPTER 10 Employee benefits

Additional information After leave taken during the year had been recorded, Tulip nv’s trial balance revealed that the provision for annual leave had a debit balance of €223 370 at 31 December 2016. Required

Prepare journal entries to account for the liability for annual leave at 31 December 2016. Exercise 10.16

ACCOUNTING FOR DEFINED BENEFIT PENSION PLANS

★★ Which of the following items in relation to a defined benefit plan are recognised in (i) profit or loss and (ii) other comprehensive income in accordance with IAS 19? (a) current service cost (b) past service cost incurred during the period (c) net interest (d) return on plan assets excluding amounts recognised in net interest (e) benefits paid to members (f) current period actuarial gains in relation to the defined benefit obligation (g) current period actuarial losses in relation to the defined benefit obligation (h) current period actuarial gains in relation to the assets of the plan (i) current period actuarial losses in relation to the assets of the plan (j) contributions paid. Exercise 10.17

ACCOUNTING FOR SICK LEAVE

★★ Rose plc provides 1 week (5 days) of accumulating non-vesting sick leave for each year of service. Sick leave

is paid at the base pay rate, which does not include commissions, bonuses and overtime. The proportion of accumulated sick leave that will be taken is estimated for each category of employee due to differences in staff turnover rates. The following summary data is derived from Rose plc’s payroll records for the year ended 31 December 2016. % of unused leave expected to be taken

Sick leave

Employee category

Base pay/day £

Balance b/d 1 January 2016 Days

Increase in leave for current service Days

Leave taken or lapsed Days

Within 12 months %

1 year later %

2 years later %

Managers Consultants Clerical staff

450 300 100

120 110 80

50 100 100

10 90 70

20 75 65

10 10 9

5 0 0

Additional information The yield on high-quality corporate bonds at 31 December 2016 is 7% for one-year bonds and 8% for twoyear bonds. After leave taken during the year had been recorded Rose plc’s trial balance at 31 December 2016 revealed the provision for sick leave had a credit balance of £13 000. Required

1. Prepare journal entries to account for the liability for sick leave at 31 December 2016. 2. State how much of the provision should be classiﬁed as a non-current liability.

Exercise 10.18

ACCOUNTING FOR BONUSES AND DEFINED CONTRIBUTION PENSION PLANS

★★ Orchid Ltd contributes to a defined contribution pension plan for its employees. Contributions have been established as 10% of wages and salaries, including bonuses, actually paid during the year. Contributions based on budgeted payroll costs were set at $100 000 per month. There is annual net settlement of pension contributions payable or refundable based on actual audited payroll information. The net settlement occurs on 31 March for the preceding year. Managers are entitled to a bonus calculated at 5% of their base salary if Orchid Ltd’s profit before tax (excluding the bonus) is more than 20% of market capitalisation of the company at the beginning of the year. The profit target was achieved in 2015 and 2016. The bonus is payable 6 months after the end of the reporting period, provided the manager has remained in the company’s employment. 2

PART 2 Elements

Managerial salaries expense Other salaries and wages Accrued wages and salaries Accrued managerial bonuses

2016 $

2015 $

4 500 000 8 000 000

4 000 000 7 800 000

12 500 000

11 800 000

300 000 ?

250 000 400 000

At 31 December 2015, Orchid Ltd correctly anticipated that all managers would be eligible for the bonus because staff turnover among managers had been very low. However, by 31 December, the company had moved to new premises and one manager, with a salary of $800 000, indicated that the additional travel was causing him to reconsider his position. The directors estimated that there was a 50% probability that the manager would resign by 30 June 2017, and an 80% probability that he would resign by 31 December 2017. Required

1. Prepare the journal entry to record the contribution to the pension plan for 2016. 2. Prepare a journal entry to record the liability, if any, arising from the bonus plan at 31 December 2016. 3. Prepare a journal entry to account for the superannuation asset or liability, if any, at 31 December 2016.

Exercise 10.19 ★★

ACCOUNTING FOR LONG SERVICE LEAVE

Bluebell plc provides credit services. Bluebell plc provides the employees with long service leave entitlements of 13 weeks of paid leave for every 10 years of continuous service. As the company has been operating for only 5 years, no employees have become entitled to long service leave. However, the company recognises a provision for long service leave using the projected unit credit approach required by IAS 19. The following information is obtained from Bluebell plc payroll records and actuarial reports for the non-managerial staff of its debt collection business at 31 December 2016:

Unit credit (years)

No. of employees

% expected to become entitled

Average annual salary

No. of years until vesting

Yield on govt. corporate bonds

1 2 3 4 5

100 85 40 32 25

20% 26% 35% 50% 65%

£40 000 £42 000 £44 000 £46 500 £49 600

9 8 7 6 5

6% 6% 5% 5% 5%

Additional information (a) The estimated annual increase in retail wages is 5% p.a. for the next 10 years, reﬂecting Bluebell plc’s policy of increasing salaries of its debt collection staff for each year of additional experience. (b) At 31 December 2015, the provision for long service leave for non-managerial debt collection staff was £132 000. Required

Prepare the journal entry to account for Bluebell plc’s provision for long service leave at 31 December 2016 in relation to the non-managerial employees of the company’s debt collection business.

Exercise 10.20

ACCOUNTING FOR DEFINED BENEFIT PENSION PLANS

★★★ Some years ago, Maple Ltd established a defined benefit pension plan for its employees. The company has since introduced a defined contribution plan, which all new staff join when commencing employment with Maple Ltd. Although the defined benefit plan is now closed to new recruits, the fund continues to provide for employees who have been with the company for a long time. The following actuarial report has been received for the defined benefit plan: CHAPTER 10 Employee benefits

2016 $ Present value of the defined benefit obligation 31 December 2015 Past service cost Net interest Current service cost Benefits paid Actuarial loss on DBO Present value of the defined benefit obligation 31 December 2016 Fair value of plan assets at 31 December 2015 Return on plan assets Contributions paid to the plan during the year Benefits paid by the plan during the year Fair value of plan assets at 31 December 2016

20 000 000 2 000 000 ? 800 000 2 100 000 100 000 $23 000 000 19 000 000 ? 1 000 000 2 100 000 $20 130 000

Additional information (a) All contributions received by the plan were paid by Maple Ltd. Employees make no contributions. (b) The interest rate used to measure the present value of the deﬁned beneﬁt obligation was 10% at 31 December 2015 and 31 December 2016. (c) The asset ceiling was nil at 31 December 2015 and 31 December 2016. Required

1. Determine the surplus or deficit of Maple Ltd’s defined benefit plan at 31 December 2016. 2. Determine the net defined benefit asset or liability that should be recognised by Maple Ltd at 31 December 2016. 3. Calculate the net interest and the return on plan assets for 2016. 4. Present a reconciliation of the opening balance to the closing balance of the net defined benefit liability (asset), showing separate reconciliations for plan assets and the present value of the defined benefit obligation. 5. Prepare a summary journal entry to account for the defined benefit pension plan in the books of Maple Ltd for the year ended 31 December 2016.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised for this edition by David Kolitz

John Wiley & Sons, Ltd, 2016

Chapter 11: Property, plant and equipment

Chapter 11 - Property, plant and equipment Discussion Questions 1.

How should items of property, plant and equipment be measured at point of initial recognition, and would gifts be treated differently from acquisitions?

Para 15 of IAS 16 requires the initial measurement to be at cost. The measurement rule applies regardless of how the entity obtains the asset. A gift has a zero cost.

How is cost determined?

Para 16 states: The cost of an item of property, plant and equipment comprises: (a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates. (b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. (c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.

What choices of measurement model exist subsequent to assets being initially recognised?

Para 29 of IAS 16 states: An entity shall choose either the cost model in paragraph 30 or the revaluation model in paragraph 31 as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.1

What factors should entities consider in choosing alternative measurement models?

Relevance of information provided: generally current information is preferred to past information. Reliability of the information: cost measures are generally more reliable than valuation measures. Cost of providing the information: Adoption of the valuation model entails costs of valuation and audit.

What is meant by ‘depreciation expense’?

Para 6 of IAS 16 defines depreciation as:

11.1

Solutions Manual to accompany Applying IFRS Standards 4e

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life

How is useful life determined?

Para 6 of IAS 16 states: Useful life is: (a) the period over which an asset is expected to be available for use by an entity; or (b) the number of production or similar units expected to be obtained from the asset by an entity Paras 56–57 state: 56.

The future economic benefits embodied in an asset are consumed by an entity principally through its use. However, other factors, such as technical or commercial obsolescence and wear and tear while an asset remains idle, often result in the diminution of the economic benefits that might have been obtained from the asset. Consequently, all the following factors are considered in determining the useful life of an asset:

(a) expected usage of the asset. Usage is assessed by reference to the asset's expected capacity or physical output. (b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance program, and the care and maintenance of the asset while idle. (c) technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset. (d) legal or similar limits on the use of the asset, such as the expiry dates of related leases. 57.

The useful life of an asset is defined in terms of the asset's expected utility to the entity. The asset management policy of the entity may involve the disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets.

What is meant by ‘residual value’ of an asset?

Para 6 of IAS 16 states: The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

Should accounting for revaluation increases and decreases be done on an asset-by-asset basis or on a class-of-assets basis?

Paras 36–38 of IAS 16 state: 36.

If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued.

37.

A class of property, plant and equipment is a grouping of assets of a similar nature and use in an entity's operations. The following are examples of separate classes: (a) land; (b) land and buildings; © John Wiley and Sons, Ltd, 2016

11.2

Chapter 11: Property, plant and equipment (c) machinery; (d) ships; (e) aircraft; (f)

motor vehicles;

(g) furniture and fixtures; and (h) office equipment. 38.

The items within a class of property, plant and equipment are revalued simultaneously to avoid selective revaluation of assets and the reporting of amounts in the financial statements that are a mixture of costs and values as at different dates. However, a class of assets may be revalued on a rolling basis provided revaluation of the class of assets is completed within a short period and provided the revaluations are kept up to date.

What differences occur between asset-by-asset or class-of-asset bases in accounting for revaluation increases and decreases?

Using an asset-by asset basis means that decrements affect the profit or loss for the period while increments are taken directly to equity. With a class basis, by netting off increments and decrements within a class, there will be a net effect, affecting either profit or loss or equity depending on whether decrements are greater than or less than increments.

10.

When should property, plant and equipment be derecognised?

Para 67 of IAS 16 states: The carrying amount of an item of property, plant and equipment shall be derecognised: (a) on disposal; or (b) when no future economic benefits are expected from its use or disposal.

11.3

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 11.1

FAIR VALUE BASIS FOR MEASUREMENT

The management of an entity has decided to use the fair value basis for the measurement of its equipment. Some of this equipment is very hard to obtain and has in fact increased in value over the current period. Management is arguing that, as there has been no decline in fair value, no depreciation should be charged on these pieces of equipment. Discuss. Para 50 of IAS 16 notes that depreciation is a process of allocation. Depreciation is not a change in value. Depreciation measures the consumption of benefits of an asset over the period. The consumption of benefits is considered to be separate from changes in the fair value of an asset and thus depreciation must be charged even though the fair value has increased.

Exercise 11.2

ANNUAL DEPRECIATION CHANGE

A company is in the movie rental business. Movies are generally kept for 2 years and then either sold or destroyed. However, management wants to show increased profits, and believes that the annual depreciation charge can be lowered by keeping the movies for 3 years. Discuss. Changing the number of years does not necessarily change the annual depreciation charge. If after 2 years the movies are worth nothing – hence they are normally destroyed at this point – then to keep the movies for another year simply means that there is no depreciation charge in the 3 rd year as all the benefits have been received by the end of the 2nd year and there are none received in the third year. If the movies could be still rented in a 3rd period, again there may be no change in the depreciation in the first two years. The depreciation charge is also a function of the residual value of the asset. Consider the following case: Scenario 1: Movie cost $30 and has a residual value at the end of year 2 of $15. Assuming equal benefits over the 2 years [unlikely], the annual depreciation charge is $7.50. Scenario 2: Movie cost $30 and has a residual value at end of year 3 of $5. Assuming equal benefits [very unlikely], the annual depreciation charge is $8.33.

Exercise 11.3

REVALUATION OF ASSETS

1. Prepare the journal entries during the period 1 July 2014 to 30 June 2015 in relation to the equipment 2. According to accounting standards, on what basis may management change the method of asset measurement, for example from cost to fair value?

1. Sonner Ltd 31 December 2014 Depreciation expense – Machine A Accumulated depreciation (1/2 x 10% x £300 000)

Dr Cr

15 000 15 000

11.4

Chapter 11: Property, plant and equipment Depreciation expense – Machine B Accumulated depreciation (1/2 x 10% x £200 000)

Dr Cr

Machine A

Machine B

Cost Accum depn Fair value Increment

300 000 135 000 165 000 180 000 15 000

10 000 10 000

Cost Accum depn

200 000 40 000 160 000 155 000 5 000

Fair value Decrement

Accumulated depreciation – Machine A Machine A (Writing the asset down to carrying amount)

Dr Cr

135 000

Machine A Gain on revaluation of machinery (OCI) Cr (Revaluation of asset)

15 000 15 000

Dr Cr

4 500

Gain on revaluation of machinery (OCI) Income tax expense (OCI) Asset revaluation surplus – Machine A Cr (Accumulation of net revaluation gain in equity)

Dr Cr

15 000

Accumulated depreciation – Machine B Machine B (Writing the asset down to carrying amount)

Dr Cr

40 000

Loss – revaluation decrement (P/L) Machine B (Revaluation of machine from £200 000 to £155 000)

Dr Cr

5 000

Depreciation expense – Machine A Accumulated depreciation (1/6 x ½ x £180 000)

Dr Cr

15 000

Depreciation expense – Machine B Accumulated depreciation (1/5 x ½ x £155 000)

Dr Cr

15 500

Income tax expense – gain on revaluation of asset (OCI) Deferred tax liability (Tax-effect of revaluation)

135000

4 500

4 500 10 500

40 000

5 000

30 June 2015

Machine A Carrying amount Fair value Decrement

£ 165 000 163 000 2 000

Machine B Carrying amount Fair value Decrement

Accumulated depreciation – Machine A Machine A (Writing down to carrying amount) © John Wiley and Sons, Ltd, 2016

15 000

15 500

£ 139 500 136 500 3 000

Dr Cr

15 000 15 000

11.5

Solutions Manual to accompany Applying IFRS Standards 4e Loss on revaluation of machinery (OCI) Machine A (Revaluation downwards)

Dr Cr

2 000

Deferred tax liability Income tax expense (OCI) (Tax-effect of revaluation decrement on asset previously revalued upwards)

Dr Cr

600

Asset revaluation surplus – Machine A Income tax expense (OCI) Loss on revaluation of machinery (OCI) Cr (Reduction in accumulated equity due to revaluation decrement)

Dr Dr

1 400 600 2 000

Accumulated depreciation – Machine B Machine B (Writing down to carrying amount)

Dr Cr

15 500

Loss – revaluation decrement Machine B (Writing down to fair value)

Dr Cr

3 000

2 000

600

15 500

3 000

2: Basis for change in accounting policy Refer to IAS 8 paragraph 9. Discuss the cost basis method and the fair value method in relation to the relevance and reliability of information. Current information is generally more relevant than past information. Determination of cost is generally more reliable than determination of fair value. Discuss the trade-off between relevance and reliability, that is, as information becomes less reliable it also loses its relevance. A fair value measure may, because of its timeliness, be more relevant but if the measure becomes more unreliable, the relevance of the information decreases.

Exercise 11.4

STRAIGHT-LINE DEPRECIATION VS DIMINISHING-BALANCE

Asia Ltd uses tractors as a part of its operating equipment, and it applies the straight-line depreciation method to depreciate these assets. Asia Ltd has just taken over Pacific Ltd, which uses similar tractors in its operations. However, Pacific Ltd has been using a diminishing-balance method of depreciation for these tractors. The accountant in Asia Ltd is arguing that for both entities the same depreciation method should be used for tractors. Provide arguments for and against this proposal. The arguments for and against must be based on the pattern in which the assets’ future economic benefits are expected to be consumed by the entities. If both entities use the assets such that the pattern of consumption of benefits is the same, then the same depreciation method should be used. If the entities use the tractors in ways such that the pattern of consumption of benefits is different then different methods of depreciation can be used. The method chosen must be applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits.

11.6

Chapter 11: Property, plant and equipment Exercise 11.5

DEPRECIATION CHARGES

A new accountant has been appointed to Dettum Ltd and has implemented major changes in the calculation of depreciation. As a result, some parts of the factory have much larger depreciation charges. This has incensed some operations managers who believe that, as they take particular care with the maintenance of their machines, their machines should not attract large depreciation charges that reduce the profitability of their operations and reflect badly on their management skills. The operations managers plan to meet the accountant and ask for change. How should the new accountant respond? The determination of the depreciation charge relies on the consideration of a large number of factors such as useful life, residual value, and consumption of benefits. Some parts of the factory may have: -

assets with high initial costs low residual values high patterns of use on initial acquisition

These parts of the factory will attract high depreciation charges. However, careful maintenance may lead to: -

higher residual values longer useful lives

The depreciation charge per annum can then be reduced. Good management will not judge performance on factors outside the control of the employees. Cost savings might be a better measure of performance than profitability.

Exercise 11.6

EXPENSING OF COSTS

Mehna Ltd has acquired a new building for £500 000. It has incurred incidental costs of £10 000 in the acquisition process for legal fees, real estate agent’s fees and stamp duties. Management believes that these costs should be expensed because they have not increased the value of the building and, if the building was immediately resold, these amounts would not be recouped. In other words, the fair value of the building is considered to still be £500 000. Discuss how these costs should be accounted for. According to para 16 of IAS 16, the cost of an asset includes any directly attributable costs. The £10 000 incidental costs should therefore be include in the cost of the asset. The cost is then £510 000. Paragraph 15 of IAS 16 requires an asset to be recognised initially at cost – in this case £510 000. If the asset is subsequently measured under the cost model: Whether or not the asset should be written down depends on whether the asset is impaired. Paragraph 63 of IAS 16 requires an entity to apply IAS 36 Impairment of Assets. If the asset is a part of a cash generating unit, and the recoverable amount of the CGU is greater than the carrying amount of the assets of the CGU then the building will not be written down. If the asset is subsequently measured under the revaluation model: As the fair value is only £500 000, a revaluation decrement would be determined and an expense recognised.

11.7

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 11.7

DEPRECIATION

Prepare the journal entries for the recording of the vehicles and the depreciation of the vehicles for each of the 3 years. The financial year ends on 30 June. Plaaz Ltd

2012 1/7

2013 30/6

1/7

2014 30/6

1/7

Vehicles Cash (Acquisition of delivery truck)

Dr Cr

50 000

Insurance expense Cash (Truck insurance)

Dr Cr

1 200

Depreciation expense - Vehicles Accumulated depreciation (Annual depreciation: 1/5 x £50 000 - £23 600)

Dr Cr

5 280

Vehicles Cash (Acquisition of flat-top truck)

Dr Cr

30 000

Vehicles Cash (Amounts paid on flat-top truck: £2 300 + £620)

Dr Cr

2 920

Servicing expense Cash (Service of flat-top truck)

Dr Cr

480

Vehicles Cash (Installation of radios to trucks)

Dr Cr

600

Insurance expense Cash (Insurance on trucks)

Dr Cr

2 100

Depreciation expense - Vehicles Accumulated depreciation (Depreciation of vehicles: 1/5 (£50 000 - £23 600) + ¼ x £300= £5 355 ½ (£32 920 + £300 – £14 600 = £9 310

Dr Cr

14 665

Insurance expense Cash (Insurance on trucks)

Dr Cr

2 100

50 000

1 200

5 280

30 000

2 920

480

600

2 100

14 665

2 100

11.8

Chapter 11: Property, plant and equipment

1/8

2015 30/6

Depreciation expense – Vehicles Accumulated depreciation (Depreciation on flat-top: 1/12 x ½ (£32 920 + £300 - £14 600)

Dr Cr

776

Accumulated depreciation – Vehicles Vehicles (Write-down of flat-top truck to carrying amount: £9 310 + £776)

Dr Cr

10 086

Vehicles Cash (Overhaul of flat-top truck)

Dr Cr

6 500

776

10 086

6 500

Depreciation expense – Vehicles Dr 10 835 Accumulated depreciation Cr 10 835 (Depreciation on vehicles: delivery truck: £5 355 as per previous year flat-top truck: 11/12 [1/3 (£32 920 + £300 - £9 310 - £776 + £6 500 – (£12 000 - £300)] = £5 480)

Exercise 11.8

DEPRECIATION

Discuss how you would account for the depreciation of the building and how the replacement of the roof would affect the depreciation calculations.

If the roof were treated as a separate component of the building: Roof: depreciation p.a. = £140 000 x 1/20 = £7 000 Rest of building: depreciation p.a. = £700 000 x 1/20 = £35 000 At 1 July 2014, the roof would have been depreciated to £91 000 (being £140,000 less 7 x £7000). This would then be written off on replacement of the roof. The new roof would be depreciated at £12 222, being 1/18 x £220 000 p.a. Further, the rest of the building would have a carrying amount of £455 000, being £700 000 less 7 x £35 000. Depreciation p.a. for the next 18 years would be £25 278. Total depreciation is then £37 500. (£91 000 {written off at 1 July 2014 } + 18 x £37 500 = £766 000) If the roof were not treated as a separate component: Depreciation p.a. = 1/20 x £840 000 = £42 000 At 1 July 2014, the building would have been depreciated to a carrying amount of £546 000, being £840 000 – 7 x £42 000. On replacement of the roof, the total depreciable cost is £766 000, being £546 000 + £220 000. Depreciation p.a. for the next 18 years is £42 556. (18 x £42 556 = £766 000)

11.9

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 11.9

REVALUATION OF ASSETS AND TAX-EFFECT ACCOUNTING

1. Provide the journal entries used to account for this machine over the period 2012 to 2015. 2. For each of the 3 years ended 30 June 2013, 2014 and 2015, calculate the carrying amount and the tax base of the asset, and determine the appropriate tax- effect entry in relation to the machine. Explain your answer. 1. Farida Ltd

Year ended 2013

Asset cost Depreciation Revaluation

Carrying Amount

Tax Base

$100 000 20 000 80 000 5 000 $85 000

$100 000 12 500 87 500 _____ $87 500

Temporary Difference

$2 500

When the asset is revalued upwards the entity will pass the entries: Accumulated depreciation Machine (Writing down to carrying amount)

Dr Cr

20 000

Machine Dr Gain on revaluation of machine (OCI) Cr (Revaluation of machine)

5 000 5 000

Income tax expense (OCI) Deferred tax liability (Tax-effect of revaluation) Gain on revaluation of machine (OCI) Income tax expense (OCI) Asset revaluation surplus (Accumulation of net revaluation gain in equity)

20 000

Dr Cr

1 500

Dr Cr Cr

5 000

1 500

1 500 3 500

Year ended 2014

Asset 1/7/13 Depreciation Revaluation down

Carrying Amount $85 000 21 250 63 750 3 750 $60 000

Tax Base

Temporary Difference

$87 500 12 500 75 000 _____ $75 000

$15 000

When the asset is revalued downwards the entity will pass the entries: Accumulated depreciation Machinery (Writing down to carrying amount)

Dr Cr

21 250

Loss on revaluation of machine (OCI) Machine (Revaluation downwards of asset)

Dr Cr

3 750

Deferred tax liability

1 125

21 250

3 750

11.10

Chapter 11: Property, plant and equipment Income tax expense (OCI) (Tax effect of revaluation decrement subsequent to upwards revaluation)

Asset revaluation surplus Income tax expense (OCI) Loss on revaluation of machine (OCI) (Reduction in equity due to downwards revaluation of asset)

Dr Dr Cr

1 125

2 625 1 125 3 750

Year ended 2015

Asset 1/7/14 Depreciation Revaluation

Carrying Amount $60 000 20 000 40 000 5 000 $45 000

Tax Base

Temporary Difference

$75 000 12 500 62 500 _____ $62 500

$17 500

When the asset is revalued upwards the entity will pass the entry: Accumulated depreciation Machine (Writing down to carrying amount)

Dr Cr

20 000 20 000

Machine Dr Gain on revaluation of machine (OCI) Cr (Revaluation of machine) Income tax expense (OCI) Deferred tax liability (Tax-effect of revaluation) Gain on revaluation of machine (OCI) Income tax expense (OCI) Asset revaluation surplus (Accumulation of net revaluation gain in equity)

5 000 5 000

Dr Cr

1 500

Dr Cr Cr

5 000

1 500

1 500 3 500

11.11

Solutions Manual to accompany Applying IFRS Standards 4e 2. For 2013: In the tax effect worksheet, the temporary difference which is a deductible difference will give rise to a deferred tax asset of 30% of $2500 = $750. However the movement during the year of a credit to the deferred tax liability will mean that the adjustment required at the end of 2013 will be a debit to the deferred tax asset of $2250 ie. $750 – ($1500): $ $ Deferred tax asset Dr 2 250 Income tax expense Cr 2 250 The net effect is a debit balance in the deferred tax account of $750. For 2014: In the tax effect worksheet, the temporary difference which is a deductible difference will give rise to a deferred tax asset of 30% of $15 000 = $4500. However, with the opening balance of $750, and the movement during the year of a debit to the deferred tax account, the adjustment required at the end of 2012 will be a debit to the deferred tax asset of $2625 ie. $4500 – ($750 + $1125). Deferred tax asset Income tax income

Dr Cr

2 625 2 625

The net effect is a debit balance in the deferred tax account of $4500.

For 2015: In the tax effect worksheet, the temporary difference which is a deductible difference will give rise to a deferred tax asset of 30% of $17 500 = $5250. However, with the opening balance of $4 500, and the movement during the year of a credit to the deferred tax liability will mean that the adjustment required at the end of 2015 will be a debit to the deferred tax asset of $2250 ie. $5250 – ($4500 - $1500): Deferred tax asset Income tax income

Dr Cr

2 250 2 250

The net effect is a debit balance in the deferred tax account of $5250. On sale of the asset for $45 000, the entity will recognise a zero gain/loss on sale. For tax purposes, there is a tax loss of $17 500 i.e. $45 000 - $62 500. The difference is $17 500. The journal entry for tax to reverse the balance in the deferred tax account is: Income tax income Deferred tax asset

Dr Cr

5 250 5 250

11.12

Chapter 11: Property, plant and equipment Exercise 11.10 ACQUISITION AND SALE OF ASSETS, DEPRECIATION (Show all workings and round amounts to the nearest pound) Prepare journal entries to record the transactions and events for the reporting period ended 30 June 2015 (narrations are not required). Thader Turf Farm Part 1 – General Journal Entries DATE 10/08/14

16/08/14

03/09/14

19/09/14

01/12/14

DETAILS

Irrigation equipment Cash

37 000

Irrigation equipment Cash

500

Repairs and maintenance expense Cash

800

37 000

500

8 00

Irrigation equipment Cash

9 600

Depreciation – Turf cutter Accumulated depreciation – Turf cutter ([£65 000 – £3 200]/5 x 5/12 = £5150)

5 150

Carrying amount – Turf cutter (£65 000 – £47 517) Accumulated depreciation – Turf cutter (£42 367 + £5150) Turf Cutter

17 483 47 517

9 600

5 150

65 000 01/12/14

28/03/15

30/06/15

Turf cutter Cash Proceeds on sale – Turf cutter

80 000

Depreciation - Building Accumulated depreciation - Building (£150 000 – £40 000)/20 x 9/12 = £4125

4 125

Accumulated depreciation – Building (£23 375 + £4125) Office building

27 500

Office building Cash

49 000

Depreciation expense – Turf cutter Accumulated depreciation – Turf cutter (£80 000 – £5 000)/6 x 7/12 = £7292

7 292

Depreciation expense – Water desalinator Accumulated depreciation – Water desalinator (£189 000 – £18 000)/9 = £19 000

19 000

Depreciation expense – Irrigation equipment Accumulated depreciation – Irrigation equipment (£47 100 – 0)/4 x 9/12 = £8831

8 831

61 000 19 000

4 125

27 500

49 000

7 292

19 000

8 831

11.13

Solutions Manual to accompany Applying IFRS Standards 4e 30/06/15

30/06/15

Depreciation expense – Building Accumulated depreciation - Building £150 000 – £27 500 + £49 000 = £171 500 (£171 500 – £40 000 + £5 000)/(20 -5 + 4) = £6658 p.a. £6658 x 3/12 = £1665

1 665

Accumulated depreciation – Water desalinator Water desalinator (Writing down to carrying amount)

19 000

1 665

19 000

Loss on revaluation of desalinator (OCI) Water desalinator (Revaluation downwards from carrying amount of £170 000 (being £189 000 - £19 000) to fair value of £165 000)

5000

Deferred tax liability Income tax expense (OCI) (Tax-effect of revaluation decrement subsequent to previous increment)

1500

Asset revaluation surplus Income tax expense (OCI) Loss on revaluation of desalinator (OCI) (Reduction in accumulated equity due to revaluation decrement on land)

3500 1 500

5 000

1500

5000

11.14

Chapter 11: Property, plant and equipment Exercise 11.11

REVALUATION OF ASSETS

Prepare the journal entries in the records of Themar Ltd to record the described events over the period 1 July 2012 to 30 June 2014, assuming the ends of the reporting periods are 30 June 2013 and 30 June 2014.

Themar Ltd 1 July 2012 Machine A Machine B Cash

Dr Dr Cr

100 000 60 000

Depreciation expense – Machine A Accumulated depreciation (1/5 x £100 000)

Dr Cr

20 000

Depreciation expense – Machine B Accumulated depreciation (1/3 x £60 000)

Dr Cr

20 000

Accumulated depreciation- Machine A Machine A (Writing down to carrying amount)

Dr Cr

20 000

160 000

30 June 2013

20 000

Machine A Dr Gain on revaluation of Machine A (OCI) Cr (Revaluation increment: £80 000 to £84 000)

4 000 4 000

Income tax expense (OCI) Deferred tax liability (Tax effect of revaluation increment)

Dr Cr

1 200

Gain on revaluation of Machine A (OCI) Dr Income tax expense (OCI) Cr Asset revaluation surplus – Machine A Cr (Accumulation of net revaluation gain in equity))

4 000

Accumulated depreciation – Machine B Machine B (Writing down to carrying amount)

Dr Cr

20 000

Expense – revaluation decrement (P&L) Machine B (Revaluation to fair value at 30/6/13)

Dr Cr

2 000

Machine C Cash (Acquisition of machine C)

Dr Cr

80 000

Depreciation expense – Machine B Accumulated depreciation (1/2 x /1/2 x £38 000)

Dr Cr

9 500

1 200

1 200 2 800

20 000

2 000

1 January 2014

80 000

9 500

11.15

Solutions Manual to accompany Applying IFRS Standards 4e Cash

Dr Cr

29 000

Carrying amount of Machine B Sold Accumulated depreciation Machine B (Carrying amount of machine sold)

Dr Dr Cr

28 500 9 500

General reserve Asset revaluation surplus – Machine A Share Capital

Dr Dr Cr

8 000 2 000

Depreciation expense – Machine A Accumulated depreciation (1/4 x £84 000)

Dr Cr

21 000

Depreciation expense – Machine C Accumulated depreciation (1/4 x ½ x £80 000)

Dr Cr

10 000

Accumulated depreciation – Machine A Machine A (Writing down to carrying amount)

Dr Cr

21 000

Loss on revaluation of Machine A (OCI) Machine A (Write down of plant from £63000 to £61000)

Dr Cr

2 000

Deferred tax liability Income tax expense (OCI) (Tax-effect on downward revaluation subsequent to upward revaluation)

Dr Cr

600

Asset revaluation surplus – Machine A Income tax expense (OCI) Loss on revaluation of plant (P&L) Loss on revaluation of plant (OCI) (Accumulation of revaluation loss to equity)

Dr Dr Dr Cr

800 600 600

Accumulated depreciation – Machine C Machine C (Writing down to carrying amount)

Dr Cr

10 000

Loss on revaluation (P&L) Machine C (Revaluation to fair value at 30/6/14)

Dr Cr

1 500

Proceeds on sale of Machine B (Sale of Machine B)

29 000

38 000

10 000

30 June 2014

Exercise 11.12

21 000

10 000

21 000

2 000

600

2 000

10 000

1 500

ACQUISITIONS, DISPOSALS, TRADE-INS, OVERHAULS, DEPRECIATION

Part A: Prepare journal entries (narrations are required) to record the transactions and events for the year ended 30 June 2013. Part B: If Axel Schulz accepts the exchange offer, what amount would the business use to record the acquisition of the fish-finding equipment? Why? Justify your answer by reference to the requirements of IAS 16 relating to the initial recognition of a property, plant and equipment item. © John Wiley and Sons, Ltd, 2016

11.16

Chapter 11: Property, plant and equipment

Part A Wremen Fishing Charters

General journal entries

DATE 26/07/12

04/12/12

06/02/13

DETAILS Depreciation – boats Accumulated depreciation – boats (Depreciation of boat 1 to date of sale: 1/12 x 1/5 [$62 000 – 3000])

Cr 983 983

Accumulated depreciation - boats Carrying amount of boat sold Boats (Derecognition of boat 1 on sale: $11 800 x 53/12 = $52 117)

52 117 9 883

Boats Proceeds on sale of boat Cash (Purchase of boat 5 and trade in of boat 1)

85 600

Depreciation – processing plant Accumulated depreciation – processing plant (Depreciation to date of overhaul: [$148 650 – 81 274] x 30% x 5/12)

8 422

Accumulated depreciation – processing plant Processing plant (Write down to carrying amount prior to overhaul)

89 696

Processing plant Cash (Overhaul of plant) (New depreciable amount : = $148 650 + $62 660 – $89 696 = $121 614)

62 660

Depreciation - boats Accumulated depreciation – boats (Depreciation to date of scrapping: [$78 600 – $3 600]/4 x 7/12 = $10 937)

10 937

Accumulated depreciation – boats Carrying amount of boat scrapped Boats (Derecognition of boat 3 at the end of its useful life: [$78 600 -$3 600]/4 x 48/12)

75 000 3 600

62 000

8 900 76 700

8 422

89 696

62 660

10 937

78 600

11.17

Solutions Manual to accompany Applying IFRS Standards 4e Part A GENERAL JOURNAL ENTRIES

DATE 30/06/13

DETAILS

Depreciation – boats Accumulated depreciation – boats (Depreciation charge for the year: Boat 2: ($66 400 – $3 400)/5 = $12 600 Boat 4: ($84 200 – $3 800)/6 = $13 400 Boat 5: ($85 600 – $4 120)/6 x 11/12 = $12 448

38 448

Depreciation – processing plant Accumulated depreciation – processing plant (Depreciation charge for the year: $121 614 x 25% x 7/12)

17 735

38 448

17 735

Part B IAS 16 requires property, plant and equipment items to be initially recognised at cost. Cost is further defined as the ‘amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction’. In this situation, the fish finder is acquired by exchange – no cash is paid – hence, the ‘cost’ of the asset will be measured by reference to the fair value of the consideration given in exchange, that is, boat 2. Thus, the fish finder would be recognised at a cost of $9100 this being the fair value of boat 2.

Exercise 11.13

REVALUATION OF ASSETS AND TAX-EFFECT ACCOUNTING

1. Calculate, by using worksheets, the amounts of income tax expense and current and deferred income tax assets/liabilities for the reporting period ended 30 June 2013. 2. Prepare the deferred tax asset and deferred tax liability accounts. Chartres Ltd 1. Determination of Taxable Income (for year ended 30 June 2013) £ Accounting profit before income tax Add: Write-down of furniture Goodwill impairment Depreciation of plant Depreciation of furniture Entertainment costs Doubtful debts expense Holiday pay expense Long service leave expense Deduct: Bad debts written off Holiday pay paid Long service leave paid Depreciation of furniture for tax Depreciation of plant for tax Taxable income Current tax liability @ 30%

£ 375 000 5 000 13 000 50 000 5 000 12 000 55 000 30 000 40 000 35 000 20 000 20 000 7 500 75 000

210 000

(157 500) 427 500 $128 250

11.18

Chapter 11: Property, plant and equipment CALCULATION OF DEFERRED TAX Carrying Amount

Assets Cash Receivables Inventory Plant Furniture Goodwill Liabilities Payables Holiday pay Long service leave Temporary differences Exempt differences Net temporary differences Deferred tax liability Deferred tax asset Beginning balances Movement during year * Adjustment *

Taxable Amount

Deductible Amount

Tax Base

Taxable Temporary Differences

82 000 545 000 158 000 320 000 65 000 50 000

0 0 158 000 (320 000) (65 000) (50 000)

0 40 000 158 000 250 000 55 000 0

82 000 585 000 158 000 250 000 55 000 0

265 000 30 000 50 000

0 0

0 (30 000) (50 000)

265 000 0 0

Deductible Temporary Differences £ 40 000 -

70 000 10 000 50 000 -

30 000 50 000

130 000 50 000

120 000 -

80 000

120 000

24 000 36 000 11 250

21 000

6 000 6 750

15 000

Furniture was revalued downwards by £5000; however, as the furniture had not previously been revalued upwards, there is no effect on the deferred tax liability. Plant was revalued upwards by £20 000 giving rise to credit to the deferred tax liability of £6000. Net movement is £6000.

The entries for income tax, current and deferred, are: Income tax expense (current) Current tax liability

Dr Cr

128 250

Deferred tax asset Deferred tax liability Income tax income (deferred)

Dr Cr Cr

15 000

128 250

6 750 8 250

11.19

Solutions Manual to accompany Applying IFRS Standards 4e 2.

1/07/12 30/06/13 1/07/13

Balance b/d

Deferred Tax Asset £ 21 000 30/06/13 15 000 36 000 36 000

Balance c/d

Deferred Tax Liability £ 1/07/12 30/06/13 24 000 30/06/13

Balance b/d Income tax expense

Balance c/d

36 000

Balance b/d Revaluation Income tax expense

24 000 1/7/13

Exercise 11.14

£ 36 000

Balance b/d

£ 11 250 6 000 6 750 24 000 24 000

COST OF ACQUISITION

1. Prepare a schedule with the following column headings. Analyse each transaction, enter the payment or receipt in the appropriate column, and total each column.

2. Prepare the journal entry to close the £1 009 700 balance of the Property ledger account. Borod Ltd 1. Item

Land

a). b). c). d). e). f). g). h). i). j). k). l). m).

170 000

TOTAL

192 900

Land Improvements

Building

Manufacturing Equipment

Other

23 000 28 000 1 700 15 000 250 000 148 000 (6 800) 350 000 22 000 1 900 4 200 2 700 -

660 000

154 100

2 700

Journal entry:

Land Buildings

Dr Dr © John Wiley and Sons, Ltd, 2016

192 900 660 000 11.20

Chapter 11: Property, plant and equipment Manufacturing equipment Repairs expense Property (Cost of acquisition reallocated)

Dr Dr Cr

154 100 2 700 1 009 700

11.21

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 11.15

DECLINE IN VALUE OF ASSETS

A new accountant has been appointed to the firm of Gutenberg Ltd, which owns a large number of depreciable assets. Upon analysing the firm’s depreciation policy, the accountant has implemented a new policy based on the principle that the depreciation rate for particular assets should measure the decline in the value of the assets. Discuss this policy change. It could be argued that there are 2 concepts of depreciation, namely: -

a process of allocation, and a change in the value of an asset.

There are at least 3 variables that cause a change in value of an asset over the period: -

a reduction in value due to the use of the asset over the period, an increase/decrease in the value due to a change in the general price level, a change in the specific price level for this type of asset

Where depreciation is calculated as an allocation of the cost of the asset, what is being measured is variable (1) above. If depreciation is measured as a change in the value of an asset, the depreciation charge is a mixture of all the above variables. IAS 16 para. 6 describes depreciation as a systematic allocation, hence adopting the process of allocation approach. Hence if the accountant wants to adopt accounting policies that are compliant with international accounting standards, then he/she will need to change the depreciation policy to one of allocation rather than change in value.

Exercise 11.16

DEPRECIATION CHARGES

The management of Carlsberg Ltd has been analysing the financial reports provided by the accountant, who has been with the firm for a number of years. Management has expressed its concern over depreciation charges being made in relation to the company’s equipment. In particular, it believes that the depreciation charges are not high enough in relation to the factory machines because new technology applied in that area is rapidly making the machines obsolete. Management’s concern is that the machines will have to be replaced in the near future and, with the low depreciation charges, the fund will not be sufficient to pay for the replacement machines. Discuss. Two key mistakes are being made by management: (i) (ii)

the depreciation charge relates to the replacement cost of the asset, and charging depreciation results in the creation of a fund for the replacement of assets.

Re (i): depreciation is an allocation of the depreciable amount of an asset. The depreciable amount is the cost or other amount substitute for cost. Under IAS 16, there are two measurement models available namely the cost model and the revaluation model. Under the revaluation model, an asset can be carried at fair value. Neither of these models result in a depreciation charge that measures the replacement cost of the asset. However, note para. 33 of IAS 16: where there is no market-based evidence of fair value, an entity may use, as an estimate of fair value, a depreciated replacement cost approach. IAS 16 does not give any information as to how this method works, for example whether it is based on the replacement cost of a similar asset or the replacement cost of a new asset. Given that replacement cost is used as an estimate of fair value, it is more likely that a replacement cost of used assets would be used. Again, the depreciation charge is not related to the cost of new replacement assets. Re (ii): Depreciation is a book entry. It does not reflect cash flows. There are no monies deposited in a sinking fund to replace the assets being depreciated. © John Wiley and Sons, Ltd, 2016

11.22

Chapter 11: Property, plant and equipment Even if the entity creates an asset replacement reserve as an appropriation of retained earnings, there is no cash fund as this is also a book entry.

Exercise 11.17

REVALUATION OF ASSETS

1. Prepare any necessary entries to revalue the building and the vehicle as at 30 June 2014. 2. Assume that the building and the vehicle had remaining useful lives of 25 years and 4 years respectively, with zero residual value. Prepare entries to record depreciation expense for the year ended 30 June 2015 using the straight-line method. Meezen Ltd General Journal A. Accumulated depreciation – Building Building (Writing down to carrying amount)

Dr Cr

100 000

Loss on revaluation of building (P&L) Loss on revaluation of building (OCI) Building (Revaluation downwards of building)

Dr Dr Cr

20 000 20 000

Deferred tax liability Income tax expense (OCI) (Tax-effect of revaluation decrement on previously revalued asset)

Dr Cr

6 000

Asset revaluation surplus - Building Income tax expense (OCI) Loss on revaluation of building (OCI) (Reduction in accumulated equity due to revaluation decrement on building)

Dr Dr Cr

14 000 6 000

Accumulated depreciation – Vehicle Vehicle (Writing down to carrying amount)

Dr Cr

40 000

Vehicle Gain on revaluation of vehicle (OCI) (Revaluation to fair value)

Dr Cr

10 000

Income tax expense (OCI) Deferred tax liability (Tax-effect of revaluation increment)

Dr Cr

3 000

Gain on revaluation of vehicle (OCI) Income tax expense (OCI) Asset revaluation surplus - vehicle

Dr Cr Cr

10 000

Depreciation expense – Building Accumulated depreciation – Building ($160 000/25)

Dr Cr

6 400

100 000

40 000

6 000

20 000

40 000

10 000

3 000

3 000 7 000

Depreciation expense – Vehicle Dr 22 500 Accumulated depreciation – Vehicle Cr ($90 000/ 4) © John Wiley and Sons, Ltd, 2016

6 400

22 500 11.23

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 11.18

BUILDING COSTS

Chua Ltd has acquired a new building. Which of the following items should be included in the cost of the building? (a) Stamp duty (b) Real estate agent’s fees (c) Architect’s fees for drawings for internal adjustments to the building to be made before use (d) Interest on the bank loan to acquire the building, and an application fee to the bank to get the loan, which is secured on the building (e) Cost of changing the name on the building (f) Cost of changing the parking bays (g) Cost of refurbishing the lobby to the building to attract customers and make it more user friendly

See paragraph 16 of IAS 16 Include: (a) (b) (c) (d) (e) (g)

stamp duty real estate agent’s fees architect’s fees interest [ may be expensed or capitalised – see IAS 123 Borrowing Costs] costs of changing name on building costs of refurbishing lobby

Exclude: (f)

these may be considered as a separate asset, depends for example whether the parking bays are an integral part of the building or external to the building

Exercise 11.19

CAPITALISATION

Rennau Ltd has acquired a new machine, which it has had installed in its factory. Which of the following items should be capitalised into the cost of the building? (a) Labour and travel costs for managers to inspect possible new machines and for negotiating for a new machine (b) Freight costs and insurance to get the new machine to the factory (c) Costs for renovating a section of the factory, in anticipation of the new machine’s arrival, to ensure that all the other parts of the factory will have easy access to the new machine (d) Cost of cooling equipment to assist in the efficient operation of the new machine (e) Costs of repairing the factory door, which was damaged by the installation of the new machine (f) Training costs of workers who will use the machine See paragraph 16 of IAS 16. Include: (a) (b) (c) (d)

labour and travel costs freight costs costs of renovating cost of cooling equipment

Exclude: (e) costs of repair – these are not directly attributable to bringing the asset to its location & condition for operation. These costs should be expensed. (f)

training costs – these benefits cannot be controlled

11.24

Chapter 11: Property, plant and equipment Exercise 11.20 DEPRECIATION CALCULATION 1. Discuss how the costs relating to the aircraft should be accounted for. 2. Determine the expenses recognised for the 2014–15 financial year.

1. Discuss: - the advantages of a components approach versus a simple depreciation of the $10 million dollars over the 10-year period. - the treatment of the upgrades of cockpit equipment - accounting for inspections 2. Aircraft body: Annual expense of $5000 for inspection for cracks Depreciation expense = 1/10 (3 000 000 – 3/7 x $2 100 000) = $210 000 Engines: Depreciation expense = 4 000 000/4 = $1 000 000 Maintenance expense = $300 000 Fittings Seats: Depreciation = 1/3 x $1 000 000 = $333 333 Annual expense = $100 000 Carpets: Depreciation = 1/5 x 50 000 = $10 000 Cleaning = $10 000 Electrical: Passenger Annual expense = $15 000 Depreciation = 1/6 x $200 000 = $33 333 Electrical: Cockpit Annual expense = $250 000 Depreciation = 1/10 x $1 500 000 = $150 000 Food preparation equipment: Annual expense = $20 000 Depreciation = 250 000/6 = $41 667 For the 2014–15 year: Total other expenses = $700 000 Annual depreciation = $778 333

11.25

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 11.21

ACQUISITIONS, DISPOSALS, DEPRECIATION

(Show all workings and round amounts to the nearest dollar.) Prepare journal entries to record the transactions and events for the period 1 July 2013 to 30 September 2016. (Narrations are not required.) Meerbeck Ltd

General journal entries DATE

DETAILS 2013 1 July

5 July

2014 30 June

2015 30 June

30 June

Equipment Cash

39 800

Equipment Cash

4 200

Depreciation – Equipment Accumulated depreciation - Equipment ($44 000 – $1 800)/10 = $4220

4 220

Depreciation – Equipment Accumulated depreciation - Equipment {($44 000 – $1200)/4 = $8560 + prospective adjustment for change in estimates [$8560 – 4220] = $4340}

12 900

Accumulated depreciation – Equipment Equipment (Write down to carrying amount)

17 120

Equipment Gain on revaluation of equipment (OCI) (Fair value $30 000; Carrying amount $26 880; Revaluation increase $3120)

3 120

39 800

4 200

Income tax expense (OCI) Deferred tax liability (Tax-effect of revaluation increment)

2016 30 June

4 220

12 900

17 120

3 120

936 936

Gain on revaluation of equipment (OCI) Income tax expense (OCI) Asset revaluation surplus (Transfer to accumulated equity subsequent to revaluation of asset)

3 120

Depreciation – Equipment Accumulated depreciation – Equipment ($30 000 – $1200)/3 = $9600

9 600

Accumulated depreciation – Equipment Equipment

9 600

936 2184

9 600

2016 30 June

9 600

11.26

Chapter 11: Property, plant and equipment (Write down to carrying amount) Loss on revaluation of plant (OCI) Loss on revaluation of plant (P&L) Plant (Fair value $16 000; Carrying amount $20 400; Revaluation decrease $4400) Deferred tax liability Income tax expense (OCI) (Tax effect on decrement relating to prior increment)

2016 30 Sept

3120 1280 4 400

936 936

Asset revaluation surplus Income tax expense (OCI) Loss on revaluation of plant (OCI) (Reduction in accumulated equity due to devaluation of plant)

2 184 936

Depreciation expense – Equipment Accumulated depreciation - Equipment 3/12 x [$16 000 – $1200]/2

1 850

Accumulated depreciation – Equipment Carrying amount of Equipment Equipment

1 850 14 150

Cash Proceeds on sale – Equipment

8 400

Exercise 11.22

3 120

1 850

16 000

8 400

CLASSIFICATION OF ACQUISITION COSTS

Using the information provided, determine what assets Alsbach Ltd should recognise and the amounts at which they would be recorded. Alsbach Ltd

Land: Option cost £100 Settlement agent Rates Land Demolition of old building Proceeds on sale of material

10 000 5 000 100 000 12 000 (5 500) £121 600

Building

Architects Council Fence Building Safety inspection Removal of safety fence

£23 000 12 000 3 400 240 000 3 000 2 000 £283 400

Improvements:

Driveway et al New fence

£54 000 8 000 £62 000

Equipment:

Cost

£64 000 © John Wiley and Sons, Ltd, 2016

11.27

Solutions Manual to accompany Applying IFRS Standards 4e Freight & Insurance Installation Safety equipment Adjustments

5 600 12 000 11 000 3 300 £95 900

Options on land not acquired: expense £200 Interest: £40 000 must be capitalised if relates to a qualifying asset; otherwise it is expensed. The only possible qualifying asset is the factory. In this example, it may be necessary to apportion the interest, depending on what loan was used for – see IAS 23 Borrowing Costs. Advertising: expense £500 Opening ceremony: expense £6000

11.28

Chapter 11: Property, plant and equipment Exercise 11.23

ACQUISITIONS, REVALUATIONS, REPLACEMENTS, DEPRECIATION

Prepare general journal entries to record the above transactions and the depreciation journal entries required at the end of each reporting period up to 30 June 2013. (Narrations are not required but show all workings.) Hamburg Trading 1.

GENERAL JOURNAL ENTRIES DATE

2013 Jan 1

June 30

2014 June 30

DETAILS Machine A Machine B Cash

40 000 100 000 140 000

Depreciation – Machinery Accumulated Depreciation – Machinery (A:[ $40 000 – $2000]/10 x 6/12 = $1900 + B: [$100 000 – $5000]/10 x 6/12 = $4750)

6 650

Depreciation – Machinery Accumulated Depreciation – Machinery (A: $40 000 – $2000/10 = $3800 + B: $100 000 – $5000/10 = $9500)

13 300

Accumulated Depreciation – Machinery Machine A (Writing down to carrying amount)

5 700

Loss on revaluation - Machinery (P&L) Machine A (Machine A: Carrying amount $34 300 =40 000 – 5700 Fair value $32 000 Revaluation decrease $2300)

2 300

Accumulated Depreciation – Machinery Machine B (Writing down to carrying amount)

14 250

Machine B Gain on revaluation of Machine B (OCI) (Machine B: Carrying amount $85 750 =$100000 – $14 250 Fair value $90 000 Revaluation increase $4250)

4 250

Income tax expense (OCI) Deferred tax liability (Tax effect of gain on revaluation)

2015 Jan 2

6 650

13 300

5 700

2 300

14 250

4 250

1 275 1 275

Gain on revaluation of Machine B (OCI) Income tax expense (OCI) Asset revaluation surplus – Machine B (Accumulation of net revaluation gain in equity)

4 250

Depreciation – Machine B Accumulated depreciation – Machine B (Depreciation to date of overhaul: [$90 000 – $4000]/8 x 6/12 = $5375)

5 375

1 275 2 975

5 375

11.29

Solutions Manual to accompany Applying IFRS Standards 4e

Mar 31

Accumulated depreciation - Machine B Machine B

5 375

Machine B Cash

66 000

Depreciation – Machine A Accumulated depreciation – Machine A (Depreciation to date of sale: [$32 000 – $1500]/8 x 9/12 = $2859)

2 859

Accumulated depreciation – Machine A Machine A Machine C Cash Loss on sale of Machine A (Trade-in of Machine A as part cost of Machine C)

2 859

66 000

Machine C Cash (Installation costs on Machine C) June 30

5 375

2 859

32 000 64 000 36 000 1141

950 950

Depreciation – Machine B Accumulated depreciation – Machine B (Depreciation of machine B: ($90 000 – $5375 + $66 000 – $9450 = $141 175 $141 175/[8 – 0.5 + 3.5] x 6/12 = $6417)

6 417

Depreciation – Machine C Accumulated depreciation – Machine C (Depreciation of Machine C: [$64 950 – 8000]/8 x 3/12 = $1780) Accumulated depreciation – Machine B Machine B (Writing down to carrying amount)

1 780

Loss on revaluation of Machine B (OCI) Machine B (Machine B: Carrying amount $144 208= $150 625 - $6417 Fair value $140 000 Revaluation decrease $4208)

4 208

6 417

1 780

6 417 6 417

4 208

1 262 Deferred tax liability Income tax expense (OCI) (Tax effect on devaluation of asset previously revalued upwards) Asset revaluation surplus – Machine B Income tax expense (OCI) Loss on revaluation of Machine B (Accumulation of net loss to equity)

1 262

2 946 1 262 4 208

11.30

Chapter 11: Property, plant and equipment Accumulated depreciation – Machine C Machine C (Writing down to carrying amount)

1 780

Machine C Gain on revaluation of Machine C (OCI) (Machine C: Carrying amount $63 170 [64 950 – 1780] Fair value $65 000 Revaluation increase $1830)

1 830

1 780

1 830

Income tax expense (OCI) Deferred tax liability (Tax effect of revaluation increment)

549 549

Gain on revaluation of Machine C (OCI) Income tax expense (OCI) Asset revaluation surplus – Machine C

Exercise 11.24

1 830 549 1 281

DEPRECIATION CALCULATION

1. Record each of the transactions. The end of the reporting period is 30 June. 2. Determine the depreciation expense for Osamu Ltd for 2013–14. Osamu Ltd 1. 2013 1/9 Depreciation expense Accumulated depreciation (Depreciation on machine to be sold: 1/6 x 10%[$8200 – $820])

Dr Cr

123

Machine Dr Cash Cr Gain on sale Cr Accumulated depreciation Dr Machine Cr (Trade-in of machine) Carrying amount of machine sold: $8200 less 38/12 x 10% [$8200 – $820] = $5863)

15 000

123

8 800 337 2 337 8 200

Depreciation expense Accumulated depreciation (Depreciation on machine sold: 1/6 x 10%[$9000 – $900])

Dr Cr

135

Cash

Dr Cr Cr Cr

7 300

Dr Cr

180

Gain on sale of machine Accumulated depreciation * Machine (Sale of machine) * 29/12 x 10% [$9000 – $900] = $1958)

135

258 1 958 9 000

2014 1/1 Depreciation expense Accumulated depreciation (Depreciation on machine sold: ½ x 10% [$4000 –$ 400])

180

11.31

Solutions Manual to accompany Applying IFRS Standards 4e Cash Loss on sale of machine Accumulated depreciation * Machine (Machine sold) *9.5 x 10% [$4000 – $400] = $3420

Dr Dr Cr Cr

500 80 3 420 4 000

2014 1/1

Working: Cost Depreciation (3 x 10% x 6 300) New motor Carrying amount

$7 000 1 890 5 110 4 800 $9 910

New depreciation per annum = 1/9 [$9910 – $991] = $991 Depreciation expense Accumulated depreciation (Depreciation on machine overhauled: ½ x 10% [$7000 – $700])

Dr Cr

315

Machine Accumulated depreciation Cash (Adjustment due to overhaul of machine)

Dr Dr Cr

2 910 1 890

Dr Cr

1 200

2014 1/4 Arm Cash (Acquisition of equipment)

315

4 800

1 200

2. Working: Machinery on hand at 1 July 2013 and still on hand at 30 June 2014: = $420 000 – $8200 – $9000 – $4000 – $7000 = $391 800 Depreciation = 10%[$391 800 – $39 180] = $35 262 Depreciation on new or replaced machines: 10% x 10/12 [$15 000 – $1500] = $1125 ½ x 1/9 [$9910 – $991] = $496 Depreciation on arm: 1/15 x 3/12 x $1200 = $20 Total depreciation for 2013-14 = $35 262 + $1125 + $496 + $20 = $36 903

11.32

Chapter 11: Property, plant and equipment Exercise 11.25 DEPRECIATION Prepare general journal entries to record the above transactions. ALICE LTD

JOURNAL ENTRIES 2014 03/01

22/06

28/08

31/12

Machine 3 Cash (Machine 3 acquired: $57 000 + $442 + $1758)

Dr Cr

59 200

Vehicles Cash (Vehicle acquired: $15 200 + $655 + $345)

Dr Cr

16 200

Depreciation expense – Machine 1 Accumulated depreciation – Machine 1 (Machine 1 depreciation: ($43 000 – $2 500)/5 x 8/12)

Dr Cr

5 400

Office furniture Dr Accumulated depreciation – Machine 1* Dr Gain on sale ** Cr Machine 1 Cr (Disposal of Machine 1 and acquisition of office furniture) * 1/5($43 000 – $2 500) x 47/12 ** Proceeds: $11 500 Carrying amount: $43 000 – $31 725 = $11 275)

11 500 31 725

59 200

16 200

5 400

225 43 000

Depreciation expense – Buildings Dr 9 036 Depreciation expense – Machinery Dr 18 540 Depreciation expense – Vehicles Dr 14 098 Depreciation expense – Office furniture Dr 457 Accumulated depreciation – Buildings Cr Accumulated depreciation – Machinery Cr Accumulated depreciation - Vehicles Cr Accumulated depreciation – Office furniture Cr (Depreciation of assets) Buildings: ($185 720 – $5000)/20 years Machinery: [Machine 2: ($48 000 – $3000)/6yrs = $7500] + [Machine 3: ($59 200 – $4000)/5yrs = $11 040]) Vehicles: [($46 800 – $19 656) x 40% = $10 858] + [$16 200 x 40% x 6/12 = $3240] Office furniture: [($11 500 – $540)/8 x 4/12 = $457)

9 036 18 540 14 098 457

Note: CA of old vehicles is now = $27 144 – $10 858 = $16 286 CA of new vehicle is now = $16 200 – $3240 = $12 960) 2015 30/04

25/05

Repairs and maintenance expense Cash (Repairs and maintenance on machinery)

Dr Cr

928

Depreciation expense – Vehicles Accumulated depreciation – Vehicles (One old vehicle depreciation: $16 286/2 x 40% x 5/12)

Dr Cr

1 357

928

1 357

11.33

Solutions Manual to accompany Applying IFRS Standards 4e

Accumulated depreciation – Vehicles * Cash Loss on vehicle sold ** Vehicles (Disposal of 1 old vehicle) * ($19 656 + $10 858)/2 + $1357 ** Proceeds of sale $6600 Carrying amount $6786

26/06

31/12

Land improvements Cash (Installation of fence)

Dr Dr Dr Cr

Dr Cr

16 614 6 600 186 23 400

5 500 5 500

Depreciation expense – Buildings Dr 9 036 Depreciation expense – Machinery Dr 18 540 Depreciation expense – Vehicles Dr 8 441 Depreciation expense – Office furniture Dr 1 370 Depreciation expense – Land improvements Dr 275 Accumulated depreciation - Buildings Cr Accumulated depreciation - Machinery Cr Accumulated depreciation - Vehicles Cr Accum. depreciation – Office furniture Cr Accum. depreciation – Land improvements Cr (Depreciation of assets) Buildings: ($185 720 - $5000)/20 yrs = $9036 Machinery: [Machine 2: ($48 000 – $3 000)/6yrs = $7 500] + [Machine 3: ($59 200 – $4 000)/5yrs = $11 040]) Vehicle: [$8 143 + $12 960] x 40% = $8 441) (Office furniture: ($11 500 -$540)/8yrs = $1 370) (Land improvements: [($5 500 – 0)/10 x 6/12 = $275)

9 036 18 540 8 441 1 370 275

CA of old vehicle is now = $8 143 – [$8 143 x 40%] = $4 886) CA of new vehicle is now = $12 960 – [$12 960 x 40%] = $7 776)

2016 05/01

Accumulated depreciation – Machine 2 Machine 2 (Machine 2 written down to CA: $7 500 x 59/12)

Dr Cr

36 875

Machine 2 Cash (Machine 2 overhauled)

Dr Cr

12 000

Machine 2’s total cost ($48 000 + $12 000) Accum. depreciation to 31/12/12 - ($7 500 x 59/12) Carrying amount at 05/01/13 Revised estimated residual value Revised depreciable amount

36 875

12 000

$60 000 (36 875) 23 125 (5 000) $18 125

M2’s remaining useful life

= = =

6 years – 4 years 11 months + 1 year 2 years 1 month 25 months

M2’s depreciation expense p.a.

$18 125/25 x 12

11.34

Chapter 11: Property, plant and equipment =

20/06

04/10

31/12

$8 700

Depreciation expense – Vehicles Accumulated depreciation – Vehicles (1 old vehicle depreciation: $4886 x 40% x 6/12)

Dr Cr

977

Vehicles * Accumulated depreciation – Vehicles ** Loss on sale of vehicle *** Cash **** Vehicles (Trade-in of old vehicle for new vehicle) * $3 700 + $22 000 + $500 + $800 **$15 257 at 31/12/11 + $3 257 + $977 = $19 491 *** Carrying amount = $3 909 = $23 400 - $19 491 Proceeds = $3 700) **** $22 000 + $500 + $800

Dr Dr Dr Cr Cr

27 000 19 491 209

Depreciation expense – Vehicles Accumulated depreciation – Vehicles (Depreciation of vehicles: $7776 x 40% x 9/12)

Dr Cr

2 333

Accumulated depreciation – Vehicles * Loss on scrapping of vehicles ** Vehicles (Vehicle scrapped) * $3240 + $5184 + $2333 ** $16 200 – $10 757

Dr Dr Cr

10 757 5 443

977

23 300 23 400

2 333

Depreciation expense - Buildings Dr 9 036 Depreciation expense – Machinery Dr 19 740 Depreciation expense – Vehicles Dr 5 400 Depreciation expense – Office furniture Dr 1 370 Depreciation expense – Land improvements Dr 550 Accumulated depreciation – Buildings Cr Accumulated depreciation – Machinery Cr Accumulated depreciation - Vehicles Cr Accumulated depreciation – Office furniture Cr Accum. Depreciation – Land improvements Cr (Depreciation expense) Buildings: ($185 720 - $5 000)/20yrs Machinery: [Machine 2 = $8700] + [Machine 3 = $55 200/5y = $11 040] Vehicles: [$27 000 x 40% x 6/12 ] Office furniture: $10 960/8 years Land improvements: $5 500/10 years)

16 200

9 036 19 740 5 400 1 370 550

Note: CA of vehicles is now = $27 000 – $5 400 = $21 600)

11.35

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 11.26

DEPRECIATION

Prepare general journal entries to record the above transactions. Chorin Ltd

GENERAL JOURNAL ENTRIES 03/08/13

15/11/13

30/12/13

10/03/14

30/06/14

Machine 4 Cash (Purchase of Machine 4)

Dr Cr

37 800

Repairs expense Cash (Payment of vehicle repairs)

Dr Cr

600

Depreciation – Vehicles Accumulated depreciation – Vehicles (Depreciation of vehicles: ($160 000 – $89 440)/4 x 30% x 6/12)

Dr Cr

2 646

Fixtures Accumulated depreciation – Vehicles * Gain on sale of vehicles ** Vehicles (Disposal of vehicle for fixtures) * $89 440/4 + $2 646 ** Carrying amount: $14 994 = $40 000 – $25 006 Proceeds: $16 000 exchange

Dr Dr Cr Cr

16 000 25 006

Depreciation – Machinery Accumulated depreciation – Machinery (Depreciation of Machine 1: $22 500/4 x 8/12)

Dr Cr

3 750

37 800

600

2 646

1 006 40 000

3 750

Cash Dr Accumulated depreciation – Machinery* Dr Loss on sale of Machine 1 ** Dr Machine 1 Cr (Sale of Machine 1) * $5 625 x 41/12 ** Carrying amount – Mach 1: $5 781 = $25 000 – $19 219 Proceeds $5000

5 000 19 219 781

Depreciation – Machinery Accumulated depreciation– Machinery (Depreciation expense) M2: $38 000/5 = $7600 M3: $28 000/4 = $7000 M4: $34 300/5 x 11/12 = $6288

Dr Cr

20 888

Depreciation – Vehicles Accumulated depreciation – Vehicles (Depreciation expense: 30% x ([$160 000 x ¾] – [$89 440 x ¾]))

Dr Cr

15 876

Depreciation expense – Building

13 680

25 000

20 888

15 876

11.36

Chapter 11: Property, plant and equipment

20/09/14

30/12/14

08/02/15

Accumulated depreciation – Building (Depreciation expense: $273 600/20)

Depreciation expense – Land improvements Accum. Depreciation – Land improvements (Depreciation expense: $18 000/15)

Dr Cr

1 200

Depreciation expense – Fixtures Accumulated depreciation – Fixtures (Depreciation expense: $13 500/5 x 6/12)

Dr Cr

1 350

Depreciation – Machinery Accumulated depreciation– Machinery (Machine 3 depreciation expense: $7000 x 3/12)

Dr Cr

1 750

13 680

1 200

1 350

1 750

Machinery (M5) Dr Accumulated depreciation – Machinery * Dr Gain on sale of machinery (M3) ** Cr Machinery (M3) Cr Cash Cr (Trade-in of Machine 3 for machine 5) * $7000 x 38/12 ** Carrying amount of Mach 3: $8 833 = $31 000 – $22 167 Proceeds $10 000

44 000 22 167

Depreciation expense – Machinery Accumulated depreciation – Machinery (Depreciation expense - Machine 2: $7600 x 6/12)

Dr Cr

3 800

Accumulated depreciation – Machinery * Loss on scrapping of Machine 2 Machinery (Scrapping of Machine 2) * $7600 x 48/12)

Dr Dr Cr

30 400 11 600

Depreciation expense – Machinery * Accumulated depreciation – Machinery (Depreciation expense – Machine 4: $6860 x 7/12)

Dr Cr

4 002

Accumulated depreciation – Machinery Dr Machinery Cr (Write-back of accumulated depreciation – Machine 4: $6860 x 18/12)

10 290

Machinery Cash (Overhaul of Machine 4)

8 000

M4:

Dr Cr

CA at 08/02/15 - (37 800 – 10 290) Add: Overhaul cost Revised CA Less: Revised RV Revised depreciable amount

1 167 31 000 34 000

3 800

42 000

4 002

10 290

8 000

$27 510 8 000 35 510 (5 000) $30 510

Revised depreciation = $30 510/2 = $15 255 p.a. 30/06/15

Depreciation expense – Machinery Accumulated depreciation – Machinery © John Wiley and Sons, Ltd, 2016

Dr Cr

11 231 11 231 11.37

Solutions Manual to accompany Applying IFRS Standards 4e (Depreciation expense for Machines 4 and 5: M4: $15 255 x 5/12 = $6356 M5: $39 000/6 x 9/12 = $4875) Depreciation expense – Vehicles Accumulated depreciation – Vehicles (Depreciation expense for vehicles: [$120 000 – $67 080 – $15 876] x 30%)

Dr Cr

11 113

Depreciation expense – Building Accumulated depreciation – Building (Depreciation expense for building: $273 600/20)

Dr Cr

13 680

Depreciation expense – Land improvements Accum. depreciation – Land improvements (Depreciation expense for land improvements: $18 000/15)

Dr Cr

1 200

Depreciation expense – Fixtures Accumulated depreciation – Fixtures (Depreciation expense for fixtures: $13 500/5)

Dr Cr

2 700

11 113

13 680

1 200

2 700

11.38

Testbank to accompany

Applying IFRS Standards 4e Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting and Emma Holmes

John Wiley & Sons, Ltd 2016

Chapter 11 Property, plant and equipment

CHAPTER 11 Property, plant and equipment

Learning Objectives: 11.1 Describe the nature of property, plant and equipment 11.2 Recall the recognition criteria for initial recognition of property, plant and equipment 11.3 Demonstrate how to measure property, plant and equipment on initial recognition 11.4 Explain the alternative ways in which property, plant and equipment can be measured subsequent to initial recognition 11.5 Explain the cost model of measurement and understand the nature and calculation of depreciation 11.6 Explain the revaluation model of measurement 11.7 Discuss the factors to consider when choosing which measurement model to apply 11.8 Account for derecognition 11.9 Implement the disclosure requirements of IAS 16.

11.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

Property, plant and equipment are assets that: Learning Objective 11.1 Understand the nature of property, plant and equipment a. are expected to be used up within the current financial period; b. are held for resale within the current period; *c. are physical in nature; d. have a remaining productive life of less than one financial year.

Property, plant and equipment includes items that are: Learning Objective 11.1 Understand the nature of property, plant and equipment a. intangible; b. held for resale; c. expected to be used up during the current period; *d. held for rental to others.

The cost of property, plant and equipment is only recognised as an asset if it is probable that the future economic benefits will flow to the entity and if: Learning Objective 11.2 Recall the recognition criteria for initial recognition of property, plant and equipment *a. the cost can be reliably measured; b. the asset has been fully paid for in cash; c. the asset has been received by the purchaser; d. it is a tangible asset.

Jackson Limited acquired a bundle of assets for a cash consideration of €200 000. The fair values of the assets on date of acquisition were as follows: • Building €132 000 • Furniture €88 000. The appropriate journal entry to record this acquisition is: Learning Objective 11.3 Demonstrate how to measure property, plant and equipment on initial recognition a. DR Property, plant and equipment €200 000 CR Cash €200 000 b.

*c.

DR CR

Property, plant and equipment Cash

€220 000

DR DR CR

Building Furniture Cash

€120 000 € 80 000

DR DR CR

Building Furniture Cash

€132 000 € 88 000

€220 000

€200 000

€220 000

11.2

Chapter 11: Property, plant and equipment

Costs that may be included in the cost of acquisition of property, plant and equipment include: ➢ ➢ ➢ ➢

Site preparation Initial delivery and handling costs Installation and assembly costs Testing whether the asset is functioning

I II III Yes Yes Yes Yes No Yes Yes Yes No Yes Yes No

IV No No No No

Learning Objective 11.3 Demonstrate how to measure property, plant and equipment on initial recognition *a. I; b. II; c. III; d. IV.

After an item of property, plant and equipment has been initially recognised at cost it may be measured using the following measurement method: Learning Objective 11.4 Explain the alternative ways in which property, plant and equipment can be measured subsequent to initial recognition a. liquidation value; b. accrual; *c. revaluation; d. realisable value.

Under the cost model, after initial recognition of a property, plant and equipment asset, the item must be carried at its: Learning Objective 11.5 Explain the cost model of measurement and understand the nature and calculation of depreciation a. residual value; *b. cost less accumulated depreciation and less accumulated impairment losses; c. initial cost; d. net present value.

Wilson Limited applied the straight-line method of depreciation to its non-current assets. The cost of the buildings was €640 000, the depreciable amount is €560 000, the residual value is €80 000 and the useful life is 8 years. The annual depreciation charge is: Learning Objective 11.5 Explain the cost model of measurement and understand the nature and calculation of depreciation a. €80 000; b. €75 000; *c. €70 000; d. €60 000.

11.3

Test Bank to accompany Applying IFRS Standards 4e

Replicator Limited acquired an item of plant with an expected useful life of 5 years. Expected total production output over this period was: • Year 1, 35 000 units • Year 2, 35 000 units • Year 3, 18 000 units • Year 4, 12 000 units. The asset cost € 100 000 and associated installation costs amounted to €20 000 and residual value is €5000. The amount of depreciation charged in the first year is: Learning Objective 11.5 Explain the cost model of measurement and understand the nature and calculation of depreciation *a. €40 250; b. €42 000; c. €35 000; d. €33 250.

10.

When a company recognises a depreciation credit resulting from a review of the estimated residual value of a depreciable asset, the depreciation debit should be recognised in accumulated depreciation and the depreciation credit should be recognised: Learning Objective 11.5 Explain the cost model of measurement and understand the nature and calculation of depreciation a. in the opening balance of retained earnings; *b. in the depreciation expense; c. directly in the depreciable asset account; d. as a gain in the current period.

11.

A change in accounting policy from the revaluation model to the cost model requires a retrospective adjustment to the: Learning Objective 11.4 Explain the alternative ways in which property, plant and equipment can be measured subsequent to initial recognition a. revenue in the profit and loss statement; b. expenses in the profit and loss statement; *c. opening balance of retained earnings; d. other comprehensive income.

12.

A non-current property, plant and equipment asset is depreciated using the straightline method. The asset was revalued upwards after four years of use. There is no change in the remaining useful life of six years or to the residual value. Which of the following relationships reflects the effect of the revaluation on the prospective depreciation of the asset? Learning Objective 11.6 Explain the revaluation model of measurement

*a. b. c. d.

Depreciation rate Same Same Higher Higher

Annual depreciation expense Higher Same Higher Same

11.4

Chapter 11: Property, plant and equipment

13.

Revaluations under IAS 16 Property, Plant and Equipment apply to: Learning Objective 11.6 Explain the revaluation model of measurement a. all assets on an individual basis; b. individual current assets only; c. individual non-current assets only; *d. assets on a class-by-class basis.

Use the following information to answer questions 14 and 15 An extract of a company’s draft statement of financial position at 30 June 2015 discloses the following: €500 000 300 000 €200 000

Plant (at cost) Less: Accumulated Depreciation

On 30 June 2016 the company assessed the fair value of the plant to be €350 000. At 30 June 2017, the carrying amount of the plant was €250 000. The tax rate is 30%. Depreciation rates are 10% p.a. (accounting) and 12.5% p.a. (tax) using the straight-line method.

14.

The journal entries necessary to record the revaluation of plant (ignoring any tax effect) at 30 June 2016 in accordance with IAS 16 Property, Plant and Equipment is: Learning Objective 11.6 Explain the revaluation model of measurement *a.

Accumulated depreciation – Plant Plant

Dr Cr

300 000

Plant Gain on revaluation - OCI

Dr Cr

150 000

Plant Gain on revaluation - OCI

Dr Cr

150 000

Gain on revaluation - OCI Asset revaluation surplus

Dr Cr

150 000

Plant Gain on revaluation - OCI Accumulated depreciation - Plant

Dr Dr Cr

150 000 150 000

300 000

150 000

300 000

11.5

Test Bank to accompany Applying IFRS Standards 4e

15.

The journal entries to adjust for the tax effect of the revaluation at 30 June 2016 is: Learning Objective 11.6 Explain the revaluation model of measurement a.

*d.

16.

Dr Cr

45 000

Asset revaluation surplus Income tax expense – OCI

Dr Cr

45 000

Income tax expense – OCI Asset revaluation surplus

Dr Cr

45 000

Income tax expense – OCI Deferred tax liability

Dr Cr

45 000

Gain on revaluation - OCI Income tax expense – OCI Asset revaluation surplus

Dr Cr Cr

150 000

45 000

45 000 105 000

Speculator Limited acquired a parcel of land for €50 000. This amount is also the tax base of the land. Two years after the acquisition date, the building was revalued to €80 000. The tax rate is 30%. The appropriate journal entry to recognise the net effect of the revaluation is: Learning Objective 11.6 Explain the revaluation model of measurement a.

*c.

17.

Income tax expense – OCI Deferred tax liability

DR CR

Gain on revaluation - OCI Asset revaluation surplus

€30 000

DR DR CR

Land Income tax expense - OCI Asset revaluation surplus

€21 000 € 9 000

DR CR CR

Land Deferred tax liability Asset revaluation surplus

€30 000

DR CR CR

Gain on revaluation - OCI Income tax expense - OCI Asset revaluation surplus

€30 000

€30 000 € 9 000 €21 000 €9 000 €21 000

Troubadour Limited had an existing revaluation surplus in respect to an item of plant that had been derecognised. An appropriate journal entry to transfer the surplus to retained earnings would include: Learning Objective 11.6 Explain the revaluation model of measurement a. DR Gain on revaluation – OCI; b. CR Asset revaluation surplus; c. DR Retained earnings; *d. CR Retained earnings.

11.6

Chapter 11: Property, plant and equipment

18.

When using the revaluation model: Learning Objective 11.7 Discuss the factors to consider when choosing which measurement model to apply a. ongoing record keeping costs are generally lower than if the cost model were used; *b. the values reported will provide more relevant information to users of the financial statements; c. depreciation costs will generally be lower than under the cost model; d. the entities financial statements will be consistent with US GAAP requirements.

19.

When an asset is sold the resulting gain or loss is: Learning Objective 11.8 Account for derecognition a. reported in other comprehensive income, normally with separate disclosure of income and the carrying amount of the asset; b. reported in other comprehensive income, normally on a net basis; c. reported in current period profit or loss, normally with separate disclosure of income and the carrying amount of the asset; *d. reported in current period profit or loss, normally on a net basis.

20.

Which of the following statements is NOT correct in relation to disclosure of property, plant and equipment balances? Learning Objective 11.9 Implement the disclosure requirements of IAS 16. a. Paragraph 79 of IAS 16 contains disclosure that are encouraged, but not required in relation to property, plant & equipment; b. An entity must disclose the useful life estimates for each class of assets; c. A summary of movements in the revaluation surplus is required to be disclosed; *d. Information on assets carried at revalued amounts must be disclosed on an individual asset basis.

21.

IAS 16 requires disclosure, for each class of property, plant and equipment: Learning Objective 11.9 Implement the disclosure requirements of IAS 16 a. the measurement bases used for determining the gross carrying amount; b. the deprecation methods used; c. the useful lives or the depreciation rates used; *d. all of the options are correct.

22.

The cost of an item of property, plant and equipment is only recognised if the cost of the item can be reliably measured and if: Learning Objective 11.2 Recall the recognition criteria for initial recognition of property, plant and equipment a. it is not directly attributable to the asset; b. it has been paid for in cash; c. the item has been received by the acquirer; *d. it is probable that future economic benefits associated with the item will flow to the entity.

23.

An entity acquired an item of plant in exchange for an item of equipment. The equipment has a carrying value of €5000 and a fair value of €6000. The journal entry to record the acquisition of the plant will show: Learning Objective 11.3 Demonstrate how to measure property, plant and equipment on initial recognition

11.7

Test Bank to accompany Applying IFRS Standards 4e

a. b. *c. d.

a loss on acquisition of €1000; proceeds on disposal of equipment of €1000; a gain on disposal of €1000; proceeds on disposal of plant of €1000.

24.

For the purposes of recognising a non-current property, plant and equipment asset, the acquisition date is determined as the date: Learning Objective 11.3 Demonstrate how to measure property, plant and equipment on initial recognition a. the contract to exchange assets is signed; b. on which the offer to acquire the asset becomes unconditional c. the consideration is paid; *d. on which the acquirer obtains control of the asset.

25.

Subsequent to the initial recognition of an asset, an entity has a choice on the measurement basis to be adopted. The choice is between: Learning Objective 11.4 Explain the alternative ways in which property, plant and equipment can be measured subsequent to initial recognition a. cash and accrual; *b. cost and revaluation; c. tax and accounting; d. current and non-current.

26.

When applying a revaluation measurement model to assets, the model: Learning Objective 11.4 Explain the alternative ways in which property, plant and equipment can be measured subsequent to initial recognition *a. applies to the entire class of non-current assets; b. may only be applied to current assets; c. is applied permanently and may not be changed; d. is applied to individual assets within a class of non-current assets.

27.

Depreciation is a process that is designed to: Learning Objective 11.5 Explain the cost model of measurement and understand the nature and calculation of depreciation a. reduce the carrying amount of an asset to reflect the diminishing fair value of the asset; b. spread the cost of an asset across a period no greater than 5 years; c. reflect the change in value of an asset as a result of obsolescence; *d. allocate the cost of an asset across its useful life to an entity.

11.8

Chapter 11: Property, plant and equipment

28.

Under IAS 16 Property, Plant and Equipment, the depreciation charge for a period reflects: Learning Objective 11.5 Explain the cost model of measurement and understand the nature and calculation of depreciation a. the fall in the fair value of the asset across the period; b. a change in the re-sale value of the asset that has occurred over the period; *c. the consumption of economic benefits over the period; d. a reduction in the estimated market value of the asset across the period.

29.

Which of the following is an argument to support the use of the revaluation model of accounting for property, plant and equipment? Learning Objective 11.7 Discuss the factors to consider when choosing which measurement model to apply: a. the revaluation model is consistent with US GAAP; b. the revaluation model can be selectively applied to individual assets; c. the ongoing costs associated with applying the revaluation model provide a disincentive to applying the model; *d. the revaluation model provides more relevant and reliable information than the cost model.

30.

ABC Limited acquired an item of plant on 1 July 2015 for €80 000. The estimated useful life of the plant at acquisition date was 5 years and the residual value €5000. The company sold the plant on 1 January 2019 for €30 000. The journal entry to reflect the sale is: Learning Objective 11.8 Account for derecognition

*d.

DR Cash DR Accumulated depreciation CR Plant CR Gain on sale

€30 000 €56 000

DR Cash CR Proceeds on sale

€30 000

DR Carrying amount of plant CR Plant

€27 500

DR Cash DR Loss on sale CR Plant

€30 000 € 2 500

DR Cash DR Accumulated depreciation CR Plant CR Gain on sale

€30 000 €52 500

€80 000 € 6 000 €30 000 €27 500

€32 500

€80 000 € 2 500

11.9

Exercises Exercise 11.15 ★

Exercise 11.16

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

DECLINE IN VALUE OF ASSETS

A new accountant has been appointed to the ﬁrm of Gutenberg Ltd, which owns a large number of depreciable assets. Upon analysing the ﬁrm’s depreciation policy, the accountant has implemented a new policy based on the principle that the depreciation rate for particular assets should measure the decline in the value of the assets. Discuss this policy change. DEPRECIATION CHARGES

★ The management of Carlsberg Ltd has been analysing the financial reports provided by the accountant, who has been with the firm for a number of years. Management has expressed its concern over depreciation charges being made in relation to the company’s equipment. In particular, it believes that the depreciation charges are not high enough in relation to the factory machines because new technology applied in that area is rapidly making the machines obsolete. Management’s concern is that the machines will have to be replaced in the near future and, with the low depreciation charges, the fund will not be sufficient to pay for the replacement machines. Discuss. Exercise 11.17 ★

REVALUATION OF ASSETS

On 30 June 2014, the statement of ﬁnancial position of Meezen Ltd showed the following non-current assets after charging depreciation: Building Accumulated Depreciation

$ 300 000 (100 000)

$200 000

Motor Vehicle Accumulated Depreciation

120 000 (40 000)

80 000

The company has adopted fair value for the valuation of non-current assets. This has resulted in the recognition in previous periods of an asset revaluation surplus for the building of $14 000. On 30 June 2014, an independent valuer assessed the fair value of the building to be $160 000 and the vehicle to be $90 000. The income tax rate is 30%. Required

1. Prepare any necessary entries to revalue the building and the vehicle as at 30 June 2014. 2. Assume that the building and vehicle had remaining useful lives of 25 years and 4 years respectively, with zero residual value. Prepare entries to record depreciation expense for the year ended 30 June 2015 using the straight-line method. Exercise 11.18

BUILDING COSTS

★★ Chua Ltd has acquired a new building. Which of the following items should be included in the cost of the building? (a) Stamp duty (b) Real estate agent’s fees (c) Architect’s fees for drawings for internal adjustments to the building to be made before use (d) Interest on the bank loan to acquire the building, and an application fee to the bank to get the loan, which is secured on the building (e) Cost of changing the name on the building (f) Cost of changing the parking bays (g) Cost of refurbishing the lobby to the building to attract customers and make it more user friendly Exercise 11.19 ★★

CAPITALISATION

CHAPTER 11 Property, plant and equipment

(e) Costs of repairing the factory door, which was damaged by the installation of the new machine (f) Training costs of workers who will use the machine

Exercise 11.20

DEPRECIATION CALCULATION

★★ On 1 July 2014, Bergfeld Airlines acquired a new aeroplane for a total cost of $10 million. A breakdown of the costs to build the aeroplane was given by the manufacturers:

Aircraft body Engines (2) Fitting out of aircraft: Fitting out of aircraft: Seats Carpets Electrical equipment — passenger seats — cockpit Food preparation equipment

$ 3 000 000 4 000 000

1 000 000 50 000 200 000 1 500 000 250 000

All costs include installation and labour costs associated with the relevant part. It is expected that the aircraft will be kept for 10 years and then sold. The main value of the aircraft at that stage is the body and the engines. The expected selling price is $2.1 million, with the body and engines retaining proportionate value. Costs in relation to the aircraft over the next 10 years are expected to be as follows: (a) Aircraft body. This requires an inspection every 2 years for cracks and wear and tear, at a cost of $10 000. (b) Engines. Each engine has an expected life of 4 years before being sold for scrap. It is expected that the engines will be replaced in 2018 for $4.5 million and again in 2022 for $6 million. These engines are expected to incur annual maintenance costs of $300 000. The manufacturer has informed Bergfeld Airlines that a new prototype engine with an extra 10% capacity should be on the market in 2020, and that existing engines could be upgraded at a cost of $1 million. (c) Fittings. Seats are replaced every 3 years. Expected replacement costs are $1.2 million in 2017 and $1.5 million in 2023. The repair of torn seats and faulty mechanisms is expected to cost $100 000 p.a. Carpets are replaced every 5 years. They will be replaced in 2019 at an expected cost of $65 000, but will not be replaced again before the aircraft is sold in 2021. Cleaning costs amount to $10 000 p.a. The electrical equipment (such as the TV) for each seat has an annual repair cost of $15 000. It is expected that, with the improvements in technology, the equipment will be totally replaced in 2020 by substantially better equipment at a cost of $350 000. The electrical equipment in the cockpit is tested frequently at an expected annual cost of $250 000. Major upgrades to the equipment are expected every 2 years at expected costs of $250 000 (in 2013), $300 000 (in 2015), $345 000 (in 2017) and $410 000 (in 2022). The upgrades will take into effect the expected changes in technology. (d) Food preparation equipment. This incurs annual costs for repair and maintenance of $20 000. The equipment is expected to be totally replaced in 2020. Required

1. Discuss how the costs relating to the aircraft should be accounted for. 2. Determine the expenses recognised for the 2014–15 ﬁnancial year.

Exercise 11.21

ACQUISITIONS, DISPOSALS, DEPRECIATION

★★ Meerbeck Ltd purchased equipment on 1 July 2013 for $39 800 cash. Transport and installation costs of $4200 were paid on 5 July 2013. Useful life and residual value were estimated to be 10 years and $1800 respectively. Meerbeck Ltd depreciates equipment using the straight-line method to the nearest month, and reports annually on 30 June. The company tax rate is 30%. In June 2015, changes in technology caused the company to revise the estimated total life from 10 years to 5 years, and the residual value from $1800 to $1200. This revised estimate was made before recording the depreciation for the ﬁnancial year ended 30 June 2015. On 30 June 2015, the company adopted the revaluation model to account for equipment. An expert valuation was obtained showing that the equipment had a fair value of $30 000 at that date. On 30 June 2016, depreciation for the year was charged and the equipment’s carrying amount was remeasured to its fair value of $16 000. On 30 September 2016, the equipment was sold for $8400 cash. 2

PART 2 Elements

Required

(Show all workings and round amounts to the nearest dollar.) Prepare general journal entries to record the transactions and events for the period 1 July 2013 to 30 September 2016. (Narrations are not required.)

Exercise 11.22

CLASSIFICATION OF ACQUISITION COSTS

★★ Alsbach Ltd began operations on 1 July 2016. During the following year, the company acquired a tract of land, demolished the building on the land and built a new factory. Equipment was acquired for the factory and, in March 2017, the factory was ready. A gala opening was held on 18 March, with the local parliamentarian opening the factory. The ﬁrst items were ready for sale on 25 March. Required

Using the information provided, determine what assets Alsbach Ltd should recognise and the amounts at which they would be recorded.

Exercise 11.23 ★★

ACQUISITIONS, REVALUATIONS, REPLACEMENTS, DEPRECIATION

Hamburg Trading operates in a very competitive ﬁeld. To maintain its market position, it purchased two new machines for cash on 1 January 2013. It had previously rented its machines. Machine A cost $40 000 and Machine B cost $100 000. Each machine was expected to have a useful life of 10 years, and residual values were estimated at $2000 for Machine A and $5000 for Machine B. On 30 June 2014, Hamburg Trading adopted the revaluation model to account for the class of machinery. The fair values of Machine A and Machine B were determined to be $32 000 and $90 000 respectively on that date. The useful life and residual value of Machine A were reassessed to 8 years and $1500. The useful life and residual value of Machine B were reassessed to 8 years and $4000. On 2 January 2015, extensive repairs were carried out on Machine B for $66 000 cash. Hamburg Trading expected these repairs to extend Machine B’s useful life by 3.5 years, and it revised Machine B’s estimated residual value to $9450. Owing to technological advances, Hamburg Trading decided to replace Machine A. It traded in Machine A on 31 March 2015 for new Machine C, which cost $64 000. A $28 000 trade-in was allowed for Machine A, and the balance of Machine C’s cost was paid in cash. Transport and installation costs of $950 were incurred in respect to Machine C. Machine C was expected to have a useful life of 8 years and a residual value of $8000. Hamburg Trading uses the straight-line depreciation method, recording depreciation to the nearest month and the nearest dollarpound. The end of its reporting period is 30 June. On 30 June 2015, fair values were determined to be $140 000 and $65 000 for Machines B and C respectively. Required

Exercise 11.24 ★★★

DEPRECIATION CALCULATION

Osamu Ltd operates a factory that contains a large number of machines designed to produce knitted garments. These machines are generally depreciated at 10% p.a. on a straight-line basis. In general, machines are estimated to have a residual value on disposal of 10% of cost. At 1 July 2013, Osamu Ltd had a total of 64 machines, and the statement of ﬁnancial position showed a total cost of $420 000 and accumulated depreciation of $130 000. During 2013–14, the following transactions occurred: (a) On 1 September 2013, a new machine was acquired for $15 000. This machine replaced two other machines. One of the two replaced machines was acquired on 1 July 2010 for $8200. It was traded in on the new machine, with Osamu Ltd making a cash payment of $8800 on the new machine. The second replaced machine had cost $9000 on 1 April 2011 and was sold for $7300. (b) On 1 January 2014, a machine that had cost $4000 on 1 July 2004 was retired from use and sold for scrap for $500. (c) On 1 January 2014, a machine that had been acquired on 1 January 2011 for $7000 was repaired because its motor had been damaged from overheating. The motor was replaced at a cost of $4800. It was expected that this would increase the life of the machine by an extra 2 years. (d) On 1 April 2014, Osamu Ltd ﬁtted a new form of arm to a machine used for putting special designs onto garments. The arm cost $1200. The machine had been acquired on 1 April 2011 for $10 000. The arm can be used on a number of other machines when required and has a 15-year life. It will not be sold when any particular machine is retired, but retained for use on other machines. CHAPTER 11 Property, plant and equipment

Required

1. Record each of the transactions. The end of the reporting period is 30 June. 2. Determine the depreciation expense for Osamu Ltd for 2013–14.

Exercise 11.25

DEPRECIATION

★★★ Springs Manufacturing, which started operations on 1 September 2010, is owned by Alice Ltd. Alice Ltd’s

accounts at 31 December 2013 included the following balances:

$91 000 (48 200) 46 800 (19 656) 81 000 185 720 (28 614)

Machinery (at cost) Accumulated Depreciation – Machinery Vehicles (at cost; purchased 21 November 2012) Accumulated Depreciation – Vehicles Land (at cost; purchased 25 October 2010) Building (at cost; purchased 25 October 2010) Accumulated Depreciation – Building

Details of machines owned at 31 December 2013 are as follows:

Machine

Purchase date

Cost

Useful life

Residual value

1 2

7 October 2010 4 February 2011

$43 000 $48 000

5 years 6 years

$2 500 $3 000

Additional information (a) Alice Ltd calculates depreciation to the nearest month and balances the records at month-end. Recorded amounts are rounded to the nearest dollar, and the end of the reporting period is 31 December. (b) Alice Ltd uses straight-line depreciation for all depreciable assets except vehicles, which are depreciated on the diminishing balance at 40% p.a. (c) The vehicles account balance reﬂects the total paid for two identical delivery vehicles, each of which cost $23 400. (d) On acquiring the land and building, Alice Ltd estimated the building’s useful life and residual value at 20 years and $5000 respectively. The following transactions occurred from 1 January 2014:

2014 Jan. 3

June 22 Aug. 28

Dec. 31 2015 April 30 May 25 June 26

Dec. 31

PART 2 Elements

Bought a new machine (Machine 3) for a cash price of $57 000. Freight charges of $442 and installation costs of $1758 were paid in cash. The useful life and residual value were estimated at 5 years and $4000 respectively. Bought a second-hand vehicle for $15 200 cash. Repainting costs of $655 and four new tyres costing $345 were paid for in cash. Exchanged Machine 1 for office furniture that had a fair value of $12 500 at the date of exchange. The fair value of Machine 1 at the date of exchange was $11 500. The office furniture originally cost $36 000 and, to the date of exchange, had been depreciated by $24 100 in the previous owner’s books. Alice Ltd estimated the office furniture’s useful life and residual value at 8 years and $540 respectively. Recorded depreciation. Paid for repairs and maintenance on the machinery at a cash cost of $928. Sold one of the vehicles bought on 21 November 2012 for $6600 cash. Installed a fence around the property at a cash cost of $5500. The fence has an estimated useful life of 10 years and zero residual value. (Debit the cost to a land improvements asset account.) Recorded depreciation.

2016 June 20

Dec. 31

Traded in the remaining vehicle bought on 21 November 2012 for a new vehicle. A tradein allowance of $3700 was received and $22 000 was paid in cash. Stamp duty of $500 and registration and third-party insurance of $800 were also paid for in cash. Recorded depreciation.

Required

Prepare general journal entries to record the above transactions. Exercise 11.26 ★★★

DEPRECIATION

Chorin Ltd started operations on 1 October 2010. Its accounts at 30 June 2013 included the following balances: $98 000 (47 886) 160 000 (89 440) 75 000 290 600 (3 420) 18 000 (300)

Machinery (at cost) Accumulated Depreciation – Machinery Vehicles (at cost; purchased 20 February 2011) Accumulated Depreciation – Vehicles Land (at cost; purchased 20 March 2013) Building (at cost; purchased 20 March 2013) Accumulated Depreciation – Building Land Improvements (at cost; purchased 20 March 2013) Accumulated Depreciation – Land Improvements

Details of machines owned at 30 June 2013 were: Machine 1 2 3

Purchase date 2 October 2010 27 December 2010 29 July 2011

Cost

Useful life

Residual value

$25 000 42 000 31 000

4 years 5 years 4 years

$2 500 4 000 3 000

Additional information (a) Chorin Ltd calculates depreciation to the nearest month and balances the records at month-end. Recorded amounts are rounded to the nearest dollar, and the end of the reporting period is 30 June. (b) Chorin Ltd uses straight-line depreciation for all depreciable assets except vehicles, which are depreciated on the diminishing balance at 30% p.a. (c) The Vehicles account balance reﬂects the total paid for four identical delivery vehicles, which cost $40 000 each. (d) On acquiring the land and building, Chorin Ltd estimated the building’s useful life and residual value at 20 years and $17 000 respectively. (e) The Land Improvements account balance reﬂects a payment of $18 000 made on 20 March 2013 for driveways and a car park. On acquiring these land improvements, Chorin Ltd estimated their useful life at 15 years with no residual value. The following transactions occurred from 1 July 2013: 2013 Aug. 3

Nov. 15 Dec. 30

2014 March 10 June 30

Purchased a new machine (Machine 4) for a cash price of $36 000. Installation costs of $1800 were also paid. Chorin Ltd estimated the useful life and residual value at 5 years and $3500 respectively. Paid vehicle repairs of $600. Exchanged one of the vehicles for items of fixtures that had a fair value of $17 000 at the date of exchange. The fair value of the vehicle at the date of exchange was $16 000. The fixtures originally cost $50 000 and had been depreciated by $31 000 to the date of exchange in the previous owner’s books. Chorin Ltd estimated the fixtures’ useful life and residual value at 5 years and $2500 respectively. Sold Machine 1 for $5000 cash. Recorded depreciation expense. (continued) CHAPTER 11 Property, plant and equipment

Sept. 20

Dec. 30 2015 Feb. 8 June 30

Traded in Machine 3 for a new machine (Machine 5). A trade-in allowance of $10 000 was received for Machine 3 and $34 000 was paid in cash. Chorin Ltd estimated Machine 5’s useful life and residual value at 6 years and $5000 respectively. Scrapped Machine 2, as it was surplus to requirements and no buyer could be found for it. Paid $8000 to overhaul Machine 4, after which Machine 4’s useful life was estimated at 2 remaining years and its residual value was revised to $5000. Recorded depreciation expense.

Required

Prepare general journal entries to record the above transactions.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 12: Leases

CHAPTER 12: Leases Discussion Questions 1.

What are ‘minimum lease payments’?

See IAS 17, paragraph 4, the definition can be expressed as follows: Minimum lease payments =

(i) + + -

Payments over the lease term (ii) Guaranteed residual value (iii) Bargain purchase option (iv) Contingent rent (v) Reimbursement of costs paid by the lessor

Discuss each component in full.

If a lease agreement states that ‘the lessee guarantees a residual value, at the end of the lease term, of $20 000’, what does this mean?

The guaranteed residual value is that part of the residual value of the leased asset guaranteed by the lessee or a third party related to the lessee (IAS 17, paragraph 4). The lessor will estimate the residual value of the leased asset at the end of the lease term based on market conditions at the inception of the lease and the lessee will guarantee that, when the asset is returned to the lessor, it will realise at least that amount. The guarantee may range from 1% to 100% of the residual value and is a matter for negotiation between lessor and lessee. Where a lessee guarantees some or all of the residual value of the asset, the lessor has transferred risks associated with movements in the residual value to the lessee.

What is meant by ‘the interest rate implicit in a lease’?

This is defined in IAS 17, paragraph 4 as the discount rate that at the inception of the lease causes the aggregate present value of: (a) the minimum lease payments; and (b) the unguaranteed residual value to be equal to the sum of: (i) the fair value of the leased asset, and (ii) any initial direct costs of the lessor. This interest rate is used to discount the minimum lease payments to their present value for recognition purposes. This discount rate is implicit in the lease because it is the terms of the lease (number, timing and quantum of repayments, guaranteed residual values or bargain purchase options) that determine its value. Any change to the terms or to the fair value will change the interest rate.

Identify three possible adverse effects on a lessee entity’s financial statements arising from the classification of a lease arrangement as a finance lease.

See section 12.4 on p. 419 of the chapter. Note the five points which represent potential adverse impacts of classifying a lease as a finance lease.

12.1

Solutions Manual to accompany Applying IFRS Standards 4e 5.

How, according to IAS 17 requirements, are operating leases accounted for by lessees?

See section 12.8 of the chapter, especially illustrative example 12.5 beginning on p. 435, and para. 33 of IAS 17.

6. Explain how a profit made by a lessee on a sale and leaseback transaction is to be accounted for. Accounting for any profit made on the sale in a ‘sale and leaseback transaction’ depends on two factors: • The relationship of the sales price to the fair value of the asset at the date of sale and • The classification of the leaseback arrangement. If the leaseback is classified as a finance lease then all profit is deferred and amortised over the lease term. If the leaseback is classified as an operating lease and: • Sales price equals fair value – the profit is recognised immediately • Sales price is less than fair value – the profit is recognised immediately unless any loss is compensated for via lower than market lease payments. If this is the case the loss is deferred and amortised. • Sales price is greater than fair value – the ‘normal’ profit is recognised immediately but the excess profit is deferred and amortised over the lease term.

12.2

Chapter 12: Leases

Exercises Exercise 12.1

IDENTIFICATION OF LEASES

For the following arrangements, discuss whether they are ‘in substance’ lease transactions, and thus fall under the ambit of IAS 17. Scenario (a) The substance of this arrangement is that Entity A has effectively sub-leased the asset to Entity B and has used the lease income stream to borrow cash. Scenario (b) This arrangement contains a lease in that: • It relates to a specific item – the refinery built on the purchaser’s site • The arrangement conveys the right to use the refinery for an agreed period of time given that there is only a remote possibility that the refinery’s output will be sold to other customers • The purchaser must make fixed unavoidable payments irrespective of whether or not it takes the refinery output. Thus, in substance, the purchaser is leasing the refinery from the seller. Scenario (c) In this example, the terms and conditions and period of each of the leases are the same. Therefore, the risks and rewards incident to ownership of the underlying asset are the same as before the arrangement. Further, the amounts owing are offset against one another, and so there is no retained credit risk. The substance of the arrangement is that no transaction has occurred. Scenario (d) The existence of the option to lease the asset for another four years, and the put option arrangement which effectively guarantees the residual value of the asset at the end of the lease mean that this is an ‘in substance’ finance lease as substantially all of the risks and rewards associated with the asset are transferred to Entity A.

Exercise 12.2 LEASE CLASSIFICATION AND DETERMINATION OF INTEREST RATES This exercise contains three multiple-choice questions. Select the correct answer and show any workings required. 1.

(c) $215 000 - $150 000 = $65 000 (profit based on fair value) $230 000 - $215 000 = $15 000 (excess profit which must be deferred and amortised over the lease term

(a) The lease is cancellable and only for two years so it is an operating lease.

(b) $25 000 + $25 000 x 3.0373 [T2 12% 4y] + $15 000 x 0.5674 [T1 12% 5y] $25 000 + 75 932.50 + 8 511.00 $109 443.50 = fair value, so 12% is the implicit interest rate

12.3

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 12.3

FINANCE LEASE

If a lease has been capitalised as a finance lease, identify two circumstances in which the lease receivable raised by the lessor will differ from the lease asset raised by the lessee. One circumstance is where there is an unguaranteed residual value in the lease contract. The lessee will value the leased asset and liability at the present value of the minimum lease payments, as defined in paragraph 4 of the standard, whereas the lease receivable will be valued at the net investment in the lease, which is the present value of the minimum lease payments plus the present value of the unguaranteed residual value, all discounted at the interest rate implicit in the lease (see. para.36 and para. 4 of the standard). A second circumstance is where the lessor is a financier who has incurred initial direct costs. In this case the lessee will value the asset at the lesser amount between fair value and the present value of minimum lease payments. The lessor will value the receivable at fair value plus initial direct costs (see para. 38 of the standard).

Exercise 12.4 1. 2.

LEASE CLASSIFICATION; ACCOUNTING BY LESSEE

Classify the lease for both lessee and lessor based on the guidance provided in IAS 17. Justify your answer. Prepare (1) the lease schedules for the lessee (show all workings), and (2) the journal entries in the books of the lessee for the year ended 30 June 2017. OTAGO LTD

The lease would be classified by both lessee and lessor as a finance lease as substantially all of the risks and rewards incidental with ownership have been transferred as a result of the lease arrangement. This is evidenced by the fact that: • the lease is non-cancellable (by definition), • the lease term, at 67%, could be argued to represent a major part of the economic life of the machine, and • the present value of the minimum lease payments is substantially all of the fair value of the machine at the inception of the lease: PV of MLP = 40 000 + 40 000 x 2.5771 [T2 8% 3 yrs] = 40 000 + 103 084 = 143 084/154 109 = 93%

2 (1). Lease schedule

MLP $ 1 July 2016 1 July 2017 1 July 2018 1 July 2019 1 July 2020

40 000 40 000 40 000 40 000 160 000

Otago Ltd (Lessee) Schedule of lease payments Interest Liability expense reduction $ $ 8 247 5 706 2 963 16 916

40 000 31 753 34 294 37 037 143 084

Liability balance $ 143 084 103 084 71 331 37 037 -

12.4

Chapter 12: Leases 2 (2).

Journal entries for the year ended 30 June 2017 Otago Ltd (Lessee) Journal entries

1 July 2016 Leased machine Lease liability (Inception of lease) Lease liability Executory costs expense Cash (First lease payment) 30 June 2017 Interest expense Interest payable (Interest accrued at balance date) Depreciation expense Accumulated depreciation (Depreciation for the year) [143 084/4]

Dr Cr

143 084

Dr Dr Cr

40 000 1 500

Dr Cr

8 247

Dr Cr

35 771

143 084

41 500

8 247

35 771

12.5

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 12.5

ACCOUNTING BY LESSEE AND LESSOR

Required 1. Prepare: (a) the lease payment schedule for the lessee (show all workings) (b) the journal entries in the records of the lessee for the year ended 30 June 2018. 2. Prepare: (a) the lease receipt schedule for the lessor (show all workings) (b) the journal entries in the records of the lessor for the year ended 30 June 2018.

CHRISTCHURCH LTD 1(a). Lease schedule

MLP $ 1 July 2016 30 June 2017 30 June 2018 30 June 2019

150 000 150 000 210 000 510 000

Wellington Ltd (Lessee) Schedule of lease payments Interest Liability expense reduction $ $ 30 984 22 652 13 741 67 377

119 016 127 348 196 259 442 623

Liability balance $ *442 623 323 607 196 259 -

Workings PV of MLP

= $150 000 x 2.643 [T2 7% 3y] + $60 000 x 0.8163 [T1 7% 3y] = $393 645 + $48 978 = $442 623

1(b). Journal entries for the year ended 30 June 2018 Wellington Ltd (Lessee) Journal entries 30 June 2018 Lease liability Interest expense Cash (Second lease payment) Depreciation expense Accumulated depreciation (Depreciation for the year) [(442 623 – 60 000)/3]

Dr Dr Cr

127 348 22 652

Dr Cr

127 541

150 000

127 541

2(a). Lease schedule

MLR $ 1 July 2016 30 June 2017 30 June 2018 30 June 2019

150 000 150 000 240 000 540 000

Christchurch Ltd (Lessor) Lease receipts schedule Interest Receivable revenue reduction $ $ 32 698 24 487 15 703 72 888

117 302 125 513 224 297 467 112

Receivable balance $ 467 112 349 810 224 297 -

12.6

Chapter 12: Leases 2(b). Journal entries for the year ended 30 June 2018 Christchurch Ltd (Lessor) Journal entries 30 June 2018 Cash Interest revenue Lease receivable (Second lease payment)

Dr Cr Cr

150 000

24 487 125 513

12.7

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 12.6 Required 1. 2.

LEASE SCHEDULES AND JOURNAL ENTRIES (YEAR 1)

Prepare the lease schedules for both the lessee and the lessor. Prepare the journal entries in the records of the lessee only for the year ended 30 June 2017. ISLAND LTD – PACIFIC LTD

1. Island Ltd (lessee) Schedule of lease payments MLP Interest Liability expense reduction $ $ $ 1 July 2016 30 June 2017 30 June 2018 30 June 2019

39 000 39 000 55 000 133 000

8 079 5 914 3 598 17 591

30 921 33 086 51 402 115 409

Liability balance $ 115 409 84 488 51 402 -

PV of MLP

= (39 000 x 2.6243 [T2 7% 3y]) + (16 000 x 0.8163 [T1 7% 3y]) = 102 348 + 13 061 = 115 409 Pacific Ltd (lessor) Schedule of lease receipts MLR Interest Receivable Receivable Revenue reduction balance $ $ $ $ 1 July 2016 120 307 30 June 2017 39 000 8 421 30 579 90 728 30 June 2018 39 000 6 281 32 719 57 009 30 June 2019 61 000 3 991 57 009 139 000 18 693 120 307 2.

Journal entries for the year ended 30 June 2017

Books of Island Ltd (lessee) 1 July 2016 Leased crane Dr Lease liability Cr (Recognition of lease asset and lease liability at the inception of the lease). 30 June 2017 Lease liability Interest expense Cash (First lease payment)

115 409 115 409

Dr Dr Cr

30 921 8 079

Depreciation expense Dr Accumulated depreciation Cr (Depreciation of the leased asset) ($33 136 = ($115 409 - $16 000)/3 years)

33 136

39 000

33 136

12.8

Chapter 12: Leases Exercise 12.7 FINANCE LEASE — LESSEE (INCLUDING DISCLOSURES) Required 1. Prepare the journal entries for Dunedin Ltd from 30 June 2014 to 30 June 2017. 2. Prepare the relevant disclosures required under IAS 17 for the years ending 30 June 2014 and 30 June 2016. 3. How would your answer to requirement 1 change if the guaranteed residual value was only $10 000, and the expected fair value at the end of the lease term was $12 000? 1. By trial and error, or a financial calculator, determine the interest rate of 5%: 10 000 now 10 000 x 1.8594 (annuity for 2 years at 5%) 12 000 x 0.86384 (PV of sum in 3 years at 5%) Total

MLP $ 30 June 2014 30 June 2014 30 June 2015 30 June 2016 30 June 2017

= = = =

Dunedin Ltd Lease payments schedule Interest Liability expense reduction $ $

10 000 10 000 10 000 12 000 42 000

10 000 8 552 8 980 11 428 38 960

1 448 1 020 572 3 040

Journal entries 30 June 2014 Leased vehicle Dr 38 960 Lease liability Cr (Recognition of lease asset and liability) Lease liability Prepaid executory costs Cash (1st lease payment) 1 July 2014 Executory costs expense Prepaid executory costs (Executory costs for the 2012-13 year)

Dr Dr Cr

10 000 1 200

Dr Cr

1 200

Dr Dr Dr Cr

8 552 1 448 1 200

Dr Cr

8 987

Dr Cr

1 200

$10 000 $18 594 $10 366 $38 960

Liability balance $ 38 960 28 960 20 408 11 428 --

38 960

11 200

1 200

30 June 2015 Lease liability Interest expense Prepaid executory costs Cash (2nd lease payment) Depreciation expense Accumulated depreciation (Depreciation of the leased asset 1/3($38 960 - $12 000))

11 200

8 987

1 July 2014 Executory costs expense Prepaid executory costs (Executory costs for 2013-14 period)

1 200

12.9

Solutions Manual to accompany Applying IFRS Standards 4e 30 June 2016 Lease liability Interest expense Prepaid executory costs Cash (3rd lease payment)

Dr Dr Dr Cr

8 980 1 020 1 200

Contingent rental expense Cash (Contingent rental paid)

Dr Cr

1 000

Depreciation expense Accumulated depreciation (Depreciation of leased asset 1/3($38 960 - $12 000))

Dr Cr

8 987

Dr Cr

1 200

Depreciation expense Accumulated depreciation (Final depreciation charge 1/3($38 960 - $12 000))

Dr Cr

8 987

Lease liability Interest expense Accumulated depreciation Leased vehicle (Return of vehicle to lessor)

Dr Dr Dr Cr

11 428 572 26 960

Loss on guaranteed residual value Cash (Payment required under guarantee)

Dr Cr

2 000

1 July 2016 Executory costs expense Prepaid executory costs (Executory costs for the 2014-15 year)

11 200

1 000

8 987

1 200

30 June 2017

8 987

38 960

2 000

2. Disclosures for years ending 30 June 2016 and 2017. Leasing Accounting policies Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases The entity as a lessee Assets held under finance leases are recognised as assets of the entity at their fair value at the date of acquisition or, if lower, at the present value of the minimum lease payments. The corresponding liability to the lessor is included in the statement of financial position as a finance lease liability. Lease payments are apportioned between finance charges and reduction of the lease liability to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income, unless they are directly attributable to qualifying assets, in which case they are capitalised in accordance with the entity’s general policy on borrowing costs.

12.10

Chapter 12: Leases Leased asset – net carrying amount The carrying amount of the entity’s plant and equipment includes an amount of $20 986 (2008 $29 973)

Finance Lease Liabilities PV of Minimum PV of Minimum Lease Payments Lease Payments

Amounts payable under finance leases: Within one year After one year but not more than five years Total minimum lease payments Less finance charges Present value of minimum lease payments

2016

2017

12 000 12 000 ( 572) 11 428

11 428 11 428

2016

10 000 8 980 12 00011 428 22 000 20 408 (1 592) 20 408

In respect of finance leases the following item has been recognised as an expense during the period: 2014 2013 Contingent rent 1 000 0 Contingent rent is payable if the lease vehicle is driven outside of the metropolitan area.

3. If the guaranteed residual value were $10 000, then, although the interest rate implicit in the lease stays at 5%, the lessee must record the leased asset and liability at the PV of the MLP, namely $37 232, calculated as follows: $10 000 deposit 10 000 $10 000 x 1.8594 (PV of annuity for 2 years at 5%) 18 594 $10 000 x 0.86384 (PV of future sum in 3 years at 5%) 8 638 37 232 The lease schedule would then be as follows: MLP

30 June 2014 30 June 2014 30 June 2015 30 June 2016 30 June 2017

Interest expense $

Liability reduction $

10 000 10 000 10 000 10 000 40 000

1 362 930 476 2 768

10 000 8 638 9 070 9 524 37 232

Liability balance $ 37 232 27 232 18 594 9 524 --

All payment journals would change to reflect the new interest expense and reduction in liability amounts. Depreciation expense per annum will change to 1/3($37 232 - $10 000) = $9 077. No payment would be required under the guarantee.

12.11

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 12.8 1. 2. 3. 4.

LEASE CLASSIFICATION; ACCOUNTING AND DISCLOSURES

State how both companies should classify the lease. Give reasons for your answer. Prepare a schedule of lease payments for Albert Ltd. Prepare a schedule of lease receipts for Birkenhead Ltd. Prepare journal entries to record the lease transactions for the year ended 30 June 2016 in the records of both companies. Prepare an appropriate note to the financial statements of both companies as at 30 June 2016.

Lease classification

The lease should be classified by both parties as a finance lease as substantially all of the risks and rewards incidental with ownership of the bulldozer have been transferred from the lessor to the lessee as indicated by the following: • • •

the lease is non-cancellable (by definition), the lease term, at 62.5%, which is, arguably, a major part of the bulldozer’s economic life, but the present value of the minimum lease payments is substantially all of the fair value of the asset at the lease inception, as calculated below: PV of MLP = $8 000 x 3.8897 [T2 9% 5 yrs] + $3 600 x 0.649931 [T1 9% 5yrs] = $33 457 this is equal to 96.1% of fair value at lease inception

Lease payment schedule for Albert Ltd

Date

Albert Ltd (Lessee) Lease payment schedule Interest Liability expense reduction $ $

MLP $

1 July 2013 30 June 2014 30 June 2015 30 June 2016 30 June 2017 30 June 2018

8 000 8 000 8 000 8 000 11 600 43 600

3 011 2 562 2 073 1 539 958 10 143

4 989 5 438 5 927 6 461 10 642 33 457

Receivable

Birkinhead Ltd (Lessor) Lease receipts schedule Interest Receivable revenue reduction $ $

Balance of liability $ 33 457 28 468 23 030 17 103 10 642

Year ended

$ 1 July 2013 30 June 2014 30 June 2015 30 June 2016 30 June 2017 30 June 2018

8 000 8 000 8 000 8 000 15 200 47 200

3 222 2 792 2 323 1 812 1 254 11 403

4 778 5 208 5 677 6 188 13 946 35 797

Balance of receivable $ 35 797 31 019 25 811 20 134 13 946

12.12

Chapter 12: Leases 4.

Journal entries for Birkenhead Ltd (lessor)

1 July 2013 Bulldozer Cash (Purchase of bulldozer)

Dr Cr

34 797

Lease receivable Bulldozer Cash (Recognition of lease receivable and payment of initial direct costs)

Dr Cr Cr

35 797

Dr Cr Cr

8 000

Leased asset Dr Lease liability Cr (Recognition of leased asset and lease liability)

33 457

30 June 2014 Cash Lease receivable Interest revenue (Receipt of first lease payment)

34 797

34 797 1 000

4 778 3 222

Journal entries for Albert Ltd (lessee) 1 July 2013

30 June 2014 Lease liability Interest expense Cash (First lease payment) Depreciation expense Accumulated depreciation (Depreciation of leased assets [(33 457 – 3 600) 5]

33 457

Dr Dr Cr

4 989 3 011

Dr Cr

5 971

8 000

5 971

Disclosure notes for year ended 30 June 2016

Birkenhead Ltd (lessor) Leasing Accounting policies Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases The entity as a lessor Amounts due from lessees under finance leases are recorded as receivable at the amount of the entity’s net investment in the leases. Finance lease income is allocated to accounting periods so as to reflect a constant periodic rate of return on the entity’s net investment outstanding in respect of the leases.

12.13

Solutions Manual to accompany Applying IFRS Standards 4e Finance Lease Receivables PV of Investment in lease receivable 2016 2016 Amounts receivable under finance leases: Within one year After one year but not more than five years Total minimum lease payments receivable Less unearned finance income Present value of minimum lease payments

8 000 31 200 39 200 ( 8 181) 31 019

5 208 25 811 31 019

PV of Investment in lease receivable 2015 2015 -

Unguaranteed residual values of assets leased under finance leases at the reporting date are estimated at $3 600 (2013 $nil)

Albert Ltd (lessee) Leasing Accounting policies Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases The entity as a lessee Assets held under finance leases are recognised as assets of the entity at their fair value at the date of acquisition or, if lower, at the present value of the minimum lease payments. The corresponding liability to the lessor is included in the statement of financial position as a finance lease liability. Lease payments are apportioned between finance charges and reduction of the lease liability to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income, unless they are directly attributable to qualifying assets, in which case they are capitalised in accordance with the entity’s general policy on borrowing costs.

Leased asset – net carrying amount The carrying amount of the entity’s plant and equipment includes an amount of $27 486 (2013 $nil) Finance Lease Liabilities PV of Minimum Lease Payments

Amounts payable under finance leases: Within one year After one year but not more than five years Total minimum lease payments Less finance charges Present value of minimum lease payments

2016

8 000 27 600 35 600 ( 7 132) 28 468

5 438 23 030 28 468

PV of Minimum Lease Payments 2015 -

2015 -

12.14

Chapter 12: Leases FINANCE LEASE — LESSEE AND LESSOR

Exercise 12.9

Assuming the lease is classified as a finance lease, prepare: 1. a schedule of lease payments for Wellington Ltd 2. journal entries in the records of Wellington Ltd for the years ending 30 June 2015, 30 June 2017 and 30 June 2018 3. a schedule of lease receipts for Dunedin Ltd 4. journal entries in the records of Dunedin Ltd for the years ending 30 June 2015, 30 June 2017 and 30 June 2018. WELLINGTON LTD – DUNEDIN LTD 1. Schedule of lease payments for lessee, Wellington Ltd PV of MLP = $10 000 + ($10 000 x 1.8334) + ($10 000 x 0.8396) = $36 730 Date

Payment $

1 July 2014 1 July 2015 1 July 2016 30 June 2017

10 000 10 000 10 000 10 000

Interest 6% $

Reduction in Liability $

1 604 1 100 566 3 270

10 000 8 396 8 900 9 434 36 730

Liability $ 36 730 26 730 18 334 9 434 -

2. Journal entries for lessee, Wellington Ltd 1 July 2014 - 30 June 2015

1 July 2014 Leased Vehicle Lease Liability

Dr Cr

36 730

Lease Liability Executory Costs Expense Cash

Dr Dr Cr

10 000 3 000

Dr Cr

1 604

Dr Cr

8 910

Dr Dr Dr Cr

8 900 1 100 3 000

30 June 2015 Interest Expense Interest Payable Depreciation Expense Accumulated Depreciation (1/3 ($36 730 - $10 000))

36 730

13 000

1 604

8 910

1 July 2016 - 30 June 2017 1 July 2016 Lease Liability Interest Payable Executory Costs Expense Cash

13 000

12.15

Solutions Manual to accompany Applying IFRS Standards 4e

30 June 2017 Depreciation Expense Accumulated Depreciation (1/3 ($36 730 - $10 000) Lease Liability Interest Expense Accumulated Depreciation Leased Vehicle

Dr Cr

8 910

Dr Dr Dr Cr

9 434 566 26 730

Dr Cr

1 000

Dr Cr

1 000

8 910

36 730

1 July 2017 - 30 June 2018

5 July 2017 Loss on Lease Payable to Lessor 13 July 2017 Payable to Lessor Cash

1 000

3. Schedule of lease payments for lessor, Dunedin Ltd PV = $37 876 (FV) + $534 (initial direct costs) = $38 410

Date

Payment

1 July 2014 1 July 2015 1 July 2016 30 June 2017

10 000 10 000 10 000 12 000

Interest 6%

Reduction in Receivable

1 705 1 207 678 3 590

10 000 8 295 8 793 11 322 38 410

Receivable 38 410 28 410 20 115 11 322 --

4. Journal entries for lessor, Dunedin Ltd

1 July 2014 - 30 June 2015 1 July 2014 Vehicle Cash

Dr Cr

37 876

Lease Receivable Cash Vehicle

Dr Cr Cr

38 410

Cash

13 000

Revenue - Reimbursement of Executory Costs Lease Receivable

Cr Cr

37 876

534 37 876

3 000 10 000 12.16

Chapter 12: Leases During 2014-15 Executory Costs Cash

Dr Cr

2 810

Dr Cr

1 705

2 810

30 June 2015 Interest Receivable Interest Revenue

1 705

1 July 2016 - 30 June 2017 1 July 2016 Cash

$ 13 000

Revenue – Reimbursement of Executory Costs Cr Interest Receivable Cr Lease Receivable Cr

3 000 1 207 8 793

During 2016-2017 Executory Costs Cash

Dr Cr

2 750

Dr Cr Cr

12 000

Cash Receivable from Lessee Proceeds on Sale of Vehicle

Dr Dr Cr

9 000 1 000

Carrying Amount of Vehicle Sold Vehicle

Dr Cr

12 000

Cash

Dr Cr

1 000

2 750

30 June 2017 Vehicle Interest Revenue Lease Receivable

678 11 322

1 July 2017 – 30 June 2018

Receivable from Lessee

10 000

12 000

1 000

12.17

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 12.10 1. 2. 3.

FINANCE LEASES VS OPERATING LEASES

Explain the difference between a finance lease and an operating lease. Explain, by reference to the requirements of IAS 17, why the consultant prefers operating to finance leases. Describe three disadvantages to the company of entering into finance lease agreements.

IAS 17, paragraph 4 defines a finance lease as ‘an agreement which transfers substantially all the risks and rewards incidental to ownership of an asset.’ An operating lease any lease other than a finance lease.

The differential accounting treatment prescribed by IAS 17 is the reason for advice given by the consultant that all leases are operating. For finance leases, the standard requires the company to recognise a lease asset (the shop) and a lease liability (the present value of the lease payments) at the inception of the lease. Subsequently, the asset is depreciated and interest expense recognised as the liability is reduced by the lease payments. This accounting treatment impacts on both the statement of financial position and statement of profit or loss and other comprehensive income. On the other hand, operating leases are treated as ‘rental arrangements’ with the lease payment recognised as an expense when paid. There is no impact on the statement of financial position.

Disadvantages of entering into finance lease agreements include: • Capitalisation of the leased asset increases non-current asset values and reduces return on asset ratios • Recognition of lease liabilities increases reported liability values adversely affecting the debt/equity ratio and liquidity/solvency ratios such as the current ratio • Reporting additional liabilities may cause a breach of debt covenants meaning that debts become due and payable immediately • Reporting additional liabilities may increase the cost of future borrowings or even adversely affect the company’s capacity to borrow further funds. • Depreciation and interest expense may result in lower reported profits • Depreciation and interest expenses are non tax deductible leading to the recognition of additional deferred tax liabilities • Disclosure requirements are significantly more onerous.

Exercise 12.11

LEASE INCENTIVES

Required Prepare journal entries to account for the lease payment in year 3 of the lease in the records of both the lessor and the lessee. Lessee - Journal entries Year 3 Lease expense Incentive from lessor* Cash (First lease payment made * 2 years x $5000/10)

Dr Dr Cr

4 000 1 000

Dr Cr Cr

5 000

Lessor - Journal entries Year 3 Cash Incentive to lessee* Lease income (First lease payment received * 2 years x $5000/10)

1 000 4 000

12.18

Chapter 12: Leases

Exercise 12.12

FINANCE LEASE — LESSOR

Required 1. Assuming the lease is classified as a finance lease, prepare the journal entries in the books of South Ltd in relation to the lease from 1 July 2013 to 31 July 2016. 2. In relation to finance leases, explain why the balance of the asset account raised by the lessee at the inception of the lease may differ from the balance of the receivable asset raised by the lessor. 1. South Ltd (lessor) Schedule of lease receipts MLR Interest Receivable revenue reduction $ $ $ 1 July 2013 1 July 2013 1 July 2014 1 July 2015 30 June 2016

10 000 10 000 10 000 12 000 42 000

1 705 1 207 678 3 590

10 000 8 295 8 793 11 322 38 410

Receivable balance $ 38 410 28 410 20 115 11 322 --

South Ltd Journal entries Year ended 30 June 2014 1 July 2013 Vehicle Dr Cash (purchase of vehicle)

37 000 Cr

37 000

Lease receivable Cash Vehicle (lease of vehicle and payment of initial direct costs)

Dr Cr Cr

38 410

Cash

Dr Cr Cr

13 000

Dr Cr

2 810

Dr Cr

1 705

Dr Cr Cr Cr

13 000

Reimbursement revenue Lease receivable

1 410 37 000

3 000 10 000

1 July 2010 – 30 June 2014 Insurance and maintenance expense Cash

2 810

30 June 2014 Interest receivable Interest revenue

1 705

Year ended 30 June 2015 1 July 2014 Cash Reimbursement revenue Interest receivable Lease receivable

3 000 1 705 8 295

12.19

Solutions Manual to accompany Applying IFRS Standards 4e 1 July 2014 – 30 June 2015 Insurance and maintenance expense Cash

Dr Cr

3 020

Dr Cr

1 207

Dr Cr Cr Cr

13 000

Dr Cr

2 750

3 020

30 June 2015 Interest receivable Interest revenue

1 207

Year ended 30 June 2016 1 July 2015 Cash Reimbursement revenue Interest receivable Lease receivable

3 000 1 207 8 793

1 July 2015 – 30 June 2016 Insurance and maintenance Expense Cash

2 750

30 June 2016 Vehicle Dr Interest revenue Lease receivable

12 000 Cr Cr

678 11 322

Year ended 30 June 2017 5 July 2016 Cash Accounts receivable/J Plum Proceeds on sale of vehicle

Dr Dr Cr

9 000 1 000

Carrying amount of vehicle sold Vehicle

Dr Cr

12 000

Dr Cr

1 000

13 July 2016 Cash Accounts receivable/J Plum

10 000

12 000

1 000

2. Two situations in which the lease receivable recorded by lessor is not the same as lease asset recorded by lessee are: 1.

There is an unguaranteed residual value. The lessor records as a lease receivable its net investment in the lease (present value of the minimum lease payments receivable and the present value of any unguaranteed residual value). The lessee, however, records as a leased asset (and lease liability) the present value of the minimum lease payments. The amount recorded by the lessee does not include any unguaranteed residual value.

and/or 2.

If the lessor or lessee has incurred initial direct costs. If lessor (other than a manufacturer/dealer lessor) has incurred initial direct costs then its lease receivable balance is equal to the fair value of the asset plus costs. If the lessee has incurred initial direct costs they are added to the value of the leased asset. © John Wiley and Sons, Ltd, 2016

12.20

Chapter 12: Leases

Exercise 12.13

LEASE CLASSIFICATION; ACCOUNTING BY LESSOR

Use the information contained in exercise 12.7 to complete the following: 1. Classify the lease for both lessee and lessor based on the guidance provided in IAS 17. Justify your answer. 2. Prepare (a) the lease schedules for the lessor (show all workings) and (b) the journal entries in the books of the lessor for the year ended 30 June 2014. NELSON LTD 1. See solution to question 12.7 part 1. 2. (1) Lease schedule

MLR $ 1 July 2013 1 July 2013 1 July 2014 1 July 2015 1 July 2016 30 June 2017

Nelson Ltd (Lessor) Lease receipts schedule Interest Receivable revenue reduction $ $

40 000 40 000 40 000 40 000 15 000 175 000

9 129 6 659 3 992 1 111 20 891

40 000 30 871 33 341 36 008 13 889 154 109

Receivable balance $ 154 109 114 109 83 238 49 897 13 889 -

2. (2) Journal entries for the lessor prepared for the year ended 30 June 2014. Nelson Ltd (Lessor) Journal entries 1 July 2013 Lease receivable Dr Inventory Cr Cost of sales Dr Sales revenue Cr (Inception of lease) (* Cost less PV of UGRV [15 000 x 0.735]) (** PV of MLP) Cash

154 109 130 000 *118 975 **143 084

Dr Cr Cr

41 500

Dr Cr

1 500

Interest receivable Dr Interest revenue Cr (Interest revenue accrued at balance date)

9 129

Reimbursement revenue Lease receivable (First lease payment received) 30 June 2014 Maintenance and insurance expense Cash (Payment of executory costs)

1 500 40 000

1 500

9 129

12.21

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 12.14

FINANCE LEASE — LESSEE

The following five multiple-choice questions relate to the information provided above. Select the correct answer and show any workings required. HAMILTON LTD Answer the multiple choice questions. 1. 2. 3. 4.

(d) $104 000 [$33 000 (1/7/14) + $33 000 (1/7/15) + $38 000 (1/7/16)] (c) Interest of $9 851 is accrued at 30/06/13 (incurred for the year 1/7/12 to 30/06/13) (d) $98 512 - $5000 {GRV}/4 {lease term} = $23 378 depreciation per annum. (c) Both unguaranteed residual values and initial direct costs can cause variations in the receivable recognised by the lessor and the payable recorded by the lessee. (a) This is a ‘contingent’ rent expense.

Exercise 12.15

LEASE CLASSIFICATION

Required Classify the lease for both New Ltd and Zealand Ltd. Justify your answer. Both companies will classify the transaction as a finance lease because under the terms of the agreement, substantially all of the risks and rewards incident to ownership of the machine have been transferred from the lessor to the lessee. This conclusion can be supported by the fact that: • the lease is non-cancellable (by definition), • the machine is to be returned at the end of the lease term with a guaranteed value of $25 000, • the PV of MLP is, at 96.5%, substantially all of the fair value of the machine at the inception of the lease. PV of MLP = $50 000 x 3.7908 [T2 5y 10%] + $25 000 x 0.6209 [T1 5y 10%] = $189 540 + $15 523 = $205 063/212 515 = 96.5%

12.22

Chapter 12: Leases Exercise 12.16 1. 2. 3. 4. 5.

SALES AND LEASEBACK

Classify the lease for both lessor and lessee. Justify your answer. Prepare a lease payments schedule and the journal entries in the records of Ultramarine Ltd for the year ending 30 June 2014. Show all workings. Prepare a lease receipts schedule and the journal entries in the records of Wanganui Ltd for the year ending 30 June 2014. Show all workings. Explain how and why your answers to requirements 1 and 2 would change if the lease agreement could be cancelled at any time without penalty. Explain how and why your answer to requirements 1, 2 and 3 would change if the processing plant had been manufactured by Wanganui Ltd at a cost of $400 000. ULTRAMARINE LTD

Classification of the lease

Both the lessor and the lessee must determine whether the lease agreement effectively transfers substantially all of the risks and rewards from the owner to the lessee. In this case, based on the following evidence, both parties should conclude that such a transfer is achieved and the lease should be classified as a finance lease: •

the lease is non-cancellable (by definition)

•

the lease term at 60% which, arguably, is for a major part of the asset’s economic life, and

•

the PV of the MLP at 96.6% represents substantially all of the asset’s fair value (see calculation below)

PV of MLP Minimum Lease Payments = ($165 000 – $15 000) x 3 [rentals net of executory costs] + $60 000 [GRV] Interest Rate 6% Pattern of Payments - Arrears PV of MLP = $150 000 x 2.6730 [T2 6% 3 years] + $60 000 x .8396 [T1 6% 3 years] = $400 950 + $50 376 = $451 326 PV/FV = $451 326/$467 100 = 96.6%

Lease payment schedule and journal entries for Ultramarine Ltd Ultramarine Ltd (Lessee) Lease Payments Schedule Date MLP Interest Reduction of Balance of Expense liability lease liability $ $ $ $ 1 July 2013 451 326 30 June 2014 150 000 27 080 122 920 328 406 30 June 2015 150 000 19 704 130 296 198 110 30 June 2016 210 000 11 890 198 110 510 000 58 674 451 326 -

12.23

Solutions Manual to accompany Applying IFRS Standards 4e Accounting for the lease in the books of Ultramarine Ltd Journal Entries – Year ended 30 June 2014 2013 1 July

2014 30 June

Cash Deferred gain on sale Processing plant (Sale of plant under sale and leaseback agreement)

Dr Cr Cr

467 100

Leased plant Dr Lease liability Cr (Recognition of lease agreement)

451 326

Lease liability Interest expense Executory costs expense Cash (First lease payment)

Dr Dr Dr Cr

122 920 27 080 15 000

Depreciation expense Dr Accumulated depreciation Cr (Depreciation of leased asset [($451 326 – 60 000)/3]

130 442 130 442

Deferred gain on sale Dr Revenue on sale Cr (Amortisation of deferred gain - $67 100/3)

22 367

67 100 400 000

451 326

165 000

22 367

12.24

Chapter 12: Leases 3.

Accounting for the lease in the books of Wanganui Ltd

Date

Wanganui Ltd (Lessor) Lease Receipts Schedule Interest Reduction in Revenue Receivable $ $

MLR $

1 July 2013 30 June 2014 30 June 2015 30 June 2016

150 000 150 000 240 000 540 000

28 591 21 306 13 589 63 486

121 409 128 694 226 411 476 514

Balance of lease Receivable $ 476 514 355 105 226 411 -

Journal Entries – Year ended 30 June 2014 2013 1 July

2014 30 June

Processing plant Dr Cash Cr (Purchase of plant from Ultramarine Ltd)

467 100

Lease receivable Dr Processing plant Cr (Recognition of lease agreement)

467 100

Lease receivable Dr Cash Cr (Payment of initial direct costs)

9 414

Cash Lease receivable Interest revenue Reimbursement revenue (First lease receipt)

467 100

9 414

Dr Cr Cr Cr

165 000

Maintenance expense Dr Cash Cr (Payment of maintenance costs)

15 000

121 409 28 591 15 000

15 000

4. As the lease is now cancellable without penalty it could be argued that the lease can no longer be classified as a finance lease and thus should be treated as an operating lease. The consequences are: From Ultramarine Ltd’s perspective 1. 2. 3. 4.

the leased asset is not capitalised – no asset/liability is raised on 1 July 2013 the profit on the sale of the processing plant can be recognised immediately in the statement of profit or loss and other comprehensive income the lease payment is treated as an expense item when paid. no depreciation expense is recorded

5. If Wanganui Ltd had manufactured the plant at cost of $400 000 then this could not be a sale and leaseback transaction. Accordingly, the following changes to the answer would occur: • •

Wanganui Ltd (lessor) would record the initial direct costs as an expense The lease receivable recorded by Wanganui Ltd would revert back to the fair value of $467 100 and the interest rate implicit in the lease would change to 7%*. © John Wiley and Sons, Ltd, 2016

12.25

Solutions Manual to accompany Applying IFRS Standards 4e * $150 000 x 2.6243 + $90 000 x 0.8163 = $393 645 + $73 467 = $467 112 •

The initial entry to record the lease in Wanganui Ltd’s books would change to: Lease receivable Dr 467 100 Sales revenue Cr Cost of sales Dr **375 511 Processing plant Cr (Initial recognition of lease and recording sale of plant)

*442 623 400 000

* Using 7%, PV of MLP = $150 000 x 2.6243 + $60 000 x 0.8163 **[$400 000 (cost of plant) less $24 489 (PV of unguaranteed residual value) = $30 000 x 0.8163]

Lease establishment expense Dr Cash Cr (Payment of establishment costs)

9 414 9 414

Thus, a profit on ‘sale’ of $67 100 (net of initial direct costs) would be recorded. •

Ultramarine Ltd (lessee) would have no ‘sale’ of plant entries and would simply record the leased asset/lease liability. As a result there will be no amortisation of the gain over the lease term.

12.26

Chapter 12: Leases Exercise 12.17

SALE AND LEASEBACK ARRANGEMENTS

Required 1. Does the Kapiti Ltd sale and leaseback arrangement involve a finance lease or an operating lease? Justify your choice. 2. Critically evaluate the accounting treatment adopted by Kapiti Ltd with respect to the sale and leaseback agreement. Refer, where necessary, to relevant sections of IAS 17. 3. Compare the resulting deferred income account with the Conceptual Framework’s definitions of and recognition criteria for the elements of financial statements. 1.

IAS 17 defines a finance lease as one which ‘transfers substantially all the risks and rewards incidental to ownership of an asset’. Given that: • Kapiti Ltd is the only entity which can legally operate the power station and obtain the benefits; • the lease term is for the remaining economic life of the power station; and • Kapiti Ltd has guaranteed the expected residual value; The arrangement is a finance lease as all the risks and rewards are transferred from the owner to the lessee.

IAS 17, paragraph 59 states: “If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over carrying amount shall not be immediately recognised as income by a seller-lessee. Instead it shall be deferred and amortised over the lease term.” What Kapiti Ltd has done is to recognise as a gain the difference between the power station’s carrying amount, at the date of sale, and its original cost. All other proceeds have been deferred. This accounting treatment is not in accordance with the standard which requires the entire gain (proceeds – carrying amount) to be deferred and amortised over the lease term. The treatment adopted by Kapiti Ltd is that mandated by IAS 17, paragraph 61 for a gain on sale arising from a sale and leaseback arrangement which involves an operating lease. As demonstrated in part (a) above this transaction is not an operating lease.

Deferral of all or some of the gain results in the creation of a ‘deferred income’ account which is reported on the statement of financial position. This account does not meet the Conceptual Framework’s definition of either an asset or a liability as there are no ‘future economic benefits’ or any ‘present obligation to make a future sacrifice of benefits’ arising from the sale transaction. The transaction gives rise to income in that there has been an increase in economic benefits during the accounting period in the form of cash received from the sale of the power station resulting in a net increase in equity. Accordingly, the ‘gain on sale’ should be recognised immediately in the statement of profit or loss and other comprehensive income as the net increase in equity has occurred and can be reliably measured. Deferral of the gain creates a balance which does not comply with the Conceptual Framework’s definitions and recognition criteria.

Exercise 12.18

FINANCE LEASE WITH GRV AND LEASEBACK VARIATIONS

Required 1. Prepare a schedule of lease receipts for Porirua Ltd and the journal entries for the year ended 30 June 2014. 2. Prepare a schedule of lease payments for Hastings Ltd and the journal entries for the year ended 30 June 2014. 3. Assume that Hastings Ltd guaranteed a residual value of only $4000. Prepare a lease schedule for both Porirua Ltd and Hastings Ltd. 4. Instead of acquiring the plant for $31 864, assume that Porirua Ltd manufactured the plant at a cost of $29 500 before entering into the lease agreement with Hastings Ltd. Prepare a schedule of lease receipts for Porirua Ltd and the journal entries for the year ended 30 June 2014. 5. Assume that Hastings Ltd manufactured the plant itself at a cost of $29 500 and sold the plant to Porirua Ltd for $31 864. Hastings Ltd then leased it back under the original terms of the finance lease, with Hastings Ltd guaranteeing a residual value of $4000. Prepare a lease schedule and journal entries for both Porirua Ltd and Hastings Ltd for the year ended 30 June 2014. © John Wiley and Sons, Ltd, 2016 12.27

Solutions Manual to accompany Applying IFRS Standards 4e

PORIRUA LTD 1.

Lease receipts schedule & lessor’s journal entries – year ended 30/6/2014

Workings: • Annual payment of $12 000 includes $2 000 executory cost reimbursement • Lessor incurred $360 initial direct costs (costs of preparing lease agreement). IAS 17, paragraph 38 requires that initial direct costs must be included as part of the lease receivable (unless the lessor is a manufacturer/dealer). The interest rate implicit in the lease is defined in such a way that the initial direct costs are automatically included in the finance lease receivable. • IAS 17, paragraph 36 requires the lessors to recognise a receivable equal to the net investment of the lease (PV of MLP receivable and PV of UGRV) Calculations Present value of the initial lease payment on 1 July 2013 $10 000 Present value of two lease payments ($10 000 x 1.7591*) 17 591 Present value of the guaranteed residual value ($6 000 x 0.7722**) 4 633 Present Value of Minimum Lease Payments: 32 224 This figure is equal to the fair value of the asset $31 864 plus the lessor’s initial direct costs $360. * **

based on an annuity rate on 2 years at 9% based on a single payment at the end of year 3 at 9%

Porirua Ltd (lessor) Schedule of lease receipts MLR Interest Receivable Revenue reduction 9% 1 July 2013 1 July 2013 1 July 2014 1 July 2015 30 June 2016

10 000 10 000 10 000 6 000 36 000

2 000 1 280 496 3 776

10 000 8 000 8 720 5 504 32 224

Receivable balance 32 224 22 224 14 224 5 504 NIL

Porirua Ltd Journal entries Year ended 30 June 2014 1 July 2013 Plant

Dr Cr

31 864

Lease receivable Plant Cash (Recognition of receivable for leased asset & payment of initial direct costs)

Dr Cr Cr

32 224

Cash

Dr Cr

12 000

Cash (Acquisition of plant)

Lease receivable Executory costs reimbursement Revenue (Receipt of 1st payment)

31 864

31 864 360

10 000 2 000

12.28

Chapter 12: Leases 1 July 2013 to 30 June 2014 Executory costs expense Cash (Payment of executory costs)

Dr Cr

2 000

Dr Cr

2 000

30 June 2014 Interest receivable Interest revenue (Accrual for interest revenue)

2 000

Lease payments schedule & lessee’s journal entries – year ended 30/6/2014 Hastings Ltd (lessee) Schedule of lease payments MLP Interest Liability Expense reduction 10% 1 July 2013 1 July 2014 I July 2015 1 July 2016

10 000 10 000 10 000 6 000 36 000

0 2 186 1 405 545 4 136

10 000 7 814 8 595 5 455 31 864

Liability balance 31 864 21 864 14 050 5 455 Nil

IAS 17 requires the lessee to recognise finance lease assets/liabilities at ‘amounts equal to fair value of leased property or, if lower, the present value of minimum lease payments’ (paragraph 20). In this case, using an interest rate of 9%, the PV of MLP ($32 224) is higher than fair value ($31 864) due to the existence of the lessor’s initial direct costs of $360 being included in the implicit rate of 9%, as well as a 100% guaranteed residual value. As the value of the lessee’s asset/liability is restricted to a maximum of fair value, the interest implicit in the lease must be recalculated for the lessee as follows: Using a 10% rate: $10 000 + $10 000 x 1.7355 [T2 10% 2y] + $6 000 x 0.7513 [T1 10% 3y] . = $10 000 + $17 355 + $4 508 = $31 864 (fair value) Hastings Ltd Journal entries Year ended 30 June 2014 1 July 2013 Leased equipment Lease liability (Recognition of lease asset and lease liability at the inception of the lease).

Dr Cr

31 864

Lease liability Executory costs expense Cash (First lease payment)

Dr Dr Cr

10 000 2 000

2 186 2 186

31 864

12 000

30 June 2014 Interest expense Interest payable (Accrued interest expense) Depreciation expense

Dr © John Wiley and Sons, Ltd, 2016

8 621 12.29

Solutions Manual to accompany Applying IFRS Standards 4e

Accumulated depreciation Cr 8 621 (depreciation of the leased asset*) As ownership is not expected to be transferred to the lessee at the end of the lease term, the asset should be depreciated over the lease term (i.e. over 3 years). Depreciation of $8 621 is calculated as follows: $8 621 = ($31 864 - $6 000)/3 years Assuming a Guaranteed Residual Value of only $4 000, prepare lease schedules for both lessor and lessee

For Porirua Ltd, as the total residual value is unchanged the receipts schedule is identical to part 1. •

For Hastings Ltd, as the guaranteed residual value has changed the present value of the minimum lease payments will need to be recalculated as follows, using the implicit rate of 9%: PV of MLP Present value of the initial lease payment on 1 July 2013 $10 000 Present value of two lease payments ($10 000 x 1.7591*) 17 591 Present value of the guaranteed residual value ($4 000 x 0.7722**) 3 089 Present Value of Minimum Lease Payments: 30 680 * based on an annuity rate on 2 years at 9% ** based on a single payment at the end of year 3 at 9% •

the payments schedule must now start with a liability of $30 680:

Hastings Ltd (lessee) Schedule of lease payments MLP Interest Liability expense reduction 9% 1 July 2013 1 July 2014 1 July 2014 1 July 2015 30 June 2016

10 000 10 000 10 000 4 000 34 000

1 861 1 129 330 3 320

10 000 8 139 8 871 3 670 30 680

Liability balance 30 680 20 680 12 541 3 670 NIL

4. Schedule of lease receipts for Pororua Ltd • As Porirua Ltd is now a manufacturer lessor, IAS 17 paragraph 42 requires a profit or loss to be recorded with respect to the plant at the commencement of the lease and the establishment costs to be recognised as an expense when the selling profit is recognised. • Porirua Ltd’s net investment in the lease is now equal to $31 864 and the interest rate implicit in the lease is 10%. Porirua Ltd (lessor) Schedule of lease receipts MLR Interest Receivable Revenue reduction 10% 1/7/2013 1/7/2013 1/7/2014 1/7/2015 30/6/2016

10 000 10 000 10 000 6 000 36 000

2 186 1 405 545 4 136

10 000 7 814 8 595 5 455 31 864

Receivable balance 31 864 21 864 14 050 5 455 NIL

Porirua Ltd © John Wiley and Sons, Ltd, 2016

12.30

Chapter 12: Leases Journal entries Year ended 30 June 2014 1 July 2013 $ Lease receivable Dr 31 864 Sales revenue* Cr Cost of sales** Dr 29 500 Inventory Cr (initial recognition of lease receivable and recording sale of plant)

$ 31 864 29 500

*Sales revenue = fair value as there is a 100% guaranteed residual value **Cost of sales = carrying amount as there is a 100% guaranteed residual value Lease establishment expenses Cash (payment of establishment costs)

Dr Cr

360

Dr Cr Cr

12 000

1 July 2013 to 30 June 2014 Executory costs expense Cash (Payment of executory costs)

Dr Cr

2 000

30 June 2014 Interest receivable Interest revenue (Accrual for interest revenue)

Dr Cr

2 186

1 July 2013 Cash Lease receivable Executory costs reimburse revenue (Receipt of 1st payment)

360

10 000 2 000

2 000

2 186

5. As the lease terms are unchanged, the schedules are the same as for Part 3.

Porirua Ltd (lessor) Schedule of lease receipts MLR Interest Receivable Revenue reduction 9% 1 July 2013 1 July 2013 1 July 2014 1 July 2015 30 June 2016

10 000 10 000 10 000 6 000 36 000

2 000 1 280 496 3 776

10 000 8 000 8 720 5 504 32 224

Hastings Ltd (lessee) Schedule of lease payments MLP Interest Liability expense reduction 9% 1 July 2013 1 July 2014 1 July 2014 1 July 2015 30 June 2016

10 000 10 000 10 000 4 000 34 000

1 861 1 129 330 3 320

10 000 8 139 8 871 3 670 30 680

Receivable balance 32 224 22 224 14 224 5 504 NIL

Liability balance 30 680 20 680 12 541 3 670 NIL

12.31

Solutions Manual to accompany Applying IFRS Standards 4e Hastings Ltd has entered into a sale & leaseback transaction. As the lease is a finance lease IAS 17, paragraph 59, requires that any excess of sales proceeds over the carrying amount of the plant be deferred and amortised over the lease term.

Hastings Ltd Journal entries Year ended 30 June 2014 1 July 2013 Cash

Inventory - Plant Cr Deferred gain on sale Cr (Sale of plant and recognition of excess proceeds as a deferred gain)

$ $ 31 864 29 500 2 364

Leased equipment Lease liability (Recognition of lease asset and lease liability at the inception of the lease).

Dr Cr

30 680

Lease liability Executory costs expense Cash (First lease payment)

Dr Dr Cr

10 000 2 000

1 861

30 June 2014 Interest expense Interest payable (Accrued interest expense)

30 680

12 000

Depreciation expense Accumulated depreciation (Depreciation of the leased asset (30 680 – 4,000)/3 = 8 893))

1 861

Dr Cr

8 893

Deferred gain on sale Dr 788 Gain on sale of leased plant Cr (Amortisation of deferred gain over lease term: $2 364/3 = $788)

8 893

788

For the journal entries for Porirua Ltd see Part 1.

12.32

Chapter 12: Leases Exercise 12.19 FINANCE LEASE — MANUFACTURER LESSOR 1. 2.

Prepare a schedule of lease receipts for Auckland Ltd. Prepare the general journal entries to record the lease transactions for the year ended 30 June 2014 in the records of Auckland Ltd.

CHRISTCHURCH LTD – AUCKLAND LTD NOT REQUIRED: PV of MLP = 96.5% of FV at the date of the lease inception [$50 000 (3.7908) + $25 000(.62092) = $189 540 + $15 523 = $205 063 PV/FV = $205 063/$212 515 = 96.5% PV of UGRV = $12 000 x 0.6209 = $7 450 1. Auckland Ltd (Lessor) Schedule of Lease Receipts Year ending

1/7/13 1/7/14 1/7/15 1/7/16 1/7/17 1/7/18

MLR

Interest revenue (10%)

Reduction of receivable

50 000 50 000 50 000 50 000 87 000 287 000

21 252 18 377 15 214 11 736 7 906 74 485

28 748 31 623 34 786 38 264 79 094 212 515

Balance of receivable 212 515 183 767 152 144 117 358 79 094 -

2. Auckland Ltd (Lessor) General Journal 2013 1 July

2013/14

2014 30 June

Lease receivable Cost of sales Inventory Sales revenue

Dr Dr Cr Cr

Lease arrangement expense Cash

Dr Cr

1 500

Executory costs expense Cash

Dr Cr

7 200

Interest receivable Interest revenue

Dr Cr

21 252

Executory costs reimbursement revenue receivable Executory costs reimbursement revenue

Dr Cr

7 500

212 515 187 550 195 000 205 065

1 500

7 200

21 252

7 500

12.33

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter12 Leases

Chapter 12 Leases Learning Objectives 12.1 discuss the characteristics of a lease 12.2 explain the difference between a finance lease and an operating lease 12.3 understand and apply the guidance necessary to classify leases 12.4 account for finance leases from the perspective of a lessee 12.5 account for finance leases from the perspective of a lessor 12.6 account for finance leases by manufacturer or dealer lessors 12.7 account for operating leases from the perspective of both lessors and lessees 12.8 recognise and account for sale and leaseback transactions 12.9 discuss changes to lease accounting.

12.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

Which of the following is included within the scope of IFRS 16 Leases? Learning Objective 12.1 discuss the characteristics of a lease a. lease agreements for motion picture films; b. lease agreements to explore for minerals; c. lease agreements for biological assets; *d. lease agreement for an oil refinery.

The user of a leased asset is referred to as the: Learning Objective 12.1 discuss the characteristics of a lease a. vendor; b. purchaser; c. lessor; *d. lessee.

Which of the following is NOT an example of a risk of ownership of an asset? Learning Objective 12.2 explain the difference between a finance lease and an operating lease a. idle capacity; *b. gains on the eventual sale of the asset; c. uninsured damage; d. technical obsolescence.

A finance lease is an agreement between an owner of an asset and a user of that asset wherein the: Learning Objective 12.2 explain the difference between a finance lease and an operating lease a. legal title to property is transferred to the lessee when the first lease payment is made; b. ownership passes to the lessor on inception date of the lease; c. substantially all of the risks and benefits of ownership remain with the lessor; *d. usual risks and benefits of ownership are transferred to the user.

Which of the following is NOT one of the situations provided in IFRS 16 Leases in relation to the classification of leases as finance leases? Learning Objective 12.3 understand and apply the guidance necessary to classify leases a. Losses from the fluctuation of the fair value of the residual accrue to the lessee; b. Leased assets are of a specialised nature; *c. The lessee has provided a guarantee that they will acquire the asset at the end of the lease term; d. The lease is for a major part of the economic life of the asset.

12.2

Chapter12 Leases

IFRS 16 Leases deems cancellable leases with which of the following characteristics to be non-cancellable:

Leases that can be cancelled upon the occurrence of some remote contingency Leases that can be cancelled only with the permission of the lessor Leases where the lessee, upon cancellation, is committed to enter into a further lease with the same lessor Leases that require the lessee to pay a substantial penalty on cancellation

I No

II Yes

III Yes

IV Yes

Yes

Learning Objective 12.3 understand and apply the guidance necessary to classify leases a. I; b. II; *c. III; d. IV.

The minimum lease payment is defined as including all of the following components except: Learning Objective 12.3 understand and apply the guidance necessary to classify leases a. bargain purchase option; *b. contingent rentals; c. a guaranteed residual value; d. the lease payments occurring over the lease term.

According to IFRS 16 Leases, because lease payments are made over the lease term, the payments made under a finance lease must be divided into the following components: ➢ ➢ ➢ ➢

Reduction of the lease liability Interest expense incurred Reimbursement of lessor costs Receipt of lease incentives

I II Yes Yes Yes No Yes Yes No No

III IV No Yes Yes No Yes No Yes Yes

Learning Objective 12.4 account for finance leases from the perspective of a lessee *a. I; b. II; c. III; d. IV.

12.3

Test Bank to accompany Applying IFRS Standards 4e

Which of the following is an appropriate journal entry for the initial recognition by a lessee of a finance lease arrangement? Learning Objective 12.4 account for finance leases from the perspective of a lessee a. DR Leased asset CR Bank loan; b. DR Cash CR Leased asset; c. DR Lease liability CR Leased asset; *d. DR Leased asset CR Lease liability.

The following information relates to questions 10-12 Adam Limited and Davies Limited enter into a finance lease agreement with the following terms: ➢ ➢ ➢ ➢ ➢

lease term is 3 years estimated economic life of the leased asset is 6 years 3 × annual rental payments of £23 000 each payment is one year in arrears residual value at the end of the lease term is not guaranteed by the lessee interest rate implicit in the lease is 7%.

10.

On inception date, the present value of the minimum lease payments is: Learning Objective 12.4 account for finance leases from the perspective of a lessee *a. £60 359; b. £64 170; c. £64 584; d. £69 000.

11.

The period over which the asset should be depreciated by the lessee is: Learning Objective 12.4 account for finance leases from the perspective of a lessee a. 3 years; b. 6 years; c. the rate as determined by the tax authorities; *d. cannot be determined from the information provided.

12.

The journal entry recorded by the lessee when the payment is made at the end of the first year is: Learning Objective 12.4 account for finance leases from the perspective of a lessee *a.

Dr Dr Cr

Interest expense Lease liability Cash

4 225 18 775

Dr Dr Cr

Lease liability Interest expense Cash

4 225 18 775

Dr Dr Cr

Interest expense Lease liability Cash

1 610 21 390

Lease liability

1 610

23 000

12.4

Chapter12 Leases

Dr Cr

Interest expense Cash

21 390 23 000

13.

In relation to finance leases, the following information must be disclosed separately in the financial statements of lessors: I Unearned finance income. II Contingent rents recognised as income in the period. III The unguaranteed residual values accruing to the benefit of the lessee. IV The accumulated allowance for uncollectible minimum lease payments receivable. Learning Objective 12.5 account for finance leases from the perspective of a lessor *a. I, II and IV only; b. I, III and IV only; c. II, III and IV only; d. II and IV only.

14.

On 30 June 2016, Mala Ltd leased a vehicle to Tango Ltd. Mala Ltd had purchased the vehicle on that day for its fair value of €89 721. The lease agreement cost Mala Ltd €1457 to have drawn up and requires Tango to reimburse Mala for annual insurance costs of €1050. The amount recorded as a lease receivable by Mala Ltd at the inception of the lease is: Learning Objective 12.5 account for finance leases from the perspective of a lessor a. €88 264; b. €89 721; c. €90 771; *d. €91 178.

15.

Which of the following is an appropriate journal entry for the initial recognition by a lessor of a finance lease arrangement? Learning Objective 12.5 account for finance leases from the perspective of a lessor *a. DR Lease receivable CR Asset; b. DR Lease receivable CR Lease liability; c. DR Leased asset: CR Cash/Trade payables; d. DR Leased asset CR Cash.

12.5

Test Bank to accompany Applying IFRS Standards 4e

16.

Nelson Ltd manufactures specialised machinery for both sale and lease. On 1 July 2016, Nelson leased a machine to Poggi Ltd. The machine cost Nelson Ltd €195 000 to manufacture, and its fair value at the inception of the lease was €212 515. The interest rate implicit in the lease is 10%, which is in line with current market rates. Under the terms of the lease, Poggi Ltd has guaranteed €25 000 of the asset’s expected residual value of €37 000 at the end of the 5-year lease term. The debit to the sales revenue account in Nelson’s books is: Learning Objective 12.6 account for finance leases by manufacturer or dealer lessors a. €187 548; b. €195 000; *c. €205 063; d. €212 515.

17.

IFRS 16 Leases requires manufacturer and dealer lessors to recognise selling profit or loss at the: Learning Objective 12.6 Account for finance leases by manufacturer or dealer lessor a. end of the lease; b. systematically recognised over the lease term; *c. commencement of the lease; d. 50% at commencement of the lease and 50% at the end of the lease.

18.

Under IFRS 16 Leases, lessors are required to account for lease receipts from operating leases as: Learning Objective 12.7 account for operating leases from the perspective of both lessors and lessees a. revenue, on a reducing balance basis over the lease term; b. income, on inception date of the lease; *c. income, on a straight-line basis over the lease term; d. revenue, at the end of the lease term.

19.

With respect to operating leases, lessors are required under IFRS 16 Leases to make the following disclosures: I Total contingent rents recognised as income in the period II Future minimum lease payments under individual, cancellable operating leases, separately III A general description of the lessee’s leasing arrangements IV Future minimum lease payments under non-cancellable operating leases in aggregate. Learning Objective 12.7 account for operating leases from the perspective of both lessors and lessees a. I, II and III only; *b. I, III and IV only; c. II and III only; d. I, II and IV only.

12.6

Chapter12 Leases

20.

A lessee when accounting for a lease incentive received under an operating lease treats is as a: Learning Objective 12.7 account for operating leases from the perspective of both lessors and lessees a. increase in rental income over the lease term; b. increase in rental expense over the lease term; *c. reduction in rental expense over the lease term; d. reduction in rental income over the lease term.

21.

Burgess Limited accepts a lease incentive to enter into a 3-year operating lease for a building. The incentive is a cash amount of £5000 received on signing of the lease agreement. The lessee initially records this transaction as follows: Learning Objective 12.7 account for operating leases from the perspective of both lessors and lessees a. DR Lease expense £5000 CR Cash £5000 b.

*d.

22.

DR CR

Incentive from lessor Cash

£5000

DR CR

Incentive to lessee Rent income

£5000

DR CR

Cash

£5000

Lease incentive from lessor

£5000.

Timely Limited accepts a lease incentive to enter into a 4-year operating lease for equipment. The incentive is cash amounting to £10 000 that will be paid on the date the lease agreement is signed. On inception of the lease, the lessor will record: Learning Objective 12.7 account for operating leases from the perspective of both lessors and lessees a. DR Cash £10 000 CR Incentive to lessee £10 000 *b.

DR CR

Incentive to lessee Cash

£10 000

DR CR

Rent income Rent expense

£10 000

DR CR

Cash

£10 000 Rent income

£10 000

12.7

Test Bank to accompany Applying IFRS Standards 4e

23.

Which of the following is an appropriate journal entry for the initial recognition by a lessee of an operating lease arrangement? Learning Objective 12.7 account for operating leases from the perspective of both lessors and lessees a. DR Leased asset CR Lease liability; *b. DR Lease rental expense CR Cash/Trade payables; c. DR Leased asset CR Cash/Trade payables; d. DR Lease asset CR Lease interest expense.

24.

If a sale and leaseback transaction results in a finance lease, IFRS 16 Leases provides the following accounting treatment for any excess of sales proceeds over the carrying amount: Learning Objective 12.8 recognise and account for sale and leaseback transactions a. recognise directly in retained earnings of the seller-lessee; b. immediately recognise as income by the seller-lessee; *c. defer and amortise over the lease term; d. include in the capitalised amount of the leased asset.

25.

A sale and leaseback transaction involves the sale of an asset that is then leased back to the: Learning Objective 12.8 recognise and account for sale and leaseback transactions *a. original owner; b. acquiring entity; c. lessor; d. purchaser.

26.

Which of the following was NOT a reason given by the IASB to remove the requirement to classify leases from any future accounting standard? Learning Objective 12.9 discuss changes to lease accounting a. All leases give rise to a right to use the leased item that meets the definition of an asset; a single conceptual model to account for all leases is preferable; b. The removal of classification will result in a simpler accounting standard; *c. Removing the classification will result in inconsistencies in how the minimum lease payments are determined for classification purposes; d. Removal of classification will result in similar transactions being accounted for in the same way.

12.8

Exercises Exercise 12.10 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

FINANCE LEASES VS OPERATING LEASES

Timaru Ltd runs a successful chain of fashion boutiques, but has been experiencing significant cash flow problems. The directors are examining a proposal made by an accounting consultant that all the shops currently owned by the company be sold and either leased back or the businesses moved to alternative leased shops. The directors are keen on the plan but are puzzled by the consultant’s insistence that all lease agreements for the shops be ‘operating’ rather than ‘finance’ leases. Required

1. Explain the difference between a finance lease and an operating lease. 2. Explain, by reference to the requirements of IAS 17, why the consultant prefers operating to finance leases. 3. Describe three disadvantages to the company of entering into finance lease agreements.

Exercise 12.11 ★

LEASE INCENTIVES

As an incentive to enter a non-cancellable operating lease for ofﬁce premises for 10 years, the lessor has offered the lessee a rent-free period of 2 years. Rental payments under the lease beginning in year 3 are $5000 p.a. Required

Prepare journal entries to account for the lease payment in year 3 of the lease in the records of both the lessor and the lessee.

Exercise 12.12 ★

FINANCE LEASE — LESSOR

On 1 July 2013, Jane Plum decided she needed a new car. She went to the local car yard, North Ltd, run by Fred Peach. Jane discussed the price of a new Roadster Special with Fred, and they agreed on a price of $37 000. As North Ltd had acquired the vehicle from the manufacturer for $30 000, Fred was pleased with the deal. On learning that Jane wanted to lease the vehicle, Fred agreed to arrange for South Ltd, a local ﬁnance company, to set up the lease agreement. North Ltd then sold the car to South Ltd for $37 000. South Ltd wrote a lease agreement, incurring initial direct costs of $1410 as a result. The lease agreement contained the following provisions: Initial payment on 1 July 2013 Payments on 1 July 2014 and 1 July 2015 Guaranteed residual value at 30 June 2016 Implicit interest rate in the lease The lease is non-cancellable.

$13 000 $13 000 $10 000 6%

South Ltd agreed to pay for the insurance and maintenance of the vehicle, the latter to be carried out by North Ltd at regular intervals. The cost of these services is valued at $3000 p.a. The vehicle had an expected useful life of 4 years. The expected residual value of the vehicle at 30 June 2016 was $12 000. Costs of maintenance and insurance incurred by South Ltd over the years ended 30 June 2014 to 30 June 2016 were $2810, $3020 and $2750 respectively. At 30 June 2016, Jane returned the vehicle to South Ltd, which sold the car for $9000 on 5 July 2016 and invoiced Jane for the appropriate balance. Jane subsequently paid the debt on 13 July 2016. Required

1. Assuming the lease is classified as a finance lease, prepare the journal entries in the books of South Ltd in relation to the lease from 1 July 2013 to 31 July 2016. 2. In relation to finance leases, explain why the balance of the asset account raised by the lessee at the inception of the lease may differ from the balance of the receivable asset raised by the lessor.

CHAPTER 12 Leases

Exercise 12.13

LEASE CLASSIFICATION; ACCOUNTING BY LESSOR

★ Use the information contained in exercise 12.7 to complete the following:

1. Classify the lease for both lessee and lessor based on the guidance provided in IAS 17. Justify your answer. 2. Prepare (a) the lease schedules for the lessor (show all workings) and (b) the journal entries in the books of the lessor for the year ended 30 June 2014.

Exercise 12.14

FINANCE LEASE — LESSEE

★ Hamilton Ltd prepares the following lease payments schedule for the lease of a machine from Hutt Ltd. The

machine has an economic life of 6 years. The lease agreement requires four annual payments of $33 000, and the machine will be returned to Hutt Ltd at the end of the lease term. The lease payments schedule is:

1 July 2012 1 July 2013 1 July 2014 1 July 2015 1 July 2016

MLP

Interest expense (10%)

Reduction in liability

$ 30 000 30 000 30 000 35 000 $125 000

$ 9 851 7 836 5 620 3 181 $26 488

$ 20 149 22 164 24 380 31 819 $ 98 512

Balance of liability $ 98 512 78 363 56 199 31 819 —

The following ﬁve multiple-choice questions relate to the information provided above. Select the correct answer and show any workings required. 1. In its notes to the accounts at 30 June 2014, Hamilton Ltd would disclose future lease payments of what amount? (a) $95 000 (c) $99 000 (b) $65 000 (d) $104 000 2. For the year ended 30 June 2013, what would Hamilton Ltd record in relation to the lease? (a) An interest payable of $26 488 (b) An interest payable of $nil (c) An interest payable of $9851 (d) An interest payable of $7836 3. How much annual depreciation expense would Hamilton Ltd record? (a) $24 628 (b) $16 419 (c) $15 585 (d) $23 378 4. If Hutt Ltd (the lessor) records a lease receivable of $102 327, the variance between this receivable and the liability of $98 512 recorded by Hamilton Ltd could be due to what? (a) Initial direct costs paid by Hutt Ltd (b) An unguaranteed residual value (c) Both of the above (d) Neither of the above 5. Assume that the 1 July 2013 lease payment included an additional amount of $3000 for exceeding a limit for machine usage hours speciﬁed in the lease agreement. Hamilton Ltd would account for this charge by recognising it as what? (a) An expense and disclosing the amount in the notes (if material) (b) Additional executory costs (c) Revenue (d) A reduction in the lease liability Exercise 12.15

LEASE CLASSIFICATION

★★ New Ltd manufactures specialised moulding machinery for both sale and lease. On 1 July 2014, New Ltd

leased a machine to Zealand Ltd. The machine being leased cost New Ltd $195 000 to make and its fair value at 1 July 2014 is considered to be $212 515. The terms of the lease are as follows: The lease term is for 5 years, starting on Annual lease payment, payable on 30 June each year Estimated useful life of machine (scrap value $2500) Estimated residual value of machine at end of lease term

PART 2 Elements

1 July 2014 $57 500 8 years $37 000

Residual value guaranteed by Zealand Ltd Interest rate implicit in the lease The annual lease payment includes an amount of $7500 to cover annual maintenance and insurance costs. Zealand Ltd may cancel the lease but only with the permission of the lessor. Zealand Ltd intends to lease a new machine at the end of the lease term.

$25 000 10%

Required

Classify the lease for both New Ltd and Zealand Ltd. Justify your answer. Exercise 12.16 ★★

SALES AND LEASEBACK

Ultramarine Ltd is asset rich but cash poor. In an attempt to alleviate its liquidity problems, it entered into an agreement on 1 July 2013 to sell its processing plant to Wanganui Ltd for $467 100. At the date of sale, the plant had a carrying amount of $400 000 and a future useful life of 5 years. Wanganui Ltd immediately leased the processing plant back to Ultramarine Ltd. The terms of the lease agreement were: Lease term Economic life of plant Annual rental payment, in arrears (commencing 30/6/14) Residual value of plant at end of lease term Residual value guaranteed by Ultramarine Ltd Interest rate implicit in the lease The lease is cancellable, but only with the permission of the lessor.

3 years 5 years $165 000 $90 000 $60 000 6%

At the end of the lease term, the plant is to be returned to Wanganui Ltd. In setting up the lease agreement Wanganui Ltd incurred $9414 in legal fees and stamp duty costs. The annual rental payment includes $15 000 to reimburse the lessor for maintenance costs incurred on behalf of the lessee. Required

1. Classify the lease for both lessor and lessee. Justify your answer. 2. Prepare a lease payments schedule and the journal entries in the records of Ultramarine Ltd for the year ending 30 June 2014. Show all workings. 3. Prepare a lease receipts schedule and the journal entries in the records of Wanganui Ltd for the year ending 30 June 2014. Show all workings. 4. Explain how and why your answers to requirements 1 and 2 would change if the lease agreement could be cancelled at any time without penalty. 5. Explain how and why your answer to requirements 1, 2 and 3 would change if the processing plant had been manufactured by Wanganui Ltd at a cost of $400 000. Exercise 12.17 ★★★

SALE AND LEASEBACK ARRANGEMENTS

Kapiti Ltd is a company involved in a diverse range of activities involving power generation, machinery retailing and agriculture. The accounting policy note attached to the 2016 financial statements included the following under the heading ‘Leases’: During the year the company entered into a refinancing arrangement which involved the sale of the Lilac Mountain power station under a sale and leaseback arrangement. The difference between the carrying amount of the power station and its original cost has been included in profit and disclosed as a gain on sale of a non-current asset. Sales proceeds in excess of the original cost have been treated as deferred income in the statement of financial position. The amount of deferred income will be systematically amortised over the term of the lease.

The power station is a unique asset in that the licence to generate power from that station is held by Kapiti Ltd and cannot be transferred. The leaseback period is for the remaining 20 years economic life of the power station and Kapiti Ltd has guaranteed its expected residual value at that time of $55 000. Required

1. Does the Kapiti Ltd sale and leaseback arrangement involve a finance lease or an operating lease? Justify your choice. 2. Critically evaluate the accounting treatment adopted by Kapiti Ltd with respect to the sale and leaseback agreement. Refer, where necessary, to relevant sections of IAS 17. 3. Compare the resulting deferred income account with the Conceptual Framework’s definitions of and recognition criteria for the elements of financial statements. CHAPTER 12 Leases

Exercise 12.18

FINANCE LEASE WITH GRV AND LEASEBACK VARIATIONS

★★★ On 1 July 2013, Porirua Ltd acquired an item of plant for $31 864. On the same date, Porirua Ltd entered into

a lease agreement with Hastings Ltd in relation to the asset. According to the lease agreement, Hastings Ltd agreed to pay $12 000 immediately, with a further two payments of $12 000 on 1 July 2014 and 1 July 2015. At 30 June 2016, the asset is to be returned to the lessor and its residual value is expected to be $6000. Hastings Ltd has agreed to guarantee the expected residual value at 30 June 2013. All insurance and maintenance costs are to be paid by Porirua Ltd and are expected to amount to $2000 p.a. The costs of preparing the lease agreement amounted to $360. The interest rate implicit in the lease is 9%. The lease is classiﬁed as a ﬁnance lease. Plant is depreciable on a straight-line basis. Required

1. Prepare a schedule of lease receipts for Porirua Ltd and the journal entries for the year ended 30 June 2014. 2. Prepare a schedule of lease payments for Hastings Ltd and the journal entries for the year ended 30 June 2014. 3. Assume that Hastings Ltd guaranteed a residual value of only $4000. Prepare a lease schedule for both Porirua Ltd and Hastings Ltd. 4. Instead of acquiring the plant for $31 864, assume that Porirua Ltd manufactured the plant at a cost of $29 500 before entering into the lease agreement with Hastings Ltd. Prepare a schedule of lease receipts for Porirua Ltd and the journal entries for the year ended 30 June 2014. 5. Assume that Hastings Ltd manufactured the plant itself at a cost of $29 500 and sold the plant to Porirua Ltd for $31 864. Hastings Ltd then leased it back under the original terms of the ﬁnance lease, with Hastings Ltd guaranteeing a residual value of $4000. Prepare a lease schedule and journal entries for both Porirua Ltd and Hastings Ltd for the year ended 30 June 2014. Exercise 12.19

FINANCE LEASE — MANUFACTURER LESSOR

★★★ Auckland Ltd manufactures specialised moulding machinery for both sale and lease. On 1 July 2013, Auckland Ltd leased a machine to Christchurch Ltd, incurring $1500 in costs to prepare and execute the lease document. The machine being leased cost Auckland Ltd $195 000 to make and its fair value at 1 July 2013 is considered to be $212 515. The terms of the lease agreement are as follows: Lease term commencing on 1 July 2013 Annual lease payment commencing on 1 July 2014 Estimated useful life of machine (scrap value $2500) Estimated residual value of machine at end of lease term Residual value guaranteed by Christchurch Ltd Interest rate implicit in the lease The lease is classified as a finance lease.

5 years $57 500 8 years $37 000 $25 000 10%

The annual lease payment includes an amount of $7500 to cover annual maintenance and insurance costs. Actual executory costs for each of the 5 years were: 2013–14 2014–15 2015–16 2016–17 2017–18

$7 200 7 700 7 800 7 100 7 000

Christchurch Ltd may cancel the lease but will incur a penalty equivalent to 2 years payments if it does so. Christchurch Ltd intends to lease a new machine at the end of the lease term. The end of the reporting period for both companies is 30 June. Required

1. Prepare a schedule of lease receipts for Auckland Ltd. 2. Prepare the general journal entries to record the lease transactions for the year ended 30 June 2014 in the records of Auckland Ltd.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Revised for this edition by David Kolitz

John Wiley & Sons, Ltd 2016

Chapter 13: Intangible assets

Chapter 13 – Intangible assets Discussion questions 1.

What are the key characteristics of an intangible asset?

Para 8 of IAS 38 defines an intangible asset as: An identifiable non-monetary asset without physical substance. Key characteristics are: ▪ Identifiable [see 2 below]: because of its emphasis on markets is inserted to exclude many possible intangibles that are difficult to measure e.g. staff morale, good customer relations ▪ Non-monetary: this characteristic excludes financial assets such as receivables from being classified as intangibles ▪ Without physical substance: excludes items of PP&E covered by IAS 16 Explain what is meant by ‘identifiability’.

Para 12 of IAS 38 states: An asset meets the identifiability criterion in the definition of an intangible asset when it: (a) is separable, i.e. is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or (b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. (c) excludes goodwill, and other possible assets such as staff morale (d) is included to allow such assets as water rights, where these were allocated by a government but if not used were unable to be on-sold and so were not separable, to be classified as intangible assets

How do the principles for amortisation of intangible assets differ from those for depreciation of property, plant and equipment? ▪ ▪ ▪ ▪

Basic principle of allocation of the depreciable amount on a systematic basis over useful life is the same. With intangibles, straight-line method is the default method where the pattern of receipt of benefits cannot be reliably determined. Not so for PPE. With intangibles can have indefinite lives, not so for PPE With intangibles with finite lives, residual value is assumed to be zero unless para 100 criteria are met. Not so for PPE. Explain what is meant by an ‘active market’.

Para 8 states: An active market is a market in which all the following conditions exist: (a) the items traded in the market are homogeneous; © John Wiley and Sons, Ltd, 2016

13.1

Solutions Manual to accompany Applying IFRS Standards 4e (b) willing buyers and sellers can normally be found at any time; and (c) prices are available to the public. Consider markets such as property and used cars compared with brand names.

How is the useful life of an intangible asset determined?

Useful life must be assessed as finite or indefinite. Note para 90 in relation to assessment of whether an indefinite useful life exists: Many factors are considered in determining the useful life of an intangible asset, including: (a) the expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team; (b) typical product life cycles for the asset and public information on estimates of useful lives of similar assets that are used in a similar way; (c) technical, technological, commercial or other types of obsolescence; (d) the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset; (e) expected actions by competitors or potential competitors; (f)

the level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity's ability and intention to reach such a level;

(g) the period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases; and (h) whether the useful life of the asset is dependent on the useful life of other assets of the entity.

What intangibles can never be recognised if internally generated? Why? Para 63 states: Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets Para 64 gives the reason: Expenditure on internally generated brands, mastheads, publishing titles, customer lists and items similar in substance cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are not recognised as intangible assets.

Explain the difference between ‘research’ and ‘development’. Para 8 contains the following definitions: Research: is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development: is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. Para 56 gives examples of research activities: (a) activities aimed at obtaining new knowledge; © John Wiley and Sons, Ltd, 2016

13.2

Chapter 13: Intangible assets (b) the search for, evaluation and final selection of, applications of research findings or other knowledge; (c) the search for alternatives for materials, devices, products, processes, systems or services; and (d) the formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems or services. Para 59 gives examples of development activities: (a) the design, construction and testing of pre-production or pre-use prototypes and models; (b) the design of tools, jigs, moulds and dies involving new technology; (c) the design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production; and (d) the design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services

Explain when development outlays can be capitalised. Para 57 states that when all the following criteria are met, development outlays can be capitalised: (a) the technical feasibility of completing the intangible asset so that it will be available for use or sale. (b) its intention to complete the intangible asset and use or sell it. (c) its ability to use or sell the intangible asset. (d) how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset. (e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset. (f)

its ability to measure reliably the expenditure attributable to the intangible asset during its development.

13.3

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 13.1

USEFUL TRADEMARK LIFE

Discuss how the company should determine the useful life of the trademark, noting in particular what form of evidence it should collect to justify its selection of useful life. X LTD

1. Does the company have an asset beyond the 5 years: - are there expected future benefits? - Can the entity control those benefits [are they controlled by the government that issues the licence? Compare with the employee who may leave] - What is the past transaction given the renewal of the trademark for any subsequent term has not yet been granted? 2. Evidence of control is the crucial element. In particular evidence relating to whether the company controls the variables that determine renewal of the trademark. For example, does renewal depend on the company meeting certain criteria which it can control, such as having good business practices, or does it depend on the whim of a government bureaucrat, which the entity cannot control. 3. Note para 90 of IAS 38: Many factors are considered in determining the useful life of an intangible asset, including: (a) the expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team; (b) typical product life cycles for the asset and public information on estimates of useful lives of similar assets that are used in a similar way; (c) technical, technological, commercial or other types of obsolescence; (d) the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset; (e) expected actions by competitors or potential competitors; (f)

the level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity's ability and intention to reach such a level;

Exercise 13.2

BRANDS AND FORMULAS

Outline the accounting for brands under IAS 38, and discuss the difficulties for standard setters in allowing the recognition of all brands and formulas on the statement of financial position. WAYNE UPTON Accounting for brands under IAS 38: (a) internally generated - internally generated intangibles must meet the recognition criteria in para 57 - para 63 specifically excludes the recognition of internally generated brands (b) acquired brands: - Recognised at cost © John Wiley and Sons, Ltd, 2016

13.4

Chapter 13: Intangible assets -

If acquired as part of a business, IFRS 3 states that no recognition criteria need be applied. Provided the asset meets the definition of an intangible asset, it must be recognised as a separate asset. As with separately acquired intangible assets, para 33 of IFRS 3 provides that, where intangible assets are acquired as part of a business combination, the effect of probability is reflected in the measurement of the asset. Hence the probability recognition criterion is automatically met. – see also paras 11–12 of IFRS 3. Initially measured at cost = fair value. Subsequently can be measured at cost or revalued amount, but use of the latter requires the existence of an active market. Amortisation based on useful life, or non-amortisation on indefinite life

Consider a major brand of whisky – Chivas Regal, Johnny Walker etc. – and debate the argument that the brand name is worthless if separated from the company, for example, could Chivas Regal sell the brand name to another company making whisky that tastes different from the Chivas Regal whisky? Or is the brand an integral part of the whole company? Compare with Coca-Cola – would a lemonade company buy the brand name Coca Cola or is the brand an integral part of the whole product of the company?

Exercise 13.3 RESEARCH AND DEVELOPMENT Discuss how the company should account for each of these outlays. SIMONSTOWN The outlays must be analysed using para 57 of IAS 38: Technical feasibility: At the end of the 2014–15 period, the company has completed the testing of the models and planned to prepare a patent application believing the product was technically feasible. Intention to complete and sell: The company always had the belief that the product would be saleable but it was not until the product was tested, found to be feasible that the company could commence plans to sell. Ability to use or sell: Because of problems with the design, it had to be modified to make the product saleable and lessen returns or warranty claims. This was completed at the end of the 2016–17 period. Existence of a market: The market was always open to such a product. However the existence of a market requires the product to be available at a price that customers would be prepared to pay. This may have been part of the reason for modifying the design in the 2016–17 period. Availability of resources: The company was not short of resources to develop this product. Ability to measure costs reliably: Cost of the product was readily available after the modifications to the design in the 2016–17 period.

All costs incurred up to the end of the 2016–17 period must be expensed. The only costs available for capitalisation are the £15 000 costs incurred in the 2017–18 period.

13.5

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 13.4

RECOGNITION OF INTANGIBLES

Discuss whether the accounting will differ depending on which method is chosen.

SOWETO LTD Purchase the software: Being an acquired intangible, the acquirer could recognise an asset, measuring it at the cost of the software.

Contract independent programmers: The amounts paid to the contractors would be capitalised as this represents the cost of the acquired software.

Buy software to include in internally developed project: Assuming the product is still in the research phase, the cost of the software would be expensed, unless the software has alternative uses or could be sold separately.

Employ programmers: Until the software meets the criteria in para 57 of IAS 38, the costs of the programmers would be expensed.

Exercise 13.5

RESEARCH AND DEVELOPMENT

Respond to Mr Bosch’s question for each of these items. STELLENBOSCH LABRATORIES LTD

The outlays must be analysed using para 57 of IAS 38: Technical feasibility: Intention to complete and sell: Ability to use or sell: Existence of a market: Availability of resources: Ability to measure costs reliably:

(a)

Dispenser pack: As the dispenser pack was a new product, costs incurred until the pack developed met the para 57 tests are expensed. In this case, determining the technical feasibility of the pack and developing a cost effective product would have been two key issues.

(b)

Converting powders to liquid form: The tests have not yet proven successful, therefore the technical feasibility test would not be met and the £590 000 must be expensed.

(c)

Costs of quality control: These costs relate to products being produced and hence can be capitalised into the products produced. No separate intangible such as “Superior Quality” could be raised as such an asset is not identifiable.

(d)

Costs of time and motion study: As the equipment is being used in current production, the costs could be capitalised into the cost of the equipment.

(e)

New prototype machine: This is a difficult one to classify. The question hinges on the “nearing completion” statement. It is a question of what has yet to be done. Questions relating to the para 57 criteria need to be asked. For example: has technical feasibility been established, and is it only minor adjustments that are being made? Do any minor adjustments have a material effect on the determination of the costs of the machine?

13.6

Chapter 13: Intangible assets Exercise 13.6

RESEARCH AND DEVELOPMENT

Discuss how Capetown Ltd should account for these costs. Provide journal entries with an explanation of why these are the appropriate entries. CAPETOWN LTD The outlays must be analysed using para 57 of IAS 38: Technical feasibility: Intention to complete and sell: Ability to use or sell: Existence of a market: Availability of resources: Ability to measure costs reliably: At 30 June 2014: The project is not commercially feasible; therefore all cost to date must be expensed: Research Costs Cash (Expensing research costs)

Dr Cr

254 000 254 000

At 31 August 2014: These costs must be expensed as the company is not yet convinced it has a product that it can sell: Research Costs Cash (Expensing research costs)

Dr Cr

120 000 120 000

At 31 October 2014 The company now has an intention to complete and sell. Potentially, due to the adjustments required by the engineering firms, the company is not yet able to measure the cost of the engine reliably. If that is the case, expenses during this period must be expensed: Research Costs Cash (Expensing research costs)

Dr Cr

65 000 65 000

1 November 2014 The company now should be able to meet all the para 57 criteria and all subsequent outlays should be capitalised

Patent Cash (Recognition of internally generated asset)

Dr Cr

35 000 35 000

31 December 2014 The project is in the development stage and all outlays can be capitalised: Patent Cash (Capitalisation of development costs)

Dr Cr

87 000 87 000

13.7

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 13.7

ACCOUNTING FOR BRANDS

The chairman of the board knows that the marketing manager is very effective at selling ideas but knows very little about accounting. The chairman has, therefore, asked you to provide him with a report advising the board on how the proposal should be accounted for under International Financial Reporting Standards and how such a proposal would affect Jon West Ltd’s financial statements.

JON WEST LTD

1. Accounting for the Guarantee •

Is there a liability? Legal or constructive? What is the past event? What obligation exists?

•

Should it be recognised?

•

How is it to be measured?

•

Contingent liability?

Expect that a provision/contingent liability would need to be raised in relation to the guarantee. Measurement issues may lead to the need for a contingent liability. 2. Can costs be capitalised into brands? •

Note one brand is internally generated and one is acquired. The internally generated brand “Artic Fresh” will not be recognised while “Tropical Taste” was acquired in a business combination. Accounting for internally generated brands differs from that for brands acquired in a business combination - explain

•

Extra outlays on the brand cannot be capitalised into an already existing brand as the outlays are generally to maintain the existing asset rather than increase the asset. Also, hard to distinguish the expenditure from that spent to develop the business as a whole.

•

IAS 38 says that brands cannot be revalued as no active market exists.

•

Can the outlay be related to the brand or is it internally generated goodwill: does it relate to the entity as a whole rather than a single asset? Cannot recognise internally generated goodwill.

•

Expected result is that any outlays would need to be expensed

3. Effects on financial statements • • • •

Liability? Provision? Contingent liability – notes only Asset? No Profit: expense relating to the guarantee provision?

13.8

Chapter 13: Intangible assets Exercise 13.8

ACCOUNTING FOR USEFUL LIFE

Discuss how the company should account for the cost of the customer list. If the cost is capitalised, discuss the determination of the useful life over which the asset is amortised. The asset is separable and meets the definition of an intangible asset. The company has acquired the list. According to para 24, the intangible must initially be measured at cost. The company can continue to use the cost method but could apply the revaluation model – is there an active market? Over what period must the asset be amortised (2 or 3 years?) purely based on expectation. However straight-line may not be appropriate if more benefits are expected to be received in the first 2 years. Should the cost of the questionnaires be added to the carrying amount of the asset as it appears that the adding of names to the list increases the life of the asset. As this amounts to the internal generation of an asset, the criteria in para 57 must be analysed.

Exercise 13.9

FINANCIAL STATEMENTS AND INTANGIBLES

Comment on the truth of this ‘popular view’. UPTON

Upton argues that ensuring all the assets and liabilities are in the statement of financial position has never been an objective of accounting. He argues that financial reporting tries to provide information about economic resources and the two groups that hold claims against those resources. It helps to correct or confirm expectations. He provides an example of the mild climate at the entity’s home office. This is not an asset of the entity but it may affect the value of things that are economic resources such as the value of the home office building. Four criteria must be met before including items in a statement of financial position: - definitions - measurability of a relevant attribute - relevance, and - reliability: representationally faithful, verifiable & neutral Information about some intangibles may be relevant, but many items are not measurable. Some assets may be measurable, but the measurement attribute may not be relevant, for example capitalisation of research costs. Recognition of expenditure for which economic benefits are not probable as assets does not provide relevant information. In outlaying the funds, management’s intention was to generate future benefits. However, the degree of certainty that economic benefits will flow to the entity beyond the current period is insufficient to warrant the recognition of an asset.

13.9

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 13.10 AMORTISATION OF INTANGIBLES Comment on whether the current IAS 38 has resolved the issues raised in this article. NICK TABAKOFF

4 key issues: 1. Amortisation: should intangibles be amortised? Argument for: the benefits are consumed; need to allocate the cost of past, consumed benefits. Assets should not be overstated. Argument against: The benefits have not declined. Also, IAS 38 does not allow the recognition of new internally generated benefits, so to write off old benefits but not allow the recognition of new benefits means a double hit to income – e.g. consider depreciation of a brand as well as expensing the costs of advertising to maintain the brand. IAS 38 allows non-amortisation under certain conditions. Is there any distortion of cash flows? No. 2. Are acquisitive companies penalised under IAS 38? Advantages to acquirers: • Easier to recognise intangibles • Can use fair value to measure compared with measurement of cost • Can recognise assets listed in para 63. Disadvantages to acquirers: • Recognition leads to amortisation expenses on recognised intangibles; affects profits. • See arguments in text as to why managers may prefer current non-recognition rules 3. Do annual reports show economic reality? This is based on the comment re economic earnings of Disney being greater than reported earnings. See the Zeff graph in the chapter comparing reported assets and market capitalisation of entities. Many internally generated assets are not recognised under IAS 38. See figure 13.1 from Jenkins and Upton again comparing the difference between market capitalisation & reported assets. 4. Is there a need for a separate standard on intangibles? The argument for a separate standard for intangibles is related to the unique measurement and relevance issues relating to intangibles. For example with measurement: Cost model: hard to isolate costs, hard to determine depreciation Revaluation model: lack of markets

13.10

Chapter 13: Intangible assets Exercise 13.11

RECOGNITION OF INTANGIBLES

Write to the directors outlining the alternative courses of action available in relation to the $2.3 million discrepancy. Your reply should cover the issues of asset recognition, measurement, classification and subsequent accounting treatment. LADYSMITH LTD Asset recognition: The trademark and the patent are intangible assets, meeting the definition in relation to identifiability as the company has legal rights to both. As the assets are acquired as part of a business combination, recognition of the assets comes under IFRS 3, in particular paras 11–12 and IAS 38 para 33 which state that no recognition criteria need be applied. Provided the assets meet the definition of an intangible asset, they must be recognised as separate assets based on their fair values at acquisition date. Initial Measurement: Measurement of the fair value of the assets is based on paras. 39–41 of IAS 38, and may be determined by: - quoted market prices in an active market – unlikely in this case; - recent transactions: unlikely in this case; or - measurement techniques, using valuers to measure the fair values of the assets. As the worth of the trademark is related to the owner of the trademark also having the patent to be able to use the formula for the special coating, it is doubtful whether the two assets can be separately valued. However, the value of the trademark may relate to the customer awareness and appeal of the current product in comparison to having to sell a new brand name.

Classification The assets when recognised are classified as non-current intangible assets.

Subsequent measurement Having initially recognised the assets, the company can choose to use the cost or the revaluation models. However, use of the revaluation model is subject to their being an active market to determine subsequent fair values of the assets. Any subsequent outlays in relation to the assets are subject to the criteria in relation to para 57 of IAS 38 prior to capitalisation of the outlays. The useful lives of the assets need to be determined to see whether they need to be amortised. If an asset has an indefinite life no amortisation is required. However, an annual impairment test in relation to such an asset is necessary.

Other assets: goodwill If the fair values of the patent and the trademark are less than the $2.3 million, then goodwill is recognised. This is also subject to an impairment test annually, but is not required to be amortised. If other intangible assets exist they should also be separated out of goodwill.

13.11

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 13.12

PATENTS

Prepare a report for Song Ltd’s accountant. SONG LTD

1. Which accounting standard should be applied to determine the appropriate accounting principles? Patents are an intangible asset as per IAS 38: - non-monetary - identifiable - lacking physical substance IAS 38 Intangibles is therefore the relevant accounting standard to apply for patents. 2. How should the various patents be accounted for at initial recognition? • Patent XC456: This is an asset acquired as a single acquisition. The probable flow recognition criterion is always met. The recognition criterion that needs to be met is the reliable measurement criterion. The asset must be measured at cost, being purchase price plus any directly attributable costs. • Patent CU254: This asset was acquired as part of a bundle of assets. The accounting will depend on whether the bundle of assets constituted a business: (a) if the bundle of assets does not constitute a business, then the patent must be recognised at cost. The cost will be determined by allocating the cost for the bundle of assets across the assets acquired on a pro rata basis, that is, using the fair value of the asset in proportion to the fair values of the total assets acquired. This means that it is necessary to determine the fair value of the patent. The hierarchy of measures of fair value will be used: - quoted market prices in an active market: this will not be applicable for patents; - prices in recent transactions of the same or similar assets: unlikely to be available for patents; - measurement techniques such as present value calculations, multiples using royalty rates etc. (b) if the bundle of assets does constitute a business using the definition of “business” in IFRS 3 Business Combinations – an integrated set of activities and assets capable of being conducted and managed for the purpose of providing a return [inputs, processes and outputs] - then there are no recognition to be applied as all recognition are assumed to be met. The asset is initially measured at cost which is the fair value of the asset, determined as described in (a) above. • Internally generated patent: Amounts spent on internally generating a patent must be classified into research and development. If classified as research, then the outlays must be expensed. If classified as development, then para 57 is applied and when all six of the criteria are met, subsequent outlays are capitalised as an asset. Examples of these criteria are: the technical feasibility of completing the asset, and an intention to complete the asset and use or sell it. Para 63 does exclude some assets from recognition, but patents are not in this list. 3. How should patents be accounted for subsequent to initial measurement? Under IAS 38, subsequent to initial recognition, an entity may choose to use the revaluation model or the cost model. However the use of the revaluation model requires the existence of an active market in order to measure the fair value. Given the unique nature of patents, an active market is unlikely to exist. Therefore the cost model must be used. Under the cost model there is the question of subsequent depreciation/amortisation of the asset. The first question will be that of the useful life of the asset. IF the asset is considered to have an indefinite useful life no amortisation is required. If the expected useful life is finite, depreciation must be charged. The determination of useful life will require an analysis of a number of factors (as per para 90) such as expected actions by competitors and the stability of the industry and changes in market demand. If an indefinite useful life is selected for a patent, then an annual impairment test is required under IAS 36 Impairment of Assets.

13.12

Chapter 13: Intangible assets IF a finite useful life is determined, the depreciable amount of the asset will be written off over the useful life on a systematic basis, with the method chosen reflecting the pattern in which the expected benefits are expected to be consumed by the entity. Where the pattern of flow of benefits cannot be determined reliably, the straight-line method must be used. Further, the residual value is assumed to be zero, unless there is a commitment by a third party to acquire the asset in the future or there exists an active market. The latter will not exist for patents.

13.13

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 13 Intangible assets

CHAPTER 13 Intangible assets

Learning objectives 13.1 Understand the key characteristics of an intangible asset 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles 13.3 Explain how to measure intangibles subsequent to initial recognition, including the principles relating to the amortisation of intangibles 13.4 Explain the accounting for retirement and disposal of intangible assets 13.5 Apply the disclosure requirements of IAS 38

13.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

Which of the following assets is regarded as meeting the identifiability criteria for recognition as an identifiable intangible asset that can be recorded as acquired in a business combination? Learning Objective 13.1 Understand the key characteristics of an intangible asset a. customer base; *b. royalty agreements; c. ongoing recruitment programs; d. strong and favourable employee relations.

For an asset to be classified as an identifiable intangible, IAS 38 Intangibles requires that it meet which of the following criteria? I. It arises from a contractual or legal right. II. Its fair value must be able to be reliably measured. III. It is separable from the entity. IV. Its cost must reliably measurable. Learning Objective 13.1 Understand the key characteristics of an intangible asset a. I or IV only; b. I or II only; c. II or III only; *d. I or III only.

A key characteristic that separates assets such as property, plant and equipment from intangible assets is: Learning Objective 13.1 Understand the key characteristics of an intangible asset a. separability; b. length of useful life; *c. lack of physical substance; d. reliability.

The two key characteristics of intangible assets are that they are identifiable and that they: Learning Objective 13.1 Understand the key characteristics of an intangible asset: a. have physical substance; b. are monetary assets; c. represent current obligations of the entity; *d. lack physical substance.

The characteristic that distinguishes the goodwill from other intangible assets is: Learning Objective 13.1 Understand the key characteristics of an intangible asset *a. identifiability; b. its nature as a monetary asset; c. that is has a physical embodiment; d. it can be separated from the entity and sold individually. Under IAS 38 Intangibles, goodwill may only be recognised as an asset if it: Learning Objective 13.1 Understand the key characteristics of an intangible asset a. arises as a result of creating new assets within the normal business operations; b. does not exceed its internally recorded cost; c. is internally generated;

13.2

Chapter 13 Intangible assets

*d.

is acquired as part of a business combination.

The measurement of fair value is determined in accordance with IFRS 13 Fair Value Measurement. IFRS 13 defines fair value as one that has all of the following conditions: I The price that would be received to sell an asset or paid to transfer a liability Is an orderly transaction between market participants Based on the measurement date.

III

Yes Yes No Yes Yes No Yes No Yes No Yes Yes

Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles a. I; b. II; c. III; *d. IV.

When an intangible asset is acquired by an exchange of assets, which of the following measures will need to be considered in the determination of that cost? Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles *a. The fair value of the asset given up; b. The initial cost of the asset given up; c. The carrying amount of the asset received; d. The replacement cost of the asset received.

Which of the following assets is regarded as meeting the identifiability criteria for recognition as an identifiable intangible asset that may be acquired in a business combination? Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles a. customer service capability; *b. newspaper mastheads; c. favourable government relations; d. presence in geographic locations.

13.3

Test Bank to accompany Applying IFRS Standards 4e

10.

Paragraph 63 of IAS 38 Intangibles, prohibits the recognition of the following internally generated identifiable intangibles:

Brands Mastheads Publishing titles Customer lists

I No No No No

II III No No Yes Yes No Yes Yes No

IV Yes Yes Yes Yes

11.

Unless acquired under a business combination, intangible assets must be initially measured using which of the following measurement approaches? Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles a. discounted cash flows; b. fair value; c. net present value; *d. cost.

12.

According to the definition provided in IAS 38 Intangibles, activities undertaken in the ‘research’ phase of the generation of an asset may include: Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles a. the application of knowledge to a design for the production of new materials; *b. original and planned investigation with the prospect of gaining new scientific knowledge; c. the use of research findings to create a substantially improved product; d. using knowledge to materially improve a manufacturing device.

13.4

Chapter 13 Intangible assets

13.

Wojtowicz Limited was involved in a mining exploration business. It commenced a project to design more efficient gold detecting equipment. The following expenditures occurred during the financial year ended 2013: • Researcher’s salary £5000 • Research consumables £3000 • Re-development of the detecting equipment £4000 • Final adjustments to the detecting equipment £2500. The amount to be capitalised by this company as an intangible asset, for the 2013 financial year, is: Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles *a. £6500; b. £8000; c. £11 500; d. £14 500.

14.

Parsons Limited was involved in a highly successful plastics manufacturing business. It commenced a project to design a more efficient extrusion system for its plastic pipes. The following outlays occurred: • January: Research salaries £50 000 • February: Research materials £30 000 • March: Re-development of the extrusion plant £400 000 • April: Final adjustments to the extrusion plant £25 000. The amount to be expensed by this company at the end of the financial year, 30 June, is: Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles a. £30 000; b. £50 000; *c. £80 000; d. £480 000.

15.

IAS 38 Intangibles, requires that an intangible asset with a finite life: Learning Objective 13.3 Explain how to measure intangibles subsequent to initial recognition, including the principles relating to the amortisation of intangibles *a. be amortised across its useful life; b. be amortised across a period of no greater than 20 years; c. not be amortised in periods when it is been properly maintained; d. not be subject to amortisation charges.

13.5

Test Bank to accompany Applying IFRS Standards 4e

16.

Under IAS 38 Intangibles, an intangible asset with an indefinite useful life is: Learning Objective 13.3 Explain how to measure intangibles subsequent to initial recognition, including the principles relating to the amortisation of intangibles a. not able to be recognised by an entity as an asset; *b. not subject to annual amortisation charges; c. amortised using the straight-line method over a period of no more than 20 years; d. amortised using the reducing balance method over a period not exceeding 5 years.

17.

Which of the following statements is NOT correct? Learning Objective 13.4 Explain the accounting for retirement and disposal of intangible assets a. intangible assets are to be derecognised when there are no expected future benefits from the asset; b. amortisation of an intangible with a finite useful life does not cease when the asset becomes temporarily idle; *c. amortisation of an intangible with an indefinite life does not cease when the asset is retired from active use; d. gains or losses on disposal are calculated as the difference between the proceeds on disposal and the carrying amount at point of sale, with amortisation calculated up to the point of sale.

18.

IAS 38 Intangibles, requires that the following items in relation to intangibles, each be disclosed separately: Learning Objective 13.5 Apply the disclosure requirements of IAS 38 a. the opening balance of each intangible; b. the closing balance of each intangible; *c. any impairment losses reversed in profit or loss during the period; d. all amounts of intangibles acquired during the period.

19.

Items such as market knowledge, effective advertising programs, fundraising capabilities and trained staff are NOT regarded as assets because they: Learning Objective 13.1 Understand the key characteristics of an intangible asset: a. are monetary items; b. cannot be measured; *c. are not controlled by the entity; d. are too difficult to manage.

20.

The recognition criteria that an asset must meet before it may be recognised and presented in the financial statements include: Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles: a. that the recognition of the asset is relevant to user decision making; *b. probability that future economic benefits will flow to the entity; c. that the information about the asset is neutral; d. a likelihood that the cost of the asset is verifiable.

13.6

Chapter 13 Intangible assets

21.

The cost of an intangible asset is comprised of the fair value of the consideration: Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles: a. less legal costs incurred in the purchase; *b. plus directly attributable costs; c. plus indirect costs; d. less directly attributable costs.

22.

The original and planned investigation undertaken with the prospect of gaining new knowledge is described as: Learning Objective 13.2 Explain the criteria relating to the initial recognition of intangible assets and their measurement at point of initial recognition, distinguishing between acquired and internally generated intangibles: a. exploration; b. development; c. investigation; *d. research.

23.

Under the revaluation method of measuring an intangible, the asset is carried at fair value and subject to charges for: Learning Objective 13.3 Explain how to measure intangibles subsequent to initial recognition, including the principles relating to the amortisation of intangibles: *a. amortisation and impairment; b. inflation in value; c. interest expense; d. increment in value.

24.

When subsequent expenditure on intangible assets occurs the costs are: Learning Objective 13.3 Explain how to measure intangibles subsequent to initial recognition, including the principles relating to the amortisation of intangibles: a. recognised directly in retained earnings account; *b. immediately expensed; c. transferred to a revaluation reserve account; d. capitalised.

25.

Which of the following statements is NOT correct? Learning Objective 13.4 Explain the accounting for retirement and disposal of intangible assets: a. intangible assets are to be derecognised on disposal; *b. amortisation of an intangible with a finite useful life ceases when the asset becomes temporarily idle; c. intangible assets are to be derecognised when there are no expected future benefits from the asset; d. gains or losses on disposal are calculated as the difference between the proceeds on disposal and the carrying amount at point of sale, with amortisation calculated up to the point of sale.

13.7

Test Bank to accompany Applying IFRS Standards 4e

26.

Which of the following statements is correct? Learning Objective 13.5 Apply the disclosure requirements of IAS 38: a. IAS 38 requires disclosures about an entity’s intangible assets, with disclosures being made on an asset by asset basis; b. Disclosures about the useful lives of intangibles are required with explanations being required where assets are assessed to have finite useful lives; c. Where the cost model is used, specific disclosures are required including assumptions made on estimating fair values; *d. Separate disclosures are required for internally generated intangibles.

13.8

Exercises Exercise 13.8 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

ACCOUNTING FOR USEFUL LIFE

A company that sells DVDs by sending emails to prospective customers has acquired a customer list from another company that also markets its products in a similar fashion. The company estimates that it will generate sales from the list for a minimum of 2 years and a maximum of 3 years. The company intends to add names to the list from answers to a questionnaire attached to each of the emails. This should extend the useful life of the list for another year. Required

Discuss how the company should account for the cost of the customer list. If the cost is capitalised, discuss the determination of the useful life over which the asset is amortised.

Exercise 13.9

FINANCIAL STATEMENTS AND INTANGIBLES

★ Upton (2001, p. 50) notes: There is a popular view of ﬁnancial statements that underlies and motivates many discussions of intangible assets. That popular view often sounds something like this: If accountants got all the assets and liabilities into ﬁnancial statements, and they measured all those assets and liabilities at the right amounts, stockholders’ equity would equal market capitalization. Right?

Required

Comment on the truth of this ‘popular view’.

Exercise 13.10 ★★

AMORTISATION OF INTANGIBLES

Nick Tabakoff (1999) stated: News Corporation is far from convinced of the merits of the standard [IAS 38]. At the Australian division, News Limited, ﬁnance director and deputy chief executive Peter McCourt says: ‘The reason you get standards like that is that they are prepared by people who are not really responsible to anybody. The business community gains nothing from writing off the value of intangibles over a limited time frame. If the standard comes in, the market will simply add back the amortisation.’ McCourt believes the standard penalises companies that are acquisitive when it comes to intangible assets. He can see no reason for the existence of the standard. ‘Who is it aimed at, who is being better informed by taking that charge? I don’t think it gets you anywhere.’ He is not alone in getting worked up about preventing accountants from minimising the values placed on intangibles. Even the legendary Berkshire Hathaway chief Warren Buffett has strong views on the issue. He has been quoted as saying: ‘Amortisation of intangibles is rubbish. It distorts true cashﬂows and thus economic reality. For example, the economic earnings of Disney are much greater than reported earnings. Accounting is pushing people to do things that are nuts.’

These comments were made before the latest revisions to IAS 38. Required

Comment on whether the current IAS 38 has resolved the issues raised in this article.

Exercise 13.11 ★★

RECOGNITION OF INTANGIBLES

Ladysmith Ltd has recently diversiﬁed by taking over the operations of Kimberley Ltd at a cost of $10 million. Kimberley Ltd manufactures and sells a cleaning cloth called the ‘Supaswipe’, which was developed by Kimberley Ltd’s highly trained and innovative research staff. The unique nature of the coating used on the ‘Supaswipe’ has resulted in Kimberley Ltd acquiring a signiﬁcant share of the South African market. A recent expansion into the Equatorial African market has proved successful. As a result of the takeover, Ladysmith Ltd acquired the following assets: Fair value (at date of acquisition) Land and buildings Production machinery Inventory Accounts receivable

$ 3 200 000 2 000 000 1 800 000 700 000 $ 7 700 000

CHAPTER 13 Intangible assets

In addition to the above, Kimberley Ltd owned, but had not recognised, the following: • trademark — ‘Supaswipe’ • patent — formula for the special coating. The research staff of Kimberley Ltd have agreed to join the staff of Ladysmith Ltd and will continue to work on a number of projects aimed at producing specialised versions of the ‘Supaswipe’. The directors have requested your assistance in accounting for the acquisition of Kimberley Ltd. In particular, they are uncertain as to the treatment of the $2.3 million discrepancy between the assets recorded by Kimberley Ltd and the price paid for the company. Required

Exercise 13.12

PATENTS

★★★ Song Ltd has recently obtained some patents considered useful in its manufacture of men’s shoes. The

patents consist of: • Patent XC456, acquired from a leather manufacturing ﬁrm for $425 000. • Patent CU254, obtained as part of a bundle of assets acquired from the conglomerate U-Beaut Fashions. Song Ltd is also in the process of preparing an application for a patent for a new process of softening leather. It has spent a number of years reﬁning this process. The accountant for Song Ltd is unsure how to account for patents under IFRSs. He has asked you to prepare a detailed report for him on the principles of how to account for patents, using the examples above to illustrate the appropriate accounting procedures. Required

Prepare a report for Song Ltd’s accountant.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 14: Business combinations

Chapter 14 – Business Combinations Discussion Questions 1.

What is meant by a ‘business combination’?

IFRS 3 Appendix A: Business: “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants” Business combination: A transaction or other event in which an acquirer obtains control of one or more businesses” Consider inputs, processes and outputs Only in a business combination can goodwill be present.

Discuss the importance of identifying the acquisition date.

Acquisition date is the date on which the acquirer obtains control of the acquiree. Important because on this date: • the fair values of the identifiable assets acquired and liabilities assumed are measured. • the fair value of the consideration transferred is measured • the goodwill or gain on bargain purchase is calculated.

What is meant by ‘contingent consideration’ and how is it accounted for?

Appendix A: Contingent consideration: Usually, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met. See IFRS 3 paras. 39-40 Para 39: The consideration transferred includes any asset or liability resulting from a contingent consideration arrangement. This is measured at fair value at acquisition date. Para 40: The acquirer shall classify the obligation to pay contingent consideration as a liability or equity. Para 58: Changes in the measurement of the obligation subsequent to acquisition date resulting from events after the acquisition date are accounted for differently depending on whether the obligation was classified as equity or debt. If classified as equity, the equity shall not be remeasured. If classified as liability, it is accounted under IAS 39 of IAS 37 as appropriate. © John Wiley and Sons, Ltd, 2016

14.1

Solutions Manual to accompany Applying IFRS Standards 4e

Explain the key components of ‘core’ goodwill.

Core goodwill has two main components: (i) Going concern goodwill: relates to the net assets of the acquiree, in that the acquiree’s net assets together are worth more than the net assets separately, caused by the synergy created by the acquiree’s net assets within the acquiree as a going concern. (ii) Combination goodwill: relates to the extra benefits accruing because of the synergy created by the acquirer and the acquiree combining together eg if the raw materials available to the acquiree are of particular use to the acquirer. These benefits could affect the recorded earnings of the acquirer or the acquiree [or both] depending on the nature of the benefits.

What recognition criteria are applied to assets acquired and liabilities assumed in a business combination?

Para 10 of IFRS 3 states that the identifiable assets acquired and liabilities assumed shall be recognised separately from goodwill. Because the assets and liabilities are measured at fair value, the assets and liabilities are recognised regardless of the degree of probability of inflow/outflow of economic benefits. The fair value reflects expectations in its measurement. The assets and liabilities recognised must meet the definitions of assets and liabilities in the Framework. [Para 11] The assets and liabilities recognised must also be part of the exchange transaction rather than resulting from separate transactions [para 12].

How is an acquirer identified?

Para 6: For each business combination, one of the combining entities shall be identified as the acquirer. Appendix A: The acquirer is the entity that obtains control of the acquiree. Appendix A: Control is the power to govern the financial and operating policies of the acquiree so as to obtain benefits from its activities. Determination of the acquirer requires judgement. Paragraphs B13-B18 of IFRS 3 provides indicators/guidelines to assist in this judgement: -

form of consideration: did one entity transfer cash or other assets for the shares of the other? [para B14]; did one entity issue its own equity interests in exchange for another entity’s equity interests? [para B15] Was there a premium paid by one of the entities? [para B16(e)] subsequent management: which entity’s management subsequently controls the business combination? What are the relative voting rights after the business combination? [para B15(a)] What is the composition of the senior management of the combined entity? [para B15(d)] large minority voting interest: The acquirer normally holds the largest minority voting interest in the combined entity. [para B15(b)] predator or target: which entity initiated the combination? [B17]. relative size of the businesses: is the fair value of one entity significantly greater than another? [para B16]]. Large entities normally takeover small entities;

14.2

Chapter 14: Business combinations 7.

Explain the key steps in the acquisition method.

IFRS 3 para 5: 1. 2. 3. 4.

identify the acquirer determine the acquisition date recognise and measure the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree recognise and measure goodwill or a gain from a bargain purchase.

How is the consideration transferred calculated?

IFRS 3 para 37 states that the consideration transferred shall be - measured at fair value, determined at acquisition date, and - calculated as the sum of the fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer, and the equity interests issued by the acquirer.

If an acquiree liquidates, what are the key accounts raised by the acquiree and which accounts are transferred to these accounts? LIQUIDATION ACCOUNT Assets taken over Liabilities arising during the liquidation process Liquidation expenses Balance to Shareholders Distribution

Contra assets Liabilities assumed Reserves Consideration received

SHAREHOLDERS’ EQUITY ACCOUNT Consideration paid to shareholders

10.

Share capital Balance Liquidation Account

How is a gain on bargain purchase accounted for?

IFRS 3 para 34 specifies the measurement of the gain. Para 36 requires an acquirer to: reassess the identification and measurement of the identifiable assets acquired and liabilities assumed, and measurement of the consideration transferred. This review is to ensure that the measurements are appropriate. Para 34 requires an acquirer, subsequent to para 36 procedures, recognise any remaining gain on bargain purchase immediately in profit or loss.

11.

Why is it important to identify an acquirer in a business combination?

Consider the example in para B18 in Appendix B to IFRS 3. Assume A Ltd and B Ltd combine together by creating C Ltd which acquires all the shares in A Ltd and B Ltd and issues its own shares in exchange. As noted in para B18, C Ltd is not necessarily the acquirer. What differences occur if either A Ltd or B Ltd is identified as the acquirer? Two effects: (i) the consideration transferred is based on what the acquirer gives up; and (ii) the acquiree’s net assets are measured at fair value. © John Wiley and Sons, Ltd, 2016

14.3

Solutions Manual to accompany Applying IFRS Standards 4e

In relation to point (ii), if A Ltd is the acquirer then in the consolidated financial statements B Ltd’s net assets are adjusted to fair value while A Ltd’s net assets are at the carrying amounts in A Ltd. If B Ltd is the acquirer, A Ltd’s net assets are adjusted to fair value while B Ltd’s net assets are at the carrying amounts in B Ltd.

14.4

Chapter 14: Business combinations

Exercises Exercise 14.1 ACCOUNTING BY THE ACQUIRER 1. 2.

Prepare the journal entries in the records of New Ltd to account for the acquisition of the assets and liabilities of Day Ltd. Prepare the journal entries assuming that the fair value of New Ltd shares was $6 per share. NEW LTD – DAY LTD

Acquisition analysis: Net fair value of identifiable assets and liabilities acquired: Land Plant Inventory Cash

$350 000 290 000 85 000 15 000 740 000

Accounts payable Loans

20 000 80 000 100 000 $640 000

Net assets Consideration transferred: 100 000 shares at $6.50 each Goodwill = $650 000 - $640 000

$650 000

$10 000

Question 1. Journal entries: New Ltd, FV of shares = $6.50 Land Plant Inventory Cash Goodwill Accounts payable Loans Share capital

Dr Dr Dr Dr Dr Cr Cr Cr

350 000 290 000 85 000 15 000 10 000 20 000 80 000 650 000

Question 2. Journal entries: New Ltd, FV of shares = $6.00 Fair value of acquiree’s net assets Consideration transferred: 100 000 x $6 Gain on bargain purchase Land Plant Inventory Cash Accounts payable Loans Share capital Gain on bargain purchase

$640 000 $600 000 $40 000 Dr Dr Dr Dr Cr Cr Cr Cr

350 000 290 000 85 000 15 000 20 000 80 000 600 000 40 000

14.5

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.2

ACQUISITION OF SHARES IN ACQUIREE

Prepare the journal entries in the records of Desert Ltd to record these events. DESERT LTD – ISLAND LTD

Consideration transferred: Shares: 2 x 100 000 x $4 Cash: $1.50 x 100 000

$800 000 150 000 $950 000

Journal entries: Desert Ltd Shares in Island Ltd Share capital Cash (Acquisition of shares in Island Ltd)

Dr Cr Cr

950 000

Share capital Cash (Share issue costs)

Dr Cr

800

800 000 150 000

800

14.6

Chapter 14: Business combinations Exercise 14.3

DETERMINING THE FAIR VALUE OF EQUITY ISSUED BY THE ACQUIRER

1. Prepare the journal entries for Trout Ltd to record the business combination at 1 December 2016, assuming the fair value of each Trout Ltd share at acquisition date is $1.90. Prepare any note disclosures for Trout Ltd at 31 December 2016 in relation to the business combination. 2. Assume the fair value of each Trout Ltd share at acquisition date is $1.90. At acquisition date, the acquirer could only determine a provisional fair value for the plant. On 1 March 2017, Trout Ltd received the final value from the independent appraisal, the fair value at acquisition date being $131 000. Assuming the plant had a further 5-year life from the acquisition date, explain how Trout Ltd will account for the business combination both at acquisition date and in the financial statements for 2017. 3. Prepare the journal entries for Trout Ltd to record the business combination at 1 December 2016, assuming the fair value of each Trout Ltd share at acquisition date is $1.70.

TROUT LTD – DORY LTD

Question 1. Net fair value of identifiable assets and liabilities of Dory Ltd Consideration transferred Goodwill

= = = = =

$175 000 100 000 shares x $1.90 $190 000 $190 000 - $175 000 $15 000

The journal entries at acquisition date, 1 December 2016 are: Cash Furniture & fittings Accounts receivable Plant Goodwill Accounts payable Current tax liability Provision for annual leave Share capital (Acquisition of business)

Dr Dr Dr Dr Dr Cr Cr Cr Cr

50 000 20 000 5 000 125 000 15 000 15 000 8 000 2 000 190 000

Check disclosures against the following paragraphs from IFRS 3 Appendix B: Paragraph B64 (a) B64 (b) B64 (d) B64 (e) B64 (f)

B64 (i)

the names and descriptions of the combining businesses the acquisition date primary reasons for the business combination a qualitative description of the factors making up goodwill the consideration transferred Fair value of each major class of consideration, including for equity instruments issued: - the number - the method of determining fair value amounts recognised for each major class of assets acquired and liabilities assumed

14.7

Solutions Manual to accompany Applying IFRS Standards 4e Question 2. See paragraphs 45–50 of IFRS 3 in relation to initial accounting determined provisionally. At 31 December 2016, the provisional amounts must be used as per journal entries in (A.) on the previous page. Note the disclosure required by paragraph B67 of IFRS 3. In 2017 as per paragraph 45, the carrying amount of the plant must be calculated as if its fair value at the acquisition date had been recognised from that date, with an adjustment to goodwill. If the plant had a 5-year life from acquisition date, Dory Ltd would have charged depreciation for 1 month in 2016. Extra depreciation of $100 is required, calculated as 1/5 x 1/12 x $6 000. The adjusting entry at 1 March 2017 is: Plant Goodwill (Adjustment for provisional accounting) Retained earnings (1/1/16) Accumulated depreciation (Adjustment to depreciation due to provisional accounting)

Dr Cr

6 000

Dr Cr

100

6 000

100

If depreciation has been calculated monthly for 2017, further adjustments would be required.

Question 3. Net fair value of identifiable assets and liabilities of Dory Ltd Consideration transferred Gain on bargain purchase

= = = = =

$175 000 100 000 shares x $1.70 $170 000 $175 000 - $170 000 $5 000

The journal entries at acquisition date, 1 December 2016 are:

Cash Furniture & fittings Accounts receivable Plant Accounts payable Current tax liability Provision for annual leave Gain on bargain purchase Share capital (Acquisition of business)

Dr Dr Dr Dr Cr Cr Cr Cr Cr

50 000 20 000 5 000 125 000 15 000 8 000 2 000 5 000 170 000

14.8

Chapter 14: Business combinations Exercise 14.4 1. 2.

IDENTIFYING THE ACQUIRER

What factors/indicators should management consider in determining which entity is the acquirer? Why is it necessary to identify an acquirer? In particular, what differences in accounting would arise if White Ltd or Cloud Ltd were identified as the acquirer?

WHITE LTD

Question 1. The acquirer is the combining entity that obtains control of the other combining entities. [Appendix A, IFRS 3]

Determination of the acquirer requires judgement. Paragraphs B13–B18 of AASB 3 provides indicators/guidelines to assist in this judgement: -

form of consideration: did one entity transfer cash or other assets for the shares of the other? [para B14]; did one entity issue its own equity interests in exchange for another entity’s equity interests? [para B15] Was there a premium paid by one of the entities? [para B16(e)] subsequent management: which entity’s management subsequently controls the business combination? What are the relative voting rights after the business combination? [para B15(a)] What is the composition of the senior management of the combined entity? [para B15(d)] large minority voting interest: The acquirer normally holds the largest minority voting interest in the combined entity. [para B15(b)] predator or target: which entity initiated the combination? [B17] relative size of the businesses: is the fair value of one entity significantly greater than another? [para B16]. Large entities normally takeover small entities;

Question 2. Why identify an acquirer? The consideration transferred is measured on the basis of the consideration given by the acquirer, while the identifiable assets and liabilities of the acquiree are measured at fair value. In relation to White Ltd – Cloud Ltd, the main effect then would be: If White Ltd is the acquirer, the identifiable assets, liabilities and contingent liabilities of Cloud Ltd would be measured at fair value while White Ltd assets and liabilities remain at their original carrying amounts. If Cloud Ltd were the acquirer, it would be White Ltd’s assets and liabilities that would be at fair value.

14.9

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.5

CONSIDERATION TRANSFERRED

Prepare all journal entries (in general form) to record the transactions in the records of (a) Monkfish Ltd and (b) Cod Ltd.

MONKFISH LTD – COD LTD

Acquisition analysis To Preference Shareholders: Cash Shares

To Ordinary Shareholders: Cash

Total

= = = =

$3.10 x 50 000 $155 000 (2 x 50 000) x $4.20 $420 000

= = = = =

($1.20 x ½ x 72 000) + ($1.20 x ½ x 72 000 x 0.925926 $43 200 + $40 000 $83 200 (3 x 72 000) x $4.20 $907 200

= =

$238 200 (Cash) + $1 327 200 (shares) $1 565 400

a) Journal entries: Monkfish Ltd 30/11/16 Preference shares in Cod Ltd Cash Share capital (Acquisition of all preference shares of Wanganui Ltd) Ordinary shares in Cod Ltd Cash Payable to ex-Cod shareholders Share capital (Acquisition of 90% of the ordinary shares of Cod Ltd)

30/11/17 Payable (to ex-Cod shareholders) Interest expense Cash (Payment of deferred amount)

Dr Cr Cr

575 000

Dr Cr Cr Cr

990 400

Dr Dr Cr

155 000 420 000

43 200 40 000 907 200

40 000 3 200 43 200

14.10

Chapter 14: Business combinations b) Journal entries: Cod Ltd

1/12/16 Shares in other companies Asset revaluation surplus (Revaluation of asset)

Dr Cr

160 000

1/12/16 Asset revaluation surplus Bonus dividend payable (Declaration of bonus dividends)

Dr Cr

32 000

Dr Cr

32 000

Bonus dividend payable Share capital – Ordinary (Payment – 16 000 ordinary shares)

160 000

32 000

14.11

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.6 ACCOUNTING FOR BUSINESS COMBINATION BY ACQUIRER, LIQUIDATION ACCOUNTS OF ACQUIREE 1. Prepare the acquisition analysis and journal entries in the books of New Starfish Ltd to record the acquisition of Tuna Ltd. 2. Prepare the Liquidation, Liquidator’s Cash, and Shareholders’ Distribution ledger accounts in the records of Tuna Ltd. NEW STARFISH LTD – TUNA LTD Question 1. Acquisition Analysis – New Starfish Ltd - Tuna Ltd Net fair value of identifiable assets and liabilities acquired Accounts receivable Inventory Plant and equipment Shares in Sefton Ltd

$56 000 39 200 140 000 22 500 $257 700

Consideration transferred Shareholders Debentures Shares Creditors Cash

‘A’ shares of Tuna Ltd Debentures in NS (1/1) B shares of Tuna Ltd Shares in NS (2/3)

20 000 20 000 x $3.50 60 000 40 000 x $2.70

Debentures issued Plus premium (10%)

30 000 3 000 33 000 31 000 21 500 5 000 16 200 106 700 (20 000)

Accounts payable Mortgage loan Liquidation costs Annual leave Total cash required Less cash already held

Goodwill

[$264 700 – $257 700]

$70 000 108 000

86 700 $264 700

$7 000

14.12

Chapter 14: Business combinations NEW STARFISH LTD General Journal Accounts receivable Inventory Plant and equipment Shares in Sefton Ltd Goodwill Payable to Tuna Ltd Share capital 7% Debentures (Acquisition of Tuna Ltd)

Dr Dr Dr Dr Dr Cr Cr Cr

56 000 39 200 140 000 22 500 7 000

Payable to Tuna Ltd Cash (Payment of consideration)

Dr Cr

86 700

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

1 600

Share capital Cash (Payment of share issue costs)

Dr Cr

900

86 700 108 000 70 000

86 700

1 600

900

Question 2. TUNA LTD General Ledger

LIQUIDATION ACCOUNT 56 000 Retained earnings 29 000 Accumulated depreciation 167 000 Receivable from New Starfish Ltd 26 000 3 000 16 200 5 000 78 000 380 200

Receivables Inventory Plant & equipment Shares in Sefton Ltd Premium on debentures Annual leave payable Liquidation costs Shareholders’ distribution

Opening balance New Starfish Ltd

Debentures in New Starfish Ltd Shares in New Starfish Ltd

75 500 40 000 264 700

380 200

LIQUIDATOR’S CASH ACCOUNT 20 000 Accounts payable 86 700 Debentures Mortgage loan Liquidation costs ______ Annual leave 106 700

31 000 33 000 21 500 5 000 16 200 106 700

SHAREHOLDERS’ DISTRIBUTION 70 000 Share capital – ‘A’ shares 108 000 Shares capital – ‘B’ Shares ______ Liquidation 178 000

40 000 60 000 78 000 178 000

14.13

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 14.7 ACCOUNTING FOR BUSINESS COMBINATION BY ACQUIRER, JOURNAL ENTRIES FOR LIQUIDATION OF ACQUIREE 1. Prepare the acquisition analysis and the journal entries to record the acquisition of Steenbras Ltd’s operations in the records of Ling Ltd. 2. Prepare the journal entries to record the liquidation of Steenbras Ltd. 3. Prepare the statement of financial position of Ling Ltd after the business combination, including any notes relating to the business combination. LING LTD – STEENBRAS LTD

Question 1. Acquisition analysis Fair value of identifiable assets and liabilities acquired: Accounts receivable Freehold land Buildings Cultivation equipment Irrigation equipment

$15 000 120 000 40 000 40 000 22 000

Loan – Bank of NZ Loan – Trevally Bros Loan – Long Cloud

(80 000) (35 000) (52 500)

$237 000

167 500 $69 500

Consideration transferred Freehold land Delivery trucks Cash Accounts payable Liquidation expenses Cash held

Goodwill Goodwill

= =

$120 000 28 000 $23 500 1 500

$25 000 (2 000)

23 000 $171 000

$171 000 - $69 500 $101 500

LING LTD General Journal Land Gain (Re-measurement as part of consideration transferred in a business combination)

Dr Cr

70 000

Loss Delivery trucks (Re-measurement as part of consideration transferred in a business combination)

Dr Cr

2 000

70 000

2 000

14.14

Chapter 14: Business combinations Accounts receivable Freehold land Buildings Cultivation equipment Irrigation equipment Goodwill Loan – Bank of NZ Loan – Trevally Bros Loan – Long Cloud Land Trucks Payable to Steenbras Ltd (Acquisition of net assets of Steenbras Ltd)

Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr Cr Cr

15 000 120 000 40 000 40 000 22 000 101 500

Payable to Steenbras Ltd Cash (Payment of the consideration transferred)

Dr Cr

23 000

80 000 35 000 52 500 120 000 28 000 23 000

23 000

STEENBRAS LTD General Journal Question 2. Liquidation Accounts receivable Freehold land Buildings Cultivation equipment Irrigation equipment (Transfer of assets)

Dr Cr Cr Cr Cr Cr

213 000

Loan – Bank of NZ Loan – Trevally Bros Loan – Long Cloud Liquidation (Transfer of liabilities)

Dr Dr Dr Cr

80 000 35 000 52 500

Retained earnings Liquidation (Transfer of retained earnings)

Dr Cr

32 000

Receivable from Ling Ltd Liquidation (Consideration transferred)

Dr Cr

171 000

Land Delivery trucks Cash Receivable from Ling Ltd (Receipt of purchase consideration)

Dr Dr Dr Cr

120 000 28 000 23 000

15 000 100 000 30 000 46 000 22 000

167 500

32 000

171 000

14.15

Solutions Manual to accompany Applying IFRS Standards 4e Liquidation Liquidation expenses payable (Expense payable)

Dr Cr

1 500

Liquidation Shareholders’ distribution (Transfer of surplus on liquidation)

Dr Cr

156 000

Liquidation expenses payable Accounts payable Cash (Payment of outstanding debts)

Dr Dr Cr

1 500 23 500

Share capital Shareholders’ distribution (Transfer of share capital)

Dr Cr

60 000

Shareholders’ distribution Land Motor vehicles Delivery trucks (Transfer of assets to shareholders)

Dr Cr Cr Cr

216 000

1 500

156 000

25 000

60 000

120 000 32 000 64 000

14.16

Chapter 14: Business combinations Question 3. LING LTD Statement of Financial Position as at 1 July 2016 Current Assets Accounts receivable (25 000 + 15 000) Total Current Assets Non-Current Assets Freehold land (250 000 + $70 000 – 120 000 + 120 000) Buildings (25 000 + 40 000) Cultivation equipment (65 000 + 40 000) Irrigation equipment (16 000 + 22 000) Delivery trucks (45 000 – 2 000 – 28 000) Motor vehicles Goodwill Total Non-current Assets Total Assets

$40 000 40 000 320 000 65 000 105 000 38 000 15 000 25 000 101 500 669 500 709 500

Current Liabilities Bank overdraft Accounts payable Total Current Liabilities Non-current Liabilities Loan – Bank of NZ (150 000 + 80 000) Loan – Trevally Bros (35 000 + 35 000) Loan – Long Cloud (70 000 + 52 500) Total Non-current Liabilities Total Liabilities Net Assets

230 000 70 000 122 500 422 500 468 000 $241 500

Equity Share capital Other reserves Retained earnings (45 000 + 148 000 – 80 000) Total Equity

$100 000 28 500 113 000 $241 500

19 500 26 000 45 500

Notes relating to the business combination. Disclosures required by the following paragraphs from AASB 3 Appendix B: Paragraph B64 (a) the names and descriptions of the combining businesses B64(b) the acquisition date B64(d) primary reasons for the business combination B64(e) a qualitative description of the factors making up goodwill B64(f) the consideration transferred Fair value of each major class of consideration, including for equity instruments issued: - the number - the method of determining fair value B64(i) amounts recognised for each major class of assets acquired and liabilities assumed B64(m) details of acquisition-related costs

14.17

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.8

ACCOUNTING FOR BUSINESS COMBINATION BY ACQUIRER

Prepare the acquisition analysis and the journal entries to record the acquisition of Warehou Ltd in the records of Sweetlip Ltd. SWEETLIP LTD – WAREHOU LTD

Acquisition Analysis Net fair value of identifiable assets and liabilities acquired: Accounts receivable Land Buildings Farm equipment Irrigation equipment Vehicles ($172 000 - $48 000)

$125 000 840 000 550 000 364 000 225 000 124 000 2 228 000 80 000 $2 148 000

Accounts payable Consideration transferred: Shares: Cash: Land:

Goodwill

100 000 x $14 per share $480 000 + $5 500 +$150 000 - $20 000

$1 400 000 615 500 220 000 $2 235 500

$2 235 500 - $2 148 000 =

$87 500

The journal entries in Sweetlip Ltd are:

Land Gain (Re-measurement as part of consideration transferred in a business combination)

Dr Cr

140 000 140 000

Accounts receivable Land Buildings Farm equipment Irrigation equipment Vehicles Goodwill Accounts payable Share capital Payable to Warehou Ltd Land (Acquisition of net assets of Warehou Ltd)

Dr Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

125 000 840 000 550 000 364 000 225 000 124 000 87 500

Payable to Warehou Ltd Cash (Payment of purchase consideration)

Dr Cr

615 500

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

25 000

Share capital Cash (Share issue costs)

Dr Cr

18 000

80 000 1 400 000 615 500 220 000

615 500

25 000

18 000

14.18

Chapter 14: Business combinations Exercise 14.9 ACCOUNTING FOR ACQUISITIONS OF A BUSINESS AND SHARES IN ANOTHER ENTITY 1. 2. 3.

Prepare the acquisition analysis and journal entries to record the acquisitions in the records of Tailor Ltd. Prepare the Liquidation account and Shareholders’ Distribution account for Flathead Ltd. Explain in detail why, if Flathead Ltd has recorded a goodwill asset of $5000, Tailor Ltd calculates the goodwill acquired via an acquisition analysis. Why does Tailor Ltd not determine a fair value for the goodwill asset and record that figure as it has done for other assets acquired from Flathead Ltd? If Tailor Ltd subsequently receives a dividend cheque for $1500 from Octopus Ltd, paid from retained earnings earned before its acquisition of the shares in Octopus Ltd, how should Tailor Ltd account for that cheque? Why? Shortly after the business combination, the liquidator of Flathead Ltd receives a valid claim of $25 000 from a creditor. As Tailor Ltd has agreed to provide sufficient cash to pay all the liabilities of Flathead Ltd at acquisition date, the liquidator requests and receives a cheque for $25 000 from Tailor Ltd. How should Tailor Ltd record this payment? Why? TAILOR LTD – FLATHEAD LTD – OCTOPUS LTD

Question 1. Acquisition Analysis – Tailor Ltd - Flathead Ltd Fair value of identifiable assets and liabilities acquired Accounts receivable Inventory Land and buildings Plant and equipment

$21 300 26 000 80 000 105 000 $232 300

Consideration transferred Shareholders Shares

Shares of Flathead Ltd Shares in Tailor Ltd (1/3) Shares in Listed Companies Creditors Cash Accounts payable Mortgage loan Liquidation costs Annual leave Total cash required Less cash already held

Goodwill

150 000 50 000

x $2.50

$49 100 30 000 8 700 29 700 117 500 (5 200)

$125 000 15 000

112 300 $252 300

$252 300 – $232 300

$20 000

Acquisition Analysis – Tailor Ltd - Octopus Ltd Consideration transferred To Shareholders: Shares Shares of Octopus Ltd Shares in Tailor Ltd (1/2) Cash 60 000/2 x $1.50

60 000 30 000

x $2.50

$75 000 45 000 $120 000 14.19

Solutions Manual to accompany Applying IFRS Standards 4e

TAILOR LTD General Journal Loss

Dr Cr

1 000

Accounts receivable Inventory Land and buildings Plant and equipment Goodwill Payable to Flathead Ltd Shares in listed companies Share capital (Acquisition of Flathead Ltd’s assets)

Dr Dr Dr Dr Dr Cr Cr Cr

21 300 26 000 80 000 105 000 20 000

Payable to Flathead Ltd Cash (Payment of consideration)

Dr Cr

112 300

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

7 600

Share capital Cash (Payment of share issue costs)

Dr Cr

950

Shares in Octopus Ltd Share capital Cash (Acquisition of shares in Octopus Ltd)

Dr Cr Cr

120 000

Shares in listed companies (Re-measurement as part of consideration transferred in a business combination)

1 000

112 300 15 000 125 000

112 300

7 600

950

75 000 45 000

Question 2. FLATHEAD LTD General Ledger

Accounts receivable Inventory Land and buildings Plant & equipment Goodwill Accounts payable Accrued leave payable Liquidation costs payable Shareholders’ distribution Loss on sale of shares

LIQUIDATION ACCOUNT 21 300 Retained earnings 30 000 Other reserves 40 000 Consideration transferred 105 000 5 000 9 100 29 700 8 700 8 000 4 000 260 800

2 000 6 500 252 300

______ 260 800

14.20

Chapter 14: Business combinations Cash (from sale of shares) Shares in Tailor Ltd

SHAREHOLDERS’ DISTRIBUTION ACCOUNT 33 000 Share capital 125 000 Liquidation 158 000

150 000 8 000 158 000

Question 3. Goodwill is measured differently for two reasons: a) b)

IFRS 3 prohibits the recognition of internally generated goodwill so the figure recorded in the books of Flathead Ltd does not represent the total goodwill of the company at acquisition date. Goodwill cannot be separated from the company and sold separately so no fair value is available. The only way goodwill can be measured is to compare the total value of the company against the fair values of its identifiable net assets, any surplus is deemed to represent the value of the net unidentifiable assets or goodwill.

Question 4. The journal entry to record the dividend cheque is: Cash

Dr Dividend revenue

1 500

(Dividend received from Octopus Ltd) All dividends are treated as revenue by the acquirer regardless out of which equity the dividend is paid.

Question 5. Tailor Ltd should post the following journal:

Goodwill

Cash (Payment to Flathead Ltd)

25 000 25 000

If the liability had been identified at acquisition date then Tailor Ltd would have paid an extra $25 000 cash to acquire the assets of Flathead Ltd. As the cost of the combination has increased (from $252 300 to $277 300) but there has been no change in the fair values of identifiable assets and liabilities, then the value of goodwill acquired must increase (from $20,000 to $45 000).

14.21

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.10 ACQUISITION OF TWO BUSINESSES 1. 2. 3.

Prepare the acquisition analysis for the acquisition transactions of Queenfish Ltd. Prepare the liquidation account for Blackfish Ltd. Prepare the journal entries for the acquisition transactions in the records of Queenfish Ltd and Hoklo Ltd. QUEENFISH LTD – BLACKFISH LTD – HOKLO LTD

Question 1. Acquisition Analysis: Queenfish Ltd – Blackfish Ltd Net fair value of identifiable assets and liabilities acquired: Land & buildings Plant & machinery Office equipment Shares in listed companies Accounts receivable Inventory

$60 000 50 000 4 000 15 000 26 000 54 000 209 000 14 000 16 000 30 000 $179 000

Accounts payable Bank loan Net fair value of identifiable assets and liabilities acquired

Consideration transferred: Shares in Queenfish Ltd Shares issued by Blackfish Ltd Shares in Queenfish Ltd to issue: (3/4 x 60 000)

60 000 45 000 x $3.00

$135 000

Cash Current tax liability Provision for leave Debentures 5% premium Liquidation costs Less cash held Total consideration

Goodwill

[$195 000 - $179 000]

$6 000 10 000 50 000 2 500 2 500 71 000 11 000

60 000 $195 000

$16 000

14.22

Chapter 14: Business combinations

Acquisition Analysis: Queenfish Ltd – Hoklo Ltd’s Spare Parts Retail Division Net fair value of identifiable assets and liabilities acquired Land & buildings Plant & machinery Office equipment Inventory Accounts receivable

$30 000 34 500 2 500 12 000 20 000 99 000

Accounts payable Provision for leave

$14 000 7 000

21 000 $78 000

Consideration transferred:

Cash Shares Land and Buildings

Goodwill

$10 000 33 000 60 000 $103 000

[11 000 x $3.00]

[$103 000 - $78 000]

$25 000

Question 2. BLACKFISH LTD General Ledger LIQUIDATION A/C Land & buildings Plant & machinery Office equipment Inventory

$25 000 36 000 4 000 54 000

Accounts receivable Shares in listed companies Goodwill Liquidation expenses Premium on debentures Shareholders distribution

26 000 15 000 7 000 2 500 2 500 75 000 $247 000

Accounts payable Bank loan Retained earnings Receivable from Queenfish Ltd

$14 000 16 000 22 000 195 000

. $247 000

14.23

Solutions Manual to accompany Applying IFRS Standards 4e Question 3. QUEENFISH LTD General Journal Land & buildings Plant & machinery Office equipment Shares in listed companies Inventory Accounts receivable Goodwill Accounts payable Bank loan Payable to Blackfish Ltd Share capital (Acquisition of assets and liabilities of Blackfish Ltd and issue of shares)

Dr Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

60 000 50 000 4 000 15 000 54 000 26 000 16 000

Share capital Cash (Payment of costs of issuing shares)

Dr Cr

2 000

Acquisition-related expenses Cash (Costs related to acquisition)

Dr Cr

2 500

Payable to Blackfish Ltd Cash (Payment of cash)

Dr Cr

60 000

Land & buildings Plant & machinery Office equipment Inventory Accounts receivable Goodwill Accounts payable Provision for leave Payable to Hoklo Ltd Share capital Land & buildings (Acquisition of the spare parts retail division of Hoklo Ltd and issue of shares)

Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr Cr

30 000 34 500 2 500 12 000 20 000 25 000

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

1 000

Payable to Hoklo Ltd Cash (Payment of purchase consideration)

Dr Cr

10 000

14 000 16 000 60 000 135 000

2 000

2 500

60 000

14 000 7 000 10 000 33 000 60 000

1 000

10 000

14.24

Chapter 14: Business combinations HOKLO LTD General Journal

Carrying amount of division sold Accounts payable Provision for leave Land & buildings Plant & machinery Office equipment Inventory Accounts receivable (Carrying amount of net assets sold)

Dr Dr Dr Cr Cr Cr Cr Cr

66 000 14 000 7 000

Receivable from Queenfish Ltd Income on sale of division (Consideration for net assets of division sold)

Dr Cr

103 000

Cash Shares in Queenfish Ltd Land & buildings Receivable from Queenfish Ltd (Receipt of consideration)

Dr Dr Dr Cr

10 000 33 000 60 000

Exercise 14.11

20 000 32 000 2 000 12 000 21 000

103 000

APPLYING IFRS 3

Provide Mr Spencer with advice on the issues that are confusing him. BASS LTD

Issue 1: How to account for the original 30% investment in Bream Ltd -

initially recorded at fair value plus transactions cost, based on para 43 of IAS 39 subsequently accounted for under IAS 39 eg could be measured at fair value with changes in value included in profit or loss or changes recognised directly in equity. On formation of the business combination, para. 42 of IFRS 3 requires that the acquirer remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognise the resultant gain/loss in profit or loss. Where the investment had been measured at fair value with increments recognised directly in equity, these amounts are transferred at acquisition date to profit or loss as well, and disclosed as reclassification adjustments.

Issue 2: What share price to use Para 27 of IFRS 3 requires the use of the fair value at the date of acquisition. This price will include all expectations of the takeover, including any premium for control. Some argue this does not reflect the cost to Bass Ltd. Issue 3: Effects of different dates IFRS 3 refers to acquisition date only. All measures of fair value are made on acquisition date, for both the consideration transferred and the assets acquired and liabilities assumed. As noted under Issue 1, the 30% investment, originally recognised at the date of exchange, the date the acquirer initially acquired that investment, must at acquisition date be remeasured to fair value.

14.25

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 14.12 1. 2.

ACCOUNTING BY AN ACQUIRER

Prepare an acquisition analysis in relation to this acquisition. Prepare the journal entries in Light Ltd to record the acquisition. LIGHT LTD – SOUND LTD

Question 1. Acquisition analysis: Fair value of identifiable assets and liabilities acquired: Current assets Non-current assets

$980 000 4 220 000 5 200 000 500 000 $4 700 000

Liabilities

Consideration transferred: Shares: 100 000 x 10 x $10 Patent Cash: 100 000 x $5.20

$10 000 000 1 000 000 520 000 $11 520 000

Goodwill = $11 520 000 - $4 700 000 = $6 820 000 Question 2. Journal entries: Light Ltd Patent Gain (Re-measurement as part of consideration transferred in a business combination)

Dr Cr

650 000

Current assets Non-current assets Goodwill Liabilities Share capital Patent Cash (Acquisition of Sound Ltd)

Dr Dr Dr Cr Cr Cr Cr

980 000 4 220 000 6 820 000

Acquisition-related expenses Cash (Payment of directly attributable costs)

Dr Cr

10 000

Share capital Cash (Costs of issuing shares)

Dr Cr

500

650 000

500 000 10 000 000 1 000 000 520 000

10 000

500

14.26

Chapter 14: Business combinations Exercise 14.13

ACCOUNTING BY AN ACQUIRER

Prepare the journal entries in Lower Ltd to record this business combination assuming that, to acquire these net assets, Lower Ltd: 1. issued 100 000 shares at $1.80 per share 2. issued 100 000 shares at $1.60 per share. LOWER LTD – HIGHER LTD

Question 1. FV of shares is $1.80 per share Net fair value of identifiable assets, liabilities and contingent liabilities acquired: Equipment Land Trucks Current assets

$50 000 80 000 40 000 10 000 180 000 16 000 $164 000

Current liabilities

Consideration transferred Shares: 100 000 x $1.80

$180 000

Goodwill = $180 000 - $164 000

$16 000

Journal entries: Lower Ltd Equipment Land Trucks Current assets Goodwill Current liabilities Share capital (Acquisition of assets and liabilities of Higher Ltd)

Dr Dr Dr Dr Dr Cr Cr

50 000 80 000 40 000 10 000 16 000 16 000 180 000

Question 2. FV of shares is $1.60 per share Net fair value of net assets acquired Consideration transferred Shares: 100 000 x $1.60 Gain on bargain purchase = $164 000 - $160 000

$164 000 $160 000 $4 000

Journal entries: Lower Ltd Equipment Dr Land Dr Trucks Dr Current assets Dr Current liabilities Cr Gain on bargain purchase Cr Share capital Cr (Acquisition of assets & liabilities of Higher Ltd)

50 000 80 000 40 000 10 000 16 000 4 000 160 000

14.27

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.14

LIQUIDATION OF THE ACQUIREE

Prepare the journal entries to liquidate Daydream Ltd. HAMILTON LTD – DAYDREAM LTD Journal entries: Daydream Ltd Liquidation Liquidation costs payable (Costs of liquidation)

Dr Cr

1 000

Liquidation costs payable Cash (Payment of costs)

Dr Cr

1 000

Liquidation account Dr Cash Cr Accounts receivable Cr Land Cr Plant Cr Vehicles Cr (Transfer of assets sold to liquidation account)

399 000

Accounts payable Dr Loans Dr Liquidation Cr (Liabilities assumed by acquirer transferred to liquidation account)

40 000 60 000

Retained earnings Dr General reserve Dr Liquidation Cr (Transfer of reserves to liquidation account)

60 000 40 000

Shares in Hamilton Ltd Cash Liquidation (Consideration received)

Dr Dr Cr

280 000 50 000

Liquidation Dr Shareholders distribution Cr (Transfer of balance of liquidation account)

130 000

Share capital Shareholders distribution (Transfer of share capital to shareholders distribution)

Dr Cr

200 000

Shareholders distribution Dr Shares in Hamilton Ltd Cr Cash Cr (Payment of consideration to shareholders)

330 000

1 000

9 000 20 000 80 000 240 000 50 000

100 000

330 000

130 000

200 000

280 000 50 000

14.28

Chapter 14: Business combinations Exercise 14.15

DETERMINING THE FAIR VALUE OF EQUITY ISSUED BY THE ACQUIRER

1. Give the journal entries necessary to record the transactions. (Show clearly to which company particular entries relate.) 2. State briefly why you selected the value adopted in recording the acquisition, and whether you consider there is any acceptable alternative recording value. 3. Show the statement of financial position of Shark Ltd after the entries have been recorded. SHARK LTD – SQUID LTD

Consideration transferred Number of shares issued

= = = = =

Cost per share Consideration transferred

½ (90% x 60 000) 27 000 $6.20 27 000 x $6.20 $167 400

Question 1. Journal entries: Shark Ltd Shares in Squid Ltd Share capital (Cost of shares acquired)

Dr Cr

167 400

Share capital Cash (Costs of shares issued)

Dr Cr

2 000

167 400

2 000

Question 2. Determining the fair value of shares issued In acquiring the Squid Ltd shares, Shark Ltd gives up 27 000 of its own shares. The problem is to determine which share price should be used to determine the cost to Shark Ltd. $6.20 is used here as it represents the fair value at date of acquisition. See Basis for Conclusions on IFRS 3 para BC342, and section 10.5 of the text.

Question 3. SHARK LTD Statement of Financial Position Current Assets

$146 000

Non-current Assets Shares in Squid Ltd Other Total Non-current Assets Total Assets

$167 400 190 000 357 400 503 400

Liabilities Creditors and provisions Net Assets Equity Share capital Reserves Asset revaluation surplus General Retained earnings Total Equity

28 000 $475 400

$245 400 $140 000 60 000

200 000 30 000 $475 400

14.29

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.16

ACCOUNTING FOR GOODWILL

Prepare a report for Ms Ball to present to the directors to help them understand the nature of goodwill and how to account for it. SILVER LTD

Nature of goodwill • • • • •

Is it an asset? 2 types: Internal vs external/acquired goodwill Nature of internal goodwill: undervalued/unrecorded assets, core goodwill Nature of acquired goodwill? Core goodwill: going concern & combination Why did acquirer pay for goodwill? Synergy – extra benefits

How to account for it • •

•

Internal goodwill IAS 38: not recognised as cannot determine a cost Acquired goodwill • Recognised only in a business combination • Measured as a residual under para 32 • Subject to annual impairment test • If allocated to CGU, write off first if impairment loss • If reversal of impairment loss, no reinstatement of goodwill Future effects on Statement of Comprehensive Income • No cause for concern • No annual amortisation • Only expense if impairment loss • Impairment loss cushioned by various accounting treatments such as use of cost method for PPE, non-recognition of internally generated goodwill & internally generated intangibles

Exercise 14.17

ACCOUNTING FOR RESEARCH

Provide the directors with advice on the accounting for the aforementioned transaction. TALL LTD

Principles in IAS 38: • • • •

Definitions of research vs development Para 57 criteria to determine what is research & development: note 2 or 3 examples of these criteria Expense research outlays, capitalise development using para 57 Never recognise certain internally generated intangibles para 63 examples to be given

How to account for the acquired research: • • •

IFRS 3 is the relevant accounting standard, not IAS 38 Measure at FV using hierarchy: active market, similar transactions & valuation techniques Intangibles that meet the recognition criteria must be accounted for separately from goodwill. Directors may prefer a classification of goodwill as the latter is not amortised, whereas intangibles generally have a finite life.

14.30

Chapter 14: Business combinations Exercise 14.18

ACCOUNTING FOR ACQUISITION-RELATED COSTS

Prepare a report for Ms Bluff on how she should explain the accounting for acquisition-related costs to the board of directors. SOUTHLAND LTD

Arguments in favour of expensing: - These costs are not part of the fair value exchange between the buyer and the seller. - The services received from the outlays have been consumed, and so do not give rise to assets. Arguments against expensing: - Inconsistent with other accounting standards such as IAS 16 Property, Plant and Equipment. - The costs are an integral part of the acquisition price, with the outlays being incurred in order to generate future benefits. Under IFRS 3, a fair value model is adopted so consistency with IAS 16 is not a strong argument. The acquirer is prepared to incur the costs at acquisition. Hence there must be an expectation on the acquirer’s part that these will be recouped via future benefits from the business combination. As noted by Ms New, business combinations do not result in immediate losses. However, because the fair value model is used, the assets acquired cannot be stated in excess of fair value – compare the initial measurement of financial instruments acquired under para 43 of IAS 39. If goodwill reflects expected future benefits and is measured as a residual, then it may be argued the total benefits acquired by the acquirer are reflected in the cost of the combination being the sum of the consideration transferred and the directly attributable costs. Under this view there would be a larger goodwill measured than currently recognised under IFRS 3, but no expense for the acquisition-related costs. Note para BC366 of the Basis for Conclusions for IFRS 3, the IASB argues: 1. Acquisition-related costs are not part of the fair value exchange between the buyer and the seller. 2. They are separate transactions for which the buyer pays the fair value for the services received. 3. These amounts do not generally represent assets of the acquirer at acquisition date because the benefits obtained are consumed as the services are received.

14.31

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.19

LIQUIDATION OF ACQUIREE, ACCOUNTING BY ACQUIRER

1. Show the Liquidation account and the Shareholders’ Distribution account in the records of Crab Ltd. 2. Prepare the journal entries in the records of Marlin Ltd to record the business combination. 3. Show the statement of financial position of Marlin Ltd after completion of the business combination. 4. On 31 July 2016, Marlin Ltd became aware that there had been an error in measuring the fair value of the plant at 1 June 2016. It had in fact a fair value at that date of $36 000. Explain how Marlin Ltd is required to adjust for that error. Marlin Ltd’s reporting period ends on 30 June. MARLIN LTD – CRAB LTD Acquisition analysis Consideration transferred

= =

$20 000 (cash) + $40 000 (shares: 16 000 x $2.50) $60 000

Question 1. Ledger Accounts – Crab Ltd Liquidation Plant Inventory Accounts receivable Goodwill Cost of liquidation

$ 30 000 26 000 20 000 10 000 1 000

Balance c/d Retained earnings

87 000 7 000 24 000

Accounts payable

$ 20 000

Marlin Ltd

60 000

Balance b/d

7 000 87 000

Shareholders’ distribution

31 000 31 000

31 000

Liquidation Distribution: cash Shares in Marlin Ltd

Question 2.

Shareholders’ Distribution $ 31 000 Share capital 19 000 40 000 90 000

$ 90 000

90 000

Journal entries: Marlin Ltd

Net fair value of identifiable assets and liabilities acquired: Plant Inventory Accounts receivable Accounts payable

Net fair value of identifiable assets and liabilities acquired Consideration transferred Goodwill

= = =

$30 000 28 000 20 000 78 000 20 000 58 000

$58 000 $60 000 $2 000

14.32

Chapter 14: Business combinations The journal entries are: Plant Inventory Accounts receivable Goodwill Accounts payable Payable to Crab Ltd Share capital (Net assets acquired from Crab Ltd and issue of shares)

Dr Dr Dr Dr Cr Cr Cr

30 000 28 000 20 000 2 000 20 000 20 000 40 000

Payable to Crab Ltd Cash (Payment of cash consideration)

Dr Cr

20 000

Acquisition-related expenses Cash (Payment of acquisition-related costs)

Dr Cr

500

Share capital Cash (Share issue costs)

Dr Cr

400

20 000

500

400

Question 3. MARLIN LTD Statement of Financial Position Current Assets Cash Accounts receivable Inventories Total Current Assets

$9 100 28 000 42 000 $79 100

Non-current Assets Plant Government bonds Goodwill Total Non-current Assets Total Assets

80 000 12 000 2 000 94 000 173 100

Current Liabilities Accounts payable Net Assets

22 000 $151 100

Equity Share capital Retained earnings Total Equity

$139 600 11 500 $151 100

14.33

Solutions Manual to accompany Applying IFRS Standards 4e Question 4.

Error adjustment

See para 42 of IAS 8 42.

Subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by: (a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or (b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented. 1

Assuming no depreciation of plant: Plant

Dr Cr Cr

Goodwill Retained earnings (op balance) (Adjustment for error)

Exercise 14.20

6 000 2 000 4 000

LIQUIDATION OF ACQUIREE, ACCOUNTING BY ACQUIRER

1. Prepare the acquisition analysis and journal entries to record the business combination in the records of Hastings Ltd. 2. Prepare the Liquidation, Liquidator’s Cash, and Shareholders’ Distribution accounts for Flounder Ltd. HASTINGS LTD – FLOUNDER LTD

Question 1. Acquisition analysis Net fair value of assets and liabilities acquired: Accounts receivable Inventory Freehold land Buildings Plant and equipment

$34 700 39 000 130 000 40 000 46 000 $289 700

Consideration transferred Shares: 2/3 x 60 00 x $3.20 Cash Accounts payable Mortgage and interest Debentures and premium Liquidation expenses

$128 000 $45 100 44 000 52 500 2 400 144 000 (12 000)

Cash held

Gain on bargain purchase

= =

132 000 $260 000

$289 700 - $260 000 $29 700

14.34

Chapter 14: Business combinations Hastings Ltd General Journal

Accounts receivable Inventory Freehold land Buildings Plant and equipment Payable to Flounder Ltd Share capital Gain on bargain purchase (Acquisition of net assets of Flounder Ltd and shares issued)

Dr Dr Dr Dr Dr Cr Cr Cr

34 700 39 000 130 000 40 000 46 000

Payable to Flounder Ltd Cash (Payment of cash consideration)

132 000 Cr

132 000

Share capital Cash (Costs of issuing shares)

1 200 Cr

1 200

132 000 128 000 29 700

Question 2. FLOUNDER LTD General Ledger

Accounts receivable Inventory Freehold land Buildings Plant and equipment Goodwill Interest payable Liquidation expenses Premium on debentures Accounts payable Shareholders’ distribution

Liquidation $ 34 700 Reserves 27 600 Retained earnings 100 000 Receivable from Hastings Ltd 30 000 46 000 2 000 4 000 2 400 2 500 1 600 68 000 318 800

$ 26 800 32 000 260 000

318 800

Opening balance Receivable from Hastings Ltd

Liquidator’s Cash $ 12 000 Liquidation expenses 132 000 Mortgage and interest Debentures and premium Accounts payable 144 000

$ 2 400 44 000 52 500 45 100 144 000

Shares in Hastings Ltd

Shareholders’ Distribution $ 128 000 Share capital Liquidation 128 000

$ 60 000 68 000 128 000

14.35

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 14.21 ACCOUNTING FOR A BUSINESS COMBINATION BY BOTH THE ACQUIRER AND THE ACQUIREE 1.

2. 3.

Show the journal entries to record the above transactions in the records of Saratoga Ltd: (a) if the fair value of the ‘A’ ordinary shares of Saratoga Ltd was $2 per share (b) if the fair value of the ‘A’ ordinary shares of Saratoga Ltd was $2.20 per share. (Assume the assets acquired constitute a business entity.) Show the journal entries in the records of Kingfish Ltd under (a) and (b) in requirement 1. Show the statement of financial position of Saratoga Ltd after the transactions, assuming the fair value of Saratoga’s Ltd’s ‘A’ ordinary shares was $2.20 per share. Provide the notes to the financial statements relating to the business combinations. SARATOGA LTD – KINGFISH LTD

Question 1. (a) Assuming the fair value of “A” ordinary shares was $2 per share Acquisition analysis Net fair value of identifiable assets and liabilities acquired

Consideration transferred Gain on bargain purchase

$22 000 (inventory)

= = = =

+ $34 000 (land and buildings) + $27 000 (plant and machinery) $83 000 40 000 shares x $2.00 $80 000 $3 000

Journal entries: Inventory Land and buildings Plant and machinery Gain on bargain purchase Share capital “A” Ordinary (Assets acquired and shares issued)

Dr Dr Dr Cr Cr

22 000 34 000 27 000 3 000 80 000

(b) Assuming the fair value of “A” ordinary shares was $2.20 per share Acquisition analysis Net fair value of identifiable assets and liabilities acquired Consideration transferred

= = = =

$83 000 40 000 shares x $2.20 $88 000 $5 000

Inventory

22 000

Land and buildings Plant and machinery Goodwill Share capital “A” Ordinary (Assets acquired and shares issued)

Dr Dr Dr Cr

34 000 27 000 5 000

Goodwill Journal entries:

88 000

14.36

Chapter 14: Business combinations Question 2. KINGFISH LTD General Journal (a) Assuming the fair value of “A” ordinary shares was $2 per share Carrying amount of segment sold Accumulated depreciation. – plant & machinery Inventory Land and buildings Plant and machinery (Transfer of assets sold)

Dr Dr Cr Cr Cr

45 000 18 000

Receivable from Saratoga Ltd Income from sale of segment (Purchase consideration)

Dr Cr

80 000

Shares in Saratoga Ltd Receivable from Saratoga Ltd (Receipt of purchase consideration)

Dr Cr

80 000

15 000 10 000 38 000

80 000

(b) Assuming the fair value of “A” ordinary shares was $2.20 per share Carrying amount of segment sold Accumulated depreciation. – plant and machinery Inventory Land and buildings Plant and machinery (Transfer of assets sold)

Dr Dr Cr Cr Cr

45 000 18 000

Receivable from Saratoga Ltd Income from sale of segment (Purchase consideration)

Dr Cr

88 000

Shares in Saratoga Ltd Receivable from Saratoga Ltd (Receipt of consideration)

Dr Cr

88 000

15 000 10 000 38 000

88 000

14.37

Solutions Manual to accompany Applying IFRS Standards 4e Question 3. SARATOGA LTD Statement of Financial Position as at 30 June 2016 Current Assets Cash Accounts receivable Inventory Total Current Assets Non-Current Assets Land and buildings Plant and machinery less Accumulated depreciation Goodwill Total Non-Current Assets Total Assets

$12 000 18 000 65 000 $95 000

57 000 $79 000 34 000

Current Liabilities Accounts payable Non-current Liabilities Debentures Total Liabilities Net Assets Equity Share capital 40 000 ordinary shares, fully paid 40 000 “A” ordinary shares, fully paid Retained earnings Total Equity

45 000 5 000 107 000 202 000

42 000 20 000 62 000 $140 000

$40 000 88 000

$128 000 12 000 $140 000

Notes relating to the business combination. Disclosures required by the following paragraphs from IFRS 3 Appendix B: Paragraph B64 (a) the names and descriptions of the combining businesses B64 (b) the acquisition date B64 (d) primary reasons for the business combination B64 (e) a qualitative description of the factors making up goodwill B64 (f) the consideration transferred Fair value of each major class of consideration, including for equity instruments issued: - the number - the method of determining fair value B64 (i) amounts recognised for each major class of assets acquired and liabilities assumed

14.38

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 14 Business combinations

CHAPTER 14 Business combinations

Learning Objectives 14.1 14.2 14.3 14.4 14.5 14.6 14.7 14.8 14.9

Understand the nature of a business combination and its various forms Explain the basic steps in the acquisition method of accounting for business combinations Account for a business combination in the records of the acquirer Recognise and measure the assets acquired and liabilities assumed in the business combination Understand the nature of and the accounting for goodwill and gain from bargain purchase Account for shares acquired in the acquiree Prepare the accounting records of the acquiree Account for subsequent adjustments to the initial accounting for a business combination Provide the disclosures required under IFRS 3.

14.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1. A business combination is defined as: Learning Objective 14.1 Understand the nature of a business combination and its various forms a. A transaction in which an acquirer obtains control of an acquiree b. A transaction in which one entity obtains control of one or more other entities *c. A transaction or other event in which an acquirer obtains control of one or more businesses d. A transaction or other event in which an entity obtains control of one or more businesses

2. In a business combination, the acquirer is the party that: Learning Objective 14.2 Explain the basic steps in the acquisition method of accounting for business combinations *a. obtains control of the other entities b. concedes control over the acquired entities c. sells the acquired entity d. receives the acquisition consideration.

3. In a business combination, the acquiree is the party that: Learning Objective 14.2 Explain the basic steps in the acquisition method of accounting for business combinations a. finances the business combination *b. gives up control over the net assets acquired c. obtains control of the net assets the other entity d. pays the acquisition consideration.

4. The acquisition date for a business combination is the date on which: Learning Objective 14.2 Explain the basic steps in the acquisition method of accounting for business combinations a. a substantive agreement between the combining parties is reached *b. the acquirer effectively obtains control of the acquiree c. the business combination is announced to the public d. the acquirer announces the acquisition to the acquiree.

Where the acquirer purchases assets and assumes liabilities of another entity it does NOT need to consider measurement of: Learning Objective 14.3 Account for a business combination in the records of the acquirer a. consideration transferred b. fair values of identifiable net assets *c. carrying amounts of identifiable net assets d. goodwill

14.2

Chapter 14 Business combinations

In order for a tangible asset to be recognised by an acquirer under a business combination it must be probable that future economic benefits will flow to the acquirer and: Learning Objective 14.4 Recognise and measure the assets acquired and liabilities assumed in the business combination *a. its fair value can be measured reliably b. it must be a non-current item c. it must be measured using the present value method d, it may not be a non-monetary asset.

The following items are NOT deemed to be items that would meet the definition of an intangible asset given by IFRS 3: Learning Objective 14.4 Recognise and measure the assets acquired and liabilities assumed in the business combination a. trademarks *b. experienced marketing team c. newspaper mastheads d. order backlogs.

Net employee benefit liabilities acquired in a business combination are measured by using the: Learning Objective 14.4 Recognise and measure the assets acquired and liabilities assumed in the business combination *a. present value method b. estimated total of future cash outflows, undiscounted c. face value of the liabilities d. cash method.

Oliveira Limited estimated that the net present value of future cash flows from Equipment acquired in a business combination is $15 000. The cost of replacing the Equipment is estimated to be $18 000. The Equipment has been independently appraised at a value of $14 000. A similar item of Equipment cost the acquirer $19 000 the previous year. The fair value at which the Equipment will be recognised when recording the business combination is: Learning Objective 14.4 Recognise and measure the assets acquired and liabilities assumed in the business combination *a. $14 000 b. $15 000 c. $18 000 d. $19 000.

14.3

Test Bank to accompany Applying IFRS Standards 4e

10.

Johnson Limited estimated the net present value of future cash flows from specialised Plant acquired under a business combination to be $30 000. A replacement cost for the Plant is estimated to be $33 000. The Plant has been independently appraised at a value of $31 000. A similar item of Plant cost the acquirer $29 000 the previous year. What is the fair value for recognition of the Plant under a business combination? Learning Objective 14.4 Recognise and measure the assets acquired and liabilities assumed in the business combination a. $29 000 b. $30 000 c. $33 000 *d. $31 000.

11.

If shares are issued as part of the consideration paid, transactions costs such as brokerage fees may be incurred. According to IFRS 3, the appropriate accounting treatment for such costs in the records of the acquirer is a debit to: Learning Objective 14.5 Understand the nature of and the accounting for goodwill and gain *a. share capital b. investments c. cash d. acquisition expenses.

12.

The consideration transferred in a business combination is measured as the fair value of the: Learning Objective 14.5 Understand the nature of and the accounting for goodwill and gain a. net assets acquired b. costs directly attributable to the combination *c. consideration given only d. consideration given plus directly attributable costs.

13.

Bolton Limited acquires the net assets of Pamelia Limited for a cash consideration of $100 000. One half is to be paid on acquisition date and one half is payable in one year’s time. The appropriate discount rate is 10% p.a. The present value of the cash outflow in one year’s time is: Learning Objective 14.5 Understand the nature of and the accounting for goodwill and gain *a. $45 454 b. $50 000 c. $54 545 d. $55 000 According to IFRS 3, a gain on bargain purchase arises when the acquirer’s interest in the fair value of the acquiree’s identifiable assets and liabilities is: Learning Objective 14.5 Understand the nature of and the accounting for goodwill and gain a. less than the carrying amount of the net assets acquired b. less than the consideration transferred *c. greater than the consideration transferred d. more than the book values of the identifiable assets acquired. 14.

14.4

Chapter 14 Business combinations

15.

Fredericks Limited acquired the identifiable assets and liabilities of Nicole Limited for €134 000. The items acquired, stated at fair value, are: • Plant €72 000 • Inventory €40 000 • Trade receivables €18 000 • Patents €10 000 • Trade payables €16 000. The difference on acquisition is: Learning Objective 14.5 Understand the nature of and the accounting for goodwill and gain a. Gain on bargain purchase €10 000 b. Gain on bargain purchase €16 000 *c. Goodwill of €10 000 d. Goodwill of €124 000.

16.

Valdez Limited acquired a 25% interest in Alaska Pty Ltd on 1 January 2016. On 15 September 2016 it acquired an additional 10% interest, and on 15 March 2017 a further 40%. According to IFRS 3, a business combination occurs on: Learning Objective 14.6 Account for shares acquired in the acquiree a. 1 January 2016 b. 15 September 2016 *c. 15 March 2017 d. All of the above

17.

Damon Limited acquired the net assets of Gina Limited. Damon Limited provided an item of equipment as part of the consideration. The fair value of the equipment was €13 000. It cost €20 000 and had a carrying amount of €12 000. Which of the following entries appropriately reflects the gain or loss on the equipment? Learning Objective 14.7 Prepare the accounting records of the acquiree a. DR Loss on sale €1 000 b. CR Loss on sale €1 000 *c. CR Gain on sale €1 000 d. Dr Gain on sale €1 000.

18. Adjustments cannot be made subsequent to the initial accounting for: Learning Objective 14.8 Account for subsequent adjustments to the initial accounting for a business combination a. Goodwill *b. Restructuring costs c. Contingent consideration d. Contingent liabilities

14.5

Test Bank to accompany Applying IFRS Standards 4e

19. IFRS 3 is relevant when accounting for a business combination that: Learning Objective 14.1 Understand the nature of a business combination and its various forms: a. involves mutual entities b. results in the formation of a joint venture *c. results in an entity acquiring the net assets of another entity d. involves entities or businesses that are not investor owned

20.

Appendix B of IFRS 3 requires disclosure of which of the following? I II III IV

details of contingent consideration the date of exchange carrying amounts of assets and liabilities in business combinations where shares are acquired a qualitative description of the factors that make up goodwill

Learning Objective 14.9 Provide the disclosures required under IFRS 3 a. I, II and IV only *b. I, III and IV only c. I, II and III only d. I, II, III and IV

21. According to IFRS 3, the method of accounting for a business combination is the: Learning Objective 14.2 Explain the basic steps in the acquisition method of accounting for business combinations: a. joint venture method b. purchase method c. market value method *d. acquisition method

22.

When an acquirer accounts for a business combination they have to consider: I. II. III. IV.

recognition of the identifiable assets acquired measurement of the identifiable assets acquired recognition of the liabilities assumed measurement of the liabilities assumed

Learning Objective 14.3 Account for a business combination in the records of the acquirer: a. I and II only *b. I, II, III and IV c. I and III only d. II and IV only

14.6

Chapter 14 Business combinations

23. When accounting for a business combination a contingent liability is recognised if: Learning Objective 14.4 Recognise and measure the assets acquired and liabilities assumed in the business combination: a. it is a present obligation that has failed to meet the recognition criteria *b. its fair value can be measured reliably c. it is a possible obligation and it is probable that it will occur d. it is probable that an outflow of resources may occur in order to settle the obligation

24. Goodwill arising in a business combination is classified as: Learning Objective 14.5 Understand the nature of and the accounting for goodwill and gain from bargain purchase: a. an item in equity b. a liability c. an expense associated with the acquisition *d. an asset

25. Goodwill is measured as the difference between the: Learning Objective 14.5 Understand the nature of and the accounting for goodwill and gain from bargain purchase: a. cost of the assets given up, and the cost of the net assets acquired b. cost of the net assets acquired, and the net present value of the consideration given up c. present value of the consideration transferred, and the present value of the net assets acquired *d. consideration transferred, and the fair value of the assets and liabilities acquired

26. Where an entity acquires shares rather than the net assets of another entity the acquirer records the shares at: Learning Objective 14.6 Account for shares acquired in the acquiree: a. fair value b. fair value less transaction costs c. consideration paid *d. fair value plus transaction costs

27.

Neil Limited sold a business to Howell Limited for $60 000. All assets were recorded by the acquiree at their fair values as follows: • Land $30 000 • Inventory $20 000 • Trade receivables $4000. When recording the sale, the acquiree recognises: Learning Objective 14.7 Prepare the accounting records of the acquiree *a. a gain on sale of $6000 b. goodwill of $6000 c. a gain on bargain purchase of $6000 d. a loss on sale of $6000

14.7

Test Bank to accompany Applying IFRS Standards 4e

28. When an acquiree disposes of a business, the gain or loss is recognised in: Learning Objective 14.7 Prepare the accounting records of the acquiree: a. retained earnings b. revaluation surplus *c. the statement of profit or loss and other comprehensive income d. capital profits

29. Subsequent to acquisition date contingent liabilities are measured at: Learning Objective 14.8 Account for subsequent adjustments to the initial accounting for a business combination: a. the amount that would be recorded in accordance with IAS 37 b. the amount initially recorded less cumulative amortisation recognised in accordance with IAS 18 c. the lower of a. and b. above *d. the higher of a. and b. above

30. The information contained within Appendix B of IFRS 3 in relation to disclosure: Learning Objective 14.9 provide the disclosures required under IFRS 3: a. is not mandatory, but contains optional additional disclosures b. contains prescribed presentation formats for disclosure of business combinations *c. is an integral part of IFRS 3 d. is complementary to the main disclosure requirements within the body of IFRS 3

14.8

Exercises Exercise 14.11 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

APPLYING IFRS 3

Bass Ltd has recently undertaken a business combination with Bream Ltd. At the start of negotiations, Bass Ltd owned 30% of the shares of Bream Ltd. The current discussions between the two entities concerned Bass Ltd’s acquisition of the remaining 70% of shares of Bream Ltd. The negotiations began on 1 January 2016 and enough shareholders in Bream Ltd agreed to the deal by 30 September 2016. The purchase agreement was for shareholders in Bream Ltd to receive in exchange shares in Bass Ltd. Over the negotiation period, the share price of Bass Ltd shares reached a low of $5.40 and a high of $6.20. The accountant for Bass Ltd, Mr Spencer, knows that IFRS 3 has to be applied in accounting for business combinations. However, he is confused as to how to account for the original 30% investment in Bream Ltd, what share price to use to account for the issue of Bass Ltd’s shares, and how the varying dates such as the date of exchange and acquisition date will affect the accounting for the business combination. Required

Provide Mr Spencer with advice on the issues that are confusing him.

Exercise 14.12

ACCOUNTING BY AN ACQUIRER

★ Light Ltd acquired all the assets and liabilities of Sound Ltd on 1 July 2016. At this date, the assets and liabilities of Sound Ltd consisted of: Carrying amount

Fair value

Current assets Non-current assets

$ 1 000 000 4 000 000

$ 980 000 4 220 000

Liabilities

5 000 000 500 000

5 200 000 500 000

$ 4 500 000

$ 4 700 000

Share capital — 100 000 shares Reserves

$ 3 000 000 1 500 000 $ 4 500 000

In exchange for these net assets, Light Ltd agreed to: • issue 10 Light Ltd shares for every Sound Ltd share — Light Ltd shares were considered to have a fair value of $10 per share; costs of share issue were $500 • transfer a patent to the former shareholders of Sound Ltd — the patent was carried in the records of Light Ltd at $350 000 but was considered to have a fair value of $1 million • pay $5.20 per share in cash to each of the former shareholders of Sound Ltd. Light Ltd incurred $10 000 in costs associated with the acquisition of these net assets. Required

1. Prepare an acquisition analysis in relation to this acquisition. 2. Prepare the journal entries in Light Ltd to record the acquisition.

Exercise 14.13

ACCOUNTING BY AN ACQUIRER

★ Lower Ltd acquired the assets and liabilities of Higher Ltd on 1 July 2016. These net assets measured at fair value consisted of: Equipment Land Trucks Current assets Current liabilities

$ 50 000 80 000 40 000 10 000 (16 000)

Required

CHAPTER 14 Business combinations

Exercise 14.14

LIQUIDATION OF THE ACQUIREE

★ Hamilton Ltd acquired all the assets and liabilities of Daydream Ltd, giving in exchange 100 000 shares,

these having a fair value of $2.80 per share, and $50 000 cash. At the acquisition date, the statement of ﬁnancial position of Daydream Ltd was as follows: $ 10 000 20 000 80 000 240 000 50 000

Cash Accounts receivable Land Plant Vehicles

$ 400 000 Accounts payable Loans

$ 40 000 60 000 $ 100 000

Share capital General reserve Retained earnings

$ 200 000 40 000 60 000 $300 000

Costs of liquidation amounted to $1000. Required

Prepare the journal entries to liquidate Daydream Ltd. Exercise 14.15

DETERMINING THE FAIR VALUE OF EQUITY ISSUED BY THE ACQUIRER

★ The following are the statements of ﬁnancial position at 30 September 2016 of Shark Ltd and Squid Ltd. Shark Ltd Share capital — 80 000 shares Asset revaluation surplus General reserve Retained earnings Creditors and provisions

$ 80 000 140 000 60 000 30 000 28 000

Non-current assets (at valuation less depreciation) Current assets

$338 000

$190 000 148 000

$338 000

Squid Ltd Share capital — 60 000 shares General reserve Retained earnings Creditors and provisions

$ 60 000 20 000 25 000 10 000

Non-current assets (at cost less depreciation) Current assets

$115 000

$ 50 000 65 000 $115 000

Additional information (a) During September the shares of the companies were selling on the stock exchange at or near the following prices: Shark Ltd

$5.80

Squid Ltd

$1.80

(b) On 30 September the directors of Shark Ltd made an offer to the shareholders of Squid Ltd to acquire their shares on the basis of one fully paid share at $1 in Shark Ltd for every two fully paid shares at $1 in Squid Ltd. The offer was open for 1 month and was contingent upon being accepted by the holders of at least 75% of Squid Ltd’s capital. (c) Immediately after the announcement, Shark Ltd’s shares rose in price on the stock exchange to $6.20 and the shares of Squid Ltd rose to $3. The shares of both companies stayed at or close to this price throughout October.

PART 2 Elements

(d) By the end of October, holders of 90% of Squid Ltd shares accepted the Shark Ltd offer and the latter company proceeds to acquire these shares on the agreed basis. (e) By mid-November, Shark Ltd shares dropped in price on the stock exchange to $5.50. (f) Costs of issuing and registering shares issued by Shark Ltd amounted to $2000. Required

1. Give the journal entries necessary to record the transactions. (Show clearly to which company particular entries relate.) 2. State brieﬂy why you selected the value adopted in recording the acquisition, and whether you consider there is any acceptable alternative recording value. 3. Show the statement of ﬁnancial position of Shark Ltd after the entries have been recorded. Exercise 14.16 ★★

ACCOUNTING FOR GOODWILL

Silver Ltd has acquired a major manufacturing division from Fern Ltd. The accountant, Ms Ball, has shown the board of directors of Silver Ltd the financial information regarding the acquisition. Ms Ball calculated a residual amount of $45 000 to be reported as goodwill in the accounts. The directors are not sure whether they want to record goodwill on Silver Ltd’s statement of financial position. Some directors are not sure what goodwill is or why the company has bought it. Other directors even query whether goodwill is an asset, with some being concerned with future effects on the statement of profit or loss and other comprehensive income. Required

Prepare a report for Ms Ball to present to the directors to help them understand the nature of goodwill and how to account for it. Exercise 14.17

ACCOUNTING FOR RESEARCH

★★ Tall Ltd has acquired all the net assets of Blacks Ltd with the latter going into liquidation. Both companies operate in the area of testing and manufacturing pharmaceutical products. One of the main reasons that Tall Ltd sought to acquire Blacks Ltd was that the latter company had an impressive record in the development of drugs for the cure of some mosquito-related diseases. Blacks Ltd employed a number of scientists who were considered to be international experts in their area and at the leading edge of research in their field. Much of the recent work undertaken by these scientists was classified for accounting purposes as research and, as per IAS 38 Intangible Assets, was expensed by Blacks Ltd. However, in deciding what it would pay to take over Blacks Ltd, Tall Ltd had paid a sizeable amount of money for the ongoing research being undertaken by Blacks Ltd as it was expected that it would be successful eventually. The accountant for Tall Ltd, Mr Basket, has suggested that the amount paid by Tall Ltd for this research should be shown as goodwill in the company’s statement of financial position. However, the directors of the company do not believe that this faithfully represents the true nature of the assets acquired in the business combination, and want to recognise this as an asset separately from goodwill. Mr Basket believes that this will not be in accordance with IAS 38. Required

Provide the directors with advice on the accounting for the aforementioned transaction.

Exercise 14.18

ACCOUNTING FOR ACQUISITION-RELATED COSTS

★★ One of the responsibilities of the Group Accountant for Southland Ltd, Ms Bluff, is to explain the accounting principles applied by the company in preparing the annual report to the company’s Board of Directors. Having analysed IFRS 3, Ms Bluff is puzzled by the requirement in paragraph 53 of IFRS 3 that any acquisition-related costs such as fees for lawyers and valuers should be expensed. Ms Bluff has analysed other accounting standards such as IAS 16 Property, Plant and Equipment and notes that under this standard such costs are capitalised into the cost of any property, plant and equipment acquired. She therefore believes that to expense such costs in accounting for a business combination would not be consistent with accounting for acquisitions of other assets. Further, Ms Bluff believes that to expense such costs would result in a loss being reported in the statement of proﬁt or loss and other comprehensive income in the period the business combination occurs. She is not sure how she will explain to the board of directors that the company makes a loss every time it enters a business combination. She believes the directors will wonder why the company enters into business combinations if immediate losses occur — surely losses indicate that bad decisions have been made by the company.

CHAPTER 14 Business combinations

Required

Prepare a report for Ms Bluff on how she should explain the accounting for acquisition-related costs to the board of directors.

Exercise 14.19

LIQUIDATION OF ACQUIREE, ACCOUNTING BY ACQUIRER

★★ Marlin Ltd, a supplier of snooker equipment, agreed to acquire the business of a rival ﬁrm, Crab Ltd,

taking over all assets and liabilities as at 1 June 2016. The price agreed on was $60 000, payable $20 000 in cash and the balance by the issue to the selling company of 16 000 fully paid shares in Marlin Ltd, these shares having a fair value of $2.50 per share. The trial balances of the two companies as at 1 June 2016 were as follows: Marlin Ltd Dr Share capital Retained earnings Accounts payable Cash Plant (net) Inventory Accounts receivable Government bonds Goodwill

Crab Ltd Cr

$100 000 12 000 2 000

$ 24 000 20 000 — 30 000 26 000 20 000 — 10 000

$ 30 000 50 000 14 000 8 000 12 000 — $114 000

Cr $ 90 000

$114 000

$110 000

All the identiﬁable net assets of Crab Ltd were recorded by Crab Ltd at fair value except for the inventory, which was considered to be worth $28 000 (assume no tax effect). The plant had an expected remaining life of 5 years. The business combination was completed and Crab Ltd went into liquidation. Costs of liquidation amounted to $1000. Marlin Ltd incurred incidental costs of $500 in relation to the acquisition. Costs of issuing shares in Marlin Ltd were $400. Required

1. Show the Liquidation account and the Shareholders’ Distribution account in the records of Crab Ltd. 2. Prepare the journal entries in the records of Marlin Ltd to record the business combination. 3. Show the statement of ﬁnancial position of Marlin Ltd after completion of the business combination. 4. On 31 July 2016, Marlin Ltd became aware that there had been an error in measuring the fair value of the plant at 1 June 2016. It had in fact a fair value at that date of $36 000. Explain how Marlin Ltd is required to adjust for that error. Marlin Ltd’s reporting period ends on 30 June.

Exercise 14.20

LIQUIDATION OF ACQUIREE, ACCOUNTING BY ACQUIRER

★★ Hastings Ltd is seeking to expand its share of the widgets market and has negotiated to take over the oper-

ations of Flounder Ltd on 1 January 2017. The statements of ﬁnancial position of the two companies as at 31 December 2016 were as follows:

Cash Accounts receivable Inventory Freehold land Buildings (net) Plant and equipment (net) Goodwill

PART 2 Elements

Hastings Ltd

Flounder Ltd

$ 23 000 25 000 35 500 150 000 60 000 65 000 25 000 $383 500

$ 12 000 34 700 27 600 100 000 30 000 46 000 2 000 $ 252 300

$ 56 000 50 000 100 000 100 000 — 28 500 49 000 $383 500

Accounts payable Mortgage loan Debentures Share capital — 100 000 shares — 60 000 shares Other reserves Retained earnings

$ 43 500 40 000 50 000 — 60 000 26 800 32 000 $ 252 300

Hastings Ltd is to acquire all the assets, except cash, of Flounder Ltd. The assets of Flounder Ltd are all recorded at fair value except: Fair value Inventory Freehold land Buildings

$ 39 000 130 000 40 000

In exchange, Hastings Ltd is to provide sufﬁcient extra cash to allow Flounder Ltd to repay all of its outstanding debts and its liquidation costs of $2400, plus two fully paid shares in Hastings Ltd for every three shares held in Flounder Ltd. The fair value of a share in Hastings Ltd is $3.20. An investigation by the liquidator of Flounder Ltd reveals that at 31 December 2016 the following debts were outstanding but had not been recorded: Accounts payable Mortgage interest

$ 1 600 4 000

The debentures issued by Flounder Ltd are to be redeemed at a 5% premium. Costs of issuing the shares were $1200. Required

ACCOUNTING FOR A BUSINESS COMBINATION BY BOTH THE ACQUIRER AND THE ACQUIREE

Saratoga Ltd was finding difficulty in raising finance for expansion. Kingfish Ltd was interested in achieving economies by marketing a wider range of products. The following shows the financial positions of the companies at 30 June 2016. Saratoga Ltd Share capital 40 000 shares 90 000 shares Retained earnings Liabilities Debentures (secured by floating charge) Accounts payable Total equity and liabilities Assets Cash Accounts receivable Inventory (at cost) Land and buildings (at cost) Plant and machinery (at cost) Accumulated depreciation on plant and machinery Total assets

Kingfish Ltd

$ 40 000 12 000

$ 90 000 30 000

52 000

120 000

20 000 42 000

— 12 000

62 000 $114 000

12 000 $132 000

$ 12 000 18 000 43 000 23 000 52 000 (34 000) $114 000

$ 24 000 20 000 47 000 19 000 41 000 (19 000) $132 000

CHAPTER 14 Business combinations

It was agreed that it would be mutually advantageous for Saratoga Ltd to specialise in manufacturing, and for marketing, purchasing and promotion to be handled by Kingfish Ltd. Accordingly, Kingfish Ltd sold part of its assets to Saratoga Ltd on 1 July 2016, the identifiable assets acquired having the following fair values: Inventory Land and buildings Plant and machinery

$22 000 (cost $15 000) $34 000 (carrying amount $10 000) $27 000 (cost $38 000, accumulated depreciation $18 000)

The acquisition was satisﬁed by the issue of 40 000 ‘A’ ordinary shares (fully paid) in Saratoga Ltd. Required

1. Show the journal entries to record the above transactions in the records of Saratoga Ltd: (a) if the fair value of the ‘A’ ordinary shares of Saratoga Ltd was $2 per share (b) if the fair value of the ‘A’ ordinary shares of Saratoga Ltd was $2.20 per share. (Assume the assets acquired constitute a business entity.) 2. Show the journal entries in the records of Kingfish Ltd under (a) and (b) in requirement 1. 3. Show the statement of financial position of Saratoga Ltd after the transactions, assuming the fair value of Saratoga’s Ltd’s ‘A’ ordinary shares was $2.20 per share. Provide the notes to the financial statements relating to the business combinations.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 15: Impairment of assets

Chapter 15 – Impairment of assets Discussion Questions 1.

What is an impairment test? It is a test to determine if an entity’s assets are overstated, that is, whether the carrying amount of the assets is greater than their recoverable amount.

Why is an impairment test considered necessary? An entity’s balance sheet may overstate the assets, either because the assets’ fair values are lower than the carrying amounts, or because the accountant’s estimates are wrong eg the calculation of depreciation requires estimates of residual value, useful life, pattern of benefits.

When should an entity conduct an impairment test? At each reporting date, an entity must assess whether there is any indication of impairment. If such an indication exists, the entity shall estimate the recoverable amount of the asset [IAS 36 para 9]

What are some external indicators of impairment? IAS 36 para 12: (a) significant decline in market value (b) significant changes in the technological, market, economic or legal environment in which the entity operates (c) increases in market interest rates (d) the carrying amount of the entity’s assets exceeds the entity’s market capitalisation

What are some internal indicators of impairment? IAS 36 para 12: (a) evidence of obsolescence or physical damage (b) assets becoming idle, plans to discontinue operations, plans to dispose of assets (c) economic performance is worse than expected

What is meant by recoverable amount? Recoverable amount is the higher of an asset’s value in use and fair value less costs of disposal.

How is an impairment loss calculated in relation to a single asset accounted for? IAS 36 para 60 Under cost model: - Recognise loss immediately in profit or loss - Write down asset – if depreciable, increase accumulated depreciation and impairment losses account © John Wiley and Sons, Ltd, 2016

15.1

Solutions Manual to accompany Applying IFRS Standards 4e Under revaluation model: as for a revaluation decrease under that model, the effect being dependent on whether there have been past revaluation increments.

What are the limits to which an asset can be written down in relation to impairment losses? An asset must be reduced to its recoverable amount.

What is a cash generating unit? The smallest identifiable group of assets that generates cash inflows largely independent of the cash flows from other assets or groups of assets.

10.

How are impairment losses accounted for in relation to cash generating units? IAS 36 para 104: - Reduce the carrying amount of any goodwill allocated to the CGU - Allocate any balance of loss to the other assets of the CGU pro rata on the basis of their carrying amounts

11.

Are there limits in adjusting assets within a cash generating unit when impairment losses occur? IAS 36 para 105: - An entity shall not reduce the carrying amount of the asset in a CGU below the highest of: - Its fair value less costs of disposal; - Its value in use; and - Zero.

12.

How is goodwill tested for impairment? IAS 36 para 80: - Allocate the goodwill to each of the acquirer’s CGUs if possible - If it cannot be allocated, treat as a corporate asset - Test goodwill annually, but note para 99 may allow use of a preceding period’s information.

13.

What is a corporate asset? An asset other than goodwill that contributes to the future cash flows of both the CGU under review and other CGUs.

14.

How are corporate assets tested for impairment? IAS 36 para 102: - Allocate if possible to CGUs - If it cannot be allocated on a reasonable and consistent basis, after testing the separate CGUs, identify the smallest group of CGUs that includes the CGU under review and to which the corporate asset can be allocated and test the group of CGUs for impairment.

15.

When can an entity reverse past impairment losses? IAS 36 para 110: At each reporting date, an entity shall assess whether there is any indication that past impairment losses – other than for goodwill – may no longer exist or have decreased. If such an indication exists, the recoverable amount is determined. If the recoverable amount exceeds the carrying © John Wiley and Sons, Ltd, 2016

15.2

Chapter 15: Impairment of assets amount, reversal may occur, subject to the para 117 limitations.

16.

What are the steps involved in reversing an impairment loss? 1. Test for indication that past losses may no longer exist or have decreased. Testing involves analysing external and internal sources of information as per para 111. 2. If test is positive, determine the recoverable amount of the asset [or CGU] 3. If the recoverable amount is greater than the carrying amount, determine the carrying amount that would have been determined had no impairment loss been recognised in prior years. 4. Subject to the limit in 3. above, if testing an individual asset, write the asset up recognising income in current period’s profit or loss. Accounting for asset depends on whether the cost model or the revaluation model is used. 5. If testing a CGU, allocate the reversal amount to the assets of the CGU – except goodwill – pro rata to carrying amounts, but ensuring that the carrying amounts of the CGU’s assets are not increased above the lower of: - Recoverable amount; and - Carrying amount had no impairment occurred. 6. Adjust depreciation/amortisation charges of assets [para 121]

15.3

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 15.1

CASH-GENERATING UNITS

Write a report to the accountant of Fresh Milk Ltd, including the following: 1. Define a CGU. 2. Explain why impairment testing requires the use of CGUs, rather than being based on single assets. 3. Explain the factors that the accountant should consider in determining the CGUs for Fresh Milk Ltd.

1. A cash-generating unit is the smallest identifiable group of assets that generates cash flows that are largely independent of the cash inflows from other assets or groups of assets. 2. The impairment test requires a comparison of the recoverable amount of an asset with the higher of the asset’s value in use and fair value less costs of disposal. Value in use requires: - an estimate of the future cash flows the entity expects to derive from the asset - expectations about variety in timing of cash flows - the price for bearing the uncertainty inherent in the asset These cash flows are based upon data such as financial budgets and forecasts. For some assets, there are no cash flows that are generated independently from those of other assets e.g. the milking machines or the machines used to separate cream from milk etc. do not generate independent cash flows. The eventual cash flows come from the sale of the milk products. These machines could be sold separately, giving a fair value less costs of disposal. However, as management has decided to use the machines rather than sell them, management has made the decision that the value in use is greater than the value via sale. 3. Cash flows must be independent of other cash flows A CGU must be the lowest aggregation of assets independently generating cash flows. Factors include (see paras 69–71 of IAS 36): - how management monitors the entity’s operations: such as product lines, businesses, individual locations, districts or regional areas. How does management break down Fresh Milk Ltd – by factory? By dairy district? By product? - how management makes decisions about continuing or disposing of the entity’s assets and operations. If management wanted to sell off part of the business but still keep a viable business remaining, how could the business be broken down into parts that could be sold off? - the existence of an active market for the output produced even if some or all of the output is used internally. In this case, the milk produced is not sold to the public or other entities but is used to make further milk products. However, as there is an active market for milk, the milk production section is potentially a separate CGU. This is because the assets in that section could generate cash flows independently of the rest of the entity. Internal transfer prices should not be used to determine recoverable amount unless these reflect the best estimate of prices that could be achieved in arm’s length transactions.

15.4

Chapter 15: Impairment of assets

Exercise 15.2

IMPAIRMENT TESTING AND GOODWILL

Write a report to management, specifically explaining: 1. the purpose of the impairment test 2. how the existence of goodwill will affect the impairment test 3. the basic steps to be followed in applying the impairment test. Your report should contain the following points. 1. The purpose of the impairment test is: -

to ensure assets are not overstated. to ensure that carrying amounts (CA) do not exceed recoverable amounts to determine the recoverable amount (RA) which is higher of FV less costs of disposal & value in use

2. The existence of goodwill will affect the impairment test as follows: -

goodwill should be allocated to each CGU based on internal management monitoring of goodwill if unallocated must be tested at smallest CGU containing the goodwill in testing a CGU containing goodwill, if an impairment loss occurs, goodwill is to be written off first once written off, goodwill cannot be written back under a reversal of impairment process CGUs containing goodwill must be tested annually, although some relief is available As internally generated goodwill cannot be recognised, any such goodwill will cushion the impairment of an impairment loss

3. The basic steps to be following in applying impairment testing 1. 2. 3. 4. 5. 6.

check for indication of impairment: external and internal sources if positive indicator, undertake test; if not no test required determine existence of CGUs [define] allocate corporate assets and goodwill measure recoverable amount: FV less costs of disposal PV of future cash flows if CGU impaired, allocate loss firstly to goodwill and then to other assets on a pro rata basis; cannot reduce CA of an asset below highest of FV less costs of disposal, value in use & zero. Assets may have been measured on cost model or revaluation model testing of indicators may indicate ability to reverse prior impairment loss

Exercise 15.3

FREQUENCY OF IMPAIRMENT TEST

Prepare a response to management. Frequency of test: For most assets, there is no specific timing for the conducting of impairment tests. Para 9 of IAS 36 states that an entity shall at each reporting date assess whether there is any indication that an asset may be impaired. Para 16 notes that irrespective of any indication of impairment, for - intangible assets with an indefinite useful life - intangible assets not yet available for use - goodwill annual impairment tests are required. © John Wiley and Sons, Ltd, 2016

15.5

Solutions Manual to accompany Applying IFRS Standards 4e But see paras 24 and 99 for relief clauses. Information needed to be generated: Para 12 outlines sources of information to indicate impairment, both internal and external. Discuss the need for an entity to install systems to generate this information, specific to that entity, so that the information is available at balance date for assessment of the need for an impairment test.

Exercise 15.4

IMPAIRMENT LOSS

Provide the journal entry(ies) for the impairment loss, assuming that the fair value less costs of disposal of the land are (a) $140 000 and (b) $145 000. TAMBO LTD If recoverable amount is $510 000, then there is an impairment loss of $30 000. Assuming the inventory is carried at the lower of costs and net realisable value, the allocation of the impairment loss is as follows:

Factory Land Equipment

(a)

Carrying Amount

Proportion

Allocation of Loss

$210 000 150 000 120 000 $480 000

21/48 15/48 12/48

13 125 9 375 7 500 30 000

196 875 140 625 112 500

If the fair value less costs of disposal of the land is $140 000, then the journal entry to record the impairment loss is: Impairment loss Accumulated depreciation and impairment losses –factory Land Accumulated depreciation and impairment losses –equipment (Allocation of impairment loss)

(b)

Net Carrying Amount

30 000

Cr Cr

13 125 9 375

7 500

If the fair value less costs of disposal of the land is $145 000, then the land cannot be written down to an amount below that figure. Hence the maximum impairment loss allocable to land is $5 000. The extra $4 375 must be allocated to the other assets.

Factory Equipment

Carrying Amount

Proportion

Allocation of Loss

$196 875 112 500 $309 375

196 875/309 375 112 500/309 375

2 784 1 591 4 375

Net Carrying Amount 194 091 110 909

The journal entry to record the impairment loss is: Impairment loss Accumulated depreciation and

30 000 15.6

Chapter 15: Impairment of assets impairment losses –factory Land Accumulated depreciation and impairment losses –equipment (Allocation of impairment loss)

Exercise 15.5

Cr Cr

15 909 5 000

9 091

IDENTIFICATION OF CGUs

Identify the cash-generating unit(s) in this scenario. Give reasons for your conclusions. Each Burger Queen restaurant should be treated as a separate CGU as the cash flows are largely independent of the other stores. The only exception to this is advertising. Although the ingredients for making the burgers are supplied at a set cost, the amount of materials used is specific to an individual restaurant. Whether a specific restaurant remains in existence is based on an analysis of the performance of that restaurant – an analysis that is independent of the other restaurants. Internal management reporting would be organized to measure performance on a restaurant-byrestaurant basis. The restaurants are in different neighbourhoods and probably have different customer bases.

Exercise 15.6

IDENTIFICATION OF CGUs

Identify the cash-generating unit(s) in this scenario. Give reasons for your conclusions. The CGU is the business as a whole. Marla needs all three factories to run the business. The jobs are allocated to a specific factory dependent on Marla’s assessment of efficiencies and current workload of each factory. The factories are not run independently. Exercise 15.7

VALUE IN USE

Evaluate management’s decision. Note Appendix A to IAS 36 – an integral part of the Standard. The Appendix reviews the traditional approach and the expected cash flow approach. The traditional approach would calculate a present value based on the most likely scenario using a cash flow of $5m whereas the expected cash flow approach would be based on the expected cash flow of $5.9m [being 70% x $5m plus 30% x $8m] Note para A10: The application of the traditional approach requires the same estimates and subjectivity without providing the computational transparency of the expected cash flow approach. Note para A12: the expected cash flow approach is subject to a cost-benefit constraint. Consider the example in paras A13 and A14.

15.7

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 15.8

WRITE-DOWN

Discuss whether the building should be written down to $8 million. Provide any journal entries necessary.

As the building generates no cash flows of its own it is not a separate CGU but is a part of the CGU being the entity as a whole. Providing the recoverable amount of the CGU exceeds the carrying amount of the CGU, there is no impairment in relation to the CGU. There is therefore no need to write the building down. The recoverable amount of individual assets is not important. The entity’s expected cash flows are not from the sale of the building. They are from the operation of the CGU.

Exercise 15.9

ASSET IMPAIRMENT

Discuss whether the network facility asset is impaired and whether it should be written down to $300 000. Provide any journal entries necessary. The carrying amount of the asset at 30 June 2016 is $350 000. Whether the asset should be written down depends on whether the asset is a part of a cash-generating unit. In this example, it appears that the network facility does not independently generate cash flows from the network. Instead the network is used as a part of the administration section, itself being a corporate asset. If the network is a part of a CGU, then there is no need to write individual assets down outside the CGU incurring an impairment loss.

15.8

Chapter 15: Impairment of assets

Exercise 15.10

ALLOCATION OF CORPORATE ASSETS AND GOODWILL

Determine how Cheng Ltd should allocate any impairment loss at 31 December 2017. CHENG LTD

Sandstone $400 200 240 120 40 200 1 200 1 170 (30)

Factory Land Equipment Inventory Goodwill Corporate property Recoverable amount Impairment loss

Sapphire $370 300 90 80 50 150 1 040 900 (140)

Silverton $120 150 250 100 30 120 770 800 0

Sandstone Unit Write down the goodwill by $30: Impairment loss Accumulated impairment losses - goodwill (Allocation of impairment loss)

Sapphire Unit Write off goodwill of $50 and allocate the $90 balance of impairment loss:

Factory Land Equipment Corporate property

Carrying Amount

Proportion

Allocation of Excess

370 300 90 150 910

37/91 30/91 9/91 15/91

36 30 9 15 90

Net Carrying Amount 334 270 81 135

As the land has a fair value less costs of disposal of $293, only $7 of the impairment loss can be allocated to it. Hence, the remaining $23 must be allocated to the other assets:

Factory Equipment Corporate property

Carrying Amount

Proportion

Allocation of Excess

334 81 135 550

334/550 81/550 135/550

14 3 _6 23

Net Carrying Amount 320 78 129

15.9

Solutions Manual to accompany Applying IFRS Standards 4e The entry is: Impairment loss Goodwill Accumulated depreciation and impairment losses – factory Land Accumulated depreciation and impairment losses – equipment Accumulated depreciation and impairment losses – corporate property (Allocation of impairment loss)

Dr Cr

140 50

Cr Cr

50 7

Exercise 15.11 ALLOCATION OF CORPORATE ASSET AND GOODWILL Prepare the journal entries required at 30 June 2017 to account for any impairment losses.

LIAO LTD Division 1: Total assets Recoverable amount Impairment loss

Division 2: Total assets Recoverable amount Impairment loss

= $422 000 + $7 000 + $80 000 = $509 000 = $415 000 = $94 000

= $306 000 + $7 000 + $80 000 = $393 000 = $310 000 = $83 000

ALLOCATION OF IMPAIRMENT LOSS DIVISION 1 Write-off goodwill of $7 000 Allocate $87 000 to all assets except cash, inventory and receivables. Plant Land Buildings HO Building

$200 000 90 000 70 000 80 000 440 000

39 545 17 796 13 841 15 818 87 000

ALLOCATION OF IMPAIRMENT LOSS DIVISION 2 Write off goodwill of $7 000 Allocate $76 000 to relevant assets Land Buildings Furniture HO Building

150 000 80 000 20 000 80 000 330 000

34 546 18 424 4 606 18 424 76 000

61 576 15 394 61 576

15.10

Chapter 15: Impairment of assets However land can only be written down by $15 000, hence need to allocate $19 546 to other assets: Buildings Furniture HO Building

61 576 15 394 61 576 138 546

8 687 2 172 8 687 19 546

Journal entries are: Impairment loss Goodwill

Dr Cr

14 000

Impairment loss Dr Accumulated depreciation and impairment losses: head office building Cr (15 818 + 18 424 + 8 687)

42 929

Impairment loss (Division 1) Dr Land Cr Accumulated depreciation and impairment losses: plant Cr Accumulated depreciation and impairment losses: buildings Cr

71 182

Impairment loss (Division 2) Dr Land Cr Accumulated depreciation and impairment losses: buildings * Cr Accumulated depreciation and impairment losses: furniture ** Cr * $18 424 + $8 687 ** $4 606 + $2 172

48 889

Exercise 15.12

14 000

42 929

17 796 39 545 13 841

15 000 27 111 6 778

CORPORATE ASSETS, ALLOCATED AND UNALLOCATED

Determine how Ararat Ltd should account for any impairment of the entity. Justify your decisions and complete any required journal entries. ARARAT LTD 3 divisions are CGUs Head office and research centre are not CGUs Allocate head office assets to each division Determine impairment of research centre with entity as a whole Step 1: Calculate impairment loss Adjust the carrying amounts of the CGUs for the allocatable corporate asset (head office) and compare with value in use to determine impairment loss.

Carrying amounts of assets Allocation of head office assets Value in use Impairment loss

Aramac 1 400 000 60 000 1 460 000 1 550 000 ______0

Alpha 980 000 60 000 1 040 000 1 000 000 (40 000)

Amby 740 000 60 000 800 000 750 000 (50 000)

15.11

Solutions Manual to accompany Applying IFRS Standards 4e Step 2: Allocate impairment loss Alpha Division

Head office Land Plant

Carrying Amount

Proportion

Allocation of loss

60 000 280 000 420 000 760 000

60/760 280/760 420/760

3 158 14 736 22 106 40 000

Adjusted carrying Amount 265 264 397 894

As the fair value less costs of disposal of the land is $270 264, then only $9 736 can be allocated to this asset. The other $5 000 must be allocated across the other assets:

Head office * Plant

Carrying Amount

Proportion

56 842 397 894 $454 736

56842/454736 397894/454736

Allocation of loss 625 4 375 $5 000

Adjusted carrying Amount 393 519

* $60 000 - $3 158 The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant ** (Impairment loss – Alpha division: ** $22 106 + $4 375)

Dr Cr

36 217 9 736

26 481

Step 3 Amby Division

Head office Land Plant

Carrying Amount

Proportion

Allocation of loss

60 000 160 000 380 000 600 000

60/600 160/600 380/600

5 000 13 333 31 667 50 000

Dr Cr

45 000

Adjusted carrying Amount 146 667 348 333

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant (Impairment loss – Amby division)

13 333

31 667

Step 4: Impairment losses for head office assets Total loss is $8783, being $3158 + $625 + $5 000

Land Plant

Carrying Amount

Proportion

Allocation of loss

110 000 70 000 $180 000

110/180 70/180

5 367 3 416 $8 783

Adjusted carrying Amount 104 633 66 584 15.12

Chapter 15: Impairment of assets

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant (Impairment loss – head office)

Dr Cr

8 783 5 367

3 416

Step 5: Research centre assets are $100 000 Carrying amount (after allocation of impairment loss): Aramac $1 460 000 Alpha 1 000 000 Amby 750 000 Research centre 100 000 3 310 000 Recoverable amount of entity 3 300 000 Impairment loss _(10 000)

Aramac: Plant Alpha: Plant Amby: Land Plant Head office: Land Plant Research Centre Land Plant

Carrying Amount

Proportion

Allocation of loss

Adjusted carrying Amount

600 000

600000/1759736

3 410

596 590

393 519

2 236

391 283

146 667 348 333

833 1 979

145 834 346 354

104 633 66 584

595 378

104 038 66 206

67 000 33 000 $1 759 736

381 188 $10 000

66 619 32 812

Impairment loss Accumulated depreciation and impairment losses – plant [Aramac] Accumulated depreciation and impairment losses – plant [Alpha] Land: Ruby Accumulated depreciation and impairment losses – plant [Amby] Land: head office Accumulated depreciation and impairment losses – plant [HO] Land: research centre Accumulated depreciation and impairment losses: plant [RC]

10 000

3 410

Cr Cr

2 236 833

Cr Cr

1 979 595

Cr Cr

378 381

188

15.13

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 15.13

IMPAIRMENT LOSS

(Show all workings) 1. Prepare the journal entries required on 30 June 2017 in relation to the measurement of the assets of Casey Ltd. 2. Assume that, as the result of the allocation of the impairment loss, the factories were to be written down to $800 000. If the fair value less costs of disposal of the factories was determined to be $750 000, outline the adjustments, if any, that would need to be made to the journal entries you prepared in requirement 1, and explain why adjustments are or are not required. CASEY LTD 1. Assets Recoverable amount Impairment loss

$1 990 000 1 820 000 170 000

Goodwill written off Balance to be allocated

20 000 150 000

Corporate headquarters Factories Intangibles

820 000 880 000 100 000 1 800 000

[$2 000 000 - $10 000 write-down of land]

68 334 73 333 8 333 150 000

751 666 806 667 91 667

Asset revaluation surplus Deferred tax liability Land

Dr Dr Cr

7 000 3 000

Accumulated impairment losses Impairment loss Goodwill

Dr Dr Cr

40 000 20 000

Impairment loss Accumulated depreciation and impairment losses – corporate headquarters Accumulated depreciation and impairment losses - factories Accumulated amortisation and impairment losses - intangibles

150 000

10 000

60 000

68 334

73 333

8 333

2. Factories written down to $800 000 FV less costs of disposal $750 000 No adjustment required. The impairment is calculated on the CGU not on individual assets. As factories are included in the CGU, they do not independently generate cash flows. Therefore it is impossible to determine value in use for factories. Hence cannot determine recoverable amount. So cannot conduct an impairment test on factories as an asset. No need to write down.

15.14

Chapter 15: Impairment of assets Exercise 15.14

DETERMINATION OF CGUs

Discuss the determination of cash-generating units for Le Bon Bus Company. Note definition of “cash-generating unit” in IAS 36. It is possible to determine the profitability of each route as costs and revenues can be isolated to each route. However, as the council contracts for a package of routes, it is not possible to stop operating a single route in the package. Hence, the tender for the package is based on the group of routes as a package. The lowest level of identifiable cash flows that are largely independent of the cash flows from other assets is the cash flows of the package of routes. The cash-generating unit is then the package of routes.

Exercise 15.15

IMPAIRMENT LOSS, GOODWILL

Prepare the journal entries to account for the impairment loss at 31 December 2017. NARRABRI LTD The carrying amount of the assets of the Toy Train Division is $500 000. If the recoverable amount is $423 000, then there is an impairment loss of $77 000. The impairment loss is firstly used to write off the goodwill - $50 000. The balance of the loss - $27 000 – is allocated across the other assets, except for inventory assuming it is recorded at the lower of cost and net realisable value:

Factory Brand

Carrying Amount

Proportion

Allocation of Loss

Net Carrying Amount

250 000 50 000 300 000

5/6 1/6

22 500 4 500 27 000

227 500 45 500

The journal entry to record the impairment loss is: Impairment loss Goodwill Accumulated depreciation and impairment losses –factory Accumulated amortisation and impairment losses –brand (Allocation of impairment loss)

Dr Cr

77 000 50 000

22 500

4 500

15.15

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 15.16 1.

IMPAIRMENT LOSS, GOODWILL, PARTLY OWNED SUBSIDIARY

Explain how the impairment loss in relation to Wodonga Ltd should be allocated. Prepare journal entry(ies) in relation to the assets of Wodonga Ltd at 31 December 2016 as a result of the impairment test. Explain the accounting for the impairment (if any) if the recoverable amount was $860 000. WINTON LTD – WODONGA LTD

1. Acquisition analysis: Fair value of identifiable net assets Net fair value acquired Consideration transferred Goodwill Goodwill for entity Goodwill to NCI

= = = = = = = =

$660 000 60% x $660 000 $396 000 $426 000 $30 000 $30 000/60% $50 000 $20 000

At 31 December 2016, the carrying amount of the assets is $820 000 plus goodwill of $50 000, namely $870 000. If the recoverable amount is $800 000, then there is an impairment loss of $70 000 The goodwill of $50 000 is then written off, and the remaining $20 000 impairment loss is allocated across the other assets of Wodonga Ltd, excluding inventory.

Property, plant & equipment

Carrying Amount

Proportion

743 000

100%

Allocation of Loss

Net Carrying Amount

20 000

723 000

The journal entry to record the impairment is: Impairment loss Goodwill Accumulated depreciation and impairment losses (Allocation of impairment loss)

Dr Cr

70 000 50 000

20 000

2. If the recoverable amount was $860 000, then the impairment loss is $10 000. Goodwill is reduced from $50 000 to $40 000, of which 60% (ie $24 000) is attributable to the parent entity. The parent entity’s goodwill is then reduced by $6000, ie, from $30 000 to $24 000. The journal entry is: Impairment loss Accumulated impairment losses – Goodwill (Allocation of impairment loss)

Dr Cr

6 000 6 000

15.16

Chapter 15: Impairment of assets Exercise 15.17

EFRAG RESPONSE TO PROPOSED AMENDMENTS

Evaluate the comments made by EFRAG. This quotation is based on the impairment test proposed in the ED prior to the issue of IAS 36. In the ED the impairment test was based on the following steps: Step 1: Determine whether an impairment loss exists by comparing the recoverable amount of the CGU with its carrying amount. Step 2: Calculate the implied value of the goodwill by comparing the recoverable amount of the CGU with the sum of the fair values of the identifiable assets and liabilities of the CGU Step 3: Compare the carrying amount of the goodwill with the implied value of goodwill. Goodwill is only written down if the implied value is less than the carrying amount. Step 4: Allocate the balance of impairment loss to other assets. In comparison with this approach, IAS 38 requires that any impairment loss be firstly written off against goodwill. The ED approach did provide cushions for goodwill as the implied value of goodwill included internally generated goodwill. Reliability is affected only in relation to the measurement of the fair values of the identifiable assets and liabilities of the CGU. It could be argued that to write down all the goodwill but not identifiable assets reduces the reliability of the information about the identifiable net assets. The ED approach was not adopted by the IASB because of the costliness of the measurement of the fair values of the identifiable assets and liabilities. This is also because an impairment test for goodwill is required annually and not just when an event triggers the test.

Exercise 15.18

DELOITTE TOUCHE TOHMATSU RESPONSE

Evaluate the comments made by Deloitte Touche Tohmatsu. Goodwill must be tested for impairment annually. The purpose of the impairment test is to determine whether goodwill should be written down. If goodwill is declining due to the nature of an entity then the test should show this effect, and in the period in which the effect occurs. The impairment test acts as an amortisation method for goodwill but does not rely on the inaccuracies of a systematic amortisation method. Choice of a systematic method is impossible as by the nature of goodwill [unidentifiable assets], the pattern of cash flows in unknown. It is impossible after acquisition to distinguish internally generated and acquired goodwill.

Exercise 15.19

IDENTIFICATION OF CGUs

1. Identify the cash-generating unit(s) in this scenario, giving reasons for your conclusions. 2. Would the determination of the cash-generating units be affected if the parts division was also responsible for kit furniture, where the parts are made available to customers for self-assembly?

There are two CGUs, namely the timber division and the combination of the parts division and the furniture division. The parts division is not a separate CGU as it cannot sell its products in an external market – the parts are only suitable for the manufacture of the furniture produced by Fad Furniture. Its cash flows are then dependent on the furniture division.

15.17

Solutions Manual to accompany Applying IFRS Standards 4e Internal transfer prices do not reflect market prices for outputs. In undertaking an impairment test for the timber division, arm’s length prices should be used. In determining whether the timber division is a separate CGU the question is whether the timber is saleable externally i.e. an ability to generate independent cash flows. Even if all the timber were used internally, if it could all be sold externally, the timber division would be a separate CGU. 2.

An assessment would have to be made on the viability of the kit furniture industry. If the kit furniture industry is purely an offshoot of the furniture industry, and is viable only because it relies on cost savings on manufacturing the parts for the furniture industry, then there is no change in the CGUs from (A). If the kit furniture industry was independently viable, then it is possible that the parts division could be broken down into two parts, one part is combined with the furniture division while the other is that dedicated to the kit furniture industry. The key question is whether the kit furniture section is the smallest identifiable group of assets that generates cash inflows that are largely independent.

Exercise 15.20

1. 2. 3.

IMPAIRMENT LOSS FOR A CASH-GENERATING UNIT, REVERSAL OF IMPAIRMENT LOSS

Prepare the journal entries for Broome Ltd at 30 June 2016 and 2017. What differences would arise in relation to the answer in requirement 1 if the recoverable amount at 30 June 2017 was $20 000 greater than the carrying amount of the unit? If the recoverable amount of the buildings at 30 June 2017 was $175 000, how would this change the answer to requirement 2? BROOME LTD

1. Carrying amount of assets: Buildings Factory machinery Goodwill Inventory Receivables Cash

$240 000 180 000 15 000 80 000 35 000 20 000 570 000 535 000 $35 000

Value in use Impairment loss

Goodwill is written down by $15 000, and the balance of the impairment loss, namely $20,000 is written off across the other relevant assets:

Buildings Machinery

Carrying Amount

Proportion

Allocation of Loss

Net Carrying Amount

240 000 180 000 420 000

24/42 18/42

11 429 8 571 20 000

228 571 171 429

The journal entry is: Impairment loss Goodwill Accumulated depreciation and impairment losses – buildings Accumulated depreciation and impairment losses – machinery (Allocation of impairment loss)

Dr Cr

35 000 15 000

11 429

8 571

15.18

Chapter 15: Impairment of assets

At 30 June 2017, the two assets are reported as follows: Buildings Accumulated depreciation and impairment losses

$420 000

Factory machinery Accumulated depreciation and impairment losses

$220 000

256 429 163 571

[180 000 + 11 429 + 65 000]

98 571 121 429

[40 000 + 8 571 + 50 000]

The carrying amounts of these assets if no impairment loss had occurred would have been: Buildings $420 000 Accumulated depreciation and impairment losses 240 000 [180 000 + 60 000] 180 000 Factory machinery Accumulated depreciation and impairment losses

$220 000 85 000 135 000

[40 000 + 45 000]

The differences between the carrying amounts recorded at 30 June 2017 and the carrying amounts if no impairment losses had been recorded are: Buildings Factory machinery

[180 000 – 163 571] [135 000 – 121 429]

$16 429 $13 571 $30 000

As the recoverable amount at 30 June 2017 exceeds the carrying amount by $30 000, then the total differences can be recognised: Accumulated depreciation and impairment losses – buildings Accumulated depreciation and impairment losses – factory machinery Income: reversal of impairment loss (Reversal of impairment loss)

16 429

Dr Cr

13 571 30 000

2. If the excess of the recoverable amount over carrying amounts at 30 June 2017 was only $20,000, then the reversal would be based on a pro rata allocation based on carrying amounts at time of reversal:

Buildings Machinery

Carrying Amount

Proportion

Allocation of Excess

Net Carrying Amount

163 571 121 429 285 000

0.57 0.43

11 479 8 521 20 000

175 050 129 950

The entry would be: Accumulated depreciation and impairment losses – buildings Accumulated depreciation and Impairment losses – factory machinery Income: reversal of impairment loss (Reversal of impairment loss)

11 479

Dr Cr

8 521

20 000

15.19

Solutions Manual to accompany Applying IFRS Standards 4e 3. If the recoverable amount of the buildings at 30 June 2017 was only $175 000, then the reversal of the impairment for buildings could only be $11 429 (i.e. $175 000 less $163 571). Hence the balance of $50 (i.e. $11 479 - $11 429) could be allocated to factory machinery. The journal entry is: Accumulated depreciation and impairment losses – buildings Accumulated depreciation and impairment losses – factory machinery Income: reversal of impairment loss (Reversal of impairment loss)

11 429

Dr Cr

8 571 20 000

The $8571 allocated to factory machinery still does not exceed the carrying amount if the asset had never been impaired. The factory machinery will now be shown as: Factory machinery Accumulated depreciation and impairment losses

Exercise 15.21

$220 000 [40 000 + 8 571 +50 000 – 8571]

90 000 $130 000

ALLOCATION OF CORPORATE ASSETS

Determine how Hay Ltd should account for any impairment loss to the entity. HAY LTD

Recoverable amount Impairment loss

Hebel $660 000 15 000 675 000 720 000 _____0

Hawker $540 000 15 000 555 000 500 000 (55 000)

Hillston $420 000 15 000 435 000 400 000 (35 000)

Total carrying amounts after adjusting for impairment loss

675 000

500 000

400 000

Carrying amount of assets Allocation of HQ

The carrying amounts of the divisions add to $1 575 000. Together with the SRC, the total is $1 591 000. This is less than the total recoverable amount of $1 620 000. Hence there is no need to write down the assets of the SRC. However, the assets of the Hawker and Hillston Divisions must be written down: Hawker Division:

Head Office Land Plant

Carrying Amount 15 000 140 000 210 000 365 000

Proportion 15/365 140/365 210/365

Allocation of Excess 2 260 21 096 31 644 55 000

Net Carrying Amount 118 904 178 356

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant (Allocation of impairment loss)

Dr Cr Cr

52 740 21 096 31 644 15.20

Chapter 15: Impairment of assets Hillston Division: Carrying Amount 15 000 80 000 190 000 285 000

Head Office Land Plant

Proportion

Allocation of Excess 1 842 9 825 23 333 35 000

15/285 80/285 190/285

Net Carrying Amount 70 175 166 667

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant (Allocation of impairment loss)

Dr Cr

33 158 9 825

23 333

The total impairment loss allocated to the head office is $4 102 (i.e. $2 260 + $1 842). This is allocated across the assets of the head office:

Head Office Carrying Amount 10 000 35 000 45 000

Land Plant

Proportion

Allocation of Excess 912 3 190 4 102

10/45 35/45

Net Carrying Amount 9 088 31 810

The journal entry is: Impairment loss Land Accumulated depreciation and impairment losses – plant (Allocation of impairment loss)

Exercise 15.22

Dr Cr

4 102 912

3 190

IMPAIRMENT, TWO CASH-GENERATING UNITS

Determine how Miles Ltd should account for the results of the impairment tests at both 31 December 2016 and 31 December 2017. MILES LTD

Jericho $850 240 54 75 25 1 244 1 044 (200)

Plant Patent Inventory Receivables Goodwill Recoverable amount Impairment loss

Jackson 825 0 75 82 20 1 002 990 (12)

In relation to Jackson, write goodwill down by $12: Impairment loss Accumulated impairment losses - goodwill

Dr Cr

12 12 15.21

Solutions Manual to accompany Applying IFRS Standards 4e In relation to Jericho, reduce goodwill by $25 and allocate the remaining $175 impairment loss to applicable assets: Carrying Amount 850 240 1 090

Plant Patent

Proportion

Allocation of Excess 136 39 175

85/109 24/109

Net Carrying Amount 714 201

As the patent has a fair value less costs of disposal of $220, only $20 of the impairment loss can be allocated to it, so the plant must be reduced by a further $19, to $695. The journal entry to record the impairment loss at 31 December 2016 is: Impairment loss Goodwill Accumulated depreciation and impairment losses – plant Accumulated impairment losses – patent (Allocation of impairment loss)

Dr Cr

200 25

Cr Cr

155 20

At 31 December 2017, the plant and patent are recorded as follows: Plant Accumulated depreciation and impairment losses

$1 500

Patent Accumulated impairment losses

$240 20 220

1 155 345

[650 +155 +350]

At 31 December 2017: In relation to Jackson, there can be no reversal of the prior goodwill impairment. In relation to Jericho, the plant would have had the following carrying amount if the impairment loss had not occurred: Plant Accumulated depreciation and impairment losses

$1 500 950 550

[650 + 300]

Hence, the maximum reversal of impairment in relation to plant is $205 (ie $550 - $345). The maximum reversal for the patent is $20. As the recoverable amount for the unit’s assets exceed the carrying amount by $180, the whole of this amount can be allocated on a pro rata basis as a reversal of impairment losses:

Plant Patent

Carrying Amount

Proportion

Allocation of Excess

345 220 565

345/565 220/565

110 70 180

Net Carrying Amount 235 150

As the patent can only be reversed to the extent of $20, then $160 can be allocated to plant, this being less than the maximum of $205. The entry for the reversal of the impairment loss is:

15.22

Chapter 15: Impairment of assets Accumulated depreciation and impairment losses – plant Accumulated impairment losses – patent Income: reversal of impairment loss (Reversal of impairment loss)

Dr Dr Cr

160 20 180

Exercise 15.23 CORPORATE ASSETS Prepare a table of the assets and liabilities of Albury Ltd, using the headings ‘Division One’, ‘Division Two’ and ‘Corporate’, after the completion of accounting for impairment losses. ALBURY LTD

Assets: Division One Assets: Division Two Corporate Goodwill

$430 000 346 000 230 000 14 000 $1 020 000

Recoverable amount

$950 000

Impairment loss

$70 000

Goodwill written off

$14 000

Amount to be allocated

$56 000

Allocation: Carrying amount Division One: Plant $200 000 Land 80 000 Buildings 70 000 Furniture & fittings 25 000 Division Two: Plant 180 000 Land 50 000 Buildings 40 000 Furniture & fittings 20 000 Corporate: Building 150 000 Furniture & fittings 80 000 $895 000

Cash Inventory Receivables Plant Accumulated depreciation & impairment losses Land Buildings Accumulated depreciation and impairment losses Furniture & fittings

Allocation

Balance

12 514 5 006 4 380 1 564

187 486 74 994 65 620 23 436

11 263 3 128 2 503 1 251

168 737 46 872 37 497 18 749

9 385 5 006 $56 000

140 615 74 994 $839 000

Division One $5 000 30 000 20 000 320 000 (132 514)

Division Two $8 000 40 000 8 000 300 000 (131 263)

74 994 110 000 (44 380)

46 872 100 000 (62 503)

$200 000 (59 385)

40 000

30 000

100 000

Corporate -

15.23

Solutions Manual to accompany Applying IFRS Standards 4e Accumulated depreciation and impairment losses Total assets

(16 564)

(11 251)

(25 006)

406 536

327 855

215 609

Provisions Borrowings Total liabilities

20 000 30 000 50 000

40 000 66 000 106 000

$356 536

221 855

$215 609

Net assets

Exercise 15.24 CORPORATE ASSET Prepare the journal entries at 30 June 2016 to record the accounting for the impairment losses. FIERY LTD Green Unit: Impairment loss is $42 000, being $520 000 less $478 000. Write-off goodwill of $20 000 Allocation of $22 000 impairment loss: Land Plant Equipment

100 000 220 000 120 000 440 000

5 000 11 000 6 000 22 000

95 000 209 000 114 000 418 000

As land has fair value less costs of disposal of $97 000, the $2 000 extra impairment loss for the land must be allocated to the other two assets: Plant Equipment

209 000 114 000 323 000

1 294 706 2 000

207 706 113 294 321 000

Dragon Unit: Impairment loss is $10 000, being $430 000 less $420 000 Write-off $10 000 of goodwill

Corporate Asset: Green 520 000 42 000

Carrying amount Impairment loss

Dragon 430 000 10 000

Headquarters 100 000

Recoverable amount Impairment loss

Entity 1 050 000 52 000 998 000 973 000 $25 000

This impairment loss is then firstly used to reduce the goodwill in the Dragon Unit. The balance of $20 000 is then used to write-down the other assets of the entity: Green Unit:

Plant Equipment

Dragon Unit:

Land Plant Equipment

207 706 113 294 64 000 115 000 200 000 © John Wiley and Sons, Ltd, 2016

5 193 2 832

202 513 110 462

1 600 2 875 5 000

62 400 112 125 195 000 15.24

Chapter 15: Impairment of assets

Headquarters

100 000 $800 000

2 500 20 000

97 500 780 000

The journal entries to record the impairment are: Impairment loss Accumulated depreciation & impairment losses - headquarters

Impairment loss – Green unit Goodwill Land Accumulated depreciation & impairment losses – plant Accumulated depreciation & impairment losses – equipment

Dr Cr Cr

Impairment loss – Dragon unit Goodwill Land Accumulated depreciation & impairment losses – plant Accumulated depreciation & impairment losses – equipment

Dr Cr Cr

2 500

50 025 20 000 3 000

17 487

9 538

24 475 15 000 1 600

2 875

5 000

Exercise 15.25 REVERSAL OF IMPAIRMENT LOSSES Prepare the journal entries relating to impairment at 30 June 2016 and 2017. REACHER LTD Impairment loss is $28 000 i.e. $300 000 less $272 000. The goodwill of $8000 is written off. The remaining $20 000 impairment loss is allocated as follows:

Land Plant

Carrying Amount 50 000 200 000 250 000

Allocation 4 000 16 000 20 000

Net Amount 46 000 184 000 230 000

At 30 June 2016, the journal entries to record the impairment are: Impairment loss Land Goodwill Accumulated depreciation & impairment losses – plant

Dr Cr Cr

28 000

4 000 8 000 16 000

At 30 June 2017, in relation to the assets previously adjusted for impairment:

15.25

Solutions Manual to accompany Applying IFRS Standards 4e

Land Plant Accumulated depreciation & impairment losses

CA at 30/6/16 46 000 250 000

CA – if no impairment 50 000 250 000

(84 400)

(75 000)

The $13 000 reversal is allocated as follows: CA at 30/6/16 Land 46 000 Plant 165 600 211 600

Difference 4 000

9 400 13 400

Allocation 2 826 10 174 13 000

However, the plant can only be revalued upwards by $9 400. The balance of $774 is allocated to the land which increases its allocation to $3 600 which is still less than $4,000. The reversal is then accounted for as follows: Land Accumulated depreciation & impairment losses - plant Income – reversal of impairment loss

3 600

Dr Cr

9 400

13 000

15.26

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 15 Impairment of assets

CHAPTER 15 Impairment of assets

Learning Objectives 15.1 15.2 15.3 15.4 15.5 15.6 15.7

Understand the purpose of the impairment test for assets Understand when to undertake an impairment test Explain how to undertake an impairment test for an individual asset Identify a cash-generating unit, and account for an impairment loss for a cashgenerating unit — not including goodwill Account for the impairment of goodwill Account for reversals of impairment losses Apply the disclosure requirements of IAS 36.

15.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1.

Under IAS 36 Impairment of Assets, the following assets are subject to impairment testing:

Inventory Assets arising from construction contracts Assets arising from employee benefits Property, plant and equipment

I Yes Yes No No

II III IV Yes No No Yes No No Yes No Yes Yes Yes No

Learning Objective 15.1 Understand the purpose of the impairment test for assets a. I; b. II; *c. III; d. IV.

If an entity does not expect to recover the carrying amount of an asset, the entity has incurred: Learning Objective 15.1 Understand the purpose of the impairment test for assets: *a. an impairment loss; b. a depreciation expense; c. an amortisation cost; d. a loss on disposal.

Which of the following assets need to be tested for impairment every year? I II III IV

intangible assets with indefinite useful lives intangible assets not yet available for use intangible assets accounted for under the revaluation method goodwill acquired in a business combination

Learning Objective 15.2 Understand when to undertake an impairment test a. I, II and III only; b. II, III and IV only; *c. I, II and IV only; d. I, III and IV only.

When goodwill is acquired under a business combination it is subject to an impairment test every: Learning Objective 15.2 Understand when to undertake an impairment test *a. year; b. two years; c. three years; d. five years.

15.2

Chapter 15 Impairment of assets

The impairment test must be applied to tangible assets: Learning Objective 15.2 Understand when to undertake an impairment test: a. at each balance date; b. every three years; c. at each reporting date including interim reporting dates such as half-year; *d. only if there is an indication that the asset may be impaired.

An impairment loss occurs when: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset a. the recoverable amount of an asset exceeds the carrying amount; *b. the carrying amount of an asset exceeds the recoverable amount; c. the asset has a zero residual value; d. the recoverable amount of an asset exceeds its initial cost.

According to IAS 36 Impairment of Assets, the recoverable amount test requires an entity to compare the fair value an asset less costs to sell, with: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset a. the amount obtainable from the sale of the asset; b. the costs directly attributable to the liquidation of the asset; c. its disposal value; *d. its value in use.

Nguyen Limited estimated that it would receive future cash flows from the use of equipment: • End of Year 1 £10 000 • End of Year 2 £50 000 • End of Year 3 £20 000 The discount rate was determined as 8%. The ‘value in use’ of the equipment is: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset a. £80 000; b. £73 600; *c. £68 000; d. £63 500.

15.3

Test Bank to accompany Applying IFRS Standards 4e

Candy Limited expected future cash flows from the use of Equipment as follows: • End of Year 1 £4000; • End of Year 2 £5000; • End of Year 3 £2000. The discount rate was determined as 5%. The value in use of the equipment is: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset *a. £10 073; b. £10 576; c. £11 000; d. £11 550.

10.

Where an asset is measured using the cost model, any impairment loss is: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset a. accumulated in a separate ‘accumulated impairment losses’ account; b. set off against the balance of revenue; c. taken directly to equity; *d. added to the balance of the accumulated depreciation account.

11.

An appropriate journal entry to recognise an impairment loss under the cost model is: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset a. DR Accumulated impairment losses CR Impairment loss b.

Accumulated impairment losses CR Asset revaluation (Equity)

*c.

Impairment loss CR Accumulated depreciation and impairment losses

Revenue CR

Impairment loss

15.4

Chapter 15 Impairment of assets

12.

Under IAS 36 Impairment of Assets, impairment of an asset, and the accounting treatment using the cost model, are as follows: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset Impairment Carrying amount of an asset is less than its recoverable amount

Accounting treatment Asset is written up to its recoverable amount

Carrying amount of an asset is less than its recoverable amount

No change to the asset value

*c.

Carrying amount of an asset is greater than its recoverable amount

Asset is written down to its recoverable amount

Carrying amount of an asset is greater than its recoverable amount

No change to the asset value

13.

When an asset is measured using the revaluation model, any impairment loss is treated as: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset *a. a revaluation decrement; b. a revaluation increment; c. a set-off against depreciation expense; d. an addition to depreciation expense.

14.

When evaluating whether an asset has been impaired, the carrying amount of the asset must be compared to recoverable amount. Recoverable amount is the higher of: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset: a. initial cost: and, fair value; *b. fair value less costs to sell: and, value in use; c. original cost: and, net present value; d. value in use: and, original cost.

15.

Value in use is: Learning Objective 15.3 Explain how to undertake an impairment test for an individual asset a. amount obtainable from disposal of an asset excluding any selling costs; b. initial cost of an asset less any expected disposal costs; c. incremental costs directly attributable to disposal of an asset; *d. the present value of future cash flows expected to be derived from an asset.

15.5

Test Bank to accompany Applying IFRS Standards 4e

16.

Constructor Limited estimated an impairment loss of €500 against its single cashgenerating unit. The company had the following assets: • Headquarters Building €1000; • Construction Plant €600; • Equipment €400. The net carrying amount of the Equipment after allocation of the impairment loss is: Learning Objective 15.4 Identify a cash-generating unit, and account for an impairment loss for a cash-generating unit — not including goodwill a. €200; b. €400; *c. €300; d. €0.

17.

In allocating an impairment loss, an entity shall not reduce the carrying amount of an asset below the highest of: Learning Objective 15.5 Account for the impairment of goodwill *a. value in use and zero; b. present value and value in use; c. cost and market value; d. initial cost and fair value.

18.

Hayfield Limited recognised an impairment loss of $200 against a cash-generating unit containing the following assets: • Buildings $500; • Roads $300; • Equipment $600. The net carrying amount of the Roads after allocation of the impairment loss is: Learning Objective 15.4 Identify a cash-generating unit, and account for an impairment loss for a cash-generating unit — not including goodwill a. $100; b. $235; *c. $257; d. $300.

19.

At reporting date Guilder Limited estimated an impairment loss of €50 000 against its single cash-generating unit. The company had the following assets: • Headquarters Building €100 000; • Plant €60 000; • Equipment €40 000. The net carrying amount of Plant after allocation of the impairment loss is: Learning Objective 15.4 Identify a cash-generating unit, and account for an impairment loss for a cash-generating unit — not including goodwill a. €60 000; *b. €45 000; c. €35 000; d. €10 000.

15.6

Chapter 15 Impairment of assets

20.

Jam Pty Ltd has two cash generating units. CGU A had a carrying amount of €700 and value in use of €750. CGU B has a carrying amount of €900 and a value in use of €800. The carrying amount of the head office assets is €400. CGUs A and B utilise the head office services equally. The impairment loss for CGU A is: Learning Objective 15.4 Identify a cash-generating unit, and account for an impairment loss for a cash-generating unit — not including goodwill a. €0; b. €50; *c. €150; d. €350.

21.

At reporting date, the carrying amount of a cash-generating unit was considered to be have been impaired by $800. The unit included the following assets: • Land $4000; • Plant $3000; • Goodwill $1000. The carrying amount of Goodwill after the impairment loss is allocated is: Learning Objective 15.5 Account for the impairment of goodwill a. $0; *b. $200; c. $900; d. $1000.

22.

At reporting date, the carrying amount of a cash-generating unit was considered to be have been impaired by $900. The unit included the following assets: • Land $4000; • Plant $3000; • Goodwill $500. The amount of impairment allocated to land is: Learning Objective 15.5 Account for the impairment of goodwill a. $200; *b. $229; c. $300; d. $514.

23.

Under IAS 36 Impairment of Assets, the impairment testing of goodwill occurs at the: Learning Objective 15.5 Account for the impairment of goodwill a. level of the entity itself; b. combined segments level; c. operating division level; *d. lowest level at which goodwill is allocated to cash-generating units.

15.7

Test Bank to accompany Applying IFRS Standards 4e

24.

The carrying amount of a cash-generating unit was considered to be impaired. The impairment loss was €600. The cash-generating unit included the following assets: • Goodwill €1000; • Buildings €2000; • Plant and Equipment €1500. The carrying amount of Goodwill after allocation of the impairment loss is: Learning Objective 15.5 Account for the impairment of goodwill a. €0; b. €867; c. €600; *d. €400.

25.

The impairment test for goodwill must be conducted: Learning Objective 15.5 Account for the impairment of goodwill a. annually, at balance date; b. once every three years at balance date; c. only if it is reasonable to expect that goodwill has been impaired; *d. annually, at the same time every year.

26.

When assessing the recoverable of assets that have previously been subject to an impairment loss, which of the following indicators assist in providing external evidence that an impairment loss has reversed: Learning Objective 15.6 Account for reversals of impairment losses a. the asset’s market value has decreased significantly during the period; b. significant changes with an adverse effect on the entity have taken place; *c. market interest rates have decreased during the period; d. internal reporting sources indicate that the economic performance of the asset will not be as good as expected.

27.

During 2016 Sacco Limited, estimated that the carrying amount of goodwill was impaired and wrote it down by €50 000. In 2017, the company reassessed goodwill was decided that the old acquired goodwill still existed. The appropriate accounting treatment in 2017 is: Learning Objective 15.6 Account for reversals of impairment losses a. reverse the previous goodwill impairment loss; b. recognise the revalued amount of goodwill by an adjustment against the asset revaluation surplus account; *c. ignore the reversal as it is prohibited by IAS 36 Impairment of Assets; d. increase goodwill by an adjustment to retained earnings.

15.8

Chapter 15 Impairment of assets

28.

Which of the following is NOT correct in relation to the reversal of an impairment loss of an individual asset? Learning Objective 15.6 Account for reversals of impairment losses a. When reversing an impairment loss the carrying amount cannot be increased to an amount in excess of the carrying amount that would have been determined had no impairment loss been recognised; b. For a depreciable asset there needs to be a calculation of carrying amount using the depreciation variables applied before the impairment loss to determine what the carrying amount would have been if there had been no impairment loss; c. If the individual asset is recorded under the cost model, then the increase in the carrying amount is recognised immediately in profit or loss; *d. Where the recoverable amount is less than the carrying amount of an individual asset, the reversal of a previous impairment loss requires adjusting the carrying amount of the asset to recoverable amount.

29.

In relation to the impairment of assets, IAS 36 Impairment of Assets, requires the following disclosures for each class of assets: I The line of the statement of profit or loss and other comprehensive income in which impairment losses are included. II The amount of reversals of impairment losses during the period. III The amount of impairment losses recognised directly in other comprehensive income. IV The beginning and ending balances of any ‘provision for impairment’ account. Learning Objective 15.7 Apply the disclosure requirements of IAS 36 *a. I, II, III and IV; b. I, II and III only; c. II and IV only; d. IV only.

30.

Which of the following is required to be disclosed for each class of assets? I the amount of impairment losses recognised in profit or loss during the period II the amount of reversals of impairment losses recognised in profit or loss during the period III the amount of impairment losses on revalued assets recognised directly in equity during the period; and IV the amount of reversals of impairment losses on revalued assets recognised directly in other comprehensive income during the period. Learning Objective 15.7 Apply the disclosure requirements of IAS 36 a. III and IV only; *b. I, II, III and IV; c. I, II and III only; d. I and II only.

15.9

Exercises Exercise 15.14 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

DETERMINATION OF CGUS

The Rennes City Council contracts out the bus routes in Rennes to various subcontractors based on a tender arrangement. Some routes, such as the Express to City routes, are profitable, while others, such as those collecting schoolchildren from remote areas, are unprofitable. As a result, the city council requires tenderers to take a package of routes, some profitable, some less so. The Le Bon Bus Company has won the contract to operate its buses with a package of five separate routes, one of which operates at a significant loss. Specific buses are allocated by the Le Bon Bus Company to each route, and cash flows can be isolated to each route because drivers and takings are specific to each route. Required

Discuss the determination of cash-generating units for Le Bon Bus Company. Exercise 15.15 ★

IMPAIRMENT LOSS, GOODWILL

On 1 January 2015, Narrabri Ltd acquired all the assets and liabilities of Oakey Ltd. Oakey Ltd has a number of operating divisions, including one whose major industry is the manufacture of toy trains, particularly those of historical signiﬁcance. The toy trains division is regarded as a cash-generating unit. In paying $2 million for the net assets of Oakey Ltd, Narrabri Ltd calculated that it had acquired goodwill of $240 000. The goodwill was allocated to each of the divisions, and the assets and liabilities acquired measured at fair value at acquisition date. At 31 December 2017, the carrying amounts of the assets of the toy train division were: Factory Inventory Brand — ‘Froggy’ Goodwill

$250 000 150 000 50 000 50 000

There is a declining interest in toy trains because of the aggressive marketing of computer-based toys, so the management of Narrabri Ltd measured the recoverable amount of the toy train division at 31 December 2017, determining it to be $423 000. Required

Prepare the journal entries to account for the impairment loss at 31 December 2017.

Exercise 15.16 ★

IMPAIRMENT LOSS, GOODWILL, PARTLY OWNED SUBSIDIARY

Winton Ltd acquired 60% of the issued shares of Wodonga Ltd on 1 January 2016 for $426 000. At this date, the net fair value of the identiﬁable assets and liabilities of Wodonga Ltd was $660 000. At 31 December 2016, the tangible assets and liabilities of Wodonga Ltd as included in the consolidated ﬁnancial statements of Winton Ltd were as follows: Property, plant and equipment Accumulated depreciation Inventory Cash Liabilities

$ 863 000 (120 000) 743 000 55 000 22 000 820 000 (50 000) $ 770 000

Goodwill had not been written down over the year. In conducting an impairment test on Wodonga Ltd as a cash-generating unit, Winton Ltd assessed the recoverable amount of Wodonga Ltd to be $800 000. Required

1. Explain how the impairment loss in relation to Wodonga Ltd should be allocated. Prepare journal entry(ies) in relation to the assets of Wodonga Ltd at 31 December 2016 as a result of the impairment test. 2. Explain the accounting for the impairment (if any) if the recoverable amount was $860 000.

CHAPTER 15 Impairment of assets

Exercise 15.17

EFRAG RESPONSE TO PROPOSED AMENDMENTS

★★ Read the following comments made by the European Financial Reporting Advisory Group (EFRAG) in its

response, dated 4 April 2003 (pp. 4–5), to the IASB on the proposed amendments to IAS 36: Impairment test

The proposed impairment test does not distinguish between acquired goodwill and pre-existing goodwill of the acquirer nor between acquired goodwill and goodwill internally generated after the combination. This results in ‘cushions’, so avoiding recognition of real impairment losses of goodwill in certain situations when the impairment test is performed. We believe that this undermines the reliability of the information obtained. The Board claims that there seems to be no alternative design for the impairment test to avoid this. This may be true for the replacement of acquired goodwill by self-generated goodwill of the acquired business but we believe a stronger effort should be made to eliminate the cushion provided by the pre-acquisition self-generated goodwill of the acquirer. The current UK accounting standard FRS 11 Impairment of Fixed Assets and Goodwill attempts to make such a distinction. We urge the Board to delete the second step of the impairment test (paragraph 86). We believe that the second step, which measures the amount of goodwill impairment by comparing its carrying amount with its implied value, is costly and does not improve the quality of the information. In our view it suffices to allocate the identified impairment firstly to goodwill and then to intangible assets with indefinite useful lives that are part of the cash-generating unit and any remainder to other assets on a pro rata basis.

Required

Evaluate the comments made by EFRAG.

Exercise 15.18

DELOITTE TOUCHE TOHMATSU RESPONSE

★★ Read the following comments made by Deloitte Touche Tohmatsu (4 April 2003, p. 7) on the proposed

amendments to IAS 36:

We agree with the conclusion that goodwill acquired in a business combination should be recognised as an asset. With regard to the accounting for goodwill after initial recognition, we generally agree with the Board’s proposal. However, we note that there may be circumstances where goodwill has a finite life. For example, this may be the case when an entity has a specified life. In certain jurisdictions such as the People’s Republic of China (the PRC), foreign investment is made by means of certain legal structures that expire after a specified number of years. At the end of the agreed period, the assets will revert to the PRC partner. In such circumstances, any goodwill will have an implied value of zero at the end of the entity’s life. Consequently, we believe that, in accounting for goodwill after initial recognition, there should be a rebuttable presumption that goodwill has an indefinite life and, therefore, accounted for at cost less any accumulated impairment losses. However, in those cases where that presumption is rebutted and sufficient persuasive evidence exists indicating that goodwill has a finite life, we believe that a method of systematic amortisation is preferable to ‘impairment only’ accounting. In such cases, we believe that goodwill, consistently with other intangible assets that have a finite life, should be amortised and tested for impairment when an indicator exists. The impairment test applied to goodwill with a definite life should be the same test as goodwill with an indefinite life.

Required

Evaluate the comments made by Deloitte Touche Tohmatsu.

Exercise 15.19

IDENTIFICATION OF CGUS

★★ Fad Furniture Ltd has three separate operating divisions. The ﬁrst, the timber division, is in charge of producing milled timber. This division manages a number of timber plantations and timber mills from which the ﬁnished timber is produced. The majority of the timber is sold, at an internal transfer price, to the second area of operations in Fad Furniture, the parts division. Any excess timber is sold to external parties. The parts division is responsible for turning the timber into parts for the making of timber furniture, both indoor and outdoor. These parts are suitable only for the manufacture of the furniture produced by Fad Furniture. The parts are then transferred at internal transfer prices to the third area of operations, the furniture division. This division assembles the furniture and delivers it to the various outlets that retail Fad Furniture’s products. Required

PART 2 Elements

Exercise 15.20 ★★

IMPAIRMENT LOSS FOR A CASH-GENERATING UNIT, REVERSAL OF IMPAIRMENT LOSS

One of the cash-generating units of Broome Ltd is associated with the manufacture of wine barrels. At 30 June 2016, Broome Ltd believed, based on an analysis of economic indicators, that the assets of the unit were impaired. The carrying amounts of the assets and liabilities of the unit at 30 June 2016 were: Buildings Accumulated depreciation — buildings* Factory machinery Accumulated depreciation — machinery** Goodwill Inventory Receivables Allowance for doubtful debts Cash Accounts payable Loans

$ 420 000 (180 000) 220 000 (40 000) 15 000 80 000 $40 000 (5 000) 20 000 30 000 20 000

* Depreciated at $60 000 p.a. ** Depreciated at $45 000 p.a.

Broome Ltd determined the value in use of the unit to be $535 000. The receivables were considered to be collectable, except those considered doubtful. The company allocated the impairment loss in accordance with IAS 36. During the 2016–17 period, Broome Ltd increased the depreciation charge on buildings to $65 000 p.a., and to $50 000 p.a. for factory machinery. The inventory on hand at 1 July 2016 was sold by the end of the year. At 30 June 2017, Broome Ltd, because of a return in the market to the use of traditional barrels for wines and an increase in wine production, assessed the recoverable amount of the cash-generating unit to be $30 000 greater than the carrying amount of the unit. As a result, Broome Ltd recognised a reversal of the impairment loss. Required

1. Prepare the journal entries for Broome Ltd at 30 June 2016 and 2017. 2. What differences would arise in relation to the answer in requirement 1 if the recoverable amount at 30 June 2017 was $20 000 greater than the carrying amount of the unit? 3. If the recoverable amount of the buildings at 30 June 2017 was $175 000, how would this change the answer to requirement 2?

Exercise 15.21

ALLOCATION OF CORPORATE ASSETS

★★ Hay Ltd has three cash-generating units, Hebel Division, Hawker Division and Hillston Division. The head ofﬁce is in the city, and the infrastructure for the divisions is located outside the city centre. Because of the potential for the company to have problems of an environmental nature or in relation to social justice, particularly with its mix of employees, Hay Ltd has recently established a social responsibility centre (SRC), which interacts with the divisions, generating information and statistics for the production of a triple-bottom-line social responsibility report. At 30 June 2017, the net assets relating to each of the divisions as well as the headquarters section and the SRC were as follows:

Land Plant and equipment Accumulated depreciation Inventories Accounts receivable Liabilities Net assets

Hebel Division

Hawker Division

Hillston Division

Head office

SRC

$ 120 000 420 000 (120 000) 150 000 90 000 660 000 60 000 $ 600 000

$ 140 000 310 000 (100 000) 110 000 80 000 540 000 50 000 $ 490 000

$ 80 000 270 000 (80 000) 100 000 50 000 420 000 50 000 $ 370 000

$ 10 000 40 000 (5 000) 0 0 45 000 0 $ 45 000

$ 5 000 15 000 (4 000) 0 0 16 000 0 $ 16 000

CHAPTER 15 Impairment of assets

Hay Ltd believes that the corporation’s headquarters supplies approximately equal service to the three divisions, and an immaterial amount to the SRC. Because the SRC has been established only recently, it is not possible at this stage to allocate the assets of the SRC to the three divisions. Economic indicators suggest that the company’s assets may have been impaired, so management has determined the value in use of each of the divisions — the head ofﬁce and the SRC do not generate cash inﬂows. The recoverable amount of the three divisions were calculated to be: Hebel Division Hawker Division Hillston Division

$720 000 500 000 400 000

Required

Determine how Hay Ltd should account for any impairment loss to the entity.

Exercise 15.22 ★★

IMPAIRMENT, TWO CASH-GENERATING UNITS

Miles Ltd has two divisions, Jericho and Jackson. Each of these is regarded as a separate cash-generating unit. At 31 December 2016, the carrying amounts of the assets of the two divisions were:

Plant Accumulated depreciation Patent Inventory Receivables Goodwill

Jericho

Jackson

$ 1 500 (650) 240 54 75 25

$1 200 (375) 75 82 20

The receivables were regarded as collectable, and the inventory’s fair value less costs of disposal was equal to its carrying amount. The patent had a fair value less costs of disposal of $220. The plant at Jericho was depreciated at $300 p.a., and that at Jackson was depreciated at $250 p.a. Miles Ltd undertook impairment testing at 31 December 2016, and determined the recoverable amounts of the two divisions to be: Jericho Jackson

$1 044 990

As a result, management increased the depreciation of the Jericho plant from $300 to $350 p.a. for the year 2016. By 31 December 2017, the performance in both divisions had improved, and the carrying amounts of the assets of both divisions and their recoverable amounts were as follows:

Carrying amount Recoverable amount

Jericho

Jackson

$ 1 322 1 502

$1 433 1 520

Required

Determine how Miles Ltd should account for the results of the impairment tests at both 31 December 2016 and 31 December 2017.

Exercise 15.23 ★★

CORPORATE ASSETS

Albury Ltd recently conducted an impairment test on the company. It determined that it had two cashgenerating units, Division One and Division Two. Both divisions were considered to be impaired, with Division One having an impairment loss of $25 000 and Division Two having an impairment loss of $30 000. These losses were allocated to the assets of the divisions in accordance with IAS 36 Impairment of Assets, with the assets and liabilities of the divisions after the allocation being recorded as follows:

PART 2 Elements

Cash Inventory Receivables Plant Accumulated depreciation Land Buildings Accumulated depreciation Furniture & fittings Accumulated depreciation Total assets Provisions Borrowings Total liabilities Net assets

Division One

Division Two

5 000 30 000 20 000 320 000 (120 000) 80 000 110 000 (40 000) 40 000 (15 000) 430 000 20 000 30 000 50 000 $ 380 000

8 000 40 000 8 000 300 000 (120 000) 50 000 100 000 (60 000) 30 000 (10 000) 346 000 40 000 66 000 106 000 $ 240 000

Albury Ltd also recorded goodwill of $14 000 (net of accumulated impairment losses of $12 000) and had corporate assets consisting of a head ofﬁce building carried at $150 000 (net of depreciation of $50 000) and furniture and ﬁttings of $80 000 (net of depreciation of $20 000). Albury Ltd determined that the recoverable amount of the entity’s assets was $950 000. The management of Albury Ltd then completed the accounting for impairment losses. The receivables in both divisions were considered to be collectable. Required

Prepare a table of the assets and liabilities of Albury Ltd, using the headings ‘Division One’, ‘Division Two’ and ‘Corporate’, after the completion of accounting for impairment losses.

Exercise 15.24 ★★

CORPORATE ASSET

Fiery Ltd is a company that is operated through two divisions, namely Green Ltd and Dragon Ltd. These divisions were regarded as separate cash-generating units. The assets of the two divisions at 30 June 2016 were as follows:

Land Plant Accumulated depreciation Equipment Accumulated depreciation Inventory Goodwill

Green Ltd

Dragon Ltd

$100 000 280 000 (60 000) 160 000 (40 000) 60 000 20 000 $520 000

$ 64 000 145 000 (30 000) 220 000 (20 000) 36 000 15 000 $430 000

Fiery Ltd had a corporate headquarters carried at an amount of $100 000. This asset could not be allocated on a reasonable basis to the cash-generating units. At 30 June 2016 there were indications that the assets of the company may be impaired. The company calculated the recoverable amounts to be as follows: Fiery Ltd Green Ltd Dragon Ltd

$973 000 $478 000 $420 000

The inventory had fair values less costs of disposal greater than the current carrying amounts. The land held by Green Ltd had fair value less costs of disposal of $97 000. Required

Prepare the journal entries at 30 June 2016 to record the accounting for the impairment losses. CHAPTER 15 Impairment of assets

Exercise 15.25

REVERSAL OF IMPAIRMENT LOSSES

★★ At 30 June 2016, Reacher Ltd reported the following assets: Land Plant Accumulated depreciation Goodwill Inventory Cash

$ 50 000 250 000 (50 000) 8 000 40 000 2 000

All assets are measured using the cost model. At 30 June 2016, the recoverable amount of the entity, considered to be a single cash-generating unit, was $272 000. For the period ending 30 June 2017, the depreciation charge on plant was $18 400. If the plant had not been impaired the charge would have been $25 000. At 30 June 2017, the recoverable amount of the entity was calculated to be $13 000 greaterâ¯than the carrying amount of the assets of the entity. As a result, Reacher Ltd recognised a reversal of the previous year’s impairment loss. Required

Prepare the journal entries relating to impairment at 30 June 2016 and 2017.

PART 2 Elements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Janice Loftus

John Wiley & Sons, Ltd, 2016

Chapter 16: Financial statement presentation

Chapter 16 – Financial statement presentation Discussion questions 1.

Describe the eight general principles to be applied in the presentation of financial statements. Which principles are more subjective? Explain your answer.

The eight general principles are: 1. Fair presentation and compliance with IFRSs – that financial statements should be faithfully represent the transactions, events and conditions of the entity in accordance with the definitions and recognition criteria specified in the Conceptual Framework, and that compliance with IFRSs is presumed to result in fair presentation (IAS 1 para. 15). 2. Going concern – that financial statements should be prepared on a going concern basis, unless management intends to liquidate or cease trading, or has no realistic alternative but to do so (IAS 1 para. 25). 3. Accrual basis of accounting – applied to financial statements other than the statement of cash flows, which is prepared on a cash basis. 4. Materiality and aggregation – that each material class of similar items should be presented separately in the financial statements, with material items being defined as those items for which omission or misstatement could individually or collectively influence the economic decisions of users (IAS 1 para. 29). Further, an entity should not obscure material items by aggregating them with immaterial items (IAS para. 30A). 5. Offsetting – of assets and liabilities, and income and expenses, shall not be offset unless required or permitted by an IFRS, but income and expenses are presented on a net basis, when this presentation reflects the substances of the transactions or events (IAS 1 para. 32). 6. Frequency of reporting – that financial statements should be presented at least annually, with paragraph 36 requiring additional disclosure where the length of the reporting period is affected by a change of the end of the reporting period. 7. Comparative information – must be presented for all financial statement items unless an IFRS permits otherwise (IAS 1 para. 38). 8. Consistency of presentation – that the presentation and classification of financial statements items should be consistent from one period to the next, unless changes are required by Accounting Standards or in the interests of more reliable and relevant presentation of financial information as may arise when there is a significant change in the nature of the entity’s operations (IAS para. 45). Most of these principles have some degree of subjectivity. IFRS are principles-based standards and their application often requires the exercise of professional judgement. For instance there is subjectivity in assessing whether transactions, events and conditions are represented faithfully because there are numerous ways in which they can be represented. See, for example, the alternative ways that certain financial instruments could be measured (refer chapter 7). The going concern assumption involves a subjective assessment of whether the entity is a going concern. Materiality is defined subjectively, based on judgements about whether it the omission or misstatement would influence users’ decisions, rather than objectively, such as a quantified test.

16.2

Solutions Manual to accompany Applying IFRS Standards 4e

Why is it important for entities to disclose the measurement bases used in preparing the financial statements?

It is important for entities to disclose the measurement bases used in preparing the financial statements because Accounting Standards permit alternatives – such as cost or fair value for PP&E. Therefore users need to know which alternatives the entity has chosen so as to understand how items are measured and for purposes of comparison with the financial statements of other entities.

3. How do the presentation and disclosure requirements of IFRS Standards reflect the objectives of financial statements? Illustrate your argument with examples from IAS 1, IAS 8 and IAS 10.

This question requires students to synthesise knowledge from the Conceptual Framework (covered in chapter 1 of the book) with material introduced in chapter 16. As stated in paragraph OB2 of the Conceptual Framework the objective of financial statements is to provide financial information about the reporting entity that is useful to current and prospective investors and creditors in making decisions about providing resources to the entity. IAS 1 requires financial statements to present fairly the financial position, financial performance and cash flows of the entity because this type of information is considered useful to decision making. Paragraph 97 of IAS 1 requires separate disclosure of the nature and amount of material items of income and expense. Material items are defined as those items for which omission or misstatement could individually or collectively influence the economic decisions of users. The requirement to present items of income and expense that could influence users’ decisions is consistent with the decisionusefulness objective of financial statements. The requirements in IAS 10 to make adjustments or disclosures in relation to events occurring after the reporting period provide more timely and comprehensive information to users of financial statements. This is consistent with the decision-useful objective of financial statements because the timeliness and comprehensiveness of information enhances its usefulness for decision making. IAS 8 requires the restatement of comparative information when there has been a change of accounting policies. This enhances the comparability of an entity’s financial statements over time, facilitating the identification of trends and the use of past accounting numbers in the prediction of future earnings and cash flows. This is of particular importance to the use of financial statements for making decisions about whether to provide resources to an entity, thus reflecting the objective of financial statements.

What is the purpose of a statement of financial position? What comprises a complete set of financial statements in accordance with IAS 1?

Refer sections 16.1 and 16.3.1. The purpose of a statement of financial position is to provide information about an entity’s financial position, by summarising the entity’s assets, liabilities and equity. It thus provides the basic information for evaluating an entity’s capital structure and analysing its liquidity, solvency and financial flexibility and also provides a basis for computing rates of return and measures of solvency and liquidity. The statement of financial position should be used in conjunction with other financial statements to obtain a more comprehensive understanding of the liquidity, solvency and financial flexibility. A complete set of financial statements comprises: © John Wiley and Sons, Ltd, 2016

16.3

Chapter 16: Financial statement presentation • • • • • •

a statement of financial position a statement of profit or loss and other comprehensive income for the period a statement of changes in equity a statement of cash flows notes, comprising significant accounting policies and other explanatory information comparative information

What are the major limitations of a statement of financial position as a source of information for users of general purpose financial statements?

Refer section 16.3. The major limitations of a statement of financial position as a source of information about an entity’s financial position are: (a) The optional measurement of certain assets, such as property, plant and equipment at historical cost or depreciated historical cost (where the asset has a limited useful life) rather than a current value. Hence there may be a lack of comparability between the statement of financial position of one entity with the statement of financial position of another. Further, the use of cost/depreciated cost as the basis of measurement leads to the statement of financial position not giving a view of a current value of recognised assets. (b) The mandatory omission of intangible self-generated assets (such as brand names and mastheads and goodwill) from the statement of financial position as required by IAS 38 Intangible Assets. (c) The omission of various rights and obligations (such as non-cancelable operating leases) from the statement of financial position. This is particularly important as their omission results in off-balance sheet liabilities and assets that distort the reported leverage of the entity. As a consequence of these limitations, the statement of financial position of an entity does not purport to present a total picture of the real worth of the entity, nor does it purport to report all assets controlled by the entity and all the obligations of the entity.

6. Under what circumstances are assets and liabilities ordinarily classified broadly in order of liquidity rather than on a current/non-current classification? Refer section 16.3.1. The presentation of the statement of financial position based on liquidity, rather than on a current/non-current basis is adopted when a presentation based on liquidity is considered to provide more relevant and reliable information. This situation is largely confined to entities such as financial institutions which do not have a clearly identifiable operating cycle, as does a manufacturer or a retailer.

Can an asset that is not realisable within 12 months ever be classified as a current asset? If so, under what circumstances?

Refer section 16.3.1. One of the criteria for classifying an asset as current under IAS 1 is that it is expected to be realised, or is intended for sale or consumption, in the entity’s normal operating cycle. Thus, if an entity’s operating cycle is longer than 12 months it is possible for an asset that is not realisable within 12 months to be classified as a current asset. Examples of operating cycles that may extend beyond 12 months include property development, construction, wine and cheese making.

16.4

Solutions Manual to accompany Applying IFRS Standards 4e

Explain the difference between classification of expenses by nature and by function.

Refer section 16.4.3. Classification of expenses by nature is according to their type of expense (such as, materials used, transport costs, employee benefits, depreciation, electricity, advertising costs, finance costs). Classification by function is according to the activity involved (such as, cost of sales, selling and distribution costs, administration, and finance costs). 9.

Does the separate identification of profit and other components of comprehensive income provide a meaningful distinction between the effects of different types of non-owner transactions and events?

The distinction between profit and other components of comprehensive income is a function of the treatment of recognised gains and losses prescribed by accounting standards. The distinction becomes blurred when similar items, such as an asset revaluation under IAS 16, are included in profit (if a loss on revaluation) and other components of comprehensive income (if a gain on revaluation).

10.

What is the objective of a statement of changes in equity?

Refer section 16.5. The main purpose of a statement of changes in equity is to report transactions with equity holders, such as new share issues and the payment of dividends, and any retrospective adjustments to the opening balances of components of equity.

11.

Why is a summary of accounting policies important to ensuring the understandability of financial statements to users of general purpose financial statements?

Refer sections 16.6 and 16.6.2. A summary of accounting policies is important to ensuring the understandability of financial statements to general users of financial statements for the following reasons: • Various options exist in certain IFRSs (such as the option to revalue property, plant and equipment as an alternative to using historical costs) and therefore it is essential that the summary of accounting policies identify which options have been adopted (where relevant). • Under IFRSs various assets of an entity (such as internally generally brand names and selfgenerated goodwill) and rights and obligations (such as non-cancelable operating leases) are not recognised in an entity’s statement of financial position. The summary of accounting policies helps ensure users of financial statements are aware of these omissions.

12. Provide an example of a judgement made in preparing the financial statements that can lead to estimation uncertainty at the end of the reporting period. Describe the disclosures that would be required in the notes.

Refer section 16.6.2. Some of the more important judgements that can lead to uncertainty required in the preparation of financial statements concern: • • •

Useful life of plant and equipment for depreciation purposes; Residual value of plant and equipment; Useful life of intangible assets, including whether the assets have an indefinite life or a finite life; © John Wiley and Sons, Ltd, 2016

16.5

Chapter 16: Financial statement presentation • • • • • •

Assessment as to whether there is any indication that an asset is impaired and, if so, the measurement of the recoverable amount of the asset, including estimating future cash flows and the appropriate discount rate for value in use measures; Estimation of the fair value of assets and liabilities acquired in a business combination; Estimation of the fair value of equity instruments forming share-based payments in transactions with employees; Estimation of provisions such as provisions for long service leave and provisions for restructuring; Estimation of the net realisable value of inventory.

Paragraph 125 of IAS 1 requires that the notes disclose information about the assumptions made concerning the future and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year (for example, assumptions used in performing significant asset impairment tests). The entity should disclose the nature and carrying amount of the assets and liabilities concerned.

13. What disclosures are required in the notes in regard to accounting policy judgements? Refer section 16.6 and 16.6.1. An entity is required by paragraph 122 of IAS 1 to disclose judgements that management has made in the process of applying accounting policies that have the most significant effect on the amounts recognised in the financial statements, e.g.: • • • • • •

14.

Assessment of the business model employed for managing financial assets (refer IFRS 9); Whether a lease is a finance or operating lease (refer IAS 17); Whether certain transactions are sales of goods or are in substance financing arrangements; Whether an active market exists for certain intangible assets to support the adoption of the fair value basis of measurement (refer IAS 38); Determining the functional currency of net investments in foreign operations, as required by IAS 21; Whether the actions of management and the Board in relation to a restructuring have been such as to constitute a constructive obligation and therefore justify the recognition of a provision for the costs of the restructuring (refer IAS 37).

What is the difference between an accounting policy and an accounting estimate? Provide an example of each.

An accounting policy is a principle or conventions applied in preparing financial statements, typically in recognising and measuring the financial effects of transactions and events. For example, recognising assets at the lower of cost and recoverable amount is an accounting policy. An accounting estimate is an estimation used in the application of accounting policies. For example, the measurement of the value-in-use of an asset requires estimation of the future cash flows to be derived from using the asset. The estimation of the depreciable amount of an asset requires an estimation of the residual value of the asset at the end of its useful life.

15.

Explain the difference between retrospective application of a change in accounting policy and prospective application of a change in accounting estimate. Why do you think the standard setters require prospective application of a change in accounting estimate?

16.6

Solutions Manual to accompany Applying IFRS Standards 4e

If an IFRS requires an entity to change an accounting policy the entity must account for that change as set out in the specific transitional provisions of the relevant accounting standard requiring the change. If the accounting standard does not specify how to account for the change, then the change must be applied retrospectively. Retrospective application is also required for voluntary changes in accounting policy. Retrospective application means applying a new accounting policy as if that policy had always been applied. When an entity applies the change retrospectively the entity must adjust the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period must be presented as if the new accounting policy had always been applied. Also, the entity must prepare at least three statements of financial position must be prepared, reporting on assets, liabilities and equity: at the end of the current period; at the end of the prior period; and at the beginning of the prior period. An accounting estimate is a judgement applied in determining the carrying amount of an item in the financial statements. An estimate may need revision if changes occur in the circumstances on which the estimate was based or as a result of new information or more experience. A change in estimate must be accounted for prospectively. Prospective application means: a) b)

applying the new accounting estimate to transactions or events occurring after the date the estimate is changed; and recognising the effect of the change in the current and future periods affected by the change but not recognising the effect in comparative information presented for any earlier period.

Presumably the standard-setters require prospective application for a change in accounting estimate on the basis that accounting estimates are judgements applied to financial statement items by the reporting entity and changes in such estimates are based on new information that wasn’t available at the time the estimate was originally made. Hence retrospective application would be inappropriate. The comparative amounts for prior periods are not restated with the benefit of hindsight. Also, given the more discretionary nature of changes in accounting estimates, the standard setters may be concerned about potential creative use of retrospective adjustments. For example, assume an entity revised its estimate of the useful life of an asset from five remaining years to three remaining years. If the change of estimate were able to be accounted for retrospectively, some of the depreciation charge applicable to the asset would be recognised directly against opening retained earnings instead of being recognised as an expense.

16.

Explain the difference between adjusting and non-adjusting events after the reporting period. Provide examples to illustrate your answer.

Adjusting events are those that provide further evidence about conditions existing at the end of the reporting period. For example, the appointment of an administrator for a major customer may provide further evidence of the collectability of receivables. A non-adjusting event provides evidence of conditions arising after the reporting period, such as damage to property arising from a flood occurring after the reporting period but before the financial statements are approved to be released.

16.7

Chapter 16: Financial statement presentation

EXERCISES Exercise 16.1

CURRENT ASSET AND LIABILITY CLASSIFICATIONS

Prepare the current assets and current liabilities sections of the statement of financial position of Joshua Limited as at 31 December 2016, using the minimum line items permitted under IAS 1. Current Assets

£’000

Cash and cash equivalents Trade and other receivables Inventories Other current assets

10 (g) 92 [(b) 100 000 – (f) 8 000] 180 [(e) 120 000 + (i) 60 000] 12 (d) 294

Current Liabilities

£’000

Trade and other payables Financial liabilities Current tax liability

107 [(a) 2 000 + (c) 85 000 + (h) 20 000] 113 [(j) 100 000 + (k) 13 000] 30 (l) 250

Exercise 16.2

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Prepare the statement of profit or loss and other comprehensive income of Lachlan Ltd for the year ended 31 December 2016, showing the analysis of expenses in the statement. Lachlan Ltd Statement of Comprehensive Income for the year ended 31 December 2016

Revenue Cost of sales Gross profit Other income Selling and distribution expenses Administrative expenses Finance costs Profit before tax Income tax expense Profit for the year Other comprehensive income: Items that may not subsequently be reclassified to profit or loss: Gain on revaluation of land, net of tax Items that may subsequently be reclassified to profit or loss: © John Wiley and Sons, Ltd, 2016

$'000 1 200 (840) 360 54 (76) (35) (18) 285 (85) 200

16.8

Solutions Manual to accompany Applying IFRS Standards 4e

Loss on revaluation of investment securities, net of tax Other comprehensive income for the year Total comprehensive income for the year

(1) 3 203

Calculations: Other income comprises: Gain on sale of plant Interest income Valuation gain on trading investments Dividend revenue

Exercise 16.3

$’000 5 24 20 5 54

STATEMENT OF CHANGES IN EQUITY

Prepare the statement of changes in equity of Riley Ltd for the year ended 31 December 2016 in accordance with IAS 1. Riley Ltd Statement of Changes in Equity for the year ended 31 December 2016

Balance at 31 December 2015 Comprehensive income for the year ended 31 December 2016 Dividends Transfers Issue of share capital Balance at 31 December 2016

Share General Capital Reserve £ £ 160 000 40 000

Revaluation Reserve £ 60 000 14 000

10 000 40 000 200 000

50 000

74 000

Retained Earnings £ 160 000

Total £ 420 000

130 000 144 000 (110 000) (110 000) (10 000) 40 000 170 000 494 000

16.9

Chapter 16: Financial statement presentation

Exercise 16.4

MATERIALITY, OFFSETTING

Identify which of the above gains and losses are permitted to be offset in Company A’s financial statements.

Foreign currency borrowings with Bank L

Loss €50m

€1m

Forward exchange contracts used as hedging instruments

Forward exchange contracts not used as hedges

Foreign currency borrowings with Bank S

Exercise 16.5

Gain

€3m

€10m

Set-off? Could be offset with foreign currency borrowings with Bank S on the basis of being similar in nature, however the amount is material so it must be presented separately. (IAS 1 para. 35) Not similar to other items so offsetting is not allowed, however the amount is not material and so is not required to be disclosed. (IAS 1 paras 29 and 35) Not similar to other items so offsetting is not allowed, however the amount is not material and so is not required to be disclosed. (IAS 1 paras 29 and 35) Could be offset with foreign currency borrowings with Bank L on the basis of being similar in nature, however the amount is material so it must be presented separately. (IAS 1 para. 35)

ACCOUNTING POLICIES, ACCOUNTING ESTIMATES

State whether each of the following is an accounting policy or an accounting estimate for Company A: (a) The useful life of depreciable plant is determined as being six years. (b) Company A recognises income arising from service contracts on the basis of the stage of completion. (c) Company A determines that it will calculate its warranty provision using past experience of defective products. (d) The current year’s warranty provision is calculated by providing for 1% of current year sales, based on last year’s warranty claims amounting to 1% of sales. a) accounting estimate b) accounting policy c) accounting policy d) accounting estimate (i.e., an accounting estimate that is determined by applying a policy of estimating warranty provisions as a % of sales based on the prior period %).

16.10

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 16.6

PREPARATION OF A STATEMENT OF FINANCIAL POSITION

Prepare the statement of financial position of Noah Ltd at 31 December 2016 in accordance with IAS 1, using the captions that a listed company is likely to use. Noah Ltd Statement of Financial Position as at 31 December 2016 $’000 Assets Current assets Cash and cash equivalents Trade and other receivables Financial assets Inventories

117 1383 20 1188

Other current assets

94 2802

Non-current assets Financial assets Property, plant and equipment Goodwill Intangible assets Deferred tax asset

30 4134 2425 65 189 6843

Total assets

9645

Equity and Liabilities Current liabilities Trade and other payables Financial liabilities Current tax payable Provisions

1746 1381 74 163 3364

Non-current liabilities Financial liabilities Provisions

1228 79 1307

Total liabilities

4671

Equity Share capital

3459

Retained earnings

1515

Total equity

4974

Total equity and liabilities

9645

16.11

Chapter 16: Financial statement presentation

Explanations: • Listed companies may use various captions in describing the minimal disclosure items required by IAS 1. The general approach adopted in the chapter solutions is to apply the captions suggested in the implementation guidance provided by the IASB for the preparation of a statement of financial position. In some instances, these may be modified as appropriate, e.g., “trade and other receivables” instead of “trade receivables”. • Trade and other receivables comprise: $’000 Trade debtors Allowance for doubtful debts Sundry debtors

1 163 (50) 270 1 383

• •

Inventories comprise raw materials ($493 000) + finished goods ($695 000) = $1 188 000. Property, plant and equipment comprises: $’000

Land Buildings Accumulated depreciation Plant and equipment Accumulated depreciation

• • • •

• • •

234 687 (80) 6 329 (3 036) 4 134

Goodwill has been separately shown in the statement of financial position because of its materiality. Other intangibles comprise brand names $40 000 + patents $25 000 = $65 000. Trade and other payables comprise trade creditors $1 078 000 + sundry creditors and accruals $568 000 + dividends payable $100 000 = $1 746 000. Current financial liabilities comprise bank overdraft $115 000 + other loans $646 000 + bank loans payable within one year $620 000. = $1 381 000. Alternatively the bank loans payable within one year may have been shown separately as the current portion of long-term borrowings. Short-term provisions comprise provision for warranty $20 000 and employee benefits $143 000 = $163 000. Non-current financial liabilities comprise bank loans of $1 848 000 less loans repayable within one year $620 000 = $1 228 000. An alternative label is long-term borrowings. Long-term provisions comprises provision for employee benefits $222 000 – amount payable within 12 months $143 000 = $79 000.

16.12

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 16.7

STATEMENT OF PROFIT OR LOSS AND COMPREHENSIVE INCOME

Prepare the statement of profit or loss and other comprehensive income of James Ltd for the year ended 31 December 2016. James Limited Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2016 $’000 Revenue 975 Share of profit of associates 15 Other income 30 Change in inventories of finished goods (25) Raw materials and consumables used (350) Employee benefit expenses (150) Depreciation of property, plant and equipment (45) Impairment loss on property (80) Finance costs (35) Other expenses (45) Profit before tax 290 Income tax expense (75) Profit for the year 215 Other comprehensive income: Items that may subsequently be reclassified to profit or loss: Loss on translation of foreign operation (25) Gain on revaluation of securities investments (net of tax) 30 Reclassification to profit on sale of securities investments, (7) net of tax Other comprehensive income for the year (2) Total comprehensive income for the year 213 Explanations • Other income comprises (b) interest income $20 000 and (d) gain on sale of securities investments $10 000. The net amount of $7000 transferred to profit comprises $10 000 before tax and associated income tax expense of $3000. • The loss on translation of foreign operations under the current rate method is recognised directly in equity in accordance with IAS 21. This solution assumes application of the currentrate method to translate the net investment in a foreign operation. • The transfer to profit on sale of securities investments is shown separately in accordance with paragraph 92 of IAS 1. This presentation shows items of comprehensive income net of tax, with related tax amounts reported in the notes. Alternatively, gross amounts (i.e., gain on revaluation gain $44 000 and amount transferred ($10 000)) and the aggregated tax effects of all items of comprehensive income (-$14 000 + $3000) may be shown separately.

16.13

Chapter 16: Financial statement presentation

Exercise 16.8 PRESENTATION OF ITEMS IN THE FINANCIAL STATEMENTS State whether each item is reported: 1. in the statement of financial position 2. in profit or loss in the statement of profit or loss and other comprehensive income 3. in other comprehensive income in the statement of profit or loss and other comprehensive income 4. in the statement of changes in equity 5. in the notes to the financial statements. (a) (b)

(g)

contingent liabilities the effect on retained earnings of the correction of a prior period error cash and cash equivalents capital contributed during the year revaluation gain on land (not reversing any previous revaluation) judgements that management has made in classifying financial assets income tax expense

(h)

provisions

5. notes 4. statement of changes in equity 1. statement of financial position 4. statement of changes in equity 3. other comprehensive income in statement of comprehensive income 5. notes 2. in profit or loss in the statement of comprehensive income 1. statement of financial position

Exercise 16.9 ACCOUNTING POLICIES, ACCOUNTING ESTIMATES, ERRORS

State whether the following changes should be accounted for and, if so, whether retrospectively or prospectively, in accordance with IAS 8: (a) A change in accounting policy made voluntarily. (b) A change in accounting policy required by an accounting standard. (c) A change in an accounting estimate. (d) An immaterial error discovered in the current year, relating to a transaction recorded two years ago. (e) A material error discovered in the current year, relating to a transaction recorded two years ago. Management determines that retrospective application would cause undue cost and effort. (f) A change in accounting policy required by an accounting standard. Retrospective application of that standard would require assumptions about what management’s intent would have been in the relevant period(s). a) b) c) d) e) f)

retrospective as required by the transitional provisions of that Standard; if not specified, then retrospective prospective the amount is immaterial and so may be ignored or corrected in the current year. retrospective; retrospective application is required unless impracticable to do so, but the definition of impracticable does not include undue cost/effort (IAS 8 para. 5) Prospective, with disclosure of the circumstances that render retrospective disclosure impracticable and a description of how, and from when, the error occurred (IAS 8 para. 49).

16.14

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 16.10 CHANGE IN ACCOUNTING ESTIMATE Prepare the note describing Company H’s change in accounting estimate for the year ended 31 December 2016, including comparative figures, in accordance with IAS 8. Show all workings.

Workings: The building has been depreciated by one third of its original cost ($1 666 667/$5 000 000). Thus one third (i.e., 5 years) of the original useful life of 15 years has lapsed. Since the total useful life is re-assessed as being 20 years, and 5 years have already elapsed, the remaining useful life is 15 years. For the year ended 31 December 2016 Company H’s depreciation expense will be $222 222. This is calculated as $3 333 333/15; i.e., the carrying amount of the asset at the date of the change in estimate, divided by the remaining useful life. Extract from Company H’s financial statements for the year ended 31 December 2016: Company H has historically depreciated its administration buildings over 15 years. As at 1 January 2016, the company’s directors determined, after a review of depreciation rates for similar buildings used in its industry, that the buildings should be depreciated over a longer period, being 20 years. The effect of the change in accounting estimate in the current period is a decrease in depreciation expense and accumulated depreciation of $111 111. In future periods annual depreciation expense will be $222 222 (2015: $333 333). There is no change to the comparative figures because the change in accounting policy is applied prospectively.

Exercise 16.11

ADJUSTING/NON-ADJUSTING EVENTS AFTER THE REPORTING PERIOD

The financial statements of Company N are authorised for issue on 12 February 2017 and the end of the reporting period is 31 December 2016. State whether each of the following material items would be an adjusting or non-adjusting event after the reporting period in the financial statements of Company N. Give reasons for your answer.

b) c)

d) e)

Non-adjusting; there is no change to conditions existing at the end of the reporting period – the amount is still owing, albeit a longer term has been given, but not so long as to cause it to be reclassified to non-current. This answer adopts the view that notwithstanding the assurances of the liquidator, Company N may still believe the receivable to be impaired because the debtor has gone into receivership. Non-adjusting; a new event after the reporting period. Non-adjusting; the company is measuring the investments at fair value, which must be determined as at the end of the reporting period. The change in fair value will be recorded in the next reporting period. If the investments were being measured at cost, however, this could be an adjusting event if it provided evidence of impairment at the end of the reporting period. Adjusting (IAS 10 para. 9(a)). Adjusting; in addition the financial statements cannot be prepared on the going concern basis (IAS 10 para. 14).

16.15

Chapter 16: Financial statement presentation

Exercise 16.12 PREPARATION OF A STATEMENT OF FINANCIAL POSITION, STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME AND STATEMENT OF CHANGES IN EQUITY Prepare the statement of financial position, statement of profit or loss and other comprehensive income and statement of changes in equity of Matthew Ltd for the year ended 31 December 2016 in accordance with the requirements of IAS 1, using statement captions that a listed company is likely to use.

Matthew Ltd Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2016 Revenue Other income Changes in inventories of work-in-progress and finished goods Raw materials used Employee benefit expense Depreciation expense Patent amortisation expense Rental expenses Advertising expenses Insurance expense Freight out expense Doubtful debts expense Other expenses Finance costs

$’000 5 000 47 (65) (2 200) (950) (226) (25) (70) (142) (45) (133) (10) (8) (30)

Profit before tax Income tax expense

1143 (320)

Profit for year

823

Other comprehensive income Items that may subsequently be reclassified to profit or loss: Deferred cash flow hedge

(65)

Total comprehensive income

758

Explanations • Other income comprises interest income $22 000 + sundry income = $47 000. • This answer assumes that the provision for employee benefits is short term.

$25

000

Matthew Ltd Statement of Financial Position at 31 December 2016

16.16

Solutions Manual to accompany Applying IFRS Standards 4e $’000 Assets Current assets Cash and cash equivalents

Trade and other receivables

504

Inventories

705 1 293

Non-current Assets Property, plant and equipment Goodwill Other intangible assets

1 322 620 90 2 032

Total assets

3 325

Equity and Liabilities Current liabilities Trade and other payables

452

Financial liabilities

110

Current tax payable

Provisions

120 717

Non-current liabilities Financial liabilities Deferred tax

432 140

Total non-current liabilities

572

Total liabilities

1 289

Equity Share capital

1 178

Retained earnings

923

Cash flow hedge

(65)

Total equity

2 036

Total equity and liabilities

3 325

Explanations • Cash and cash equivalents comprise cash $4000 + cash on deposit, at call $80 000 = $84 000. • Inventories comprise raw materials $320 000 + finished goods $385 000 = $705 000. • Trade and other receivables comprise: $'000 Trade debtors

495

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Chapter 16: Financial statement presentation

Allowance for doubtful debts Other debtors

(18) 27 504

•

Property, plant and equipment comprises: $'000

Land Buildings Accumulated depreciation Plant and equipment Accumulated depreciation

94 220 (52) 1 380 (320) 1 322

• •

Current financial liabilities comprises the current portion of long-term borrowings $20 000 + $90 000 = $110 000. Non-current financial liabilities comprise: $'000

Banks loans Repayable within 12 months Other loans Repayable within 12 months

92 (20) 450 (90) 432

Refer to the Statement of Changes in Equity for workings for equity balances.

Matthew Ltd Statement of Changes in Equity for the year ended 31 December 2016 Share Retained Cash Flow Capital Earnings Hedge $’000 $’000 $’000 Balance at 31 December 2015 Comprehensive income for the year Dividends Dividends reinvested

1137

Balance at 31 December 2016

1178

310 823

0 (65)

(210)

$’000 1447 758 (210) 41

41 923

Total

(65)

2 036

16.18

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 16.13

FAIR PRESENTATION

Advise the directors how this problem should be addressed in the financial statements in accordance with IAS 1. As the company is not permitted to depart from IFRSs, the directors should provide additional disclosure to mitigate the perceived misleading aspects. Disclosures should include the relevant Standard, the nature of the requirement, why its application is perceived to be misleading, and the adjustment required, in the view of management, to achieve a fair presentation. For example, if the matter pertained to the recognition of an impairment loss, the directors should state that IAS 36 requires the reduction of the carrying amount of an asset or cash generating unit to its recoverable amount and the recognition of an impairment loss. The directors should explain why they believe this to be misleading, and disclose the carrying amount of the asset and corresponding increase in profit before tax that would, in their view, provide a fair presentation.

Exercise 16.14

MATERIALITY AND AGGREGATION

State whether each of the following statements is true or false: (a) A material item is determined solely on the basis of its size. (b) A class of assets or liabilities is determined by reference to items of a similar nature or function. (c) Inventories and trade accounts receivable may be aggregated in the statement of financial position. (d) Cash and cash equivalents may be aggregated in the statement of financial position. a) b) c) d)

False – size or nature, or combination of both (IAS 1 para. 7) True – IAS 1 para. 29 False –IAS 1 para. 29, 54 True – IAS 1 para. 29, 54

Exercise 16.15

CLASSIFICATION OF ITEMS IN THE STATEMENT OF FINANCIAL POSITION

Assume you are the accountant responsible for preparing the statement of financial position of Jack Limited. In which caption and classification on the statement of financial position would you include each of the above accounts? If you need additional information to finalise your decision as to the appropriate classification or caption, indicate what information you require. Account a) Trade receivables b) Work in progress c) Trade creditors d) Prepayments e) Property

f) Goodwill

Caption Trade and other receivables Inventories Trade and other payables Other current assets Property, plant and equipment or Investment property, as applicable Intangible assets or other (1) © John Wiley and Sons, Ltd, 2016

Classification Current assets Current assets Current liabilities Current assets Non-current assets

Non-current assets 16.19

Chapter 16: Financial statement presentation

g) Debentures payable

Financial liabilities

h) Preference share capital

Issued capital and reserves or Financial liabilities depending on whether the instruments meet the definition of a liability or equity Other liabilities or a separate caption if material

i) Unearned revenue

j) Accrued salaries l) Share capital

Trade and other payables Issued capital and reserves

Current and/or or noncurrent liabilities depending when payment is due Equity or if they are a liability current or non-current liabilities depending on the date or period of redemption Current or non-current liabilities depending on the applicable period of the unearned revenue Current liabilities Equity

Explanation (1) Although IAS 38 defines intangible assets as identifiable, the “intangible assets” caption in the statement of financial position typically includes any goodwill that has been recognised.

Exercise 16.16

CURRENT ASSET CLASSIFICATIONS

Prepare the current asset section of the statement of financial position of Thomas Ltd as at 31 December 2016, using the minimum line items permitted under IAS 1. Current assets Cash and cash equivalents Trade receivables Financial assets Inventories Other current assets

$ 30 000 120 000 20 000 100 000 8 000 278 000

Explanations: • Investments in corporate bonds, item (e), have been excluded on the grounds that realisation within twelve months is not anticipated. • Paragraph 56 of IAS 1 precludes the classification of deferred tax assets, item (g), as a current asset under any circumstances.

16.20

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 16.17

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Prepare the statement of profit or loss and other comprehensive income of William Ltd for the year ended 31 December 2016, showing the analysis of expenses in the statement. William Ltd Statement of Profit or Loss and other Comprehensive Income for the year ended 31 December 2016

Revenue Cost of sales Gross profit Other income Selling and distributions expenses Administrative expenses Finance costs Profit before tax Income tax expense Profit for the year Other comprehensive income: Items that may subsequently be reclassified to profit or loss: Gain on revaluation of financial investments, net of tax Total comprehensive income for the year

$’000 950 (600) 350 35 (50) (30) (15) 290 (75) 215

20 235

Explanation: Other income comprises (b) interest revenue $25 000 and (c) gain on sale of plant and equipment $10 000.

Exercise 16.18

PREPARATION OF A STATEMENT OF FINANCIAL POSITION

Prepare the statement of financial position of Samuel Ltd at 31 December 2016 in accordance with IAS 1, using the captions that a listed entity is likely to use. Samuel Ltd Statement of Financial Position as at 31 December 2016 $’000 Assets Current assets Cash and cash equivalents

211

Trade and other receivables

1984

Inventories

1683

Other current assets

141 4019

Non-current Assets Financial assets

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Chapter 16: Financial statement presentation

Property, plant and equipment Goodwill Other intangible assets

6174 2530 110 8866

Total assets

12 885

Equity and Liabilities Current liabilities Trade and other payables

2457

Financial liabilities

425

Current tax payable

152

Short-term provisions

626 3660

Non-current liabilities Financial liabilities Deferred tax liability Long-term provisions

3615 420 103 4138

Total liabilities

7798

Equity Share capital Reserves Retained earnings

3500 106 1481

Total equity

5087

Total equity and liabilities

12 885

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Solutions Manual to accompany Applying IFRS Standards 4e

Explanations: • Cash and cash equivalents comprise cash $175 000 + deposits at call $36 000 = $211 000. • Trade and other receivables comprises trade debtors $1 744 000 – allowance for doubtful debts $80 000 + sundry debtors $320 000 = $1 984 000. • Inventories comprise raw materials $490 000 + work in progress $151 000 + finished goods $1 042 000 = $1 683 000. • Other current assets comprise prepayments. • Property, plant and equipment comprises: $’000 Land Buildings Accumulated depreciation Plant and equipment Accumulated depreciation Leased assets Accumulated depreciation

250 1 030 (120) 8 275 (3 726) 775 (310) 6 174

• • • • • •

Goodwill has been separately disclosed on the face of the statement of financial position given its materiality and comprises cost $3 200 000 – accumulated impairment $670 000 = $2 530 000. Trade and other payables comprises trade creditors $ 1 617 000 + sundry creditors and accruals $715 000 = $2 332 000. Short-term borrowings comprise the bank overdraft $350 000. Current financial liabilities comprise the following items payable within 12 months: lease liabilities $125 000 + debentures $300 000 = $425 000. Short-term provisions comprise: current portion of the provision for employee benefits $192 000 + provision for restructuring $412 000 + current portion of the provision for warranty $22 000 ($42 000 - $20000) = $626 000. Non-current financial liabilities comprise: $’000

Banks loans Debentures Repayable within 12 months Other loans Lease liabilities Repayable within 12 months

2 215 675 (300) 800 350 (125) 3615

• •

Long-term provisions comprise provision for employee benefits $275 000 – portion currently payable $192 000 + provision for warranty to be incurred beyond one year $20 000 = $103 000. Reserves comprise Investment Revaluation Surplus $25 000 + Land Revaluation Reserve $81 000 = $106 000.

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Chapter 16: Financial statement presentation

Exercise 16.19

PREPARATION OF A STATEMENT OF FINANCIAL POSITION

Prepare the statement of financial position of Lucas Ltd at 31 December 2016 in accordance with IAS 1, using the captions that a listed company is likely to use. Lucas Ltd Statement of Financial Position as at 31 December 2016 £ Assets Current assets Cash and cash equivalents Trade and other receivables Financial assets

119 869 21 071 68 455 209 395

Non-current Assets Financial assets Deferred tax asset

1 880 472 655 1 881 127

Total assets

2 090 522

Equity and Liabilities Current liabilities Trade and other payables

10 616

Current tax payable

242

Short-term provisions

525 11 383

Non-current liabilities Deferred tax liability Long-term provisions

56 414 227 56 641

Total liabilities

68 024

Equity Share capital Reserves Retained earnings

1 368 024 376 090 278 384

Total equity

2 022 498

Total equity and liabilities

2 090 522

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Solutions Manual to accompany Applying IFRS Standards 4e

Explanations • Cash and cash equivalents: cash £7000 + deposits at call £112 869 = £119 869. • Trade and other receivables comprise dividends receivable £15 693 + interest receivable £478 + outstanding settlements receivable £4900 = £21 071. • Long-term provisions: provision for employee benefits £752 – £525 = $227. • Trade and other payables comprises outstanding settlements payable £10 253 + interest payable £280 + other payables £83 = £10 616.

Exercise 16.20

PREPARATION OF A STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Prepare the statement of profit or loss and other comprehensive income of Oliver Ltd for the year ended 31 December 2016 in accordance with IAS 1, showing the analysis of expenses by function in the statement. Oliver Ltd Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2016 $'000 Sales revenue 1 300 Cost of sales (820) Gross profit 480 Other income 41 Selling and distribution expenses (175) Administrative expenses (152) Research costs (58) Finance costs (34) Profit before tax 102 Income tax expense (31) Profit for the year 71 Other comprehensive income: Items that may not subsequently be reclassified to profit or loss: Asset revaluation 100 Income tax relating to asset revaluation (30) Other comprehensive income for the year 70 Total comprehensive income for the year 141 Explanations • Other income $41 000 comprises $’000 Gain on sale of plant Interest income Rental income Royalties Other revenue

26 2 2 1 1 41

16.25

Chapter 16: Financial statement presentation •

Research costs comprise research expense $51 000 and amortisation of patents $7000 = $58 000. • Finance costs comprise interest on borrowings $33 000 + sundry borrowing costs $1000 = $34 000. • Selling and distribution expenses comprise: $’000 Advertising costs 25 Sales staff 97 Freight-out Shipping supplies expense Depreciation on sales equipment

•

Administrative expenses comprise:

Administrative expenses Legal and professional fees Office rent expense Insurance expense Depreciation of office equipment Stationery and supplies Miscellaneous expenses

•

32 16 5 175

$’000 72 13 30 14 16 5 2 152

Alternatively, the asset revaluation may have been shown in the statement of comprehensive income net of tax, with the tax effect reported in the notes.

16.26

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 16.21

PREPARATION OF A STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Prepare the statement of profit or loss and other comprehensive income of Liam Ltd for the year ended 31 December 2016, in accordance with IAS 1. Liam Ltd Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2016 Income from investments Interest income Net loss on investments held for trading Other income Administrative expenses Finance costs

€’000 980 90 (20) 10 (75) (15)

Profit before tax Income tax expense

970 (280)

Profit for year

690

Other comprehensive income: Items that may subsequently be reclassified to profit or loss: Revaluation gain on investments

Income tax relating to revaluation gain

(21)

Other comprehensive income

Total comprehensive income for the year

739

Explanations • Income from investments comprises dividends from investments €920 000 + distributions from trusts €60 000 = €980 000. • Interest income comprises interest on deposits €80 000 + income from bank bills (which is in the nature of interest) €10 000 = €90 000. • Net loss on investments held for trading comprises income from dealing in securities and derivatives €40 000 – loss on credit derivatives held for trading €60 000 = Loss €20 000. These items are presented on a net basis as permitted by paragraph 35 of IAS 1

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Chapter 16: Financial statement presentation

Exercise 16.22

PRESENTATION OF ITEMS IN THE FINANCIAL STATEMENTS

State whether each item is reported: 1. in the statement of financial position 2. in profit or loss in the statement of profit or loss and other comprehensive income 3. in other comprehensive income in the statement of profit or loss and other comprehensive income 4. in the statement of changes in equity 5. in the notes to the financial statements. (a)

loss on revaluation of shares held for trading

(b)

finance expenses

(c)

aggregate dividends declared and paid during the year revaluation loss on building (not reversing any previous revaluation)

(d)

(e) (f) (g) (h)

allowance for doubtful debts transfer from retained earnings to general reserve contractual commitments under an operating lease deferred tax liability

2. profit or loss in the statement of profit or loss and other comprehensive income 2. profit or loss in the statement of profit or loss and other comprehensive income 4. statement of changes in equity 2. profit or loss in the statement of profit or loss and other comprehensive income 5. notes 4. statement of changes in equity 5. notes 1. statement of financial position

Explanation: The allowance for doubtful debts is included in the carrying amount of receivables in the statement of financial position. However, the amount of the allowance for doubtful debts is reported in the notes.

16.28

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 16.23

PREPARATION OF A STATEMENT OF FINANCIAL POSITION AND STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Prepare the statement of financial position and statement of profit or loss and other comprehensive income of Ryan Ltd for the year ended 31 December 2016 in accordance with IAS 1, using statement captions that a listed company is likely to use. Ryan Ltd Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2016 £'000 Revenue 7 360 Cost of sales (4 978) Gross profit 2 382 Other income 15 Share of profits of associates 36 Selling and distributions expenses (1 510) Administrative expenses (420) Finance costs (80) Profit before tax 423 Income tax expense (141) Profit for year 282 Other comprehensive income: Items that may subsequently be reclassified to profit or loss: Gain on revaluation of investments 23 Related income tax (8) Other comprehensive income 15 Total comprehensive income 297 Explanations • Other income comprises rent received £9000 + other income £6000 = £15 000. • Selling and distribution expenses comprises distribution expenses £143 000 + sales and marketing expenses £1 367 000 = £1 510 000. • Finance costs comprise interest paid £74 000 + other borrowing expenses £6000 = £80 000.

Ryan Ltd Statement of Financial Position as at 31 December 2016 £'000 Assets Current assets Cash and cash equivalents

170

Trade and other receivables

870

Financial assets

Inventories

1 243 2 333 © John Wiley and Sons, Ltd, 2016

16.29

Chapter 16: Financial statement presentation

Non-current Assets Property, plant and equipment Goodwill Investments accounted for using the equity method Financial assets

1 525 1 450 375 270 3 620

Total assets

5 953

Equity and Liabilities Current liabilities Trade and other payables

820

Financial liabilities

425

Current tax payable

Short-term provisions

212 1 487

Non-current liabilities Financial liabilities Deferred tax liability Long-term provisions

496 100 43 639

Total liabilities

2 126

Equity Share capital Reserves Retained earnings

2 920 15 892

Total equity

3 827

Total equity and liabilities

5 953

Explanation • Cash and cash equivalents comprises cash at bank £20 000 + cash on deposits, at call £150 000 = £170 000. • Trade and other receivables comprises trade debtors £740 000 – allowance for doubtful debts £24 000 + other debtors £154 000 = £870 000. • The financial assets classified as current comprise the current portion of the employee share plan loans £50 000. • Inventories comprises raw materials £53 000 + finished goods £1 190 000 = £1 243 000. • Property, plant and equipment comprises: £’000 Land and buildings 426 Accumulated depreciation (61)

16.30

Solutions Manual to accompany Applying IFRS Standards 4e

Plant and equipment Accumulated depreciation

2 100 (940) 1 525

• • • • •

The financial assets classified as non-current comprises investments in securities £60 000 + employee share plan loans £260 000 – amount due within one year £50 000 = £270 000. Short-term financial liabilities comprises bank loans £25 000 + other loans £400 000 = £425 000. Short-term provisions comprise employee benefits £110 000 + provision for restructuring £62 000 (to be fully implemented within one year) + provision for warranty £40 000 (six-month warranty period) = £212 000. Long-term provisions comprise employee benefit provisions £153 000 – payable within one year £110 000 = £43 000. Non-current financial liabilities: £’000

Banks loans Repayable within 12 months Other loans Repayable within 12 months

111 (25) 810 (400) 496

•

Retained earnings comprise balance 1 January 2016 £760 000 + profit for year £282 000 – dividends £150 000 = £892 000.

16.31

Chapter 16: Financial statement presentation

Exercise 16.24

PREPARATION OF A STATEMENT OF FINANCIAL POSITION, STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME AND STATEMENT OF CHANGES IN EQUITY

Prepare the statement of financial position, statement of profit or loss and other comprehensive income and statement of changes in equity of Jacob Ltd for the year ended 31 December 2016 in accordance with the requirements of IAS 1, using statement captions that a listed company is likely to use. Jacob Ltd Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2016 Revenue Cost of sales

$'000 4 469 (2 987)

Gross profit Other income Selling and distribution expenses Administrative expenses Finance costs

1 482 6 (906) (252) (48)

Profit before tax Income tax expense

282 (85)

Profit for year

197

Other comprehensive income Items that may not subsequently be reclassified to profit or loss: Revaluation of land, net of tax

Items that may subsequently be reclassified to profit or loss Revaluation of investments, net of tax

Other comprehensive income

Total comprehensive income

239

Explanations • Selling and distribution expenses comprise distribution expenses $86 000 + sales and marketing expenses $820 000 = $906 000. • Finance costs comprise interest $44 000 + other borrowing costs $4000 = $48 000. • Alternatively, each items of other comprehensive income may be reported at gross e.g., land revaluation $50 000 + revaluation of investments $10 000, less tax related to other comprehensive income ($18 000).

16.32

Solutions Manual to accompany Applying IFRS Standards 4e

Jacob Ltd Statement of Financial Position at 31 December 2016 $'000 Assets Current assets Cash and cash equivalents

104

Trade and other receivables

529

Inventories

902 1535

Non-current Assets Property, plant and equipment Goodwill Other intangible assets Financial assets

917 870 45 225 2057

Total assets

3592

Equity and Liabilities Current liabilities Trade and other payables

510

Financial liabilities

140

Current tax payable

Short-term provisions

99 774

Non-current liabilities Long-term borrowings Deferred tax liability Long-term provisions

496 135 31

Total liabilities

1436

662

Equity Share capital

1691

Reserves

Retained earnings

373

Total equity

2156

Total equity and liabilities

3642

16.33

Chapter 16: Financial statement presentation

Explanations • •

Cash and cash equivalents comprises cash on hand $4000 + cash on deposit, at call $100 000 = $104 000. Trade and other receivables comprise: $'000

Trade debtors Allowance for doubtful debts Sundry debtors

450 (14) 93 529

• • •

Inventories comprise raw materials $188 000 + finished goods $714 000 = $902 000. Intangible assets comprise patents $48 000 less accumulated amortisation $3000 = $45 000. Property, plant and equipment comprise: $'000

Land and buildings Accumulated depreciation – buildings Plant and equipment Accumulated depreciation – plant and equipment

257 (36) 1260 (564) 917

• • •

Current financial liabilities comprises bank loans $30 000 payable within one year + other loans $110 000 payable within one year = $140 000. Short-term provisions comprise $62 000 + warranty provision $37 000 = $99 000. Non-current financial liabilities comprise: $'000

Banks loans Repayable within 12 months Other loans Repayable within 12 months

66 (30) 570 (110) 496

• • •

Long-term provisions comprise employee benefit provisions $93 000 – 62 000 = $31 000. Reserves comprise land revaluation surplus $50 000 + investments revaluation surplus $42 000 = $92 000. Refer to the statement of changes in equity for working for retained earnings.

16.34

Solutions Manual to accompany Applying IFRS Standards 4e

Jacob Ltd Statement of Changes in Equity for the year ended 31 December 2016 Share Capital

Balance at 31 December 2015 Comprehensive income for the year Dividends Dividends reinvested Issues of share capital for cash Balance at 31 December 2016

$'000 1 541

30 120 1 691

Land Revaluation Surplus

Investment

$'000 15 35

Retained

Total

Revaluation Earnings Surplus $'000 $'000 35 326 7 197 (150)

373

16.35

$'000 1 917 239 (150) 30 120 2 156

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 16 Financial Statement Presentation

Chapter 16

Financial Statement Presentation

Learning Objectives 16.1 16.2 16.3

16.4 16.5 16.6 16.7

16.8

Describe the main components of financial statements Explain the general principles underlying the preparation and presentation of financial statements Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/and/or in the notes Apply the requirements for the presentation of information in the statement of profit or loss and other comprehensive income and/and/or in the notes Apply the requirements for the presentation of information in the statement of changes in equity and/and/or in the notes Discuss the disclosures required by IAS 1 in the notes to the financial statements Apply the requirements of IAS 8 regarding the selection and application of accounting policies, and in respect of accounting for changes in accounting policies, changes in accounting estimates and errors Distinguish between adjusting and non-adjusting events after the reporting period in accordance with IAS 10.

16.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

The requirements of IAS 1 Presentation of Financial Statements apply to the following sets of financial statements: Learning Objective 16.1 Describe the main components of financial statements a. condensed financial statements; b. interim financial statements; *c. general-purpose financial statements; d. special purpose financial statements.

Items that are dissimilar in nature must be presented separately in financial statements unless: Learning Objective 16.2 Explain the general principles underlying the preparation and presentation of financial statements *a. they are immaterial; b. they are financial items in which case they can be off-set; c. the directors approve of an aggregation of the items; d. the auditors approval to aggregate the items is obtained.

Assets and liabilities, and income and expenses may be off-set if: Learning Objective 16.2 Explain the general principles underlying the preparation and presentation of financial statements a. they are financial assets and liabilities; b. they are in respect of borrowing and lending activities such as interest revenue and interest expense; *c. required or permitted by a standard; d. there is no tax effect.

The primary source of information about an entity’s financial position is to be found in its: Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. statement of profit or loss and other comprehensive income; *b. statement of financial position; c. statement of changes in equity; d. statement of cash flows.

16.2

Chapter 16 Financial Statement Presentation

According to IAS 1 Presentation of Financial Statements, a required format for the presentation of a statement of financial position is: Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. not prescribed and no guidance is provided in the standard; *b. not prescribed but guidance is provided in the standard for a suitable format; c. prescribed by the standard; d. not prescribed by the standard but details are found in the Company Act or in the civil code.

Which of the following items, if it exists, must be presented as a line item in the statement of financial position? Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes *a. Trade and other receivables; b. Revenue; c. Cost of sales; d. Share of profit of associates.

An entity is required to classify its assets and liabilities as current or non-current unless it is considered more relevant and provide more reliable information to present them according to their: Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. value; *b. liquidity; c. age; d. physical nature.

Under IAS 1 Presentation of Financial Statements, which of the following items is disclosed separately on the face of a statement of financial position? Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. Income tax expense; b. Revenue; *c. Investment property; d. Profit attributable to members of the parent.

16.3

Test Bank to accompany Applying IFRS Standards 4e

Typically industries where operating cycles may exceed twelve months include: Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. food preparation; b. manufacturing; c. retail; *d. real estate development.

10.

The following are normally presented in a statement of financial position as current items: Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. deferred tax liabilities; *b. trade payables; c. deferred tax assets; d. goodwill.

11.

If a liability satisfies the following criterion it will be classified as non-current: Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. due to be settled within twelve months of the balance date; b. expected to be settled in the entity’s normal operating cycle; *c. due to be settled more than twelve months after the statement of financial position date; d. it is held primarily for the purpose of being traded.

12.

At reporting date for Year 1, Elpha Limited had a loan from its bankers that it expected to settle within three months. The loan term was renegotiated after reporting date and before the authorisation date of the financial statements, and the repayment date was extended by two years. For Year 1 financial statement presentation purposes this loan is classified by Elpha Limited as: Learning Objective 16.3 Apply the requirements for the classification of items reported in the statement of financial position, and apply the requirements for the presentation of information in the statement of financial position and/or in the notes a. a non-current liability; *b. a current liability; c. a contingent liability; d. an off-statement of financial position liability.

16.4

Chapter 16 Financial Statement Presentation

13.

According to IAS 1 Presentation of Financial Statements, a required format for the presentation of the statement of profit or loss and other comprehensive income is: Learning Objective 16.4 Apply the requirements for the presentation of information in the statement of profit or loss and other comprehensive income and/or in the notes a. prescribed by the standard; b. not prescribed and no guidance is provided in the standard for a suitable format; *c. not prescribed but guidance is provided in the standard for a suitable format; d. prescribed by the standard and further details are found in the Company Act or in the civil code.

14.

IAS 1 Presentation of Financial Statements requires the following items to be disclosed separately in the statement of profit or loss and other comprehensive income: I Cost of sales. II Revenue. III Finance costs. IV Share of the profit or loss from associates. V Tax expense relating to extraordinary events. VI Tax expense relating to ordinary activities. VII Profit or loss. Learning Objective 16.4 Apply the requirements for the presentation of information in the statement of profit or loss and other comprehensive income and/or in the notes a. I, II, VI and VII only; b. I, II, III and V only; *c. II, III, IV, VI and VII only; d. I, III, V and VII only.

15.

Which of the following items, if it exists, does NOT have to be presented as a line item on the face of a statement of profit or loss and other comprehensive income? Learning Objective 16.4 Apply the requirements for the presentation of information in the statement of profit or loss and other comprehensive income and/or in the notes a. revenue; *b. closing inventory; c. profit or loss attributable to non-controlling interests; d. post-tax profit or loss of discontinued operations.

16.

In respect to the statement of profit or loss and other comprehensive income of an entity, IAS 1 Presentation of Financial Statements prescribes: Learning Objective 16.4 Apply the requirements for the presentation of information in the statement of profit or loss and other comprehensive income and/or in the notes a. a fixed format for the presentation of items in the statement of profit or loss and other comprehensive income; *b. line items that are considered to be of sufficient importance to warrant presentation; c. the presentation of line items of revenue, but not of income; d. the presentation of line items comprising total expenses, but not line items comprising total revenue.

16.5

Test Bank to accompany Applying IFRS Standards 4e

17.

Under IAS 1 Presentation of Financial Statements profit or loss attributable to noncontrolling interests is prescribed for presentation in: Learning Objective 16.4 Apply the requirements for the presentation of information in the statement of profit or loss and other comprehensive income and/or in the notes a. an equity statement; b. a statement of financial position; *c. a statement of profit or loss and other comprehensive income; d. a statement of cash flows.

18.

Included in a statement of changes in equity are the following items: I Opening and closing balances. II Profit or loss for the period. III Gains or losses not recognised in the statement of profit or loss and other comprehensive income. IV New share issues. V Dividends paid. Learning Objective 16.5 Apply the requirements for the presentation of information in the statement of changes in equity and/or in the notes a. I, II & III only; b. II, III and IV only; c. I, IV and V only; *d. I, II, IV and V only.

19.

Which of the following note disclosures are NOT required by IAS 1 Presentation of Financial Statements? Learning Objective 16.6 Discuss the disclosures required by IAS 1 in the notes to the financial statements a. Sources of estimation uncertainty in relation to impairment of assets; b. Dividends declared after end of reporting period but before the financial statements are authorised for issue; c. the country of incorporation of the entity; *d. the names and qualifications of all directors of the entity.

20.

Where an accounting estimate has been revised materially the item is: Learning Objective 16.7 Apply the requirements of IAS 8 regarding the selection and application of accounting policies, and in respect of accounting for changes in accounting policies, changes in accounting estimates and errors a. to be accounted for retrospectively; b. not required to be recognised in the current period; *c. to be accounted prospectively; d. to be adjusted in the comparative numbers of previous periods.

16.6

Chapter 16 Financial Statement Presentation

21.

Which of the following statements in relation to errors is correct? Learning Objective 16.7 Apply the requirements of IAS 8 regarding the selection and application of accounting policies, and in respect of accounting for changes in accounting policies, changes in accounting estimates and errors *a. Errors must be accounted for on a retrospective basis; b. Under the “all inclusive” concept of profit, accounting errors must be recognised in profit and loss for the period; c. All errors, regardless of their size must be corrected as soon as they are discovered; d. Where the error is considered to be fundamental, the prior year financial statements must be recalled and reissued.

22.

If an entity receives information after end of reporting period that one of its assets was impaired at end of reporting period by a material amount it must: Learning Objective 16.8 Distinguish between adjusting and non-adjusting events after the reporting period in accordance with IAS 10 *a. adjust the amounts recognised in the financial statements to reflect the impairment; b. notify all shareholders in writing; c. disclose the impairment in the notes but not recognise the amount in the financial statements; d. include the impairment loss as a contingent liability.

23.

Which of the following events occurring after the reporting date but before the financial report is authorised for issue is NOT an example of an adjusting event? Learning Objective 16.8 Distinguish between adjusting and non-adjusting events after the reporting period in accordance with IAS 10 *a. a decline in the market value of a listed security; b. the notification of the insolvency of a debtor; c. an event that indicates that the going concern basis of accounting may not be appropriate; d. the sale of inventories after the reporting date for an amount below cost.

24.

A set of financial statement prepared in accordance with IAS 1 Presentation of Financial Statements comprises: I. A statement of financial position. II. A statement of profit or loss and other comprehensive income. III. A statement of cash flows. IV. A statement of changes in equity. V. Notes. Learning Objective 16.1 Describe the main components of financial statements a. I, II, and IV; *b. I, II, III IV and V: c. I, III and IV; d. I, II, III and IV.

16.7

Test Bank to accompany Applying IFRS Standards 4e

25.

Under IAS 1 Presentation of Financial Statements, financial statements must be prepared and presented at least: Learning Objective 16.2 Explain the general principles underlying the preparation and presentation of financial statements *a. annually; b. half-yearly; c. each three months; d. at the end of each month of operations.

26.

The application of International Financial Reporting Standards with additional disclosure where necessary is presumed to result in financial statements that: Learning Objective 16.2 Explain the general principles underlying the preparation and presentation of financial statements *a. will result in a fair presentation; b. contain only material items; c. are free from error and misstatement; d. are unbiased.

27.

Included in a statement of changes in equity are the following items: I Opening and closing balances. II Profit or loss for the period. III New share issues. IV Dividends paid. Learning Objective 16.5 Apply the requirements for the presentation of information in the statement of changes in equity and/or in the notes a. I, II & III only; b. II, III and IV only; c. I, II and IV only; d.* I, II, III and IV.

28.

In relation to ‘retained earnings’, IAS 1 Presentation of Financial Statements mandates the following disclosures: I. Any changes during the reporting period. II. The related tax adjustments in respect to any changes during the period. III. The beginning balance. IV. The balance at reporting date. Learning Objective 16.5 Apply the requirements for the presentation of information in the statement of changes in equity and/or in the notes a. I, II, III and IV; b. II, III and IV only; *c. I, III and IV only; d. III and IV only.

16.8

Chapter 16 Financial Statement Presentation

29.

The issuing of bonus shares in lieu of a cash dividend would be separately disclosed in an entity’s Learning Objective 16.5 Apply the requirements for the presentation of information in the statement of changes in equity and/or in the notes a. Statement of Financial Position; b. Statement of Comprehensive Income; *c. Statement of Changes in Equity; d. Statement of Cash Flows.

30.

Which of the following is NOT an example of an adjusting event under IAS 10 Events after the Reporting Period? Learning Objective 16.8 Distinguish between adjusting and non-adjusting events after the reporting period in accordance with IAS 10 a. the settlement after reporting date but prior to the date that the financial statements are authorised for issue of a court case which had commenced prior to reporting date; b. the sale of inventories after reporting date but prior to the date that the financial statements are authorised for issue for an amount below cost; *c. uninsured damage to a material item of machinery after reporting date but prior to the date that the financial statements are authorised for issue for an amount below cost; d. receipt of advice after reporting date but prior to the date that the financial statements are authorised for issue that a material debtor has been placed in liquidation.

16.9

Exercises Exercise 16.13 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

FAIR PRESENTATION

The directors of a company that is required to prepare ﬁnancial reports under domestic corporations law conclude that applying the requirements of IAS 36 Impairment of Assets would not provide a fair presentation because the resulting $80 000 impairment loss is temporary. The domestic corporations law prohibits departure from the requirements of IFRSs. Required

Advise the directors how this problem should be addressed in the ﬁnancial statements in accordance with IAS 1.

Exercise 16.14 ★

Exercise 16.15 ★

MATERIALITY AND AGGREGATION

State whether each of the following statements is true or false: (a) A material item is determined solely on the basis of its size. (b) A class of assets or liabilities is determined by reference to items of a similar nature or function. (c) Inventories and trade accounts receivable may be aggregated in the statement of ﬁnancial position. (d) Cash and cash equivalents may be aggregated in the statement of ﬁnancial position.

CLASSIFICATION OF ITEMS IN THE STATEMENT OF FINANCIAL POSITION

The general ledger trial balance of Jack Limited includes the following accounts that are reported in the statement of ﬁnancial position: (a) Trade receivables (g) Debentures payable (b) Work in progress (h) Preference share capital (c) Trade creditors (i) Unearned revenue (d) Prepayments (j) Accrued salaries (e) Property (l) Share capital Additional information Jack Limited classiﬁes assets and liabilities into current and non-current categories and uses the minimum line items permitted under IAS 1. Required

Assume you are the accountant responsible for preparing the statement of financial position of Jack Limited. In which caption and classification on the statement of financial position would you include each of the above accounts? If you need additional information to finalise your decision as to the appropriate classification or caption, indicate what information you require.

Exercise 16.16 ★

CURRENT ASSET CLASSIFICATIONS

The general ledger trial balance of Thomas Limited includes the following asset accounts at 31 December 2016: $ 100 000 (a) Inventory 120 000 (b) Trade receivables 8 000 (c) Prepaid insurance 20 000 (d) Listed shares held for trading purposes 80 000 (e) Investments in corporate bonds 30 000 (f) Cash 15 000 (g) Deferred tax asset Additional information • Thomas Limited’s investments in corporate bonds are held as part of a long-term investment strategy. • The company classiﬁes assets and liabilities using a current/non-current basis. Required

Prepare the current asset section of the statement of ﬁnancial position of Thomas Ltd as at 31 December 2016, using the minimum line items permitted under IAS 1. CHAPTER 16 Financial statement presentation

Exercise 16.17

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

★ The general ledger trial balance of William Ltd includes the following accounts at 31 December 2016: $ 950 000 (a) Sales revenue

25 000 10 000 600 000 15 000 50 000 30 000 75 000

(b) Interest revenue (c) Gain on sale of plant and equipment (d) Cost of sales (e) Finance expenses (f) Selling and distribution costs (g) Administrative expenses (h) Income tax expense

Additional information • A revaluation gain of $20 000 net of tax was recognised for securities investments held during 2016. William Ltd recognises gains and losses on revaluation of securities in other comprehensive income. • No securities investments were sold during the year. • William Ltd uses the single statement format for the statement of proﬁt or loss and other comprehensive income and classiﬁes expenses by function. Required

Prepare the statement of proﬁt or loss and other comprehensive income of William Ltd for the year ended 31 December 2016, showing the analysis of expenses in the statement. Exercise 16.18

PREPARATION OF A STATEMENT OF FINANCIAL POSITION

★ The summarised general ledger trial balance of Samuel Ltd, a manufacturing company, includes the fol-

lowing accounts at 31 December 2016:

Cash Deposits, at call Trade receivables Allowance for doubtful debts Sundry receivables Prepayments Raw materials inventory Work in progress Finished goods inventory Investments in listed companies Land, at valuation Buildings, at cost Accumulated depreciation – buildings Plant and equipment Accumulated depreciation – plant and equipment Leased assets Accumulated amortisation – leased assets Goodwill Accumulated impairment – goodwill Patents Trade creditors Sundry creditors and accruals Bank loans Debentures payable Other loans Lease liabilities Current tax payable Deferred tax liability Provision for employment benefits Provision for restructuring Provision for warranty Share capital Investments revaluation surplus Land revaluation surplus Retained earnings

Dr 175 000 36 000 1 744 000 $

PART 3 Presentation and disclosures

80 000

320 000 141 000 490 000 151 000 1 042 000 52 000 250 000 1 030 000 120 000 8 275 000 3 726 000 775 000 310 000 3 200 000 670 000 110 000 1 617 000 840 000 2 215 000 675 000 800 000 350 000 152 000 420 000 275 000 412 000 42 000 3 500 000 25 000 81 000 1 481 000 $17 791 000

$17 791 000

Additional information • Bank loans and ‘other loans’ are all repayable beyond 1 year. • $300 000 of the debentures is repayable within 1 year. • Lease liabilities include $125 000 payable within 1 year. • Investments in listed companies are long-term investments. • Provision for employment beneﬁts includes $192 000 payable within 1 year. • The planned restructuring is intended to be completed within 1 year. • Provision for warranty includes $20 000 estimated to be incurred beyond 1 year. Required

Prepare the statement of ﬁnancial position of Samuel Ltd at 31 December 2016 in accordance with IAS 1, using the captions that a listed entity is likely to use. Exercise 16.19

PREPARATION OF A STATEMENT OF FINANCIAL POSITION

★ The summarised general ledger trial balance of Lucas Ltd, an investment company, includes the following accounts at 31 December 2016: Cash at bank Deposits at call Dividends receivable Interest receivable Settlements receivable Trading securities Listed securities Deferred tax asset Settlements payable Interest payable Other payables Current tax payable Provision for employee benefits Deferred tax liability Share capital Revaluation surplus – investments Retained earnings

Dr 7 000 112 869 15 693 478 4 900 68 455 1 880 472 655

£2 090 522

10 253 280 83 242 752 56 414 1 368 024 376 090 278 384

£2 090 522

Additional information • Provision for employee beneﬁts includes £525 payable within 1 year. • The listed securities are held as long-term investments. • The deferred tax asset and deferred tax liability do not satisfy the criteria for offsetting in accordance with IAS 12 Income Taxes. Required

Prepare the statement of ﬁnancial position of Lucas Ltd at 31 December 2016 in accordance with IAS 1, using the captions that a listed company is likely to use. Exercise 16.20 ★

PREPARATION OF A STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

The general ledger trial balance of Oliver Ltd, a medical manufacturing and research company, includes the following accounts at 31 December 2016. Dr Sales revenue Interest income Gain on sale of plant Rental income Royalty income Other revenue Cost of sales

Cr $1 300 000 2 000 26 000 2 000 10 000 1 000

$820 000 (continued) CHAPTER 16 Financial statement presentation

Interest on borrowings Sundry borrowing costs Research expense Advertising expense Sales staff salaries Amortisation of patents Freight out Shipping supplies Depreciation on sales equipment Administrative salaries Legal and professional fees Office rent expense Insurance expense Depreciation of office equipment Stationery and supplies Miscellaneous expenses Income tax expense

33 000 1 000 51 000 25 000 97 000 7 000 32 000 16 000 5 000 72 000 13 000 30 000 14 000 16 000 5 000 2 000 31 000

Additional Information • Land was revalued by $100 000 during the year ended 31 December 2016. The related tax was $30 000. • Oliver Ltd uses the single statement format for the statement of proﬁt or loss and other comprehensive income. Required

Prepare the statement of proﬁt or loss and other comprehensive income of Oliver Ltd for the year ended 31 December 2016 in accordance with IAS 1, showing the analysis of expenses by function in the statement. Exercise 16.21 ★

PREPARATION OF A STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

The general ledger trial balance of Liam Ltd, an investment company, includes the following revenue and expense items for the year ended 31 December 2016: Dr Dividends from investments Distributions from trusts Interest on deposits Interest income from bank bills Income from dealing in securities and derivatives (held for trading purposes) Loss on credit derivatives (held for trading) Other income Interest expense Administrative salaries and wages Sundry administrative expenses Income tax expense

Cr €920 000 60 000 80 000 10 000 40 000

€ 60 000 10 000 15 000 30 000 45 000 280 000

Additional information • A gain of €70 000 on the revaluation of long-term investments was recognised in other comprehensive income and accumulated in the investment revaluation reserve. The related tax was €21 000. • No long-term investments were sold during the. • Liam Ltd uses the single statement format for the statement of proﬁt or loss and other comprehensive income. • Liam Ltd presents an analysis of expenses by function in the statement of proﬁt or loss and other comprehensive income. Required

Prepare the statement of proﬁt or loss and other comprehensive income of Liam Ltd for the year ended 31 December 2016, in accordance with IAS 1.

PART 3 Presentation and disclosures

Exercise 16.22 ★★

PRESENTATION OF ITEMS IN THE FINANCIAL STATEMENTS

Consider the following items for Daniel Ltd at 31 December 2016: (a) loss on revaluation of shares held for trading (b) ﬁnance expenses (c) aggregate amount of dividends declared and paid during the year (d) revaluation loss on building (not reversing any previous revaluation) (e) allowance for doubtful debts (f) transfer from retained earnings to general reserve (g) contractual commitments under an operating lease (h) deferred tax liability. Required

State whether each item is reported: 1. in the statement of financial position 2. in profit or loss in the statement of profit or loss and other comprehensive income 3. in other comprehensive income in the statement of profit or loss and other comprehensive income 4. in the statement of changes in equity 5. in the notes to the financial statements. Exercise 16.23 ★★

PREPARATION OF A STATEMENT OF FINANCIAL POSITION AND STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

The summarised general ledger trial balance of Ryan Ltd, a spare parts manufacturer, for the year ended 31 December 2016 is detailed below: Dr Sales of goods Share of profits of associates accounted for using the equity method Rent received Other income Cost of sales Distribution expenses Sales and marketing expenses Administration expenses Interest expense Other borrowing expenses Income tax expense (recognised in profit or loss) Cash at bank Deposits, at call Trade receivables Allowance for doubtful debts Other receivables Employee share plan loans Raw materials inventory Finished goods inventory Investment in associates accounted for using the equity method Land and buildings Accumulated depreciation – buildings Plant and equipment Accumulated depreciation – plant and equipment Investment in securities Goodwill Bank loans Other loans Trade payables Provision for employee benefits Provision for restructuring Provision for warranty Income tax payable

Cr £ 7 360 000 36 000 9 000 6 000

£ 4 978 000 143 000 1 367 000 420 000 74 000 6 000 141 000 20 000 150 000 740 000 24 000 154 000 260 000 53 000 1 190 000 375 000 426 000 61 000 2 100 000 940 000 60 000 1 450 000 111 000 810 000 820 000 153 000 62 000 40 000 30 000 (continued)

CHAPTER 16 Financial statement presentation

Deferred tax liability Issued capital Retained earnings, 1 January 2016 Dividends paid Investments revaluation reserve

100 000 2 920 000 760 000 150 000 15 000 £14 257 000

£14 257 000

Additional information • Employee share plan loans receivable include £50 000 due within 1 year. • £25 000 of bank loans is repayable within 1 year. • £400 000 of other loans is repayable within 1 year. • Provision for employee beneﬁts includes £110 000 payable within 1 year. • The planned restructuring is intended to be fully implemented within 1 year. • Provision for warranty is in respect of a 6-month warranty on certain goods sold. • The investments in securities were acquired during the current year and were revalued by £23 000 at the end of the reporting period. The related income tax was £8000. • The investments in securities are held as part of a long-term investment strategy. • Ryan Ltd uses the single statement format for the statement of proﬁt or loss and other comprehensive income and presents an analysis of expenses by function in the statement. Required

Prepare the statement of ﬁnancial position and statement of proﬁt or loss and other comprehensive income of Ryan Ltd for the year ended 31 December 2016 in accordance with IAS 1, using statement captions that a listed company is likely to use. PREPARATION OF A STATEMENT OF FINANCIAL POSITION, STATEMENT OF PROFIT OR LOSS AND ★★★ OTHER COMPREHENSIVE INCOME AND STATEMENT OF CHANGES IN EQUITY

Exercise 16.24

The summarised general ledger trial balance of Jacob Ltd, a manufacturing company, for the year ended 31 December 2016 is detailed below: Dr Sales of goods Interest income Cost of sales Distribution expenses Sales and marketing expenses Administration expenses Interest expense Other borrowing expenses Income tax expense Cash on hand Cash on deposit, at call Trade debtors Allowance for doubtful debts Other debtors Raw materials inventory Finished goods inventory Listed investments Land and buildings Accumulated depreciation – buildings Plant and equipment Accumulated depreciation – plant and equipment Patents Accumulated amortisation of patent Goodwill Bank loans Other loans Trade creditors

PART 3 Presentation and disclosures

Cr $4 469 000 6 000

$2 987 000 86 000 820 000 252 000 44 000 4 000 85 000 4 000 100 000 450 000 14 000 93 000 188 000 714 000 225 000 257 000 36 000 1 260 000 564 000 48 000 3 000 870 000 66 000 570 000 510 000

Provision for employee benefits Warranty provision Current tax payable Deferred tax liability Retained earnings, 1 January 2016 Dividends paid Land revaluation surplus Investments revaluation surplus Share capital

93 000 37 000 25 000 135 000 326 000 150 000

$8 637 000

50 000 42 000 1 691 000 $8 637 000

Additional information • Share were issued during 2016 for $120 000. • Share capital was $1 541 000 at 31 December 2015. • Of the $150 000 dividend, $30 000 was reinvested as part of a dividend reinvestment plan. • The balances of the Land Revaluation Surplus and the Investments Revaluation Surplus at 31 December 2015 were $15 000 credit and $35 000 credit, respectively. • The following revaluations were recognised during the year ended 31 December 2016: land revalued upward by $50 000 (related income tax $15 000) and investments were revalued upward by $10 000 (related income tax $3000). • The investments are held as part of a long-term investment strategy. • $30 000 of bank loans is repayable within 1 year. • $110 000 of other loans is repayable within 1 year. • The provision for employee benefits includes $62 000 payable within 1 year. • The warranty provision is in respect of a 12-month warranty given on certain goods sold. • Jacob Ltd uses the single statement format for the statement of profit or loss and other comprehensive income and classifies expenses by function within the statement. Required

Prepare the statement of ﬁnancial position, statement of proﬁt or loss and other comprehensive income and statement of changes in equity of Jacob Ltd for the year ended 31 December 2016 in accordance with the requirements of IAS 1, using statement captions that a listed company is likely to use.

CHAPTER 16 Financial statement presentation

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Janice Loftus

John Wiley & Sons, Ltd, 2016

Chapter 17: Statement of cash flows

Chapter 17: Statement of cash flows Discussion questions 1.

What is the purpose of a statement of cash flows?

Refer to section 17.1. The purpose of a statement of cash flows is to present information about changes in the cash and cash equivalents of an entity during the period classified by operating, investing and financing activities.

How might a statement of cash flows be used?

Refer to section 17.1. A statement of cash flows may be used by investors, creditors and other users of financial statements to assist in: (a) evaluating an entity’s ability to generate cash and cash equivalents (b) predicting future cash flows and (c) evaluating the accuracy of past predictions of future cash flows. Further, when used with other financial statements, the statement of cash flow may help users in: (i) evaluating an entity’s financial structure and its ability to meet its obligations and to pay dividends; (ii) evaluating an entity’s capacity to affect the amount, timing and certainty of future cash flows and to adapt to changing business opportunities and circumstances; (iii) evaluating the quality of an entity’s earnings by understanding the reasons for the difference between an entity’s profit and the cash and cash equivalents generated from operating activities, which are more readily identified when an entity uses the indirect method of presenting net cash flows from operating activities (iv) comparing the operating performance of different entities; this comparison is assisted by the fact that net operating cash flows reported in a statement of cash flows are unaffected by different accounting choices and judgments under accrual accounting (although they may be affected by decisions such as when to pay accounts). 3.

What is the meaning of cash equivalent?

Refer to section 17.2. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. They are held for the purpose of meeting short-term commitments and are not for investment or other purposes.

17.2

Solutions Manual to accompany Applying IFRS Standards 4e 4.

Explain the required classifications of cash flows under IAS 7.

Refer to section 17.3. Cash flows must be classified into cash flows from operating, investing and financing activities. Operating activities are the principal revenue-producing activities of an entity and any other activities that do not fall within investing and financing activities. Such cash flows include receipts from customers, and payments to suppliers and employees. Operating cash flows may also include interest and dividends received (though these items may be classified as investing) and interest paid (though this item may be classified as financing). Similarly, income tax paid is classified as operating unless it tax can be specifically identified with financing or investing activities. Investing activities are the acquisition and disposal of long-term assets (such as property, plant and equipment, subsidiaries, businesses and intangibles) and other investments not included in cash equivalents (such as shares in other entities). Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of an entity (such as the issue of new shares, buyback of shares, new borrowings, repayment of borrowings and the payment of dividends, though payment of dividends is sometimes classified as an operating activity).

What sources of information are usually required to prepare a statement of cash flows?

Refer to section 17.5. The required sources of information include the statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity and other accounting records that provide details such as the composition of account balances and non-cash financing and investment transactions. A statement of cash flows is usually prepared by firstly determining the net change in each class of assets, liabilities and equities over the relevant period from the comparative statements of financial position, and then further analysing the net amount of change in each to enable the relevant receipts and payments to be identified. For example, the net change in net plant and equipment needs to be analysed between cash flows for purchases of new plant and equipment, changes arising from the disposal of plant and equipment and depreciation charged. Changes in the amount of outstanding accounts payable for the purchase of plant and equipment also need to be taken into account, together with any acquisitions or disposals for non-cash consideration (such as the issue of shares or through long-term borrowings or by way of a finance lease).

6. Explain the differences between the presentation of cash flows from operating activities under the direct method and their presentation under the indirect method. Do you consider one method to be more useful than the other? Why? Refer to section 17.4.1. Under the direct method of presentation classes of operating cash receipts and payments are disclosed, such as receipts from customers and payments to suppliers and employees, to arrive at cash generated from operations. Under the indirect method the starting point is the profit before tax and this is first adjusted for the effects of transactions of a non-cash nature (such as depreciation, impairment of non-current assets), and then for any deferrals or accruals of past or future operating cash receipts or payments (e.g. increases or decreases in the amount of receivables or payables outstanding, changes in provisions) and items of income or expense included in the profit before tax that are associated with investing or financing activities (such as gain or loss on sale of plant and equipment). Both methods have their advantages and disadvantages. The direct method shows the gross inflows and outflows that will assist a user in predicting future cash inflows and outflows and allows a comparison to be made of cash receipts from customers with reported revenues. This comparison will assist in evaluating the quality of revenues. However, while the indirect method does not disclose the gross inflows and outflows arising from an entity’s operations, it does report a complete reconciliation of the operating profit before tax with the cash generated from operations. This is particularly useful in evaluating the quality of the earnings of © John Wiley and Sons, Ltd, 2016

17.3

Chapter 17: Statement of cash flows an entity, especially if earnings are being manipulated by management through varying accruals and provisions, such as a provision for restructuring.

The statement of cash flows is said to be of assistance in evaluating the financial strength of an entity, yet the statement can exclude significant non-cash transactions that can materially affect the financial strength of an entity. How does IAS 7 seek to overcome this issue?

Refer sections 17.6.2 and 17.6.3. IAS 7 seeks to overcome the problem referred to above by way of disclosure. Entities must disclose investing and financing transactions that do not involve cash flows, such as the acquisition of assets by means of a finance lease or by assuming other liabilities, or through an equity issue, conversion of debt to equity, refinancing of a long-term debt, and the payment of dividends through a share reinvestment scheme. In the case of changes in the financial strength of an entity that may arise from the purchase or sale of subsidiaries or other business units, IAS 7 requires the aggregate cash flows from the acquisition of subsidiaries and other business units and the aggregate cash flows from the disposal of subsidiaries and other business units to be reported in the investing section of the statement of cash flows. This reporting is then required to be supplemented by separate disclosure in the notes of the aggregate: • purchase or disposal consideration • the portion of the purchase or disposal consideration discharged by means of cash or cash equivalents • the amount of cash or cash equivalents in the subsidiary or business unit acquired or disposed of • the amount of the assets and liabilities other than cash or cash equivalents in the subsidiary or business unit acquired or disposed of, summarised by each major category. 8.

An entity may report profits over a number of successive years and still experience negative net cash flows from its operating activities. How can this happen?

This situation is typical of an entity that is growing in size, such that increases in receivables, inventories and prepayments exceed increases in accounts payable, accrued liabilities and provisions. The collection of cash from customers usually lags the payment to suppliers for purchases of goods and services. In a growth phase, this may generate negative operating cash flows because the entity incurs cash outflows to increase its working capital, particularly inventories, to accommodate expected increases in the volume of future sales.

An entity may report losses over a number of successive years and still report positive net cash flows from operating activities over the same period. How can this happen?

This situation is typical of an entity that has large non-cash charges to the statement of profit or loss and other comprehensive income, such as depreciation, impairment losses and increasing provisions, including provisions for employee benefits. It may also arise when an entity decreases in size by reducing the level of inventories where this is not accompanied by large cash outflows for restructuring or retrenchments.

10.

What supplementary disclosures are required when a consolidated statement of cash flows is being prepared for a group that has obtained or lost control of a subsidiary?

Refer to section 17.6.2. IAS 7 requires the separate reporting of the aggregate cash flows paid for the acquisition of subsidiaries, net of cash acquired, and the aggregate cash flows from the disposal of subsidiaries, net of cash disposed of, in the investing section of the statement of cash flows. This reporting must be supplemented by separate disclosure in the notes of the aggregate: • •

purchase or disposal consideration the portion of the purchase or disposal consideration discharged by means of cash or cash equivalents © John Wiley and Sons, Ltd, 2016

17.4

Solutions Manual to accompany Applying IFRS Standards 4e • •

the amount of cash or cash equivalents in the subsidiary acquired or disposed of and the amount of the assets and liabilities other than cash or cash equivalents in the subsidiary acquired or disposed of, summarised by each major category.

17.5

Chapter 17: Statement of cash flows

Exercises Exercise 17.1

CASH RECEIVED FROM CUSTOMERS

Calculate cash received from customers by Ruby Inc. for the year ended 31 December 2017. Increase in net accounts receivable from 31 December 2016 to 31 December 2017 = 220 000 – 180 000 = 40 000 Cash received from customers = Sales – Increase in net accounts receivable – Doubtful debts expense – Discount allowed = = 1 800 000 – 40 000 - $55 000 - $35 000 = $1 670 000 Accounts Receivable (net) Dr $ 180 000 Doubtful Debts Expense 1 800 000 Discount Allowed Cash at Bank (cash received) Balance 31 Dec 1 980 000

Balance b/fwd Sales Revenue

Exercise 17.2

Cr $ 55 000 35 000 1 670 000 220 000 1 980 000

CASH PAYMENTS TO SUPPLIERS

Calculate cash payments to suppliers for the year ended 31 December 2017.

Inventory Accounts payable

2016

2017

£ 170 000 50 000

£ 210 000 65 000

Increase (Decrease) £ 40 000 15 000

Cash payments to suppliers = Cost of goods sold + Increase in inventory – Increase in accounts payable = 1 700 000 + 40 000 – 15 000 = £1 725 000

17.6

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 17.3

INVESTING CASH FLOWS

Determine the amount of investing net cash outflows Navy Inc. would report in its statement of cash flows for the year ended 31 December 2017.

Purchase of land Purchase of plant Proceeds from sale of plant Net investing cash flows

Exercise 17.4

$ (200 000) (250 000) 42 000 $(408 000)

FINANCING CASH FLOWS

Determine the amount of net cash from financing activities Mustard Ltd would report in its statement of cash flows for the year ended 31 December 2017.

Proceeds from borrowings Issue of shares Dividends paid Net financing cash flows

$ 250 000 300 000 (200 000) $ 350 000

17.7

Chapter 17: Statement of cash flows Exercise 17.5 1. 2.

PREPARATION OF A STATEMENT OF CASH FLOWS

Using the indirect method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017. Prepare the operating section of the statement of cash flows using the direct method. Worksheet

Cash Trade receivables Investments in financial assets Plant Accumulated depreciation Trade accounts payable Interest payable Current tax payable Deferred tax liability Borrowings Share capital Retained earnings

2016 Dr $ $ 25 000 (12) 20 000 50 000 (2) 15 000 40 000 (3) 10 000 130 000 (11) 50 000 (45 000) 200 000 6 000 (4) 2 000 7 000 (6) 7 000 20 000 0 40 000 (9) 30 000 100 000 27 000 (10) 23 000 (8) 31 000 200 000

Operating activities Profit before tax Increase in trade receivables Decrease in trade payables Interest expense Gain on revaluation of financial investments Depreciation Cash generated from operations Interest paid Income taxes paid Net cash from operating activities Investing activities

Cr $

(7) 15000

(8) 8 000 (8) 3 000 (9) 30 000 (1) 132 000

(2) 15 000 (4) 2 000 (5) 14 000 (3) 10 000

(8) 8000 (8) 3 000 172 000

Purchase of plant

4 000 0 28 000 3 000 10 000 130 000 105 000 280 000

(1) 132 000

(7) 15 000 161 000

2017 $ 45 000 65 000 50 000 180 000 (60 000) 280 000

27 000 (5) 14 000 (6) 7000 (8) 31 000

132 000 (15 000) (2 000) 14 000 (10 000) 15 000 134 000 (21 000) (20 000)

79 000

93 000

(11) 50 000 50 000

(50 000) (50 000)

Financing activities Dividend paid Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

(10) 23 000 (23 000) 23 000 (23 000) (12) 20 000 25 000 $45 000

17.8

Solutions Manual to accompany Applying IFRS Standards 4e Explanations: (1) Profit before tax $132 000 (profit $101 000 + tax expense $31 000). Refer to explanation item (8) for income tax expense. (2) Increase in Trade receivables $15 000. (3) Gain on revaluation of financial assets recognised in profit. (4) Decrease in Trade accounts payable $2000. (5) Interest expense $14 000 as per additional information item (d). (6) Decrease in interest payable, which reflects a payment of interest in excess of the current period interest expense. (7) There were no disposals of plant; hence, the increase in accumulated depreciation must represent the depreciation for the year $15 000. (8) Income tax expense $31 000, refer additional information item (d) and increase in Current tax payable $8000 and Deferred tax liability $3000. (9) Borrowing of $30 000 settled through the issue of shares. This transaction does not involve a cash flow. (10) Dividend paid $23 000 (refer additional information). (11) There were no disposals of plant, hence the increase in the plant must represent the purchase of plant $50 000. (12) Increase in cash and cash equivalents. Black Inc. Statement of Cash Flows for the year ended 31 December 2017 $ Cash flows from operating activities Profit before tax 132 000 Interest expense 14 000 Depreciation of plant 15 000 Gain on revaluation of financial (10 000) assets Increase in trade receivables (15 000) Decrease in trade accounts (2 000) payable Cash generated from operations 134 000 Interest paid (21 000) Income tax paid (20 000) Net cash from operating activities 93 000 Cash flows from investing activities Purchase of plant (50 000) Net cash used in investing activities (50 000) Cash flows from financing activities Dividends paid (23 000) Net cash from financing activities (23 000) Net increase in cash and cash equivalents 20 000 Cash and cash equivalents at beginning of year 25 000 Cash and cash equivalents at end of year $45 000 b) Cash received from customers = Service revenue – increase in accounts receivable = $300 000 - $15 000 = $285 000 Revenue + Gain on Revaluation Expenses (excluding tax expense) = Profit before tax Hence, total expenses excluding income tax expense = Revenue + Gain on Revaluation –Profit before tax: Hence, total expenses excluding income tax expense = $300 000 +$10 000 - $132 000 = $178 000 © John Wiley and Sons, Ltd, 2016 17.9

Chapter 17: Statement of cash flows

$ 178 000 (15 000) (14 000) 149 000 2 000 151 000

Total expenses - depreciation - interest expense Expenses for supply of goods and services + decrease in accounts payable Cash paid for supply of goods and services

$ Cash flows from operating activities Cash collected from customers Cash paid for supply of goods and services Interest paid Income tax paid Net cash from operating activities

Exercise 17.6

285 000 (151 000) (21 000) (20 000) 93 000

PREPARATION OF A STATEMENT OF CASH FLOWS

Using the direct method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017.

2016

Cash Trade receivables Inventory Investments in shares Plant Accumulated depreciation Accounts payable Accrued interest Current tax payable Deferred tax liability Borrowings Share capital Investment revaluation reserve Retained earnings Receipts from customers Sales Increase in receivables Cash received

£ 30 000 46 000 30 000 35 000 125 000 (23 000) 243000 39 000 3 000 10 000 60 000 100 000 31 000 243 000

2017

Increase (decrease) £ £ 68 000 38 000 70 000 24 000 32 000 2 000 40 000 5 000 150 000 25 000 (35 000) 12 000 325000 43 000 5 000 12 000 1 500 100 000 100 000 3 500 60000 325 000

4 000 2 000 2 000 1 500 40 000 3 500 29 000

700 000 (24 000) 676 000

Payments to suppliers and employees Cost of sales Distribution costs 62 000 Administration costs 74 000

483 000

17.10

Solutions Manual to accompany Applying IFRS Standards 4e Depreciation (see explanation) Increase in inventory Increase in accounts payable Total payments Interest paid Interest expense Increase in accrued interest Interest paid Income tax paid Income tax expense Increase in tax payable Income tax paid Investments Revaluation gain net of tax Increase in deferred tax liability Increase in investments Borrowings Increase in borrowings Repayment of borrowings Cash proceeds from borrowing

(12 000)

124 000 2 000 (4 000) 605 000 6 000 (2 000) 4000 23 000 (2 000) 21 000 3 500 1 500 5 000 40 000 35 000 75 000

Explanations • As there were no disposals of plant, the increase in plant can be assumed to equal purchases of plant and depreciation expense is equal to the increase in accumulated depreciation. • The net increase in borrowings of £40 000 is determined after taking into account repayment of borrowings of £35 000, as per additional information item (e). Thus the proceeds of additional borrowings during the year can be calculate as £40 000 + £35 000 = £75. Denim Ltd Statement of Cash Flows for the year ended 31 December 2017 £ Cash flows from operating activities Receipts from customers Payments to suppliers and employees Cash generated from operations Interest paid Income tax paid Net cash from operating activities Cash flows from investing activities Purchase of plant Net cash used in investing activities Cash flows from financing activities Repayment of borrowings Proceeds from borrowings Dividend paid Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

676 000 (605 000) 71 000 (4 000) (21 000) 46 000 (25 000) (25 000) (35 000) 75 000 (23 000) 17 000 38 000 30 000 £68 000

17.11

Chapter 17: Statement of cash flows Exercise 17.7

PREPARATION OF A STATEMENT OF CASH FLOWS

1. Using the direct method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017, including a reconciliation of cash flows arising from operating activities to profit. 2. Using the indirect method, prepare the operating activities section of the statement of cash flows in accordance with IAS 7.

Cash Trade receivables Inventory Land (at valuation) Plant Accumulated depreciation Accounts payable – plant purchases Trade payables Accrued liabilities – interest Other accrued liabilities Current tax payable Provision for employee benefits Dividend payable Borrowings Deferred tax liability Share capital Revaluation surplus Retained earnings Operating activities Receipts from customers Payments to suppliers & employees

Gain on sale of plant Dividend income Interest expense Income tax paid Investing activities Purchase of plant Proceeds from sale of plant

Worksheet 2016 Dr £ £ 20 000 184 000 (1) 20 000 100 000 (2) 60 000 150 000 (9) 12 000 460 000 (11)145 000 (90 000) (13) 25 000 824 000

Cr £ (20) 2 000

(12) 85 000 (10) 55 000 (19) 22 000

50 000 (3) 17 000 12 000 45 000 (5) 2 000 30 000 38 000 195 000 (15) 90 000 58 000 (8) 23 000 350 000 12 000 34 000 (17) 124 000 824 000 3 580 000 (3 249 000)

(7) 4 000 (10) 55 000

16 000 4 000 (8 000) (4) (103 000) (6) 240 000 (21)

(4) 4 000 (6) 4 000 (7) 4 000 (18) 60 000 (9) 4 000 (16) 30 000 (9) 8 000 (21) 240 000

(1) 20 000 (2) 60 000 (3) 17 000 (5) 2 000 (14) 16 000

4 000 4 000

(19) 22 000 (12) 85 000 (14) 16 000

(8) 23 000

(11) 145 000 (13) 25 000

2017 £ 18 000 204 000 160 000 162 000 520 000 (120 000) 944 000 22 000 33 000 16 000 43 000 34 000 42 000 60 000 105 000 39 000 380 000 20 000 150 000 944 000 3 560 000

(3 269 000) 291 000 0 4 000 (4 000) (122 000) 169 000 (123 000) 76 000 (47 000)

Financing activities Repayment of borrowings Dividends

(16) 30 000 (18) 60 000 © John Wiley and Sons, Ltd, 2016

(15) 90 000 (17) 124 000

(90 000) (34 000) (124 000) 17.12

Solutions Manual to accompany Applying IFRS Standards 4e Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

(20)

(2 000) 20 000 £18 000

Explanations The calculation of cash receipts from customers is sales for the year £3 580 000. Payments to suppliers and employees is calculated as follows:

Cost of sales Distributions expenses Administrative expenses Other expenses

£'000 2 864 185 160 40 £3 249

(1) (2) (3) (4) (5) (6) (7) (8)

Increase in trade receivables £20 000. Increase in inventory £60 000. Decrease in trade payables (excludes plant purchases) £17 000. Increase in accrued interest £4000. Decrease in other accrued liabilities £2000. Increase in current tax payable £4000. Increase in provision for employee benefits £4000. Decrease in deferred tax liability related to amounts recognised in profit, calculated as £58 000 + recognised in OCI £4000 and accumulated in the Revaluation surplus (see item 9) - £39 000 = £23 000. (9) Land revaluation comprises: Increase in value of land £12 000; related deferred tax £4000 (refer additional information); revaluation gain (net) £8000. (10) Depreciation for year £55 000 (a non-cash expense included in the operating expenses used as the starting point for payments to suppliers and employees). This amount has been calculated as: the closing balance of accumulated depreciation £120 000 + accumulated depreciation on plant sold £25 000 – opening balance of accumulated depreciation £90 000 = £55 000. (11) Plant additions for year £145 000. This amount has been calculated as the difference between the closing balance of plant £520 000 + cost of plant sold £85 000 – opening balance of plant £460 000 = £145 000. (12) Cost of plant sold £85 000 (see additional information). (13) Accumulated depreciation on plant sold £25 000 (see additional information). (14) Gain on sale of plant £16 000 is excluded from cash receipts from operating activities; proceeds from sale of plant, which is provided in the additional information is reflected in the worksheet as the carrying amount of the plant sold = £85 000 – Accumulated depreciation £25 000 + gain on sale of plant £16 000 = £76 000. (There are no accounts receivable adjustments for the disposal of plant.) (15) Repayment of borrowings £90 000 (£195 000 - £105 000). (16) Increase in share capital £30 000 arose from the company’s dividend reinvestment scheme, a noncash adjustment (refer additional information). (17) Represents dividends declared out of profits for the year (£64 000 + £60 000 = £124 000). (18) Represents final dividend payable £60 000 (refer statement of financial position at 31 December 2017). The dividend paid of £34 000 represents the interim dividend of £64 000 – dividends re-invested £30 000. Note there was no dividend payable at 31 December 2016. (19) Increase in accounts payable for purchase of plant (refer additional information). (20) Decrease in cash and cash equivalents £2 000. (21) Profit for the year. 1) Aqua Ltd Statement of Cash Flows for the year ended 31 December 2017 £ Cash flows from operating activities © John Wiley and Sons, Ltd, 2016

17.13

Chapter 17: Statement of cash flows Receipts from customers Payments to suppliers and employees Cash generated from operations Dividends received Interest paid Income tax paid Net cash from operating activities Cash flows from investing activities Purchase of plant Proceeds from sale of plant Net cash used in investing activities Cash flows from financing activities

3 560 000 (3 269 000) 291 000 4 000 (4 000) (122 000) 169 000 (123 000) 76 000 (47 000)

Repayment of borrowings

(90 000)

Dividend paid Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

(34 000) (124 000) (2 000) 20 000 £18 000

2) Aqua Ltd Cash flows from Operating Activities for the year ended 31 December 2017 £ Cash flows from operating activities Profit before tax 343 000 Interest expense 8 000 Depreciation of plant 55 000 Gain on sale of plant (16 000) Increase in trade receivables (20 000) Increase in inventory (60 000) Decrease in trade accounts (17 000) payable Decrease in accrued liabilities – (2 000) other Increase in provision for 4 000 employee benefits Cash generated from operations 295 000 Interest paid (4 000) Income tax paid (122 000) Net cash from operating activities 169 000

17.14

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 17.8

PREPARING STATEMENT OF CASH FLOWS WITH NOTES

Using the direct method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017. 2. Prepare any notes to the statement of cash flows that you consider are required by IAS 7. 3. Prepare the operating activities section of the statement of cash flows using the indirect method of presentation in accordance with IAS 7 for the year ended 31 December 2017.

Worksheet 2016 Dr $ $ 16 000 (29) 6 000 40 000 (29) 30 000 110 000 (2) 7 000 (12 000) 2 000 (15) 1 000 194 000 (4) 6 000 13 000 230 000 (21) 60 000 600 000 (22) 150 000 (140 000) (25) 10 000 80 000 (13) 20 000 120 000 1 253 000

Cash at bank Cash deposits Accounts receivable Allowance for doubtful debts Interest receivable Inventory Prepayments Land Plant Accumulated depreciation Investment in associates Brand names Accounts payable

180 000

Accrued liabilities

85 000

Current tax payable Current portion of long-term borrowings Borrowings (non-current)

40 000 20 000 98 000

Deferred tax liability Employee benefits Share capital Retained earnings

35 000 40 000 500 000 255 000

Cr $

2017

(3)

4 000

(5)

4 000

(24) 50 000 (9) 50 000 (12) 8 000 (10) 30 000 (6) 10 000 (23) 6 000 (17) 1 000 (7) 6 000 (19) 3 000

(27) 20 000

(18) 47 000 (28) 70 000

(26) 10 000 (22) 50 000 (20) 5 000 (8) 3 000 (28) 30 000 (1) 157 000

(1) 157 000 (2) (3)

7 000

4 000 (4) 6 000

(5) 4 000 (6) 10 000 (7) 6 000 (8) 3 000 (9) 50 000 (10) 30 000 (11) 8 000 (13) 20 000 (14) 2 000 (16) 21 000

196 000 92 000 43000 20 000 138 000 40 000 43 000 530 000 295 000 1 397 000

1 253 000 Operating activities Profit before tax Increase in accounts receivable Increase in allowance for doubtful debts Increase in inventory Decrease in prepayments Increase in trade payables Increase in accrued liabilities Increase in employee benefits Depreciation expense Impairment of brand names Gain on sale of plant Share of profits of associate Interest income Interest expense

22 000 70 000 117 000 (16 000) 3 000 200 000 9 000 290 000 700 000 (180 000) 92 000 90 000 1 397 000

157 000 (7 000) 4 000 (6 000) 4 000 10 000 6 000 3 000 50 000 30 000 (8 000) (20 000) (2 000) 21 000 17.15

Chapter 17: Statement of cash flows Cash generated from operations Dividend received Interest received Interest paid Income taxes paid

285 000 (12) 8 000 (14) 2 000 (17) 1 000 (19) 3 000 (20) 5 000 304 000

Net cash from operating activities Investing activities Purchase of land Purchase of plant Proceeds from sale of plant

(23) 6 000 (24) 50 000 (11) 8 000 64 000

Financing activities Proceeds from borrowings Repayment of borrowings Dividend paid Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

43 000 (15) 1 000 (16) 21 000 (18) 47 000 112 000 (21) 60 000 (22) 100 000 (25) 10 000 170 000

(26) 10 000

10 000

(27) 20 000 (28) 40 000 60 000 (29)

242 000 8 000 1 000 (20 000) (39 000) 192 000 (60 000) (94 000) 48 000 (106 000) 10 000 (20 000) (40 000) (50 000) 36 000 56 000 92 000

Explanations (1) Profit before tax $157 000. (2) Increase in accounts receivable $7000. (3) Increase in allowance for doubtful debts $4000. Thus combing (2) and (3), net receivables increased by $3000. (4) Increase in inventory $6 000. (5) Decrease in prepayments $4000. (6) Increase in accounts payable (excluding payable arising from the purchase of plant) $10,000. (7) Increase in accrued liabilities (other than accrued interest) $ 6000. (8) Increase in provision for employee benefits $3000. (9) Depreciation for year $50 000. (10) Impairment of brand names $30 000. (11) Gain on sale of plant $8000. (12) Dividend received from associate $8000. Dividends received must be disclosed separately per IAS 7 para. 31. (13) Share of profit of associate $20 000. (14) Interest income $2000. (15) Increase in interest receivable $1000. (16) Interest expense $21 000. (17) Increase in accrued liabilities relating to interest payable $1000. Refer to additional information item 8. (18) Income tax expense $47 000. (19) Increase in income tax payable $3000. (20) Increase in deferred tax liability $5000. This increment has been recognised as the deferred component of income tax expense per additional information note 9, as there were valuation gains or losses recognised directly in equity during 2013. (21) Purchase of land $60 000 (refer to additional information item 3). (22) Purchase of plant $150 000; this includes $50 000 purchase financed by the vendor; hence, $50 000 of the increase in plant and the increase in borrowings does not involve a cash flow. (23) Increase in accounts payable arising from the purchase of plant $6000. Refer to additional information item7. (24) Cost of plant disposed $50 000. Refer to additional information item 5.

17.16

Solutions Manual to accompany Applying IFRS Standards 4e (25)

(26)

(27) (28) (29)

Accumulated depreciation on plant disposed $10 000; note the proceeds on sale is determined by adding the gain on sale $8000 to the carrying amount of the plant sold ($50 000 – $10 000) = $48 000. Proceeds from borrowings $10 000. This is determined by difference: Non-current borrowings at end of year $138 000 – vendor finance borrowing $50 000 + current portion of long-term borrowing $20 000 (reclassified as current; the prior year balance is assumed to have been paid during the year) – non-current borrowings at beginning of year $98 000 = $10 000. $20 000 repayment of borrowings. Refer to (26) above. Dividends paid in cash during the year $40 000; dividends re-invested $30 000 (adjusted against share capital) (refer additional information point 10). Increase in cash and cash equivalents $36 000. This comprises: Increase in cash at bank $6000 + increase in cash deposits $30 000.

Calculations for direct method of presenting cash flows from operating activities Receipts from customers: $ Sales 1 780 000 Increase in accounts receivable (7 000) Bad debts written off (2 000) Discount allowed (8 000) Cash received from customers 1 763 000

Payments to suppliers and employees: Cost of sales Salaries and wages Other expenses (excluding impairment) Increase in inventory Decrease in prepayments Increase in accounts payable (excluding payable relating to the purchase of plant) Increase in accrued liabilities (other than interest) Increase in employee benefits

$ 1 030 000 352 000 156 000 6 000 (4 000) (10 000) (6 000) (3 000) 1 521 000

1. Blue Ltd Statement of Cash Flows for the year ended 31 December 2017 $ Cash flows from operating activities Cash received from customers Payment to suppliers and employees Cash generated from operations Interest received Dividend received Interest paid Income tax paid Net cash from operating activities

1 763 000 (1 521 000) 242 000 1 000 8 000 (20 000) (39 000) 192 000

Cash flows from investing activities Purchase of land

(60 000)

17.17

Chapter 17: Statement of cash flows Purchase of plant Proceeds from sale of plant Net cash used in investing activities

(94 000) 48 000 (106 000)

Cash flows from financing activities Proceeds from borrowings Repayment of borrowings Dividends paid Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

10 000 (20 000) (40 000) (50 000) 36 000 86 000 $122 000

2. Notes Cash and cash equivalents comprise:

Cash at bank Cash deposits

2017 $ 22 000 70 000 $92 000

2016 $ 16 000 40 000 $56 000

Notes to the statement of cash flows

Non-cash financing and investing activities; (a) During the year ended 31 December 2017 plant acquired at a cost of $50 000 was financed by the vendor of the plant. (b) During the year ended 31 December 2017 dividends amounting to $30 000 were re-invested under the company’s dividend re-investment scheme. 3. Cash flows from operating activities: indirect method $ Cash flows from operating activities Profit before tax 157 000 Depreciation 50 000 Interest income (2 000) Interest expense 21 000 Impairment of brand names 30 000 Gain on sale of plant (8 000) Share of profits of associate (20 000) Increase in accounts receivable (3 000) Increase in inventory (6 000) Decrease in prepayments 4 000 Increase in accounts payable (excluding payable 10 000 relating to the purchase of plant) Increase in accrued liabilities 6 000 Increase in provision for employee benefits 3 000 Cash generated from operations 242 000 Interest received 1 000 Interest paid (20 000) © John Wiley and Sons, Ltd, 2016 17.18

Solutions Manual to accompany Applying IFRS Standards 4e Dividend received Income tax paid Net cash from operating activities

Exercise 17.9

8 000 (39 000) 192 000

CASH RECEIVED FROM CUSTOMERS

Calculate cash received from customers for the year ended 31 December 2017.

Accounts receivable

2016 € 200 000

2017 € 240 000

Increase € 40 000

Cash received from customers = Sales – Increase in accounts receivable – Bad debts written-off – Discounts allowed = 2 100 000 – 40 000 – 50 000 – 17 000 = € 1 993 000

Exercise 17.10

PREPARATION OF A STATEMENT OF CASH FLOWS

Using the indirect method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017. Worksheet 2016 Dr Cr € € € 40 000 (2) 15 000 47 000 (3) 33 000 80 000 (4) 10 000 130 000 (6) 90 000 (5) (12 000) (5) (28 000) (45 000) (5) 28 000 (7) 43 000 252 000

Cash Trade receivables Land Plant Accumulated depreciation

Trade accounts payable Current tax payable Deferred tax liability Share capital Retained earnings

23 000 52 000 (9) (22 000)

(8) 42 000

(10) 3 000 (11) 50 000 (1) 30 000 (1) 90 000 (12) 47 000 - (10) 3 000 (4) 10 000 252 000 100 000 77 000

Investment revaluation surplus

Operating activities Profit before tax Increase in accounts receivable Gain on disposal of plant Increase in accounts payable Depreciation of plant Cash generated from operations Income tax paid

(1) 90 000 (3) 33 000 (5) (3 000) (8) 42 000 (7) 43 000

(1) 30 000 (9) 22 000

2017 € 55 000 80 000 90 000 180 000 (60 000) 345 000 65 000 30 000 3 000 150 000 90 000 7 000 345 000 90 000 (33 000) (3 000) 42 000 43 000 139 000 (52 000)

17.19

Chapter 17: Statement of cash flows Net cash from operating activities Investing activities Purchase of plant Proceeds from sale of plant

87 000 (6) 90 000 (5) 15 000

Financing activities Proceeds from share issue (11) 50 000 Dividends paid (12) 47 000 Net cash from financing activities Net increase in cash and cash equivalents (2) Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

(90 000) 15 000 (75 000) 50 000 (47 000) 3 000 15 000 40 000 $55 000

Explanations: (1) Profit before tax €90 000 (comprising profit for period €60 000 + income tax expense €30 000. € (2) Increase in cash €15 000. (3) Increase in accounts receivable €33 000. (4) The increase of €10 000 in land results from a revaluation of land recognised in other comprehensive income and accumulated in equity. (5) The plant with an original cost of €40 000 had a carrying amount of €12 000. Thus the accumulated depreciation must have been €28 000 (€40 000 - €12 000). The gain on disposal was €3000, being the difference between the cash proceeds of €15 000 and the carrying amount of €12 000. The gain on disposal is added back to profit in calculating cash generated from operations. The sale proceeds is an investing cash flow. (6) The change in the cost of plant, after allowing for the disposal of plant costing €40 000 represents purchase of plant: €180 000 - (€130 000-€40 000) = €90 000. (7) The change in accumulated depreciation, after allowing for the reduction in accumulated depreciation for plant that was sold, represents the depreciation for the year: €60 000 – (€45 000 - €28 000) = €43 000. (8) Increase in trade accounts payable €42 000. (9) Decrease in current tax payable €32 000. (10) As the revaluation of land increased the reserve surplus by €7000, the corresponding tax effect must be €3000 (€10 000 - €7000). This fully explains the increase in the deferred tax liability. (11) Increase in share capital €50 000 represents proceeds from share issue. (12) Dividends paid €47 000.

Schwarz GmbH Statement of Cash Flows for the year ended 31 December 2017 € Cash flows from operating activities Profit before tax Depreciation of plant Increase in trade receivables Gain on disposal of plant Increase in trade accounts payable Cash generated from operations Income tax paid Cash from operating activities

90 000 43 000 (33 000) (3 000) 42 000 139 000 (52 000) 87 000

Cash flows from investing activities Purchase of plant Proceeds from sale of plant Net cash used in investing activities

(90 000) 15 000 (75 000)

17.20

Solutions Manual to accompany Applying IFRS Standards 4e

Cash flows from financing activities Proceeds from share issue Dividends paid Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

Exercise 17.11

50 000 (47 000) 3 000 15 000 40 000 $55 000

NET INVESTING CASH FLOWS

Prepare the investing section of the statement of cash flows for Global Group for the year ended 31 December 2017.

Land, at independent valuation Plant, at cost Accumulated depreciation Investments Goodwill

2016 € 100 000 70 000 (20 000) 30 000

Dr € (1) 20 000 (2) 10 000

(6) 8 000 (3) 8 000 (4) 7 000

25 000

(5) 5 000

Deferred tax liability

2017 € 120 000 80 000 (28 000) 45 000 20 000

(1) 6 000 (3) 2 000

Land revaluation surplus Investments revaluation reserve Impairment of goodwill Depreciation expense

Cr €

20 000 5 000

(1) 14 000 (3) 6 000

34 000 11 000

(2) 10 000 (4) 7 000

(10 000) (7 000)

(5) 5 000 (6) 8 000

Investing activities Purchase of plant Purchase of investments

Explanations: (1) There are no acquisitions or disposals of land. Hence, the increase results from the revaluation of land at independent valuation amounting to €20 000. The credit adjustments are to deferred tax liability €6000, per additional information item (c), and to land revaluation surplus €14 000 for the revaluation increment, net of tax (calculated as €20 000 -€6000). (2) There are no disposals of plant; hence, the increase in plant represents additions amounting to €10 000. (3) There were no disposals of investments. The investments revaluation reserve has increased by €6000 and there is related increase in deferred tax liability of €2000. Hence the revaluation of investments must have amounted to €8000. (4) Since investments increased by €15 000 the difference is accounted for by the purchase of additional investments €7000 (15 000 – 8000). (5) The change in goodwill is wholly accounted for by the impairment write-off €5000. (6) For completeness, the increase in accumulated depreciation and the corresponding depreciation expense are illustrated. The depreciation expense reflects a non-cash expense included in profi for the period. © John Wiley and Sons, Ltd, 2016

17.21

Chapter 17: Statement of cash flows Hence, investing activities comprise: € (10 000) (7 000) $(17 000)

Purchase of plant Purchase of investments Net investing cash flows

Exercise 17.12

NET FINANCING CASH FLOWS

Prepare the financing section of the statement of cash flows for Jade Inc. for the year ended 31 December 2017. 2016 $

Dr $ (2) 80 000

Cr $

Borrowings

100 000

(1) 20 000

Share capital

200 000

Retained earnings

75 000

(2) 80 000 (3) 50 000 (5) 30 000 (6) 20 000 (4) 90 000

Property

Operating activities Profit for year

(5) 70 000

2017 $

210 000 250 000 95 000

(4) 90 000

Financing activities Repayment of borrowings Proceeds from borrowings Dividends - cash Share issue - cash

(1) 20 000 (3) 50 000 (5) 40 000 (6) 20 000

(20 000) 50 000 (40 000) 20 000

Explanations: (1) Represents repayment of borrowings $20 000 (refer additional information). (2) Vendor finance $80 000 for the acquisition of property. This is a non-cash transaction (refer additional information). (3) New cash borrowings $40 000 - plug figure (210 000 – 80 000 – 100 000 + 20 000). (4) Represents profit for year $90 000 (refer additional information). (5) Dividends comprise dividends settled under share investment scheme ($30 000) and paid in cash ($40 000). (6) Calculated by difference, share issue for cash $20 000 (250 000 – 30 000 – 200 000). Hence, financing activities comprise: Financing activities Proceeds from borrowings Repayment of borrowings Share issue Dividends paid Net financing cash flows

$ 50 000 (20 000) 20 000 (40 000) $ 10 000

17.22

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 17.13

1. 2.

CASH RECEIPTS FROM CUSTOMERS AND CASH PAID TO SUPPLIERS AND EMPLOYEES

Calculate the amount of cash received from customers during the year ended 31 December 2017. Calculate the amount of cash paid to suppliers and employees during the year ended 31 December 2017.

Accounts receivable Inventories Prepaid expenses Accounts payable for inventory Provision for employee benefits Accruals – Interest Accruals – Other

Cash received from customers =

Cash paid to suppliers and Employees: = Cost of goods sold + Expenses

2016

2017

£ 40 000 32 000 1 000 15 000 5 000 700 3 300

£ 50 000 34 000 3 000 16 000 5 500 850 2 950

Increase (Decrease) £ 10 000 2 000 2 000 1 000 500 150 (350) £ 600 000 (10 000) $590 000

Sales - Increase in receivables

£ 480 000 - Depreciation - Interest

75 000 (5 000) (2 000)

+ Increase in inventories + Increase in prepayments - Increase in accounts payable - Increase in provision for employee benefits + Decrease in other accruals (excluding interest)

Exercise 17.14

68 000 2 000 2 000 (1 000) (500) 350 £550 850

PREPARATION OF A STATEMENT OF CASH FLOWS

Using the indirect method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017.

Cash Accounts receivable - sale of plant Accounts receivable - other Prepayments Inventory Land Plant

Worksheet 2016 Dr € € 96 000 (18) 22000 147 000 20 000 60 000 (4) 44 000 40 000 368 000 (14) 72 000

Cr € (23) 47 000 (2) (3)

6 000 5 000

(16) 20 000

2017 € 49 000 22 000 141 000 15 000 104 000 40 000 420 000 17.23

Chapter 17: Statement of cash flows Accumulated depreciation Deferred tax asset

(45 000) 20 000 706 000

(17) 5 000 (13) 4 000

Accounts payable - purchase of plant Accounts payable - other Accrued liabilities - interest Accrued liabilities - other Current tax payable Dividend payable Borrowings Share capital Retained earnings

34 000 6 000 3 000 33 000 24 000 56 000 173 000 335 000 42 000

(15) 34 000

(8) 30 000

(5) 44 000 (10) 1 000 (6) 5 000 (12) 7 000 (22) 6 000

(11) 46 000 (21) 84 000

(19) 4 000 (20) 10 000 (1) 138 000

706 000 Operating activities Profit before tax Decrease in accounts receivable Decrease in prepayments Increase in inventory Increase in accounts payable Increase in accrued liabilities Depreciation Gain on sale of plant Interest expense Interest paid Income tax paid

Financing activities Borrowings Dividends

50 000 4 000 38 000 31 000 50 000 177 000 345 000 50 000 745 000

(1) 138 000 (2) 6 000 (3) 5 000 (4) 44 000 (5) 44 000 (6) 5 000 (8) 30 000 (7) 6 000 234 000 (10) 1 000 (12) 7 000

7 000

(9)

242 000

51 000 (9) 6 000 (11) 46 000 (13) 4 000 107 000

(16) 20 000 (7) 7 000 27 000

(14) 72 000 (15) 34 000 (17) 5 000 (18) 22 000 133 000

Investing activities Purchase of plant Proceeds from sale of plant

(70 000) 24 000 745 000

(19) 4 000 (20) 10 000 14 000

Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

138 000 6 000 5 000 (44 000) 44 000 5 000 30 000 (7 000) 6 000 183 000 (5 000) (43 000) 135 000

(106 000) (106 000)

4 000 (21) 84 000 (22) 6 000 90 000 (23)

(80 000) (76 000) (47 000) 96 000 49 000

Explanations (1) Profit before tax €138 000, being profit €92 000 + income tax expense €46 000. (2) Decrease in net accounts receivable (excluding receivables arising from the sale of plant) €6000. (3) Decrease in prepayments €5000. (4) Increase in inventory €44 000. (5) Increase in accounts payable (excluding accounts payable arising from the purchase of plant) €44 000. (6) Increase in accrued liabilities (excluding interest accrued liabilities) €5000. © John Wiley and Sons, Ltd, 2016

17.24

Solutions Manual to accompany Applying IFRS Standards 4e Gain on sale of plant €7000. Proceeds $22 000 – carrying amount of plant sold €15 000 = € 7000. Refer also to explanation items (16), (17) and (18). (8) Depreciation for the year €30 000. (9) Adjustment for interest expense €6000. (10) Increase in accrued interest; note that interest paid €5000 = the interest expense €6000 – increase in accrued interest €1000. (11) Income tax expense for year €46 000. Refer also to explanation item (1). (12) Increase in current tax payable €7000. (13) Increase in deferred tax asset €4000. Income tax expense comprises the current component of income tax expense and the movement in deferred tax accounts, unless recognised directly in equity. (14) Plant additions for year €72 000. Refer additional information. (15) Decrease in plant accounts payable €34 000. (16) Cost of plant sold €20 000. (17) Accumulated depreciation on plant sold €5000. (18) Increase in accounts receivable arising from sale of plant €22 000; hence, there is no cash received in the current year arising from the sale of plant. (19) Increase in borrowings €4000. In the absence of other information it is assumed there are no loan repayments. (20) Dividends reinvested as share capital €10 000 (refer additional information). (21) Dividends declared out of profits for the year €84 000. (22) Decrease in dividend payable €6000. Note dividends paid comprises dividend payable 31 December 2016 €56 000 + Interim dividend €34 000 – Reinvested dividends €10 000 = €80 000. (23) Decrease in cash €47 000. Note that the doubtful debts expense is not used to calculate net cash from operating activities under the indirect method. It is a component of the movement in net receivables. (7)

French Fashion Company Statement of Cash Flows for the year ended 31 December 2017 € Cash flows from operating activities Profit before tax Interest expense Depreciation of plant Gain on sale of plant Decrease in accounts receivable Increase in inventory Decrease in prepayments Increase in accounts payable Increase in accrued liabilities Cash generated from operations Interest paid Income tax paid Net cash from operating activities

138 000 6 000 30 000 (7 000) 6 000 (44 000) 5 000 44 000 5 000 183 000 (5 000) (43 000) 135 000

Cash flows from investing activities Purchase of plant Net cash used in investing activities

(106 000) (106 000)

Cash flows from financing activities Proceeds from borrowings Dividends paid Net cash from financing activities Net decrease in cash and cash equivalents

4 000 (80 000) (76 000) (47 000)

17.25

Chapter 17: Statement of cash flows Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

Exercise 17.15 1. 2.

96 000 €49 000

PREPARATION OF STATEMENT OF CASH FLOWS

Using the direct method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017. Prepare the operating activities section of the statement of cash flows using the indirect method of presentation.

Worksheet 2016 Dr $ $ 45 000 69 000 (2) 38 000 (3 000) (1) 2 000 45 000 (4) 22 000 53 000 (8) 7 000 187 000 (10) 38 000 (35 000) 361 000

Cash Trade receivables Allowance for doubtful debts Inventory Investments Plant Accumulated depreciation Accounts payable Accrued interest Current tax payable Deferred tax

65 000 5 000 15 000 30 000

Borrowings Share capital Investment revaluation reserve Retained earnings

80 000 100 000 2 000 64 000 361 000

Operating activities Receipts from customers

Cash generated from operations Interest paid Income taxes paid

(14) 33 000

(774 000) (5) 10 000 (3) (76 000) 5 000 (11) 18 (96 000) 000 89 000 (7 000) (6) 2 000 (24 000) (7) 3 000 (9) 5 000 58 000 (13)

Net cash from operating activities Investing activities Purchase of plant Net cash used in investing activities Financing activities Borrowings Dividend paid Net cash used in financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year

(11) 18 000 (5) 10 000 (6) 2 000 (7) 3 000 (8) 2 000 (9) 5 000 (12) 20 000

1 035 000

Payments to suppliers and employees

Cr $ (15) 10 000 (1) 2 000 (2) 5 000

(8) 5 000 (13) 58 000

(2) 33 000 (3) 5 000 (4) 22 000

75 000 7 000 18 000 37 000 100 000 100 000 7 000 89 000 433 000

997 000

(935 000) 62 000 (5 000) (16 000) 41 000 (10) 38 000

(12) 20 000

2017 $ 35 000 105 000 (6 000) 67 000 60 000 225 000 (53 000) 433 000

(14) 33 000 (15)

(38 000) (38 000) 20 000 (33 000) (13 000) (10 000) 45 000 17.26

Solutions Manual to accompany Applying IFRS Standards 4e Cash and cash equivalents at end of year

$35 000

Explanations (1) The bad debt write-off does not affect the movement in net receivables. (2) The increase in net receivables $33 000 comprises the increase in gross receivables of $38 000 net of increase in allowance for doubtful debts is $5000. (3) The doubtful debts expense is $5000. Refer additional information. The doubtful debts expense is deducted from sales revenue in the calculation of cash collected from customers because it is a component of the movement in net receivables that does not represent cash collected from customers. The doubtful debts expense is deducted from administration expenses in calculating cash paid to suppliers and employees. (4) Increase in inventory $22 000. (5) Increase in accounts payable $10 000. (6) Increase in accrued interest $2 000. (7) Increase in current tax payable $3000. (8) Deferred tax on revaluation of investments $2000. The revaluation gain in the statement of comprehensive income is net of tax. As there were no acquisitions or disposals of investments during the year, the increase in investments, $7000, is the revaluation increment. The related deferred tax amount is the difference between the revaluation increment and the revaluation gain ($7000 - $5000). (9) Deferred tax included in income tax expense for the year $5000 (other movement in deferred tax for the year). (10) Purchase of plant $38 000 (there are no disposals, refer additional information). (11) Depreciation for year $18 000. As expenses are classified by function in the statement of comprehensive income, the depreciation expense is not shown as a separate item. It must be deducted from expenses in the calculation of cash paid to suppliers of goods and services. (12) New borrowings $20 000 (in the absence of other information, this has been calculated as the difference between borrowings at 31 December 2016 and at 31 December 2017). (13) Profit for the year $58 000. (14) Dividends paid $33 000 (refer additional information). (15) Decrease in cash $10 000.

1) Bronze Inc. Statement of Cash Flows for the year ended 31 December 2017 $ Cash flows from operating activities Receipts from customers Payments to suppliers and employees Cash generated from operations Interest paid Income tax paid Net cash from operating activities Cash flows from investing activities Purchase of plant Net cash used in investing activities © John Wiley and Sons, Ltd, 2016

997 000 (935 000) 62 000 (5 000) (16 000) 41 000 (38 000) (38 000) 17.27

Chapter 17: Statement of cash flows Cash flows from financing activities Proceeds from borrowings Dividend paid Net cash used in financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

20 000 (33 000) (13 000) (10 000) 45 000 $35 000

2) Cash flows from operating activities presented using the indirect method $ Cash flows from operating activities Profit before tax Interest expense Depreciation expense Increase in net receivables Increase in inventories Increase in accounts payable Cash generated from operations Interest paid Income tax paid Net cash from operating activities

Exercise 17.16 1. 2.

82 000 7 000 18 000 (33 000) (22 000) 10 000 62 000 (5 000) (16 000) 41 000

PREPARATION OF STATEMENT OF CASH FLOWS INFORMATION

Prepare statement of cash flows using the indirect method of presentation of operating activities. Prepare the operating activities section of the statement of cash flows using the direct method of presentation.

Deposits at call Accounts receivable Allowance for doubtful debts Inventory Prepayments Land Buildings Accumulated depreciation Plant Accumulated depreciation

Accounts payable

Worksheet 2016 Dr € € 19 000 (22) 11 000 200 000 (2) 71 000 (19 000) (3) 4 000 654 000 (4) 16 000 52 000 (5) 3 000 400 000 1 175 000 (14) 675 000 (200 000) 850 000 (15) 160 000 (375 000) (17) 50 000 2 756 000 553 000 © John Wiley and Sons, Ltd, 2016

Cr €

(6) 35 000 (16) 70 000 (6) 127 000

(8) 17 000

2017 € 30 000 271 000 (15 000) 670 000 55 000 400 000 1 850 000 (235 000) 940 000 (452 000) 3 514 000 570 000 17.28

Solutions Manual to accompany Applying IFRS Standards 4e Interest payable Dividend payable Current tax payable Borrowings Deferred tax liability Share capital Retained earnings

25 000 205 000 70 000 900 000 12 000 800 000 191 000

(9) 250 000 (20) 430 000

(11) 5 000 (21) 25 000 (12) 7 000 (18) 400 000 (13) 4 000 (19) 200 000 (1) 780 000

291 000 3 514 000

2 756 000 Operating activities Profit before tax Increase in accounts receivable Decrease in allowance for doubtful debts Increase in inventory Increase in prepayments Increase in accounts payable Interest expense Depreciation expense Gain on sale of plant Cash generated from operations Interest paid Income taxes paid Net cash from operating activities Investing activities Purchase of buildings Purchase of plant Proceeds from sale of plant Net cash used in investing activities Financing activities Proceeds from borrowings Proceeds from share issue Dividends paid Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at 31 December 2017

(1) 780 000 (2) 71 000 (3) 4 000 (4) 16 000 (5) 3 000

(16) 70 000 (7) 18 000 88 000 (18) 400 000 (19) 200 000 (21) 25 000 625 000

780 000 (71 000) (4 000)

(7) 18 000 112 000 (10) 70 000 (9) 250 000

(16 000) (3 000) 17 000 70 000 162 000 (18 000) 917 000 (65 000) (239 000)

320 000

613 000

(14) 675 000 (15) 160 000 (17) 50 000

(675 000) (160 000)

(8) 17 000 (10) 70 000 (6) 162 000 1 029 000 (11) 5 000 (12) 7 000 (13) 4 000 1 045 000

30 000 230 000 77 000 1 300 000 16 000 1 000 000

885 000

(20) 430 000 430 000 (22)

38 000 (797 000) 400 000 200 000 (405 000) 195 000 11 000 19 000 30 000

Explanations (1) Profit before income tax $780 000. (2) Decrease in accounts receivable $20 000. (3) Decrease in allowance for doubtful debts $4000. Considered with item (2), net receivables decreased by $16 000. (4) Increase in inventory $16 000. (5) Increase in prepayments $3000. (6) Depreciation of buildings $35 000 (able to be calculated by difference, as there are no disposals of buildings); depreciation of plant $127 000 (see additional information, point 3). Total depreciation expense = $162 000. (7) Gain on sale of plant $18 000 (refer statement of comprehensive income). (8) Increase in accounts payable $17 000. (9) Income tax expense $250 000. (10) Interest expense $70 000 (refer statement of comprehensive income). © John Wiley and Sons, Ltd, 2016 17.29

Chapter 17: Statement of cash flows (11) (12) (13) (14) (15) (16) (17)

(18) (19) (20) (21) (22)

Increase in interest payable $5000. Increase in current tax payable $7000. The increase in deferred tax liability $4000 is recognised as income tax expense per additional information note 5. Buildings additions $675 000 (calculated by difference as there are no disposals). Plant additions $160 000 (refer additional information point 3). Plant disposals $70 000 (refer additional information point 3). Accumulated depreciation on disposals $50 000 (refer additional information point 3). Note that proceeds from sale of plant is then calculated as the sum of the carrying amount of plant sold, $20 000 ($70 000 - $50 000) and the gain on sale $18 000 = $38 000. Proceeds from borrowings $400 000 (refer additional information point 6); this amount accounts for the movement in the amount of borrowings between 2012 and 2013. Increase in share capital $200 000 (refer additional information point 7). Dividends for year $430 000 ($200 000 + $230 000). Increase in final dividend payable $25 000. Cash and cash equivalents comprise deposits on call $11 000.

Braun GmbH Statement of Cash Flows for the year ended 31 December 2017 $ Cash flows from operating activities Profit before tax Depreciation Interest expense Gain on sale of plant Increase in accounts receivable (net) Increase in inventory Increase in prepayments Increase in accounts payable Cash generated from operations Interest paid Income tax paid Cash flows from investing activities Purchase of plant Purchase of buildings Proceeds from sale of plant Net cash used in investing activities Cash flows from financing activities Proceeds from borrowings Proceeds from share issue Dividend paid Net generated from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

780 000 162 000 70 000 (18 000) (75 000) (16 000) (3 000) 17 000 917 000 (65 000) (239 000) 613 000 (160 000) (675 000) 38 000 (797 000) 400 000 200 000 (405 000) 195 000 11 000 19 000 €30 000

2) Cash flows from operating activities presented using the direct method

Workings for direct method: Cash collected from customers = sales - increase in net receivables – doubtful debts expense © John Wiley and Sons, Ltd, 2016

17.30

Solutions Manual to accompany Applying IFRS Standards 4e

= $8 550 000 - $75 000 - $7 000 = $8 468 000 Cash paid to suppliers of goods and services: Cash paid to suppliers of inventory: Cost of goods sold Increase in inventory Increase in accounts payable Cash paid to providers of services: Distribution costs Administration costs Depreciation Doubtful debts expense Increase in prepayments Cash providers of goods and services

$ 4 517 000 16 000 (17 000) 1 635 000 1 566 000 (162 000) (7 000) 3 000

4 516 000

3 042 000 $7 551 000

Cash flows from operating activities Cash collected from customers Payments for goods and services Cash generated from operations Interest paid Income tax paid Net cash from operating activities

8 468 000 (7 551 000) 917 000 (65 000) (239 000) 613 000

17.31

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 17:Statement of cash flows

Chapter 17 Statement of cash flows Learning Objectives 17.1 17.2 17.3 17.4 17.5 17.6

Explain the purpose of a statement of cash flows and its usefulness Explain the definition of cash and cash equivalents Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities Contrast the direct and indirect methods of presenting net cash flows from operating activities Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions Prepare other disclosures required or encouraged by IAS 7

17.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple choice 1.

Which of the following items must be separately disclosed in the Statement of Cash Flows? I. Dividends paid II. Interest received III. Dividends received IV. Interest paid V. Auditor’s remuneration paid Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions *a. I, II, III and IV only; b. II, III and IV only; c. I, II and V only; d. II, III, IV and V only.

According to IAS 7 Statement of Cash Flows, which of the following items does NOT fall within the definition of cash? Learning Objective 17.2 Explain the definition of cash and cash equivalents a. Bank notes and coins; b. Non-bank bills readily convertible to cash; c. An investment with a short maturity of, say, three months or less from the date of acquisition; *d. Trade receivables.

Which of the following items is classified as part of ‘operating activities’ in the Statement of Cash Flows? Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities a. Depreciation of non-current assets; *b. Receipts from customers from the sale of goods; c. Bad debts expense; d. Proceeds from the sale of non-current assets.

The following item is classified as part of ‘investing activities’ in the Statement of Cash Flows: Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities a. depreciation of non-current assets; b. interest received from investments; *c. acquisition of non-current assets; d. proceeds from an issue of shares.

17.2

Chapter 17: Statement of cash flows

The following item is classified as a ‘financing activity’ in the Statement of Cash Flows: Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities a. interest paid on debentures; b. cash received from trade receivables; *c. cash payment on redemption of the company’s debentures; d. cash payment to purchase debentures of another entity.

Operating activities on a Statement of Cash Flows are generally associated with: Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities a. movements in non-current liabilities of an entity; *b. revenues and expenses of an entity; c. acquisitions of non-current assets of an entity; d. changes in equity of an entity.

Items classified as ‘financing activities’ on an entity’s Statement of Cash Flows are usually associated with: Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities *a. movements in non-current liabilities and equity; b. sales of goods and services by the entity; c. disposal of non-current assets; d. purchase of shares by the entity.

Which of the following cash flow activities are regarded as investing cash flows? Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities a. income taxes paid; b. interest paid; *c. acquisition of subsidiary net of cash acquired; d. proceeds from issue of debentures.

Brett Limited had a net profit after tax of $850 000 for the financial year. Included in this profit was: ➢ Depreciation expense of $120 000 ➢ Gain on disposal of investments of $28 000 Also, Trade Receivables increased by $39 000 and Inventories decreased by $12 000. The cash flow from operating activities during the year was: Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions a. $731 000; b. $785 000; *c. $915 000; d. $969 000.

17.3

Test Bank to accompany Applying IFRS Standards 4e

10.

The following information was extracted from the records of Ustinof Limited: ➢ Opening balance of Equipment: $360 000 ➢ Closing balance of Equipment: $400 000 ➢ Cost of new Equipment: $80 000 ➢ Proceeds from disposal of Equipment: $6000 (Cost $40 000; Carrying amount $10000) The total cash flows from investing activities is equal to: Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions a. $40 000 cash outflow; *b. $74 000 cash outflow; c. $76 000 cash outflow; d. $80 000 cash outflow.

Use the following information to answer questions 11 to 13 A company reported the following information for a financial year: Profit from ordinary activities before income tax expense Income tax expense Depreciation expense Issue of shares Loan made to another company Increase in trade receivables Decrease in inventories Cash received from loans receivable Dividends paid

£ 72 000 20 000 8 000 40 000 6 000 1 000 2 000 4 000 2 000

11.

What is the net cash inflow (outflow) from operating activities? Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions a. £45 000; b. £59 000; c. £60 000; *d. £61 000.

12.

What is the net cash inflow (outflow) from investing activities? Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions a. £2000 net cash inflow; b. £6000 net cash inflow; *c. £(2000) net cash outflow; d. £(4000) net cash outflow.

17.4

Chapter 17: Statement of cash flows

13.

What is the net cash inflow (outflow) from financing activities? Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions *a. £38 000 net cash inflow; b. £40,000 net cash inflow; c. £42,000 net cash inflow; d. £(2000) net cash outflow.

14.

Which of the following items should be disclosed in a Statement of Cash Flows? Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions a. Payment of dividends through a share investment scheme; b. Acquisition of an investment in a subsidiary for consideration consisting of an exchange of non-current assets and liabilities; *c. Proceeds from the issue of debentures; d. Refinancing of long-term debt.

15.

IAS 7 Statement of Cash Flows requires that investing and financing transactions that do NOT require the use of cash or cash equivalents should be: Learning Objective 17.2 Explain the definition of cash and cash equivalents *a. excluded from a Statement of Cash Flows; b. included in a Statement of Cash Flows before operating, investing and financing activities; c. presented in the Statement of Cash Flows after operating activities and before investing and financing activities; d. presented in a Statement of Cash Flows after the operating, investing and financing activities have been presented.

16.

During the financial year Sugianto Limited had sales of £42 000. The opening balance of trade receivables was £9000, and the closing balance was £12 700. Bad debts amounting to £700 were written off during the period. The cash receipts from sales during the year amounted to: Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions *a. £37 600; b. £39 000; c. £38 300; d. £45 700.

17.5

Test Bank to accompany Applying IFRS Standards 4e

17.

Warner Limited had the following cash flows during a reporting period: ➢ Acquisition of subsidiary, net of cash flows: €250 000 ➢ Dividends paid: €65 000 ➢ Repayment of borrowings: €90 000 ➢ Interest paid on borrowings: €57 000 ➢ Proceeds from disposal of plant: €215 000 What is the amount of the cash flows from financing activities of Warner Limited for the reporting period? Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions a. Net cash inflow €155 000; *b. Net cash outflow €155 000; c. Net cash inflow €212 000; d. Net cash outflow €212 000.

18.

During the financial year Marina Limited had sales of €720 000. The opening balance of trade receivables was €103 000, and the ending balance was €139 000. Bad debts of €34 000 were written off during the period. The cash receipts from customers during the year were equal to: Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions *a. €650 000; b. €718 000; c. €722 000; d. €790 000.

19.

During the financial year, Cresswell Limited had cost of sales of €260 000. Opening and closing balances of inventory and trade payables are shown below: ➢ Inventory ➢ Trade Payables

Opening balance €46 000 €18 000

Closing balance €55 000 €26 000

A discount of €2000 for prompt payment was received. The amount of cash paid for goods purchased during the year was: Learning Objective 17.5 Prepare a statement of cash flows and use a worksheet to prepare a statement of cash flows with more complex transactions *a. €259 000; b. €263 000; c. €275 000; d. €279 000.

17.6

Chapter 17: Statement of cash flows

20.

Katsis Limited had the following cash flows during the reporting period: ➢ Acquisition of intangibles: €30 000 ➢ Proceeds from disposal of plant: €28 000 ➢ Receipts from customers: €832 000 ➢ Payments to suppliers: €593 000 ➢ Interest received: €17 600 ➢ Income taxes paid: €45 500 The net cash flows from operating activities was: Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities *a. €211 100; b. €239 100; c. €256 600; d. €269 100.

21.

The basis of measurement used in the Statement of Cash Flows is: Learning Objective 17.1 Explain the purpose of a statement of cash flows and its usefulness: a. accrual; *b. cash and cash equivalents; c. net present value; d market value.

22.

An item or transaction will qualify for classification as a cash equivalent: Learning Objective 17.2 Explain the definition of cash and cash equivalents: a. if it has a remaining term of more than three months but no more than six months b. its term to maturity is no greater than twelve months c. it has a fixed maturity date of greater than twelve months *d. only if it had a maturity of less than three months at the date of acquisition.

23.

Bank borrowings are ordinarily classified as: Learning Objective 17.2 Explain the definition of cash and cash equivalents: a. operating activities, except for bank overdrafts that are repayable on demand and which form an integral part of an entity’s cash management; b. investing activities, except for bank overdrafts that are repayable on demand and which form an integral part of an entity’s cash management; c. financing activities, except for bank overdrafts that are repayable on demand; *d financing activities, except for bank overdrafts that are repayable on demand and which form an integral part of an entity’s cash management.

24.

For cash flow reporting purposes, operating activities include: Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities a. buying and selling of non-current assets; b. incurring and extinguishing equity and debt; c. acquisition and disposal of investments; *d. activities not otherwise classified as financing and investing.

17.7

Test Bank to accompany Applying IFRS Standards 4e

25.

Which of the following descriptions is the best for ‘cash flows from investing activities’? Those activities that relate to __________________. Learning Objective 17.3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities a. changing the size or financial structure of an entity; b. altering the composition of the debt of an organisation; *c. the acquisition or disposal of non-current assets; d. restructuring the working capital components of a business.

26.

The Statement of Cash Flows presentation method that separates gross cash inflows from cash outflows is known as the: Learning Objective 17.4 Contrast the direct and indirect methods of presenting net cash flows from operating activities: a. equity method; *b. direct method; c. set-off method; d. net method.

27.

Cash flows arising from the following operating, investing or financing activities may be reported on a net basis when: Learning Objective 17.4 Contrast the direct and indirect methods of presenting net cash flows from operating activities: a. cash receipts and payments for items in which the turnover is slow, the amounts are large, and the maturities are short; b. cash receipts and payments for items in which the turnover is quick, the amounts small, and the maturities are short; c.* cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short; d. cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are long-term.

28.

Cash flows arising from each of the following activities of a financial institution may be reported on a net basis: I cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity date II the placement of deposits with and withdrawal of deposits from other financial institutions III cash advances and loans made to customers and the repayment of those advances and loans IV cash receipts and payments for the acceptance and repayment of deposits with no fixed maturity date Learning Objective 17.4 Contrast the direct and indirect methods of presenting net cash flows from operating activities: a. I , II and IV; b. II, III and IV; c. I, III and IV; *d. I, II and III.

17.8

Chapter 17: Statement of cash flows

29.

The components of cash and cash equivalents: Learning Objective 17.6 Prepare other disclosures required or encouraged by IAS 7 a. may be disclosed at the option of the entity and reconciled to amounts reported in the statement of financial position; b. must be disclosed and reconciled to amounts reported in the statement of comprehensive income; *c. must be disclosed and reconciled to amounts reported in the statement of financial position; d. must be disclosed and reconciled to amounts reported in the statement of changes in equity.

30.

IAS 7 encourages, but does NOT require, the disclosure of: I the amount of undrawn borrowing facilities that may be available for future operating activities and to settle capital commitments, indicating any restrictions on the use of these facilities II the aggregate amount of cash flows that represent increases in operating capacity separately from those cash flows that are required to maintain operating capacity III the amount of the cash flows arising from the operating, investing and financing activities of each reportable segment IV the name(s) of the entity’s banks Learning Objective 17.6 Prepare other disclosures required or encouraged by IAS 7: a. I, II and IV; b. II, III and IV; c. I, III and IV; *d. I, II and III.

17.9

Exercises Exercise 17.9 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

CASH RECEIVED FROM CUSTOMERS

At 31 December 2016, Orange GmbH had accounts receivable of €200 000. At 31 December 2017, accounts receivable were €240 000 and sales for the year amounted to €2 100 000. Bad debts amounting to €50 000 had been written off during the year, and discounts of €17 000 had been allowed in respect of payments from customers made within prescribed credit terms. Orange GmbH did not have an allowance for doubtful debts in either year. Required

Calculate cash received from customers for the year ended 31 December 2017.

Exercise 17.10

PREPARATION OF A STATEMENT OF CASH FLOWS

★ A summarised comparative statement of ﬁnancial position of Schwarz GmbH is presented below:

Cash Trade receivables Land Plant Accumulated depreciation Trade accounts payable Current tax payable Deferred tax liability Share capital Retained earnings Asset revaluation surplus

31 Dec 2016 € 40 000 47 000 80 000 130 000 (45 000) €252 000 23 000 52 000 — 100 000 77 000 — €252 000

31 Dec 2017 € 55 000 80 000 90 000 180 000 (60 000) €345 000 65 000 30 000 3 000 150 000 90 000 7 000 €345 000

Additional information (a) Plant that originally cost €40 000, and had a carrying amount of €12 000, was sold for €15 000. (b) There were no acquisitions or disposals of land during the year. (c) The proﬁt for the year was €60 000, after income tax expense of €30 000. (d) A dividend of €47 000 was paid during the year. (e) The only item of other comprehensive income was a gain on revaluation of land and its associated tax effect. Required

Using the indirect method of presenting cash ﬂows from operating activities, prepare a statement of cash ﬂows in accordance with IAS 7 for the year ended 31 December 2017.

Exercise 17.11 ★★

NET INVESTING CASH FLOWS

The statement of ﬁnancial position of Global Group at 31 December 2017 recorded the following items:

Land, at fair value Plant, at cost Accumulated depreciation Investments Goodwill Land revaluation surplus Investments revaluation reserve Additional information Impairment of goodwill

31 Dec 2016

31 Dec 2017

€100 000 70 000 (20 000) 30 000 25 000 20 000 5 000

€120 000 80 000 (28 000) 45 000 20 000 34 000 11 000

—

5 000

CHAPTER 17 Statement of cash flows

(a) There were no acquisitions or disposals of land. (b) There were no disposals of plant or investments. (c) The increase in the land revaluation surplus is net of deferred tax of €6000. (d) The Investments are measured at fair value with gains and losses accumulated in the Investments revaluation reserve. The increase for the year is net of deferred tax of €2000. Required

Prepare the investing section of the statement of cash ﬂows for Global Group for the year ended 31 December 2017.

Exercise 17.12 ★★

NET FINANCING CASH FLOWS

The following information has been extracted from the accounting records of Jade Inc.:

Borrowings Share capital Property revaluation surplus Retained earnings

31 Dec 2016 $100 000 200 000 50 000 75 000

31 Dec 2017 $210 000 250 000 60 000 95 000

Additional information (a) Borrowings of $20 000 were repaid during the year ended 31 December 2017. New borrowings include $80 000 vendor finance arising on the acquisition of a property. (b) The increase in share capital includes $30 000 arising from the company’s dividend reinvestment scheme. (c) The movement in retained earnings comprises profit for the year $90 000, net of dividends $70 000. (d) There were no dividends payable reported in the statement of financial position at either 31 December 2016 or 31 December 2017. Required

Prepare the ﬁnancing section of the statement of cash ﬂows for Jade Inc. for the year ended 31 December 2017.

Exercise 17.13 ★★★

CASH RECEIPTS FROM CUSTOMERS AND CASH PAID TO SUPPLIERS AND EMPLOYEES

The accounting records of Indigo Ltd recorded the following information:

Accounts receivable Inventories Prepaid expenses Accounts payable for inventory purchased Provision for employee expenses Other accruals (including accrued interest: 2016 – £700; 2017 – £850) Sales revenue Cost of sales Expenses (including £5000 depreciation and £2000 interest)

31 Dec 2016

31 Dec 2017

£40 000 32 000 1 000 15 000 5 000 4 000

£ 50 000 34 000 3 000 16 000 5 500 3 800 600 000 480 000 75 000

The accounting records of Indigo Ltd recorded the following information: Required

1. Calculate the amount of cash received from customers during the year ended 31 December 2017. 2. Calculate the amount of cash paid to suppliers and employees during the year ended 31 December 2017.

Exercise 17.14 ★★

PREPARATION OF A STATEMENT OF CASH FLOWS

A summarised comparative statement of ﬁnancial position of The French Fashion Company is presented below:

PART 3 Presentation and disclosures

Cash Accounts receivable (net) Prepayments Inventory Land Plant Accumulated depreciation Deferred tax asset Accounts payable Accrued liabilities Current tax payable Dividend payable Borrowings Share capital Retained earnings

31 Dec 2016 € 96 000 147 000 20 000 60 000 40 000 368 000 (45 000) 20 000 €706 000 € 40 000 36 000 24 000 56 000 173 000 335 000 42 000 €706 000

31 Dec 2017 € 49 000 163 000 15 000 104 000 40 000 420 000 (70 000) 24 000 €745 000 € 50 000 42 000 31 000 50 000 177 000 345 000 50 000 €745 000

Additional information (a) Plant additions amounted to €72 000 during 2017. Plant with a carrying amount value of €15 000 (cost €20 000, accumulated depreciation €5000) was sold for €22 000. The proceeds for the sale of plant had not been received by 31 December 2017. (b) Accounts payable at 31 December 2016 include €34 000 arising from the acquisition of plant. (c) Accrued liabilities include accrued interest of €3000 at 31 December 2016 and €4000 at 31 December 2017. (d) The increase in share capital of €10 000 arose from the reinvestment of dividends. (e) The profit for the year ended 31 December 2017 was €92 000, after interest expense of €6000 and income tax expense of €46 000. There were no other items of comprehensive income. (f) The French Fashion Company classifies interest as an operating activity. (g) Dividends declared out of profits for the year were: interim dividend €34 000, final dividend €50 000. Required

Using the indirect method of presenting cash ﬂows from operating activities, prepare a statement of cash ﬂows in accordance with IAS 7 for the year ended 31 December 2017.

Exercise 17.15 ★★

PREPARATION OF A STATEMENT OF CASH FLOWS

A summarised comparative statement of ﬁnancial position of Bronze Inc. is presented below, together with a statement of proﬁt or loss and other comprehensive income for the year ended 31 December 2017.

Cash Trade receivables Allowance for doubtful debts Inventory Investments Plant Accumulated depreciation Accounts payable Accrued interest Current tax payable Deferred tax Borrowings Share capital Investment revaluation reserve Retained earnings

31 Dec 2016 $ 45 000 69 000 (3 000) 45 000 53 000 187 000 (35 000) $ 361 000 $ 65 000 5 000 15 000 30 000 80 000 100 000 2 000 64 000 $ 361 000

31 Dec 2017 $ 35 000 105 000 (6 000) 67 000 60 000 225 000 (53 000) $433 000 $ 75 000 7 000 18 000 37 000 100 000 100 000 7 000 89 000 $433 000

CHAPTER 17 Statement of cash flows

Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2017 Sales Cost of sales Gross profit Distribution expenses Administration expenses Interest expense Profit before tax Income tax expense Profit for the year Other comprehensive income Gain on revaluation of investments (net of tax) Total comprehensive income

$ 1 035 000 (774 000) 261 000 (76 000) (96 000) (7 000) 82 000 (24 000) 58 000

5 000 63 000

Additional information (a) The movement in the allowance for doubtful debts for the year comprises: Balance at 31 December 2016 Charge for year Bad debts written off Balance at 31 December 2017

$ 3 000 5 000 (2 000) 6 000

(b) The investments are measured at fair value, with gains and losses recognised in other comprehensive income, and accumulated in the investment revaluation reserve. (c) There were no disposals of plant during the year. (d) A dividend of $33 000 was paid during the year. (e) There were no acquisitions or disposals of investments during the year. (f) Bronze Inc. classiﬁes interest as an operating activity. Required

1. Using the direct method of presenting cash flows from operating activities, prepare a statement of cash flows in accordance with IAS 7 for the year ended 31 December 2017. 2. Prepare the operating activities section of the statement of cash flows using the indirect method of presentation. Exercise 17.16 ★★

PREPARATION OF STATEMENT OF CASH FLOWS INFORMATION

The statement of proﬁt or loss and other comprehensive income and comparative statements of ﬁnancial position of Braun GmbH are as follows: Braun GmbH Statement of Financial Position as at 31 December

Current assets Deposits at call Accounts receivable Allowance for doubtful debts Inventory Prepayments Non-current assets Land Buildings Accumulated depreciation — buildings Plant Accumulated depreciation — plant Total assets

PART 3 Presentation and disclosures

2016 € 000

2017 € 000

19 200 (19) 654 52 906

30 271 (15) 670 55 1 011

400 1 175 (200) 850 (375) 1 850 €2 756

€ 400 1 850 (235) 940 (452) 2 503 €3 514

Current liabilities Accounts payable Interest payable Final dividend payable Current tax payable Non-current liabilities Borrowings Deferred tax liability Total liabilities Equity Share capital Retained earnings Total liabilities and equity

553 25 205 70 853

570 30 230 77 907

900 12 912 1 765

1 300 16 1 316 2 223

800 191 991 €2 756

1 000 291 1 291 €3 514

Braun GmbH Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2017 €’000 8 550 4 517

Sales Less: Cost of sales Gross profit Gain on sale of plant

4 033 18

Distribution expenses

4 051 (1 635 )

Administration expenses

(1 566 ) (70 )

Interest expense Profit before tax

780

Income tax expense

(250 ) 530 — € 530

Profit for the period Other comprehensive income Total comprehensive income

The following additional information has been extracted from the accounting records of Braun GmbH: €’000 1.

Movement in allowance for doubtful debts: Balance 31 December 2016 Charge for year Bad debts written off

19 7 (11)

Balance 31 December 2017

€’000

Building additions were completed. There were no disposals.

The movement in plant and accumulated depreciation on plant comprised:

Cost

Accumulated depreciation

Balance 31 December 2016 Additions — paid for in cash Disposals Depreciation

850 160 (70) —

375 — (50) 127

Balance 31 December 2017

940

452 (continued)

CHAPTER 17 Statement of cash flows

Cost 4.

There was no outstanding interest payable at year-end. Interest is classified as an operating activity.

Income tax expense comprised: Income tax currently payable Deferred income tax

246 4

Additional cash borrowings

400

Movement in equity Balance 31 December 2016 Additional shares issued for cash Profit for the period Interim dividend — cash Final dividend payable Balance 31 December 2017

Accumulated depreciation

Share capital

Retained earnings

800 200 — —

191 — 530 (200) (230) 291

1 000

Required

1. Prepare a statement of cash ﬂows using the indirect method of presentation of operating activities. 2. Prepare the operating activities section of the statement of cash ﬂows using the direct method of presentation.

PART 3 Presentation and disclosures

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ruth Picker and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 18 Operating Segments

Chapter 18 – Operating Segments Discussion questions 1.

Segment disclosures are widely regarded as some of the most useful disclosures in financial reports because of the extent to which they disaggregate financial information into meaningful and often revealing groupings. Discuss this assertion by reference to the objectives of financial reporting by segments.

Many entities operate in different geographical areas or provide products or services that are subject to differing rates of profitability, opportunities for growth, future prospects and risks. Disaggregation into meaningful and often revealing groupings assists users to better understand the entity’s past performance, to better assess the entity’s risks and returns, and make more informed judgements about the entity as a whole. For example, an entity may appear profitable on a consolidated basis but the segment disclosures reveal that one part of the business is performing poorly while another part is performing well. Over time the poorly performing part may affect the entire entity’s performance. This affects the entity’s share price because analysts frequently look at predicted future cash flows in making their share price determinations

Explain what the “management approach” used in IFRS 8 means.

The management approach means that the segment information is based on what is reported internally to the Chief Operating Decision-Maker (CODM). Whatever the CODM uses to measure and assess the operating segment is what is disclosed externally under IFRS 8. The only item that must be disclosed is “a measure” of segment result. That measure is whatever the CODM uses and need not be the IFRS reported profit. Other items, such as segment assets and segment liabilities, are only reported externally if they are also reported internally to the CODM for the segments. This also extends to the allocation of amounts of profit or loss and assets and liabilities to segments. If the CODM uses information based on amounts that are allocated to segments, then those amounts should be allocated for the purposes of disclosing ‘a measure’. If the CODM does not use that information, the amounts should not be allocated.

3. Evaluate whether the reconciliations required by paragraph 28 of IFRS 8 address a concern about lack of comparability between entities caused by management’s ability to select any measurement basis it chooses in reporting segment information. The reconciliations do address the concerns to some extent because they require a reconciliation of the measure of segment results used by the CODM to the reported IFRS profit. Paragraph 27 also requires disclosure of the nature of any differences between the measure used by management and that required for IFRS reporting. These reconciliations and disclosures are also required for segment assets and liabilities, but only if they are reported in the first place. However the reconciliations are not required for each reportable segment – only for the total of all segments, so users’ concerns may not be fully addressed.

18.1

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 18.1

DEFINING OPERATING SEGMENTS

List the four key steps. The four key steps are: 1. Identify the CODM; 2. Determine whether the component can generate revenue and incur expenses from its business activities; 3. Determine whether the component’s operating results are regularly reviewed by the CODM as a basis for resource allocation and performance assessment; and 4. Determine whether discrete financial information is available for the component.

Exercise 18.2

AGGREGATING OPERATING

Identify which operating segments, if any, meet the aggregation criteria of IFRS 8, paragraph 12. Give reasons for your answer. In order to be aggregated, the operating segments must have similar economic characteristics and be similar in each of the following respects: 1. 2. 3. 4. 5.

The nature of the products and services; The nature of the production processes; The type or class of customer; The distribution methods; and The nature of the regulatory environment, if applicable.

Since only one product is produced and there is no further information on the production processes, one can assume that these are similar in all operating segments. The US and Canadian markets have similar economic characteristics. They are also closely linked so it is likely that their customer profiles and distribution methods are similar. Australia and Germany are each self-sustaining markets. Only Germany appears to have a special regulatory environment. From the information provided, it would appear that the US and Canada could be aggregated into one operating segment, but further information about customers and distribution methods is required.

Exercise 18.3

IDENTIFYING REPORTABLE SEGMENTS

Using the information from exercise 18.2, identify Company B’s reportable segments. There is no further quantitative information, but based on the information provided, Company B has three reportable segments – North America (including Canada), Germany and Australia.

18.2

Chapter 18 Operating Segments Exercise 18.4

DISCLOSURES

State whether each of the following statements is true or false, by reference to the relevant requirements of IFRS 8: 1. Company X must disclose EBITDA for each reportable segment. 2. Company X must disclose total assets for each reportable segment. 3. Company X must reconcile the total EBITDA of Segments A, B and C to its reported IFRS profit before income tax and discontinued operations. 4. Company X must disclose total liabilities for each reportable segment. 5. Company X must disclose depreciation and amortisation for each reportable segment. 6. Company X must disclose revenue from external customers for each of Product P, Product Y and Service Z. 1. Company X must disclose EBITDA for each reportable segment. TRUE. (Para.23 of IFRS 8) 2. Company X must disclose total assets for each reportable segment. FALSE. A measure of total assets for each reportable segment is not reported to the CODM (para. 23 of IFRS 8). 3. Company X must reconcile the total EBITDA of Segments A, B and C to its reported IFRS profit before income tax and discontinued operations. TRUE. (Para. 28(b) of IFRS 8). 4. Company X must disclose total liabilities for each reportable segment. FALSE. A measure of total liabilities for each reportable segment is not reported to the CODM (para. 23 of IFRS 8) 5. Company X must disclose depreciation and amortisation for each reportable segment. TRUE. These are reported to the CODM for each reportable segment (para. 23(e) of IFRS 8). 6. Company X must disclose revenue from external customers for each of Product P, Product Y and Service Z. TRUE. (para. 32 of IFRS 8).

EXERCISE 18.5

REPORTABLE SEGMENTS, ALLOCATING AMOUNTS TO SEGMENTS

State whether the following statements are true or false. Give reasons for your answers. 1. Company A has three reportable segments. 2. The revenue figure that should be used by the general department stores segment for the purposes of determining whether or not it is a reportable segment is $350 million. 3. Company A must disclose the toy stores segment liabilities after deducting the $45 million owed to general department stores. 4. The assets figure that should be used by the general department stores segment for the purposes of determining whether or not it is a reportable segment is $900 million. 5. The assets figure that should be used by the general department stores segment for the purposes of determining whether or not it is a reportable segment is $855 million. 6. The assets figure that should be used by the general department stores segment for the purposes of determining whether or not it is a reportable segment is $877 million. 7. Company A must disclose a reconciliation of total segment assets to its consolidated assets of $1132m. 1. Company A has three reportable segments. FALSE. Total segment revenue (external) is only 68% of consolidated revenue (550/800) and therefore additional reportable segments must be identified. (IFRS 8 para.15). 2. The revenue figure that should be used by the general department stores segment for the purposes of determining whether or not it is a reportable segment is $350 million. FALSE. Segment revenue includes revenue from other segments (IFRS 8 para. 5(a) and 13(a)). Therefore the revenue from toy stores is included and the figure to be used is $400m. 3. Company A must disclose the toy stores segment liabilities after deducting the $45 million owed to general department stores. FALSE. Segment liabilities are not reported to the CODM and thus are not required to be disclosed. (IFRS 8, para. 23). 4. The assets figure that should be used by the general department stores segment for the purposes of determining whether or not it is a reportable segment is $900 million. FALSE. Intra-segment assets ($23m) are reported to the CODM and are eliminated in determining reportable segments. 5. The assets figure that should be used by the general department stores segment for the purposes of © John Wiley and Sons, Ltd, 2016

18.3

Solutions Manual to accompany Applying IFRS Standards 4e determining whether or not it is a reportable segment is $855 million. FALSE. Inter-segment assets ($45m) are reported to the CODM but are NOT used by the CODM as the basis for determining reportable segments. 6. The assets figure that should be used by the general department stores segment for the purposes of determining whether or not it is a reportable segment is $877 million. TRUE. Intra-segment assets ($23m) are reported to the CODM and are eliminated in determining reportable segments. 7. Company A must disclose a reconciliation of total segment assets to its consolidated assets of $1,132m. TRUE. Segment assets are reported to the CODM so these must be disclosed (IFRA 8, para.23) by segment and a reconciliation of all segment assets to consolidated assets is required by para. 28(c). Consolidated assets are calculated as $1,200 m - $23m - $45m.

18.4

Chapter 18 Operating Segments Exercise 18.6

ANALYSING THE SEGMENT INFORMATION

Analyse Company A’s business with reference to its reported segment information. Show all workings to support your analysis. Workings: France Revenue from external customers Intersegment revenue Total EBITDA EBITDA margin (EBITDA/Rev enue)

22 300 000

22 300 000 6 400 0 00 29%

German y 35 654 000

35 654 000 7 325 0 00 21%

U.K

India

China

ANZ

Total

Consolidated

21 587 600

5 356 8 00

7 324 800

8 763 4 00

100 986 60 0

125 000 0001

10 000 000

10 000 00 0

15 356 800 5 324 0 00 35% total; 99% if based only on external revenue s

17 324 80 0 7 625 000

21 587 600 5 325 0 00 25%

44% total; more than 100% if based only on external revenues

20 000 000

8 763 4 00 2 325 0 00 27%

Net profit Net profit margin Total assets Return on assets

120 986 60 0 34 324 000 28% total; 34% if based only on external revenues

25 625 000 21% 1 041 670 000 2% (based on net profit) 3% based on segment EBITDA

Key findings: 1. Inter-segment revenues from the manufacturing countries (India and China) account for 17% of total segment revenue. 2. By allowing inter-segment revenues to be included in determining reportable segments, IFRS 8 allows management to clearly show the extent to which vertical integration affects the business. In this case the vertical integration is creating profit centres at the manufacturing locations. 3. China is the most profitable segment of the business, even though its revenues are only the fourth largest. 4. India is the second most profitable segment of the business, even though its revenues are only the fifth largest. 5. Germany has the highest revenues but is the least profitable segment. 6. Management uses EBITDA to manage the business and thus would focus on the EBITDA margin of 34% (based on external revenues) rather than the net profit margin of 21% (IFRS net profit as a % of consolidated revenues). 7. The EBITDA margin of 28% (based on total segment revenues including inter-segment revenues) is still higher than the net profit margin. Other factors/costs must be affecting the measurement of the

Additional revenue of 24,013,400 has not been attributed to segments. The 75% revenue threshold test is met based on external revenues (IFRS 8 para. 15) even though inter-segment revenues are included when determining reportable segments (IFRS 8 para.13(a)). External revenues are 81% of consolidated revenues.

18.5

Solutions Manual to accompany Applying IFRS Standards 4e IFRS net profit. These costs have not been identified as relevant to the segments; otherwise they would be regularly reported to the CODM. 8. The return on assets is very low, on both a net profit and EBITDA basis. Assets have not been allocated to the segments so it is not possible to identify where assets may be under-utilised. 9. Home furniture is generating the highest revenue but there is not enough information provided to tell whether it is the most profitable product, because the segments have been identified on a geographic basis, not a product basis. (The information disclosed in accordance with IFRS 8 para. 32 is revenues only, not a measure of result by product).

Exercise 18.7

IDENTIFYING REPORTABLE SEGMENTS

Identify Company A’s reportable segments in accordance with IFRS 8. Explain your answer. All three segments are reportable segments because each equals or exceeds at least one of the 10% thresholds set out in paragraph 13 of IFRS 8. Department stores and liquor stores exceed all three and toy stores exceeds only the segment results threshold. Because total revenue attributable to the reportable segments exceeds 75% of total consolidated revenue, there is no requirement to identify additional segments in accordance with paragraph 15 of IFRS 8.

Exercise 18.8

ANALYSING THE INFORMATION PROVIDED

Using the information provided about Company A in exercise 18.7, analyse the relative profitability of the reportable segments.

Revenue Segment result Assets Segment profit margin Segment return on assets Profitability ranking

General department stores $ 400m 15m 900m 4%

Liquor stores

Toy stores

All segments

$ 100m 7m 200m 7%

$ 50m 4m 100m 8%

$ 550m 26m 1 200m 5%

worst

middle

best

The segment profitability analysis reveals that the department store segment, although by far the largest in terms of revenues and assets, is the least profitable, whereas the smallest segment is the most profitable.

18.6

Chapter 18 Operating Segments Exercise 18.9

DISCLOSURES

For each item listed, state whether or not it would be disclosed for each of the reportable segments, identify the segments for which it would be disclosed and explain what other disclosures, if any, are required in accordance with IFRS 8. 1. Interest income – not reported to the CODM on a segment basis but regularly provided to the CODM for the group as a whole 2. Dividend income – not reported to the CODM on a segment basis but regularly provided to the CODM for the group as a whole 3. Share of profits from investments in equity-method associates attributable to segment A – reported to the CODM for Segment A 4. Interest expense – not reported to the CODM on a segment basis but regularly provided to the CODM for the group as a whole 5. Revenues from external customers for each of Segment A and Segment B 6. The amount of investments in associates accounted for by the equity method attributable to segment A 7. Payables and trade creditors attributable to segment B but not reported to the CODM 8.Borrowing costs that have been capitalised for Segment B and are regularly reported to the CODM. 1. Interest income – not reported to the CODM on a segment basis but regularly provided to the CODM for the group as a whole. NO. It is not reported to the CODM on a segment basis (para. 23). 2. Dividend income – not reported to the CODM on a segment basis but regularly provided to the CODM for the group as a whole. No – not required by IFRS 8 and not reported to the CODM on a segment basis. 3. Share of profits from investments in equity-method associates attributable to segment A – reported to the CODM for Segment A. YES – must be disclosed for Segment A, because it is reported to the CODM for Segment A. (para. 23(g) of IFRS 8) 4. Interest expense - not reported to the CODM on a segment basis but regularly provided to the CODM for the group as a whole. NO. It is not reported to the CODM on a segment basis (para. 23). 5. Revenues from external customers for each of Segment A and Segment B. YES, for each of Segment A and B (para. 23(a) of IFRS 8) but only if reported to the CODM. Further, para. 33 requires entity-wide segment disclosures of revenues from external customers attributed to geographic regions, regardless of whether these are reported to the CODM. 6. The amount of investments in associates accounted for by the equity method attributable to segment A. YES – but only if reported to the CODM (para. 24 of IFRS 8). 7. Payables and trade creditors attributable to segment B but not reported to the CODM. NO – not reported to the CODM (para. 23 of IFRS 8) 8. Borrowing costs that have been capitalised for Segment B and are regularly reported to the CODM. YES – must be disclosed for Segment B (para. 23(i) of IFRS 8), assuming they are material.

18.7

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Yeny Lukito, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 18 Operating segments

CHAPTER 18 Operating Segments Learning Objectives 18.1 18.2 18.3 18.4 18.5 18.6 18.7 18.8 18.9

Discuss the objectives of financial reporting by segments Identify the types of entities that are within the scope of IFRS 8 Explain and evaluate the controversy surrounding the issuance of IFRS 8 Identify operating segments in accordance with IFRS 8 Distinguish between operating segments and reportable segments Apply the definition of reportable segments Explain the disclosure requirements of IFRS 8 Analyse the disclosures made by companies applying IFRS 8 in practice Discuss the outcome of the post-implementation review of IFRS 8.

18.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

1. IFRS 8 Operating Segments is primarily a: Learning Objective 18.1 Discuss the objectives of financial reporting by segments: *a. disclosure standard; b. measurement standard; c. definition standard; d. conceptual standard.

2. A key objective of providing financial reporting information by segment is: Learning Objective 18.1 Discuss the objectives of financial reporting by segments. a. to allow detailed analysis to be undertaken by users such as segment profit margin analysis; b. to allow the user to better understand the entity’s future performance; c. to highlight poorly performing areas of an entity’s business to users; *d. to allow users to better assess the entity’s risks and returns.

Complete the following sentence: IFRS 8 Operating Segments is applicable for financial reporting periods _____ on or after 1 January 2009. Early adoption is _______. Learning Objective 18.1 Discuss the objectives of financial reporting by segments. a. ending, not permitted; b. ending, permitted; c. beginning, not permitted; *d. beginning, permitted.

4. Segment disclosures are designed to: Learning Objective 18.1 Discuss the objectives of financial reporting by segments. a. combine components of consolidated financial data to provide a higher level of summarisation; b. condense particular items of consolidated financial data into one financial statement; *c. disaggregate selected consolidated financial data; d. aggregate revenues and expenses so that only net profit is shown for each important segment.

18.3

Chapter 18 Operating segments

IFRS 8 Operating Segments applies to: I. public companies II. listed entities III. entities in the process of listing IV. any entity who voluntarily chooses to apply it Learning Objective 18.2 Identify the types of entities that are within the scope of IFRS 8. a. I, II and III only; *b. II, III and IV only; c. I, II and IV only; d. I, III and IV only.

If an entity presents both consolidated financial statements and parent entity financial statements in the same financial report, it must present: Learning Objective 18.2 Identify the types of entities that are within the scope of IFRS 8. a. segment data only on the basis of the parent entity financial statements; *b. segment data only on the basis of the consolidated financial statements; c. condensed segment data that includes revenue information only; d. segment information on the basis of both the consolidated and the parent financial information.

For financial reporting periods commencing prior to 1 January 2009, the accounting standard relating to segment reporting was: Learning Objective 18.3 Explain and evaluate the controversy surrounding the issuance of IFRS 8. a. IFRS 8 Operating Segments; *b. IAS 14 Segment Reporting; c. IAS 14 Operating Segments; d. IFRS 8 Segment Reporting.

Compared to IAS 14 Segment Reporting, IFRS 8 Operating Segments can be described as being: Learning Objective 18.3 Explain and evaluate the controversy surrounding the issuance of IFRS 8. a. more closely aligned to other accounting standards; b. preferred in the European Union to its predecessor; *c. less prescriptive; d. less onerous in terms of disclosure.

18.4

Test Bank to accompany Applying IFRS Standards 4e

Which of the following statements is correct about the controversial issues surrounding IFRS 8? Learning Objective 18.3 Explain and evaluate the controversy surrounding the issuance of IFRS 8. *a. The management approach adopted in IFRS 8 was argued to put preparers’ needs ahead of users’ needs. b. Despite the objections from different parties, all IASB board members at the time unanimously agreed that IFRS 8 should replace IAS 14. c. The European Parliament was not able to endorse IFRS 8 due to strong oppositions from European countries. d. The proponents of IAS 14 argued that IFRS 8 contains too many mandatory disclosure requirements compared to IAS 14. The following criteria are the key decision points in identifying an entity’s component as an operating segment, except for: Learning Objective 18.4 Identify operating segments in accordance with IFRS 8. *a. the component’s manager is part of the CODM; b. discrete financial information are available for the component; c. the component is able to generate revenue and incur expenses from its business activities; d. the component’s operating results are regularly reviewed by the CODM. 10.

11. IFRS 8 prescribes that an operating segment must be identified on the basis of: Leaning Objective 18.4 Briefly compare IFRS 8 with its predecessor standard IAS 14. a. geographic location; b. predominant sources of risks and returns; *c. the way information is reported internally to the CODM; d. the usefulness of financial information available to users.

12.

Based on the information provided below, which business unit(s) should be identified as TeeVee Ltd’s operating segment(s)?

Can the component generate revenue and incur expenses from its business activities? Are the component’s operating results regularly reviewed by the CODM? Is discrete financial information available for the component?

Glee Yes

Homeland CSI Yes Yes

Yes

Learning Objective 18.4 Identify operating segments in accordance with IFRS 8. a. Glee only; *b. Homeland only; c. CSI only; d. Glee and CSI.

18.5

Chapter 18 Operating segments

13.

Which of the followings are the requirements under IFRS 8?

Identifying primary and secondary segments. Disclosure of reliance on major external customers.

14.

Cherry Group has operating segments in three different locations. Total assets for each segment are as follows:

Identifying operating segments based on predominant sources of risks and returns. II. V. Preparing segment information in conformity with accounting policies for preparing financial statements. III. Disclosure of a measure of VI. Does not distinguish between revenues and profit or loss and total assets. expenses from internal and external customers. Leaning Objective 18.4 Briefly compare IFRS 8 with its predecessor standard IAS 14. a. I, II, III. b. II, IV, VI. c. I, III, V. *d. II, III, VI.

➢ ➢ ➢

IV.

Melbourne $400 000 Sydney $80 000 Adelaide $20 000

Which operating segment(s) should be disclosed as reportable segment(s) of Cherry Group? Learning Objective 18.5 Distinguish between operating segments and reportable segments. a. All segments are reportable segments; b. Melbourne and Sydney are the only reportable segments; c. Sydney and Adelaide are the only reportable segments; *d. Melbourne is the only reportable segment.

15. Additional segments must be identified as reportable segments until at least: Learning Objective 18.5 Distinguish between operating segments and reportable segments. *a. 75% of total entity revenue is included in reportable segments; b. 75% of total entity assets are included in reportable segments; c. 75% of total entity liabilities are included in reportable segments; d. 75% of total entity equity is included in reportable segments.

18.6

Test Bank to accompany Applying IFRS Standards 4e

16.

Under IFRS 8, two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principle of the standard, the segments have similar economic characteristics, and the segments are similar in each of the following respects: I. II. III. IV.

the nature of the production processes the markets in which the products are sold are closely related the type or class of customer for their products and services the nature of the regulatory environment

Learning Objective 18.5 Distinguish between operating segments and reportable segments. a. I, II and III only; *b. I, III and IV only; c. I, II and IV only; d. II, III and IV only. What is the reasonable maximum number of an entity’s reportable segments according to the additional guidance provided in IFRS 8? Learning Objective 18.5 Distinguish between operating segments and reportable segments. a. 8; *b. 10; c. 12; d. There is no maximum number provided in the guidance. 17.

18.

One of the conditions used to determine if two or more operating segments may be aggregated into a single operating segment is: Learning Objective 18.5 Distinguish between operating segments and reportable segments. a. the segments have the same manager in charge; b. the aggregation is deemed to provide useful information for users; c. the segments have similar operating results; *d. the segments have similar methods used to distribute their product or provide their services.

19. Segments that do not satisfy the requirements of a reportable segment must: Learning Objective 18.5 Distinguish between operating segments and reportable segments. a. not be disclosed at all in the financial report; b. be reported in the notes to the financial statements; *c. be combined and disclosed as ‘all other segments’; d. be combined with the smallest reportable segment.

18.7

Chapter 18 Operating segments

20. If an operating segment does not meet all of the thresholds of significance, it: Learning Objective 18.5 Distinguish between operating segments and reportable segments. a. may not be designated as a reportable segment; *b. may still be designated as a reportable segment; c. must be combined with the largest of the other segments and reported in aggregate; d. is insignificant and cannot be reported separately.

21.

Huey, Dewey, and Louie are the three operating segments of Donald Company. Which of the following statements is correct based on the information provided below?

In $000

Huey

Revenue Profit/loss Assets

Dewey

275 100 355

130 30 215

Louie 410 185 750

Total operating segments 815 315 1320

Other business units 295 60 310

Total Donald Company 1110 375 1630

Learning Objective 18.6 Apply the definition of reportable segments. a. Huey, Dewey, and Louie are reportable segments of Donald Company. b. Only Dewey and Louie should be disclosed as reportable segments. c. Dewey is not a reportable segment as it does not satisfy the profit/loss quantitative threshold. *d. Donald Company needs to identify another reportable segment from ‘other business units’ component.

22.

Assuming the three business units below are operating segments and all revenue earned are from external customers, in which of the following scenarios does Colourband Ltd need to identify another reportable segment to be disclosed?

Revenue in $000

Red

Blue

Green

Total operating segments

I. II. III.

75 110 230

160 140 250

320 275 375

555 525 855

Other business units 250 175 315

Total Colourband Ltd 805 700 1170

Learning Objective 18.6 Apply the definition of reportable segments. a. I only. b. I and II. *c. I and III. d. II and III.

18.8

Test Bank to accompany Applying IFRS Standards 4e

23. Under IFRS 8 all entities to which the standard applies are required to disclose: Learning Objective 18.7 Explain the disclosure requirements of IFRS 8. a. a reconciliation of total segment expenses to total consolidated expenses; b. factors used to identify all segments; *c. the basis of accounting for any transactions between reportable segments; d. a measure of segment liabilities.

24.

Which of the following statements is incorrect? IFRS 8 requires external revenue by product to be disclosed on an entity wide basis by all entities to which IFRS 8 applies: Learning Objective 18.7 Explain the disclosure requirements of IFRS 8. a. unless the information has already been provided as part of the reportable segment information; b. unless the information is not available and the cost to develop it would be excessive; c. and must be calculated based on the financial information used to produce the entity’s financial statements; *d. unless providing such information would be considered to damage the entity’s competitive advantage.

25. Under IFRS 8, entities are required to provide reconciliations on the followings, except for: Learning Objective 18.7 Explain the disclosure requirements of IFRS 8. a. the total of the reportable segment’s measures of profit and loss to the entity’s profit or loss; *b. the total of the reportable segment’s equity to the entity’s equity; c. the total of the reportable segment’s revenue to the entity’s revenue; d. the total of the reportable segment’s liabilities to the entity’s liabilities;

26.

Which of the following information is not required to be disclosed by entities complying with IFRS 8? Learning Objective 18.7 Explain the disclosure requirements of IFRS 8. *a. the identity of external customers from which the entity earns at least 10% of its revenue; b. the total of the reportable segments’ liabilities to the entity’s liabilities; c. the nature and effect of the changes in measurement of segment profit or loss; d. revenues from external customers located in foreign countries.

18.9

Chapter 18 Operating segments

27. IFRS 8 requires disclosure in relation to which of the following? Learning Objective 18.8 Explain the disclosure requirements of IFRS 8. a. the basis of accounting for all segments; b. the nature of any difference between the measurement of the reportable segments’ revenue and the entity’s revenue; *c. the nature of any difference between the measurement of the reportable segments’ assets and liabilities and the entity’s assets and liabilities; d. the nature and effect of all symmetrical allocations to reportable segments.

18.10

Exercises Exercise 18.7 ★★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

IDENTIFYING REPORTABLE SEGMENTS

Company A is a listed diversiﬁed retail company. Its stores are located mainly in the United Kingdom. It has three main types of stores: general department stores, liquor stores and specialist toy stores. Each of these stores has different products, customer types and distribution processes. In accordance with IFRS 8, Company A has identiﬁed three operating segments: general department stores, liquor stores and specialist toy stores. All three business units earn most of their revenue from external customers. Total consolidated revenue of company A is $600 million. General department stores $m

Liquor stores $m

Toy stores $m

All segments $m

Revenue

400

100

550

Segment result (profit)

Assets

900

200

100

1 200

Required

Identify Company A’s reportable segments in accordance with IFRS 8. Explain your answer. Exercise 18.8 ★★

Exercise 18.9 ★★

ANALYSING THE INFORMATION PROVIDED

Using the information provided about Company A in exercise 18.4, analyse the relative proﬁtability of the reportable segments.

DISCLOSURES

Company X, a listed manufacturing company, has two reportable segments, A and B. Both A and B are manufacturing segments. Required

CHAPTER 18 Operating segments

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Victoria Wise, revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 19 Other key notes disclosures

Chapter 19 – Other key notes disclosures Discussion questions Related party disclosures 1. Why do standard setters formulate rules for the disclosure of related party relationships? The standard setters formulate rules to govern the disclosure of related party transactions to ensure that an organisation’s financial statements contain the disclosures necessary to an understanding of the potential effect of transactions and outstanding balances and commitments with related parties.

2. Explain why key management personnel are regarded as related parties. Key management personnel are regarded as people who have the authority and responsibility to plan, direct and control the activities of organisations. This has the potential to affect the profit and loss and the financial position of the organisation. As such they are regarded as related parties of those organisations, and their related party relationship must be disclosed.

3. Explain why a parent company and its subsidiary entities are regarded as related parties. A subsidiary entity might operate on the instructions of its parent entity and this relationship has the potential to affect the risks and opportunities faced by both of the entities. For this reason parent and subsidiary entities are regarded as ‘related’ and information about transactions between them, outstanding balances, and commitments is necessary to enable a full understanding of the risks and opportunities.

4. Distinguish between control, joint control and significant influence. Control is deemed to be when an investor is exposed, or has rights to variable returns from its involvement in the investee and has the ability to affect those returns through its power over the investee. Joint control is the contractually agreed sharing of control of an arrangement. Significant influence is the power to participate in the financial and operating policy decisions of an entity, and may be gained by share ownership, statute or agreement.

19.1

Solutions Manual to accompany Applying IFRS Standards 4e

5. Explain how an entity determines whether a family member is a related party. IAS 24 sets out the broad criterion of “those family members who may be expected to influence, or be influenced by, that person”. This is sufficiently broad to allow for different cultural settings, allowing for different levels of family tie that might arise within, say, an extended family. IAS 24 supplements this general criterion by giving examples: “(a) that person’s children and spouse or domestic partner; (b) children of that person’s spouse or domestic partner; and (c) dependants of that person or that person’s spouse or domestic partner.”

Earnings per share 1. What is the earnings per share ratio used for? The earnings per share ratio is used to compare the after-tax profit available to ordinary shareholders of an entity on a per share basis, with that of other entities. 2. Why is a time-weighting factor used to determine the number of shares that is used in the calculation of basic earnings per share? As the earnings per share calculation is focused on the ordinary equity of an entity, the denominator in the calculation contains only ordinary share capital. Because entities are able to make new share issues during a reporting period, the number of shares on issue can increase. They are also able to repurchase or cancel shares, which will decrease the number of shares on issue, and to split or to consolidate shares which will vary the number of shares on issue. Other actions, including the conversion of convertible preference shares or other convertible securities into ordinary shares, can also vary the amount of shares outstanding. Accordingly, the number of ordinary shares that is used in the calculation of basic earnings per share is adjusted by a time-weighting factor, which is the number of days in the reporting period that the shares are outstanding as a proportion of the total number of days in the period (IAS 33, paragraph 20). 3. What is the treatment applied to treasury shares when calculating the weighted average number of shares used in the earnings per share calculation? Shares that are repurchased and held by the issuing entity are termed ‘Treasury’ shares. If a purchase of Treasury shares (share repurchase) occurs, then the weighted average number of shares outstanding for the period in which the transaction takes place must be adjusted for the reduction in the number of shares from the date of the event (IAS 33, paragraph 29). 4. Distinguish between basic earnings per share and diluted earnings per share. ‘Basic’ earnings per share is a ratio of the profit (or loss) attributable to ordinary shareholders, and the weighted average number of ordinary shares outstanding during the relevant reporting period. ‘Diluted’ earnings per share is a ratio which recognises the potential dilutive effect of the basic earnings per share ratio from the assumption that the entity’s convertible securities are converted, its warrants or options are exercised, or that its contingently issuable shares are issued. 5. Explain the effect of potential ordinary shares on the calculation of diluted earnings per share. In the measurement of diluted earnings per share, adjustments must be made to the profit(or loss) attributable to ordinary shareholders for: the after-tax amount of dividends, interest or other income or expenses © John Wiley and Sons, Ltd, 2016

19.2

Chapter 19 Other key notes disclosures recognised in the reporting period in respect of dilutive securities that would no longer arise if they were converted to ordinary shares. Adjustments must also be made to increase the weighted average number of ordinary shares outstanding to reflect what the weighted average would have been; assuming that all potential ordinary shares (dilutive securities) had been converted.

6. Why are retrospective adjustments made to earnings per share ratios? Retrospective adjustments are made to earnings per share ratios in order to restate the values of relevant items so that valid comparisons across time can be made. If, for example, the number of issued shares increases during a reporting period as a result of a bonus issue for no consideration, then the operating profit for the whole period in which the bonus issue occurred will be attributable to the increased number of shares, and not to the lesser number of shares outstanding at the beginning of the reporting period.

19.3

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 19.1

SCOPE OF IAS 24

Which of the following is the related-party of an entity within the scope of IAS 24? Give reasons for your answer. (a) A person who has the authority to plan, direct and control the activities of the entity (b) The domestic partner and children of a director of the entity. (c) The non-dependent sister of a director of the entity. (d) A subsidiary company that is directly controlled by the entity. (a) (b)

Yes. Such persons are regarded as key management personnel of the entity. Yes. Under IAS 24, paragraph 9, the children, spouse or domestic partner, other children of the spouse or domestic partner, and dependents of the key management person or of their spouse or domestic partner, are all regarded as related parties of the entity. Yes. IAS 24, paragraph 9 considers members of the same corporate group to be related parties. No. If the share investment made by the employee is an arm’s length transaction and the terms and conditions are not more favourable than would occur with other non-related parties, then the dividends on those share investments are not regarded as related party transactions. If the employee is a key management person, then, yes, the dividend payment to that employee would be considered a related party transaction.

Exercise 19.2

RECOGNITION PRINCIPLES

Determine whether the consultancy service provided by Jay is a related party transaction that should be disclosed in the financial statements of Armstrong Ltd. Explain your answer. As Jay is a director of the entity Armstrong Ltd, IAS 24, paragraph 9 regards any transactions between her and the entity to be as related party transactions. This related party transaction must be disclosed in the financial statements of Armstrong Ltd.

Exercise 19.3

DETERMINING WHETHER PARTIES ARE RELATED

Determine the related party relationships for Cannes Ltd. In this set of circumstances, Jacques is a related party of Cannes Ltd because Jacques controls Cannes Ltd. As Jacques controls Cannes Ltd and he is also a member of the key management personnel of Revoir Ltd, Cannes Ltd and Revoir Ltd are considered to be related parties.

19.4

Chapter 19 Other key notes disclosures

Exercise 19.4

EFFECT OF RELATED PARTY DISCLOSURES

Identify the disclosures that IAS 24 requires to be provided regarding key management personnel. Do you think the costs of making such disclosures outweigh the benefits? Explain your answer. The disclosures regarding remuneration (compensation) paid to key management personnel are contained in IAS 24. These disclosures are quite broad and include: • Compensation arrangements for short-term, long-term, termination, and share-based payment benefits. • Principles of compensation arrangements for key management personnel • Equity instruments and transactions, as part of share-based remuneration. Students should be encouraged to discuss the issue of costs and benefits of making disclosures. Disclosure provides information that enables users of financial statements to assess the risks and opportunities associated with entities. Arguably, asymmetric information creates costs to users. However, all disclosures have an attaching production cost to the entity providing that data.

Exercise 19.5

COMPONENTS OF BASIC EARNINGS PER SHARE

Which of the following is a component of earnings used in the calculation of basic earnings per share? Give reasons for your answer. a) b) c) d) e)

Profit before tax expense Preference dividends declared during the period Income tax expense Profit from discontinued operations Prior year dividend paid to holders of cumulative preference shares

IAS 33, paragraphs 12 and 13 set out the components of earnings used in the calculation of basic earnings per share. Accordingly: a) b) c) d) e)

Profit before income tax expense is included Preference dividends declared during the period are deducted (excluded) Income tax expense is deducted (excluded) Profit from discontinued operations is deducted (excluded) Prior year dividend paid to holders of cumulative preference shares are deducted (excluded)

Exercise 19.6

BONUS ISSUE OF SHARES

Calculate the 2013 and 2012 basic earnings per share amounts that Regis Ltd must disclose in its financial statements for the year ended 31 December 2013. Bonus issue on 1 March 2013

200 000 x 2

Basic earnings per share 31 December 2013

900 000 200 000 + 400 000

$1.50

Basic earnings per share 31 December 2012

600 000 200 000 + 400 000

$1.00

400 000

19.5

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 19.7

THEORETICAL EX-RIGHTS VALUE

Determine the theoretical ex-rights value per share. One for three rights issue: Number of shares on issue Number of new shares 30 000/3 Theoretical ex-rights number of shares

30 000 =

10 000 40 000

Calculate the theoretical ex-rights value per share: (30 000 x $6) + (10 000 x $4) 40 000 180 000 + 40 000 40 000 = $5.5

Exercise 19.8

RIGHTS ADJUSTMENT FACTOR AND ADJUSTED BASIC EARNINGS PER SHARE

Use the theoretical ex-rights value per share determined in Exercise 19.7 to calculate the adjustment factor, and calculate adjusted basic earnings per share. Adjustment factor: Theoretical ex-rights value per share (from Exercise 20.7) Share price immediately before the exercise of rights

Adjustment factor

Adjustment factor = 1.09

$6 $5.5

$5.5

Calculate adjusted basic earnings per share: 109 725 (30 000 x 1.09 x 3/12) + (10 000 x 9/12) 109 725 15 675

= $7

19.6

Chapter 19 Other key notes disclosures

Exercise 19.9

EFFECT OF SHARE OPTIONS ON DILUTED EARNINGS PER SHARE

Prepare a schedule setting out the calculation of basic earnings per share and diluted earnings per share Basic earnings per share is calculated as follows Profit attributable to ordinary shareholders for the reporting period 30 June 2014 Weighted average shares on issue during the period Basic earnings per share

Earnings $

Diluted earnings per share is calculated as follows Weighted average number of shares under option Weighted average number of shares that would have been issued at average market price, is (24 000 x $1.50)/$2.40 Diluted earnings per share

Exercise 19.10

Per share $

96 000 480 000 0.20

24 000 (15 000)

96 000

489 000

0.196

RECOGNITION PRINCIPLES

Is the pension scheme a related party of the Alworth Company? Explain. IAS 24, paragraph 21 considers post-employment benefit plans to be related party entities. The defined benefit pension scheme operated by Alworth Company would be regarded as a related party, and any transactions with that entity would need to be disclosed in the financial statements of the Alworth Company.

Exercise 19.11

DISCLOSURE

Prepare appropriate disclosures reflecting the related party relationship and transactions between Urton Company and its employee Marion for the period ended 30 June 2015. Transactions with the Urton Company and related parties Details of certain transactions between Urton Company and related parties are set out below: Urton Company granted 50 000 options to a member of its key management personnel, Marion. The options are conditional upon Marion remaining with the Urton Company for a period of three years. Marion purchased goods from the Urton Company which were billed at normal commercial rates and terms.

19.7

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 19.12

EXEMPTION FROM DISCLOSURE FOR GOVERNMENT-RELATED ENTITIES

Determine the extent to which Telephony Ltd can apply the partial disclosure exemption for government-related entities. IAS 24, paragraph 25 provides an exemption from some of the disclosure requirements for transactions between entities. Telephony Ltd can apply the exemption for transactions with Productivity Agency, Outcomes Ltd and Networks Ltd.

Exercise 19.13

CONTRACTS WITH KEY MANAGEMENT PERSONNEL

Identify any related party transactions between Mr Hegarty and (1) Citadel Resources, (2) OZ Minerals. Explain how these related party transactions might be capable of affecting the profit or loss or the financial position of the entities involved. This is a complex set of circumstances and related party transactions are unclear. It is questionable from this information whether Mr Hegarty can be considered a related party of Citadel Resources as he is described as a consultant. If however, he was a member of the key management personnel, then any consultancy transactions he engaged in with Citadel Resources would be considered to be related party transactions. The information does not indicate the nature of Mr Hegarty’s position at OZ Minerals, however, the existence of a ‘golden handshake’ might indicate that he was either a director or a member of the key management personnel. If so, then any transactions between Mr Hegarty and OZ Minerals would be regarded as related party transactions.

Exercise 19.14

IDENTIFYING RELATED PARTY TRANSACTIONS

Choose one entity from each of the following three business sectors and identify the types of transactions (e.g. goods and services) that the entities might engage in with related parties under normal commercial terms and conditions. (a) Transport sector (b) Retailing sector (c) Construction sector Expect the students to be innovative in the examples of arm’s length transactions they provide. Some examples are shown below. (a) Transport: Emirates: family holidays using air transport, purchased on-line (b) Retailing: Aldi supermarket: normal weekly groceries purchased in a Aldi supermarket by the spouse or children of a director of Aldi (c) Construction: Mr. Bricolage: purchase of paving tiles and cement through a commercial outlet, by the son of a director of Mr. Bricolage

19.8

Chapter 19 Other key notes disclosures

Exercise 19.15

SCOPE OF IAS 33

If an entity presents both consolidated and separate financial statements, what is the basis of determination of basic earnings per share disclosures? Give reasons for your answer. If an entity presents both consolidated and separate financial statements, the IAS 33 disclosures relating to basic earnings per share are determined on the basis of consolidated information. This disclosure is provided for in IAS 33, paragraph 4.

Exercise 19.16

MEASURING BASIC EARNINGS PER SHARE

Calculate Samira Ltd’s 2014 basic earnings per share ratio. $450 000 1 800 000

Exercise 19.17

$0.25

MEASUREMENT PRINCIPLES IN IAS 33

Are the treasury shares acquired in this transaction included in the weighted average number of shares outstanding when determining basic earnings per share? Explain your answer. The treasury shares are not included in the number of shares outstanding when determining the basic earnings per share. The entity’s resources are reduced by any consideration paid in purchasing treasury shares, so if a purchase of treasury shares occurs, then the weighted average number of shares outstanding for the period must be adjusted for the reduction in the number of shares from the date of the event.

Exercise 19.18

SPLIT SHARE CATEGORISING

Should the entity recognise the additional shares in the weighted average number of shares used in calculating basic earnings per share? Explain. The share split involves no consideration and has no corresponding increase in the entity’s resources. Therefore, the number of ordinary share outstanding before the event must be adjusted for the proportionate change in the number of outstanding as if it had occurred at the beginning of the earliest presented in the financial statements (IAS 33, paragraph 28). For example, under a share split, multiplying the number of ordinary shares outstanding before the share split determines the number of additional ordinary shares.

19.9

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 19.19

DETERMINING THE ADDITIONAL SHARES FROM POTENTIALLY DILUTIVE OPTIONS

Calculate the additional shares attributable to ordinary shareholders from the potentially dilutive options. Potential ordinary shares from dilutive options Increase in earnings Additional shares issued for no consideration 5 000 x ($3.75 - $3.00)/3.75 Earnings per additional share

Exercise 19.20

$0 1 000 $0

DISCLOSURE

Prepare an appropriate note to be included in the financial statements of Washington Ltd disclosing the information concerning the classification of potential ordinary shares. Note X. Earnings per share (a) Information concerning rights and options granted to employees Rights Rights granted to employees under the Executive Performance Share Plan (EPSP) are considered to be potential ordinary shares and have been included in the determination of diluted earnings per share to the extent to which they are dilutive. The rights have been excluded in the determination of basic earnings per share. Options Options granted to employees under the EPSP have a term of 5 years and vest when executives satisfy individual performance conditions. The options are considered to be potential ordinary shares and have been included in the determination of diluted earnings per share to the extent to which they are dilutive. In the current year the options are considered anti-dilutive (previous year; dilutive). The options could potentially dilute basic earnings per share in the future. The options have been excluded in the determination of basic earnings per share.

19.10

Chapter 19 Other key notes disclosures

Exercise 19.21

THEORETICAL EX-RIGHTS VALUE, RIGHTS ADJUSTMENT FACTOR AND BASIC EARNINGS PER SHARE

Determine the theoretical ex-rights value per share, the rights adjustment factor, and the basic earnings per share. One for five rights issue: Number of shares on issue Number of new shares 60 000/5 Theoretical ex-rights number of shares

60 000 =

12 000 72 000

Theoretical ex-rights value per share: (60 000 x 3) + (12 000 x 2) 60 000 + 12 000 204 000 72 000

$2.83

Rights adjustment factor: $3 2.83

1.06

Basic earnings per share: 244 650 (60 000 x 1.06 x 3/12) + (72 000 x 9/12) 244 650 69 900

$3.50

19.11

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Elisabetta Barone and Yeny Lukito

John Wiley & Sons, Ltd 2016

Chapter 19 Other key notes disclosures

Learning Objectives 19.1

Explain the potential effect of related party relationships

19.2

Explain the objective and scope of IAS 24

19.3

Identify an entity’s related parties

19.4

Identify relationships that do not give rise to a related party relationship as envisaged under IAS 24

19.5

Describe and apply the disclosures required by IAS 24

19.6

Explain why a government-related entity has a partial exemption from related party disclosures

19.7

Explain the objective of IAS 33

19.8

Discuss the application and scope of IAS 33

19.9

Discuss the components of basic earnings per share and examine how it is measured

19.10

Explain the concept of diluted earnings per share and how it is measured

19.11

Explain the need for retrospective adjustment of earnings per share

19.12

Describe and apply the disclosure requirements of IAS 33.

19.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1. Disclosure of related parties is essential in financial reporting because: Learning Objective 19.1 Explain the potential effect of related party relationships a. related parties cannot be trusted; b. there are certain limits imposed on entities in regards to how many related party transactions they could have; *c. related parties have the potential to affect an entity’s profit or loss and financial position that might not otherwise occur; d. a high number of corporate collapses are caused by related party transactions.

The scope of IAS 24 states that IAS 24 shall be applied in identifying the followings, except for: Learning Objective 19.2 Explain the objective and scope of IAS 24 a. outstanding balances, including commitments, between an entity and its related parties; *b. insider trading with related parties; c. circumstances in which disclosures of transactions with related parties are required; d. related party relationships and transactions.

3. An entity is related to a reporting entity if any of the following conditions apply, except: Learning Objective 19.3 Identify an entity’s related parties *a. the reporting entity has significant economic dependence on the entity; b. both entities are joint venture of the same third party; c. the entity is the subsidiary of the reporting entity; d. the entity is a post-employment benefit plan for the reporting entity’s employees.

The power to participate in the financial and operating policy decisions of an entity is known as: Learning Objective 19.3 Identify an entity’s related parties a. control; *b. significant influence; c. share ownership; d. joint control. Aladdin is the owner and founder of Genie Limited. Aladdin’s wife, Jasmine, has a controlling investment in Jafar Limited. Which of the followings describes the relationship between Genie Limited and Jafar Limited? Learning Objective 19.3 Identify an entity’s related parties a. Genie Limited and Jafar Limited are not related parties. b. No disclosure about transactions with Jafar Limited is required in the financial statements of Genie Limited. *c. Genie Limited is a related party of Jafar Limited. d. Genie Limited has control over Jafar Limited. 5.

19.2

Chapter 19 Other key notes disclosures

Galaxy Limited is a listed company operating in retail industry with three business units: Milky Way, Andromeda, and Whirlpool. Which of the followings is likely to be the key management personnel of Galaxy Limited? Learning Objective 19.3 Identify an entity’s related parties *a. The general manager of Milky Way; b. The managing director’s personal assistant; c. The company’s auditor; d. The company’s IT manager.

7. An entity in which an investor has significant influence is known as: Learning Objective 19.3 Identify an entity’s related parties a. a joint venture; b. a related party; c. a subsidiary; *d. an associate.

8. Two entities are not regarded as related parties simply because: Learning Objective 19.4 Identify relationships that do not give rise to a related party relationship as envisaged under IAS 24 a. one entity is a post- employment benefit plan for the other entity; b. one entity is a subsidiary of the other entity; c. a member of the key management personnel of one entity controls the other entity; *d. a member of the key management personnel of one entity has significant influence over the other entity.

John Berry is one of the non-executive directors of Monash Company. In this current financial year, Monash Company had transactions with the following entities: I. Borrowed money from ABC Bank. II. Purchased raw materials from Deakin Company. III. Loaned money to one of its subsidiaries, Swinburne Company, with 10% per annum. IV. Sold products to Melbourne Company, of which John Berry is also a director. Which transactions are not related party transactions between Monash Company and another entity? Learning Objective 19.4 Identify relationships that do not give rise to a related party relationship as envisaged under IAS 24 a. I and II only; b. II and III only; *c. I, II and IV; d. II, III, and IV.

19.3

Test Bank to accompany Applying IFRS Standards 4e

10.

According to IAS 24, related party disclosures are required irrespective of whether there have been related party transactions when: Learning Objective 19.5 Describe and apply the disclosures required by IAS 24 a. significant influence exists; *b. control exists; c. economic dependence exists; d. all of the above.

11.

The following remuneration categories must be disclosed for key management personnel, except for: Learning Objective 19.5 Describe and apply the disclosures required by IAS 24 a. termination benefits; b. post-employment benefits; *c. bonus payments; d. share-based payments.

12. IAS 24: Learning Objective 19.1 Explain the potential effect of related party relationships a. prescribes how transactions with related parties are to be measured; b. defines the recognition criteria of related party transactions; c. explains the format of financial statements of entities with related parties; *d. deals purely with related party disclosures.

13.

In the case where financial statements of parent entity or the ultimate controlling entity are not made publicly available, the reporting entity must disclose: Learning Objective 19.5 Describe and apply the disclosures required by IAS 24 a. the name of the entity’s largest shareholder; *b. the name of the next most senior parent entity whose financial statements are publicly available; c. the reason of why the parent entity does not make its financial statements publicly available; d. the level of share ownership of the next most senior parent entity.

14.

A government entity controls both Edward Limited and Jacob Limited. Bella Limited and Jasper Limited are the subsidiaries of Edward Limited. Carlisle Cullen is the managing director of Edward Limited. Edward Limited can apply the partial exemption of disclosures in paragraph 25 of IAS 24 to transactions with the following parties, except for: Learning Objective 19.6 Explain why a government-related entity has a partial exemption from related party disclosures *a. Carlisle Cullen; b. Jacob Limited; c. Bella Limited; d. the government entity.

19.4

Chapter 19 Other key notes disclosures

15.

Willow Limited and Rupert Limited are the two subsidiaries of Buffy Company. Dan Sanders, one of the directors of Buffy Company, is also a director of Rupert Limited. Dan’s wife, Sandra, has 10% of shareholding in Rupert Limited. Which of the followings are related parties to Willow Limited? Learning Objective 19.3 Identify an entity’s related parties a. Buffy Company and Dan Sanders; *b. Buffy Company and Rupert Limited; c. Rupert Limited and Dan Sanders; d. Dan Sanders and Sandra Sanders.

16.

Which of the following is the related party of a reporting entity within the scope of IAS 24? Learning Objective 19.3 Identify an entity’s related parties a. The domestic partner of a director of the reporting entity. b. A supplier of the reporting entity. c. The non-dependent children of the reporting entity’s CEO. *d. Another subsidiary of the reporting entity’s parent.

17. Examples of related party transactions that must be disclosed include: Learning Objective 19.5 Describe and apply the disclosures required by IAS 24 a. settlement of liabilities; b. disposal of assets; c. purchase or sales of goods; *d. all of the above.

18.

Jon holds an investment in Voight Limited that gives him a significant influence over the company. Jon’s daughter, Angelina, also has a significant influence over another entity, Jolie Limited. What is the relationship between Voight Limited and Jolie Limited? Learning Objective 19.3 Identify an entity’s related parties a. Voight Limited is a related party of Jolie Limited. b. Voight Limited has a significant influence over Jolie Limited. *c. Voight Limited and Jolie Limited are not related parties. d. Voight Limited has control over Jolie Limited.

19.

Maria is one of the directors in Leo Limited, which is one the subsidiaries of Aries Limited. She also has a joint control with Mimi in Virgo Limited. In this circumstance, the followings are related parties to Leo Limited, except for: Learning Objective 19.3 Identify an entity’s related parties *a. Mimi; b. Maria; c. Aries Limited; d. Virgo Limited.

19.5

Test Bank to accompany Applying IFRS Standards 4e

20.

Which of the followings are most likely to be considered as key management personnel of an entity? I. Chief Financial Officer II. Admin Officer III. Non-executive directors IV. General Manager Learning Objective 19.3 Identify an entity’s related parties a. I, II, and III; b. II, III, and IV; *c. I, III, and IV; d. I, II, III, and IV.

21.

VicEd is a government agency that controls Science Limited. Science Limited has two subsidiaries: Bio Limited and Chem Limited. To which entities can Bio Limited apply the disclosure exemption in paragraph 25 of IAS 24? Learning Objective 19.6 Explain why a government-related entity has a partial exemption from related party disclosures a. VicEd Limited only; b. Science Limited only; c. Science Limited and Chem Limited only; *d. VicEd Limited, Science Limited, and Chem Limited.

22.

If an entity chooses to apply the disclosure exemption in paragraph 25 of IAS 24, it is still required to do the followings, except: Learning Objective 19.6 Explain why a government-related entity has a partial exemption from related party disclosures a. disclose the nature of the relationship with the government-related entities; b. identify the government to which it is related; *c. the nature and amount of every transaction with government-related entities; d. a qualitative or a quantitative indication of the extent of other transactions that are collectively significant.

23.

Which of the following transactions are not related party transactions for an entity? I. An employee purchased the entity’s products on normal trading terms. II. The entity made an agreement with a trade union about increase in employee’s wages. III. A subsidiary of the entity supplied raw materials to the entity. IV. The entity lent money to one of its directors. Learning Objective 19.4 Identify relationships that do not give rise to a related party relationship as envisaged under IAS 24 *a. I and II only; b. I and III only; c. II and IV only; d. III and IV only.

19.6

Chapter 19 Other key notes disclosures

24. The minimum disclosures for related party transactions include the followings, except: Learning Objective 19.5 Describe and apply the disclosures required by IAS 24 a. provision of doubtful debts related to outstanding balances; b. the amount of transactions; c. the amount of the outstanding balances and commitments; *d. the key management personnel of the related party. Harry is a non-executive director of Potter Limited and Hogwarts Limited. Harry’s wife, Ginny, is a non-executive director of Weasley Limited. Which of the following statements is correct? Learning Objective 19.4 Identify relationships that do not give rise to a related party relationship as envisaged under IAS 24 a. Harry is not a related party to Potter Limited. *b. Potter Limited and Hogwarts Limited are not related parties. c. Ginny is a related party to Hogwarts Limited. d. Potter Limited and Weasley Limited are related parties. 25.

26.

Metro Limited is a subsidiary of Matrix Limited. Which of the followings is not a related party to Metro Limited? Learning Objective 19.4 Identify relationships that do not give rise to a related party relationship as envisaged under IAS 24 a. A pension scheme that offers benefits to employees of Metro Limited. b. The Managing Director of Matrix Limited. c. An associate of Metro Limited. *d. A distributor of Metro Limited’s products.

27. The contractually agreed sharing of control over an economic entity is known as: Learning Objective 19.3 Identify an entity’s related parties a. significant influence; b. significant control; *c. joint control; d. joint venture.

28.

Drew is one of the directors of Mellor Limited. In the current financial year, Mellor Limited paid £50 000 to Advice Agency, where Drew’s brother works, for the consultancy services it provided. In addition, Mellor Limited also paid £2000 to Drew for a once-off consultancy he provided on a specific project. Which of the following statements describes the relationship between Drew, Mellor Limited, and Advice Agency? Learning Objective 19.3 Identify an entity’s related parties a. Advice Agency is a related party to Mellor Limited. b. Drew is not a related party to Mellor Limited. *c. The £50 000 consultancy fee is not a related party transaction. d. The £2000 consultancy fee is not a related party transaction.

19.7

Test Bank to accompany Applying IFRS Standards 4e

29.

David is the general manager of Awesome Limited and is considered to be the member of key management personnel. The following transactions occurred between David and Awesome Limited: • David purchased a product of Awesome Limited on normal trading terms; • David received remuneration from Awesome Limited amounting to £100 000; • Awesome Limited issued 20 000 options to David, which can be converted into Awesome Limited’s shares if target profit margin of 25% is achieved in the next three years. Which of the above transactions must be disclosed as related party transactions? Learning Objective 19.5 Describe and apply the disclosures required by IAS 24 a. The purchase of product and David’s remuneration. *b. David’s remuneration and the grant of options. c. The purchase of product and the grant of options. d. All of the above transactions are related party transactions. 30. Earnings per share is calculated by comparing an entity’s: Learning Objective 19.7 Explain the objective of IAS 33 a. revenue with the number of ordinary shares it has on issue b. profit with the number of shareholders *c. profit with the number of ordinary shares it has on issue d. revenue with the number of shareholders

31.

Earnings per share disclosed by reporting entities have limitations because of the: I different accounting methods that can be used in the determination of profit II different amounts of profit depending on the size of the entity III ability of an entity to change the number of shares used in the denominator IV different numbers of shareholders depending on the size of the entity Learning Objective 19.7 Explain the objective of IAS 33 a. I and IV b. II and III c. II and IV *d. I and III

32. EPS refers to: Learning Objective 19.7 Explain the objective of IAS 33 a. equity per share b. earnings per shareholder *c. earnings per share d. earnings per subsidiary

19.8

Chapter 19 Other key notes disclosures

33. Earnings per share is calculated by: Learning Objective 19.7 Explain the objective of IAS 33 a. dividing profit or loss attributable to ordinary shareholders of a parent entity, by the number of ordinary shares the entity has on issue at the beginning of the reporting period *b. dividing profit or loss attributable to ordinary shareholders of a parent entity, by the weighted average number of ordinary shares the entity has on issue during the reporting period c. dividing profit or loss attributable to preference shareholders of a parent entity, by the weighted average number of ordinary shares the entity has on issue during the reporting period d. dividing profit or loss attributable to ordinary shareholders of a parent entity, by the number of ordinary shares the entity has on issue at the end of the reporting period

34.

Under paragraph 4, if an entity presents both consolidated and separate financial statements, the IAS 33 disclosures need only be determined on the basis of: Learning Objective 19.8 Discuss the application and scope of IAS 33 a. parent entity only b. subsidiary entities only *c. consolidated information d. the entity has choice of either parent entity or consolidation

35. IAS 33 applies to the computation and presentation of earnings per share by: Learning Objective 19.8 Discuss the application and scope of IAS 33 a. only reporting entities whose shares are publicly traded *b. reporting entities whose shares are publicly traded, or of entities that are in the process of issuing ordinary shares that will be traded in public markets c. only those entities that are in the process of issuing ordinary shares that will be traded in public markets d. both reporting and non-reporting entities

36. The number of shares used in the calculation of earnings per share is: Learning Objective 19.9 Discuss the components of basic earnings per share and examine how it is measured a. the number of ordinary and preference shares adjusted by a time-weighting factor which is the number of days in the reporting period that the shares are outstanding as a proportion of the total number of days in the period b. the number of preference shares adjusted by a time-weighting factor which is the number of days in the reporting period that the shares are outstanding as a proportion of the total number of days in the period c. the average of the number of ordinary shares outstanding at the beginning and end of the reporting period *d. the number of ordinary shares adjusted by a time-weighting factor which is the number of days in the reporting period that the shares are outstanding as a proportion of the total number of days in the period

19.9

Test Bank to accompany Applying IFRS Standards 4e

37.

XYZ Ltd has 10 000 ordinary shares on issue at 1 July 2015 which is the beginning of its reporting period. On 1 May 2016, it issued a further 2000 ordinary shares for cash. The weighted average number of shares for use in the earnings per share calculation is: Learning Objective 19.9 Discuss the components of basic earnings per share and examine how it is measured a. 10 000 shares *b. 10 333 shares c. 11 000 shares d. 12 000 shares

38.

The profit or loss that is used in the calculation of basic earnings per share is calculated as: Learning Objective 19.9 Discuss the components of basic earnings per share and examine how it is measured a. Profit before tax expense b. Profit before tax expense – tax expense c. Profit before tax expense – tax expense – ordinary dividends *d. Profit before tax expense – tax expense – preference dividends

39.

ABC Ltd has 21 000 ordinary shares on issue at 1 January 2016 which is the beginning of its reporting period. On 30 June 2016, it issued a further 2000 ordinary shares for cash. On 1 November 2016, ABC Ltd repurchased 600 shares at fair value in a market transaction. The weighted average number of shares for use in the earnings per share calculation is: Learning Objective 19.9 Discuss the components of basic earnings per share and examine how it is measured a. 21 000 shares b. 21 700 shares *c. 21 900 shares d. 22 400 shares

40.

Mary Ltd determined its profit attributable to ordinary shareholders for the reporting period ended 30 June 2016 as £720 000. The number of ordinary shares on issue up to 31 October 2015 was 50 000. Mary Ltd announced a two-for-one bonus issue of shares effective for each ordinary share outstanding at 31 October 2015. Basic earnings per share at 30 June 2016 is: Learning Objective 19.9 Discuss the components of basic earnings per share and examine how it is measured *a. £4.80 b. £6.17 c. £7.20 d. £9.60

19.10

Chapter 19 Other key notes disclosures

Use the following information to answer questions 41 and 42 Harry Ltd determined its profit attributable to ordinary shareholders for the reporting period ended 30 June 2016 as €960 000. The average market price of the entity’s shares during the period is €4.00 per share. The weighted average number of ordinary shares on issue during the period is 1 000 000. The weighted average number of shares under share options arrangements during the year is 200 000 and the exercise price of shares under option is €3.50. 41. The basic earnings per share at 30 June 2016 is: Learning Objective 19.10 Explain the concept of diluted earnings per share and how it is measured a. €0.80 *b. €0.96 c. €3.50 d. €4.00

42. The diluted earnings per share at 30 June 2016 is: Learning Objective 19.10 Explain the concept of diluted earnings per share and how it is measured a. €0.80 *b. €0.94 c. €1.24 d. €4.00

43.

For the purposes of calculating diluted earnings per share, an entity shall adjust the profit attributable to ordinary shareholders by the after-tax effect of the following item(s) related to dilutive potential ordinary shares: Learning Objective 19.10 Explain the concept of diluted earnings per share and how it is measured a. dividends only *b. dividends, interest, other income or expenses c. interest only d. other income or expenses only

44.

If all of the dilutive securities were converted into ordinary shares, the diluted earnings per share ratio: Learning Objective 19.10 Explain the concept of diluted earnings per share and how it is measured a. may include an adjustment to increase the weighted average number of ordinary shares that would be outstanding b. must include an adjustment to decrease the weighted average number of ordinary shares that would be outstanding c. must include an adjustment to increase the number of ordinary shares that would be outstanding *d. must include an adjustment to increase the weighted average number of ordinary shares that would be outstanding

19.11

Test Bank to accompany Applying IFRS Standards 4e

45.

A company issues bonus shares for no consideration on 1 August 2014. For the reporting period ended 30 June 2015, the calculation of: Learning Objective 19.11 Explain the need for retrospective adjustment of earnings per share a. only basic earnings per share must be adjusted retrospectively for all periods that are presented in the financial statements b. only the diluted earnings per share must be adjusted retrospectively for all periods that are presented in the financial statements *c. both basic earnings per share and diluted earnings per share must be adjusted retrospectively for all periods that are presented in the financial statements d. both basic earnings per share and diluted earnings per share may be adjusted retrospectively at the option of the entity for all periods that are presented in the financial statements

46.

Any errors or adjustments resulting from changes in accounting policies that are accounted for retrospectively require: Learning Objective 19.11 Explain the need for retrospective adjustment of earnings per share a. a retrospective adjustment to basic earnings per share only b. a retrospective adjustment to diluted earnings per share only c. no retrospective adjustment to either basic or diluted earnings per share *d. a retrospective adjustment to both basic and diluted earnings per share

47.

The basic earnings per share and diluted earnings per share ratios must be presented in an entity’s: Learning Objective 19.12 Describe and apply the disclosure requirements of IAS 33 a. statement of financial position even if the amounts are negative *b. statement of profit or loss and other comprehensive income even if the amounts are negative c. statement of profit or loss and other comprehensive income only if the amounts are positive d. statement of changes in equity even if the amounts are negative

48.

Paragraphs 70–73 of IAS 33 prescribe various disclosures relating to earnings per share. The disclosures include: I the amounts used as the numerators (earnings) in the ratios II a reconciliation of the earnings amounts to the profit or loss attributable to the parent entity for the period including the individual effect of each class of instruments that affects earnings per share III the number of ordinary shares outstanding at the end of the financial year IV the weighted average number of ordinary shares used as the denominator in the ratios Learning Objective 19.12 Describe and apply the disclosure requirements of IAS 33 a. I, II and III b. I, III and IV c. II, III and IV *d. I, II and IV

19.12

Chapter 19 Other key notes disclosures

49. If the entity has a discontinued operation, then it must also calculate and disclose the: Learning Objective 19.12 Describe and apply the disclosure requirements of IAS 33 *a. the basic and diluted earnings per share ratios for the discontinued operation in the statement of profit or loss and other comprehensive income. b. the basic earnings per share ratio only for the discontinued operation in the statement of profit or loss and other comprehensive income. c. the diluted earnings per share ratio only for the discontinued operation in the statement of profit or loss and other comprehensive income. d. the basic and diluted earnings per share ratios for the discontinued operation in the statement of profit or loss and other comprehensive income only if the discontinued operation contributed a profit in the current reporting period

19.13

Exercises Exercise 19.10 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

RECOGNITION PRINCIPLES

Alworth Company operates a pension scheme that offers defined benefit pensions for the benefit of the company’s employees. At the end of the reporting period, the present value of the defined benefit obligation is $105 million and the fair value of the defined benefit scheme assets is $109 million. Required

Is the pension scheme a related party of the Alworth Company? Explain. Exercise 19.11 ★★

DISCLOSURE

During the period ended 30 June 2015, Marion, an employee of Urton Company, purchased goods from the company on normal commercial terms and conditions. Marion receives remuneration consisting of cash and other short-term beneﬁts amounting to $180 000. During the 30 June 2015 ﬁnancial year, Marion also received a grant of 50 000 options from the company which is conditional on her continuing to work for the company for the next 3 years. Marion is considered to be a member of the key management personnel of the Urton Company. Required

Prepare appropriate disclosures reﬂecting the related party relationship and transactions between Urton Company and its employee Marion for the period ended 30 June 2015. Exercise 19.12 ★★

EXEMPTION FROM DISCLOSURE FOR GOVERNMENT-RELATED ENTITIES

Productivity Agency is a government organisation which directly controls another entity, Outcomes Ltd, and through its interest in Outcomes Ltd it indirectly controls Telephony Ltd and Networks Ltd. Required

Determine the extent to which Telephony Ltd can apply the partial disclosure exemption for governmentrelated entities. Exercise 19.13 ★★★

CONTRACTS WITH KEY MANAGEMENT PERSONNEL

IAS 24 notes (paragraphs 5 and 6) that related party relationships are a normal feature of commerce and business and cautions that a related party relationship could have an effect on the proﬁt or loss and ﬁnancial position of an entity. For example, related parties could enter into transactions that unrelated parties would not. The following extract outlines details of a contract between a publicly listed company, Citadel Resources, and a consultant, Mr Owen Hegarty. Mining identity Owen Hegarty has stepped down from his consulting role at up-and-coming gold miner Citadel Resources Group amid a political storm over executive pay. Mr Hegarty’s departure from Citadel also follows the emergence of a rival Canadian bidder for the giant Martabe gold deposit in Indonesia, being sold by troubled OZ Minerals. Citadel announced yesterday that Mr Hegarty’s contract as a senior adviser to the company had been terminated by ‘mutual agreement’. Mr Hegarty took on the role at Citadel just nine months ago, after receiving an $8.35 million golden handshake from OZ Minerals — a product of the $12 billion marriage of Oxiana and Zinifex last year. Many shareholders expressed outrage at the size of Mr Hegarty’s payout in light of the disastrous turn of events at OZ Minerals soon after its creation. Mr Hegarty is believed to be the front-runner to acquire the $325 million Martabe project — a former Oxiana asset — from OZ Minerals. Source: Williams (2009, p. 63).

Required

IDENTIFYING RELATED PARTY TRANSACTIONS

Many entities have transactions with related parties which occur under normal terms and conditions. For example, banks provide a wide range of banking and other ﬁnancial services and products, some of which are used by bank directors and their close family members. CHAPTER 19 Other key notes disclosures

Required

SCOPE OF IAS 33

★ If an entity presents both consolidated and separate ﬁnancial statements, what is the basis of determina-

tion of basic earnings per share disclosures? Give reasons for your answer.

Exercise 19.16

MEASURING BASIC EARNINGS PER SHARE

★ On 30 June 2014, Samira Ltd determines proﬁt attributable to ordinary shareholders as $450 000. At the

beginning of the reporting period the company had 1 800 000 ordinary shares outstanding. The company had no share issues during the period. Required

Calculate Samira Ltd’s 2014 basic earnings per share ratio. Exercise 19.17

MEASUREMENT PRINCIPLES IN IAS 33

★ The directors of Johannsen Group have decided to repurchase 100 000 ordinary shares in an on-market

arm’s length transaction. Required

Are the treasury shares acquired in this transaction included in the weighted average number of shares outstanding when determining basic earnings per share? Explain your answer. Exercise 19.18

SHARE SPLIT CATEGORISING

★ An entity announces a share split to occur in the current reporting period. There is no consideration payable by existing shareholders and therefore no corresponding increase in the entity’s resources. Required

Should the entity recognise the additional shares in the weighted average number of shares used in calculating basic earnings per share? Explain. Exercise 19.19 ★★

DETERMINING THE ADDITIONAL SHARES FROM POTENTIALLY DILUTIVE OPTIONS

Tennyson Ltd has 20 000 ordinary shares outstanding during the reporting period ended 30 June 2015. The average market price of its ordinary shares during the period was $3.75 per share. The company also has 5000 options on issue with an exercise price of $3.00 each. Required

Calculate the additional shares attributable to ordinary shareholders from the potentially dilutive options. Exercise 19.20

DISCLOSURE

★★★ Washington Ltd operates an Executive Performance Share Plan (EPSP). Under this plan, the company grants rights to employees which are convertible into ordinary shares of the company. It also grants options under the EPSP. The options have a term of 5 years and are converted into ordinary shares when the executives satisfy their individual performance conditions. The options granted during the current reporting period are considered anti-dilutive; however, in past years the options granted have been dilutive. Required

Prepare an appropriate note to be included in the ﬁnancial statements of Washington Ltd disclosing the information concerning the classiﬁcation of potential ordinary shares.

PART 3 Presentation and disclosures

Exercise 19.21 ★★★

THEORETICAL EX-RIGHTS VALUE, RIGHTS ADJUSTMENT FACTOR AND BASIC EARNINGS PER SHARE

At the beginning of the current reporting period (1 January 2014) Petrov Ltd has 60 000 ordinary shares on issue. The company announced a one-for-ﬁve rights issue on 1 January 2014. The exercise price is $2 and the last date to exercise the rights is 1 April 2014. The market price of one share immediately before exercise on 1 April 2014 was $3. At the end of the current reporting period (31 December 2014), Petrov Ltd determined proﬁt attributable to ordinary shareholders at $244 650. Required

Determine the theoretical ex-rights value per share, the rights adjustment factor, and the basic earnings per share.

CHAPTER 19 Other key notes disclosures

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo, revised for this edition by Gilad Livne and David Kolitz

John Wiley & Sons, Ltd, 2016

Solutions Manual to accompany Applying IFRS Standards 4e

Chapter 20 – Consolidation: controlled entities Discussion questions 1.

What is a subsidiary?

A subsidiary is an entity that is controlled by another entity, a parent.

What is meant by the term “control”?

An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. 3.

When are potential voting rights considered when deciding if one entity controls another?

Potential voting rights are rights to obtain voting rights of an investee, such as within an option or convertible instrument. Potential voting rights are only considered if the rights are substantive i.e. practical or utilitarian. This depends on the terms and conditions associated with the options. If an investor holds options that are deeply out of the money – such that the investee would never exercise those options – the options would not be considered to be substantive.

Are only those entities in which another entity owns more than 50% of the issued shares classified as subsidiaries?

No. The criterion for consolidation is not based on percentage ownership, but rather it is based on the concept of control. However, when the percentage interest is below 50%, judgement on the existence of control is required. In forming this judgement, the accountant has to rely on evidence to form an opinion. 5.

What benefits could be sought by an entity that obtains control over another entity?

Consider: -

Dividends Returns from structuring activities with the investee e.g. obtaining a supply of raw material, access to a port facility Returns from denying or regulating access to a subsidiary’s assets e.g. a patent for a competing product Returns from economies of scale Remuneration from provision of services such as servicing of assets, and management

20.1

Chapter 23 Consolidation: controlled entities

EXERCISES Exercise 20.1

CONVERTIBLE DEBENTURES

Discuss whether Soup Ltd is a subsidiary of Pea Ltd. PEA LTD – SOUP LTD

Pea Ltd Convertible debentures

Soup Ltd Mr Smith owns 100% of shares

The question is whether Pea Ltd is a parent of Soup Ltd. This depends on whether Pea Ltd controls Soup Ltd. Consider the definition of control as per Appendix A of IFRS 10. Key question: As Pea Ltd holds convertible debentures, does this give it control over Soup Ltd? Mr Smith actually controls Soup Ltd but the IFRS 10 concept of control is a capacity to control, a power to govern concept rather than an actual control concept. Pea Ltd can be considered a passive controller. The holder of a presently exercisable instrument has the capacity to control. It has the unilateral ability to exercise the instrument and thus obtain the power to determine financial and operating policy. By not exercising the conversion option, Pea Ltd is implicitly accepting the policy determinations of Soup Ltd. An analogy can be drawn with delegated authority. Mr Smith knows that if he fails to gain the approval of Pea Ltd for his actions, then the latter can exercise control by converting the debentures. The instrument must be currently exercisable. An alternative position is that Mr Smith controls until Pea Ltd actually chooses to exercise the conversion option. Pea Ltd cannot actually make any policy decisions in relation to Soup Ltd. It must first exercise the conversion option. It may never exercise that option. In that case, Mr Smith determines all policies in relation to Soup Ltd. Mr Smith has current capacity to control; this would change if Pea Ltd exercised its options. But until it takes that step, it does not have the current capacity to control. Given that Pea Ltd has not exercised the option, do the shareholders in Pea Ltd want or need information about the combined entity of the two companies? A further point of discussion is whether the likelihood of exercise of the conversion option should be part of the decision process. Under IFRS 10, the rights must be substantive in order for control to exist. For example, because of economic conditions, Pea Ltd may not want to exercise the options. If it is detrimental to the holder of the options to exercise the options, the holder does not have control over the other entity. Review illustrative examples 20.1 and 20.2 in the text.

20.2

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 20.2

OPTIONS

Discuss whether Palau Ltd is the parent of Cook Islands Ltd.

Palau Ltd

PALAU LTD–INDIA LTD–COOK ISLANDS LTD 40% 40% Cook Islands Ltd

India Ltd

Kobe Ltd

20%

As Palau Ltd holds options in Cook Islands Ltd, it has the potential to control that entity. However, including the options when determining control depends on whether the options are substantive i.e. whether it is in the interest of Palau Ltd to exercise the options. The options are currently out of the money. Hence the options should not be included in the determination of control. However, if there are other reasons why Palau may be able to increase its returns from Cook Islands Ltd such as access to facilities/scarce resources then even if the options are out of the money, Palau Ltd may still consider that it is worthwhile to exercise the options. In such cases, the options would be included in the decision on who controls Cook Islands Ltd. Exercise 20.3

CONTROL

1. Advise Pluto Ltd as to whether, under IFRS 10, it controls Sun Ltd and/or Saturn Ltd. Support your conclusion. 2. Would your conclusion be different if the remaining shares in Sun Ltd were owned by three institutional investors each holding 20%? If so, why? PLUTO LTD–SUN LTD–SATURN LTD 1. Pluto Ltd 40%

35%

Sun Ltd

Saturn Ltd 17%

- NCI is a diverse group - low attendance at AGM - Pluto Ltd expects to appoint 3/5 directors

- NCI is small group - keen interest - interested in directors

Consider the definition of control. Power to govern or capacity to control depends on an entity having the ability to direct the policies of another entity so as to affect the returns of that entity and to be able to use that power to increase those returns. Determination of control is a judgement. Ability to exert control depends on such factors as: - size of the voting interest - the dispersion of other shareholdings - level of disorganisation or apathy of the NCI shareholders - attendance at AGMs - contractual arrangements - arrangements between friendly parties

20.3

Chapter 23 Consolidation: controlled entities

Applying these to the above example, it is expected that Sun Ltd is a subsidiary. If Sun Ltd is a subsidiary, then Saturn Ltd is also a subsidiary as Pluto Ltd would control 52% of the vote.

2. A change in the relative ownerships within Sun Ltd would suggest that, dependent on other factors, it would lose its subsidiary status. Saturn Ltd would also then lose its subsidiary status

Exercise 20.4

SUBSIDIARY STATUS

Discuss the potential for Soup Ltd being classified as a subsidiary of Pumpkin Ltd. PUMPKIN LTD–SOUP LTD

Pumpkin Ltd

Soup Ltd 40% -

Situation 1 Discuss: -

the concept of control the need for judgement factors to consider when determining the existence of control: - NCI = 60% - no other party > 3% interest - only 75% attendance at AGM last year apply to above situation

It will probably be concluded that Pumpkin Ltd is the parent of Soup Ltd. Situation 2 Consider: - The difference between actual control and capacity to control: the party actually controlling the other entity may not have the capacity to control. Just because Pumpkin Ltd’s nominees are elected as Board members does not automatically mean that it becomes the parent of Soup Ltd. It simply means that it actually controls that entity. The question is whether it has the capacity to control. - Attendance at AGMs: If holders of 90% of the voting shares attended the AGM, then holders of 50% of the shares could have outvoted Pumpkin Ltd. They may allow Pumpkin Ltd to manage Soup Ltd because of the great managerial skills or business connections of Pumpkin Ltd. In this case, Pumpkin Ltd is not the parent of Soup Ltd. - The purpose of consolidation: If Pumpkin Ltd is actually controlling Soup Ltd, even though it does not have the capacity to control, would the shareholders of Pumpkin Ltd be interested in a set of consolidated financial statements for the combined group? Does the issue of accountability provide sufficient grounds for the consolidation of the two entities?

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Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 20.5

DETERMINING SUBSIDIARY STATUS

In the following independent situations, determine whether a parent–subsidiary relationship exists, and which entity, if any, is a parent required to prepare consolidated financial statements under IFRS 10. 1. Perth Ltd is a company that was hurt by a recent global financial crisis. As a result, it experienced major trading difficulties. It previously obtained a significant loan from Fremantle Bank, and when Perth Ltd was unable to make its loan repayments, the bank made an agreement with Perth Ltd to become involved in the management of that company. Under the agreement between the two entities, the bank had authority for spending within Perth Ltd. Perth Ltd’s managers had to obtain authority from the bank for acquisitions over $10 000, and was required to have bank approval for its budgets. 2. Broome Ltd owns 80% of the equity shares of Shark Bay Ltd, which owns 100% of the shares of Geraldton Ltd. All companies prepare reports under IFRS Standards. Although the shares of Shark Bay Ltd are not traded on any stock exchange, its debt instruments are publicly traded. 3. Denmark Ltd is a major financing company whose interest in investing is return on the investment. Denmark Ltd does not get involved in the management of its investments. If the investees are not managed properly, Denmark Ltd sells its shares in that investee and selects a more profitable investee to invest in. It previously held a 35% interest in Esperance Ltd as well as providing substantial convertible debt finance to that entity. Recently, Esperance Ltd was having cash flow difficulties and persuaded Denmark Ltd to convert some of the convertible debt into equity so as to ease the effects of interest payments on cash flow. As a result, Denmark Ltd’s equity interest in Esperance Ltd increased to 52%. Denmark Ltd still wanted to remain as a passive investor, with no changes in the directors on the board of Esperance Ltd. These directors were appointed by the holders of the 48% of shares not held by Denmark Ltd. PERTH LTD–BROOME LTD–DENMARK LTD In each of these circumstances the following principles from the Basis of Conclusions to IFRS 10 should be used: B2

To determine whether it controls an investee an investor shall assess whether it has all the following: (a) power over the investee; (b) exposure, or rights, to variable returns from its involvement with the investee; and (c) the ability to use its power over the investee to affect the amount of the investor’s returns.

B3 Consideration of the following factors may assist in making that determination: (a) the purpose and design of the investee; (b) what the relevant activities are and how decisions about those activities are made; (c) whether the rights of the investor give it the current ability to direct the relevant activities; (d) whether the investor is exposed, or has rights, to variable returns from its involvement with the investee; and (e) whether the investor has the ability to use its power over the investee to affect the amount of the investor’s returns 1.

This question will be looked at under two scenarios: (i) Perth Ltd is not a subsidiary of any other entity. The key issue is whether the fact that the bank has authority in relation to acquisitions and approval of budgets is sufficient to give the bank the status of a parent. The bank will receive a return from Perth Ltd in the form of interest on the loan. Fremantle Bank Has: - Power over Perth Ltd, as it has rights arising from the legal contract

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Chapter 23 Consolidation: controlled entities

It can affect some of the relevant activities e.g. acquisitions, but not others such as appointment of key management personnel.

Perth Ltd will not be a subsidiary of Fremantle Bank because: The bank is not exposed to variable returns from its involvement with Perth Ltd. The interest payments are not affected by the profitability of Perth Ltd. - It cannot use its power over Perth Ltd to affect the amount of its returns, as the returns are fixed interest payments. -

(ii) Perth Ltd is a wholly owned subsidiary of another entity, Mandurah Ltd. The key issue in this scenario is whether the authority given to the bank in relation to acquisitions and budget approval is sufficient to state that Mandurah Ltd does not control Perth Ltd. The key issue is whether Mandurah Ltd still has power over Perth Ltd given the arrangements with the bank. Relevant activities over which a parent should have power include: (a) selling and purchasing of goods or services; (b) managing financial assets during their life (including upon default); (c) selecting, acquiring or disposing of assets; (d) researching and developing new products or processes; and (e) determining a funding structure or obtaining funding. Decisions about relevant activities include: (a) establishing operating and capital decisions of the investee, including budgets; and (b) appointing and remunerating an investee’s key management personnel or service providers and terminating their services or employment. The key issue then is whether Mandurah Ltd has the ability to direct the relevant activities i.e. those activities that most significantly affect the investee’s returns. It is probable that Mandurah Ltd no longer controls Perth Ltd as the bank can veto any changes to significant transactions for the benefit of Mandurah Ltd. It can deny the company its ability to make acquisitions, and it can reject moves within a budget to undertake changes in inventory production. 2.

Broome Ltd

80%

Shark Bay Ltd

100%

Geraldton Ltd

The issue is whether Shark Bay Ltd needs to prepare a set of consolidated financial statements for itself and Geraldton Ltd. Note that paragraph 4 of IFRS 10 states that an entity that is a parent shall present consolidated financial statements except: (a) a parent need not present consolidated financial statements if it meets all the following conditions: (i) it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and all its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements; (ii) its debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets); (iii) it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and (iv) its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with International Financial Reporting Standards (IFRSs). Note all criteria are required to be met. In this example: (i) Geraldton Ltd is a wholly owned subsidiary of Shark Bay Ltd (ii) The ultimate parent, Broome Ltd, prepares reports under IFRSs

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Solutions Manual to accompany Applying IFRS Standards 4e

However, the debt instruments of Shark Bay Ltd are traded publicly which means that it breaches 4(a)(iii) above. Hence Shark Bay Ltd is not exempt from preparing consolidated financial statements. Both Broome Ltd and Shark Bay Ltd would be required to prepare consolidated financial statements.

Denmark Ltd currently holds 52% of the shares of Esperance Ltd. It does not want to become involved in the management of Esperance Ltd, and the directors are appointed by the noncontrolling interest (NCI). Control is not based on actual control but on the capacity to control. Denmark Ltd - has power over the investee via its share ownership - is exposed to variable returns via dividends arising from its share ownership - has the ability to affect those returns as it can become involved in management whenever it wishes, given its superior voting power. Denmark Ltd is a parent of Esperance Ltd and hence must prepare consolidated financial statements. Further, when Denmark Ltd held a 35% interest in Esperance Ltd it also held convertible debt in that entity which could, if converted, give it an equity interest of 52%. In this situation, Denmark Ltd was a parent of Esperance Ltd and should have prepared consolidated financial statements. It would appear under the circumstances that the conversion was substantive i.e. economically feasible, and currently exercisable.

Exercise 20.6 LESS THAN MAJORITY OWNERSHIP Provide a report to Pink Ltd on whether it should regard Scarlet Ltd as a subsidiary in its preparation of consolidated financial statements at 31 December 2015. PINK LTD–SCARLET LTD 40% Pink Ltd Discuss: -

Scarlet Ltd

the concept of control the need for judgement factors to consider when determining the existence of control, such as: - NCI is 60% - 65% of voters attended AGM - no block holdings of shares apply to above situation

It is expected that Pink Ltd is the parent of Scarlet Ltd. Do all parent entities have to prepare consolidated financial statements? Paragraph 4 of IFRS 10 establishes which entities must prepare consolidated financial statements.

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Chapter 23 Consolidation: controlled entities

Exercise 20.7

OPTIONS

Discuss whether Comoros Ltd is a subsidiary of any of the other entities. BRUNEI LTD–BURMA LTD–BHUTAN LTD Facts: Brunei Ltd Burma Ltd Bhutan Ltd

each have 1/3 of ordinary shares of Comoros Ltd

Brunei Ltd owns call options that would give it 100% of the voting rights of Comoros Ltd. Management do not intend to exercise the options, presumably because it is not in their economic interest to do so. As the options are not substantive, they should not be considered in determining control. Comoros Ltd is not a subsidiary of any of the three companies.

Exercise 20.8

CONVERTIBLE DEBT

Discuss whether Pin Ltd is a parent of Sharp Ltd. POINT LTD–PIN LTD–SHARP LTD Point Ltd

55% Sharp Ltd

Pin Ltd 45% Pin Ltd holds convertible debt in Sharp Ltd that would, on exercise, give it 70% of Sharp Ltd. However, this would result in a substantial increase in Pin Ltd’s debt-equity ratio raising doubts about the company’s capacity to exercise the options. When considering potential voting rights, an investor shall consider the purpose and design of the instrument, as well as the purpose and design of any other involvement the investor has with the investee. This includes an assessment of the various terms and conditions of the instrument as well as the investor’s apparent expectations, motives and reasons for agreeing to those terms and conditions. If the investor also has voting or other decision-making rights relating to the investee’s activities, the investor assesses whether those rights, in combination with potential voting rights, give the investor power. In this situation, although the debt instruments are convertible at a substantial price, they are currently convertible and the conversion feature gives Pin Ltd the power to affect the returns from Sharp Ltd. The existence of the potential voting rights are considered and it could be determined that Pin Ltd not Point Ltd controls Sharp Ltd. An investor, in assessing whether it has power, considers only substantive rights relating to an investee (held by the investor and others). For a right to be substantive, the holder must have the practical ability to exercise that right. It is necessary to consider any barriers that might prevent the holder from exercising the rights. Examples of such barriers include: (i) financial penalties and incentives that would prevent (or deter) the holder from exercising its rights.

20.8

Solutions Manual to accompany Applying IFRS Standards 4e

(ii)

an exercise or conversion price that creates a financial barrier that would prevent (or deter) the holder from exercising its rights. (iii) terms and conditions that make it unlikely that the rights would be exercised, for example, conditions that narrowly limit the timing of their exercise. (iv) the absence of an explicit, reasonable mechanism in the founding documents of an investee or in applicable laws or regulations that would allow the holder to exercise its rights. (v) the inability of the holder of the rights to obtain the information necessary to exercise its rights. (vi) operational barriers or incentives that would prevent (or deter) the holder from exercising its rights (e.g. the absence of other managers willing or able to provide specialised services or provide the services and take on other interests held by the incumbent manager). (vii) legal or regulatory requirements that prevent the holder from exercising its rights (e.g. where a foreign investor is prohibited from exercising its rights). If Pin Ltd does not have the financial ability to enter into the conversion of the debt, then it does not have the practical ability to exercise those rights. Hence, the existence of the convertible debt cannot affect the determination of control. Point Ltd would then be the parent of Sharp Ltd

Exercise 20.9

DETERMINING SUBSIDIARY STATUS

In the following independent situations, determine whether a parent–subsidiary relationship exists and which entity, if any, is a parent required to prepare consolidated financial statements under IFRS 10. 1. Albany Ltd and Busselton Ltd each hold 50% of the shares in Dunsborough Ltd, all companies being involved in the computer software industry. Albany Ltd agrees that Busselton Ltd should provide the management of Dunsborough Ltd because of the expertise provided by its managing director, Bob Gates. Busselton Ltd receives a management fee for providing its expertise. 2. Alice Ltd has recently acquired a 35% interest in Springs Ltd, a company that has discovered large deposits of iron ore. Alice Ltd has extensive experience in the mining industry and, as a result, has been able to have four of its directors elected to the board of Springs Ltd, which has six directors in total. 3. Darwin Ltd holds 30% of the shares issued by Arnhem Ltd. The other shareholders come from mixed backgrounds, but each holds on average 10% of shares in Darwin Ltd. There are seven directors of Arnhem Ltd. Four of these are appointed by Darwin Ltd. The other three directors are appointed by three of the other shareholders who have an interest in the management of the company. Most of the remaining shareholders live outside Australia and rarely attend board meetings of Darwin Ltd unless they have other business to attend to in Australia around the same time as the board meetings are held. ALBANY LTD–ALICE LTD–DARWIN LTD In each of these circumstances the following principles from the Basis of Conclusions to IFRS 10 should be used: B2

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Chapter 23 Consolidation: controlled entities

Both Albany Ltd and Busselton Ltd hold 50% of the shares in Dunsborough Ltd, with Busselton Ltd actually directing Dunsborough Ltd because of its management expertise. In this circumstance, Dunsborough Ltd is not a subsidiary of either company. Neither investor has the power over Dunsborough Ltd, as neither investor holds existing rights to enable it to direct the relevant activities of Dunsborough Ltd. Although Albany Ltd allows Busselton Ltd to currently manage the investee, it can step in at any time and challenge the management arrangements. As neither investor holds more than 50% of the shares, neither has power. Hence there is no need for any consolidated financial statements to be prepared.

Alice Ltd currently has the ability to elect a majority of directors of Springs Ltd. This has occurred potentially just because of its expertise in the mining industry. As in (a) above, this does not give it power over Springs Ltd. There is no information to suggest that the other 65% of shareholders in Springs Ltd could not get together and change the management of Springs Ltd. Alice Ltd does not have power over Springs Ltd. Alice Ltd does not have to prepare consolidated financial statements.

Currently Darwin Ltd holds 30% of the shares of Arnhem Ltd. The remaining shareholders consist of 7 shareholders having on average 10% of Arnhem Ltd’s shares. In relation to these investors: - most live outside Australia - most do not attend AGMs Where an investor has less than a 50% holding of shares in the investee, judgement is required to determine whether control exists. It is necessary to examine the potential actions of the holders of the other shares in Arnhem Ltd. In this case, it is difficult to make a decision as: - The fact that there are only 7 others shareholders with 10% each, only 3 of these need to get together to have the same voting capacity as Darwin Ltd. This lessens the likelihood of Darwin Ltd having control. - The fact that most live outside Australia lessens the probability of these shareholders getting together to take control. However, they could give their proxies to each other. - The attendance at AGMs is low by the other shareholders. This however can change if these shareholders become dissatisfied with Darwin Ltd as a manager. - The other shareholders have an interest in management shown by their appointing 3 of the directors – only 1 less than Darwin’s 4 directors. As the shareholders have an interest – as opposed to being apathetic – the probability of becoming involved if they become dissatisfied with Darwin Ltd is higher. On balance, Darwin Ltd is probably not a parent of Arnhem Ltd as it does not have sufficient power to continue to direct the relevant activities of Arnhem Ltd.

20.10

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 20.10 DETERMINING PARENT STATUS Given that there is no guarantee that the bank will always support Japan Ltd, particularly if there is a potential for economic loss, discuss whether Japan Ltd is a parent of Maldives Ltd.

Discuss: the concept of control the need to apply judgement these situations are often referred to “strawmen” – other parties that act as agents or in conjunction with the NCI. In the example in this question, the NCI has an assurance that the voting of the investment bank will always be aligned with its own, ensuring that it cannot be outvoted. If control is the basis for consolidation, a factor to consider is the influence available through a friendly party. Note however, that there is no guarantee that the investment bank will always vote with the NCI – the relationship may change over time. However, many of the other factors considered in relation to an NCI and control, such as the attendance at the AGM and the size of blocks of shareholdings may also change over time.

Exercise 20.11 RIGHTS TO VARIABLE RETURNS Discuss: 1. the place of a returns criterion in the definition of control 2. possible returns that could occur as a result of obtaining control of another entity 3. the need to place a specified level of returns in the definition of control.

The concept of control has basically 3 tests: - power over the investee - exposure, or rights, to variable returns from its involvement with the investee; and - the ability to use its power over the investee to affect the amount of the investor’s returns 1. Place of a returns criterion: The objective is to identify entities that are effectively able to use the assets and direct the activities of another and to benefit from such use as if those assets were held and those activities were undertaken on their behalf. It is doubtful that an entity would control another if there were no benefits in doing so. Assets are repositories of benefits. One holds assets in order to receive the benefits. 2. Possible returns: - cash distribution via dividends or residual interest - production of product or service complementary to the operation of the parent e.g. guaranteed source of raw material such as sand useful to the parent’s manufacture of glass. - the subsidiary has assets of use to the parent e.g. a patent that it may use or may control the production of competing products by others 3. Need for a specified level of returns: For example, must the parent be entitled to at least 50% of the returns from the subsidiary? If the returns were purely dividends/residual interest, this may be of interest. Given the variety of possible returns as noted above, the concept of a majority of returns seems both unnecessary and unworkable as the measurement of the relative returns would be very difficult. Measurement of the relative worth of different types of returns could be difficult. The ability to control is not dependent on the level of returns to be received. If the need for consolidation is based on concepts such as accountability, then the level of returns is not important. It is more crucial to determine whether management can affect the returns from another entity.

20.11

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Yeny Lukito and Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 20 Consolidation: controlled entities

Chapter 20 Consolidation: controlled entities Learning Objectives 20.1 20.2 20.3 20.4 20.5

Explain the meaning of consolidated financial statements Discuss the meaning and application of the criterion of control Discuss which entities should prepare consolidated financial statements Understand the relationship between a parent and an acquirer in a business combination Explain the differences in disclosure requirements between single entities and consolidated entities.

20.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1.

The entity that is represented by a single set of consolidated financial statements known as a consolidated financial report is: Learning Objective 20.1 Explain the meaning of consolidated financial statements. *a. an economic entity; b. a parent entity; c. a subsidiary entity; d. a partnership.

When one entity controls the business operations of another entity, the business combination results in the following type of relationship: Learning Objective 20.1 Explain the meaning of consolidated financial statements. *a. parent-subsidiary; b. partnership; c. a merger; d. dual-listed.

3. For the purposes of consolidated financial reporting, a group is: Learning Objective 20.1 Explain the meaning of consolidated financial statements. a. an entity that has no subsidiaries; *b. a parent entity and all its subsidiaries; c. an entity that has one or more subsidiaries; d. a subsidiary entity of another entity. 4. IFRS 10 defines a ‘parent’ and a ‘subsidiary’ as: Learning Objective 20.1 Explain the meaning of consolidated financial statements.

a. b. c. *d.

Parent An entity which owns more than 50% of the voting shares of another entity. An entity which owns more than 20% of the voting shares of another entity. An entity that has one or more subsidiaries. An entity that controls another entity.

Subsidiary An entity in which another entity owns more than 50% of the voting shares. An entity which is owned partly by another entity. An entity which is controlled by a parent entity. An entity which is controlled by another entity.

A single set of financial statements, that combines the separate sets of financial statements for a number of entities, which are managed as a single economic entity, is known as: Learning Objective 20.1 Explain the meaning of consolidated financial statements. a. a concise financial report; b. a condensed financial report; c. new entity financial statements; *d. consolidated financial statements.

20.2

Chapter 20 Consolidation: controlled entities

The process of preparing the combined financial statements of a group of entities is known as: Learning Objective 20.1 Explain the meaning of consolidated financial statements. a. accrual accounting; b. condensation; c. accumulation; *d. consolidation.

A group of entities formed by A Limited (parent entity), B Limited (subsidiary entity) and C Limited (subsidiary entity) has the following Trade Receivables balances: ➢ ➢ ➢

A Limited $12 000 B Limited $15 000 C Limited $10 000

The consolidated financial statements show the following amount as the consolidated Trade Receivables balance: Learning Objective 20.1 Explain the meaning of consolidated financial statements. a. $12 000; b. $13 000; c. $25 000; *d. $37 000.

The process of aggregating individual sets of financial statements to produce consolidated financial statements requires: Learning Objective 20.1 Explain the meaning of consolidated financial statements. *a. that no adjustments be entered into the individual ledger accounts of entities in the group; b. balance sheet date adjusting journal entries to be recorded in the ledger accounts of the subsidiaries; c. accruals of expenses and revenue, directly into the retained earnings ledger account of the parent entity; d. balance sheet date adjusting entries directly into the ledger accounts of the parent entity only.

9. The key criterion for the consolidation of the separate financial statements of entities is: Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. substance over form; *b. control; c. the existence of contracts for the supply of goods between the entities; d. capacity of the accounting systems to facilitate the necessary combination process;

20.3

Test Bank to accompany Applying IFRS Standards 4e

10. In a consolidated group of entities, control over the subsidiaries in the group: Learning Objective 20.2 Discuss the meaning and application of the criterion of control. *a. may not be shared control; b. can be shared with other parties; c. can be less than 100% control; d. can be less than 50% control.

11.

According to IFRS 10, which of the following factors indicate the existence of control? I. II. III. IV.

Possessing existing rights that give the current ability to direct the relevant activities. Shared power in the governance of financial and operating policies of another entity so as to obtain benefits. The power to govern the operating policies of an entity so as to obtain benefits. Ownership of more than 50% of the voting power in the subsidiary.

Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. I, II and III only; *b. I and IV only; c. II and IV only; d. IV only.

12. When deciding whether or not control exists over one entity by another entity: Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. the controlling entity must have exercised its power to control; *b. it is sufficient that the controlling entity has the capacity to control; c. the controlling entity must be actively involved in governing the operations of the other entity; d. it is necessary that the controlling entity has exerted its control over the financing policies of the other entity.

13.

For one entity to control another entity, the percentage of share ownership held by the controlling entity: Learning Objective 20.2 Discuss the meaning and application of the criterion of control. *a. can be nil; b. must be greater than 20%; c. must be greater than 50%; d. must be 100%.

14. Which is not one of the three elements of control? Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. the ability to use power over the investee to affect the amount of the investor’s returns; *b. holding majority voting rights; c. power over the investee; d. exposure, or rights, to variable returns from involvement with the investee.

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Chapter 20 Consolidation: controlled entities

15. Which of the following is correct in relation to rights in the context of control? Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. The rights must be protective rights. b. The rights must arise from a legal contract. c. The rights may be administrative. *d. The rights must be substantive rights.

16. If a controlling entity has delegated control to another entity, the parent is deemed to be: Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. the delegated party who is actively exercising control; b. both the delegating party and the party to whom control has been delegated; *c. the entity who delegated the control; d. neither entity as actual control has been lost.

17.

Control is automatically presumed to exist where the parent either directly or indirectly through subsidiaries owns: Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. more than 25% but less than 50% of the voting power of an entity; b. more than 10% but less than 25% of the voting power of an entity; c. not more than 49% of the voting power of an entity; *d. more than 50% of the voting power of an entity.

18.

Unicorn Trustees has a fiduciary relationship with Amble Limited enabling it to direct certain activities of Amble Limited. As a result of this relationship: Learning Objective 20.2 Discuss the meaning and application of the criterion of control. a. Unicorn Trustees is regarded as a parent entity of Amble Limited; b. Amble Limited is regarded as a subsidiary of Unicorn Trustees; *c. a parent-subsidiary relationship is not regarded as existing between these two parties; d. a parent-subsidiary relationship is regarded as existing between these two parties as Unicorn is able to direct the activities of Amble Limited.

19.

All parent entities are required to present consolidated statements unless the following conditions apply to them: I. The parent is a wholly owned subsidiary. II. The parent is a partly owned subsidiary and its owners do not object to the nonpresentation of consolidated financial statements. III. The parent’s debt or equity securities are traded in a public market. IV. The parent is not in the process of applying to issue any securities in a public market. Learning Objective 20.3 Discuss which entities should prepare consolidated financial statements. a. I and II only; b. I, II and III only; *c. I, II and IV only; d. I, II, III and IV.

20.5

Test Bank to accompany Applying IFRS Standards 4e

20.

A Ltd is a listed public company and has an 80% controlling interest in B Pty Ltd. B Pty Ltd is the parent of C Pty Ltd. In which of the following situations will B Pty Ltd not be required to prepare consolidated financial statements? Learning Objective 20.3 Discuss which entities should prepare consolidated financial statements. a. If B Pty Ltd prepares separate financial statements that comply with IFRS. *b. If the other owners of B Pty Ltd have consented to the non-preparation. c. Where it is likely that there are external users dependant on the information. d. B Pty Ltd would never be required to prepare consolidated financial statements.

21.

Two entities A Limited and B Limited together form a third entity, C Limited. C Limited acquires A Limited and B Limited. According to IFRS 3 Business Combinations: Learning Objective 20.4 Understand the relationship between a parent and an acquirer in a business combination. a. A Limited and B Limited cease to exist and C Limited is the acquirer; b. the combined A Limited and B Limited is the acquirer of C Limited; c. C Limited is considered to be the acquirer; *d. C Limited is not to be considered to be the acquirer.

22. In a business combination: Learning Objective 20.4 Understand the relationship between a parent and an acquirer in a business combination. a. it is not necessary to identify the acquirer as long as parent entity has been identified; b. the parent entity will always be the acquirer; *c. the accounting acquirer is the entity that becomes the controlling entity; d. the legal acquirer is the entity that becomes the controlling entity.

23.

Which of the following statements applies to reverse acquisitions?

The accounting acquirer would III. issue equity shares to the accounting acquire. The legal acquirer is identified IV. as accounting acquiree.

The legal subsidiary has the power to govern the financial and operating policies of the combined entity. II. Consolidated financial statements prepared following a reverse acquisition are issued under the name of the accounting acquirer. Learning Objective 20.4 Understand the relationship between a parent and an acquirer in a business combination. a. I and III; b. I and IV; *c. II and III; d. II and IV.

24.

Truong Limited acquired 60% of the shares of Quang Limited through the Australian Securities Exchange. The share acquisition cost Truong Limited $500 000. As a result of the share acquisition, Truong Limited gained control over Quang Limited. In its accounting records, Truong will recognise: Learning Objective 20.5 Explain the differences in disclosure requirements between single entities and consolidated entities. *a. an investment at a cost of $500 000

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Chapter 20 Consolidation: controlled entities

b. c. d.

an investment with a market value of $300 000 an increase in share capital of $500 000 an increase in share capital of $300 000.

25.

If an investor entity owns more than half of the voting or potential voting power of an investee and does not account for the investment as a subsidiary, IFRS 12 requires the following disclosure: Learning Objective 20.5 Explain the differences in disclosure requirements between single entities and consolidated entities. a. the reasons why the ownership of the investee does not constitute control; b. the nature of the relationship between the investor and investee; *c. the significant judgements and assumptions it has made in determining the nature of the interest in the other entity; d. the amount of any repayments of borrowings between the investor and investee during the period.

26.

If a parent entity chooses not to prepare consolidated financial statements, IAS 27 Separate Financial Statements requires the following disclosures in the separate financial statements of the parent: I. II. III. IV.

The name, country of residence and voting power of the directors of the parent. That the exemption from consolidation has been used. A list of significant investments including the proportion of ownership. A description of the method used to account for the investments.

Learning Objective 20.5 Explain the differences in disclosure requirements between single entities and consolidated entities. a. I, II and IV only; *b. II, III and IV only; c. II and III only; d. IV only.

27.

According to IFRS 12, parent entities are required to disclose: I. II. III. IV.

Summarised financial information about each subsidiary. A list of significant investments in subsidiaries. If the subsidiary is not wholly owned, the names of all other members. The country of incorporation of subsidiaries.

Learning Objective 20.5 Explain the differences in disclosure requirements between single entities and consolidated entities. *a. I, II and IV only; b. II, III and IV only; c. I and IV only; d. I, II, III and IV.

28. The main characteristic of a structured entity according to IFRS 12 is that: Learning Objective 20.5 Explain the differences in disclosure requirements between single entities and consolidated entities.

20.7

Test Bank to accompany Applying IFRS Standards 4e

a. *b. c. d.

the parent entity must have more than 80% of voting rights in the structured entity in order to gain control; voting or similar rights are not the dominant factor in deciding who controls the entity; the legal acquirer of such entity will become the accounting acquiree; it is controlled by two or more parent entities.

20.8

Exercises Exercise 20.7 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

OPTIONS

Brunei Ltd, Burma Ltd and Bhutan Ltd each own one-third of the ordinary shares that carry voting rights at a general meeting of shareholders of Comoros Ltd. Brunei Ltd, Burma Ltd and Bhutan Ltd each have the right to appoint two directors to the board of Comoros Ltd. Brunei Ltd also owns call options that are exercisable at a ﬁxed price at any time and, if exercised, would give it all the voting rights in Comoros Ltd. The management of Brunei Ltd does not intend to exercise the call options, even if Burma Ltd and Bhutan Ltd do not vote in the same manner as Brunei Ltd. Required

Discuss whether Comoros Ltd is a subsidiary of any of the other entities. Exercise 20.8 ★

CONVERTIBLE DEBT

Point Ltd and Pin Ltd own 55% and 45% respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Sharp Ltd. Pin Ltd also holds debt instruments that are convertible into ordinary shares of Sharp Ltd. The debt can be converted at a substantial price, in comparison with Pin Ltd’s net assets, at any time, and if converted would require Pin Ltd to borrow additional funds to make the payment. If the debt were to be converted, Pin Ltd would hold 70% of the voting rights and Point Ltd’s interest would reduce to 30%. Given the effect of increasing its debt on its debt–equity ratio, Pin Ltd does not believe that it has the ﬁnancial ability to enter into conversion of the debt. Required

Discuss whether Pin Ltd is a parent of Sharp Ltd. Exercise 20.9 ★★

DETERMINING SUBSIDIARY STATUS Required

In the following independent situations, determine whether a parent–subsidiary relationship exists and which entity, if any, is a parent required to prepare consolidated ﬁnancial statements under IFRS 10. 1. Albany Ltd and Busselton Ltd each hold 50% of the shares in Dunsborough Ltd, all companies being involved in the computer software industry. Albany Ltd agrees that Busselton Ltd should provide the management of Dunsborough Ltd because of the expertise provided by its managing director, Bob Gates. Busselton Ltd receives a management fee for providing its expertise. 2. Alice Ltd has recently acquired a 35% interest in Springs Ltd, a company that has discovered large deposits of iron ore. Alice Ltd has extensive experience in the mining industry and, as a result, has been able to have four of its directors elected to the board of Springs Ltd, which has six directors in total. 3. Darwin Ltd holds 30% of the shares issued by Arnhem Ltd. The other shareholders come from mixed backgrounds, but each holds on average 10% of shares in Darwin Ltd. There are seven directors of Arnhem Ltd. Four of these are appointed by Darwin Ltd. The other three directors are appointed by three of the other shareholders who have an interest in the management of the company. Most of the remaining shareholders live outside Australia and rarely attend board meetings of Darwin Ltd. unless they have other business to attend to in Australia around the same time as the board meetings are held. Exercise 20.10 ★★

DETERMINING PARENT STATUS

Japan Ltd has 37% of the voting interest in Maldives Ltd. An investment bank with which Japan has business relationships holds a 15% voting interest. Because of the closeness of the business relationship with the bank, Japan Ltd believes it can rely on the bank’s support to ensure it cannot be outvoted at general meetings of Maldives Ltd. Required

Given that there is no guarantee that the bank will always support Japan Ltd, particularly if there is a potential for economic loss, discuss whether Japan Ltd is a parent of Maldives Ltd.

CHAPTER 20 Consolidation: controlled entities

Exercise 20.11 ★★

RIGHTS TO VARIABLE RETURNS

Some have argued that the criteria for consolidation should be control plus significant risks and rewards of ownership or economic benefits. These parties argue that the consolidated financial statements are not meaningful if they include subsidiaries in which the parent’s level of returns is less than 50% or is not significant. Required

Discuss: 1. the place of a returns criterion in the definition of control 2. possible returns that could occur as a result of obtaining control of another entity 3. the need to place a specified level of returns in the definition of control.

PART 4 Economic entities

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo, revised for this edition by David Kolitz and Gilad Livne

John Wiley & Sons, Ltd, 2016

Solutions Manual to accompany Applying IFRS Standards 4e

Chapter 21 – Consolidation: wholly owned subsidiaries Discussion Questions 1. Explain the purpose of the pre-acquisition entries in the preparation of consolidated financial statements.

The purpose of the pre-acquisition entry is to: - prevent double counting of the assets of the economic entity - prevent double counting of the equity of the economic entity - recognise any gain on bargain purchase A simple example such as that below could be used to illustrate these points: A Ltd has acquired all the issued shares of B Ltd. The balance sheets of both companies immediately after acquisition are as follows: Share capital Reserves

£200 100 300

Shares in B Ltd Cash

150 150 300

Share capital Reserves

Cash

£100 50 150 -150 150

The balance of the “Shares in B Ltd” account can be changed to introduce goodwill/ gain on bargain purchase amounts amounts.

2. When there is a dividend payable by the subsidiary at acquisition date, under what conditions should the existence of this dividend be taken into consideration in preparing the preacquisition entries? Discuss: - the difference between ex div and cum div acquisitions - the effects on the acquisition journal entry in the records of the parent under each circumstance. Assume for example that A Ltd acquires all the issued shares of B Ltd for £500 000 when at acquisition date B Ltd has recorded a dividend payable of £10,000. - the effects on the acquisition analysis - the differences in the pre-acquisition entries at acquisition date if the acquisition is cum div versus ex div. [ the cum div entry will need to eliminate the dividend receivable raised by the parent and the dividend payable raised by the subsidiary]

3. Is it necessary to distinguish pre-acquisition dividends from post-acquisition dividends? Discuss: -

the definition of acquisition date the meaning of pre-acquisition and post-acquisition equity according to para 38A of IFRS10 an entity shall recognise a dividend from a subsidiary in profit or loss ie as revenue – regardless of whether it is paid from pre- or post-acquisition equity

21.1

Chapter 24: Consolidation: wholly owned subsidiaries 4. If the subsidiary has recorded goodwill in its records at acquisition date, how does this affect the preparation of the consolidation adjustment entries? Discuss: - the difference between internally generated and acquired goodwill, and how the goodwill can be internally generated to the subsidiary but acquired by the parent - the effects on the worksheet in relation to the goodwill eg if the subsidiary has recorded goodwill of £50 and the parent acquires all the shares in a subsidiary for £4,050 when the equity of the subsidiary is £3 950 Parent Goodwill

Subsidiary 50

Cr 100

Group 150

In calculating the net fair value of the identifiable assets and liabilities acquired, there must be an adjustment for the unidentifiable asset, goodwill, to calculate the goodwill acquired by the group. The goodwill acquired, but not recorded, is recognised in the business combination valuation entries. The pre-acquisition entries will eliminate the BCVR as pre-acquisition equity. On consolidation, the adjustment columns in the worksheet contain the adjustment necessary so that the group goodwill is shown in the consolidated balance sheet. This amount is the total of the goodwill recognised by the subsidiary at acquisition date and the goodwill recognised on consolidation. This equals the total goodwill acquired by the parent in its acquisition of the subsidiary.

5. Explain how the existence of a bargain purchase affects the pre-acquisition entries, both in the year of acquisition and in subsequent years. Explain the meaning of and accounting for a bargain purchase as per IFRS 3 Year of acquisition: Excess is shown in the pre-acquisition entry as a gain. Subsequent years: The excess is subsumed into the opening balance of retained earnings. It reduces the balance recorded by the subsidiary as the parent paid less for the subsidiary than the fair value of the identifiable assets and liabilities of the subsidiary.

21.2

Solutions Manual to accompany Applying IFRS Standards 4e

Exercises Exercise 21.1 ACCOUNTING FOR ASSETS AND LIABILITIES Write a report for the accountant at Mensa Ltd advising on the following issues: 1. Should the adjustments to fair value be made in the consolidation worksheet or in the accounts of Cancer Ltd? 2. What equity accounts should be used when revaluing the assets, and should different equity accounts such as income (similar to recognition of an excess) be used in relation to recognition of liabilities? 3. Do these equity accounts remain in existence indefinitely, since they do not seem to be related to the equity accounts recognised by Cancer Ltd itself? MENSA LTD

1. From the point of view of IFRS 3 and IFRS10, there is no specification on where the adjustments are made. However if the assets of the subsidiary are adjusted to fair value in the accounts of the subsidiary itself then this amounts to adoption of the revaluation model by the subsidiary and all the regulations in IAS16 and IAS38 apply. In particular, the assets must be continuously adjusted to reflect current fair values. If, on the other hand, the adjustments are made in the consolidation worksheet, this is a recognition on consolidation of the cost of the assets to the group entity rather than an adoption of the revaluation model. Hence the recognition of the subsidiary’s assets at fair value is to measure cost to the acquirer. There is then no need to make subsequent adjustments to the assets when the fair values change. Because of the costs associated with using the revaluation model, it is expected that most entities will make the adjustments in the consolidation worksheet rather than in the accounts of the subsidiary itself. 2. The accounting standards do not specify the name of the equity account raised on valuation of the assets and liabilities of the subsidiary. Hence, an asset revaluation reserve account could be used for the assets. Leo et al uses a BCVR because adjustments are made to both assets and liabilities and the BCVR is then a generic account for all adjustments arising as a result of the business combination. It is not appropriate to use income for liabilities as the recognition of equity for both assets and liabilities does not affect current period profit or loss. There is no gain by the acquirer on recognition of assets or liabilities not recognised by the subsidiary. 3. The BCVR remains in existence while the underlying assets and liabilities remain unsold, unconsumed or unsettled. With asset revaluation reserves under the revaluation model there is no requirement that it ever be transferred to retained earnings, although this is normal practice and is allowed under IAS16. Similarly, the BCV reserves could remain indefinitely. However, the extra benefits/expenses resulting from using the assets or settling the liabilities will flow into the subsidiary’s retained earnings account. Hence the group recognises the net benefits in the BCVR while the subsidiary recognises them in retained earnings. This situation requires an adjustment in the consolidation worksheet every year while such a difference in equity classification occurs. If on consolidation as the assets are used up or sold and the liabilities settled the BCVR is transferred to retained earnings, no subsequent consolidation adjustment is required.

21.3

Chapter 24: Consolidation: wholly owned subsidiaries Exercise 21.2

CONSOLIDATION WORKSHEET ENTRIES 1 YEAR AFTER ACQUISITION DATE

Prepare the consolidation worksheet entries at 30 June 2014 for the preparation of the consolidated financial statements of Pisces Ltd. PISCES LTD – URSA LTD Fair value adjustments total £15 000 pre-tax or £ 10, 500 after-tax. Hence, fair value of net assets acquired is £280 500 (270 000 + 10 500).

Acquisition analysis at 1 July 2013: 1st July 2013 Consideration paid

£283 000

Less: Fair value of net assets acquired

280 500

Goodwill

2 500

Business combination valuation entries at 30 June 2014 Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

80 000

Depreciation expense Accumulated depreciation (1/5 x £10 000 p.a.)

Dr Cr

2 000

Deferred tax liability Income tax expense (30% x £2 000)

Dr Cr

600

Cost of sales Income tax expense Business combination valuation reserve

Dr Cr

5 000

Goodwill Business combination valuation reserve

Dr Cr

2 500

Dr Dr Dr Dr Cr

20 000 200 000 50 000 13 000

70 000 3 000 7 000

2 000

600

1 500

3 500

2 500

Pre-acquisition entries at 30 June 2014 Retained earnings (1/7/13) Share capital General reserve Business combination valuation reserve Shares in Ursa Ltd

283 000

Exercise 21.3 ACQUISITION ANALYSIS, PARENT HOLDS PREVIOUSLY ACQUIRED SHARES IN SUBSIDIARY, WORKSHEET ENTRIES AT ACQUISITION DATE Prepare the acquisition analysis at 1 July 2014, and the consolidation worksheet entries for preparation of consolidated financial statements of Pavo Ltd at that date.

21.4

Solutions Manual to accompany Applying IFRS Standards 4e PAVO LTD – OCTANS LTD Analysis of fair value adjustments: Item Inventory Plant Brands R&D Contingent liability Total fair value adjustments (pre-tax) Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 4 000 5 000 50 000 20 000 (10 000) 69 000 20 700 48 300

Hence, the fair value of net assets acquired is £248 300. Analysis of total consideration: Item Value of 40% stake Purchase of 60% Dividend receivable

102 000 153 000 (5 000) 250 000

Determination of goodwill: 1 July 2014

1st July 2014 Total consideration paid

£250 000

Less: Fair value of net assets acquired

248 300

Goodwill

1 700

Note that after the acquisition on 1 July 2014 Pavo Ltd shows in its standalone balance sheet two related accounts: Investment in Octans Ltd Dividend receivable

£252 000 5 000

Business combination valuation entries at 1 July 2014 Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

4 000

Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Brands Deferred tax liability Business combination valuation reserve

Dr Cr Cr

50 000

In-process research Deferred tax liability

Dr Cr

20 000

1 200 2 800

15 000 1 500 3 500

15 000 35 000

6 000 21.5

Chapter 24: Consolidation: wholly owned subsidiaries Business combination valuation reserve

14 000

Business combination valuation reserve Deferred tax asset Provision for damages

Dr Dr Cr

7 000 3 000

Goodwill Business combination valuation reserve

Dr Cr

1 700

Retained earnings (1/7/14) Share capital Business combination valuation reserve Shares in Octans Ltd

Dr Dr Dr Cr

40 000 160 000 50 000

Dividend payable Dividend receivable

Dr Cr

5 000

10 000

1 700

Pre-acquisition entries at 1 July 2014

Exercise 21.4

250 000

5 000

BUSINESS COMBINATION VALUATION AND PRE-ACQUISITION ENTRIES

Prepare the consolidation worksheet entries for the preparation of consolidated financial statements for Pyxis Ltd and its subsidiary Gemini Ltd as at: 1. 1 July 2013 2. 30 June 2014. PYXIS LTD – GEMINI LTD

Analysis of fair value adjustments: Item Inventory Land Plant Total fair value adjustments (pre-tax) Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 8 000 15 000 10 000 33 000 9 900 23 100

Hence, the fair value of net assets acquired is £209 100. Determination of goodwill: 1 July 2013

1st July 2013 Total consideration paid

£218 500

Less: Fair value of net assets acquired

209 100

Goodwill

9 400

21.6

Solutions Manual to accompany Applying IFRS Standards 4e 1. Worksheet entries at 1 July 2013 Business combination valuation entries Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

8 000

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

15 000

Accumulated depreciation - equipment Equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

50 000

Goodwill Business combination valuation reserve

Dr Cr

9 400

Dr Dr Dr Dr Cr

36 000 100 000 50 000 32 500

2 400 5 600

4 500 10 500

40 000 3 000 7 000

19 400

2. Pre-acquisition entries Retained earnings (1/7/13) Share capital General reserve Business combination valuation reserve Investment in Gemini Ltd

218 500

2. Worksheet entries at 30 June 2014 Business combination valuation entries The entries at 1 July 2013 are affected by: - the sale of the inventory - the depreciation of the equipment Cost of sales Income tax expense Business combination valuation reserve

Dr Cr

8 000

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

15 000

Accumulated depreciation - equipment Equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

50 000

Depreciation expense Accumulated depreciation (10% x £10 000)

Dr Cr

1 000

Deferred tax liability Income tax expense (30% x £1 000)

Dr Cr

300

Goodwill Business combination valuation reserve

Dr Cr

9 400

2 400

5 600

4 500 10 500

40 000 3 000 7 000

1 000

300

9 400

21.7

Chapter 24: Consolidation: wholly owned subsidiaries Pre-acquisition entries The pre-acquisition entries are affected by: - transfer from general reserve £25 000 Retained earnings (1/7/13) Share capital General reserve Business combination valuation reserve Shares in Gemini Ltd

Dr Dr Dr Dr Cr

36 000 100 000 50 000 32 500

Retained earnings General reserve

Dr Cr

25 000

Exercise 21.5

218 500

25 000

BARGAIN PURCHASE

Compile a detailed report on the nature of an excess, how it should be accounted for and the effects of its recognition on subsequent consolidated financial statements. CARINA LTD

1. 2.

The gain arises as a result of a bargain purchase. IFRS 3 requires that, on calculation of a gain on bargain purchase, the acquirer reassess the identification and measurement of the identifiable assets and liabilities. After this reassessment, any remaining excess is recognised as current period income. The gain on bargain purchase is all post-acquisition as it is in excess of the pre-acquisition equity equal to the net fair value of the identifiable assets and liabilities of the subsidiary. In subsequent periods, it is included in retained earnings (opening balance) – it reduces the adjustment to the opening balance of retained earnings. Example: Assume at acquisition date the recorded retained earnings was £10 000 and a gain on bargain purchase of £1000 arose. In the first period subsequent to acquisition date, the subsidiary recorded a profit of £5000. In the first period subsequent to acquisition the group would recognise a zero balance in retained earnings and a profit of £6000, being the recorded £5000 plus the £1000 gain on bargain purchase [all post-acquisition]. In the following period, the subsidiary would report an opening balance of £15 000 and the preacquisition entry would show a debit adjustment to retained earnings (opening balance) of £9000, thus showing a post-acquisition balance of £6000.

21.8

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 21.6

PARENT HOLDS PREVIOUSLY ACQUIRED INVESTMENT, CONSOLIDATION WORKSHEET

1. Prepare the consolidation worksheet entries for the preparation of consolidated financial statements for Reticulum Ltd and its subsidiary, Dorado Ltd, as at 1 July 2013. 2. Prepare the consolidation worksheet entries and the consolidation worksheet for the preparation of consolidated financial statements for Reticulum Ltd and its subsidiary, Dorado Ltd, as at 30 June 2015. RETICULUM LTD – DORADO LTD Analysis of fair value adjustments 1 July 2013: Item Inventory Plant Total fair value adjustments (pre-tax) Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 5 000 10 000 15 000 4 500 10 500

Hence, the fair value of net assets acquired is £90 500. Analysis of total consideration 1 July 2013: Item Value of 20% stake Purchase of 80%

£ 20 400 81 600 102 000

Determination of goodwill: 1 July 2013 1st July 2013 Total consideration paid

£102 000

Less: Fair value of net assets acquired

90 500

Goodwill

11 500

1. CONSOLIDATION WORKSHEET ENTRIES AT 1 JULY 2013 1. Business combination valuation entries Accumulated depreciation – plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

5 000

Dr Cr

11 500

Goodwill Business combination valuation reserve

10 000 3 000 7 000

1 500 3 500

11 500

21.9

Chapter 24: Consolidation: wholly owned subsidiaries 2. Pre-acquisition entries Retained earnings (1/7/13) Share capital Business combination valuation reserve Investment in Dorado Ltd

Dr Dr Dr Cr

30 000 50 000 22 000 102 000

CONSOLIDATION WORKSHEET ENTRIES AT 30 JUNE 2015

1. Business combination valuation entries Plant (1)

Accumulated Depreciation – Equipment Depreciation expense Retained Earnings - 1 July 2014 Equipment - Cost Deferred Tax Liability** Tax Expense Business Combination Valuation Reserve

16 000*

Dr Dr Cr Cr Cr Cr

2 000 1 400 10 000 1 800 600 7 000

* 20 000 - 2 x 2 000 ** 10 000 x 30% x (3/5) Note the total effect on retained earnings as of 30 June 2015 is a reduction of 2 800 (2 000 + 1 400 - 600). Inventory (2)

Retained Earnings - 1 July 2014 Business Combination Valuation Reserve

3 500

This brings the total effect on retained earnings as of 30 June 2015 to a reduction of 6 300. Goodwill (3)

Goodwill Business combination valuation reserve Dr

11 500

2. Pre-acquisition entries With the above entries (1)-(2) we now need to record: (4)

Retained earnings Share capital Business combination valuation reserve Investment in Dorado Ltd

As of 30 June 2015 Cash Accounts receivable Inventory Investment in Dorado Ltd Plant Accum depreciation Goodwill Total Assets

Reticulum Ltd 13 000 30 000 70 000 102 000

Dorado Ltd 14 000 25 000 50 000 -

200 000 (85 000) 330 000

80 000 (44 000) 125 000

30 000

Dr Dr Cr

50 000 22 000 102 000

Adjustments Dr Cr

1 3

16 000 11 500 27 500

Group

102 000

10 000

1 1

112 000

27 000 55 000 120 000 270 000 (113 000) 11 500 370 500 21.10

Solutions Manual to accompany Applying IFRS Standards 4e Provisions Deferred tax liability Payables Total Liabilities

65 000 20 000 85 000

10 000 5 000 15 000

Share capital

150 000

50 000

Profit before tax Income tax expense Profit Retained earnings (1/7/14)

50 000 20 000 30 000 50 000

40 000 15 000 25 000 35 000

2 000

Transfer to general reserve Retained earnings (30/6/15) General reserve Total Equity Total Liabilities and equity Total adjustments Business combination valuation reserve

(20 000)

(5 000)

(25 000)

60 000

55 000

78 700

35 000 245 000 330 000

5 000 110 000 125 000

1 800

1 2 4

1 400 3 500 30 000

600 2 400

114 400

114 400 7 000 3 50011 500

125 000

1 1

86 900 86 900

22 000

75 000 1 800 25 000 101 800 150 000

600

4 330 000

1 800

88 000 34 400 53 600 50 100

40 000 268 700 370 500

1 2 3

370 500

21.11

Chapter 24: Consolidation: wholly owned subsidiaries Exercise 21.7 BARGAIN PURCHASE, CONSOLIDATION WORKSHEET 1. Prepare the consolidated financial statements for Cepheus Ltd at 31 December 2013. 2. Prepare the valuation and pre-acquisition entries at 31 December 2017, assuming that, on consolidation, business combination valuation reserves are transferred to retained earnings when the related asset is sold or fully consumed. CEPHEUS LTD – AQUARIUS LTD Acquisition analysis The fair value of net assets acquired at 1 January 2013: Item Inventory Plant and machinery Total fair value adjustments (pre-tax) Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 3 000 2 000 5 000 1 500 3 500

Hence, the fair value of net assets acquired is £123 500. Analysis of total consideration 1 January 2013: Item Purchase

£ 130 000

Determination of goodwill: 1 January 2013 1st January 2013 Total consideration paid

£130 000

Less: Fair value of net assets acquired

123 500

Goodwill

6 500

1. THE WORKSHEET ENTRIES AT 31 DECEMBER 2013 ARE: 1. Business combination valuation entries Inventory

(1)

Inventory Cost of sales Deferred Tax Liability Tax expense Business Combination Valuation Reserve To record the expensing of half of purchase day inventory

Dr Dr Cr Cr Cr

1 500 1 500

Dr Dr Cr Cr Cr Cr

19 600* 400

450 450 2 100

Plant and machinery (2)

Accumulated depreciation Depreciation expense Plant and machinery - cost Tax expense Deferred tax liability Business Combination Valuation Reserve

18 000 120 480** 1 400

21.12

Solutions Manual to accompany Applying IFRS Standards 4e * 20 000 - 2000/5 ** 2000 x (4/5) x 30% Goodwill (3) Goodwill Business Combination Valuation Reserve

Dr Cr

6 500 6 500

2. Pre-acquisition entries At 1 January 2013: Retained earnings (1/1/13) Share capital Asset revaluation surplus Business combination valuation reserve Investment in Aquarius Ltd

Dr Dr Dr Dr Cr

40 000 60 000 20 000 10 000 130 000

At 31 December 2013: After recording the above entries (1)-(3) we need to pass this entry: (4)

Retained Earnings (1 January 2013) Share capital Asset revaluation surplus Business Combination Valuation Reserve Investment in Aquarius Ltd.

Cepheus Ltd Land Plant & machinery Accum depreciation Inventory Investment in Aquarius Goodwill Total assets Liabilities

Aquarius Ltd 20 000 575 000 120 000 (20 000) (25 000) 15 000 23 000 130 000 -

138 000

42 000

4 000

40 000

Dr Dr Cr Cr

60 000 20 000 10 000 130 000

Adjustments Dr Cr

3 700 000

18 000

2 1

130 000

19 600 1 500

6 500 27 600

100 000

15 000

1 2

Income tax expense

20 000

5 000

Profit Retained earnings (1/1/13) Retained earnings (31/12/13) Asset revaluation surplus Share capital Total equity

80 000 103 000

10 000 40 000

183 000

50 000

30 000

24 000

20 000

445 000 658 000

60 000 134 000

60 000 121 900

1 2

1 500 400

1 2

24 430 88 670 103 000

40 000 41 900

46 930 113 100

450 120 4

20 000 677 000 (25 400) 39 500 -6 500 717 600

148 000 450 480

Profit before tax

Group

570

191 670 34 000

570

445 000 670 670

21.13

Chapter 24: Consolidation: wholly owned subsidiaries Total liabilities and equity

700 000

138 000

Total adjustments BCVR

121 900

1 500

149 500 10 000

149 500 2 100 1 400 6 500

717 600

1 2 3

CEPHEUS LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 31 December 2013 Profit before income tax Income tax expense Profit for the period Other comprehensive income Gains on revaluation of assets Comprehensive income

£113 100 24 430 £88 670 19 000 £107 670

CEPHEUS LTD Consolidated Statement of Changes in Equity for financial period ending 31 December 2013

Share Capital Balance 1. 1. 2013 Comprehensive income Balance 31.12.2013

445 000 445 000

Revaluation Surplus 15 000 19 000 34 000

Retained Earnings 103 000 88 670 191 670

Total 563 000 107 670 670 670

CEPHEUS LTD Consolidated Statement of Financial Position as at 31 December 2013

Current Assets Inventories Non-current Assets Goodwill Property, plant and equipment: Land Plant & machinery Accumulated depreciation Total Non-current Assets

£39 500 6 500 20 000 £677 000 (25 400)

651 600 671 600

Total Assets

£717 600

Liabilities

46 930

Equity Share capital Retained earnings

£445 000 191 670

Asset revaluation surplus Total Equity

34 000 670 670

Total Liabilities and Equity

£717 600

21.14

Solutions Manual to accompany Applying IFRS Standards 4e 2. WORKSHEET ENTRIES AT 31 DECEMBER 2017 1. Business combination valuation entries Inventory (1) Retained earnings 1.1.2017 Dr 2 100 Business Combination Valuation Reserve Cr 2 100 To record the expensing of purchase day inventory (assuming it either sold by 2017 or written-off) Plant and machinery (2)

Retained earnings 1.1.2017 Accumulated depreciation Depreciation expense Plant and machinery - cost Tax expense Business Combination Valuation Reserve

Dr Dr Dr Cr Cr Cr

1 120 18 000** 400

Dr Cr

6 500

40 000

Dr Dr Dr Cr

60 000 20 000 10 000

18 000 120 1 400

* 2 000 x (4/5) x 70% ** 20 000 - 2 000 x (5/5) ** 2000 x (4/5) x 30% Goodwill (3)

Goodwill Business Combination Valuation Reserve

6 500

2. Pre-acquisition entries

(4)

Retained Earnings (1 January 2017) Share capital Asset revaluation surplus Business Combination Valuation Reserve Investment in Aquarius Ltd.

130 000

21.15

Chapter 24: Consolidation: wholly owned subsidiaries Exercise 21.8 1. 2. 3.

REVALUATION IN SUBSIDIARY’S RECORDS

Prepare the consolidation worksheet entries at 30 June 2014 assuming Grus Ltd revalued the land and plant to their fair values in its records just before it was acquired at 1 July 2013. Prepare the consolidation worksheet entries at 30 June 2014 assuming all business combination valuations are made in the consolidation worksheet. If the balance of inventory was sold, what would be the business combination valuation and pre-acquisition entries at 30 June 2015, assuming requirement 2 above? CANCER LTD – GRUS LTD

Part 1: Grus revalued land and plant before acquisition Effect of revaluation: Net assets pre-revaluation Increase in fair value of land and plant Deferred tax liability Revalued net assets

90 000 6 000 (1 800) 94 200

Acquisition analysis The fair value of net assets acquired at 1 July 2013: Item Inventory Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 4 000 (1 200) 2 800

Hence, the fair value of net assets acquired is £97 000. Analysis of total consideration 1 July 2013: Item Purchase

£ 100 000

Determination of goodwill: 1 July 2013 1st July 2013 Total consideration paid

£100 000

Less: Fair value of net assets acquired

97 000

Goodwill

3 000

Worksheet entries at 30 June 2014: land & plant revalued by subsidiary 1. Business combination valuation entries Inventory (1) Cost of goods sold Inventory Deferred tax liability Tax expense Business Combination Valuation Reserve To record the expensing of 90% purchase day inventory

Dr Dr Cr Cr Cr

3 600 400 120 1080 2 800

21.16

Solutions Manual to accompany Applying IFRS Standards 4e Plant and land: Nothing to record, as the plant depreciation is based on revalued figures Goodwill (2)

Goodwill Business Combination Valuation Reserve

Dr Cr

3 000

20 000

Dr Dr Dr Cr Cr

40 000 30 000 4 200 5 800

3 000

2. Pre-acquisition entries

(3)

Retained Earnings (1 July 2013) Share capital General reserve Asset revaluation surplus Business Combination Valuation Reserve Investment in Aquarius Ltd.

100 000

Part 2: Grus did not revalue land and plant before acquisition (hence net assets = 90 000) The fair value of net assets acquired at 1 July 2013: Item Inventory Land Plant Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 4 000 4 000 2 000 10 000 (3 000) 7 000

Hence, the fair value of net assets acquired is £97 000. Analysis of total consideration 1 July 2013: Item Purchase

100 000

Determination of goodwill: 1 July 2013 1st July 2013 Total consideration paid

£100 000

Less: Fair value of net assets acquired

97 000

Goodwill

3 000

21.17

Chapter 24: Consolidation: wholly owned subsidiaries Worksheet entries at 30 June 2014: land & plant not revalued by subsidiary 1. Business combination valuation entries Inventory Cost of goods sold Inventory Deferred tax liability Tax expense Business Combination Valuation Reserve To record the expensing of 90% purchase day inventory (1)

Plant and land (2) Accumulated depreciation Depreciation expense Land - cost Plant and machinery - cost Deferred tax liability Tax expense Business Combination Valuation Reserve

Dr Dr Cr Cr Cr

3 600 400

Dr Dr Dr Cr Cr Cr Cr

7 600* 400 4 000

120 1080 2 800

6 000 1 680** 120 4 200

* 8000 - 2 000/5 ** With respect to land: 1 200; with respect to plant: 480 [2 000 x (4/5) x 30%]

Goodwill (2)

Goodwill Business Combination Valuation Reserve

Dr Cr

3 000

20 000

Dr Dr Cr Cr

40 000 30 000 10 000

Dr Cr

2 800

Dr Dr Dr Dr Cr Cr Cr Cr

280 7 200* 400 4 000

3 000

2. Pre-acquisition entries (3)

Retained Earnings (1 July 2013) Share capital General reserve Business Combination Valuation Reserve Investment in Aquarius Ltd.

100 000

Part 3. 1. Business combination valuation entries 30 June 2015 Inventory Retained earnings 1 July 2014 Business Combination Valuation Reserve To record past expensing of purchase day inventory (1)

Plant and land (2) Retained Earnings (1 July 2014) Accumulated depreciation Depreciation expense Land - cost Plant and machinery - cost Deferred tax liability Tax expense Business Combination Valuation Reserve

2 800

6 000 1 560** 120 4 200

* 8000 - 2 000 x (2/5) ** With respect to land: 1 200; with respect to plant: 360 [2 000 x (3/5) x 30%] © John Wiley and Sons, Ltd, 2016

21.18

Solutions Manual to accompany Applying IFRS Standards 4e

Goodwill (2)

Goodwill Business Combination Valuation Reserve

Dr Cr

3 000

20 000

Dr Dr Cr Cr

40 000 30 000 10 000

3 000

2. Pre-acquisition entries 30 June 2015 (3)

Retained Earnings (1 July 2014) Share capital General reserve Business Combination Valuation Reserve Investment in Aquarius Ltd.

100 000

21.19

Chapter 24: Consolidation: wholly owned subsidiaries Exercise 21.9 CONSOLIDATION WORKSHEET AND RESERVE TRANSFER 1. Prepare the consolidation worksheet entries at 30 June 2016. 2. Complete the worksheet extract above. TRIANGULUM LTD – CYGNUS LTD Acquisition analysis The fair value of net assets acquired At 1 July 2012: Item Plant R&D Inventory Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 2 000 2 000 1 000 5 000 (1 500) 3 500

Hence, the fair value of net assets acquired is £118 500. Analysis of total consideration 1 July 2012: Item Cash Dividend receivable Total

£ 127 000 (6 000) 121 000

Determination of goodwill: 1st July 2012 Total consideration paid

£121 000

Less: Fair value of net assets acquired

118 500

Goodwill

2 500

21.20

Solutions Manual to accompany Applying IFRS Standards 4e 1. Worksheet entries at 30 June 2016: 1. Business combination valuation entries 1

Accumulated depreciation Retained earnings (1/7/15) Depreciation expense Plant Deferred tax liability Income tax expense Business combination valuation reserve

Dr Dr Dr Cr Cr Cr Cr

18400* 840** 400

* 20 000 - 4 x 400 ** 3 x 400 x 70% *** 400 x 30% 2 Research & development (intangible asset) Deferred tax liability Business combination valuation reserve

Dr Cr Cr

2 000

Dr Cr

700

Retained earnings (1/7/15) Business combination valuation reserve

18 000 120*** 120 1 400

600 1 400

700

To record the effect on past earnings of fair value adjustment of 1 000 to inventory 4 Goodwill Dr 2 500 Business combination valuation reserve Cr

2 500

Pre-acquisition entries At 1/7/12: Retained earnings (1/7/12) Share capital General reserve Business combination valuation reserve Investment in Cygnus Ltd

Dr Dr Dr Dr Cr

12 000 85 000 18 000 6 000

Dividend payable Dividend receivable

Dr Cr

6 000

121 000

6 000

At 30/6/16 5

Retained earnings (1/7/15) Share capital General reserve Business combination valuation reserve Investment in Cygnus Ltd

Dr Dr Dr Dr Cr

12 000 85 000 18 000 6 000

Retained earnings General reserve

Dr Cr

3 000

121 000

3 000

21.21

Chapter 24: Consolidation: wholly owned subsidiaries 2. Worksheet Extract

Triangulum Ltd

Cygnus Ltd

Adjustments Dr

Profit for the period

6 000

4 000

400 (1)

Retained earnings (1/7/15)

22 000

18 000

40 (1) 700 (3) 12 000 (2)

28 000

22 000

Transfer from general reserve

5 000

3 000

Retained earnings (30/6/16)

33 000

25 000

120 (1)

Group

£ 9 720 26 460

36 180 3 000 (6)

5 000 41 180

21.22

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 21.10 BARGAIN PURCHASE, CONSOLIDATION WORKSHEET Prepare the consolidated financial statements for the year ended 30 June 2015. EQUULEUS LTD – FORNAX LTD

Acquisition analysis at 1 July 2013: The fair value of net assets acquired At 1 July 2013: Item Land Plant Inventory Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 2 000 1 000 1 000 4 000 (1 200) 2 800

Hence, the fair value of net assets acquired is £16 300. Analysis of total consideration 1 July 2013: Item Cash

£ 15 000

Determination of goodwill: 1st July 2013 Total consideration paid

£15 000

Less: Fair value of net assets acquired

16 300

Negative goodwill - bargain purchase

(1 300)

Worksheet entries at 1 July 2013 1. Business combination valuation entries

Inventory Inventory Deferred tax liability Business Combination Valuation Reserve

Dr Cr Cr

1 000

Plant and land (2) Accumulated depreciation - plant Land - cost Plant and machinery - cost Deferred tax liability Business Combination Valuation Reserve

Dr Dr Dr Cr Cr

500 2 000 500

Negative Goodwill (3) Business Combination Valuation Reserve Gain on bargain purchase

Dr Cr

1 300

(1)

300 700

900 2 100

1 300

21.23

Chapter 24: Consolidation: wholly owned subsidiaries 2. Pre-acquisition entries (4)

Business Combination Valuation Reserve Share capital - Fornax General reserve - Fornax Retained earnings 1 July 2013 - Fornax Investment in Fornax Ltd

Dr Dr Dr Dr Cr

1 500 10 000 2 000 1 500

Dr Cr

700

Dr Dr Dr Dr Cr Cr Cr

140 200 100* 500

Dr Cr Cr

2 000

Dr Cr

1 300

Business Combination Valuation Reserve Share capital - Fornax General reserve - Fornax Retained earnings 1 July 2013 - Fornax Investment in Fornax Ltd

Dr Dr Dr Dr Cr

1 500 10 000 2 000 1 500

Retained earnings 1 July 2014 - Fornax General reserve in Fornax Ltd

Dr Cr

500

15 000

Worksheet entries at 30 June 2015 1. Business combination valuation entries Inventory (1) Retained earnings 1 July 2014 Business Combination Valuation Reserve To record past expensing of purchase day inventory Plant (2) Retained earnings 1 July 2014 Depreciation expense Accumulated depreciation - plant Plant and machinery - cost Income tax expense Deferred tax liability Business Combination Valuation Reserve * 500 - 200 x 2 ** 1000 x (3/5) x 30% Land 3 Gain on disposal of land Income tax expense Business Combination Valuation Reserve Negative goodwill (4) Business Combination Valuation Reserve Retained earnings 1 July 2014 To record the gain on bargain purchase

700

60 180 700

600 1 400

1 300

2. Pre-acquisition entries (5)

15 000

500

21.24

Solutions Manual to accompany Applying IFRS Standards 4e Equuleus Ltd 3 000 300 3 000 15 000

Fornax Ltd 4 000 360 2 000 -

8 600 17 000 (5 000) 41 900

5 100 8 000 (1 000) 18 460

Liabilities

5 000

1 300

Profit before tax

3 200

1 800

Inventory Cash Financial assets Investment in Fornax Ltd Land Plant Accum depreciation Total assets

Adjustments Dr Cr

15 000

2 2

500 100 600

1 300

240

Profit Retained earnings (1/7/14)

1 900 1 500

1 560 2 100

Dividend paid Retained earnings (30/6/15) Share capital General reserve

(500) 2 900

0 3 660

25 000 8 000 35 900 1 000

10 000 3 000 16 660 500

36 900 41 900

17 160 18 460

Other components

Total equity Total liabilities and equity Total adjustments Business combination valuation reserve

7 000 660 5 000 -13 700 25 500 (5 900) 45 960

15 000 180

6 480 2 800

2 3 Income tax expense

Group

200 2 000

2 200 700 140 1 500 500

1 2 5 6

2 5

60 600 660

2 3

1 300

5 040

1 960

10 000 2 000

500

17 040 17 040

2 460 2 640

17 640

17 640 700 70000 1 400

4 5

1 300 1 500

880 1 920 2 060

(500) 3 480

25 000 9 500 37 980 1 800

39 480 45 960

1 2 3

21.25

Chapter 24: Consolidation: wholly owned subsidiaries FORNAX LTD Consolidated Statement of profit or Loss and Other Comprehensive Income for financial year ended 30 June 2015 Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: decrements Comprehensive income for the period

£2 800 880 £1 920 (300) £1 620

FORNAX LTD Consolidated Statement of Changes in Equity for financial year ended 30 June 2015

Share Capital Balance 1. 7. 2014 Comprehensive income Dividend Balance 30.6.2015

25 000

General Reserve 9 500

25 000

9 500

Retained Earnings 2 060 1 920 (500) 3 480

Other

Total

1 800 (300)

38 360 1 620 (500) 39 480

1 500

FORNAX LTD Consolidated Statement of Financial Position as at 30 June 2015 Current Assets Inventory Financial assets Cash Total Current Assets Non-current Assets Property, plant and equipment: Land Plant Accumulated depreciation – Plant Total Non-current Assets Total Assets Liabilities

£7 000 5 000 660 £12 660

£13 700 25 500 (5 900) 33 300 £45 960 6 480

Equity Share capital Reserves: General reserve Other components of equity Retained earnings Total Equity Total Equity and Liabilities

£25 000 9 500 1 500 3 480 39 480 £45 960

21.26

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 21.11

HANDLING RESEARCH OUTLAYS

Advise the group accountant of Lynx Ltd on what accounting is most appropriate for these circumstances. LYNX LTD

Accounting for research and development in the subsidiary itself is governed by IAS 38 Intangible Assets. Research outlays are expensed under IAS 38 para 54. Recognition of intangibles acquired in a business combination is discussed in paras 33–41 of IAS 38. Para 13 of IFRS 3 recognises that some intangible assets not recognised by an acquiree may be recognisable by the acquirer. In a business combination the intangible asset is measured at its fair value, using the hierarchy in IAS 38. In order to recognise an intangible asset, it must meet the definition of an asset. In preparing the consolidated financial statements, Lynx Ltd will recognise the in-process research asset in its business combination valuation entries, for example: In-Process Research Deferred Tax Liability Business Combination Valuation Reserve

Dr Cr Cr

x x x

The tax-effect, in this case a liability relating to the expected tax to be paid on the earnings from the research asset, is recognised. In future periods, the in-process research will be subject to the amortisation procedures in IAS 38, resulting in further BCVR entries such as: Amortisation Expense Accumulated Amortisation

Dr Cr

Deferred Tax Liability Income Tax Expense

Dr Cr

When the In-Process research is fully amortised, the BCVR will be transferred to retained earnings, and no future consolidation adjustments will be necessary.

21.27

Chapter 24: Consolidation: wholly owned subsidiaries Exercise 21.12

UNRECORDED LIABILITY

Give the group accountant your opinion on the accounting at acquisition date for consolidation purposes, as well as any subsequent effects when the entity either wins or loses the case. SCORPIO LTD Under para 27 of IAS 37 Provisions, Contingent Liabilities and Contingent Assets, an entity’s contingent liabilities are not recognised in the accounts of the entity but are reported by way of note to the accounts. Under IFRS 3 para 36, an acquirer must recognise at the acquisition date the acquiree’s identifiable assets and liabilities that satisfy the recognition criteria at their fair values at that date. Para 23 of IFRS 3 state that the requirements of IAS 37 do not apply in determining which contingent liabilities to recognise as of acquisition date. However, the liability recognised must be a present obligation – not a possible obligation. Also, contrary to IAS 37, the acquirer recognises contingent liability even if it not probable that an outflow of resources will be required. The fair value measurement takes into account the probability of outflows occurring. Scorpio Ltd must then recognise the liability in its consolidated financial statements at fair value. This is done using the BCVR entries, assuming a fair value of £40 000: Business Combination Valuation Reserve Deferred Tax Asset Provision for Damages

Dr Dr Cr

28 000 12 000 40 000

If Norma Ltd wins the court case and no damages have to be paid, the consolidation worksheet entry changes to: Transfer from BCVR Income Tax Expense Gain from Court Case

Dr Dr Cr

28 000 12 000 40 000

If Norma Ltd loses the court case and pays damages of an amount less than £40 000, say £30 000, then the worksheet entry is: Transfer from BCVR Income Tax Expense Gain from Court Case Damages Expense

Dr Dr Cr Cr

28 000 12 000 10 000 30 000

If Norma Ltd loses the court case and pays damages of an amount equal to or greater than £40 000, say £50 000, then the worksheet entry is: Transfer from BCVR Income Tax Expense Damages Expense

Dr Dr Cr

28 000 12 000 40 000

In relation to the court costs, assume that Norma Ltd has at the date of acquisition already incurred court costs of, say, £10 000 and expects to win the case and get these costs reimbursed. Under IAS 37, Norma Ltd does not itself recognise a contingent asset in its records. Further under IFRS 3, contingent assets are not recognised by the acquirer as a part of step 3 of the acquisition method. They therefore do not affect the consolidation process. If the £10 000 were received by Norma Ltd in a later period upon winning the court case, it would be recognised as a gain by both Norma Ltd and the group.

21.28

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 21.13

UNRECORDED INTANGIBLE

Prepare the consolidation worksheet entries for the preparation of consolidated financial statements at 30 June 2017. SCULPTOR LTD – VIRGO LTD

Analysis of fair value adjustments 1 July 2013: Item Trademark Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 20 000 6 000 14 000

Hence, the fair value of net assets acquired is £248 000. Analysis of total consideration 1 July 2013: Item Fair value of Sculptor shares Dividend receivable Total

£ 250 000 (10 000) 240 000

Determination of goodwill: 1 July 2013 1st July 2013 Total consideration paid

£240 000

Less: Fair value of net assets acquired

248 000

Negative goodwill (bargain purchase)

(8 000)

Note that on 1 July 2013 the business valuation entries are: Trademarks Deferred tax liability Business combination valuation reserve Business combination valuation reserve Profit and Loss

Dr Cr Cr

20 000 6 000 14 000

Dr Cr

8 000 8 000

And pre-acquisition entries on the same date: Retained earnings (1/7/13) Share capital Business combination valuation reserve Investment in Virgo Ltd

Dividend payable Dividend receivable

Dr Dr Dr Cr

84 000 150 000 6 000

Dr Cr

10 000

240 000

10 000

21.29

Chapter 24: Consolidation: wholly owned subsidiaries 1. Business combination valuation entries at 30 June 2017

(1)

Trademark Retained Earnings - 1 July 2016 Amortisation expense Tax expense Deferred Tax Liability Business Combination Valuation Reserve

Dr Dr Dr

0 10 500 5 000 1 500 0 14 000

Cr Cr

Note that the total effect on retained earnings on 30 June 2017 is a reduction of 14 000 (2)

Business Combination Valuation Reserve Retained Earnings - 1 July 2016 To record the effect of the gain that arose on bargain acquisition

Dr Cr

8 000

Dr Dr Dr Cr

6 000 34 000 200 000

8 000

2. Pre-acquisition entries

At 30 June 2017 Pre-acquisition entry With the above entries (1)-(2) we need now to record

(3)

Business Combination Valuation Reserve Retained Earnings - 1 July 2016* Share capital** Investment in Virgo Ltd

240 000

* 84 000 - 50 000 ** 150 000 + 50 000

Exercise 21.14

BARGAIN PURCHASE, PARENT HOLDS PREVIOUSLY ACQUIRED INVESTMENT IN SUBSIDIARY, CONSOLIDATION WORKSHEET

1. Prepare the consolidation worksheet entries, the consolidation worksheet and the consolidated statement of financial position for Volans Ltd and its subsidiary, Tucana Ltd, as at 1 July 2014. 2. Prepare the consolidation worksheet entries for the preparation of consolidated financial statements for Volans Ltd and its subsidiary, Tucana Ltd, as at 30 June 2015. VOLANS LTD – TUCANA LTD Analysis of fair value adjustments 1 July 2014: Item Inventory Plant Total fair value adjustments (pre-tax) Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 3 000 5 000 8 000 2 400 5 600

Hence, the fair value of net assets acquired is £130 600. © John Wiley and Sons, Ltd, 2016

21.30

Solutions Manual to accompany Applying IFRS Standards 4e Analysis of total consideration 1 July 2014: Item Value of 10% stake Purchase of 90% Dividend receivable

£ 13 800 124 200 (10 000) 128 000

Determination of goodwill: 1 July 2014 1st July 2014 Total consideration paid

£128 000

Less: Fair value of net assets acquired

130 600

Negative goodwill - bargain purchase

(2 600)

1. WORKSHEET ENTRIES AT 1 JULY 2014 1. Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

3 000

Retained earnings (1/7/14) Share capital Other components of equity Business combination valuation reserve Gain on bargain purchase (consol. P&L) Investment in Tucana Ltd

Dr Dr Dr Dr Cr Cr

30 000 80 000 15 000 5 600

Dividend payable Dividend receivable

Dr Cr

10 000

10 000 1 500 3 500

900 2 100

2. Pre-acquisition entries

Cash Accounts receivable Dividend receivable Inventory Shares in Tucana Ltd Plant Accum depreciation Total assets Provisions Dividend payable

Volans Ltd 25 800 26 200 10 000 55 000 128 000 190 000 (65 000) 370 000

Tucana Ltd 10 000 25 000

88 000 20 000

27 000 10 000

42 000 100 000 (15 000) 162 000

2 600 128 000

10 000

Adjustments Dr Cr

Group

10 000

128 000 10 000

2 1

3 000

15 000 18 000

10 000

148 000

35 800 51 200 -100 000 -280 000 (65 000) 402 000 115 000 20 000

21.31

Chapter 24: Consolidation: wholly owned subsidiaries Deferred tax liability

Total Liabilities Share capital Retained earnings Other components of equity Total equity Total liabilities and equity

108 000 180 000 58 200 23 800

37 000 80 000 30 000 15 000

262 000 370 000

125 000 162 000

2 2 2

Total adjustments Business combination valuation reserve

10 000 80 000 30 000 15 000

1 500 900 2 400

1 1

2 600

125 000 1350000

2 600 5 000

153 000

5 600

3 500 2 100

2 400 137 400 180 000 60 800 23 800 264 600 402 000

1 1

VOLANS LTD Consolidated Statement of Financial Position as at 1 July 2014 Current assets: Cash and equivalents Receivables Inventories Total current assets Non-current assets: Property, plant and equipment: Plant Accumulated depreciation Total non-current assets Total assets

280 000 (65 000) 215 000 £402 000

Current liabilities: Provisions Dividend payable Deferred tax liability Total liabilities

115 000 20 000 2 400 137 400

Equity Share capital Retained earnings Other components of equity Total equity

180 000 60 800 23 800 264 600

Total liabilities and equity

£402 000

£35 800 51 200 100 00 187 000

21.32

Solutions Manual to accompany Applying IFRS Standards 4e 2. WORKSHEET ENTRIES AT 30 JUNE 2015 1. Business combination valuation entries

Plant: (1)

Accumulated Depreciation – Equipment Depreciation expense Plant - Cost Deferred Tax Liability Tax expense Business Combination Valuation Reserve

14 000

Dr Cr Cr Cr Cr

1 000

3 000

10 000 1 200 300 3 500

Inventory: (2)

Cost of sales Tax expense Business Combination Valuation Reserve

900 2 100

2. Pre-acquisition entries

(3)

Retained Earnings (1 July 2014) Share capital Other components of equity Business Combination Valuation Reserve Investment in Tucana Ltd. Gain on bargain purchase

30 000

Dr Dr Dr Cr Cr

80 000 15 000 5 600 128 000 2 600

Exercise 21.15 GAIN ON BARGAIN PURCHASE Prepare the consolidation worksheet adjustment entries for the preparation of consolidated financial statements at 30 June 2018. CENTAURUS LTD – COLUMBA LTD Analysis of fair value adjustments 1 July 2014: Item Inventory Plant Total fair value adjustments (pre-tax) Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 6 000 4 000 10 000 3 000 7 000

Hence, the fair value of net assets acquired is £255 000. Analysis of total consideration 1 July 2014: Item Purchase Dividend receivable

250 000 (10 000) 240 000 © John Wiley and Sons, Ltd, 2016

21.33

Chapter 24: Consolidation: wholly owned subsidiaries Determination of goodwill: 1 July 2014 1st July 2014 Total consideration paid

£240 000

Less: Fair value of net assets acquired

255 000

Negative goodwill - bargain purchase

(15 000)

WORKSHEET ENTRIES AT 30 JUNE 2018 1. Business combination valuation entries Inventory (1) Inventory Retained Earnings - 1 July 2017 Deferred Tax Liability Business Combination Valuation Reserve To record the expensing of purchase day inventory

Dr Dr Cr Cr

0 4 200

Bargain purchase (2) Business Combination Valuation Reserve Retained Earnings - 1 July 2017 To record the effect of the gain that arose on bargain acquisition

Dr Cr

15 000

Dr Dr Dr Cr Cr Cr Cr

154 800* 800 1 680**

Plant and equipment (3) Accumulated depreciation Depreciation expense Retained earnings 1 July 2017 Plant and equipment - cost Tax expense Deferred tax liability Business Combination Valuation Reserve

0 4 200

15 000

154 000 240 240*** 2 800

* 158 000 - 4 000 x (4/5) ** 800 x 3 x 70% *** 800 x 30% Note that the total effect of the additional depreciation on consolidated retained earnings as at 30 June 2018 is a reduction of 2 240 (800 + 1 680 - 240). The total effect on retained earnings on 30 June 2018 is an increase of 8560 (15 000 - 4 200 - 2 240)

2. Pre-acquisition entries At 1/7/14 Retained earnings (1/7/14) Share capital Business combination valuation reserve Investment in Columba Ltd Dividend payable Dividend receivable

Dr Dr Cr Cr

98 000 150 000

Dr Cr

10 000

8 000 240 000

10 000 21.34

Solutions Manual to accompany Applying IFRS Standards 4e

With above entries (1)-(3) the pre-acquisition entry at 30/6/18 is

(4)

Retained Earnings (1 July 2017) Share capital Business Combination Valuation Reserve Investment in Columba Ltd.

98 000

Dr Cr Cr

150 000 8 000 240 000

21.35

Chapter 24: Consolidation: wholly owned subsidiaries Exercise 21.16 1. 2.

BARGAIN PURCHASE, CONSOLIDATION WORKSHEET

Prepare the consolidated statement of financial position immediately after Antlia Ltd’s acquisition of shares in Andromeda Ltd. Prepare the consolidation worksheet entries required for the consolidation worksheet at 30 June 2017, assuming both dividends were paid during September 2016. Assume all inventory on hand at 1 July 2016 was sold in the following 3 months, and that the machinery has a further 4-year life. ANTLIA LTD – ANDROMEDA LTD

(Solution in £'000) Acquisition analysis The fair value of net assets acquired at 1 July 2016: Item Land Machinery Inventory Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 40 20 20 80 (24) 56

Hence, the fair value of net assets acquired is £506. Analysis of total consideration 1 July 2016: Item Fair value of shares issued Cash Dividend receivable Total

£ 400* 100** (15) 485

* 200 000 shares x £2 each ** 200 000 shares at 50p each Determination of goodwill 1st July 2016 Total consideration paid

£485

Less: Fair value of net assets acquired

506

Negative goodwill - bargain purchase

1. Consolidation worksheet entries at 1 July 2016 1. Business combination valuation entries 1

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

Accumulated depreciation Machinery Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

12 28

30 6 14 21.36

Solutions Manual to accompany Applying IFRS Standards 4e 3

Inventory Deferred tax liability Business combination valuation reserve Business combination valuation reserve Gain on bargain purchase

Dr Cr Cr Dr Cr

Retained earnings (1/7/16) Share capital General reserve Asset revaluation surplus Business combination valuation reserve

Dr Dr Dr Dr Dr

160 200 50 40 35

Investment in Andromeda Ltd

6 14 21 21

2. Pre-acquisition entries 5

Dividend payable Dividend receivable

485

Dr Cr

15 15

Consolidated Statement of Financial Position at 1 July 2016

Investment in Andromeda Ltd Land Machinery Accum depreciation Dividend receivable Inventory Cash Total assets Dividend payable Provisions Deferred tax liability

Antlia Andromeda Ltd Ltd 485 -

Adjustments Dr Cr 485

400 500 (100) 15 480 100 1 880

200 250 (50) 75 5 480

10 320

15 15

20 110

530

-640 720 (100) -575 105 1 940 10 335

12 6 6 24

Total liabilities

330

Share capital General reserve Asset revaluation surplus Retained earnings Total equity

1 000 200 150

200 50 40

5 5 5

200 50 40

200 1 550

160 450

21 21

Total liabilities and equity Total adjustments Business combination valuation reserve

1 880

480

465

575 35 21

575 28 14 14

5 4

Group

1 2 3

24 369 1 000 200 150

221 1 571 1 940

1 2 3

21.37

Chapter 24: Consolidation: wholly owned subsidiaries ANTLIA LTD Consolidated Statement of Financial Position as at 1 July 2016 (in £’000) Current Assets: Inventory Cash Total Current Assets Non-current Assets: Property, plant and equipment Land Machinery Accumulated depreciation Total Non-current Assets Total Assets

£575 105 680

£640 720 (100)

Equity Share capital Reserves: General Asset revaluation surplus Retained earnings Total Equity

1 260 1 260 £1 940

£1 000 200 150 221 1 571

Liabilities: Dividend payable Provisions Total Liabilities Total Equity and Liabilities

10 359 369 £1 940

2. Consolidation worksheet entries at 30 June 2017 1. Business combination valuation entries 1

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

Accumulated depreciation Depreciation expense Income tax expense Machinery Deferred tax liability Business combination valuation reserve *(1/4 x £20)

Dr Dr Cr Cr Cr Cr

45 5*

Dr Cr

12 28

1.5 30 4.5** 14

**(30% x £15) 3

Cost of sales Income tax expense Business combination valuation reserve Business combination valuation reserve Gain on bargain purchase

Cr Dr Cr

14 21 21

21.38

Solutions Manual to accompany Applying IFRS Standards 4e 2. Pre-acquisition entries 5

Retained earnings (1/7/16) Share capital General reserve Asset revaluation surplus Business combination valuation reserve

Dr Dr Dr Dr Dr

Investment in Andromeda Ltd

Exercise 21.17

160 200 50 40 35 485

UNRECORDED LIABILITIES AND RESERVE TRANSFERS

Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements for Delphinus Ltd and its subsidiary, Telescopium Ltd, as at 31 December 2014. DELPHINUS LTD – TELESCOPIUM LTD

Acquisition analysis at 1 July 2014:

The fair value of net assets acquired At 1 July 2014: Item Machinery Inventory Contingent liability Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 15 000 5 000 (5 000) 15 000 (4 500) 10 500

Hence, the fair value of net assets acquired is £112 500. Analysis of total consideration 1 July 2014: Item Cash

£ 122 250*

*147 250 - 25 000 Determination of goodwill: 1st July 2014 Total consideration paid

£122 250

Less: Fair value of net assets acquired

112 500

Goodwill

2 500

21.39

Chapter 24: Consolidation: wholly owned subsidiaries Worksheet entries at 31 December 2014

1. Business combination valuation entries 1

Machinery Depreciation expense Accumulated depreciation Deferred tax liability Business combination valuation reserve Income tax expense

Dr Dr Cr Cr Cr Cr

15 000 1 500*

Inventory Cost of sales Deferred tax liability Income tax expense Business combination valuation reserve

Dr Dr Cr Cr Cr

500 4 500

* 10% x 5 000 x 30% Goodwill Business combination valuation reserve

Dr Cr

9 750

Business combination valuation reserve Income tax expense Deferred tax asset Provision for damages Gain on reduction in provision

Dr Dr Dr Cr Cr

3 500 1 200 300

Dr Dr Dr Dr Cr

12 000 75 000 15 000 20 250

Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve Investment in Telescopium Ltd

Dr Dr Dr Dr Cr

12 000 100 000 15 000 20 250

General reserve Retained earnings

Dr Cr

6 500

1 500* 4 050** 10 500 450

*(1/5 x ½ x £15 000) ** 90% x £15 000 x 30%

150* 1 350 3500

9 750

1 000 4 000

2. Pre-acquisition entries At 1/7/14: Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve Investment in Telescopium Ltd

122 250

At 31/12/14: 5

147 250

6 500

21.40

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 21.18

CONSOLIDATION WORKSHEET, UNRECOGNISED INTANGIBLES AND LIABILITIES

Prepare the consolidated financial statements for Auriga Ltd as at 30 June 2016. Your answer should include all consolidation adjustment journal entries and a consolidation worksheet. AURIGA LTD – PERSEUS LTD Acquisition analysis at 1 July 2013: The fair value of net assets acquired At 1 July 2013: Item Land Plant Inventory Patent Guarantee Deferred tax liability Total fair value adjustments (after-tax)

Fair Value Adjustment 10 000 3 000 4 000 6 000 (5 000) 18 000 (5 400) 12 600

Hence, the fair value of net assets acquired is £147 600. Analysis of total consideration 1 July 2013: Item Cash

£ 160 000

Determination of goodwill: 1st July 2013 Total consideration paid

£160 000

Less: Fair value of net assets acquired

147 600

Goodwill

12 400

Worksheet entries at 1 July 2013

1. Business combination valuation entries Inventory (1) Retained earnings 1 July 2015 Business Combination Valuation Reserve

Dr Cr

2 800

Plant (2) Retained earnings 1 July 2015 Depreciation expense Gain on disposal Income tax expense Business Combination Valuation Reserve

Dr Dr Dr Cr Cr

840 300 1 500

2 800

540 2 100

NBV of plant when sold 2.5 years after acquisition (in consolidated statements): 49 000; hence gain is 1 000. However, Perseus recognised gain of 2 500 based on NBV of 47 500.

21.41

Chapter 24: Consolidation: wholly owned subsidiaries Land (3)

Retained earnings 1 July 2015 Business Combination Valuation Reserve

Dr Cr

7 000 7 000

Perseus recognised a gain of 30 000, but for the group the gain was 20 000 - hence need to reduce retained earnings by 10 000 x 70%. Patent (4)

Retained earnings 1 July 2015 Patent Amortisation expense Income tax expense Deferred tax liability Business Combination Valuation Reserve

Dr Dr Dr Cr Cr Cr

1 400 3 000 1 000

Guarantee (5) Business Combination Valuation Reserve Income tax expense Gain on elimination of contingent liability

Dr Dr Cr

3 500 1 500

Goodwill (6) Goodwill Business Combination Valuation Reserve

Dr Cr

12 400

Dr Dr Dr Cr

25 000 100 000 35 000

Inventory Retained earnings 1 July 2015 Business Combination Valuation Reserve

Dr Cr

2 800

Plant (2) Retained earnings 1 July 2015 Depreciation expense Gain on disposal Income tax expense Business Combination Valuation Reserve

Dr Dr Dr Cr Cr

840 300 1 500

300 900 4 200

5 000

12 400

2. Pre-acquisition entries (7)

Business Combination Valuation Reserve Share capital - Perseus Retained earnings 1 July 2013 - Perseus Investment in Perseus Ltd

160 000

Worksheet entries at 30 June 2016 1. Business combination valuation entries

(1)

2 800

540 2 100

NBV of plant when sold 2.5 years after acquisition (in consolidated statements): 49 000; hence gain is 1 000. However, Perseus recognised gain of 2 500 based on NBV of 47 500. Land (3)

Retained earnings 1 July 2015 Business Combination Valuation Reserve

Dr Cr

7 000 7 000

Perseus recognised a gain of 30 000, but for the group the gain was 20 000 - hence need to reduce retained earnings by 10 000 x 70%.

21.42

Solutions Manual to accompany Applying IFRS Standards 4e Patent (4)

Retained earnings 1 July 2015 Patent Amortisation expense Income tax expense Deferred tax liability Business Combination Valuation Reserve

Dr Dr Dr Cr Cr Cr

1 400 3 000 1 000

Guarantee (5) Business Combination Valuation Reserve Income tax expense Gain on elimination of contingent liability

Dr Dr Cr

3 500 1 500

Goodwill (6) Goodwill Business Combination Valuation Reserve

Dr Cr

12 400

Dr Dr Dr Cr

25 000 100 000 35 000

300 900 4 200

5 000

12 400

2. Pre-acquisition entries (7)

Business Combination Valuation Reserve Share capital - Perseus Retained earnings 1 July 2013 - Perseus Investment in Perseus Ltd

160 000

21.43

Chapter 24: Consolidation: wholly owned subsidiaries Auriga Ltd

Perseus Ltd

Adjustments Dr Cr

Investment in Perseus Cash Financial assets Inventory Plant & equipment Accum depreciation Goodwill Patent Total assets

160 000

5 000 10 000 30 000 140 000 (62 000) 283 000

14 000 5 000 21 000 163 000 (37 000) 166 000

Payables Loan Defer. tax liability Total liabilities

19 000 25 000 44 000

8 000 0 8 000

Profit before tax

50 000

15 000

Tax expense

20 000

6 000

Profit Retained earnings (1/7/15)

30 000 37 000

9 000 45 000

160 000

6 4

2 2 4 5

1 2 3 4 7

67 000 20 000 47 000 150 000 12 000

20 000 34 000 100 000 20 000

Asset reval surplus (30/6/16)

20 000

Other com (30/6/16) Total equity Total liabilities and equity

10 000 239 000 283 000

4 000 158 000 166 000

Dividend paid T’fer to gen reserve Ret earn. (30/6/16) Share capital General reserve

Total adjustments Business comb. valuation reserve

12 400 3 000 15 400

300 1 500 1 000 1 500 4 300 2 800 840 7 000 1 400 35 000

Group 7

160 000

19 000 15 000 51 000 303 000 (99 000) 12 400 6 000 304 400

900 900

27 000 25 000 900 52 900

5 000

67 200

540 300 5 840

2 4

26 660 40 540 34 960

54 000

51 340 100 000

75 500 20 000 20 000 35 500 150 000 32 000

5 840

20 000

5 7

151 340 151 340

5 840 6 740

166 740

166 740 2 800 2 100 7 000 4 200 12 400

3 500 25 000

14 000 251 500 304 400

2 3 4 6

21.44

Solutions Manual to accompany Applying IFRS Standards 4e AURIGA LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for year ended 30 June 2016 Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: losses on financial assets Gains on revaluation of assets Comprehensive income for the period

£67 200 26 660 $40 540 (14 000) 6 000 £32 540

AURIGA LTD Consolidated Statement of Changes in Equity for year ended 30 June 2016

Balance 1. 7. 2015 Transfers Comprehensive income Dividend Balance 30.6.2016

Share Capital

General Reserve

Retained Earnings

150 000

12 000 20 000

34 960 (20 000) 40 540

25 000

32 000

(20 000) 35 500

Asset Revaluation Surplus 14 000

Other

Total

28 000

238 960

6 000

(14 000)

32 540

20 000

14 000

(20 000) 251 500

AURIGA LTD Consolidated Statement of Financial Position as at 30 June 2016 Current Assets Cash Financial assets Inventory Total Current Assets

£19 000 15 000 51 000 85 000

Non-current Assets Property, plant, and equipment Accumulated depreciation Goodwill Intangibles: Patent Accumulated amortisation Total Non-current Assets Total Assets

£303 000 (99 000) 6 000 (3 000)

204 000 12 400 __3 000 219 400 £304 400

Equity Share capital Reserves: General reserve Asset revaluation surplus Other components of equity Retained earnings Total Equity Current Liabilities Payables Non-current Liabilities Loan Deferred tax liability Total Liabilities Total Equity and Liabilities © John Wiley and Sons, Ltd, 2016

£150 000 32 000 20 000 14 000 35 500 251 500 27 000 25 000 __900 52 900 £304 400 21.45

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 21 Consolidation: wholly owned subsidiaries

Chapter 21 Consolidation: wholly owned subsidiaries Learning Objectives 21.1 21.2 21.3 21.4 21.5

21.6 21.7

Understand the nature of the group covered in this chapter, and the initial adjustments required in the consolidation worksheet Explain how a consolidation worksheet is used Prepare an acquisition analysis for the parent’s acquisition in a subsidiary Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries Prepare the worksheet entries in periods subsequent to the acquisition date, adjusting for movements in assets and liabilities since acquisition date and dividends from preacquisition equity Prepare the worksheet entries where the subsidiary revalues its assets at acquisition date Prepare the disclosures required by IFRS 3 and IFRS 12.

21.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1.

When preparing consolidated financial statements, adjustments for pre-acquisition equity and inter-entity transactions are recorded: Learning Objective 21.1 Understand the nature of the group covered in this chapter, and the initial adjustments required in the consolidation worksheet a. in the accounting records of the parent entity b. in the accounting records of the subsidiary *c. on a consolidation worksheet d. in the accounting records of the reporting entity. If the end of a subsidiary’s reporting period does not coincide with the end of the parent entity’s reporting period, adjustments must be made for the effects of significant events that occur between these dates as long as the difference between the ends reporting periods differs by no more than: Learning Objective 21.1 Understand the nature of the group covered in this chapter, and the initial adjustments required in the consolidation worksheet a. one month *b. three months c. four months d. six months 2.

Eeny Limited has two subsidiary entities, Meeny Limited and Miney Limited. Eeny Limited owns 100% of the shares in both entities. Details of issued share capital are: ➢ Eeny Limited $100 000 ➢ Meeny Limited $30 000 ➢ Miney Limited $15 000 The consolidated share capital amount of the Eeny Meeny Miney group is: Learning Objective 21.4 Explain how a consolidation worksheet is used a. $45 000 b. $55 000 *c. $100 000 d. $145 000.

If the cost of a business combination is greater than the acquired interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the acquiree: Learning Objective 21.3 Prepare an acquisition analysis for the parent’s acquisition in a subsidiary a. a gain on bargain purchase results *b. goodwill has been acquired and must be recognised c. the difference is treated as a special equity reserve in the acquirer’s accounting records d. the difference is treated as a loss and immediately charged to profit or loss of the period in which the business combination occurred.

21.2

Chapter 21 Consolidation: wholly owned subsidiaries

When a parent entity has previously held an investment in a subsidiary prior to gaining control the effect on the consolidation process is as follows: Learning Objective 21.3 Prepare an acquisition analysis for the parent’s acquisition in a subsidiary a. there is no impact *b. the change in the fair value of the previously held interest is recognised in profit or loss c. the change in the fair value of the previously held interest is recognised in retained earnings d. the change in the fair value of the previously held interest is recognised in other comprehensive income

Nelson Limited has two subsidiary entities, Poggi Limited and Holly Limited. Nelson Limited owns 100% of the shares in both entities. Details of issued share capital are: ➢ Nelson Limited $100 000 ➢ Poggi Limited $30 000 ➢ Holly Limited $15 000 The worksheet adjustment entry made in order to determine the amount of consolidated share capital is: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries a. DR Share capital $145 000 CR Shares in subsidiaries $145 000 b.

*c.

DR CR

Share capital Shares in subsidiaries

$100 000

DR CR CR

Share capital Shares in Poggi Limited Shares in Holly Limited

$45 000

DR CR CR CR

Share capital Shares in Nelson Limited Shares in Poggi Limited Shares in Holly Limited

$145 000

$100 000

$30 000 $15 000

$100 000 $30 000 $15 000

Company X acquired Company Y when the carrying value of Company Y’s plant was $50 000. The fair value of the plant on acquisition date was $65 000. The company tax rate was 30%. How much is the amount of the business combination valuation reserve that must be recognised? Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries a. $3500 *b. $10 500 c. $15 000 d. $65 000

21.3

Test Bank to accompany Applying IFRS Standards 4e

A Limited acquired B Limited for $110 000. At acquisition date the fair value of the B Limited’s Land asset was $40 000 and the book value was $30 000. If the company tax rate is 30%, which of the following is the appropriate adjustment to recognise the tax effect of the business combination revaluation of land? Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries a. DR Deferred tax liability $3 000 *b. CR Deferred tax liability $3 000 c. DR Deferred tax asset $3 000 d. CR Deferred tax liability $3 000.

On 1 July 20X6, P Limited acquired all the issued shares of S Limited for $50 000 when the equity of S Limited consisted of: ▪ Share Capital $35 000 ▪ Retained Earnings $15 000 The pre-acquisition entry at 1 July 20X6 is: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries a. Shares in S Limited Dr 50 000 Opening Retained earnings Cr 15 000 Share capital Cr 35 000 *b

Opening Retained earnings Share capital Shares in S Limited

Dr Dr Cr

15 000 35 000

Opening Retained earnings Share capital Shares in S Limited

Dr Dr Cr

35 000 15 000

Goodwill Share capital Shares in S Limited

Dr Dr Cr

15 000 35 000

50 000

10.

On 1 July 20X6 Possum acquired a 100% interest in Echidna. At that time Echidna had goodwill of $5000 recorded in its statement of financial position as a result of a previous business combination. The total goodwill arising on Possum’s acquisition of Echidna was $12 000. The goodwill recognised on consolidation in the business combination valuation entry as a result of Possum’s acquisition of Echidna is: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries a. nil b. $5 000 *c. $7 000 d. $12 000

21.4

Chapter 21 Consolidation: wholly owned subsidiaries

11.

At the date of acquisition a subsidiary had recorded a dividend payable of $10 000. The consolidation adjustment needed at the date of acquisition in relation to this event is: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries *a. DR Dividend payable $10 000 CR Dividend receivable $10 000 b.

$10 000

Dividend revenue Dividend declared Shares in subsidiary Dividend receivable

$10 000

Cash

$10 000

DR CR

Shares in subsidiary

$10 000

12.

One year after acquisition date, the goodwill acquired was regarded as having become impaired by $20 000. The appropriate consolidation adjustment in relation to the impairment will include the following line: Learning Objective 21.5 Prepare the worksheet entries in periods subsequent to the acquisition date, adjusting for movements in assets and liabilities since acquisition date and dividends from pre-acquisition equity a. DR Goodwill $20 000 b. DR Share capital $20 000 c. CR Business combination valuation reserve $20 000 *d. CR Accumulated impairment losses $20 000.

13.

In relation to pre-acquisition of a subsidiary entity, which of the following events can cause a change in the pre-acquisition entry subsequent to acquisition date? I Transfers from post-acquisition retained earnings II Bonus dividends paid from pre-acquisition equity III Transfers from pre-acquisition retained earnings IV Impairment of goodwill Learning Objective 21.5 Prepare the worksheet entries in periods subsequent to the acquisition date, adjusting for movements in assets and liabilities since acquisition date and dividends from pre-acquisition equity a. I, II, III and IV b. I, III and IV only *c. II and III only d. III and IV only.

21.5

Test Bank to accompany Applying IFRS Standards 4e

14.

Parent Limited acquired 100% of a subsidiary on 1 July 20X7. At acquisition date the subsidiary had the following equity items: Retained earnings $24 000 Share capital $33 000 Business combination revaluation reserve $10 000 In the year following the acquisition the subsidiary paid a bonus dividend of $14 000 out of pre-acquisition retained earnings. The following consolidation adjustment is needed in the consolidation worksheet for 30 June 20X8: Learning Objective 21.5 Prepare the worksheet entries in periods subsequent to the acquisition date, adjusting for movements in assets and liabilities since acquisition date and dividends from pre-acquisition equity *a. DR Share capital $14 000 CR Bonus dividend paid $14 000 b.

14 000

Shares in subsidiary Share capital Bonus dividend paid Retained earnings

$14 000

Retained earnings Share capital

$14 000

15.

At acquisition date a wholly owned subsidiary had the following equity items: Retained earnings $14 000 Share capital $30 000 General reserve $6000 In the year following the acquisition the subsidiary transferred $10 000 from preacquisition retained earnings to general reserve. At the reporting date following the reserve transfer, the following consolidation adjustment is needed: Learning Objective 21.5 Prepare the worksheet entries in periods subsequent to the acquisition date, adjusting for movements in assets and liabilities since acquisition date and dividends from pre-acquisition equity a. DR Transfer to general reserve $10 000 CR General reserve $10 000 b.

*d.

General reserve Shares in subsidiary

$10 000

Shares in subsidiary Retained earnings

$10 000

General reserve Transfer to general reserve

$10 000

21.6

Chapter 21 Consolidation: wholly owned subsidiaries

16.

On 1 January 20X2 A Ltd acquired all the issued shares in B Ltd. At that date the inventory of B Ltd had a carrying amount $5000 lower than its fair value. The inventory was all sold by 30 June 20X4. At 30 June 20X5 the consolidation adjustment against inventory in relation to the transaction will be: Learning Objective 21.5 Prepare the worksheet entries in periods subsequent to the acquisition date, adjusting for movements in assets and liabilities since acquisition date and dividends from pre-acquisition equity a. a debit of $5000 b. a credit of $5000 c. a debit of $3500 *d. nothing For entities wanting to use the cost model of accounting, the revaluation of a subsidiary’s assets would be undertaken in the: Learning Objective 21.6 Prepare the worksheet entries where the subsidiary revalues its assets at acquisition date a. subsidiary’s records b. parent entity’s records *c. consolidation worksheet d. notes to the consolidated financial statements. 17.

18.

In a business combination the revaluation of non-current assets in the records of the subsidiary means that the subsidiary has effectively adopted the: Learning Objective 21.6 Prepare the worksheet entries where the subsidiary revalues its assets at acquisition date a. parent-entity model of consolidation b. proprietary model of accounting c. cost model of accounting *d. revaluation model of accounting.

19.

The key principle relating to the disclosure of information about business combinations is to disclose information that: Learning Objective 21.7 Prepare the disclosures required by IFRS 3 and IFRS 12 *a. enables users to evaluate the nature and financial effect of business combinations that occurred during the reporting period b. enables the preparation of the consolidated financial statements in the most cost-effective manner c. does not give an advantage to the competitors of a business group d. provides users with information about the parent entity only.

21.7

Test Bank to accompany Applying IFRS Standards 4e

20.

Consolidated financial statements are prepared using the following presentation method: Learning Objective 21.2 Explain how a consolidation worksheet is used: a. one-line; *b. line-by-line; c. gross; d. liquidation.

21.

Leader Limited acquired 100% of the share capital of Follower Limited. Follower had issued share capital of $100 000. The book values of Follower Limited’s assets were: Land $50 000, Equipment $60 000. The fair values of these assets were: Land $90 000, Equipment $70 000. The tax rate is 30%. The fair value of the identifiable net assets is: Learning Objective 21.3 Prepare an acquisition analysis for the parent’s acquisition in a subsidiary: *a. $135 000; b. $110 000; c. $160 000; d. $100 000.

22.

There is no recognition of a deferred tax item in respect to Goodwill because it is a residual amount and the recognition of a deferred tax item would: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries: a. decrease the carrying amount of Goodwill; *b. increase the carrying amount of Goodwill; c. decrease the profit on consolidation; d. increase the profit on consolidation. A typical pre-acquisition consolidation worksheet entry to eliminate a parent entity’s investment in a subsidiary would include the following entry: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries: a. DR Share capital of parent $X; b. CR Share capital of subsidiary $X; *c. CR Shares subsidiary $X; d. DR Shares of subsidiary $X. 23.

The effect of the pre-acquisition entry is to eliminate the asset, ‘Shares in subsidiary’ and replace it with the: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries: *a. net assets of the subsidiary; b. profit of the subsidiary; c. equity accounts of the subsidiary; d. cash and cash equivalents held by the subsidiary. 24.

21.8

Chapter 21 Consolidation: wholly owned subsidiaries

25.

Excelsior Limited acquired 100% of the shares in Arthur Limited on a cum.div. basis for $100 000. At acquisition date the subsidiary had a declared dividend of $5000. The pre-acquisition entry must include the following line: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries: a. DR Shares in subsidiary $105 000; b. DR Shares in subsidiary $100 000; *c. DR Shares in subsidiary $95 000; d. DR Shares in subsidiary $5 000.

26.

Where a parent entity acquires an investment in a subsidiary for less than the fair value of the identifiable net assets and contingent liabilities acquired, it is necessary to recognise the item in the consolidation worksheet as a gain in bargain purchase and then to: Learning Objective 21.4 Prepare the worksheet entries at the acquisition date, being the business combination valuation entries and the pre-acquisition entries: a. transfer it to a business combination valuation reserve account b. goodwill; c. investment in the shares of the subsidiary; *d. profit or loss.

27. Which of the following items cannot be revalued in the books of the subsidiary? Learning Objective 21.6 Prepare the worksheet entries where the subsidiary revalues its assets at acquisition date: *a. inventory b. land c. plant and equipment d. goodwill

28.

Which accounting standard established the disclosure requirements relating to a parent’s interests in subsidiaries? Learning Objective 21.7 Prepare the disclosures required by IFRS 3 and IFRS 12: a. IFRS 3 Business Combinations b. IFRS 10 Consolidated Financial Statements *c. IFRS 12 Disclosure of Interests in Other Entities d. IAS 27 Separate Financial Statements

21.9

Exercises Exercise 21.11 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

HANDLING RESEARCH OUTLAYS

Lynx Ltd has just acquired all the issued shares of Indus Ltd. The accounting staff at Lynx Ltd has been analysing the assets and liabilities acquired in Indus Ltd. As a result of this analysis, it was found that Indus Ltd had been expensing its research outlays in accordance with IAS 38 Intangible Assets. Over the past 3 years, the company has expensed a total of £20 000, including £8000 immediately before the acquisition date. One of the reasons that Lynx Ltd acquired control of Indus Ltd was its promising research ﬁndings in an area that could beneﬁt the products being produced by Lynx Ltd. There is disagreement among the accounting staff as to how to account for the research abilities of Indus Ltd. Some of the staff argue that, since it is research, the correct accounting is to expense it, and so it has no effect on accounting for the group. Other members of the accounting staff believe that it should be recognised on consolidation, but are unsure of the accounting entries to use, and are concerned about the future effects of recognition of an asset, particularly as no tax advantage remains in relation to the asset. Required

Advise the group accountant of Lynx Ltd on what accounting is most appropriate for these circumstances.

Exercise 21.12 ★

UNRECORDED LIABILITY

Scorpio Ltd has ﬁnally concluded its negotiations to take over Norma Ltd, and has secured ownership of all the shares of Norma Ltd. One of the areas of discussion during the negotiation process was the current court case that Norma Ltd was involved in. The company was being sued by some former employees who were retrenched, but are now claiming damages for unfair dismissal. The company did not believe that it owed these employees anything. However, realising that industrial relations was an uncertain area, particularly given the country’s current confusing industrial relations laws, it had raised a note to the accounts issued before the takeover by Scorpio Ltd reporting the existence of the court case as a contingent liability. No monetary amount was disclosed, but the company’s lawyers had placed a £56 700 amount on the probable payout to settle the case. The accounting staff of Scorpio Ltd is unsure of the effect of this contingent liability on the accounting for the consolidated group after the takeover. Some argue that it is not a liability of the group and so should not be recognised on consolidation, but are willing to accept some form of note disclosure. A further concern being raised is the effects on the accounts, depending on whether Norma Ltd wins or loses the case. If Norma Ltd wins the court case, it will not have to pay out any damages and could get reimbursement of its court costs, estimated to be around £40 000. Required

Give the group accountant your opinion on the accounting at acquisition date for consolidation purposes, as well as any subsequent effects when the entity either wins or loses the case.

Exercise 21.13 ★★

UNRECORDED INTANGIBLE

On 1 July 2013, Sculptor Ltd acquired all the share capital (cum div.) of Virgo Ltd, giving in exchange 50 000 shares in Sculptor Ltd, these having a fair value at acquisition date of £5 per share. Costs incurred in undertaking the acquisition amounted to £10 000. The dividend payable at the acquisition date was paid in September 2013. At 30 June 2013, the statement of ﬁnancial position of Virgo Ltd was as follows: Statement of Financial Position as at 30 June 2013 Plant and equipment Intangibles Current assets

£218 000 6 000 44 000 £268 000

Share capital (150 000 shares) Retained earnings Dividend payable Other liabilities

£150 000 84 000 10 000 24 000 £268 000

The recorded amounts of the identiﬁable assets and liabilities of Virgo Ltd at the acquisition date were equal to their fair values. Virgo Ltd had not recorded an internally developed trademark. Sculptor Ltd valued this at £20 000. It was assumed to have a 4-year life. The tax rate is 30%. CHAPTER 21 Consolidation: wholly owned subsidiaries

On 31 December 2015, Virgo Ltd paid a bonus share dividend from pre-acquisition proﬁts, the dividend being one share for every three held. Required

Prepare the consolidation worksheet entries for the preparation of consolidated ﬁnancial statements at 30 June 2017. Exercise 21.14 ★★

BARGAIN PURCHASE, PARENT HOLDS PREVIOUSLY ACQUIRED INVESTMENT IN SUBSIDIARY, CONSOLIDATION WORKSHEET

As part of a corporate expansion plan, Volans Ltd acquired the remaining shares (cum div.) of Tucana Ltd on 1 July 2014 for £124 200 cash. At this date, it already held 10% of the shares of Tucana Ltd which it had acquired two years previously for £10 000. These financial instruments were recorded by Volans Ltd at fair value with changes in gain value being recognised in profit and loss. The fair value at 1 July 2014 was £13 800. The statements of financial position of both companies at 30 June 2014 were as follows:

Cash Receivables Shares in Tucana Ltd Inventory Plant Accumulated depreciation Total assets Provisions Dividend payable Total liabilities

Volans Ltd £ 150 000 26 200 13 800 55 000 190 000 (65 000) £ 370 000

Tucana Ltd £ 10 000 25 000 42 000 100 000 (15 000) £ 162 000

88 000 20 000 108 000

27 000 10 000 37 000

Share capital Other components of equity Retained earnings Total equity Provisions Dividend payable Total liabilities Total equity and liabilities and equity

£ 180 000 23 800 58 200 262 000 88 000 20 000 108 000 £ 370 000

80 000 15 000 30 000 125 000 27 000 10 000 37 000 £ 162 000

Cash Receivables Shares in Tucana Ltd Inventory Plant Accumulated depreciation Total assets

£ 150 000 26 200 13 800 55 000 190 000 (65 000) £ 370 000

10 000 25 000

42 000 100 000 (15 000) £ 162 000

All identiﬁable assets and liabilities of Tucana Ltd were recorded at fair value as at 1 July 2014 except for the following:

Inventory Plant (cost £100 000)

Carrying amount

Fair value

£42 000 85 000

£45 000 90 000

The plant is expected to have a further useful life of 5 years. Inventory held at 1 July 2014 was all sold by 30 June 2015. The dividend payable at 1 July 2014 was paid in October 2014. The company tax rate is 30%. Required

1. Prepare the consolidation worksheet entries, the consolidation worksheet and the consolidated statement of ﬁnancial position for Volans Ltd and its subsidiary, Tucana Ltd, as at 1 July 2014. 2. Prepare the consolidation worksheet entries for the preparation of consolidated ﬁnancial statements for Volans Ltd and its subsidiary, Tucana Ltd, as at 30 June 2015. 2

PART 4 Economic entities

Exercise 21.15 ★★

GAIN ON BARGAIN PURCHASE

The statement of ﬁnancial position of Columba Ltd at 30 June 2014 was as follows: Columba Ltd Statement of Financial Position as at 30 June 2014 Inventory Plant and equipment Accumulated depreciation

£ 44 000 £ 390 000 (158 000) 232 000 6 000 £282 000

Patent Total assets Dividend payable Other liabilities Total liabilities

10 000 24 000 34 000

Share capital (150 000 shares) Retained earnings Total equity Dividend payable Other liabilities Total liabilities Total equity and liabilities and equity Inventory Non-current assets: Plant and equipment Accumulated depreciation

£150 000 98 000 248 000 10 000 24 000 34 000 £282 000 £ 44 000 £ 390 000 (158 000) 232 000 6 000

Goodwill Total assets

238 000 £282 000

The recorded amounts of the identiﬁable assets and liabilities of Columba Ltd at this date were equal to their fair values except for inventory and plant and equipment, whose fair values were £50 000 and £236 000 respectively. The plant and equipment has a further 5-year life. All the inventory was sold by Columba Ltd by December 2014. The tax rate is 30%. On 1 July 2014, Centaurus Ltd acquired all the shares (cum div.) in Columba Ltd, giving in exchange 50 000 shares in Centaurus Ltd, these having a fair value at acquisition date of £5 per share. Costs incurred by Centaurus Ltd in undertaking the acquisition amounted to £10 000. The dividend payable was paid in August 2014. Required

Prepare the consolidation worksheet adjustment entries for the preparation of consolidated ﬁnancial statements at 30 June 2018. Exercise 21.16

BARGAIN PURCHASE, CONSOLIDATION WORKSHEET

★★ The account balances of Antlia Ltd and Andromeda Ltd at 1 July 2016 were as follows:

Land Machinery Accumulated depreciation Inventory Cash Total assets Dividend payable Provisions Total liabilities

Antlia Ltd 400 000 500 000 (100 000) 480 000 200 000 £ 1 480 000 10 000 320 000 330 000

Andromeda Ltd 200 000 250 000 (50 000) 75 000 5 000 £ 480 000 15 000 15 000 30 000 (continued)

CHAPTER 21 Consolidation: wholly owned subsidiaries

Antlia Ltd £ 600 000 — 200 000 150 000 200 000 1 150 000 £ 1 480 000

Share capital — 600 000 shares/200 000 shares — 200 000 shares General reserve Asset revaluation surplus Retained earnings Total equity Total Liabilities and equity

Andromeda Ltd £ 200 000— £ 200 000 50 000 40 000 160 000 450 000 £ 480 000

The fair values of Andromeda Ltd’s assets at 1 July 2016 were: Land Machinery Inventory

£240 000 220 000 95 000

The two companies decided to combine on 1 July 2016 with Antlia Ltd issuing one share (fair value £2) and 50p cash for each share in Andromeda Ltd. Andromeda Ltd’s shares were acquired cum div. The tax rate is 30%. Required

1. Prepare the consolidated statement of ﬁnancial position immediately after Antlia Ltd’s acquisition of shares in Andromeda Ltd. 2. Prepare the consolidation worksheet entries required for the consolidation worksheet at 30 June 2017, assuming both dividends were paid during September 2016. Assume all inventory on hand at 1 July 2016 was sold in the following 3 months, and that the machinery has a further 4-year life. Exercise 21.17 ★★★

UNRECORDED LIABILITIES AND RESERVE TRANSFERS

On 1 July 2014, Delphinus Ltd acquired all the share capital of Telescopium Ltd when the equity of Telescopium Ltd consisted of: 100 000 ordinary shares issued at £1, paid to 75p each General reserve Retained earnings

£ 75 000 15 000 12 000

All identiﬁable assets and liabilities of both companies were recorded at fair value except:

Inventory Machinery (net)

Carrying amount

Fair value

£20 000 80 000

£25 000 95 000

The machinery has a further 5-year life. Of the inventory on hand at 1 July 2014, 90% was sold by 31 December 2014. At 1 July 2014, Telescopium Ltd was involved in a court case with an entity that was claiming damages from it. Telescopium Ltd had not raised a liability in relation to any expected damages. Delphinus Ltd measured the fair value of the liability at £5000. By 31 December 2014, the expectation of winning the court case had improved, so the fair value was considered to be £1000. The tax rate is 30%. Valuation adjustments are made on consolidation. On 1 November 2014, Telescopium Ltd transferred £6500 out of retained earnings in existence at 1 July 2014 to the general reserve account. On 1 December 2014, Telescopium Ltd made a call of 25p per share, all call money being received by 20 December 2014. At 31 December 2014, the statement of ﬁnancial position of Delphinus Ltd showed shares in Telescopium Ltd at £147 250. Required

Prepare the consolidation worksheet entries for the preparation of the consolidated ﬁnancial statements for Delphinus Ltd and its subsidiary, Telescopium Ltd, as at 31 December 2014. 4

PART 4 Economic entities

Exercise 21.18

CONSOLIDATION WORKSHEET, UNRECOGNISED INTANGIBLES AND LIABILITIES

★★★ Auriga Ltd gained control of Perseus Ltd by acquiring all its shares on 1 July 2013. The equity at that date was: Share capital Retained earnings

£100 000 35 000

At 1 July 2013, all the identiﬁable assets and liabilities of Perseus Ltd were recorded at fair value except for:

Inventory Land Plant (cost £120 000)

Carrying amount

Fair value

£ 18 000 120 000 95 000

£ 22 000 130 000 98 000

The inventory was all sold by 30 June 2014. The plant had a further 5-year life but was sold on 1 January 2016 for £50 000. The land was sold in March 2014 for £150 000. Where revalued assets are sold or fully consumed, any associated amounts in the business combination valuation reserve are transferred to retained earnings. At 1 July 2013, Perseus Ltd had guaranteed a loan taken out by Swede Ltd. Perseus Ltd had not raised a liability in relation to the guarantee but, as Swede Ltd was not performing well, Auriga Ltd valued the contingent liability at £5000. In January 2016, Swede Ltd repaid the loan. Perseus Ltd had also invented a special tool and patented the process. No asset was raised by Perseus Ltd, but Auriga Ltd valued the patent at £6000, with an expected useful life of 6 years. The tax rate is 30%. Financial information for these companies for the year ended 30 June 2016 is as follows: Auriga Ltd £ 5 000 10 000 30 000 140 000 (62 000) 160 000 £283 000

Perseus Ltd £ 14 000 5 000 21 000 163 000 (37 000) — £166 000

19 000 25 000 44 000

8 000 — 8 000

Profit before tax Income tax expense Profit for the year Other recognised income and expense: Gains on plant revaluation Gains on financial assets

£ 50 000 (20 000) 30 000

£ 15 000 (6 000) 9 000

6 000 (4 000)

0 (10 000)

Comprehensive income for the year

£ 32 000

£ (1 000)

Profit Retained earnings (1 July 2015)

Retained earnings (30 June 2016)

£ 30 000 37 000 67 000 (20 000) — (20 000) £ 47 000

Share capital General reserve Asset revaluation surplus Retained earnings

£150 000 12 000 20 000 47 000

£100 000 20 000 — 34 000

Cash Financial assets Inventory Plant and equipment Accumulated depreciation Investment in Perseus Ltd Total assets Payables Loan Total liabilities

Dividend paid Transfer to general reserve

9 000 45 000 54 000 — (20 000) (20 000) £ 34 000

(continued) CHAPTER 21 Consolidation: wholly owned subsidiaries

Other components of equity Total equity Payables Loan Total liabilities Total liabilities and equity and liabilities Cash Financial assets Inventory Plant and equipment Accumulated depreciation Shares in Perseus Ltd Total assets

Auriga Ltd 10 000 239 000 19 000 25 000 44 000 £283 000

Perseus Ltd 4 000 158 000 8 000 — 8 000 £166 000

5 000 10 000 30 000 140 000 (62 000) 160 000 £283 000

£ 14 000 5 000 21 000 163 000 (37 000) — £166 000

6 000 (4 000) £ 30 000 £ 32 000

0 (10 000) £ 9 000 £ (1 000)

Additional information: Other recognised income and expense: Gains on plant revaluation Gains on financial assets Profit for the year Comprehensive income for the year

The transfer to general reserve during the year ended 30 June 2016 was from proﬁts earned before 1 July 2013. Required

Prepare the consolidated ﬁnancial statements for Auriga Ltd as at 30 June 2016. Your answer should include all consolidation adjustment journal entries and a consolidation worksheet.

PART 4 Economic entities

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Gilad Livne and David Kolitz

John Wiley & Sons, Ltd, 2016

Chapter 22: Consolidation: intragroup transactions

Chapter 22 – Consolidation: intragroup transactions Discussion Questions 1. Why is it necessary to make adjustments for intragroup transactions? The consolidated financial statements are the statements of the group, an economic entity consisting of the parent and its subsidiaries. The consolidated financial statements then can only contain profits, assets and liabilities that relate to parties external to the group. Adjustments must then be made for intragroup transactions as these are internal to the economic entity, and do not reflect the effects of transactions with external parties. This is also consistent with the entity concept of consolidation, which defines the group as the net assets of the parent and the net assets of the subsidiary. Transactions between these parties must then be adjusted in full as both parties are within the economic entity.

2. In making consolidation worksheet adjustments, sometimes tax-effect entries are made. Why? Accounting for tax is governed by IAS 12 Income Tax. Deferred tax accounts are raised when a temporary difference arises because the tax base of an asset or liability differs from the carrying amount. Some consolidation adjustments result in changing the carrying amounts of assets and liabilities. Where this occurs a temporary difference arises as there is no change to the tax base. In these situations, tax-effect entries, require the raising of deferred tax assets and liabilities, are necessary. Consider an example of an item of inventory carried at cost of $10 000 being sold by a parent to a subsidiary for $12 000, the inventory still being on hand at the end of the period. The tax rate is 30%. In the consolidation worksheet there is a credit adjustment to inventory of $2000 as the cost to the economic entity differs from that to the subsidiary. In the subsidiary’s accounts, the inventory is carried at $12 000 and has a tax base of $12 000, giving rise to no temporary differences. From the group’s point of view, the asset has a carrying amount of $10 000, giving a temporary difference of $2000. As the expected future deduction is greater than the assessable amount, a deferred tax asset exists for the group. This has no effect on the amount of tax payable in the current period.

Why is it important to identify transactions as current or previous period transactions? Current period transactions affect different accounts than previous period transactions. For example, current period sales of inventory affect sales and cost of sales accounts, whereas previous period sales of inventory affect retained earnings. If the transactions are not correctly placed into a time context, then the adjustments used for those transactions may be inappropriate.

22.1

Solutions Manual to accompany Applying IFRS Standards 4e 4. Where an intragroup transaction involves a depreciable asset, why is depreciation expense adjusted? The cost of the asset to the group is different from that recorded by the acquirer of the depreciable asset within an intragroup transaction. The acquirer records depreciation on the cost to the acquirer while in the consolidated financial statements, the group wants to show depreciation calculated on cost to the group. Hence an adjustment is necessary. If a profit is made on an intragroup sale of a depreciable asset, then the cost of the asset to the group is less than the cost recorded by the acquirer of the asset. Hence an adjustment is necessary to reduce the depreciation expense and accumulated depreciation in relation to the asset.

5. Are adjustments for post-acquisition dividends different from those for pre-acquisition dividends? Explain. There is no difference in the accounting for pre-acquisition or post-acquisition dividends. They are all accounted for as post-acquisition dividends. The adjustment is to dividend revenue recorded by the parent and dividends paid recorded by the subsidiary. The treatment of all dividends as post-acquisition dividends is hard to justify conceptually and this decision was made by the standard-setters on pragmatic grounds. Refer to IAS 27 and IFRS 9 (para 5.7.6). 6. What is meant by “realisation of profits”? Profit is realised when an entity or an economic entity transacts with another external entity. For a group or economic entity this is consistent with the concept that the consolidated financial statements show only the results of transactions with external entities. The consolidated statement of profit or loss and other comprehensive income will thus show only realised profits. Profits recognised by group members on sale of assets within the group are unrealised profits. With transferred inventory involvement of an external party, or realisation, occurs when the inventory is on-sold to an external entity. With transferred depreciable assets, realisation occurs as the asset is used up, as the benefits are received by the group as a result of use of the asset. The proportion of profits realised in any one period is measured by reference to the depreciation charged on the transferred asset. Profits recorded from intragroup services are considered to be immediately realised.

7. When are profits realised in relation to inventory transfers within the group? Realisation occurs on involvement of an external entity, namely when the inventory is on-sold to an entity that is not a member of the group.

22.2

Chapter 22: Consolidation: intragroup transactions

EXERCISES Exercise 22.1 1. 2.

CONSOLIDATION ADJUSTMENTS

Discuss whether the entries suggested by Li Chen are correct, explaining on a line-by-line basis the correct adjustment entries. Determine the consolidation worksheet entries in the following year, assuming the inventory is onsold, and explain the adjustments on a line-by-line basis. JESSICA LTD

1. The correct entry is: Sales Cost of sales Inventory

Dr Cr Cr

15 000

Deferred tax asset Income tax expense

Dr Cr

450

13 500 1 500 450

Sales:

Recorded sales = $15 000 + $8 000 = $23 000 Group sales = $8000 [external entity sales only] Adjustment = $15 000 Cost of sales: Recorded = $12 000 + ½ x $15 000 = $19 500 Group = ½ x $12 000 = $6000 Adjustment = $13 500 Inventory: Recorded = ½ x $15 000 = $7500 Group = ½ x $12 000 = $6000 Adjustment = $1500 DTA:

As inventory in the first adjustment is reduced by $1 500, this changes the carrying amount of the asset. A change in the carrying amount creates a temporary difference between it and the tax base giving rise to a deferred tax benefit which will be reversed on sale of the asset to an external entity.

2. Assuming the inventory is on-sold, the entry in the following year is: Retained earnings (op bal) Income tax expense Cost of sales

Dr Dr Cr

1 050 450 1 500

Retained earnings (op bal): In the prior period, Jessica Ltd recorded an after tax profit of $2 100 on sale of inventory to Amelie Ltd. Half of this inventory was on-sold to an external entity, leaving half the profit, $1050, unrealised. Hence prior period profit is reduced by $1 050. Income tax expense: In the prior period, the group raised a deferred tax asset of $450. When the inventory is on-sold this year the account is reversed effectively crediting the deferred tax asset account and debiting the income tax expense. Cost of sales: Recorded = ½ x $15 000 = $7500 Group = ½ x $12 000 = $6000 Adjustment = $1500

22.3

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 22.2 ELIMINATION OF INVESTMENT IN SUBSIDIARY AND INTRAGROUP TRANSACTIONS, NO FAIR VALUE — CARRYING AMOUNT DIFFERENCES AT ACQUISITION DATE Assuming consolidated financial statements are required for the period 1 January 2015 to 31 December 2016, provide journal entries (including the elimination of investment in subsidiary) to show the adjustments that would be made in the consolidation worksheets.

MOLLY LTD - MIA LTD At 1 January 2013: Net fair value of identifiable assets and liabilities of Mia Ltd Consideration transferred Goodwill

= = = =

$200 000 + $50 000 + $20 000 (equity) $270 000 $300 000 $30 000

Business combination valuation entry 31 December 2016 Goodwill Business combination valuation reserve

Dr Cr

30 000 30 000

Pre-acquisition entry at 31 December 2016 Retained earnings (1/1/15) Share capital General reserve Business combination valuation reserve Shares in Mia Ltd

Dr Dr Dr Dr Cr

50 000 200 000 20 000 30 000

Transfer from general reserve General reserve

Dr Cr

15 000

Debentures Debentures in Molly Ltd

Dr Cr

100 000

Revenue - debenture interest Interest expense

Dr Cr

7 000

Accounts payable Accounts receivable

Dr Cr

1 000

Revenue - services fees Advertising expenses

Dr Cr

8 000

Sales revenue Cost of sales Inventory

Dr Cr Cr

5 500

Deferred tax asset Income tax expense

Dr Cr

120

Retained earnings (1/1/15) Income tax expense Cost of sales

Dr Dr Cr

700 300

Sales revenue Cost of sales Plant & machinery

Dr Cr Cr

6 000

300 000

15 000

Adjustments for intragroup transactions (a)

(b)

(c)

(d)

(e)

100 000

7 000

1 000

8 000

5 100 400

120

1 000

4 000 2 000 22.4

Chapter 22: Consolidation: intragroup transactions

(f)

Deferred tax asset Income tax expense

Dr Cr

600

Accumulated depreciation Depreciation expense (10% x 1/2 x $2 000)

Dr Cr

100

Income tax expense Deferred tax asset

Dr Cr

Dividend revenue Dividend paid

Dr Cr

63 000

600

100

63 000

Exercise 22.3 INTRAGROUP TRANSACTIONS, EXPLANATION OF RATIONALE 1. Prepare the adjustments required in the consolidation worksheet at 30 June 2016, assuming an income tax rate of 30%. 2. Explain the rationale behind each of the entries you have prepared. ALEXIS LTD – RUBY LTD 1. (a)

(b)

Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

2 100 900

Retained earnings (1/7/15) Deferred tax asset Machinery

Dr Dr Cr

14 000 6 000

Accumulated depreciation Depreciation expense Retained earnings (1/7/15)

Dr Cr Cr

3 000

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

600 300

3 000

20 000

2 000 1 000

900

2. (a) Retained earnings: In the previous period, Ruby Ltd recorded a $3000 before-tax profit, or a $2100 aftertax profit on sale of inventory within the group. Because the sale did not involve external entities, the profit must be eliminated on consolidation. Cost of sales: In the current period, the transferred inventory is sold to external entities. Alexis Ltd records cost of sales at $3000 greater than to the group. Hence, cost of sales is reduced by $3000. Note that this increases group profit by $3000, reflecting the realisation of the profit to the group in the current period (due to the sale to an external party), when it was recognised by the legal entity in the previous period. Income tax expense: At the end of the previous period, in the consolidated statement of financial position a deferred tax asset of $900 (30% x $3000) was raised because of the difference in cost of the inventory recorded by the legal entity and that recognised by the group. This deferred tax asset is reversed when the asset is sold. The adjustment to income tax expense reflects the reversal of the deferred tax asset raised at the end of the previous period. (b) © John Wiley and Sons, Ltd, 2016

22.5

Solutions Manual to accompany Applying IFRS Standards 4e In the prior period, Ruby Ltd sold machinery to Alexis Ltd at an after-tax profit of $14 000 which is calculated as follows: Proceeds on sale $100 000 (based on depreciation of $10 000 at 10% p. a. straight-line) less carrying amount of $80 000 = $20 000 profit before tax, or $14 000 profit after tax.

Retained earnings: As there were no external parties to the group involved in this transaction, the profit is unrealised to the group. Hence, retained earnings (1/7/15) must be reduced by $14 000. Machinery: The machinery is still held by Alexis Ltd at 30 June 2016, and recorded at $100 000 cost. The cost to the group is $80 000. As the asset must be reported in the consolidated financial statements at cost to the group, machinery must be reduced by $20 000. Deferred tax asset: A change in the carrying amount of the asset causes a temporary difference between the carrying amount and the tax base of the asset. As the carrying amount is reduced, a deferred tax asset of $6000 (30% x $20 000) is raised.

Depreciation expense and accumulated depreciation: The asset is depreciated by the Alexis Ltd at $10 000 p.a. (being 10% x $100 000) while the depreciation to the group is $8000 (being 10% x $80 000). Hence depreciation p.a. must be reduced by $2000. As the transfer occurred on 1 January 2015, this means a reduction to prior period depreciation, via retained earnings of half a year’s depreciation, $1000, and a reduction in current depreciation expense of $2000. This means a reduction to accumulated depreciation of $3000.

Deferred tax asset and income tax expense: As changes to accumulated depreciation change the carrying amount of the asset, there is a tax-effect to be considered. The deferred tax asset raised in relation to the sale of the asset within the group is reversed as the asset is depreciated. Hence, there is an overall reversal of $900, being 30% x $3000, being the change to accumulated depreciation with resultant effects on tax expense both in the current period of $600 (30% x $2000) and the prior period of $300 (30% x $1000).

Exercise 22.4 STATEMENTS

CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL

Prepare the consolidated financial statements for Sienna Ltd and its subsidiary for the year ended 30 June 2016. SIENNA LTD – AMBER LTD At 1 July 2015: Net fair value of identifiable assets and liabilities of Amber Ltd

Consideration transferred Goodwill

= = =

$120 000 + $12 000 + $20 000 + $4000 (equity) + $1 000 (1 – 30%) (inventory) + $8 000 (1 – 30%) (R&D) - $7 000 (1 -30%) (liability) $157 400 $160 000 $2 600

1. Business combination valuation entries Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr Cr

1 000 300 700 22.6

Chapter 22: Consolidation: intragroup transactions Research & development Deferred tax liability Business combination valuation reserve

Dr Cr Cr

8 000

Amortisation expense Accumulated amortisation

Dr Cr

2 000

Business combination valuation reserve Deferred tax asset Provision for guarantee

Dr Dr Cr

4 900 2 100

Goodwill Business combination valuation reserve

Dr Cr

2 600

Retained earnings (1/7/15) Share capital Business combination valuation reserve General reserve Other components of equity Shares in Amber Ltd

Dr Dr Dr Dr Dr Cr

12 000 120 000 4 000 20 000 4 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

700

2 400 5 600

2 000

7 000

2 600

2. Pre-acquisition entries

160 000

700

3. Dividend declared Dividend payable Dividend declared

Dr Cr

7 200

Dividend revenue Dividend receivable

Dr Cr

7 200

Dividend revenue Interim dividend paid - 2014-15 profits

Dr Cr

5 000

Dividend revenue Interim dividend paid: 2015-16 profits

Dr Cr

4 800

Debentures Debentures in Amber Ltd Income on redemption of debentures

Dr Cr Cr

60 000

Interest revenue Interest expense

Dr Cr

3 600

Sales revenue Cost of sales Inventory

Dr Cr Cr

40 000

Deferred tax asset Income tax expense

Dr Cr

600

7 200

4. Dividend paid

5 000

4 800

5. Debentures

57 000 3 000

3 600

6. Unrealised profit in closing inventory

38 000 2 000

600 22.7

Solutions Manual to accompany Applying IFRS Standards 4e

7. Sale of inventory for use as non-current asset Sales revenue Cost of sales Plant and machinery

Dr Cr Cr

30 000

Deferred tax asset Income tax expense

Dr Cr

1 800

Accumulated depreciation Depreciation expense (10% x $6000 x ½)

Dr Cr

300

Income tax expense Deferred tax asset

Dr Cr

24 000 6 000

1 800

8. Depreciation on plant and machinery

300

22.8

Chapter 22: Consolidation: intragroup transactions Sienna Ltd 234 800

Amber Ltd 200 000

Other income Dividend revenue

6 600 17 000

Cost of sales

258 400 123 000

200 000 120 000

1 000

Other expenses

34 600

20 000

2 000

Profit before tax Tax expense

157 600 100 800 32 000

140 000 60 000 20 000

68 800 24 000

40 000 12 000

12 000

-92 800 18 000

-52 000 5 000

700

16 000 16 000 8 000

4 800 7 200 --

58 000 34 800

17 000 35 000

320 000 60 000 414 800 5 000

120 000 20 000 175 000 4 000

3 000 8 000

(2 000) 2 000

422 800 --

177 000 --

422 800

177 000

Sales revenue

Profit Retained earnings (1/7/15) Transfer from BCVR Dividend paid: 2012/15 2013/16 Dividend declared Transfer to general reserve Retained earnings (30/6/16) Share capital General reserve Other comp. of equity (1/7/15) Gains/Losses Other comp. of equity (30/6/16) Business comb. valuation reserve Total equity

6 7 5 3 4 4

Adjustments Dr Cr 40 000 30 000 3 600 3 000 7 200 5 000 4 800 38 000 24 000 3 600 300

300 600 1 800

Group 364 800 5

6 7 5 8

1 6 7

6 000 --

370 800 182 000 52 700 234 700 136 100 49 390

86 710 24 000 700

5 000

4 800 7 200

4 3

-110 710 18 000 16 000 16 000 8 000 58 000 52 710

2 2

120 000 20 000

4 000

320 000 60 000 432 710 5 000 1 000 6 000

1 2

4 900 4 000

5 600 2 600 700

1 1 2

438 710 --

438 710

22.9

Solutions Manual to accompany Applying IFRS Standards 4e Sienna Ltd

Amber Ltd

Adjustments Dr Cr

Group 16 000 20 800 14 840 21 000 7 000 20 000 20 400 120 040 558 750

Dividend payable Provisions Bank overdraft Current tax liability Contingency Debentures Def. tax liability Total liabilities Total equity and liabilities

16 000 12 000 11 000 13 000 52 000 474 800

7 200 8 800 14 840 10 000 80 000 5 000 125 840 302 840

7 200

60 000

Deferred tax asset

1 6 7

1 000 27 000 (500)

Cash Receivables Allowance – doubtful debts Financial assets Inventory Plant and machinery Accumulated depreciation Land Debentures in Amber Ltd Shares in Amber Ltd Research & development Accumulated amortisation Goodwill Total assets

7 000

2 400

4 410

40 12 100 (300)

7 200

1 040 31 900 (800)

20 000 48 000 100 000 (40 000)

10 000 47 000 70 000 (26 000)

2 000 6 000

6 7

30 000 93 000 164 000 (65 700)

102 300 57 000

190 000 -

57 000

160 000 -

160 000

-8 000

2 000

(2 000)

474 800

302 840

2 100 600 1 800

300

8 000

2 600 341 890

341 890

292 300 --

2 600 558 750

SIENNA LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2016 Revenues: Sales revenues Other revenues

$364 800 6 000 370 800

Expenses from ordinary activities Cost of sales Other expenses Profit before income tax Income tax expense Profit for the period Other comprehensive income Other components of equity: Gains on financial assets Comprehensive income for the period $ 87 710 © John Wiley and Sons, Ltd, 2016

182 000 52 700 234 700 136 100 49 390 $86 710 1 000

22.10

Chapter 22: Consolidation: intragroup transactions SIENNA LTD Consolidated Statement of Changes in Equity for financial year ended 30 June 2016 Comprehensive income for the period

$87 710

Retained earnings: Balance at 1 July 2015 Profit for the period Transfer to general reserve Dividend paid Dividend declared Balance at 30 June 2016

$24 000 86 710 (8 000) (34 000) (16 000) $52 710

Share capital: Balance at 1 July 2015 Balance at 30 June 2016

$320 000 $320 000

General reserve: Balance at 1 July 2015 Transfer from retained earnings Balance at 30 June 2016

$52 000 8 000 $60 000

Other components of equity at 1 July 2015 Gains Other components of equity at 30 June 2016

$5 000 1 000 $6 000

SIENNA LTD Consolidated Statement of Financial Position as at 30 June 2016 ASSETS Current Assets Cash assets Financial assets Receivables Allowance for doubtful debts Inventories Total Current Assets Non-current Assets Property, plant and equipment: Plant and machinery Accumulated depreciation Land Goodwill Deferred tax assets Intangibles: Research & development Accumulated amortisation Total Non-current Assets Total Assets

$1 040 30 000 $31 900 (800)

164 000 (65 700) 98 300 292 300

8 000 (2 000)

31 100 93 000 155 140

390 600 2 600 4 410

6 000 403 610 $558 750

22.11

Solutions Manual to accompany Applying IFRS Standards 4e EQUITY AND LIABILITIES Equity Share capital General reserve Other components of equity Retained earnings Total Equity

$320 000 60 000 6 000 52 710 $438 710

Current Liabilities Payables: Dividend payable Provisions Interest-bearing liabilities: Bank overdraft Tax liabilities Total Current Liabilities Non-current Liabilities Contingent liability Interest-bearing liabilities: Debentures Tax liabilities: Deferred tax liability Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

16 000 20 800 14 840 21 000 72 640 7 000 20 000 20 400 47 400 $120 040 $558 750

Exercise 22.5 CONSOLIDATION WORKSHEET, IMPAIRMENT OF GOODWILL 1. Prepare the consolidated statement of profit or loss and other comprehensive income for Amy Ltd and its subsidiary, Zara Ltd, at 31 December 2016. 2. Discuss the concept of ‘realisation’ using the intragroup transactions in this question to illustrate the concept. AMYLTD – ZARA LTD At 1 January 2016: Net fair value of identifiable assets and liabilities of Zara Ltd

Consideration transferred Goodwill

= = = = =

$10 000 + $3 000 (equity) + $400 (1 – 30%) (inventory) $13 280 $20 000 - $3 000 dividend $17 000 $3 720

1. Worksheet entries 1. Business combination valuation entries Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

360

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

Goodwill Business combination valuation reserve

Dr Cr

3 720

108

252

12 28

3 720

22.12

Chapter 22: Consolidation: intragroup transactions 2. Pre-acquisition entries Retained earnings (1/1/16) Share capital Business combination valuation reserve Shares in Zara Ltd

Dr Dr Dr Cr

3 000 10 000 4 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

252

Impairment loss - goodwill Accumulated impairment losses

Dr Cr

1 860

17 000

252

1 860

3. Dividend paid Dividend revenue Interim dividend paid

Dr Cr

1 000

Sales revenue Cost of sales Inventory

Dr Cr Cr

5 000

Deferred tax asset Income tax expense

Dr Cr

300

Dr Cr

500

22 000

1 000

4. Sales

4 000 1 000

300

5. Management services Other income Other expenses

500

6. Sale of machinery Proceeds on sale of property, plant & equipment Carrying amount of property. plant and equipment sold Machinery Deferred tax asset Income tax expense

Cr Cr

20 000 2 000

Dr Cr

600

Accumulated depreciation Depreciation expense (20% x $2000 x 1/2)

Dr Cr

200

Income tax expense Deferred tax asset

Dr Cr

600

7. Depreciation

200

22.13

Solutions Manual to accompany Applying IFRS Standards 4e

Sales revenue Other income Dividend revenue Cost of sales Other expenses

Amy Ltd 25 000 1 000 1 000 27 000 21 000 3 000

Zara Ltd 23 600 2 000 25 600 18 000 1 000

24 000 3 000 5 000

19 000 6 600 22 000

4 000

20 000

1 000

2 000

4 000 1 350

8 600 1 950

2 650 6 000

6 650 3 000

3 000

252

8 650 2 500 6 150

9 650 1 000 8 650

Profit from trading Proceeds on sale of PPE Carrying amount of PPE sold Gain/loss on sale of PPE Profit before tax Tax expense

Profit Retained earnings (1//1/16) Transfer from BCV reserve Dividend paid Retained earnings (31/12/16)

4 5 3

Adjustments Dr Cr 5 000 500 1 000

1 2

360 1 860

Group

4 000 500 200

4 5 7

43 600 2 500 -46 100 35 360 5 160 40 520 5 580 5 000

22 000 20 000

4 000 1 000

108 300 600

1 4 6

6 580 2 352

4 228 6 000 252

1 000

10 228 2 500 7 728

ZARA LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 31 December 2016 Revenue: sales Other income

$43 600 2 500 $46 100

Expenses: Cost of sales Other

35 360 5 160

Gain on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive income: Gains on financial assets Comprehensive income for the period $5 878

40 520 5 580 1 000 6 580 2 352 $4 228 1 650

22.14

Chapter 22: Consolidation: intragroup transactions 2. Concept of realisation ▪ ▪ ▪

▪

Realisation occurs on involvement of an external entity Sale of inventory: realisation occurs when inventory is on-sold to external party – see worksheet adjustment (4) where adjustment is made for unrealised profits Sale of plant: realisation occurs as plant is used up and benefits received – see worksheet adjustments (6) and (7). Note that the gain on sale is considered to be fully unrealised but as the asset is depreciated, profit is realised; the credit to depreciation expense in adjustment (7) means an increase in group profit. Services: Profits/losses on services are realised immediately; see adjustment (5)

Exercise 22.6 CONSOLIDATION WORKSHEET, CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME Prepare the consolidated statement of profit or loss and other comprehensive income for the year ended 30 June 2016. JASMINE LTD – POPPY LTD

At 1 July 2014: Net fair value of identifiable assets and liabilities of Poppy Ltd

Consideration transferred Goodwill

= ($40 000 + $4000 + $2800) (equity) $1000 (1 – 30%) (plant) + $500 (1 – 30%) (inventory) = $47 850 = $50 000 = $2150

1. Business combination valuation entries Accumulated depreciation Plant & equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Depreciation expense Retained earnings (1/7/15) Accumulated depreciation

Dr Dr Cr

200 200

Deferred tax liability Income tax expense Retained earnings (1/7/15)

Dr Cr Cr

120

Goodwill Business combination valuation reserve

Dr Cr

19 000 300 700

400

60 60 2 150 2 150

2. Pre-acquisition entries Retained earnings (1/7/15)* Share capital Asset revaluation surplus Business combination valuation reserve Shares in Poppy Ltd

Dr Dr Dr Dr Cr

3 150 40 000 4 000 2 850 50 000

* $2800 + ($500 - $150) (inventory)

22.15

Solutions Manual to accompany Applying IFRS Standards 4e 3. Dividend paid Dividend revenue Dividend paid

Dr Cr

2 000 2 000

4. Dividend declared Dividend revenue Dividend receivable

Dr Cr

2 400

Dividend payable Dividend declared

Dr Cr

2 400

Dr Dr Cr

350 150

Dr Cr

5 600

2 400

5. Profit in beginning inventory Retained earnings (1/7/15) Income tax expense Cost of sales

500

6. Sales: Jasmine Ltd – Poppy Ltd Sales revenue Cost of sales

5 600

7. Profit in ending inventory: sales from Poppy Ltd to Jasmine Ltd Sales revenue Cost of sales Inventory

Cr Cr

Deferred tax asset Income tax expense

Dr Cr

120

Proceeds on sale of office furniture Carrying amount of office furniture sold – other expenses Office furniture

3 000

Deferred tax asset Income tax expense

Dr Cr

150

Accumulated depreciation Depreciation expense (10% x 1/2 x $500)

Dr Cr

Income tax expense Deferred tax asset (30% x $25 – rounded upwards)

Dr Cr

4 400 4 000 400

120

8. Sale of furniture

Cr Cr

2 500 500

150

9. Depreciation

Sales revenue Proceeds from sale of furniture

Jasmine Ltd 78 000

Poppy Ltd 40 000

3 000

6 7 8

Adjustments Dr Cr 5 600 4 400 3 000

Group 108 000 0 22.16

Chapter 22: Consolidation: intragroup transactions Dividend revenue

4 400

1 600

Cost of sales

82 400 60 000

44 600 30 000

Other expenses

10 800

7 500

Profit before tax Tax expense

70 800 11 600 3 000

37 500 7 100 2 200

8 600 14 500

4 900 2 800

23 100 4 000 8 000 12 000 11 100

7 700 2 000 2 400 4 400 3 300

Profit Retained earnings 1/7/15)

Dividend paid Dividend declared Retained earnings (30/6/16)

3 4

2 000 2 400

200

1 600

500 5 600 4 000 2 500 25

5 6 7 8 9

5 9

150 8

60 120 150

1 7 8

1 2 5

200 3 150 350

2 000 2 400

2 3

109 600 79 900

15 975 95 875 13 725 5 028

8 697 13 660

22 357 4 000 8 000 12 000 10 357

JASMINE LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2016 Revenues: Sales revenue $108 000 Dividend revenue 1 600 $109 600 Expenses: Cost of sales 79 900 Other expenses 15 975 95 875 Profit before income tax 13 725 Income tax expense 5 028 Profit for the period $8 697 Other comprehensive income: Asset revaluations: Increments 2 500 Comprehensive income for the period $ 11 197

22.17

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 22.7 CONSOLIDATED WORKSHEET, CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME 1. Prepare the consolidated statement of profit or loss and other comprehensive income as at 31 March 2016. Assume a tax rate of 30%. ABBY LTD – ELLA LTD

At 1 April 2015: Net fair value of identifiable assets and liabilities of Ella Ltd

= $80 000 + $5000 + $5000 (equity) - $2000 (goodwill) + $2000 (1 – 30%) (inventory)

+ $3000 (1 – 30%) (plant) Consideration transferred Goodwill acquired Goodwill not recorded

= = = = = =

$91 500 $100 000 - $4000 (div. receivable) $96 000 $4500 $4500 - $2000 $2500

1. Business combination valuation entries Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

2 000 600

1 400

Goodwill Business combination valuation reserve

Dr Cr

2 500

Impairment loss – goodwill Accumulated impairment losses – goodwill

Dr Cr

1 500

Retained earnings (1/4/15) Share capital Asset revaluation surplus Business combination valuation reserve Shares in Ella Ltd

Dr Dr Dr Dr Cr

5 000 80 000 7 100 3 900

Transfer from business combination valuation reserve Business combination valuation reserve (Transfer on sale of inventory)

Dr Cr

1 400

2 500

1 500

2. Pre-acquisition entries

96 000

1 400

3. Sales: Abby Ltd – Ella Ltd

Sales revenue Cost of sales

Dr Cr

40 000

Dr Cr Cr

10 000

40 000

4. Sales: Ella Ltd – Abby Ltd Sales revenue Cost of sales Inventory

9 500 500 22.18

Chapter 22: Consolidation: intragroup transactions Deferred tax asset Income tax expense

Dr Cr

150

Proceeds on sale of non-current asset Carrying amount of non-current asset sold Inventory

30 000

Deferred tax asset Income tax expense

Dr Cr

600

Dr Cr

4 000

150

5. Sale of non-current asset - inventory

Cr Cr

28 000 2 000

600

6. Dividend paid Dividend revenue Dividend paid

4 000

22.19

Solutions Manual to accompany Applying IFRS Standards 4e

Sales revenue Proceeds on sale of non-current asset Dividend revenue

Cost of sales Other expenses Profit before tax Tax expense

Profit Retained earnings (1/4/15) Transfer from BCV reserve Dividend paid Retained earnings (31/3/16)

Abby Ltd 146 000

Ella Ltd 120 000 0

3 4 5

Adjustments Dr Cr 40 000 10 000 30 000

30 000 4 000

4 000

180 000 88 000

120 000 68 000

2 000

44 000 132 000 48 000 12 000

19 000 87 000 33 000 14 000

1 500

36 000 10 000

19 000 5 000

5 000

1 400

46 000 8 000 38 000

24 000 4 000 20 000

Group 216 000 0 0

40 000 9 500 28 000

3 4 5

600 150 600

1 4 5

216 000 108 500 36 500 145 000 71 000 24 650

46 350 10 000 1 400

4 000

56 350 8 000 48 350

ABBY LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 31 March 2016 Revenue: Sales revenue Expenses: Cost of sales Other Profit before income tax Income tax expense Profit for the period Other comprehensive income: Asset revaluation surplus: increments Comprehensive income for the period $49 650

$216 000 $108 500 36 500

145 000 71 000 24 650 $46 350 3 300

22.20

Chapter 22: Consolidation: intragroup transactions Exercise 22.8 CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS Prepare the consolidated financial statements as at 31 December 2016. LARA LTD – JADE LTD

At 31 December 2011: Net fair value of identifiable assets and liabilities of Jade Ltd

= = = =

Consideration transferred Goodwill

($100 000 + $25 000 + $20 000) (equity) + $5 000 (1 – 30%) (plant) $148 500 $160 000 $11 500

1. Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Depreciation expense Retained earnings (1/1/16) Accumulated depreciation (1/10 x $5 000 p.a.)

Dr Dr Cr

500 2 000

Deferred tax liability Income tax expense Retained earnings (1/1/16)

Dr Cr Cr

750

Goodwill Business combination valuation reserve

10 000 1 500 3 500

2 500

150 600

Dr Cr

11 500 11 500

2. Pre-acquisition entries At 31/12/11: Retained earnings (31/12/11) Share capital General reserve Business combination valuation reserve Shares in Jade Ltd

Dr Dr Dr Dr Cr

20 000 100 000 25 000 15 000 160 000

The entry at 31/12/16 is adjusted for: - the reduction in general reserve to pay unpaid shares Retained earnings (1/1/16) Share capital General reserve Business combination valuation reserve Shares in Jade Ltd

Dr Dr Dr Dr Cr

20 000 120 000 5 000 15 000

Dr Cr Cr

20 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

270

160 000

3. Profit in ending inventory Sales

19 100 900

270 22.21

Solutions Manual to accompany Applying IFRS Standards 4e 4. Inventory to machinery transfer Retained earnings (1/1/16) Deferred tax asset Plant and machinery

Dr Dr Cr

5 250 2 250

Accumulated depreciation Retained earnings (1/1/16) Depreciation expense ($750 p.a. for 3 ½ years)

Dr Cr Cr

2 625

Income tax expense Retained earnings (1/1/16) Deferred tax asset

Dr Dr Cr

225 563

Plant & machinery Proceeds on sale of non-current asset Carrying amount of asset sold

Dr Dr Cr

5 000 50 000

Income tax expense Deferred tax liability

Dr Cr

1 500

Depreciation expense Accumulated depreciation

Dr Cr

250

Deferred tax liability Income tax expense

Dr Cr

7 500

5. Depreciation

1 875 750

788

6. Sale of machinery

55 000

1 500

7. Depreciation

250

8. Dividend declared Dividend payable Dividend declared

Dr Cr

8 000

Dividend revenue Dividend receivable

Dr Cr

8 000

22.22

Chapter 22: Consolidation: intragroup transactions Lara Ltd Sales revenue Other income Cost of sales Other expenses

Profit from trading Proceeds – sale of non-current asset Carrying amount of non-current assets sold Gain/(loss) on sale of non-current assets Profit before tax Tax expense

Profit Retained earnings (1/1/16)

Dividend declared Retained earnings (31/12/16) Share capital General reserve ARS (1/1/16) Increments ARS (31/12/16) Other comp (1/1/16) Gains Other comp (31/12/16) Business combination valuation reserve Total equity

Jade Ltd

250 000 20 000 270 000 188 000 28 000

120 000 5 000 125 000 80 000 5 000

216 000 54 000 14 000

85 000 40 000 50 000

18 000

55 000

(4 000)

(5 000)

50 000 20 000

35 000 10 000

30 000 40 000

25 000 65 000

70 000 10 000 60 000

90 000 8 000 82 000

500 000 25 000 585 000 8 000 2 000 10 000 595 000 12 000 3 000 15 000

120 000 5 000 207 000 7 000 (1 000) 6 000 213 000 8 000 2 000 10 000

610 000 --

223 000 --

610 000

223 000

Adjustments Dr 3 8

20 000 8 000

1 7

500 250

Group

19 100 750

3 5

350 000 17 000 367 000 248 900 33 000 281 900 85 100 14 000

50 000 55 000

18 000

(4 000)

5 6

225 1 500

150 270 75

1 3 7

1 2 4 5

2 000 20 000 5 250 563

600 1 875

1 5

8 000

2 2

120 000 5 000

15 000

81 100 31 230

49 870 79 662

129 532 10 000 119 532 500 000 25 000 644 532 15 000 1 000 16 000 660 532 20 000 5 000 25 000

3 500 11 500

1 1

685 532 --

685 532

22.23

Solutions Manual to accompany Applying IFRS Standards 4e Lara Ltd

Jade Ltd

Deferred tax liability

6 240

5 200

Current tax liability Payables Total liabilities Total equity and liabilities

22 000 22 000 50 240 660 240

18 000 14 000 37 200 260 200

Plant & machinery

425 000

Accumulated depreciation Motor vehicles Accumulated depreciation Receivables Financial assets Inventory Bank Deferred tax asset

(300 000)

Shares in Jade Ltd Goodwill

Adjustments Dr Cr 1 7

750 75

8 000

337 000

5 000

(261 000)

1 5

15 000 2 625

284 200 (160 000)

152 600 (100 000)

25 000 60 000 106 440 46 900 12 700

7 310 40 000 72 000 5 990 6 300

160 000 -660 240

--260 200

Group

1 500 1 500

1 6

13 615 40 000 28 000 81 615 767 147

10 000 7 500 2 500 250

1 4

749 500 (546 125)

7 436 800 (260 000)

3 4

270 2 250

11 500 293 758

8 000

900

788

160 000

24 310 100 000 177 540 52 890 20 732 -11 500 767 147

293 758

LARA LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 31 December 2016 Revenues: Sales revenue Other income Expenses: Cost of sales Other expenses

$350 000 17 000

$367 000

248 900 33 000

281 900 85 100 (4 000) 81 100 31 230 $49 870

Gain/(loss) on sale of non-current assets Profit before income tax Income tax expense Profit for the period Other comprehensive income: Asset revaluation surplus: increments Available-for-sale financial assets: gains Comprehensive income for the period

1 000 5 000 $ 55 870

LARA LTD Consolidated Statement of Changes in Equity for financial year ended 31 December 2016 Comprehensive income for the period

$55 870

Retained earnings: © John Wiley and Sons, Ltd, 2016

22.24

Chapter 22: Consolidation: intragroup transactions Balance at 1 January 2016 Profit for the period Dividend provided Balance at 31 December 2016 Share capital: Balance at 1 January 2016 Balance at 31 December 2016 General reserve: Balance at 1 January 2016 Balance at 31 December 2016 Asset revaluation surplus: Balance at 1 January 2016 Increments Balance at 31 December 2016 Other components of equity Balance at 1 January 2016 Gains Balance at 31 December 2016

$79 662 49 870 (10 000) $119 532 $500 000 $500 000 $25 000 $25 000 $15 000 1 000 $16 000 $20 000 5 000 $25 000

LARA LTD Consolidated Statement of Financial Position as at 31 December 2016 ASSETS Current Assets Receivables Inventories Cash assets: Bank Financial assets Total Current Assets

$24 310 177 540 52 890 100 000 354 740

Non-current Assets Property, plant and equipment: Plant & machinery Accumulated depreciation Motor vehicles Accumulated depreciation Tax assets: Deferred tax asset Goodwill Total Non-current Assets Total Assets

$749 500 (546 125) 436 800 (260 000)

EQUITY AND LIABILITIES Equity Share capital General reserve Asset revaluation surplus Other components of equity Retained earnings Total Equity Current Liabilities Payables Current tax liabilities Total Current Liabilities Non-current Liabilities Deferred tax liability Total Liabilities Total Equity and Liabilities

$203 375 176 800

380 175 20 732 11 500 412 407 $767 147

$500 000 25 000 16 000 25 000 119 532 $685 532 28 000 40 000 68 000 13 615 81 615 $767 147

22.25

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 22.9

CONSOLIDATION WORKSHEET

Prepare the consolidation worksheet for the preparation of the consolidated financial statements for the period ended 30 June 2016. MONIQUE LTD – MADELEINE LTD

At 1 July 2014: Net fair value of identifiable assets and liabilities of Madeleine Ltd

= = =

Consideration transferred Goodwill

$80 000 + $16 000 + $21 000 (equity) + $1 000 (1 – 30%) (vehicles) + $8 000 (1 – 30%) (furniture) + $6 000 (1 – 30%) (land) + $6 000 (1 – 30%) (inventory) $131 700 $137 200 $5 500

The subsidiary would pass the following entry: Land Deferred tax liability Asset revaluation surplus

Dr Cr Cr

6 000 1 800 4 200

1. Business combination valuation entries At 1 July 2014: Accumulated depreciation -vehicles Motor vehicles Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

3 000

Accumulated depreciation - F&F Furniture & fittings Deferred tax liability Business combination valuation reserve

Dr Dr Cr Cr

6 000 2 000

Goodwill Business combination valuation reserve At 30 June 2016: Depreciation expense – motor vehicles Carrying amount of non-current assets sold Income tax expense Retained earnings (1/7/15) Transfer from business combination valuation reserve

Dr Cr

2 000 300 700

2 400 5 600 5 500 5 500

Dr Dr Cr Dr Cr

125 625

Accumulated depreciation - F&F Furniture & fittings Deferred tax liability Business combination valuation reserve

Dr Dr Cr Cr

6 000 2 000

Depreciation expense Retained earnings (1/7/15) Accumulated depreciation – F&F

Dr Dr Cr

1 000 1 000

225 175 700

2 400 5 600

2 000 22.26

Chapter 22: Consolidation: intragroup transactions Deferred tax liability Income tax expense Retained earnings (1/7/15) Goodwill Business combination valuation reserve

Dr Cr Cr

600

Dr Cr

5 500

Dr Dr Dr Dr Dr Cr

21 000 80 000 16 000 4 200 16 000

Dr Dr Dr Dr Cr

29 400 80 000 16 000 11 800

Dr Cr

700

300 300

5 500

2. Pre-acquisition entries At 1 July 2013: Retained earnings (1/7/12) Share capital General reserve Asset revaluation surplus Business combination valuation reserve Shares in Madeleine Ltd

137 200

At 30 June 2015: Retained earnings (1/7/13)* Share capital General reserve Business combination valuation reserve Shares in Madeleine Ltd

137 200

(* $21 000 + ($6 000 - $1 800) (inventory) + $4 200 transfer from ARS for land) Transfer from business combination valuation reserve Business combination valuation reserve

700

3. Current dividend paid Dividend revenue Interim dividend paid

Dr Cr

2 000

Dividend payable Final dividend declared

Dr Cr

3 000

Dividend revenue Dividend receivable (Other assets)

Dr Cr

3 000

Dr Dr Cr

140 60

Sales revenue Cost of sales Inventory

Dr Cr Cr

15 000

Deferred tax asset Income tax expense

Dr Cr

300

2 000

4. Dividend declared

3 000

5. Profit in opening inventory Retained earnings (1/7/15) Income tax expense Cost of sales

200

6. Profit in ending inventory

14 000 1 000

300

22.27

Solutions Manual to accompany Applying IFRS Standards 4e 7.Sale of furniture & fittings Retained earnings (1/7/15) Deferred tax asset Furniture & fittings

Dr Dr Cr

700 300

Accumulated depreciation – F&F Depreciation expense Retained earnings (1/7/15)

Dr Cr Cr

150

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

30 15

Dr Cr

10 000

1 000

8. Depreciation

100 50

9. Advances Advance from Monique Ltd Advance to Madeleine Ltd

Sales revenue Other income

Monique Madeleine Ltd Ltd 85 000 65 000 23 000 22 000

Cost of sales

108 000 65 000

87 000 53 500

Other expenses

22 000

27 000

Profit before tax Tax expense

87 000 21 000 7 200

80 500 6 500 2 000

Profit Retained earnings (1/7/15)

13 800 16 000

4 500 29 500

Transfer from BCVR

-29 800 4 000 10 000 14 000 15 800

-34 000 2 000 3 000 5 000 29 000

170 000 41 000 --

80 000 22 000 --

226 800 120 000

131 000 --

10 000

3 000

Dividend paid Dividend declared Retained earnings (30/6/16) Share capital General reserve Business comb. valuation reserve Total equity Debentures Def. tax liability Dividend payable

6 3 4

1 1 1

10 000

Adjustments Dr Cr 15 000 2 000 3 000

125 625 1 000

200 14 000 100

Group 135 000 40 000

5 6 8

5 8

60 30

225 300 300

1 1 6

1 1 2 5 7 8 2

175 1 000 29 400 140 700 15 700

300 50

1 8

700

2 000 3 000

3 4

2 2 2

1 4

80 000 16 000 11 800

600 3 000

5 600 5 500 700

2 400

1 1 2

175 000 104 300 50 650

154 950 20 050 8 465

11 585 14 420

-26 005 4 000 10 000 14 000 12 005 170 000 47 000 --

229 005 120 000 1 800 10 000 22.28

Chapter 22: Consolidation: intragroup transactions Current tax liability Other payables Advance from Madeleine Ltd Total liabilities Total equity and liabilities

8 000 34 800 --

2 500 10 100 10 000

172 800 399 600

25 600 156 600

10 000

10 500 44 900 -187 200 416 205

22.29

Solutions Manual to accompany Applying IFRS Standards 4e

Monique Ltd

Madeleine Ltd

Group Adjustments Dr

Shares in Madeleine Ltd Land Motor vehicles Accumulated depreciation Furniture & fittings Accumulated depreciation Inventory Deferred tax asset

137 200

-28 000 (4 000)

24 480 22 000 (2 000)

34 000 (2 000)

37 300 (6 000)

171 580 16 200

70 320 7 400

Advance to Madeleine Ltd Other assets Goodwill Total assets

10 000

8 620 -399 600

3 100 -156 600

Cr 137 200

-24 480 50 000 (6 000)

1 1 8

2 000 6 000 150

6 7

300 300

5 500 189 620

1 000 2 000

7 1

72 300 (3 850)

1 000 45

6 8

240 900 24 155

10 000

3 000

8 720 5 500 416 205

189 620

MONIQUE LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 30 June 2016 Revenues: Sales revenue Other Expenses: Cost of sales Other Profit before income tax Income tax expense Profit for the period Comprehensive income for the period

$135 000 40 000 104 300 50 650

$175 000

154 950 20 050 8 465 $11 585 $11 585

MONIQUE LTD Consolidated Statement of Changes in Equity for financial year ended 30 June 2016 Comprehensive income for the period Retained earnings: Balance at 1 July 2015 Profit for the period Dividend paid Dividend declared Balance at 30 June 2016 Share capital: Balance at 1 July 2015 Balance at 30 June 2016 General reserve: Balance at 1 July 2015 Balance at 30 June 2016 © John Wiley and Sons, Ltd, 2016

$11 585 $14 420 11 585 (4 000) (10 000) $12 005 $170 000 $170 000 $47 000 $47 000 22.30

Chapter 22: Consolidation: intragroup transactions

MONIQUE LTD Consolidated Statement of Financial Position as at 30 June 2016 ASSETS Current Assets Inventories Non-current Assets Property, plant and equipment Land Furniture and fittings Accumulated depreciation Motor vehicles Accumulated depreciation Other assets Goodwill Tax assets: Deferred tax asset Total Non-current Assets Total Assets

$240 900

$24 480 $72 300 (3 850) 50 000 (6 000)

EQUITY AND LIABILITIES Equity Share capital General reserve Retained earnings Total Equity Current Liabilities Dividend payable Current tax liabilities Other payables Total Current Liabilities Non-current Liabilities: Deferred tax liabilities Interest-bearing liabilities: Debentures Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

68 450 44 000

136 930 8 720 5 500 24 155 175 305 $416 205

$170 000 47 000 12 005 $229 005 10 000 10 500 44 900 65 400 1 800 120 000 121 800 $187 200 $416 205

22.31

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 22.10

INCOME ON REDEMPTION

What does this account represent? Would an adjustment to income, or subsequently to retained earnings, have to be made for the rest of the life of the group? If not, what event would cause the discontinuation of this adjustment entry? LEAH LTD Assume debentures have a nominal value of $100 and are acquired on the open market for $90. The consolidation adjustment entry is: Debentures Income on redemption Debentures in Subsidiary

Dr Cr Cr

100 10 90

The economic entity has made a gain on buying its own debentures. Effectively, the group has derecognised a liability at a gain. While the debentures remain unredeemed, a similar entry is made every year, with a credit to retained earnings instead of income on redemption. When the debentures are eventually redeemed [assume a subsequent period], the subsidiary will pay the nominal amount to the debenture holders. Hence the parent will receive $100 on redemption, passing the entry: Cash Debentures in Subsidiary Income on redemption

Dr Cr Cr

100 90 10

From the economic entity’s point of view the gain/income was made when the group derecognised the liability on the parent acquiring the subsidiary’s debentures. Hence, in the year of redemption, the group will not recognise a gain. The consolidation adjustment is: Income on redemption Retained earnings (op bal)

Dr Cr

10 10

No consolidation adjustments are required in future periods.

22.32

Chapter 22: Consolidation: intragroup transactions Exercise 22.11 INTRAGROUP TRANSACTIONS Layla Ltd owns all the share capital of Isabel Ltd. In relation to the following intragroup transactions, prepare adjusting journal entries for the consolidation worksheet at 30 June 2016. Assume an income tax rate of 30% and that all income on sale of assets is taxable and expenses are deductible. (a) During the year ending 30 June 2016, Isabel Ltd sold $50 000 worth of inventory to Layla Ltd. Isabel Ltd recorded a $10 000 profit before tax on these transactions. At 30 June 2016, Layla Ltd has one quarter of these goods still on hand. (b) Isabel Ltd sold a warehouse to Layla Ltd for $100 000. This had originally cost Isabel Ltd $82 000. The transaction took place on 1 January 2015. Layla Ltd charges depreciation at 5% p.a. on a straight-line basis. (c) During the 2015–16 period, Layla Ltd sold inventory costing $12 000 to Isabel Ltd for $18 000. One third of this was sold to Olivia Ltd for $9500 and one-third to Taylah Ltd for $9000. (d) On 1 January 2015, Isabel Ltd sold inventory costing $6000 to Layla Ltd at a transfer price of $8000. On 1 September 2015, Layla Ltd sold half these goods back to Isabel Ltd, receiving $3000 from Isabel Ltd. Of the remainder kept by Layla Ltd, half was sold in January 2016 to Anna Ltd at a loss of $200. (e) On 25 June 2016, Layla Ltd declared a dividend of $10 000. On the same day, Isabel Ltd declared a $5000 dividend. (f) On 1 October 2015, Layla Ltd issued 1000 15% debentures of $100 at nominal value. Isabel Ltd acquired 400 of these. Interest is payable half-yearly on 31 March and 30 September. Accruals have been recognised in the legal entities’ accounts. (g) During the 2014–15 period, Layla Ltd sold inventory to Isabel Ltd for $10 000, recording a before-tax profit of $2000. Half this inventory was unsold by Isabel Ltd at 30 June 2015. LAYLA LTD – ISABEL LTD

(a)

(b)

(c)

(d)

Sales revenue Cost of sales Inventory

Dr Cr Cr

50 000

Deferred tax asset Income tax expense

Dr Cr

750

Retained earnings (1/7/15) Deferred tax asset Warehouse

Dr Dr Cr

12 600 5 400

Accumulated depreciation Depreciation expense Retained earnings (1/7/15)

Dr Cr Cr

1 350

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

270 135

Sales revenue Cost of sales Inventory

Dr Cr Cr

18 000

Deferred tax asset Income tax expense

Dr Cr

600

Retained earnings (1/7/15) Income tax expense Sales revenue Cost of sales Inventory

Dr Dr Dr Cr Cr

1 400 600 3 000

Deferred tax asset

150

47 500 2 500

750

18 000

900 450

405

16 000 2 000

600

4 500 500

22.33

Solutions Manual to accompany Applying IFRS Standards 4e Income tax expense (e)

(f)

(g)

150

Dividend payable Dividend declared

Dr Cr

5 000

Dividend revenue Dividend receivable

Dr Cr

5 000

Debentures Debentures in Layla Ltd

Dr Cr

40 000

Interest revenue Interest expense (15% x $40 000 x ¾)

Dr Cr

4 500

Interest payable Interest receivable (15% x $40 000 x ¼)

Dr Cr

1 500

Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

700 300

5 000

40 000

4 500

1 500

1 000

22.34

Chapter 22: Consolidation: intragroup transactions Exercise 22.12

INTRAGROUP TRANSACTIONS

Addison Ltd owns all of the share capital of Erin Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated fi nancial statements as at 30 June 2016. Assume an income tax rate of 30% and that all income on sale of assets is taxable and expenses are deductible. (a) In January 2016, Addison Ltd sells inventory to Erin Ltd for $15 000. This inventory had previously cost Addison Ltd $10 000, and it remains unsold by Erin Ltd at the end of the period. (b) All the inventory in (a) above is sold to Olivia Ltd, an external party, for $20 000 on 2 February 2016. (c) Half the inventory in (a) above is sold to Taylah Ltd, an external party, for $9000 on 22 February 2016. The remainder is still unsold at the end of the period. (d) Addison Ltd, in March 2016, sold inventory for $10 000 that was transferred from Erin Ltd 3 years ago. It had originally cost Erin Ltd $6000, and was sold to Addison Ltd for $12 000. ADDISON LTD – ERIN LTD

(a)

(b)

(c)

(d)

Sales revenue Cost of sales Inventory

Dr Cr Cr

15 000

Deferred tax asset Income tax expense (30% x $5000)

Dr Cr

1 500

Sales revenue Cost of sales

Dr Cr

15 000

Sales revenue Cost of sales Inventory

Dr Cr Cr

15 000

Deferred tax asset Income tax expense (30% x $2500)

Dr Cr

750

Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

4 200 1 800

10 000 5 000

1 500

15 000

12 500 2 500

750

6 000

22.35

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 22.13 1. 2.

CONSOLIDATION WORKSHEET, INTRAGROUP TRANSACTIONS

Prepare the adjusting journal entries for the consolidation worksheet at 30 June 2016. Prepare the consolidated statement of profit or loss and other comprehensive income, consolidated statement of changes in equity and the consolidated statement of financial position at 30 June 2016. In relation to parts (a) and (b) in the additional information, explain why you made the consolidation adjustment worksheet entries used in preparing the consolidated financial statements at 30 June 2016. MAYA LTD – BROOKE LTD

At 1 July 2013: Net fair value of identifiable assets and liabilities of Brooke Ltd

= Consideration transferred = Goodwill = 1. Consolidation Worksheet Entries 1. Business combination valuation entries

$300 000 + $30 000 + $10 000 + $30 000 (equity) + $10 000 (1 – 30%) (inventory) + $5 000 (1 – 30%) (machinery) - $12 000 (1 – 30%) (liability) $372 100 $396 000 $23 900

Depreciation expense Gain on sale/Carrying amount of asset sold Income tax expense Retained earnings (1/7/13) Transfer from business combination valuation reserve Goodwill Business combination valuation reserve

Dr Dr Cr Dr

500 2 500 900 1 400

Cr Dr Cr

3 500 23 900 23 900

2. Pre-acquisition entries at 30 June 2014 Retained earnings (1/7/13) * Share capital Other reserves Other components of equity Business combination valuation reserve Shares in Brooke Ltd * = $10 000 +$7 000 - $8 400

Dr Dr Dr Dr Dr Cr

8 600 300 000 30 000 30 000 27 400

Share capital Other reserves

Dr Cr

30 000

396 000

30 000

Note: as the Other Reserves account is closed as a result of the whole balance being used for the bonus issue, no line item appears in the consolidation worksheet. Transfer from business combination valuation reserve Business combination valuation reserve 3. Sale of Plant Retained earnings (1/7/15) Deferred tax asset Plant

Dr Cr

3 500

Dr Dr Cr

2 800 1 200

3 500

4 000

22.36

Chapter 22: Consolidation: intragroup transactions 4. Depreciation of Plant Accumulated depreciation Retained earnings (1/7/15) Depreciation expense

Dr Cr Cr

800

Retained earnings (1/7/15) Income tax expense Deferred tax asset

Dr Dr Cr

120 120

Dr Dr Cr

350 150

Dividend payable Dividend declared

Dr Cr

4 000

Dividend revenue Dividend receivable

Dr Cr

4 000

400 400

240

5. Profit in Opening/Closing Inventory Retained earnings (1/7/15) Deferred tax asset Inventory

500

6. Dividend payable

Profit before tax

Maya Brooke Ltd Ltd 80 000 90 000

Tax expense Profit Retained earnings (1/7/15)

35 000 45 000 15 000

40 000 50 000 12 000

Transfer from BCVR

60 000 10 000 50 000

62 000 4 000 58 000

800 000

330 000

Dividend declared Retained earnings (30/6/16) Share capital BCVR

Other components of equity (1/7/15) Gains/losses Other components of equity (30/6/16) Total equity Debentures Other current liabilities Dividend payable Total liabilities

4 000

1 1 6 4

Adjustments Dr Cr 500 400 2 500 4 000 120 900

1 2 3 4 5 2

1 400 8 600 2 800 120 350 3 500

Group 4

163 400

74 220 89 180 14 130

400

3 500

4 000

-103 310 10 000 93 310

2 2 2

300 000 30 000 27 400

850 000 140 000

388 000 72 000

30 000

10 000 150 000

8 000 80 000

18 000 200 000

1 000 000 100 000 34 700 10 000 144 700

468 000 40 000 40 000 4 000 84 000

1 093 310 140 000 74 700 10 000 224 700

4 000

800 000 23 900 3 500

1 2

-893 310 182 000

22.37

Solutions Manual to accompany Applying IFRS Standards 4e Total equity and liabilities

1 144 700

552 000

Shares in Brooke Inventory Financial assets Bank Plant & machinery Accumulated depreciation Land Deferred tax asset

396 000 -180 000 160 000 229 000 215 000 25 000 10 000 372 500 212 000 (212 000) (110 000) 154 200 -

65 000 -

Goodwill Total assets

1 144 700

552 000

1 318 010

800

3 5 1

1 200 150 23 900 441 340

396 000 500 4 000

2 5 6

4 000

240

441 340

-339 500 440 000 35 000 580 500 (321 200) 219 200 1 110 23 900 1 318 010

2. BROOKE LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 30 June 2016 Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: gains on financial assets Comprehensive income for the period

$163 400 74 220 $89 180 18 000 $107 180

BROOKE LTD Consolidated Statement of Changes in Equity for financial year ended 30 June 2016 Comprehensive income for the period

$107 180

Retained earnings: Balance at 1 July 2015 Profit for the period Dividend declared Balance at 30 June 2016

$14 130 89 180 (10 000) $93 310

Share capital: Balance at 1 July 2015 Balance at 30 June 2016

$800 000 $800 000

Other components of equity: Balance at 1 July 2015 Gains Balance at 30 June 2016

$182 000 18 000 $200 000

22.38

Chapter 22: Consolidation: intragroup transactions BROOKE LTD Consolidated Statement of Financial Position as at 30 June 2016 ASSETS Current Assets Inventories Financial assets Cash assets: Bank Total Current Assets Non-current Assets Property, plant and equipment: Plant and machinery Accumulated depreciation Land Tax assets: Deferred tax assets Goodwill Total Non-current Assets Total Assets

$339 500 440 000 35 000 814 500

$580 500 (321 200) 259 300 219 200

EQUITY AND LIABILITIES Equity Share capital Other components of equity Retained earnings Total Equity Current Liabilities Payables: Dividend payable Other Non-current Liabilities: Interest-bearing liabilities: Debentures Total Liabilities Total Equity and Liabilities

478 500 1 110 23 900 503 510 $1 318 010

$800 000 200 000 __93 310 1 093 310

$10 000 74 700

84 700

140 000 _224 700 $1 318 010

3. (a) Retained earnings: As there were no external parties to the group involved in this transaction, the profit is unrealised to the group. Hence, retained earnings (1/7/15) must be reduced by $2 800 (profit after tax). Machinery: The machinery is still held by Brooke Ltd at 30 June 2016 and recorded at $4 000 more than the cost to the group. As the asset must be reported in the consolidated financial statements at cost to the group, machinery must be reduced by $4 000. Deferred tax asset: A change in the carrying amount of the asset causes a temporary difference between the carrying amount and the tax base of the asset. As the carrying amount is reduced, a deferred tax asset of $1 200 (30% x $4 000) is raised.

Depreciation expense and accumulated depreciation: The asset is depreciated by Brooke Ltd based on the price paid to Maya Ltd which includes the unrealised profit of $4 000. Depreciation for the group should be based on cost to the group which means depreciation p.a. must be reduced by $400 (10% x $4 000). A reduction to prior period depreciation, via retained earnings of $400, and a reduction in current depreciation expense of $400. This means a reduction to accumulated depreciation of $800.

22.39

Solutions Manual to accompany Applying IFRS Standards 4e reversal of $240, being 30% x $800, being the change to accumulated depreciation with resultant effects on tax expense both in the current period and prior period of $120 (30% x $400).

(b) Retained earnings: In the previous period, Brooke Ltd recorded a $500 before-tax profit, or a $350 aftertax profit on sale of inventory within the group. Because the sale did not involve external entities, the profit must be eliminated on consolidation. Inventory: At 30 June 2016, Maya Ltd still has the inventory on hand from intragroup transactions in the prior period and records them at cost which includes an unrealised profit of $500. The cost of this inventory to the group is $500 less, hence inventory is then reduced by $500. Deferred tax asset/income tax expense: A change in the carrying amount of the asset inventory causes a temporary difference between the carrying amount and the tax base of the asset. As the carrying amount is reduced, a deferred tax asset of $150 (30% x $500) is raised.

22.40

Chapter 22: Consolidation: intragroup transactions Exercise 22.14

GOODWILL, CONSOLIDATION WORKSHEET, INTRAGROUP TRANSACTIONS

Prepare a worksheet for consolidating the financial statements of Summer Ltd and Keira Ltd as at 30 June 2016. SUMMER LTD – KEIRA LTD At 1 July 2014: Net fair value of identifiable assets and liabilities of Keira Ltd

Consideration transferred Goodwill

= = =

$44 000 + $4000 (equity) + $3000 (1 – 30%) (inventory) + $10 000 (1 – 30%) (land) + $2000 (1 – 30%) (machinery) $58 500 $60 000 $1500

1. Business combination valuation entries Accumulated depreciation Machinery Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

20 000

Depreciation expense Retained earnings (1/7/15) Accumulated depreciation

Dr Dr Cr

400 400

Deferred tax liability Income tax expense Retained earnings (1/7/15)

Dr Cr Cr

240

Dr Cr

1 500

Dr Dr Dr Cr

4 000 44 000 12 000

Dr Dr Dr Cr

13 100 44 000 2 900

Goodwill Business combination valuation reserve

18 000 600 1 400

800

120 120

1 500

2. Pre-acquisition entries At 1/7/14: Retained earnings (1/7/14) Share capital Business combination valuation reserve Shares in Keira Ltd

60 000

At 30/6/14: Retained earnings (1/7/15)* Share capital Business combination valuation reserve Shares in Keira Ltd

60 000

(* = $4000 + $2100 + $7000) 3. Sales and profit in closing inventory Sales revenue Cost of sales Inventory

Dr Cr Cr

17 000

Deferred tax asset Income tax expense

Dr Cr

16 800 200

60 22.41

Solutions Manual to accompany Applying IFRS Standards 4e

4. Profit in opening inventory Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

280 120

Proceeds on sale of machinery Carrying amount of machinery sold Machinery

Dr Cr Cr

10 000

Deferred tax asset Income tax expense

Dr Cr

150

Accumulated Depreciation - machinery Depreciation expense

Dr Cr

Income tax expense Deferred tax asset

Dr Cr

Machinery Retained earnings (1/7/15) Deferred tax liability

Dr Cr Cr

500

Depreciation expense Retained earnings (1/7/15) Accumulated Depreciation

Dr Dr Cr

50 25

Deferred tax liability Income tax expense Retained earnings (1/7/15)

Dr Cr Cr

Proceeds on sale of machinery Carrying amount of machinery sold Inventory

Dr Cr Cr

6 000

Deferred tax asset Income tax expense

Dr Cr

300

400

5. Sale of machinery - current period

9 500 500

150

6. Sale of Machinery: prior period

350 150

15 8

7. Sale of plant to inventory

5 000 1 000

300

22.42

Chapter 22: Consolidation: intragroup transactions Summer Ltd 43 000 20 600

Keira Ltd 52 000 30 900

3 200 5 300 1 200

6 000 2 700 2 600

30 300 12 700 6 000

42 200 9 800 10 000

5 000

9 500

1 000

500

13 700 7 400

10 300 4 700

Profit Retained earnings (1/7/15)

6 300 32 000

5 600 21 000

Retained earnings (30/6/16) Share capital BCVR

38 300

26 600

64 000 --

44 000 --

Total equity

102 300

70 600

Current liabilities Deferred tax liability

21 400 -

17 000 -

Total liabilities Total equity and liabilities

21 400 123 700

17 000 87 600

Sales revenue Cost of sales Selling expenses Admin expenses Depreciation

Profit from trading Proceeds from sale of machinery Carrying amount of machinery sold Gain/loss on sale of machinery Profit before tax Tax expense

1 6

5 7

Adjustments Dr Cr 17 000 16 800 400

400 50

Group

3 4

78 000 34 300 9 200 8 000 4 200 55700 22 300 -

10 000 6 000 9 500 5 000

5 7

4 5

120 15

120 60 150 15 300

1 3 5 6 7

1 2 4 6

400 13 100 280 25

120 350 8

1 6 6

22 300 11 590

10 710 39 673

50 383 2 2

44 000 2 900

1 400 1 500

1 1

64 000 -114 383

1 6

240 23

600 150

1 6

38 400 487 38 887 153 270

22.43

Solutions Manual to accompany Applying IFRS Standards 4e

Summer Ltd 38 000

Keira Ltd 71 500

Accumulated depreciation Inventory

(12 200)

(22 300)

19 000

16 400

Shares in Keira Ltd Receivables Deferred tax asset

60 000 5 500 5 400

8 300 6 300

Plant (net) Goodwill Total assets

8 000 123 700

7 400 87 600

Machinery

6 1 5

Adjustments Dr Cr 500 18 000 500 20 000 800 50 75 200 1 000 60 000

3 5 7

60 150 300

1 500 117 113

117 113

Group 1 5 1 6 3 7 2 5

91 500 (15 325) 34 200 -13 800 12 195

15 400 1 500 153 270

22.44

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Test Bank to accompany Applying IFRS Standards 4e

Chapter 22 Consolidation: intragroup transactions Learning Objectives 22.1 22.2 22.3 22.4 22.5

Explain the need for making adjustments for intragroup transactions Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory Prepare worksheet entries for intragroup services such as management fees Prepare worksheet entries for intragroup dividends Prepare worksheet entries for intragroup borrowings.

22.1

Chapter 22 Consolidation: intragroup transactions

Multiple Choice Questions 1. IFRS 10 requires that intragroup transactions be: Learning Objective 22.1 Explain the need for making adjustments for intragroup transactions a. eliminated on consolidation to the extent of the parent’s interest in the subsidiary. b. adjusted for in the books of the parent and subsidiary to the extent of the parent’s interest in the subsidiary. c. adjusted for in full in the books of the parent and subsidiary. *d. eliminated in full on consolidation.

2. The test indicating that an intragroup business transaction has been realised is: Learning Objective 22.1 Explain the need for making adjustments for intragroup transactions *a. the involvement of an external party in the transaction b. the generation of profit from the transaction c. whether or not an operating profit or loss occurred as a result of the transaction d. the presence of only entities within the group as parties to the transaction.

A subsidiary entity sold inventory to its parent entity at a profit of £4 000. The goods had originally cost the subsidiary £10 000. At the end of the year all the inventory was still on hand. The adjustment entry to deal with this transaction on consolidation would include the following line item: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory *a. CR Inventory £4 000 b. CR Inventory £6 000 c. CR Inventory £10 000 d, CR Inventory £14 000.

A subsidiary entity sold inventory to its parent entity at a profit of £8 000. The goods had originally cost the subsidiary £20 000. At the end of the year all the inventory was still on hand. The adjustment entry to deal with this transaction on consolidation would include the following line item: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. CR Cost of sales £28 000 *b. CR Cost of sales £20 000 c. CR Cost of sales £12 000 d. CR Cost of sales £8 000.

22.2

Test Bank to accompany Applying IFRS Standards 4e

A subsidiary entity sold goods to its parent entity at a profit of £10 000. The goods had originally cost the subsidiary £15 000. At reporting date, the parent still held all of the goods. Which of the following adjustments must be included as part of the consolidation entry to eliminate this transaction? Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory *a. CR Inventory £10 000 b. CR Inventory £15 000 c. DR Inventory £25 000 d. DR Inventory £15 000

In May 20X7, a parent entity sold inventory to a subsidiary entity for £30 000. The inventory had previously cost the parent entity £24 000. The entire inventory is still held by the subsidiary at reporting date, 30 June 20X7. Ignoring tax effects, the adjustment entry in the consolidation worksheet at reporting date is: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. Cash Dr 24 000 Sales revenue Cr 24 000 Cost of sales Dr 24 000 Inventory Cr 24 000 b.

Sales revenue Cash Inventory Cost of sales

Dr Cr Dr Cr

24 000

Sales revenue Cost of sales Inventory

Dr Cr Cr

30 000

Sales revenue Cost of sales Inventory

Dr Cr Cr

30 000

24 000 24 000 24 000

6 000 24 000

24 000 6 000

During the year ended 30 June 20X7 a subsidiary entity sold inventory to its parent entity at a profit of £8 000. The goods had originally cost the subsidiary £20 000. At the end of 30 June 20X7 all the inventory was still on hand. Ignoring tax effects, the adjustment entry to deal with this transaction on consolidation during the year ended 30 June 20X8 would include the following line item: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. DR Cost of sales £8 000 b. CR Cost of sales £8 000 c. DR Cost of sales £20 000 *d. CR Cost of sales £20 000.

22.3

Chapter 22 Consolidation: intragroup transactions

A subsidiary entity sold inventory to a parent entity for $30 000. The inventory had previously cost the subsidiary entity $24 000. By reporting date the parent entity had sold 75% of the inventory to a party outside the group. The company tax rate is 30%. The adjustment entry in the consolidation worksheet at reporting date is: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. Sales revenue Dr 30 000 Cost of sales Cr 24 000 Inventory Cr 6 000 Deferred tax asset Dr 1 800 Income tax expense Cr 1 800 *b

Sales revenue Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr Cr Dr Cr

30 000

Sales revenue Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr Cr Dr Cr

22 500

Sales revenue Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr Cr Dr Cr

7 500

28 500 1 500 450 450

18 000 4 500 1 350 1 350

6 000 1 500 450 450

Angelo Limited sold inventory to its parent entity at a profit of $4 000. The inventory cost Angelo Limited $16 000. At the end of the reporting period the parent had sold 50% of the inventory to an external party. The consolidation adjustment entry (excluding tax effects) will eliminate unrealised profit amounting to: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory *a. $2 000 b. $4 000 c. $12 000 d. $16 000

22.4

Test Bank to accompany Applying IFRS Standards 4e

10.

During the year ended 30 June 20X7 a subsidiary entity sold inventory to a parent entity for $30 000. The inventory had previously cost the subsidiary entity $24 000. By 30 June 20X7 the parent entity had sold 75% of the inventory to a party outside the group. The company tax rate is 30%. The adjustment entry in the consolidation worksheet at 30 June 20X8 is: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. Sales revenue Dr 30 000 Cost of sales Cr 28 500 Inventory Cr 1 500 Deferred tax asset Dr 450 Income tax expense Cr 450 b.

*c.

Retained earnings Income tax expense Cost of sales

Dr Dr Cr

1 400 600

Retained earnings Income tax expense Cost of sales

Dr Dr Cr

1 050 450

Retained earnings Inventory Deferred tax asset Retained earnings

Dr Cr Dr Cr

1 500

2 000

1 500

1 500 450 450

11.

During the year ended 30 June 20X7, a parent entity rents a warehouse from a subsidiary entity for $100 000. The company tax rate is 30%. The consolidation adjustment entry needed at reporting date is: Learning Objective 22.3 Prepare worksheet entries for intragroup services such as management fees *a. Rent revenue Dr 100 000 Rent expense Cr 100 000 b.

Rent revenue Rent expense Income tax expense Deferred tax liability

Dr Cr Dr Cr

100 000

Rent revenue Rent expense Deferred tax asset Income tax expense

Dr Cr Dr Cr

100 000

Rent expense Rent revenue

Dr Cr

100 000

100 000 30 000 30 000

100 000

22.5

Chapter 22 Consolidation: intragroup transactions

12.

If a dividend is paid out of profits that are earned after the acquisition date, it is known as: Learning Objective 22.4 Prepare worksheet entries for intragroup dividends a. a final dividend *b. a post-acquisition dividend c. a temporary dividend d. a pre-acquisition dividend.

13.

Andronico Limited provided an advance of $500 000 to its subsidiary Galactico Limited. On consolidation the following adjustment is needed in relation to this intragroup advance: Learning Objective 22.5 Prepare worksheet entries for intragroup borrowings a. no adjustment needed b.

*c.

Advances to subsidiaries Advances from parent

$500 000

Advances from parent Advances to subsidiaries

$500 000

Advances from parent Cash

$500 000

14.

JoJo Ltd provided an advance of $500 000 to its subsidiary BoBo Ltd. Interest of $50 000 was charged during the year ended 30 June 20X8. On consolidation the following adjustment is needed at 30 June 20X8 in relation to the interest charged: Learning Objective 22.5 Prepare worksheet entries for intragroup borrowings a. no adjustment needed; *b.

Interest revenue Interest expense

$50 000

Interest expense Interest revenue

$50 000

Retained earnings Cash

$50 000

15. A consolidation adjustment entry made to eliminate the intragroup sales of inventory at a profit would take the following form: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. DR Cost of Sales, CR Sales, CR Inventory *b. DR Sales, CR Cost of Sales, CR Inventory c. DR Cash, DR Cost of Sales, CR Inventory d. DR Inventory, CR Sales, CR Cash.

22.6

Test Bank to accompany Applying IFRS Standards 4e

Jameson purchased goods from its subsidiary for €10 000. The goods cost the subsidiary €6000. At reporting date, Jameson still held all of the goods. The company rate of tax is 30%. Which of the following consolidation adjustment entries is correct? Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. DR Income tax expense €1 200, CR Deferred tax liability €1 200 b. DR Income tax expense €1 200, CR Deferred tax asset €1 200 *c. DR Deferred tax asset €1 200, CR Income tax expense €1 200 d. DR Deferred tax liability €1 200, CR Income tax expense €1 200. 16.

A subsidiary sold inventory to a parent entity for €10 000. The inventory originally cost the subsidiary €6000. At the end of the reporting period the parent had sold 50% of the inventory to an external party. The company tax rate is 30%. The deferred tax item that is recognised on consolidation is: Learning Objective 22.2 Prepare worksheet entries for intragroup transactions involving profits and losses in beginning and ending inventory a. CR Deferred tax liability €1 200 b. CR Deferred tax liability €600 c. DR Deferred tax asset €1 200 *d. DR Deferred tax asset €600. 17.

18.

When eliminating an intragroup service which of the following would appear in the consolidation worksheet entry? Learning Objective 22.3 Prepare worksheet entries for intragroup services such as management fees a. Dr Services expense *b. Dr Services revenue c. Cr Income tax expense d. Cr Deferred tax liability.

19.

When a subsidiary declares a final dividend payable to a parent who has a 100% interest in the subsidiary the parent recognises a dividend receivable and the subsidiary recognises a dividend payable. In addition to the elimination of these two items on consolidation, the following items must also be eliminated: Learning Objective 22.4 Prepare worksheet entries for intragroup dividends a. Dividend declared and Retained earnings *b. Dividend declared and Dividend revenue c. Dividend revenue and Cash d. Dividend declared and Cash.

20. A consolidation worksheet adjustment to eliminate the effect of interest revenue and interest expense relating to intragroup advances has the following tax effect: Learning Objective 22.5 Prepare worksheet entries for intragroup borrowings *a. No tax effect; b. Increase in deferred tax asset; c. Increase in deferred tax liability; d. Decrease in income tax expense.

22.7

Exercises Exercise 22.10 ★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

INCOME ON REDEMPTION

The parent entity, Leah Ltd, has purchased on the open market, for an amount less than nominal value, some debentures previously issued by its wholly owned subsidiary, Natalie Ltd. The group accountant for Leah Ltd, James Cong, has stated that the adjustment in the consolidation worksheet includes the raising of an account Income on Redemption. He is unsure whether this is correct. Required

Exercise 22.11 ★

Exercise 22.12 ★

Exercise 22.13 ★★

INTRAGROUP TRANSACTIONS

Layla Ltd owns all the share capital of Isabel Ltd. In relation to the following intragroup transactions, prepare adjusting journal entries for the consolidation worksheet at 30 June 2016. Assume an income tax rate of 30% and that all income on sale of assets is taxable and expenses are deductible. (a) During the year ending 30 June 2016, Isabel Ltd sold $50 000 worth of inventory to Layla Ltd. Isabel Ltd recorded a $10 000 proﬁt before tax on these transactions. At 30 June 2016, Layla Ltd has onequarter of these goods still on hand. (b) Isabel Ltd sold a warehouse to Layla Ltd for $100 000. This had originally cost Isabel Ltd $82 000. The transaction took place on 1 January 2015. Layla Ltd charges depreciation at 5% p.a. on a straight-line basis. (c) During the 2015–16 period, Layla Ltd sold inventory costing $12 000 to Isabel Ltd for $18 000. Onethird of this was sold to Olivia Ltd for $9500 and one-third to Taylah Ltd for $9000. (d) On 1 January 2015, Isabel Ltd sold inventory costing $6000 to Layla Ltd at a transfer price of $8000. On 1 September 2015, Layla Ltd sold half these goods back to Isabel Ltd, receiving $3000 from Isabel Ltd. Of the remainder kept by Layla Ltd, half was sold in January 2016 to Anna Ltd at a loss of $200. (e) On 25 June 2016, Layla Ltd declared a dividend of $10 000. On the same day, Isabel Ltd declared a $5000 dividend. (f) On 1 October 2015, Layla Ltd issued 1000 15% debentures of $100 at nominal value. Isabel Ltd acquired 400 of these. Interest is payable half-yearly on 31 March and 30 September. Accruals have been recognised in the legal entities’ accounts. (g) During the 2014–15 period, Layla Ltd sold inventory to Isabel Ltd for $10 000, recording a before-tax proﬁt of $2000. Half this inventory was unsold by Isabel Ltd at 30 June 2015.

INTRAGROUP TRANSACTIONS

Addison Ltd owns all of the share capital of Erin Ltd. In relation to the following intragroup transactions, all parts of which are independent unless speciﬁed, prepare the consolidation worksheet adjusting entries for preparation of the consolidated ﬁnancial statements as at 30 June 2016. Assume an income tax rate of 30% and that all income on sale of assets is taxable and expenses are deductible. (a) In January 2016, Addison Ltd sells inventory to Erin Ltd for $15 000. This inventory had previously cost Addison Ltd $10 000, and it remains unsold by Erin Ltd at the end of the period. (b) All the inventory in (a) above is sold to Olivia Ltd, an external party, for $20 000 on 2 February 2016. (c) Half the inventory in (a) above is sold to Taylah Ltd, an external party, for $9000 on 22 February 2016. The remainder is still unsold at the end of the period. (d) Addison Ltd, in March 2016, sold inventory for $10 000 that was transferred from Erin Ltd 3 years ago. It had originally cost Erin Ltd $6000, and was sold to Addison Ltd for $12 000.

CONSOLIDATION WORKSHEET, INTRAGROUP TRANSACTIONS

On 1 July 2013, Maya Ltd acquired cum div. all the shares of Brooke Ltd, at which date the equity and liability sections of Brooke Ltd’s statement of ﬁnancial position showed the following balances: Share capital (300 000 shares) Other reserves Retained earnings Other components of equity Dividend payable

$300 000 30 000 10 000 30 000 20 000

CHAPTER 22 Consolidation: intragroup transactions

The dividend payable was subsequently paid in August 2013. A bonus dividend, on the basis of one ordinary share for every ten ordinary shares held, was paid in January 2016 out of other reserves existing at acquisition date. On 1 July 2013, all the identiﬁable assets and liabilities of Brooke Ltd were recorded at fair value except for:

Inventory Machinery (cost $200 000)

Carrying amount

Fair value

$120 000 160 000

$130 000 165 000

The inventory was all sold by 30 November 2013. The machinery had a further 5-year life but was sold on 1 January 2016. At the acquisition date, Brooke Ltd had a contingent liability of $20 000 that Maya Ltd considered to have a fair value of $12 000. This liability was settled in June 2014. At 1 July 2013, Brooke Ltd had not recorded any goodwill. On 30 June 2016, the trial balances of Maya Ltd and Brooke Ltd were as follows: Trial Balances as at 30 June 2016 Shares in Brooke Ltd Inventory Financial assets Bank Plant and machinery Land Income tax expense Dividend declared Share capital Other components of equity Retained earnings (1/7/15) Profit before income tax Debentures Other current liabilities Dividend payable Accumulated depreciation — plant and machinery

Maya Ltd $ 396 000 180 000 229 000 25 000 372 500 154 200 35 000 10 000 $ 1 401 700 $ 800 000 150 000 15 000 80 000 100 000 34 700 10 000 212 000 $ 1 401 700

Brooke Ltd $ — 160 000 215 000 10 000 212 000 65 000 40 000 4 000 $706 000 $330 000 80 000 12 000 90 000 40 000 40 000 4 000 110 000 $706 000

Additional information (a) At 30 June 2015, Maya Ltd has on hand some items of inventory purchased from Brooke Ltd in June 2014 at a proﬁt of $500. (b) The other components of equity relate to the ﬁnancial assets. At 1 July 2015, the balances of this account were $140 000 (Maya Ltd) and $72 000 (Brooke Ltd). (c) The tax rate is 30%. Required

1. Prepare the adjusting journal entries for the consolidation worksheet at 30 June 2016. 2. Prepare the consolidated statement of profit or loss and other comprehensive income, consolidated statement of changes in equity and the consolidated statement of financial position at 30 June 2016. 3. In relation to parts (a) and (b) in the additional information, explain why you made the consolidation adjustment worksheet entries used in preparing the consolidated financial statements at 30 June 2016.

Exercise 22.14

GOODWILL, CONSOLIDATION WORKSHEET, INTRAGROUP TRANSACTIONS

★★ Summer Ltd owns all the shares of Keira Ltd. The shares were acquired on 1 July 2014 by Summer Ltd at a cost of $60 000. At acquisition date, the capital of Keira Ltd consisted of 44 000 ordinary shares each fully paid at $1. There were retained earnings of $4000. All the identiﬁable assets and liabilities of Keira Ltd were recorded at amounts equal to fair value, except for:

PART 4 Economic entities

Inventory Land Machinery (cost $100 000)

Carrying amount

Fair value

$12 000 60 000 80 000

$15 000 70 000 82 000

The land was sold on 1 June 2015 for $94 000. The machinery had a further 5-year life. The inventory was all sold by 31 December 2014. Keira Ltd has not recorded any goodwill at 1 July 2014. Goodwill has not been impaired. The trial balances of the two entities at 30 June 2016 are shown below. Additional information (a) Intragroup sales of inventory for the year ended 30 June 2016 from Summer Ltd to Keira Ltd, $14 000; and from Keira Ltd to Summer Ltd, $3000. (b) Intragroup inventory on hand: (i) at 1 July 2015: held by Keira Ltd, purchased from Summer Ltd at a profit of $400. (ii) at 30 June 2016: held by Summer Ltd, purchased from Keira Ltd at a profit of $200. (c) Keira Ltd had purchased from Summer Ltd an item of inventory which Summer Ltd had treated as plant. Carrying amount in Summer Ltd’s records at time of sale (1 January 2016) was $5000 and it was sold at a profit of $1000. The item is still on hand in Keira Ltd’s inventory at 30 June 2016. (d) The income tax rate is 30%. Trial Balances as at 30 June 2016 Summer Ltd Dr Share capital Retained earnings (1/7/15) Current liabilities Machinery Shares in Keira Ltd Inventory Receivables Sales revenue Cost of sales Selling expenses Administrative expenses Depreciation/amortisation expenses Income tax expense Accumulated depreciation — machinery Deferred tax assets Plant (net of depreciation) Proceeds from sale of machinery Carrying amount of machinery sold

Cr $ 64 000 32 000 21 400

Keira Ltd Dr

$ 71 500 — 16 400 8 300

$ 38 000 60 000 19 000 5 500

52 000

43 000 30 900 6 000 2 700 2 600 4 700

20 600 3 200 5 300 1 200 7 400 12 200 5 400 8 000

22 300 6 300 7 400

6 000 5 000 $178 600

Cr $ 44 000 21 000 17 000

$178 600

10 000 9 500 $166 300

$166 300

Required

Prepare a worksheet for consolidating the ﬁnancial statements of Summer Ltd and Keira Ltd as at 30 June 2016.

CHAPTER 22 Consolidation: intragroup transactions

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo, revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 23: Consolidation: Non-controlling interest

Chapter 23: Consolidation: noncontrolling interest Discussion questions 1.

What is meant by the term “non-controlling interest” (NCI)? NCI is the term used for the ownership interest in a subsidiary other than the parent. It is defined in IFRS 10 as: The equity in a subsidiary not attributable, directly or indirectly, to a parent.

How does the existence of an NCI affect the business combination valuation entries? There is no effect. However if the full goodwill method is used, the recognition of the subsidiary’s goodwill is made via a BCVR entry. In contrast, where the partial goodwill method is used, goodwill is recognised in the pre-acquisition entry. Why? The BCVR entries, apart from that for goodwill, are prepared because of the requirement of IFRS 3 to show the identifiable assets and liabilities of the acquiree at fair value. The determination of fair value is not affected by the parent’s ownership in the subsidiary.

How does the existence of an NCI affect the elimination of investment and recognition of goodwill entries? There is no effect on the elimination of investment. Under full goodwill, the NCI’s fair value is taken into account in determining goodwill on acquisition. Under partial goodwill the adjustments are essentially unchanged, although the parent’s investment is offset against the share of the subsidiary’s net assets.

Why is it necessary to change the format of the worksheet where a NCI exists in the group? The IASB require the disclosure of the equity of the group, as well as the relative proportions of the parent and the subsidiary. For a wholly owned subsidiary situation, the final column in the worksheet represents the group position which is also the parent’s position, as there is no NCI. Where an NCI exists, having determined the group position, the equity must be divided into parent share and the NCI share. Hence, the worksheet must have additional columns to divide the group equity into the relative shares of the parent and the NCI. This is done by calculating the NCI share and subtracting it from the group equity so that the final column is then the parent entity’s share.

Explain how the adjustment for intragroup transactions affects the calculation of the NCI share of equity. The NCI does not affect the adjustment itself, as the full effects of the intragroup transaction are adjusted for on consolidation. However, where the subsidiary records profit which is unrealised to the group, this affects the calculation of the NCI. The NCI is entitled only to a share of consolidated equity rather than subsidiary equity. Hence, where the subsidiary has recorded unrealised profit, the NCI share of the recorded profit of the group must be adjusted for any of that profit which is unrealised. In the Step 2 & Step 3 calculations of the NCI share of equity, this is a share of recorded © John Wiley and Sons, Ltd, 2016 23.1

Solutions Manual to accompany Applying IFRS Standards 4e equity. As adjustments are made for intragroup transactions, where these transactions reflect adjustments for unrealised subsidiary profit, an adjustment is also made to the NCI share of profit. The net result is then that the NCI gets a share of realised subsidiary equity.

Explain whether an NCI adjustment needs to be made for all intragroup transactions. An NCI adjustment does NOT need to be made for all intragroup transactions. An NCI adjustment only needs to be made where the adjustment is for unrealised profit recorded by the subsidiary. Hence the transaction must be an upstream – subsidiary to parent – transaction in order for an NCI adjustment to be made. Further the upstream transaction must relate to unrealised subsidiary profit.

What is meant by ‘realisation of profit’? Profit is realised when the group transacts with an entity external to the group. The point of realisation depends then on identifying when the external entity is involved. With inventory (and other sale) transactions the point of realisation is easily identified as it is the point of sale when the external entity is involved. It is at this point that the group recognises profit on sale, being the excess of the sale proceeds over the cost to the group of the item being sold. With assets not sold but used by the group then any gain on the transfer of the assets between group members should be eliminated because profit cannot be recognised until it has been realised by the sale to a third party.

With intragroup services, the profits must be eliminated. Profits arising from, say, the provision of management services to a fellow subsidiary cannot be recognised by the group as a whole.

23.2

Chapter 23: Consolidation: Non-controlling interest

Exercises Exercise 23.1

EQUITY CLASSIFICATION

Discuss the differences that would arise in the consolidated financial statements if the noncontrolling interests were classified as debt rather than equity, and the reasons the standard setters have chosen the equity classification in IFRS 10.

FALCON TRUCKS LTD 1.

Prime users: There is nothing in either IAS 1 or IFRS 10 that indicates who the prime users of the consolidated financial statements are. In the income statement there is no preference given to the parent over the NCI, although in the balance sheet, the NCI is limited to a one-line disclosure. The Framework also gives no preference to either the parent or the NCI.

NCI as equity or liability: The main argument for the NCI being classified as equity is that it better fits the definition of equity. The subsidiary has no present obligation in relation to the NCI so the NCI does not meet the definition of a liability. Some people argue that the NCI should be disclosed separately from equity and liabilities – the “mezzanine” treatment. This argument relates to the utility of financial statements in relation to the user group, the parent shareholders. It is argued that this form of presentation provides more relevant information to the parent shareholders.

Disclosure requirements: Statement of Profit or Loss and Other Comprehensive Income: IAS 1 para 83: Disclose both NCI and parent share of profit/loss for the period AND share of total comprehensive income for the period Statement of Financial Position: IAS 1 para 54 (q) and (r): NCI share of equity, and share capital and reserves attributable to parent Statement of Changes in Equity: IAS 1 para 106 (a): total comprehensive income for the period, showing that attributable to the parent and that attributable to the NCI. If the NCI were classified as debt, any dividends would be disclosed as an expense, while the NCI would not receive a share of profit. In the statement of financial position the NCI would be shown under liabilities, while in the statement of changes in equity there would be no NCI information.

23.3

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.2

1. 2. 3.

CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, PARTIAL GOODWILL METHOD

Prepare the consolidation worksheet entries immediately after acquisition date. Prepare the consolidation worksheet entries for Jellyfish Ltd at 30 June 2017. Assume a profit for Mouse Ltd for the 2010–11 period of $40 000. Prepare the consolidated financial statements as at 30 June 2016. JELLYFISH LTD – MOUSE LTD

75% Jellyfish Ltd

Mouse Ltd Jellyfish Ltd 75% NCI 25%

Pre-acquisition analysis At 1 July 2010: Net fair value of identifiable assets and liabilities of Mouse Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill: parent only

= = = = = = =

($100 000 + $60 000 + $40 000) (equity) + $40 000 (1 – 30%) (plant) + $50 000 (1 – 30%) (land) + $30 000 (1 – 30%) (inventory) $284 000 $250 000 25% x $284 000 $71 000 $321 000 $321 000 - $284 000 $37 000

1. Consolidation worksheet entries at 1 July 2010 i. Business combination valuation entries Plant Accumulated depreciation Deferred tax liability Business combination valuation reserve

Dr Dr Cr Cr

20 000 20 000

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

50 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

30 000

Dr Dr Dr Dr Dr Cr

30 000 75 000 45 000 63 000 37 000

12 000 28 000

15 000 35 000

9 000 21 000

ii. Pre-acquisition entries Retained earnings (1/7/10) Share capital General reserve Business combination valuation reserve Goodwill Shares in Mouse Ltd

250 000

23.4

Chapter 23: Consolidation: Non-controlling interest iii. NCI in equity at 1/7/10 Retained earnings (1/7/10) Share capital General reserve Business combination valuation reserve NCI

Dr Dr Dr Dr Cr

10 000 25 000 15 000 21 000

Plant Accumulated depreciation Deferred tax liability Business combination valuation reserve

Dr Dr Cr Cr

20 000 20 000

Depreciation expense Accumulated depreciation (10% x $40 000 p.a.)

Dr Cr

4 000

Deferred tax liability Income tax expense

Dr Cr

1 200

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

50 000

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

30 000

71 000

2. Worksheet Entries at 30 June 2011 i. Business combination valuation entries

12 000 28 000

4 000

1 200

15 000 35 000

9 000

21 000

ii. Pre-acquisition entries Retained earnings (1/7/10) Share capital General reserve Business combination valuation reserve Goodwill Shares in Mouse Ltd

Dr Dr Dr Dr Dr Cr

30 000 75 000 45 000 63 000 37 000

Transfer from business combination valuation reserve Business combination valuation reserve (75% x $21 000)

Dr Cr

15 750

250 000

15 750

23.5

Solutions Manual to accompany Applying IFRS Standards 4e iii.

NCI in equity at 1/7//10 Retained earnings (1/7/09) Share capital General reserve Business combination valuation reserve NCI

iv.

Dr Dr Dr Dr Cr

10 000 25 000 15 000 21 000 71 000

NCI in equity: 1/7/07 - 30/6/11 NCI share of profit Dr NCI Cr (25% x [$40 000 – ($4 000 - $1 200) – ($30 000 - $9 000)]) Transfer from business combination valuation reserve Business combination valuation reserve (25% x $21 000)

4 050 4 050

Dr Cr

5 250

Plant Accumulated depreciation Deferred tax liability Business combination valuation reserve

Dr Dr Cr Cr

20 000 20 000

Depreciation expense Retained earnings (1/7/12) Accumulated depreciation

Dr Dr Cr

4 000 20 000

Deferred tax liability Income tax expense Retained earnings (1/7/12)

Dr Cr Cr

7 200

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

50 000

5 250

3. Worksheet entries at 30 June 2016 i. Business combination valuation entries

12 000 28 000

24 000

1 200 6 000

15 000 35 000

ii. Pre-acquisition entries Retained earnings (1/7/12) * Share capital General reserve Business combination valuation reserve Shares in Mouse Ltd

Dr Dr Dr Dr Cr

82 750 75 000 45 000 47 250 250 000

* = $30 000 + $37 000 goodwill + 75% x $21 000 (BCVR – inventory)

23.6

Chapter 23: Consolidation: Non-controlling interest iii. NCI in equity at 1/7/07 Retained earnings (1/7/08) Share capital General reserve Business combination valuation reserve NCI

Dr Dr Dr Dr Cr

10 000 25 000 15 000 21 000

Dr Dr Cr Cr

5 250 5 000

71 000

iv. NCI in equity: 1/7/07 - 30/6/12 Retained earnings (1/7/11) General reserve Business combination valuation reserve NCI

5 250 5 000

(RP: 25% ($75 000 - $40 000 – ($20 000 - $6 000)) GR: 25% ($80 000 - $60 000)) v. NCI in equity: 1/7/12- 30/6/13 NCI share of profit NCI (25% ($33 000 – ($4 000 - $1 200))) Financial Statements Sales revenue Cost of sales Other expenses Profit before tax Tax expense Profit for the period Retained earnings (1/7/12) Retained earnings (30/6/13) Capital General reserve BCV reserve

Jellyfish Ltd 510 600 225 000 285 600 65 000

Mouse Ltd 80 000 35 000 45 000 7 000

220 600

38 000

50 000 170 600

5 000 33 000

120 000

75 000

Dr Cr

Adjustments Dr Cr

7 550

Group

NCI Dr

Parent Cr

590 600 260 000 330 600 76 000

4 000

254 600 1 200

1 2

20 000 82 750

6 000

290 600 108 000

53 800 200 800 98 250

7 550

193 250

3 4

10 000 5 250

83 000

299 050

400 000 100 000 60 000 80 000

2 2

75 000 45 000

47 250

7 550

425 000 95 000 28 000 35 000

1 1

15 750

276 250

3 3 4 3

25 000 15 000 5 000 21 000

Total equity: parent Total equity: NCI

400 000 75 000 5 250

-751 250

Total equity

750 600 288 000

Payables Deferred tax liabilities Total liabilities

72 900 -

12 000 -

72 900

12 000

834 800

7 200

12 000 15 000

1 1

88 800

71 000 5 000 7 550 88 800

3 4 5

83 550

834 800

84 900 19 800 104 700

23.7

Solutions Manual to accompany Applying IFRS Standards 4e Shares in Mouse Ltd Plant Accum. depreciation Land Current assets Goodwill Total assets

250 000

425 500 190 000 (124 000) (24 000)

1 1

20 000 20 000

110 000 162 000

50 000

50 000 84 000

823 500 300 000

250 000

24 000

635 500 (152000)

371 200 371 200

210 000 246 000 939 500

JELLYFISH LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2013 Revenues: Sales revenue Expenses: Cost of sales Other expenses

$590 600 260 000 76 000 336 000 254 600 53 800 200 800

Profit before income tax Income tax expense Profit for the period Attributable to: Parent shareholders Non-controlling interest

193 250 7 550 $200 800 JELLYFISH LTD Consolidated Statement of Changes in Equity for the year ended 30 June 2013

Comprehensive income for the period Non-controlling interest Parent shareholders

$200 800 $7 550 $193 250 Group

Parent

Retained earnings: Balance at 1 July 2012 Profit for the period Balance at 30 June 2013

$98 250 200 800 $299 050

$83 000 193 250 $276 250

Business combination valuation reserve: Balance at 1 July 2012 Balance at 30 June 2013

$15 750 $15 750

Share capital: Balance at 1 July 2012 Balance at 30 June 2013

$425 000 $425 000

$400 000 $400 000

General reserve: Balance at 1 July 2012 Balance at 30 June 2013

$95 000 $95 000

$75 000 $75 000

23.8

Chapter 23: Consolidation: Non-controlling interest JELLYFISH LTD Consolidated Statement of Financial Position as at 30 June 2013 ASSETS Current Assets Non-current Assets: Property, plant and equipment Plant Accumulated depreciation Land Total Non-current Assets Total Assets EQUITY AND LIABILITIES Equity attributable to owners of the parent: Share capital Other reserves: General reserve Retained earnings Parent Interest Non-controlling Interest Total Equity Current Liabilities Payables Non-current Liabilities Tax liabilities: Deferred tax liability Total Liabilities Total Equity and Liabilities

$246 000

$635 500 (152 000) 210 000

693 500 693 500 $939 500

$400 000 75 000 276 250 751 250 83 550 834 800 84 900 19 800 104 700 $939 500

23.9

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.3 1. 2. 3.

CONSOLIDATION WORKSHEET ENTRIES INCLUDING NCI

What are the entries for the consolidation worksheet if prepared immediately after 1 July 2016? What are the entries for the consolidation worksheet if prepared at 30 June 2017? Assume a profit for Rudny Ltd for the 2016–17 period of $20 000. If the non-controlling interest had a fair value of $31 800 on 1 July 2016, and the full goodwill method had been used, what entries in parts 1 and 2 above would change? Prepare the changed entries. NORILSK LTD – RUDNY LTD 90% Norilsk Ltd

Rudny Ltd Norilsk Ltd 90% NCI 10%

At 1 July 2016: Net fair value of identifiable assets and liabilities of Rudny Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill of the parent

= = = = = = =

$200 000 + $80 000 (equity) + $10 000 (1 – 30%) (land) + $2 000 (1 – 30%) (inventory) + $20 000 (1 – 30%) (machinery) $302 400 $290 160 10% x $302 400 $30 240 $320 400 $320 400 - $302 400 $18 000

1. Worksheet entries at 1 July 2016 i. Business combination valuation entries Land

ii.

Dr Cr Cr

10 000

Deferred tax liability Business combination valuation reserve Machinery Deferred tax liability Business combination valuation reserve

Dr Cr Cr

20 000

Inventory Deferred Tax Liability Business combination valuation reserve

Dr Cr Cr

2 000

Dr Dr Dr Dr Cr

180 000 72 000 20 160 18 000

Dr Dr Dr Cr

20 000 8 000 2 240

3 000 7 000

6 000 14 000

600 1 400

Pre-acquisition entries Share capital Retained earnings (1/7/16) Business combination valuation reserve Goodwill Shares in Rudny Ltd

290 160

iii. NCI share of equity at 1 July 2016 Share capital Retained earnings (1/7/16) Business combination valuation reserve NCI

30 240 23.10

Chapter 23: Consolidation: Non-controlling interest 2.

Worksheet entries at 30 June 2017

i. Business combination valuation entries Land

Dr Cr Cr

10 000

Deferred tax liability Business combination valuation reserve

Machinery Deferred tax liability Business combination valuation reserve

Dr Cr Cr

20 000

Depreciation expense Accumulated depreciation (1/10 x $20 000)

Dr Cr

2 000

Deferred tax liability Income tax expense

Dr Cr

600

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

2 000

3 000 7 000

6 000 14 000

2 000

600

1 400

ii. Pre-acquisition entries Retained earnings (1/7/16) Share capital Business combination valuation reserve Goodwill Shares in Rudny Ltd

Dr Dr Dr Dr Cr

72 000 180 000 20 160 18 000

Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

1 260

Dr Dr Dr Cr

20 000 2 240 8 000

NCI share of profit Dr NCI Cr (10% ($20 000 – ($2 000 - $600) – ($2 000 – $600)))

1 720

290 160

1 260

iii. NCI share of equity at 1 July 2016 Share capital Business combination valuation reserve Retained earnings (1/7/16) NCI iv. NCI share of equity: 1/7/16 - 30/6/17

Transfer from business combination valuation reserve Business combination valuation reserve (10% x $1 400)

Dr Cr

30 240

1 720

140 140

23.11

Solutions Manual to accompany Applying IFRS Standards 4e 3. FULL GOODWILL METHOD NCI has fair value of $31 800 At 1 July 2016: Net fair value of identifiable assets and liabilities of Rudny Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Goodwill of Subsidiary Fair value of Rudny Ltd

= = = = = =

$200 000 + $80 000 (equity) + $10 000 (1 – 30%) (land) + $2 000 (1 – 30%) (inventory) + $20 000 (1 – 30%) (machinery) $302 400 $290 160 $31 800 $321 960 $321 960 - $302 400 $19 560 = =

$31 800/10% $318 000

Net fair value of identifiable assets and liabilities Goodwill of subsidiary

= =

$302 400 $15 600

Goodwill of parent Goodwill acquired Goodwill of subsidiary Goodwill of parent (control premium)

= = =

$19 560 $15 600 $3 960

There will need to be an additional BCVR entry: Goodwill Business combination valuation entry The pre-acquisition entry at 1 July 2016 would change to: Share capital Retained earnings (1/7/16) Business combination valuation reserve * Goodwill Shares in Rudny Ltd * 90% [$22 400 + $15 600]

Dr Cr

15 600

Dr Dr Dr Dr Cr

180 000 72 000 34 200 3 960

Dr Dr Dr Cr

20 000 8 000 3 800

15 600

290 160

The Step 1 NCI would change to: Share capital Retained earnings (1/7/16) Business combination valuation reserve * NCI * 10% [$22 400 + $15 600]

31 800

23.12

Chapter 23: Consolidation: Non-controlling interest Exercise 23.4 CONSOLIDATION WORKSHEET ENTRIES, BARGAIN PURCHASE, RECORDED GOODWILL

Prepare the worksheet entries for the preparation of the consolidated financial statements of Petrel Ltd and its subsidiary, Ibis Ltd, at 30 June 2016. PETREL LTD – IBIS LTD

75% Petrel Ltd

Ibis Ltd Petrel Ltd 75% NCI 25%

At 1 July 2013: Net fair value of assets and liabilities of Ibis Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Gain on bargain purchase

= = = = = = =

($100 000 + $20 000 + $40 000) (equity) + $5 000 (1 – 30%) (inventory) + $6 000 (1 – 30%) (plant) + $1 000 (1 – 30%) (fittings) + $20 000 (1 – 30%) (land) - $1 000 (1 – 30%) (receivables) $181 700 $123 525 25% x $181 700 $45 425 $168 950 $181 700 - $168 950 $12 750

1. Business combination valuation entries at 30 June 2015 Carrying amount of plant sold Depreciation expense Income tax expense Income tax expense Retained earnings (1/7/14) Transfer from business combination valuation reserve

Dr Dr Cr Cr Dr

Accumulated depreciation – fittings Fittings Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

30 000

Depreciation expense Retained earnings (1/7/14) Accumulated depreciation

Dr Dr Cr

200 400

Deferred tax liability Income tax expense Retained earnings (1/7/14)

Dr Cr Cr

180

Land

Dr Cr Cr

20 000

Deferred tax liability Business combination valuation reserve

3 000 600 180 900 1 680

4 200

29 000 300 700

600

60 120

6 000 14 000

23.13

Solutions Manual to accompany Applying IFRS Standards 4e 2. Pre-acquisition entries At 1 July 2013: Retained earnings (1/7/13) Share capital General reserve Business combination valuation reserve Gain on bargain purchase Shares in Cassowary Ltd

Dr Dr Dr Dr Cr Cr

30 000 75 000 15 000 16 275

Dr Dr Dr Dr Cr

19 350 75 000 15 000 14 175

12 750 123 525

At 30 June 2015: Retained earnings (1/7/14) * Share capital General reserve Business combination valuation reserve ** Shares in Cassowary Ltd

123 525

* $30 000 + [75% x 70% x ($5 000 - $1 000)] - $12 750 (gain on bargain purchase) ** 16 275 – [75% x 70% x ($5 000 -$1 000)] Transfer from business combination valuation reserve Business combination valuation reserve (75% x $4 200)

Dr Cr

3 150

Dr Dr Dr Dr Cr

10 000 25 000 5 000 5 425

Retained earnings (1/7/13) Dr NCI Cr (25% ($80 000 - $40 000 – $1 680 – ($400 - $120))

9 510

General reserve NCI (25% ($30 000 - $20 000))

Dr Cr

2 500

NCI

Dr Cr

700

3 150

2. NCI share of equity at 1/7/13 Retained earnings (1/7/13) Share capital General reserve Business combination valuation reserve NCI

45 425

3. NCI share of equity: 1/7/13 - 30/6/14

Business combination valuation reserve (25% x 70%($5 000 - $1 000))

9 510

2 500

700

23.14

Chapter 23: Consolidation: Non-controlling interest 4. NCI share of equity: 1/7/14 - 30/6/15 NCI share of profit Dr NCI Cr (25% [$15 000 – ($3000 + $600 - $180 - $900) – ($200 - $60)]) Transfer from business combination valuation reserve Business combination valuation reserve (25% x $4200)

3 085 3 085

Dr Cr

1 050

Asset revaluation surplus NCI (25% x $3000)

Dr Cr

750

NCI

Dr Cr

1 250

Dr Cr

1 000

Dr Cr

3 750

Dividend payable Dividend declared (75% x $4000)

Dr Cr

3 000

Dividend revenue Dividend receivable

Dr Cr

3 000

Dividend paid (25% x $5000)

NCI Dividend declared (25% x $4000)

1 050

750

1 250

1 000

5. Interim dividend paid Dividend revenue Dividend paid (75% x $5000)

3 750

6. Dividend declared

3 000

23.15

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.5 CONSOLIDATION WORKSHEET ENTRIES, MULTIPLE YEARS, PARTIAL GOODWILL METHOD 1. Prepare the consolidation worksheet entries as at 1 July 2012. 2. Prepare the consolidation worksheet entries for the year ended 30 June 2013. 3. Prepare the consolidation worksheet entries for the year ended 30 June 2014. 4. Prepare the consolidation worksheet entries for the year ended 30 June 2015. 5. Prepare the consolidation worksheet entries for the year ended 30 June 2016. EAGLE LTD – HERON LTD

75% Eagle Ltd

Heron Ltd Eagle Ltd 75% NCI 25%

Acquisition analysis 1 July 2012 Net fair value of identifiable assets and liabilities of Heron Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill – parent only

= = = = = =

($80 000 + $20 000 + $40 000) (equity) + $20 000 (1 – 30%) (land) + $6 000 (1 – 30%) (plant) + $4 000 (1 – 30%) (inventory) $161 000 $125 750 25% x $161 000 $40 250 $166 000 $5 000

1. Consolidation Worksheet Entries - 1 July 2012 i. Business combination valuation entries Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

4 000

Dr Dr Dr Dr Dr Dr Cr

30 000 60 000 15 000 10 500 5 250 5 000

9 000 1 800 4 200

1 200 2 800

ii. Pre-acquisition entries Retained earnings (1/7/12) Share capital General reserve Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Heron Ltd

125 750

23.16

Chapter 23: Consolidation: Non-controlling interest iii. NCI share of equity at 1 July 2012 Share capital Retained earnings (1/7/12) General reserve Asset revaluation surplus Business combination valuation reserve NCI

Dr Dr Dr Dr Dr Cr

20 000 10 000 5 000 3 500 1 750

Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Depreciation expense Accumulated depreciation - plant (1/3 x $6 000 p.a.)

Dr Cr

2 000

Deferred tax liability Income tax expense

Dr Cr

600

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

4 000

40 250

Consolidation Worksheet Entries - 30 June 2013

i. Business combination valuation entries

9 000 1 800 4 200

2 000

600

1 200

2 800

ii. Pre-acquisition entry Retained earnings (1/7/12) Share capital General reserve Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Heron Ltd

Dr Dr Dr Dr Dr Dr Cr

30 000 60 000 15 000 10 500 5 250 5 000

Transfer from business combination valuation reserve Business combination valuation reserve (75% x 70% x $4 000)

Dr Cr

2 100

Dr Dr Dr Dr Dr Cr

20 000 10 000 5 000 3 500 1 750

125 750

2 100

iii. NCI share of equity at 1 July 2012 Share capital Retained earnings (1/7/11) General reserve Asset revaluation surplus Business combination valuation reserve NCI

40 250

23.17

Solutions Manual to accompany Applying IFRS Standards 4e iv. NCI share of equity: 1 July 2012 - 30 June 2013 NCI share of profit Dr NCI Cr (25% [$10 000 – ($2 000 - $600) – ($4 000 - $1 200)]) Transfer from business combination valuation reserve Business combination valuation reserve (25% x 70% x $4 000)

1 450

Dr Cr

700

Dr Cr

500

Accumulated depreciation - plant Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Depreciation expense Retained earnings (1/7/13) Accumulated depreciation - plant

Dr Dr Cr

2 000 2 000

Deferred tax liability Income tax expense Retained earnings (1/7/13)

Dr Cr Cr

1 200

Retained earnings (1/7/12) * Share capital General reserve Asset revaluation surplus (1/7/12) Business combination valuation reserve Goodwill Shares in Heron Ltd *RE: [$30 000 + $2 100 BCVR - inventory]

Dr Dr Dr Dr Dr Dr Cr

32 100 60 000 15 000 10 500 3 150 5 000

Transfer from asset revaluation surplus Asset revaluation surplus (75% x 70% x $20 000)

Dr Cr

10 500

Dr Dr Dr Dr Dr Cr

20 000 10 000 5 000 3 500 1 750

Asset revaluation surplus NCI (25% x $2 000)

1 450

700

500

Consolidation Worksheet Entries - 30 June 2014

i. Business combination valuation entries

9 000 1 800 4 200

4 000

600 600

ii. Pre-acquisition entries

125 750

10 500

iii. NCI share of equity at 1 July 2012 Share capital Retained earnings (1/7/12) General reserve Asset revaluation surplus Business combination valuation reserve NCI

40 250

23.18

Chapter 23: Consolidation: Non-controlling interest iv. NCI share of equity: 1 July 2012 - 30 June 2013 Retained earnings (1/7/12) Asset revaluation surplus Business combination valuation reserve NCI (RE: 25% ($10 000 – [$2 000 - $600]) ARS: 25% x $2 000 BCVR: 25% x 70% x $4 000)

Dr Dr Cr Cr

2 150 500 700 1 950

v. NCI share of equity: 1 July 2013 - 30 June 2014

NCI share of profit Dr NCI Cr (25% ($23 000 – [$2 000 - $600] – [$20 000 - $6 000]))

1 900

Transfer from asset revaluation surplus Asset revaluation surplus (25% x 70% x $20 000)

Dr Cr

3 500

Asset revaluation surplus NCI (25% x $5 000)

Dr Cr

1 250

Dr Cr Dr

2 000

1 900

3 500

1 250

Consolidation Journal entries - 30 June 2015

i. Business combination valuation entries Depreciation expense - plant Income tax expense Retained earnings (1/7/14) Transfer from business combination valuation reserve

600 2 800

4 200

ii. Pre-acquisition entries Retained earnings (1/7/14) * Share capital General reserve Business combination valuation reserve Goodwill Shares in Heron Ltd * $30 000 + 70% x 75% ($20 000 + $4 000) Transfer from business combination valuation reserve Business combination valuation reserve (75% x 70% x $6 000)

Dr Dr Dr Dr Dr Cr

42 600 60 000 15 000 3 150 5 000

Dr Cr

3 150

Dr Dr Dr Dr Dr Cr

20 000 10 000 5 000 3 500 1 750

125 750

3 150

iii. NCI share of equity at 1 July 2012 Share capital Retained earnings (1/7/14) General reserve Asset revaluation surplus Business combination valuation reserve NCI

40 250

23.19

Solutions Manual to accompany Applying IFRS Standards 4e iv. NCI share of equity: 1 July 2012 - 30 June 2014 Retained earnings (1/7/13) Asset revaluation surplus Business combination valuation reserve NCI RE: 25% ($10 000 + $23 000 – $2 800) BCVR: 25% (70% x $4 000) ARS: 25% ($2 000 + $5 000 - $14 000) v. NCI share of equity: 1 July 2014 - 30 June 2015 NCI Dr NCI share of profit/loss (25% [(6 000) – ($2 000 - $600)]) Transfer from business combination valuation reserve Business combination valuation reserve (25% x 70% x $6 000) Asset revaluation surplus NCI (25% x $7 000) 5.

Dr Cr Cr Cr

7 550 1 750 700 5 100

1 850 Cr

1 850

Dr Cr

1 050

Dr Cr

1 750

Retained earnings (1/7/12) * Dr Share capital Dr General reserve Dr Goodwill Dr Shares in Heron Ltd Cr * [$30 000 + 75% x 70%($20 000 + $6000 + $4000)]

45 750 60 000 15 000 5 000

1 050

1 750

Consolidation Journal Entries - 30 June 2016

i. Pre-acquisition entry

125 750

ii. NCI share of equity at 1 July 2012 Share capital Retained earnings (1/7/12) General reserve Asset revaluation surplus Business combination valuation reserve NCI

Dr Dr Dr Dr Dr Cr

20 000 10 000 5 000 3 500 1 750

Dr Cr Cr

6 750

Dr Cr

5 500

40 250

iii. NCI share of equity: 1 July 2012 - 30 June 2015 Retained earnings (1/7/12) Business combination valuation reserve NCI (RE: [25% ($10 000 + $23 000 - $6000)] ARS: 25% ($2000 + $5000 + $7 000 - $14 000) BCVR: 25% x 70% x ($6000 + $4000)

1 750 5 000

iv. NCI share of equity: 1 July 2015 - 30 June 2016 NCI share of profit NCI (25% x $22 000])

5 500

23.20

Chapter 23: Consolidation: Non-controlling interest Exercise 23.6

CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, FULL GOODWILL METHOD

Prepare the consolidated financial statements for Osprey Ltd and its subsidiary as at 30 June 2015. OSPREY LTD - KITE LTD

75% Osprey Ltd

Kite Ltd Osprey Ltd 75% NCI 25%

Acquisition analysis At 1 July 2014: Net fair value of identifiable assets and liabilities of Kite Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

Goodwill of subsidiary: Fair value of Kite Ltd Net fair value of identifiable assets and liabilities of Kite Ltd Goodwill of Kite Ltd Goodwill of Osprey Ltd: Goodwill acquired Goodwill of Kite Ltd Goodwill of Osprey Ltd - control premium

= = = = = = = =

$400 000 + $50 000 + $40 000 + $30 000 + $40 000(equity) $560 000 (75% x 400 000 shares) x $1.50 per share $450 000 $147 000 $597 000 $597 000 - $560 000 $37 000

= =

$147 000/0.25 $588 000

= = =

$560 000 $588 000 - $560 000 $28 000

= =

$37 000 $28 000

$9 000

1. Business combination valuation entries Goodwill Business combination valuation reserve

Dr Cr

28 000

Dr Dr Dr Dr Dr Dr Dr Cr

30 000 300 000 37 500 30 000 22 500 21 000 9 000

28 000

2. Pre-acquisition entries At 1 July 2014 Retained earnings (1/7/14) Share capital General reserve Asset revaluation surplus (1/7/14) Other components of equity (1/7/14) Business combination valuation reserve Goodwill Shares in Kite Ltd

450 000

23.21

Solutions Manual to accompany Applying IFRS Standards 4e At 30 June 2015: Retained earnings (1/7/14) Share capital General reserve Asset revaluation surplus (1/7/14) Other components of equity (1/7/14) Business combination valuation reserve Goodwill Shares in Kite Ltd

Dr Dr Dr Dr Dr Dr Dr Cr

30 000 300 000 37 500 30 000 22 500 21 000 9 000

Dr Dr Dr Dr Dr Dr Cr

10 000 100 000 12 500 10 000 7 500 7 000

NCI share of profit NCI (25% x $223 200)

Dr Cr

55 800

Gains/Losses - asset revaluation surplus NCI (25% [$60 000 - $40 000])

Dr Cr

5 000

Gains/Losses - other components of equity NCI (25%[$40 000 - $30 000])

Dr Cr

2 500

NCI

Dr Cr

7 500

Dr Cr

2 500

Dr Cr

22 500

Dividend payable Dividend declared (75% x $10 000)

Dr Cr

7 500

Dividend revenue Dividend receivable

Dr Cr

7 500

450 000

3. NCI share of equity of at 1/7/14 Retained earnings (1/7/14) Share capital General reserve Asset revaluation surplus (1/7/14) Other components of equity (1/7/14) Business combination valuation reserve NCI 4.

147 000

NCI share of equity: 1/7/14 - 30/6/15

Dividend paid (25% x $30 000) NCI Dividend declared (25% x $10 000)

55 800

5 000

2 500

7 500

2 500

5. Dividend paid Dividend revenue Dividend paid (75% x $30 000)

22 500

6. Dividend declared

7 500

23.22

Chapter 23: Consolidation: Non-controlling interest 7. Advance Advance from Osprey Ltd Advance to Kite Ltd

Dr Cr

80 000 80 000

8. Sale of inventory: Osprey Ltd to Kite Ltd Sales revenue Cost of sales Inventory

Dr Cr Cr

55 000

Deferred tax asset Income tax expense

Dr Cr

1 500

Proceeds on sale of equipment – other income Dr Carrying amount of equipment sold – other expenses Cr Equipment Cr

60 000

Deferred tax asset Income tax expense

Dr Cr

2 400

Dr Cr

1 400

Accumulated depreciation Depreciation expense (10% x $8 000)

Dr Cr

800

Income tax expense Deferred tax asset

Dr Cr

240

Dr Cr

140

50 000 5 000

1 500

9. Sale of equipment: Kite Ltd to Osprey Ltd

52 000 8 000

2 400

10. NCI adjustment NCI NCI share of profit (25% ($8 000 - $2 400))

1 400

11. Depreciation

800

240

12. NCI adjustment NCI share of profit NCI (25% ($800 - $240))

140

23.23

Solutions Manual to accompany Applying IFRS Standards 4e Financial Statements Sales revenue Cost of sales Other income

Other expenses Profit before tax Tax expense

Osprey Ltd 878 900 374 400 504 500 302 100

Kite Ltd 388 900 112 400 276 500 112 500

112 400

50 000

Ret. earnings (1/7/14)

112 000

BCVR General reserve ARS (1/7/14) Gains/losses ARS (30/6/15) Other comp (op) Gains/losses Other comp. (cl) Total equity: parent Total equity: NCI

Group

22 500 7 500 60 000 800 52 000

11 9

590 400 273 200

478 000 223 200

Ret. earnings (30/6/15) Share capital

5 6 9

806 600 389 000 216 200 115 800

Profit

Dividend paid Div. declared

Adjustments Dr Cr 55 000 50 000

40 000

24 000

50 000

1 724 000 673 200 40 000 40 000 30 000 20 000 70 000 60 000 25 000 30 000 5 000 10 000 30 000 40 000

Total equity

1 824 000 773 200

Current liabilities Total liabilities Total equity and liabilities

177 000 124 400

240

1 500 2 400

8 9

320 000 175 000

Inventory Financial assets Shares in Kite

287 500 210 600 280 000 204 000 450 000

55 800 140 10 000

1 400

1 212 800 436 800 776 000 324 600

1 100 600 279 200

158 740 662 660

4 12 122 000 3

30 000

22 500 7 500

2 2 2

300 000 21 000 37 500

30 000

22 500

5 6

784 660 47 500 52 500 100 000 684 660 1300 000

28 000

7 000 36 500 2 028 160 50 000 50 000 100 000 32 500 15 000 47 500

2 175 660 6 7

7 500 80 000

608 120 112 000

7 500 2 500

4 4

3 100 000

720 120 40 000 50 000 90 000 630 120 1 200 000

3 3

7 000 12 500

0 24 000

3 4

-10 000 5 000

3 4

7 500 2 500

1 854 120 40 000 45 000 85 000 25 000 12 500 37 500 1 976 620

4 4 10

7 500 2 500 1 400

147 000 55 800 5 000 2 500 140 221 840 221 840

3 4 4 4 12

199 040

2 175 660

213 900

177 000 124 400 2001000 897 600

Receivables

Parent Cr

821 400

590 000 263 200 40 000 30 000 50 000 10 000 90 000 40 000 500 000 223 200 1 200 000 400 000

NCI Dr

213 900 2 389 560

7 500 80 000 5 000

6 7 8

407 500

450 000

493 100 484 000

23.24

Chapter 23: Consolidation: Non-controlling interest Other investments Equipment Accum depreciation Deferred tax asset Land Goodwill

47 000

650 000 360 000 (250 000) (160000 ) --216 500 108 000 ---

47 000

800

8 9

1 500 2 400

1 2

2 001 000 897 600

8 000

1 002 000 (409 200)

240

3 660

28 000 9 000 715 440 715 440

324 500 37 000 2 389 560

OSPREY LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2015 Income: Sales revenue Other income Total income Expenses: Cost of sales Other Total expenses Profit before income tax Income tax expense Profit for the period Other comprehensive income: Asset revaluation surplus: gains Other components of equity: gains Comprehensive income for the period

$1 212 800 324 600 1 537 400 436 800 279 200 716 000 821 400 158 740 $662 660 50 000 15 000 $727 660

Profit for the period attributable to: Parent interest Non-controlling interest

$608 120 $ 54 540 $662 660

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

665 620 62 040 $727 660

OSPREY LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2015

Comprehensive income for the period

Group $727 660

Parent $665 620

Retained earnings: Balance at 1 July 2014 Profit for the period Dividend paid Dividend declared Balance at 30 June 2015

$122 000 662 660 (47 500) (52 500) $684 660

$112 000 608 120 (40 000) (50 000) $630 120

23.25

Solutions Manual to accompany Applying IFRS Standards 4e General reserve: Balance at 1 July 2014 Balance at 30 June 2015

$36 500 $36 500

$24 000 $24 000

Share capital Balance at 1 July 2014 Balance at 30 June 2015

$1 300 000 $1 300 000

$1 200 000 $1 200 000

Asset revaluation reserve: Balance at 1 July 2014 Gains/Losses Balance at 30 June 2015

$50 000 50 000 $100 000

$40 000 45 000 $85 000

Other components of equity: Balance at 1 July 2014 Gains/Losses Balance at 30 June 2015

$32 500 15 000 $47 500

$25 000 12 500 $37 500

Business combination valuation reserve: Balance at 1 July 2014 Balance at 30 June 2015

$7 000 $7 000

OSPREY LTD Consolidated Statement of Financial Position as at 30 June 2015 ASSETS Current Assets Receivables Inventory Financial assets Non-current Assets Property, plant and equipment Land Equipment Accumulated depreciation Goodwill Deferred tax assets Other investments Total Non-current Assets Total Assets EQUITY AND LIABILITIES Equity attributable to equity holders of the parent Share capital Reserves: General reserve Asset revaluation surplus Other components of equity Retained earnings Parent Interest Non-controlling Interest Total Equity Total Liabilities: Current Liabilities Total Equity and Liabilities

$407 500 493 100 484 000

$324 500 1 002 000 (409 200)

$1 384 600

917 300 37 000 3 660 47 000 1 004 960 $2 389 560

$1 200 000 24 000 85 000 37 500 630 120 1 976 620 199 040 2 175 660 213 900 $2 389 560

23.26

Chapter 23: Consolidation: Non-controlling interest

Exercise 23.7

ADJUSTMENT FOR THE NCI SHARE OF EQUITY

Write a report to Raz convincing him that his argument is fallacious.

WHALE SUBMARINE WORKS LTD 1. The need to adjust for the NCI share of equity in relation to intragroup transactions: If the NCI is classified as equity, it is entitled to consolidated equity. Note that consolidated equity is basically subsidiary equity adjusted for the effects of intragroup transactions – that is, realised subsidiary equity. If it were classified as a liability of the subsidiary then the calculation of the NCI would be based on the obligation held by the subsidiary. 2. Vehicles & services: Profit is realised when the group transacts with an entity external to the group. The point of realisation depends then on identifying when the external entity is involved. With inventory (and other sales) transactions the point of realisation is easily identified as it is the point of sale when the external entity is involved. It is at this point that the group recognises profit on sale, being the excess of the sale proceeds over the cost to the group of the item being sold. With assets used by the group such as depreciable assets, the group does not interact with an external entity. It is then impossible to determine a point of realisation based on direct involvement of the group with an external entity. The point of realisation is then based on indirect involvement. The depreciable asset is used by the group to assist in its interaction with external entities eg by making inventories for sale to external entities. The depreciation charge measures the extent of that involvement in any one year as the depreciation charge is based on para 60 of IAS 16 which notes that the depreciation charge reflects the pattern of benefits consumed by the entity. Realisation of profit then occurs as the asset is used up or consumed by the entity. Realisation is then achieved in proportion to the depreciation charge made on the asset. With transactions such as services, the subsidiary records revenue, which increases subsidiary profit. This profit is not recognised by the group. However, no adjustment is made to the NCI share of equity as a result of this transaction. This is because of the difficulty of determining a point of realisation as no external entity is ever involved in this transaction.

23.27

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.8

THE STEP APPROACH

Prepare a report for Nikki, explaining the step approach to the calculation of NCI and the effects of this approach in the years after acquisition date. FROG LTD – KOVROV LTD The 3 steps are: 1. Share of equity at acquisition date. 2. Share of the change in equity between the acquisition date and the beginning of the current period. 3. Share of change in equity in the current period. In preparing the consolidated financial statements at, say, 30 June 2013, the consolidation worksheet prepared at 30 June 2012 will contain Steps 1 and 2 for the 2013 worksheet: - Step 1 journal entry never changes - Step 2 for 2013 is the combination of Steps 2 and 3 for 2012. Hence in 2013, the only new calculations relate to Step 3, namely the share of changes in equity for the 2012–13 period.

Exercise 23.9

EFFECTS OF INTRAGROUP TRANSACTIONS

Prepare a report for Star, explaining these two areas of concern. MOTH CEMENT WORKS LTD Why is it necessary? Under IFRSs, the NCI is classified as equity, mainly because the NCI does not fit the definition of a liability. If the NCI is classified as equity, it is entitled to a share of consolidated equity. Consolidated equity is determined after adjusting for the effects of intragroup transactions. Consolidated equity for the NCI is then subsidiary equity adjusted for the effects of those intragroup transactions affecting subsidiary equity– that is, realised subsidiary equity. Is it necessary to make NCI adjustments in relation to all intragroup transactions? The NCI does not affect the adjustment itself, as the full effects of the intragroup transaction are adjusted for on consolidation. However, where the subsidiary records profit which is unrealised to the group, this affects the calculation of the NCI. The NCI is entitled only to a share of consolidated equity rather than subsidiary equity. Hence, where the subsidiary has recorded unrealised profit, the NCI share of the recorded profit of the group must be adjusted for any of that profit which is unrealised. In the Step 2 & Step 3 calculations of the NCI share of equity, this is a share of recorded equity. As adjustments are made for intragroup transactions, where these transactions reflect adjustments for unrealised subsidiary profit, an adjustment is also made to the NCI share of profit. The net result is then that the NCI gets a share of realised subsidiary equity. However, an NCI adjustment does NOT need to be made for all intragroup transactions. An NCI adjustment only needs to be made where the adjustment is for unrealised profit recorded by the subsidiary. Hence the transaction must be an upstream – subsidiary to parent – transaction in order for an NCI adjustment to be made. Further the upstream transaction must relate to unrealised subsidiary profit.

23.28

Chapter 23: Consolidation: Non-controlling interest Exercise 23.10 CONSOLIDATION WORKSHEET ENTRIES, DIVIDENDS, EQUITY TRANSFERS 1. 2.

Prepare the worksheet entries for the preparation of the consolidated financial statements of Crocodile Ltd and its subsidiary, Turtle Ltd, at 30 June 2015. Assume Crocodile Ltd uses the full goodwill method and the value of the non-controlling interest at 1 July 2012 was $49 250. Prepare the entries that would differ from those in requirement 1. CROCODILE LTD – TURTLE LTD

80% Crocodile Ltd

Turtle Ltd Crocodile Ltd 80% NCI 20%

1.: PARTIAL GOODWILL METHOD At 1 July 2012: Net fair value of identifiable assets and liabilities of Turtle Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill acquired – parent only Unrecorded goodwill acquired

= = = = = = = = = =

($100 000 +$40 000 + $50 000) (equity) + $20 000 (1 – 30%) (land) + $5 000 (1 – 30%) (plant) + $50 000 (1 – 30%) (patent) - $5 000 (goodwill) $237 500 $202 000 – (80% x $5 000) (divs rec) $198 000 20% x $237 500 $47 500 $245 500 $245 500 - $237 500 $8 000 $8 000 - (80% x $5 000) $4 000

CONSOLIDATION WORKSHEET ENTRIES AT 30 JUNE 2015 i. Business combination valuation entries Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

20 000

Depreciation expense Cost of plant sold Income tax expense Retained earnings (1/7/14) Transfer from business combination valuation reserve

Dr Dr Cr Dr

500 2 500

Accumulated depreciation –fittings Fittings

Dr Cr

20 000

Patent Deferred tax liability Business combination valuation reserve

Dr Cr Cr

50 000

6 000 14 000

900 1 400

3 500

20 000

15 000 35 000

23.29

Solutions Manual to accompany Applying IFRS Standards 4e ii. Pre-acquisition entries Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve Goodwill Shares in Turtle Ltd

Dr Dr Dr Dr Dr Cr

40 000 80 000 32 000 42 000 4 000

Transfer from business combination valuation reserve Business combination valuation reserve (80% x 70% x $5000)

Dr Cr

2 800

Dr Dr Dr Dr Cr

10 000 20 000 8 000 10 500

198 000

2 800

iii. NCI share of equity at 1/7/12 Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve NCI

iv.

48 500

NCI share of equity: 1/7/12 - 30/6/14 Retained earnings (1/7/14) Dr 4 920 NCI Cr (20% ($20 000 + $25 000 - $5000 GR - $1400 depn - ($6000 + $8000) divs)

4 920

General reserve NCI (20% x $5000)

1 000

Dr Cr

1 000

NCI share of profit NCI (20%($30 000 - ($500 + $2500 - $900))

Dr Cr

5 580

General reserve Transfer to general reserve (20% x $6000)

Dr Cr

1 200

Dr Cr

700

Dr Cr

1 000

Dr Cr

1 600

v. NCI share of equity: 1/7/14 - 30/6/15

Transfer from business combination valuation reserve Business combination valuation reserve (20% x 70% x $5000) NCI Dividend paid (20% x $5000) NCI Dividend declared (20% x $8000)

5 580

1 200

700

1 000

1 600

23.30

Chapter 23: Consolidation: Non-controlling interest vi. Dividend paid Dividend revenue Dividend paid (80% x $5000)

Dr Cr

4 000

Dividend payable Dividend declared (80% x $8000)

Dr Cr

6 400

Dividend revenue Dividend receivable

Dr Cr

6 400

4 000

vii. Dividend declared

6 400

2: FULL GOODWILL METHOD At 1 July 2012: Net fair value of identifiable assets and liabilities of Turtle Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Recorded goodwill Unrecorded goodwill Goodwill of Turtle Ltd: Fair value of Turtle Ltd

= = = = = = = =

= =

$49 250/0.2 $246 250

Net fair value of identifiable assets and liabilities of Turtle Ltd = Goodwill of Turtle Ltd = Recorded goodwill = Unrecorded goodwill = Goodwill of Crocodile Ltd: Goodwill acquired Goodwill of Turtle Ltd Goodwill of Crocodile Ltd – control premium

$237 500 $8 750 $5 000 $3 750

= =

$9 750 $8 750

$1 000

23.31

Solutions Manual to accompany Applying IFRS Standards 4e DIFFERENT ENTRIES: Business combination valuation entries Goodwill Business combination valuation reserve

Dr Cr

3 750 3 750

Pre-acquisition entry Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve * Goodwill Shares in Turtle Ltd * $42 000 + 80% x $3750 (goodwill)

Dr Dr Dr Dr Dr Cr

40 000 80 000 32 000 45 000 1 000

Dr Dr Dr Dr Cr

10 000 20 000 8 000 11 250

198 000

NCI share of equity at 1/7/12 Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve * NCI * $10 500 + 20% x $3750

49 250

23.32

Chapter 23: Consolidation: Non-controlling interest Exercise 23.11

CONSOLIDATION WORKSHEET ENTRIES, MULTIPLE YEARS, FULL GOODWILL METHOD

1. Prepare the consolidation worksheet entries as at 1 July 2012. 2. Prepare the consolidation worksheet entries for the year ended 30 June 2013. 3. Prepare the consolidation worksheet entries for the year ended 30 June 2014. 4. Prepare the consolidation worksheet entries for the year ended 30 June 2015. WHALE LTD – GLIDER LTD

60% Whale Ltd

Glider Ltd Whale Ltd NCI

60% 40%

Acquisition analysis At 1/7/12: Net fair value of identifiable assets and liabilities of Glider Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = =

($120 000 + $10 000 + $30 000) (equity) + $10 000 (1 – 30%) (equipment) + $10 000 (1 – 30%) (land) + $5 000 (1 – 30%) (inventory) $177 500 $111 700 $74 100 $185 800 $8 300

= =

$74 100/0.4 $185 250

= =

$177 500 $7 750

= =

$8 300 $7 750

$550

Goodwill of Glider Ltd: Fair value of Glider Ltd Net fair value of identifiable assets and liabilities of Glider Ltd Goodwill of Glider Ltd Goodwill of Whale Ltd: Goodwill acquired Goodwill of Glider Ltd Goodwill of Whale Ltd – control premium

1. Consolidation worksheet entries at 1 July 2012 i. Business combination valuation entries Accumulated depreciation – equipment Equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

10 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

5 000

Goodwill Business combination valuation reserve

Dr Cr

7 750

5 000 3 000 7 000

3 000 7 000

1 500 3 500

7 750 23.33

Solutions Manual to accompany Applying IFRS Standards 4e

ii. Pre-acquisition entry Share capital Retained earnings (1/7/12) General reserve Business combination valuation reserve Goodwill Shares in Glider Ltd iii.

Dr Dr Dr Dr Dr Cr

72 000 18 000 6 000 15 150 550

Dr Dr Dr Dr Cr

12 000 48 000 4 000 10 100

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

10 000

Accumulated depreciation – equipment Equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

15 000

Depreciation expense Accumulation depreciation (20% x $10 000)

Dr Cr

2 000

Deferred tax liability Income tax expense

Dr Cr

600

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

2 500

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

2 500

Goodwill Business combination valuation reserve

Dr Cr

7 750

NCI share of equity at 1 July 2012 Retained earnings (1/7/12) Share capital General reserve Business combination valuation reserve NCI

111 700

74 100

Consolidation Worksheet Entries at 30 June 2013

i. Business combination valuation entries

3 000 7 000

5 000 3 000 7 000

2 000

600

750

1 750

750 1 750

7 750

23.34

Chapter 23: Consolidation: Non-controlling interest ii.

Pre-acquisition entry Retained earnings (1/7/12) Share capital General reserve Business combination valuation reserve Goodwill Shares in Glider Ltd

Dr Dr Dr Dr Dr Cr

18 000 72 000 6 000 15 150 550

Transfer from business combination valuation reserve Business combination valuation reserve (60% x 70% x ½ x $5 000)

Dr Cr

1 050

Dr Dr Dr Dr Cr

12 000 48 000 4 000 10 100

NCI share of profit Dr NCI Cr (40% ($15 000 – ($2 000 - $600) – ($2 500 - $750)))

4 740

111 700

1 050

iii. NCI share of equity at 1 July 2012 Retained earnings (1/7/12) Share capital General reserve Business combination valuation reserve NCI

74 100

iv. NCI share of equity: 1/7/12 – 30/6/13

Transfer from business combination valuation reserve Business combination valuation reserve (40% x ½ x $3 500) 3.

4 740

Dr Cr

700

Depreciation expense Carrying amount of equipment sold Income tax expense Retained earnings (1/7/13) Transfer from business combination valuation reserve

Dr Dr Cr Dr

1 000 7 000

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

10 000

Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

2 500

Goodwill Business combination valuation reserve

Dr Cr

700

Consolidation worksheet entries at 30 June 2014

i. Business combination valuation entries

2 400 1 400

7 000

3 000 7 000

750

1 750 7 750 7 750

23.35

Solutions Manual to accompany Applying IFRS Standards 4e ii. Pre-acquisition entries Retained earnings (1/7/13) * Share capital General reserve Business combination valuation reserve ** Goodwill Shares in Glider Ltd

Dr Dr Dr Dr Dr Cr

19 050 72 000 6 000 14 100 550

Dr Cr

1 050

Dr Cr

4 200

Dr Dr Dr Dr Cr

12 000 48 000 4 000 10 100

Dr Cr Cr

5 440

111 700

* $18 000 + $1 050 ** $15 150 – (½ x 60% x 70% x $5 000) Transfer from business combination valuation reserve Business combination valuation reserve (Sale of inventory: 60% x 70% x ½ x $5 000) Transfer from business combination valuation reserve Business combination valuation reserve (Sale of equipment: 60% x 70% x $10 000)

1 050

4 200

iii. NCI share of equity at 1 July 2012 Retained earnings (1/7/12) Share capital General reserve Business combination valuation reserve NCI

74 100

iv. NCI share of equity: 1/7/12– 30/6/13 Retained earnings (1/7/12) Business combination valuation reserve NCI (RE: 40% ($15 000 – $1400))

700 4 740

v. NCI share of equity: 1/7/13 – 30/6/14 NCI share of profit Dr NCI Cr (40% ($27 000 – ($1000 + $7000 - $2400) – ($2500 - $750)) Transfer from business combination valuation reserve Business combination valuation reserve (40% x [$7000 + $1750])

Dr Cr

7 860 7 860

3 500 3 500

23.36

Chapter 23: Consolidation: Non-controlling interest 4.

Consolidation Worksheet Entries at 30 June 2015

i. Business combination valuation entries

ii.

Land Deferred tax liability Business combination valuation reserve

Dr Cr Cr

10 000

Goodwill Business combination valuation reserve

Dr Cr

7 750

Impairment loss – goodwill Accumulated impairment losses– goodwill

Dr Cr

3 000

Dr Dr Dr Dr Dr Cr

24 300 72 000 6 000 8 850 550

Dr Dr Dr Dr Cr

12 000 48 000 4 000 10 100

Dr Cr Cr

16 800

Dr Cr

4 800

3 000 7 000

7 750

3 000

Pre-acquisition entries Retained earnings (1/7/14)* Share capital General reserve Business combination valuation reserve Goodwill Shares in Glider Ltd

111 700

* $18 000 + 60% ($7000 + $3500)

iii. NCI share of equity at 1 July 2012 Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve NCI

74 100

iv. NCI share of equity: 1/7/12 – 30/6/14 Retained earnings (1/7/14) Business combination valuation reserve NCI (RE: 40% ($15 000 + $27 000) BCVR: 40% x ($7000 + $3500)

4 200 12 600

v. NCI share of equity: 1/7/14 – 30/6/15 NCI share of profit NCI (40% x $12 000)

4 800

23.37

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.12

CONSOLIDATION WORKSHEET, UNRECORDED INTANGIBLE, DIVIDENDS, FULL GOODWILL METHOD

Prepare the consolidated financial statements of Tiger Ltd as at 30 June 2015. TIGER LTD – LION LTD 70% Tiger Ltd

Lion Ltd Tiger Ltd 70% NCI 30%

Acquisition analysis 1 July 2012: Net fair value of identifiable assets and liabilities of Lion Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Recorded goodwill Unrecorded goodwill

Goodwill of Lion Ltd: Fair value of Lion Ltd Fair value of identifiable assets and liabilities of Lion Ltd Goodwill of Lion Ltd Unrecorded goodwill

Goodwill of Tiger Ltd: Goodwill acquired Goodwill of Lion Ltd Goodwill of Tiger Ltd – control premium

= = = = = = = = =

($100 000 + $31 000 + $25 000 + $9 000) (equity) + $15 000 (1 – 30%) (plant) +$20 000 (1 – 30%) (brand) - $10 000 (goodwill) $179 500 $141 950 – (70% x $10 000) $134 950 $57 000 $191 950 $12 450 $10 000 $12 450 – $10 000 $2 450

= =

$57 000/0.3 $190 000

= = = = =

$179 500 $190 000 - $179 500 $10 500 $10 500 – $10 000 $500

= = =

$12 450 $10 500 $1 950

23.38

Chapter 23: Consolidation: Non-controlling interest 1. Business combination valuation entries 30 June 2015 Carrying amount of plant sold Depreciation expense Income tax expense Retained earnings (1/7/14) Transfer from business combination valuation reserve

Dr Dr Cr Dr

6 000 3 000

Brand name Deferred tax liability Business combination valuation reserve

Dr Cr Cr

20 000

Accumulated depreciation - vehicles Vehicles

Dr Cr

17 000

Goodwill Business combination valuation reserve

Dr Cr

500

2 700 4 200

10 500

6 000 14 000

17 000

500

2. Pre-acquisition entries Pre-acquisition entry 1 July 2012 Retained earnings (1/7/12) Share capital General reserve Other components of equity Business combination valuation reserve * Goodwill Shares in Lion Ltd ** * = 70% x $25 000 ** = $141 950 – (70% x $10 000)

Dr Dr Dr Dr Dr Dr Cr

17 500 70 000 21 700 6 300 17 500 1 950

Dividend payable Dividend receivable

Dr Cr

7 000

134 950

7 000

Pre-acquisition entry at 30 June 2015 Retained earnings (1/7/14) * Share capital General reserve Other components of equity (1/7/14) Business combination valuation reserve Goodwill Shares in Lion Ltd * RE: $17 500 -+ 70% x $20 000 (general reserve) Transfer from business combination valuation reserve Business combination valuation reserve (70% x $10 500 - plant)

Dr Dr Dr Cr Dr Dr Cr

31 500 70 000 7 700 6 300 17 500 1 950

Dr Cr

7 350

134 950

7 350

23.39

Solutions Manual to accompany Applying IFRS Standards 4e 3. NCI share of equity at 1 July 2012 Share capital Retained earnings (1/7/13) General reserve Other components of equity Business combination valuation reserve * NCI * = 30% x $25 000

Dr Dr Dr Dr Dr Cr

30 000 7 500 9 300 2 700 7 500

Dr Dr Cr Cr

10 740 600

NCI share of profit NCI (30% [$36 000 – ($6000 + $3000 - $2700)])

Dr Cr

8 910

NCI

Dr Cr

600

Dr Cr

3 150

Dr Cr

2 400

Dr Cr

5 600

57 000

4. NCI share of equity: 1 July 2013 - 30 June 2014 Retained earnings (1/7/14) Other components of equity (1/7/14) General reserve NCI RE: 30% ($65 000 - $25 000) - $4200) GR: 30% ($31 000 - $11 000) OCE: 30% ($11 000 - $9000)

6 000 5 340

5. NCI share of equity: 1 July 2014 - 30 June 2015

Losses on other components of equity (30% [$9000 - $11 000])

Transfer from business combination valuation reserve Business combination valuation reserve (30% x $10 500) NCI Dividend paid (30% x $8000)

8 910

600

3 150

2 400

6. Dividend paid Dividend revenue Dividend paid (70% x $8000)

5 600

23.40

Chapter 23: Consolidation: Non-controlling interest Financial Statements Revenues Expenses

Tiger Lion Ltd Ltd 280 000 190 000 220 000 140 000

Profit before tax Tax expense Profit for period Retained earnings (1/7/14) Transfer from BCVR

60 000

50 000

26 000 34 000 76 000

14 000 36 000 65 000

Dividend paid Retained earnings (30/6/15) Share capital Other comps of equity (op) Gains/losses Other comps of equity (cl) General reserve BCV reserve

6 1 1

Adjustments Dr Cr 5 600 6 000 3 000

2 000 6 000

2 700 1 2

4 200 31 500

7 350

70 000

6 300

37 300 58 100 105 300

10 500

3 150

5 600

166 550 22 400 144 150

130 000 274 150 8 700

Deferred tax liabilities Payables Total equity & liabilities

Financial assets Cash Vehicles Accumulated depreciation Plant & equipment Accumulated depreciation Land Trade marks

5 3 4

8 910 7 500 10 740

49 190 87 060

3 150

2 400

30 000

3 4

2 700 600

0 8 700

7 700

17 500

14 000 500 7 350

136 250 20 000 116 250

100 000 216 250 5 400 600

600 6 000

282 850 47 300

9 300

6 000

222 250 44 000

4 350

7 500

3 150

1 1 2

Total equity: parent Total equity: NCI Total equity

Parent Cr

464 400 369 000

(2 000) 9 000

196 000 202 000 44 000 11 000

NCI Dr

95 400

110 000 101 000 20 000 8 000 90 000 93 000

100 000 100 000 190 000 193 000 4 000 11 000

Group

266 250 5 5 240 000 213 000 --

334 500

6 000

32 000 38 000 372 500

20 000

50 000

22 050 43 000 35 000 50 000 (12 000) (30 000)

17 000 1

17 000

1 1

200 000

(50 000) (75 000)

(125 000)

-80 000

3 4 5

68 250

334 500

65 050 68 000 (25 000)

80 000 120 000

30 000 --

83 400

57 000 5 340 8 910 83 400

6 000

20 000 12 000 20 000 12 000 260 000 225 000

30 000

2 400 600

23.41

Solutions Manual to accompany Applying IFRS Standards 4e Brand name Shares in Lion Ltd Goodwill

-134 950

---

10 000

1 2

Accumulated impairment

(3 000)

260 000 225 000

20 000 134 950

500 1 950

20 000 -12 450 (3 000)

198 600 198 600

372 500

TIGER LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2015 Revenues Expenses Profit before income tax Income tax expense Profit for the period Comprehensive income for the period

$464 400 369 000 95 400 37 300 $58 100 $ 58 100

Profit for the period attributable to: Parent interest Non-controlling interest

$49 190 8 910 $58 100

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

$49 790 $8 310 $58 100

TIGER LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2015 Group $58 100

Parent $49 790

105 300 58 100

87 060 49 190

3 150 (22 400) $144 150

-(20 000) $116 250

Business combination valuation reserve: Balance at 1 July 2014 Transfer to retained earnings Balance at 30 June 2015

7 500 (3 150) $4 350

-___-____-

General reserve: Balance at 1 July 2014 Balance at 30 June 2015

$47 300 $47 300

$44 000 $44 000

Other components of equity: Balance at 1 July 2014 Gains/Losses Balance at 30 June 2015

$8 700 ___0 $8 700

$5 400 _600 $6 000

Share capital: Balance at 1 July 2014

$130 000

$100 000

Comprehensive income for the period Retained earnings: Balance at 1 July 2014 Profit for the period Transfer from business combination valuation reserve Dividend paid Balance at 30 June 2015

23.42

Chapter 23: Consolidation: Non-controlling interest Balance at 30 June 2015

$130 000

$100 000

TIGER LTD Consolidated Statement of Financial Position as at 30 June 2015 ASSETS Current Assets Cash Financial assets Total Current Assets Non-current Assets Property, plant and equipment: Vehicles less Accumulated depreciation Plant and equipment Accumulated depreciation Land Intangible assets: Trade marks Brand name Goodwill Accumulated impairment Total Non-current Assets Total Assets

65 050 50 000 $115 050

$68 000 25 000 200 000 125 000

Equity and Liabilities Equity attributable to equity holders of the parent Share capital Reserves: General reserve Other components of equity Retained earnings Parent Interest Non-controlling Interest Total Equity Current Liabilities Payables Non-current Liabilities Tax liabilities: Deferred tax liability Total Liabilities Total Equity and Liabilities

$43 000 75 000 30 000 80 000 20 000 12 450 (3 000)

148 000

100 000 9 450 257 450 $372 500

$100 000 44 000 6 000 116 250 266 250 68 250 334 500 32 000 6 000 38 000 $372 500

23.43

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.13 CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, FULL GOODWILL METHOD Prepare the consolidated financial statements for the year ended 30 June 2016. CHEETAH LTD – BAT LTD

75% Cheetah Ltd

Bat Ltd Cheetah Ltd 75% NCI 25%

Acquisition analysis At 1 July 2011: Net fair value of identifiable assets and liabilities of Bat Ltd (a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Goodwill of Bat Ltd: Fair value of Bat Ltd Net fair value of identifiable assets and liabilities of Bat Ltd Goodwill of Bat Ltd

= = = = = =

$30 000 + $6 000 (equity) $36 000 $27 600 $9 000 $36 600 $600

= =

$9 000/25% $36 000

= =

$36 000 zero

Goodwill of Cheetah Ltd: Goodwill acquired = Goodwill of Bat Ltd = Goodwill of Cheetah Ltd – control premium =

$600 0 $600

1. Business combination valuation entry No entries necessary 2. Pre-acquisition entry At 1 July 2011: Retained earnings (1/7/11) Share capital Goodwill Shares in Bat Ltd

Dr Dr Dr Cr

4 500 22 500 600

Dr Dr Dr Cr

4 500 22 500 600

27 600

At 30 June 2016: Retained earnings (1/7/15) Share capital Goodwill Shares in Kookabura Ltd

27 600

23.44

Chapter 23: Consolidation: Non-controlling interest 3 NCI share of equity at 1/7/11 Retained earnings (1/7/15) Share capital NCI

Dr Dr Cr

1 500 7 500

Dr Dr Cr

2 125 1 000

9 000

4. NCI share of equity: 1/7/11 - 30/6/15 Retained earnings (1/7/15) Other components of equity (1/7/15) NCI RP: 25% ($14 500 - $6 000) OCE: 25% x $4 000

3 125

5. NCI share of equity: 1/7/15 - 30/6/16 NCI share of profit NCI (25% x $6 500)

Dr Cr

1 625

Gain/Losses: other components of equity NCI (25% x $1000)

Dr Cr

250

NCI

Dr Cr

600

Dr Dr Cr

560 240

Dr Cr

140

Dr Cr Cr

19 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

360

Dr Cr

210

Dividend paid (25% x $2 400)

1 625

250

600

6. Profit in opening inventory: Bat Ltd - Cheetah Ltd Retained earnings (1/7/15) Income tax expense Cost of sales

800

7. NCI adjustment NCI share of profit Retained earnings (1/7/15) (25% x $560)

140

8. Profit in ending inventory: Bat Ltd - Cheetah Ltd Sales

17 800 1 200

360

9. NCI adjustment NCI NCI share of profit (25% x $840)

210

23.45

Solutions Manual to accompany Applying IFRS Standards 4e

10. Debentures 10% Debentures 10% Debentures in Bat Ltd

Dr Cr

2 500

Dr Cr

250

Dr Cr

1 800

2 500

11. Debenture interest Interest revenue Financial expenses

250

12. Dividend paid Dividend revenue Dividend paid (75% x $2 400) Financial Statements Sales revenue Interest rev. Dividend rev. Cost of sales Financial exp. Selling exp. Other exp. Profit before tax Tax expense Profit Retained earnings (1/7/15) Dividend paid Retained earnings (30 /6/16) Share capital

Other comp (op) Gains/losses Other comp (cl) Total equity: parent Total equity: NCI

Cheetah Bat Ltd Ltd 50 000 80 000 250 -1 800 -52 050 80 000 34 000 58 500

8 11 12

1 500 4 000 1 500 41 000 11 050

2 000 6 000 1 500 68 000 12 000

5 000 6 050

5 500 6 500

19 000

14 500

2 6

25 050 2 400 22 650

21 000 2 400 18 600

40 000

30 000

62 650 0 0 0

48 600 4 000 1 000 5 000

Adjustments Dr Cr 19 000 250 1 800

240

Group

800 17 800 250

6 8 11

360

4 500 560

22 500

NCI

Parent

1 625 140 1 500 2 125

210

8 915

140

24 955

600

33 870 2 400 31 470

111 000 --111 000 73 900 3 250 10 000 3 000 90 150 20 850 10 380 10 470 28 440

1 800

5 7 3 4

38 910 3 000 35 910

47 500 83 410 4 000 1 000 5 000

Total equity

62 650

53 600

88 410

Current tax liabilities

8 500

2 900

7 500

4 5

1 000 250

5 9

600 210

14 950

40 000 71 470 3 000 750 3 750 75 220 9 000 3 125 1 625 250 14 950

3 4 5 5

13 190

88 410

23.46

Chapter 23: Consolidation: Non-controlling interest Debentures Total liabilities Total equity and liabilities

-8 500 71 150

5 000 7 900 61 500

2 500

2 500 13 900 102 310

Plant Accum depreciation Shares in Bat Ltd Debentures in Bat Ltd Inventory Cash Financial assets Deferred tax asset Goodwill Total assets

30 000 (17000)

60 000 (30500)

27 600

2 500

12 000 14 050 0

15 500 500 11 000

1 200

26 300 14 550 11 000

2 000

5 000

360

-71 150

-61 500

600 52 310

90 000 (47 500)

7 360 -52 310

600 102 310

CHEETAH LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2016 Revenue Sales revenue Expenses: Cost of sales Financial Selling Other

$111 000

Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: gains Comprehensive income for the period Profit for the period attributable to: Parent interest Non-controlling interest

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

73 900 3 250 10 000 3 000 90 150 20 850 10 380 $10 470 1 000 $11 470

$8 915 1 555 $10 470

$9 665 1 805 $11 470

23.47

Solutions Manual to accompany Applying IFRS Standards 4e CHEETAH LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2016

Comprehensive income for the period

Group $11 470

Parent $9 665

Retained earnings: Balance at 1 July 2015 Profit for the period Dividend paid Balance at 30 June 2016

$28 440 10 470 (3 000) $35 910

$24 955 8 915 (2 400) $31 470

Other components of equity: Balance at 1 July 2015 Gains/losses Balance at 30 June 2016

$4 000 1 000 $5 000

$3 000 750 $3 750

Share capital: Balance at 1 July 2015 Balance at 30 June 2016

$47 500 $47 500

$40 000 $40 000

CHEETAH LTD Consolidated Statement of Financial Position as at 30 June 2016 ASSETS Current Assets Inventories Cash Financial assets Total Current Assets Non-current Assets Property, plant and equipment Plant Accumulated depreciation Tax assets: Deferred tax asset Intangible assets: Goodwill Total Non-current Assets Total Assets Equity and Liabilities Equity attributable to equity holders of the parent Share capital Reserves: Other components of equity Retained earnings Parent Entity Interest Non-controlling Interest Total Equity Current Liabilities: Tax liabilities Non-current Liabilities: Interest-bearing liabilities: Debentures Total Liabilities Total Liabilities and Equity

$26 300 14 550 11 000 51 850

$90 000 (47 500)

42 500 7 360 __600 50 460 $102 310

$40 000 3 750 31 470 75 220 13 190 $88 410 11 400 2 500 $13 900 $102 310

23.48

Chapter 23: Consolidation: Non-controlling interest Exercise 23.14 CONSOLIDATED WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, PARTIAL GOODWILL METHOD 1. 2.

Prepare the consolidation worksheet entries necessary for preparation of the consolidated financial statements for Honeyeater Ltd and its subsidiary for the year ended 30 June 2016. Prepare the consolidated statement of profit or loss and other comprehensive income and statement of changes in equity for Lizard Ltd and its subsidiary at 30 June 2016. LIZARD LTD – HONEYEATER LTD

80% Lizard Ltd

Honeyeater Ltd Lizard Ltd 80% NCI 20%

1. Consolidation worksheet entries Acquisition analysis At 1 July 2015: Net fair value of identifiable assets and liabilities of Honeyeater Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill acquired Unrecorded goodwill

= = = = = = = = =

($250 000 + $10 000 + $10 000 + $15 000) (equity) + $10 000 (1 – 30%) (inventory) + $20 000 (1 –30%) (land) + $20 000 (1 – 30%) (plant) + $10 000 (1 – 30% ) (patent) - $25 000 (goodwill) $302 000 $264 800 20% x $302 000 $60 400 $325 200 $325 200 - $302 000 $23 200 $23 200 – (80% x $25 000) $3 200

i. Business combination valuation entries at 30 June 2016 Cost of sales Income tax expense Transfer from business combination valuation reserve

Dr Cr

Carrying amount of land sold Income tax expense Transfer from business combination valuation reserve

Dr Cr

Trademark Deferred tax liability Business combination valuation reserve

Dr Cr Cr

10 000

Accumulated depreciation - P&E Plant and equipment Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

130 000

Depreciation expense - P&E Dr Accumulated depreciation - P&E ($20 000 /5)

10 000 3 000

7 000 20 000 6 000

14 000

3 000 7 000

110 000 6 000 14 000

4 000 Cr

4 000 23.49

Solutions Manual to accompany Applying IFRS Standards 4e Deferred tax liability Income tax expense

Dr Cr

1 200

Retained earnings (1/7/15) Share capital General reserve Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Honeyeater Ltd

Dr Dr Dr Dr Dr Dr Cr

8 000 200 000 8 000 12 000 33 600 3 200

Transfer from general reserve General reserve (80% x $8000)

Dr Cr

6 400

Transfer from business combination valuation reserve Business combination valuation reserve (Sale of inventory: 80% x $7000)

Dr Cr

5 600

Transfer from business combination valuation reserve Business combination valuation reserve (Sale of land: 80% x $14 000)

Dr Cr

11 200

Dr Dr Dr Dr Dr Cr

2 000 50 000 2 000 3 000 8 400

1 200

ii. Pre-acquisition entry 30/6/16

264 800

6 400

5 600

11 200

iii. NCI share of equity at 1 July 2015 Retained earnings (1/7/15) Share capital General reserve Asset revaluation surplus Business combination valuation reserve NCI

65 400

23.50

Chapter 23: Consolidation: Non-controlling interest iv. NCI share of equity: 1/7/15 – 30/6/16 NCI share of profit Dr NCI Cr (20% ($30 000 – ($10 000 - $3000) – ($20 000 - $6000) – ($4000 – $1200)))

1 240

Transfer from general reserve General reserve (NCI share of reserve transfer)

Dr Cr

1 600

Dr Cr

4 200

Gains/Losses: asset revaluation surplus NCI (20% x $5000)

Dr Cr

1 000

NCI Dr Interim dividend paid (20% x $10 000)

2 000 Cr

2 000

NCI Dr Final dividend declared (20% x $4000)

800 Cr

800

Transfer from business combination valuation reserve Business combination valuation reserve (20% ($7000 + $14 000))

1 240

1 600

4 200

1 000

v. Interim dividend paid Dividend revenue Interim dividend paid (80% x $10 000)

Dr Cr

8 000

Dividend payable Final dividend declared (80% x $4000)

Dr Cr

3 200

Dividend revenue Dividend receivable

Dr Cr

3 200

8 000

vi. Final dividend declared

3 200

vii. Intragroup sales of inventory: Honeyeater Ltd – Lizard Ltd Sales Cost of goods sold Inventory

Dr Cr Cr

8 000

Deferred tax asset Income tax expense

Dr Cr

300

Dr Cr

140

7 000 1 000

300

viii. NCI adjustment NCI NCI share of profit (20% x $700)

140

23.51

Solutions Manual to accompany Applying IFRS Standards 4e ix. Transfer of plant to inventory: Honeyeater Ltd – Lizard Ltd Proceeds on sale of plant Carrying amount of plant sold Inventory

Dr Cr Cr

15 000

Deferred tax asset Income tax expense

Dr Cr

1 500

Dr Cr

700

10 000 5 000

1 500

x. NCI adjustment NCI NCI share of profit (20%($5000 - $1500))

700

23.52

Chapter 23: Consolidation: Non-controlling interest 2. Financial Statements Sales revenue Other income

Cost of sales Other expenses Profit before tax Tax expense

Lizard Ltd

Honeyeater Ltd 200 000 172 000 85 000 35 000

285 000 207 000 162 000 128 000 53 000 31 000

Adjustments Dr Cr

Group

7 5 6 9

8 000 8 000 3 200 15 000

364 000 93 800

1 1 1

10 000 20 000 4 000

Parent Cr

140 700

457 800 293 000 98 000 391 000 66 800

18 000

Profit

50 000

30 000

Retained earnings (1/7/15) Transfer from BCV reserve Transfer from general reserve

30 000

10 000

8 000

2 2 2

5 600 11 200 6 400

80 000 12 000 6 000

48 000 10 000 4 000

18 000 62 000

14 000 34 000

ARS (1/7/15) Gains/Losses ARS (30/6/16)

0 0 0

15 000 5 000 20 000

12 000

BCVR

33 600

Retained earnings (30/6/16)

7 9

215 000 159 000 70 000 48 000 20 000

Dividend paid Dividend declared

7 000 10 000

NCI Dr

3 000 6 000 1 200 300 1 500

7 000 14 000

8 000 3 200

1 1 1 7 9

1 1

5 6

26 000

40 800

1 240

32 000

2 000

30 000

4 200

1 600

78 600 14 000 6 800

2 000 800

8 10

4 4

20 800 57 800

7 000 14 000 5 600 11 200

1 1 2 2

70 400 12 000 6 000 18 000 52 400

3 000 5 000 8 000

3 4

3 000 1 000

4 200

8 400

40 400

0 4 000 4 000 4 200

23.53

Solutions Manual to accompany Applying IFRS Standards 4e LIZARD LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for financial year ended 30 June 2016 Income: Sales revenue Other income

$364 000 93 800 457 800

Expenses: Cost of sales Other Profit before income tax Income tax expense Profit for the period Other comprehensive income: Asset revaluation surplus: gains Comprehensive income for the period Profit for the period attributable to: Parent interest Non-controlling interest Comprehensive income for the period attributable to: Parent interest Non-controlling interest

293 000 98 000 391 000 66 800 26 000 $40 800 5 000 $45 800

$40 400 400 $40 800 $44 400 1 400 $45 800

23.54

Chapter 23: Consolidation: Non-controlling interest LIZARD LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2016

Comprehensive income for the period

Group $45 800

Parent $44 400

Retained earnings: Balance at 1 July 2015 Profit for the period Transfer from general reserve Transfer from business combination valuation reserve Dividend paid Dividend declared Balance at 30 June 2016

$32 000 40 800 1 600 4 200 (14 000) (6 800) $57 800

$30 000 40 400 (12 000) (6 000) $52 400

General reserve: [Assumes no balances in parent entity’s accounts] Balance at 1 July 2015 $2 000 Transfer to retained earnings 1 600 Balance at 30 June 2016 $400

Business combination valuation reserve: Balance at 1 July 2015 Transfer to retained earnings Balance at 30 June 2016

$8 400 4 200 $4 200

Asset revaluation surplus: Balance at 1 July 2015 Gains/losses Balance at 30 June 2016

$3 000 5 000 $8 000

$0 4 000 $4 000

23.55

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.15 CONSOLIDATION WORKSHEET ENTRIES 1. 2.

Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Marine Ltd at 30 June 2017 using the partial goodwill method. Prepare the entries that would change in requirement 1 above if the full goodwill method were used. The fair value of the non-controlling interest at 1 July 2012 was $12 900. MARINE LTD – WHALE LTD 75% Marine Ltd

Whale Ltd Marine Ltd 75% NCI 25%

1: PARTIAL GOODWILL METHOD Acquisition analysis At 1 July 2012: Net fair value of identifiable assets and liabilities of Whale Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

($20 000 + $2 000 + $10 000) (equity) + $10 000 (1 – 30%)(machinery) + $4 000 (1 – 30%) (inventory) - $2 000 (1 – 30%) (receivables) $40 400

= = = =

$40 000 25% x $40 400 $10 100 $50 100

= =

$50 100 - $40 400 $9 700

i. Business combination valuation entries at 30/6/17 Depreciation expense Carrying amount of machinery sold Retained earnings (1/7/16) Income tax expense Transfer from business combination valuation reserve (Depreciation is 20% x $10 000 per annum)

Dr Dr Dr Cr

1 000 1 000 5 600 600

7 000

ii. Pre-acquisition entries at 30/6/17 Pre-acquisition entries at 1/7/12 Retained earnings (1/7/12) Share capital Business combination valuation reserve General reserve Goodwill Shares in Whale Ltd Pre-acquisition entry at 30/6/17: Retained earnings (1/7/16) * Share capital Business combination valuation reserve General reserve Goodwill

Dr Dr Dr Dr Dr Cr

Dr Dr Dr Dr Dr

7 500 15 000 6 300 1 500 9 700 40 000

8 550 15 000 5 250 1 500 9 700 23.56

Chapter 23: Consolidation: Non-controlling interest Shares in Whale Ltd

40 000

* 75%[$10 000 + $2 800 (inventory) – $1 400 (receivables)]

Transfer from business combination valuation reserve Business combination valuation reserve (75% x $7000)

Dr Cr

5 250

Dr Dr Dr Dr Cr

2 500 5 000 2 100 500

Dr Dr Cr Cr

1 100 500

NCI share of profit NCI (25%($15 600 – ($1000 + $1000 - $600)))

Dr Cr

3 550

General reserve Transfer to general reserve (25% x $1000)

Dr Cr

250

Gains/Losses: asset revaluation surplus NCI (25% x $500)

Dr Cr

125

5 250

iii. NCI share of equity at 1/7/12 Retained earnings (1/7/16) Share capital Business combination valuation reserve General reserve NCI

10 100

iv. NCI share of equity: 1/7/12 - 30/6/16 Retained earnings (1/7/16) Asset revaluation surplus (1/7/16) Business combination valuation reserve NCI RE: 25% ($20 000 - $10 000 - $5600) BCVR: 25% (70% [$4000 - $2000]) ARS: 25% x $2000

350 1 250

v. NCI share of equity: 1/7/16 - 30/6/17

Transfer from business combination valuation reserve Business combination val’n reserve (Sale of machinery: 25% x $7000) NCI Interim dividend paid (25% x $8000) NCI Final dividend declared (25% x $4000)

3 550

250

125

Dr Cr

1 750

Dr Cr

2 000

Dr Cr

1 000

1 750

2 000

1 000

23.57

Solutions Manual to accompany Applying IFRS Standards 4e vi. Interim dividend paid Dividend revenue Interim dividend paid (75% x $8000)

Dr Cr

6 000

Dividend payable Final dividend declared (75% x $4000)

Dr Cr

3 000

Dividend revenue Dividend receivable

Dr Cr

3 000

6 000

vii. Final dividend declared

3 000

viii. Profit in closing inventory: Marine Ltd – Whale Ltd Sales

Dr Cr Cr

40 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

120

Dr Cr

39 600 400

120

ix. NCI adjustment NCI NCI share of profit (25% x $280)

x. Sale of non-current asset to inventory in prior period: Marine Ltd– Whale Ltd Retained earnings (1/7/16) Income tax expense Cost of sales

Dr Dr Cr

140 60

Dr Cr

200

xi. NCI adjustment NCI share of profit Retained earnings (1/7/16) (25% x $140)

xii. Sale of non-current asset: Marine Ltd – Whale Ltd Proceeds on sale of non-current assets Carrying amount of plant sold Plant

Dr Cr Cr

2 000

Deferred tax asset Income tax expense

Dr Cr

240

Dr Cr

140

1 200 800

240

xiii. NCI adjustment NCI NCI share of profit (25% x $560)

140

23.58

Chapter 23: Consolidation: Non-controlling interest xiv. Depreciation Accumulated depreciation Depreciation expense (1/2 x 2.5% x $800)

Dr Cr

Income tax expense Deferred tax asset

Dr Cr

1.75

xv. NCI adjustment NCI share of profit NCI (25% x $7)

1.75

2: FULL GOODWILL METHOD Acquisition analysis At 1 July 2012: Net fair value of identifiable assets and liabilities of Whale Ltd

($20 000 + $2 000 + $10 000) (equity) + $10 000 (1 – 30%)(machinery) + $4 000 (1 – 30%) (inventory) - $2 000 (1 – 30%) (receivables) $40 400

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b)

= = =

$40 000 $12 900 $52 900

Goodwill

$12 500

Goodwill of Whale Ltd: Fair value of Whale Ltd

= =

$12 900/25% $51 600

Net fair value of identifiable assets and liabilities of Whale Ltd Goodwill of Whale Ltd

= =

$40 400 $11 200

Goodwill of Marine Ltd: Goodwill acquired Goodwill of Whale Ltd Goodwill of Marine Ltd – control premium

= = =

$12 500 $11 200 $1 300

DIFFERENT ENTRIES 1. Business combination valuation entries at 30/6/17 Goodwill Business combination valuation reserve 2.

Dr Cr

11 200 11 200

Pre-acquisition entry at 30/6/17: Retained earnings (1/7/16) * Dr Share capital Dr Business combination valuation reserve ** Dr General reserve Dr Goodwill Dr Shares in Whale Ltd Cr * 75%[$10 000 + $2800 (inventory) – $1400 (receivables)] ** 75% [$7000 + $11 200] © John Wiley and Sons, Ltd, 2016

8 550 15 000 13 650 1 500 1 300 40 000

23.59

Solutions Manual to accompany Applying IFRS Standards 4e 3. NCI share of equity at 1/7/12 Retained earnings (1/7/16) Share capital Business combination valuation reserve * General reserve NCI * 25% x [$8400 + $11 200]

Dr Dr Dr Dr Cr

2 500 5 000 4 900 500 12 900

Exercise 3.16 CONSOLIDATION WORKSHEET ENTRIES, RECORDED GOODWILL 1.

Prepare consolidated worksheet journal entries for preparing the consolidated financial statements of Penguin Ltd at 30 June 2020 using the full goodwill method. Assume the fair value of the non-controlling interest at 1 July 2017 was $67 000. Prepare the entries that would change in requirement 1 above if the partial goodwill method were used. PENGUIN LTD – ROSS LTD

80% Penguin Ltd

Ross Ltd Penguin Ltd 80% NCI 20%

1: FULL GOODWILL METHOD Acquisition analysis At 1 July 2017: Net fair value of identifiable assets and liabilities of Ross Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Recorded goodwill Unrecorded goodwill Goodwill of Ross Ltd: Fair value of Ross Ltd Net fair value of identifiable assets and liabilities of Ross Ltd Goodwill of Ross Ltd Recorded goodwill Unrecorded goodwill Goodwill of Penguin Ltd: Goodwill acquired Goodwill of Ross Ltd Goodwill of Penguin Ltd

= = = = = = = =

$200 000 + $50 000 + $50 000 (equity) + $15 000 (1 – 30%) (P&M) + $5 000 (1 – 30%) (vehicles) + $5 000 (1 – 30%) (inventory) - $20 000 (goodwill) $297 500 $290 000 – (80% x $20 000) $274 000 $67 000 $341 000 $43 500 $20 000 $23 500

= =

$67 000/20% $335 000

= = = =

$297 500 $37 500 $20 000 $17 500

= = =

$43 500 $37 500 $6 000

23.60

Chapter 23: Consolidation: Non-controlling interest i. Business combination valuation entries At 1 July 2017: Accumulated depreciation - P&M Plant & machinery Deferred tax liability Business combination valuation reserve (Depreciation per annum = $3000)

Dr Cr Cr Cr

125 000

Accumulated depreciation - vehicles Vehicles Deferred tax liability Business combination valuation reserve (Depreciation per annum = $500)

Dr Cr Cr Cr

10 000

Inventory Deferred tax liability Business combination valuation reserve

Dr Cr Cr

5 000

Accumulated depreciation - buildings Buildings

Dr Cr

5 000

Goodwill Business combination valuation reserve

Dr Cr

17 500

110 000 4 500 10 500

5 000 1 500 3 500

1 500 3 500

5 000

17 500

At 30 June 2020: Plant & Machinery not sold Accumulated depreciation - P&M Plant & machinery Deferred tax liability Business combination valuation reserve (Depreciation per annum = $2400)

Dr Cr Cr Cr

95 000

Depreciation expense Retained earnings (1/7/19) Accumulated depreciation - P&M

Dr Dr Cr

2 400 4 800

Deferred tax liability Income tax expense Retained earnings (1/7/19)

Dr Cr Cr

2 160

Dr Dr Dr Cr

300 1 500 840

83 000 3 600 8 400

7 200

720 1 440

Plant & Machinery sold Depreciation expense Carrying amount of P&M sold Retained earnings (1/7/19) Income tax expense Transfer from business combination valuation reserve

540 2 100

23.61

Solutions Manual to accompany Applying IFRS Standards 4e Vehicles Accumulated depreciation - vehicles Vehicles Deferred tax liability Business combination valuation reserve (Depreciation per annum = $500)

Dr Cr Cr Cr

10 000

Depreciation expense - vehicles Retained earnings (1/7/19) Accumulated depreciation - vehicles

Dr Dr Cr

500 1 000

Deferred tax liability Income tax expense Retained earnings (1/7/19)

Dr Cr Cr

450

Dr Cr

5 000

Dr Cr

17 500

Retained earnings (1/7/17) Share capital Asset revaluation surplus Business combination valuation reserve Goodwill Shares in Ross Ltd

Dr Dr Dr Dr Dr Cr

40 000 160 000 40 000 28 000 6 000

Dividend payable Dividend receivable

Dr Cr

16 000

Retained earnings (1/7/19) * Share capital Business combination valuation reserve ** Asset revaluation surplus Goodwill Shares in Ross Ltd ** * $40 000 + (80% x $3 500)BCVR – inventory ** 80% x $31 500

Dr Dr Dr Dr Dr Cr

42 800 160 000 25 200 40 000 6 000

Transfer from asset revaluation surplus Asset revaluation surplus (80% x $10 000)

Dr Cr

8 000

Dr Cr

1 680

5 000 1 500 3 500

1 500

150 300

Buildings Accumulated depreciation - buildings Buildings

5 000

Goodwill Goodwill Business combination valuation reserve

17 500

ii. Pre-acquisition entries At 1 July 2017:

274 000

16 000

At 30 June 2020:

Transfer from business combination valuation reserve Business combination valuation reserve (Transfer on sale of plant: 80% x $2100)

274 000

8 000

1 680

23.62

Chapter 23: Consolidation: Non-controlling interest iii. NCI share of equity at 1 July 2017 Retained earnings (1/7/19) Share capital Asset revaluation surplus Business combination valuation reserve * NCI * (20% x $17 500) + $3500 goodwill

Dr Dr Dr Dr Cr

10 000 40 000 10 000 7 000 67 000

iv. NCI share of equity: 1 July 2017 to 30 June 2019 Retained earnings (1/7/19)* Dr 1 020 Business combination valuation reserve Cr NCI Cr *(20% ($60 000 - $50 000 – ($4800 - $1 440) - $840 – ($1000 - $300)))

700 320

v. NCI share of equity: 1 July 2019 to 30 June 2020 NCI share of profit Dr 4 342 NCI Cr (20% ($25 000 – ($2400 - $720) – ($1500 + $300 - $540) – ($500 - $150)) Asset revaluation surplus NCI (20% x $3000)

Dr Cr

600

Dr Cr

420

Transfer from asset revaluation surplus Asset revaluation surplus (20% x $10 000)

Dr Cr

2 000

General reserve Transfer to general reserve (20% x $20 000)

Dr Cr

4 000

NCI

Dr Cr

1 000

Dr Cr

1 600

Dr Cr

4 000

Dividend payable Dividend declared (80% x $8000)

Dr Cr

6 400

Dividend revenue Dividend receivable

Dr Cr

6 400

Transfer from business combination valuation reserve Business combination valuation reserve (20% x $2100)

Dividend paid (20% x $5000) NCI Dividend declared (20% x $8000)

4 342

600

420

2 000

4 000

1 000

1 600

vi. Dividend paid in current period Dividend revenue Dividend paid (80% x $5000)

4 000

vii. Dividend declared in current period

6 400

6 400 23.63

Solutions Manual to accompany Applying IFRS Standards 4e viii. Unrealised profit in opening inventory: Ross Ltd to Penguin Ltd Retained earnings (1/7/19) Income tax expense Cost of sales

Dr Dr Cr

1 400 600

Dr Cr

280

2 000

ix. NCI adjustment NCI share of profit Retained earnings (1/7/19) (20% x $1400)

280

x. Unrealised profit in closing inventory: Ross Ltd to Penguin Ltd Sales revenue Cost of sales Inventory

Dr Cr Cr

50 000

Deferred tax asset Income tax expense

Dr Cr

300

Dr Cr

140

49 000 1 000

300

xi. NCI adjustment NCI NCI share of profit (20%($1000 - $300))

140

2: PARTIAL GOODWILL METHOD Acquisition analysis At 1 July 2017: Net fair value of identifiable assets and liabilities of Ross Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Unrecorded goodwill

$200 000 + $50 000 + $50 000 (equity) + $15 000 (1 – 30%) (P&M) + $5 000 (1 – 30%) (vehicles) + $5 000 (1 – 30%) (inventory) - $20 000 (goodwill) $297 500

= = = = =

$290 000 – (80% x $20 000) $274 000 20% x $297 500 $59 500 $333 500

= = =

$36 000 $36 000 - (80% x $20 000) $20 000

23.64

Chapter 23: Consolidation: Non-controlling interest i. Business combination valuation entries No entry for goodwill ii. Pre-acquisition entries At 30 June 2020: Retained earnings (1/7/19) * Share capital Business combination valuation reserve ** Asset revaluation surplus Goodwill Shares in Ross Ltd * $40 000 + (80% x $3500)BCVR - inventory ** 80% x $14 000

Dr Dr Dr Dr Dr Cr

42 800 160 000 11 200 40 000 20 000

Dr Dr Dr Dr Cr

10 000 40 000 10 000 3 500

274 000

iii. NCI share of equity at 1 July 2017 Retained earnings (1/7/19) Share capital Asset revaluation surplus Business combination valuation reserve * NCI * 20% x $17 500

63 500

23.65

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.17 BARGAIN PURCHASE, CONSOLIDATION WORKSHEET ENTRIES Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Earthworm Ltd at 30 June 2018. EARTHWORM LTD – EAGLE LTD

70% Earthworm Ltd

Acquisition analysis At 1 July 2014: Net fair value of identifiable assets and liabilities of Eagle Ltd

Eagle Ltd Earthworm Ltd 70% NCI 30%

($100 000 + $20 000 + $52 000)(equity) + $4 000 (1 – 30%) (plant) + $1 000 (1 – 30%) (vehicles) + $4 000 (1 – 30%) (inventory)

- $2000 (1 – 30%) (receivables) =

– $3 500 (goodwill) $173 400

Aggregate of (a) and (b)

= = = =

$119 380 30% x $173 400 $52 020 $171 400

Gain on bargain purchase

$2 000

(a) Consideration transferred (b) Non-controlling interest

1. Business combination valuation entries Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

34 000

Depreciation expense Retained earnings (1/7/17) Accumulated depreciation

Dr Dr Cr

500 1 500

Deferred tax liability Income tax expense Retained earnings (1/7/17)

Dr Cr Cr

600

Cost of vehicles sold Depreciation expense Retained earnings (1/7/17) Income tax expense Transfer from business combination valuation reserve Accumulated depreciation Furniture & fittings

Dr Dr Dr Cr

200 200 420

30 000 1 200 2 800

2 000

150 450

120

Cr Dr Cr

700 25 500 25 500

23.66

Chapter 23: Consolidation: Non-controlling interest 2. Pre-acquisition entries Entry at 1 July 2014 Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve Goodwill Shares in Eagle Ltd Gain on bargain purchase

Dr Dr Dr Dr Cr Cr Cr

36 400 70 000 14 000 3 430

Dividend payable Dividend receivable

Dr Cr

3 500

Dr Dr Dr Dr Cr Cr

24 880 77 000 17 500 2 450

2 450 119 380 2 000

3 500

Entry at 30 June 2018 Retained earnings (1/7/17) * Share capital General reserve ** Business combination valuation reserve *** Goodwill Shares in Eagle Ltd ***

2 450 119 380

* $24 880 = $36 400 - $15 000 (2016 transfer) + $1 960 (inventory) - $980 (accounts receivable) - $2000 (gain on bargain purchase) ** $17 500 = $14 000 - $7000 (bonus) + $15 000 (2016 transfer) *** $2450 = 70%($2800 + $700) Transfer from general reserve General reserve (70% x $10 000)

Dr Cr

7 000

Dr Cr

490

Dr Dr Dr Dr Cr

15 600 30 000 6 000 1 470

Dr Cr

3 000

General reserve Dr Retained earnings (1/7/17) Dr Business combination val’n reserve Cr NCI Cr (GR: 30% x $15 000 RE: 30% [$66 800 - $52 000 – ($1500 - $450) - $420] BCVR: 30% x 70%($4000 - $2000))

4 500 3 999

Transfer from business combination valuation reserve Business combination valuation reserve (70% x $700) 3. NCI share of equity at 1 July 2014 Retained earnings (1/7/17) Share capital General reserve Business combination valuation reserve NCI

7 000

490

53 070

4. NCI share of equity: 1/7/14 - 30/6/17 Share capital General reserve (30% x $10 000 bonus issue)

3 000

420 8 079

23.67

Solutions Manual to accompany Applying IFRS Standards 4e 5. NCI share of equity: 1/7/17 - 30/6/18 NCI share of profit NCI

Dr Cr

6 291 6 291

(30% [$21 600 – ($500 - $150) – ($200 + $200 - $120)]) Transfer from general reserve General reserve (30% x 10 000)

Dr Cr

3 000

Dr Cr

210

Dr Cr

2 400

Dr Cr

4 800

Dr Cr

5 600

Dividend revenue Dividend receivable

Dr Cr

11 200

Dividend payable Dividend declared (70% $16 000)

Dr Cr

11 200

Transfer from business combination valuation reserve Business combination val’n reserve (30% x $700)

NCI Dividend paid (30% x $8000) NCI Dividend declared (30% x $16 000)

3 000

210

2 400

4 800

6. Dividend paid Dividend revenue Dividend paid (70% x $8000)

5 600

7. Dividend declared

11 200

23.68

Chapter 23: Consolidation: Non-controlling interest Exercise 23.18 CONSOLIDATION WORKSHEET, REVALUATION IN SUBSIDIARY’S RECORDS, PARTIAL GOODWILL METHOD 1. 2.

Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Gabby Ltd at 30 June 2018. Prepare the consolidated statement of profit or loss and other comprehensive income and statement of changes in equity at 30 June 2018. GABBY LTD – MOON LTD

80% Gabby Ltd

Moon Ltd Gabby Ltd 80% NCI 20%

1. Acquisition analysis At 1 July 2016: Net fair value of assets and liabilities of MoonLtd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

($150 000 + $30 000 + $20 000) (equity) + $10 000 (1 – 30%) plant + $40 000 (1 – 30%) land $235 000 $198 000 20% x $235 000 $47 000 $245 000 $10 000

i. Pre-acquisition entries at 30/6/18 Retained earnings (1/7/17) * Share capital Asset revaluation surplus General reserve Goodwill Shares in Moon Ltd * = 80% ($20 000 + $10 000 transfer)

Dr Dr Dr Dr Dr Cr

24 000 120 000 28 000 16 000 10 000

Transfer from asset revaluation surplus Asset revaluation surplus

Dr Cr

22 400

Dr Dr Dr Dr Cr

4 000 30 000 7 000 6 000

Dr Dr Cr Cr

8 000 3 000

198 000

22 400

ii. NCI share of equity at 1/7/16 Retained earnings (1/7/17) Share capital Asset revaluation surplus General reserve NCI iii. NCI share of equity: 1/7/16-30/6/17 Retained earnings (1/7/17) Asset revaluation surplus General reserve NCI (RE: 20% ($60 000 - $20 000) GR: 20% x $10 000 ARS: 20% [$50 000 - $35 000])

47 000

2 000 9 000

23.69

Solutions Manual to accompany Applying IFRS Standards 4e iv. NCI share of equity: 1/7/17-30/6/18 NCI share of profit NCI (20% x $80 000)

Dr Cr

16 000

Transfer from asset revaluation surplus Asset revaluation surplus (20% x $28 000)

Dr Cr

5 600

Gains/Losses: asset revaluation surplus NCI (20% x $5000)

Dr Cr

1 000

General reserve Transfer to general reserve (20% x $15 000)

Dr Cr

3 000

NCI

Dr Cr

3 000

Dr Cr

4 000

Dr Cr

12 000

Dividend payable Dividend declared (80% x $20 000)

Dr Cr

16 000

Dividend revenue Dividend receivable

Dr Cr

16 000

Dividend paid (20% x $15 000) NCI Dividend declared (20% x $20 000) v.

5 600

1 000

3 000

4 000

Dividend paid this period Dividend revenue Dividend paid (80% x $15 000)

vi.

16 000

12 000

Dividend declared this period

16 000

vii. Unrealised profit in opening inventory: Moon Ltd to Gabby Ltd Retained earnings (1/7/17) Income tax expense Cost of sales (Unrealised profit is 10% x $2000)

Dr Dr Cr

140 60 200

viii. NCI adjustment NCI share of profit Retained earnings (1/7/17) (20% x $140)

Dr Cr

28 28

ix. Unrealised profit in closing inventory: Moon Ltd to Gabby Ltd Sales revenue Cost of sales Inventory

Dr Cr Cr

35 000

Deferred tax asset Income tax expense

Dr Cr

900

32 000 3 000

900 23.70

Chapter 23: Consolidation: Non-controlling interest x. NCI adjustment NCI

Dr Cr

NCI share of profit (20% x $2100)

420 420

xi. Sale of inventory to non-current asset: Moon Ltd to Gabby Ltd Retained earnings (1/7/17) Deferred tax asset Plant

Dr Dr Cr

7 000 3 000

Dr Cr

1 400

Accumulated depreciation Depreciation expense Retained earnings (1/7/17) (Depreciation of 20% x $10 000 p.a.)

Dr Cr Cr

3 000

Income tax expense Retained earnings (1/7/17) Deferred tax asset

Dr Dr Cr

600 300

Dr Dr Cr

280 140

10 000

xii. NCI adjustment NCI Retained earnings (1/7/17) (20% x $7000)

1 400

xiii. Depreciation on plant

2 000 1 000

900

xiv. NCI adjustment NCI share of profit Retained earnings (1/7/17) NCI (20% x ($2000 - $600) p.a.)

420

23.71

Solutions Manual to accompany Applying IFRS Standards 4e Financial Statements Sales revenue Other revenue

Gabby Moon Ltd Ltd 920 000 780 000 65 000 82 000

Cost of sales

985 000 862 000 622 000 580 000

Other expenses Profit before tax Tax expense Profit

110 000

80 000

Retained earnings (1/7/17)

80 000

60 000

28 000

Ret. earnings (30/6/18)

Group

7 9 13

7 13

60 600

900

50 000

Transfer to RE Gains/losses ARS (30/6/18)

0 0

(28 000) 5 000 27 000

383 000

69 760 161 440

1 7 11 13 1

24 000 140 7 000 300 22 400

1 000

109 560

5 600

12 000 16 000

5 6

45 000 50 000 145 000 118 000

1 784 000 1 169 800

1 552 800 231 200

15 000 20 000

ARS (1/7/17)

Parent Cr

1 665 000 119 000

190 000 168 000 - 15 000 20 000 25 000

NCI Dr

845 000 742 000 140 000 120 000 40 000

Transfer to general reserve Dividend paid Dividend declares

200 32 000 2 000

223 000 162 000

30 000

Transfer from ARS

9 5 6

Adjustments Dr Cr 35 000 12 000 16 000

4 8 14 2 3 14

16 000 28 280 4 000 8 000 140

5 600

420

1 0

145 552

28 1 400

8 1 2

98 848

276 600 15 000

3 000

244 400 12 000

23 000 29 000

3 000 4 000

4 4

20 000 25 000

67 000 209 600

28 000

22 000 22 400

(5 600) 5 000 21 400

57 000 187 400

2 3

7 000 3 000

1 000

12 000 5 600

0 4 000 16 000

23.72

Chapter 23: Consolidation: Non-controlling interest 2. GABBY LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2018 Income: Sales Other

$1 665 000 119 000 1 784 000

Expenses: Cost of sales Other

1 169 800 383 000 1 552 800 231 200 69 760 $161 440

Profit before income tax Income tax expense Profit for the period Other comprehensive income; Revaluation of assets: gains Comprehensive income for the period

5 000 $166 440

Profit for the period attributable to: Parent interest Non-controlling interest

$145 552 $15 888

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

$149 552 $16 888

GABBY LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2018

Comprehensive income for the period

Group $166 440

Parent $149 552

Retained earnings: Balance at 1 July 2017 Profit for the period Transfer from asset revaluation surplus Transfer to general reserve Dividend paid Dividend declared Balance at 30 June 2018

$109 560 161 440 5 600 (15 000) (23 000) (29 000) $209 600

$98 848 145 552 (12 000) (20 000) (25 000) $187 400

General reserve: [Assumes no balances in parent entity’s accounts] Balance at 1 July 2017 $4 000 Transfer to retained earnings 15 000 Balance at 30 June 2018 $19 000

$12 000 $12 000

Asset revaluation surplus: [Assumes no balances in parent entity’s accounts] Balance at 1 July 2017 $22 000 Increment 5 000 Transfer to retained earnings (5 600) Balance at 30 June 2018 $21 400

12 000 4 000 _____$16 000

23.73

Solutions Manual to accompany Applying IFRS Standards 4e Exercise 23.19 CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, FULL GOODWILL METHOD Prepare the consolidated financial statements for Spider Ltd and its subsidiary, Bird Ltd, for the year ended 30 June 2016. SPIDER LTD – BIRD LTD

80% Spider Ltd

Bird Ltd Spider Ltd 80% NCI 20%

Acquisition analysis At 1 July 2013: Net fair value of assets and liabilities of Bird Ltd =

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill Goodwill of Bird Ltd: Fair value of Bird Ltd Net fair value of identifiable assets and liabilities of Bird Ltd Goodwill of Bird Ltd Goodwill of Spider Ltd: Goodwill acquired Goodwill of Bird Ltd Goodwill of Spider Ltd: control premium

= = = = =

$100 000 + $3 000 + $37 000 (equity) + $5 000 (1 – 30%) (plant) + $8 000 (1 – 30%) (land) $149 100 $131 600 $31 500 163 100 $14 000

= =

$31 500/20% $157 500

= =

$149 100 $8 400

= =

$14 000 $8 400

$5 600

1. Business combination valuation entries At 30 June 2016: Accumulated depreciation Plant Deferred tax liability Business combination valuation reserve

Dr Cr Cr Cr

25 000

Depreciation expense Retained earnings (1/7/15) Accumulated depreciation ($5000/10 = $500 p.a.) Deferred tax liability Income tax expense Retained earnings (1/7/15)

Dr Dr Cr

500 1 000

Dr Cr Cr

450

Goodwill Business combination valuation reserve

Dr Cr

8 400

20 000 1 500 3 500

1 500

150 300

8 400

23.74

Chapter 23: Consolidation: Non-controlling interest 2.

Pre-acquisition entries Retained earnings (1/7/15)* Share capital General reserve Business combination valuation reserve ** Goodwill Shares in Bird Ltd

Dr Dr Dr Dr Dr Cr

34 080 80 000 2 400 9 520 5 600 131 600

* = (80% x $37 000) + $4480 transfer from BCVR (land) ** 80% x ($3500 + $8400) 3.

NCI share of equity at 1/7/13 Retained earnings (1/7/15) Share capital General reserve Business combination valuation reserve * NCI * 20% x ($9100 + $8400)

Dr Dr Dr Dr Cr

7 400 20 000 600 3 500

Dr Dr Dr Cr Cr

1 460 1 400 1 600

NCI share of profit NCI (20% ($18 000 – ($500 - $150)))

Dr Cr

3 530

Gains/Losses: other components of equity NCI (20%[$10 000 - $8000])

Dr Cr

400

NCI

Dr Cr

2 000

Dr Cr

1 000

NCI share of equity: 1/7/13 - 30/6/15 Retained earnings (1/7/15) General reserve Other components of equity (1/7/15) Business combination valuation reserve NCI (RE: 20% ($45 000 - $37 000 – ( $1 000 - $300)) GR: 20% ($10 000 - $3 000) BCVR: 20% x $5600 OCE: 20% x $8000)

31 500

1 120 3 340

NCI share of equity: 1/7/15 - 30/6/16

Interim dividend paid (20% x $10 000) NCI Final dividend declared (20% x $5000)

3 530

400

2 000

1 000

6. Unrealised profit in opening inventory: Spider Ltd to Bird Ltd Retained earnings (1/7/15) Income tax expense Cost of sales

Dr Dr Cr

1 750 750 2 500

23.75

Solutions Manual to accompany Applying IFRS Standards 4e 7. Unrealised profit in closing inventory: Bird Ltd to Spider Ltd Sales

Dr Cr Cr

60 000

Cost of sales Inventory Deferred tax asset Income tax expense

Dr Cr

1 500

Dr Cr

700

55 000 5 000

1 500

8. NCI adjustment NCI NCI share of profit (20% x $3500)

700

9. Inventory to non-current asset transfer: Bird Ltd – Spider Ltd The sale occurred in the previous period. Retained earnings (1/7/15) Deferred tax asset Plant

Dr Dr Cr

3 500 1 500

Dr Cr

700

5 000

10. NCI adjustment NCI Retained earnings (1/7/15) (20% x $3500) 11.

700

Depreciation on inventory to non-current asset transfer Prior Period: Recorded

20% x 1/2 x $20 000 = $2 000

Group Difference

= =

20% x 1/2 x $15 000 = $1 500 $500

Current Period Recorded Group Difference

= = =

20% x $20 000 = $4 000 20% x $15 000 = $3 000 $1 000

Accumulated depreciation Depreciation expense Retained earnings (1/7/15)

Dr Cr Cr

1 500

Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

300 150

Dr Dr Cr

140 70

1 000 500

450

12. NCI adjustment NCI share of profit Retained earnings (1/7/15) NCI

210

23.76

Chapter 23: Consolidation: Non-controlling interest 13. Intragroup services Management and consulting fees Administrative expenses Manufacturing expenses

Dr Cr Cr

5 000

Debentures Debentures in Bird Ltd

Dr Cr

100 000

Debenture interest revenue Financial expenses

Dr Cr

5 000

Dr Cr

8 000

Dividend payable Final dividend declared (80% x $5000)

Dr Cr

4 000

Dividend from Bird Ltd Dividend receivable

Dr Cr

4 000

2 200 2 800

14. Debentures

100 000

5 000

15. Dividend paid Dividend from Bird Ltd Interim Dividend Paid (80% x $10 000)

8 000

16. Dividend declared

4 000

23.77

Solutions Manual to accompany Applying IFRS Standards 4e Financial Statements Sales revenue Interest revenue Management fees Dividend revenue Total revenues Cost of sales

Spider Bird Ltd Ltd 316 000 220 000 5 000 --

Manufacturing expenses Depreciation Administrative Financial Other Total expenses Profit before tax Tax expense

90 000

15 000 15 000 15 000 8 000 11 000 5 000 14 000 12 000 275 000 185 000 63 000 35 000

25 000

17 000

6 11

Profit for period

38 000

18 000

Retained earnings (1/7/15)

50 000

45 000

88 000 3 000

63 000 --

10 000 10 000 23 000 65 000

10 000 5 000 15 000 48 000

Transfer to gen. reserve Dividend paid Div. declared Retained earnings (30/6/16) Share capital General reserve

Other comp (op) Gains/losses Other comp (cl) BCVR

7 14

Adjustments Dr Cr 60 000 5 000

Group

5 000

12 000

15 16

8 000 4 000

6 7 13

500

1 000 2 200 5 000

11 13 14

29 500 20 800 11 000 26 000 392 000 84 000

750 300

150 1 500

1 7

41 400

300 000 100 000 50 000 10 000

1 000 34 080 1 750 3 500 150

300 500

1 11

55 320

8 000 4 000

2 2

15 16

39 630

700

47 090

80 000 2 400

320 000 57 600 449 520

10 000 8 000 3 000 2 000 13 000 10 000 428 000 168 000 ---

18 000 5 000 23 000 472 520 2 380

9 520

3 500 8 400

1 1

86 720 3 000

12 000 11 000 26 000 71 920

415 000 158 000

428 000 168 000 25 000 17 000

5 12 3 4 12

97 920 3 000

Parent interest NCI

Current tax liability

700

147 200

42 600 1 2 6 9 11

3 530 140 7 400 1 460 70

476 000 157 500

2 500 55 000 2 800

60 000

Parent Cr

476 000 --

5 000

338 000 220 000 130 000 85 000

NCI Dr

474 900 42 000

2 000 1 000

3 3 4

5 5

20 000 600 1 400

10 000 10 000 23 000 63 720

300 000 55 600 419 320

4 5

1 600 400

3 500

1 120

5 5 8 10

2 000 1 000 700 700

31 500 3 340 3 530 400 210 44 500

3 4 5 5 12

44 500

16 400 4 600 21 000 440 320 0 440 320 34 580

474 900

23.78

Chapter 23: Consolidation: Non-controlling interest Deferred tax liability Dividend payable Debentures Other liabilities Total equity and liabilities

7 000

450

1 500

10 000

5 000

4 000

11 000

200 000 100 000

100 000

200 000

90 000 12 000 325 000 141 000 753 000 309 000

Debentures in Bird Ltd Shares in Bird Ltd Plant

100 000

131 600

Accum. depreciation Other deprec. assets Accumulated depreciation Inventory Financial assets Deferred tax asset Land Div. rec'able Goodwill

(65 000) (55 000)

Total assets

753 000 309 000

102 000 363 050 837 950

120 000 102 000

76 000

8 050

1 11

25 000 1 500

100 000 131 600 20 000 5 000 1 500

1 9 1

197 000 (95 000)

55 000

131 000

(40 000) (25 000)

(65 000)

90 000 50 000

85 000 60 000

85 400

30 000

201 000 4 000 --

57 000 ---

7 9

1 2

1 500 1 500

5 000

170 000 110 000

450

117 950

4 000

258 000 -14 000

8 400 5 600 363 900 363 900

837 950

23.79

Solutions Manual to accompany Applying IFRS Standards 4e SPIDER LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 30 June 2016 Revenue: Sales Expenses: Cost of sales

$476 000 157 500

Manufacturing

147 200

Depreciation Administrative Financial Other

29 500 20 800 11 000 26 000 392 000 84 000 41 400 $42 600

Profit before income tax Income tax expense Profit for the period Other comprehensive income: Other components of equity: gains Comprehensive income for the period

5 000 $ 47 600

Profit for the period attributable to: Parent entity interest Non-controlling interest

$39 630 $2 970

Comprehensive income for the period attributable to: Parent interest Non-controlling interest

$44 230 $3 370

SPIDER LTD Consolidated Statement of Changes in Equity for the financial year ended 30 June 2016

Comprehensive income for the period

Group $47 600

Parent $44 230

Retained earnings: Balance at 1 July 2015 Profit for the period Transfer to general reserve Dividend paid Dividend declared Balance at 30 June 2016

$55 320 42 600 (3 000) (12 000) (11 000) $71 920

$47 090 39 630 (3 000) (10 000) (10 000) $63 720

General reserve: Balance at 1 July 2015 Transfer from retained earnings Balance at 30 June 2016

$54 600 3 000 $57 600

$52 600 3 000 $55 600

Business combination valuation reserve Balance at 1 July 2015 Balance at 30 June 2016

$2 380 $2 380

---

Other components of equity: Balance at 1 July 2015 Gains/Losses Balance at 30 June 2016

$18 000 5 000 $23 000

$16 400 $4 600 $21 000

23.80

Chapter 23: Consolidation: Non-controlling interest SPIDER LTD Consolidated Statement of Financial Position as at 30 June 2016 Current Assets Inventories Financial assets

$170 000 110 000 280 000

Non-current Assets Property, plant and equipment Plant Accumulated depreciation Land Other depreciable assets Accumulated depreciation Tax assets: Deferred tax asset Goodwill Total Non-current Assets Total Assets

197 000 (95 000) 258 000 360 000 131 000 (65 000) 117 950 14 000 557 950 $837 950

Equity and liabilities Equity attributable to equity holders of the parent Share capital Reserves: General reserve Other components of equity Retained earnings Parent Entity Interest Non-controlling Interest Total Equity Current Liabilities Tax liabilities: Current tax liability Payables: Dividend payable Other Total Current Liabilities Non-current Liabilities Interest-bearing liabilities: Debentures Tax liabilities: Deferred tax liability Total Non-current Liabilities Total Liabilities Total Equity and Liabilities

$300 000 55 600 21 000 63 720 440 320 34 580 474 900

42 000 11 000 102 000 155 000 200 000 8 050 208 050 363 050 $837 950

23.81

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 23 Consolidation: non-controlling interest

Chapter 23 Consolidation: non-controlling interest Learning Objectives 23.1 23.2 23.3 23.4 23.5

Discuss the nature of the non-controlling interest (NCI) Explain the effects of the NCI on the consolidation process Explain how to calculate the NCI share of equity Explain how the calculation of the NCI is affected by the existence of intragroup transactions Explain how the NCI is affected by the existence of a gain on bargain purchase.

23.1

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1. A non-controlling interest (NCI) is a contributor of: Learning Objective 23.1 Discuss the nature of the non-controlling interest (NCI) *a. equity to a consolidated group; b. debt to a consolidated group; c. assets to a consolidated group; d. profit to a consolidated group. 2. According to IFRS 10, the term ‘non-controlling interest’ means: Learning Objective 23.1 Discuss the nature of the non-controlling interest (NCI) a. the total equity of the combined group b. the equity in the parent entity other than the portion owned by the subsidiary entity c. the equity in the economic entity other than that which can be attributed to the subsidiary entity *d. equity in a subsidiary not attributable, directly or indirectly, to a parent.

3. According to IFRS 10, NCI is classified as: Learning Objective 23.1 Discuss the nature of the non-controlling interest (NCI) a. part of the equity of the parent entity *b. part of the equity of the group c. a liability of the parent entity d. a liability of the group.

When preparing and presenting a consolidated statement of comprehensive income the NCI is: Learning Objective 23.1 Discuss the nature of the non-controlling interest (NCI) a. presented as a separate component of revenue b. shown as a separate component of profit before tax and a separate component of tax expense c. shown as a separate component of each line item *d. presented as a separate portion of profit or loss.

5. In a consolidated statement of financial position, the NCI is shown: Learning Objective 23.1 Discuss the nature of the non-controlling interest (NCI) a. separately within the non-current liabilities b. separately within the non-current investments *c. separately within the equity section d. as part of the total current liabilities of the group.

23.2

Chapter 23 Consolidation: non-controlling interest

When preparing a consolidated statement of changes in equity, IFRS 10 requires that any NCI in equity of subsidiaries is: Learning Objective 23.1 Discuss the nature of the non-controlling interest (NCI) a. shown as a one-line item b. disclosed in the statement of financial position, and not in the statement of changes in equity c. shown as a share of total ending equity of the subsidiary only *d. shown on a line-by-line basis.

A NCI is entitled to a share of: I Equity of the parent at acquisition date II Current period profit or loss of the subsidiary entity III Changes in equity of the subsidiary since acquisition date and the beginning of the financial period IV Equity of the subsidiary at acquisition date Learning Objective 23.1 Discuss the nature of the non-controlling interest (NCI) a. I, II and III b. I and II only *c. II, III and IV only d. III only. Xin Limited paid €12 000 for 75% of Yan Limited. At the date of acquisition Yan Limited had equity as follows: ➢ Share capital of €10 000 ➢ Retained earnings of €5000 ➢ Other reserves of €3000 All of Yan Limited’s assets and liabilities were recorded at fair value. The fair value of identifiable net assets acquired by Xin Limited amounted to: Learning Objective 23.2 Explain the effects of the NCI on the consolidation process a. €9750 b. €12 000 *c. €13 500 d. €18 000 8.

When preparing a set of consolidated financial statements, the pre-acquisition entry relates to: Learning Objective 23.2 Explain the effects of the NCI on the consolidation process a. both the parent and the NCI in the subsidiary; *b. only the investment by the parent in the subsidiary; c. only the investment by the NCI in the subsidiary; d. the total investment by the parent in the subsidiary plus the after tax effect of the investment by the NCI.

23.3

Test Bank to accompany Applying IFRS Standards 4e

10.

Company A Limited owns 70% of the share capital of Company B Limited. Company B Limited paid a dividend of £10 000 during the financial period. The adjustment entries in the consolidation worksheet for the dividend include: Learning Objective 23.2 Explain the effects of the NCI on the consolidation process: *a. DR Dividend revenue £7 000; b. DR Dividend revenue £10 000; c. DR Dividend payable £7 000; d. DR Dividend payable £10 000.

11.

Lu Nan Limited acquired 80% of the share capital and reserves of Hui Limited for £20 000. Share capital was £10 000 and reserves amounted to £6000. All assets and liabilities were recorded at fair value except plant which was recorded at £1000 below fair value. The company tax rate was 30%. The partial goodwill method is adopted by the group. The amount of goodwill acquired by Lu Nan Limited in this business combination was: Learning Objective 23.2 Explain the effects of the NCI on the consolidation process a. £4000 *b. £6640 c. £7200 d. £13 360.

12.

Jiminez Limited acquired 80% of the share capital and reserves of Mustang Limited for £180 000. Share capital was £100 000 and reserves amounted to £50 000. All assets and liabilities were recorded at fair value except buildings which was recorded at £10 000 below fair value. The fair value of the NCI at the date of Jiminez’s acquisition was £35 000 and the full goodwill method is adopted by the group. If the company tax rate was 30%, the goodwill recorded in relation to this business combination amounts to: Learning Objective 23.2 Explain the effects of the NCI on the consolidation process a. £3 600 b. £23 000 c. £54 400 *d. £58 000.

13.

Jiminez Limited acquired 80% of the share capital and reserves of Mustang Limited for £180 000. Share capital was £100 000 and reserves amounted to £50 000. All assets and liabilities were recorded at fair value except buildings which was recorded at £10 000 below fair value. The fair value of the NCI at the date of Jiminez’s acquisition was £35 000 and the partial goodwill method is adopted by the group. If the company tax rate was 30%, the goodwill recorded in relation to this business combination amounts to: Learning Objective 23.2 Explain the effects of the NCI on the consolidation process a. £3 600 b. £23 000 *c. £54 400 d. £58 000.

23.4

Chapter 23 Consolidation: non-controlling interest

14.

Jiminez Limited acquired 80% of the share capital and reserves of Mustang Limited for $180 000. Share capital was $100 000 and reserves amounted to $50 000. All assets and liabilities were recorded at fair value except buildings which was recorded at $10 000 below fair value. The fair value of the NCI at the date of Jiminez’s acquisition was $35 000. If the company tax rate was 30%, and the partial goodwill method was adopted, the NCI share of equity at the date of acquisition was: Learning Objective 23.3 Explain how to calculate the NCI share of equity a. $30 000 *b. $31 400 c. $35 000 d. $43 000.

15.

Jiminez Limited acquired 80% of the share capital and reserves of Mustang Limited for $180 000. Share capital was $100 000 and reserves amounted to $50 000. All assets and liabilities were recorded at fair value except buildings which was recorded at $10 000 below fair value. The fair value of the NCI at the date of Jiminez’s acquisition was $35 000. If the company tax rate was 30%, and the full goodwill method was adopted, the NCI share of equity at the date of acquisition was: Learning Objective 23.3 Explain how to calculate the NCI share of equity a. $30 000 b. $31 400 *c. $35 000 d. $43 000.

16.

Petros Limited is a subsidiary of Butros Limited. When Butros acquired its 60% interest, the retained earnings of Petros Limited were $20 000. At the beginning of the current period Petros Limited’s retained earnings had increased to $50 000. Petros earned profit of $10 000 during the current period. The share of the NCI in the closing retained earnings of Petros Limited at reporting date is: Learning Objective 23.3 Explain how to calculate the NCI share of equity a. $20 000 *b. $24 000 c. $32 000 d. $36 000

17.

During the current year a partly owned subsidiary has made a transfer from retained earnings to a general reserve. Which of the following lines would appear in the NCI journal relating to the current year transfer? Learning Objective 23.3 Explain how to calculate the NCI share of equity a. DR NCI b. DR Retained earnings c. CR General reserve *d. CR Transfer to general reserve

23.5

Test Bank to accompany Applying IFRS Standards 4e

18.

A NCI in a subsidiary entity is entitled to a share of the following items:

Subsidiary equity at acquisition date Changes in equity since acquisition date Changes in equity of the current period

I II III Yes Yes Yes Yes No No No Yes No

IV Yes Yes Yes

Learning Objective 23.3 Explain how to calculate the NCI share of equity a. I; b. II; c. III; *d. IV.

19.

P Ltd paid $169 600 for 80% of the shares of S Ltd on 1 July 2013. All identifiable assets and liabilities of the subsidiary were recorded at fair value, except for land for which the fair value was $10 000 greater than cost. The tax rate is 30%. The NCI in S Ltd was considered to have a fair value of $42 000 and the group applies the full goodwill method. At acquisition date, the equity of S Ltd consisted of: ➢ Share capital $100 000 ➢ General reserve $60 000 ➢ Retained earnings $40 000 The control premium paid by P Ltd is: Learning Objective 23.3 Explain how to calculate the NCI share of equity a. $600 *b. $1600 c. $3000 d. $4600

20.

A Ltd holds a 60% interest in B Ltd. On 1 January 2014 B Ltd paid an interim dividend of €25 000 and on 30 June 2014 B Ltd declared a final dividend of €15 000. The NCI journals at 30 June 2014 will include: Learning Objective 23.3 Explain how to calculate the NCI share of equity a. DR Interim dividend paid €10 000 *b. DR NCI €16 000 c. CR Dividend receivable €6 000 d. CR Final dividend declared €9 000

21.

A Ltd holds a 60% interest in B Ltd. A Ltd sells inventory to B Ltd during the year for $10 000. The inventory originally cost $7000. At the end of the year 50% of the inventory is still on hand. The tax rate is 30%. The NCI adjustment required in relation to this transaction is a debit of: Learning Objective 23.4 Explain how the calculation of the NCI is affected by the existence of intragroup transactions *a. NIL b. $420 c. $630 d. $1050.

23.6

Chapter 23 Consolidation: non-controlling interest

22.

A transaction requiring an adjustment to the calculation of a NCI share of equity has the following characteristics: I. The transaction must result in the subsidiary recording a profit or a loss. II. After the transaction the other party to the transaction must have on hand an asset on which unrealised profit is accrued. III. The initial consolidation adjustment must affect both the statement of financial position and statement of comprehensive income. Learning Objective 23.4 Explain how the calculation of the NCI is affected by the existence of intragroup transactions a. I and II only; *b. I, II and III; c. II and III only; d. None of the above.

23.

A Ltd holds a 60% interest in B Ltd. B Ltd sells inventory to A Ltd during the year for £10 000. The inventory originally cost £7000. At the end of the year 50% of the inventory is still on hand. The tax rate is 30%. The NCI adjustment required in relation to this transaction is a debit of: Learning Objective 23.4 Explain how the calculation of the NCI is affected by the existence of intragroup transactions a. NIL *b. £420 c. £630 d. £1050.

24. In respect to the intragroup transfer of services any profit or loss is regarded as: Learning Objective 23.4 Explain how the calculation of the NCI is affected by the existence of intragroup transactions: a. insignificant and so not adjusted when performing NCI calculations; b. extraordinary and so ignored for consolidation reporting purposes; *c. immediately realised; d. unrealised.

25.

A Ltd holds a 60% interest in B Ltd. On 1 July 2014 B Ltd transferred a depreciable non-current asset to A Ltd at a profit of £5000. The remaining useful life of the asset at the date of transfer was 4 years and the tax rate is 30%. The impact of the above on the NCI share of profit for the year ended 30 June 2015 is: Learning Objective 23.4 Explain how the calculation of the NCI is affected by the existence of intragroup transactions a. an increase of £2625 b. a decrease of £2625 c. an increase of £1050 *d. a decrease of £1050.

23.7

Test Bank to accompany Applying IFRS Standards 4e

26. If a gain on bargain purchase arises on a business combination, the NCI: Learning Objective 23.5 Explain how the NCI is affected by the existence of a gain on bargain purchase. a. is allocated 100% of the gain *b. has no involvement with the gain c. is entitled to a proportionate share of the gain based on its level of share ownership d. receives a proportionate share of the gain after adjustments for tax effects have been made.

23.8

Exercises Exercise 23.11

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

CONSOLIDATION WORKSHEET ENTRIES, MULTIPLE YEARS, FULL GOODWILL METHOD

★★ On 1 July 2012, Whale Ltd acquired 60% of the shares of Glider Ltd for $111 700. At this date, the equity

of Glider Ltd consisted of:

Share capital General reserve Retained earnings

$120 000 10 000 30 000

At this date, the identiﬁable assets and liabilities of Glider Ltd were recorded at fair value except for the following assets:

Equipment (cost $80 000) Land Inventory

Carrying amount $65 000 80 000 45 000

Fair value $75 000 90 000 50 000

Adjustments for the differences between carrying amounts and fair values are to be made on consolidation. The equipment has a further 5-year life. Half the inventory on hand at the acquisition date was sold by 30 June 2013, with the remainder being sold in the 2013–14 ﬁnancial year. At 30 June 2015, the goodwill was written down by $3000 as the result of an impairment test. Whale Ltd uses the full goodwill method. The fair value of the non-controlling interest at 1 July 2012 was $74 100. During the 3 years since acquisition, Glider Ltd has recorded the following annual results: Year ended 30-Jun-2013 30-Jun-2014 30-Jun-2015

Profit $15 000 27 000 12 000

There have been no transfers to or from the general reserve or any dividend paid or declared by Glider Ltd since the acquisition date. The equipment owned by Glider Ltd on 1 July 2012 was sold on 1 January 2014 for $70 000. On consolidation, the group transfers the valuation reserve to retained earnings when an asset is sold or fully consumed. The tax rate is 30%. Required

Exercise 23.12

CONSOLIDATION WORKSHEET, UNRECORDED INTANGIBLE, DIVIDENDS, FULL GOODWILL METHOD

★★ On 1 July 2012, Tiger Ltd acquired 70% of the shares (cum div.) of Lion Ltd for $141 950. At this date, the

equity of Lion Ltd consisted of:

Share capital General reserve Retained earnings Other components of equity

$100 000 31 000 25 000 9 000

Lion Ltd’s records showed a dividend payable at 1 July 2012 of $10 000. The dividend was paid on 1 November 2012.

CHAPTER 23 Consolidation: non-controlling interest

A comparison of the carrying amounts and fair values of the assets of Lion Ltd at 1 July 2012 revealed the following:

Plant (cost $75 000) Vehicles (cost $40 000) Goodwill

Carrying amount $ 45 000 23 000 10 000

Fair value $ 60 000 23 000

Adjustments for the differences in carrying amounts and fair values are recognised on consolidation. Both plant and vehicles were expected to have a further 5-year life, with benefits being received evenly over those periods. Lion Ltd had not recorded an internally generated brand name for an item that was considered by Tiger Ltd to have a fair value of $20 000. The brand name is regarded as having an indefinite useful life. At 30 June 2013, goodwill was considered to be impaired by $1000, and a further impairment loss of $2000 was recognised in 2014. Tiger Ltd uses the full goodwill method. The fair value of the noncontrolling interest at 1 July 2012 was $57 000. Additional information (a) The dividends paid and declared since 1 July 2012 are: • $10 000 dividend declared in June 2013, paid in October 2013 • $5000 dividend declared in June 2014, paid in September 2014 • $8000 dividend paid in April 2015. (b) In June 2014, Lion Ltd transferred an amount of $20 000 from the general reserve to retained earnings. (c) The plant on hand at 1 July 2012 was sold on 30 June 2015. On consolidation, the group decided to transfer the valuation reserve relating to the plant to retained earnings. (d) The Other Components of Equity account reflects movements in the fair values of available-for-sale financial assets. The balances of this account at 1 July 2014 were $4000 (Tiger Ltd) and $11 000 (Lion Ltd). (e) On 30 June 2015, the financial data of both companies were: Tiger Ltd $280 000 220 000

Lion Ltd $190 000 140 000

Profit before tax Income tax expense

60 000 26 000

50 000 14 000

Profit for the period Retained earnings (1/7/14)

34 000 76 000

36 000 65 000

Total available for appropriation Dividend paid

110 000 20 000

101 000 8 000

Retained earnings (30/6/15) Share capital General reserve Other components of equity Payables

90 000 100 000 44 000 6 000 20 000

93 000 100 000 11 000 9 000 12 000

$ 260 000

$ 225 000

$ 22 050 20 000 35 000 (12 000) 80 000 (50 000) 30 000 — — — 134 950

$ 43 000 30 000 50 000 (30 000) 120 000 (75 000) — 10 000 (3 000) 80 000 —

$260 000

$225 000

Revenues Expenses

Cash Financial assets Vehicles Accumulated depreciation Plant and equipment Accumulated depreciation Land Goodwill Accumulated impairment Trademarks Shares in Goanna Ltd

Required

Prepare the consolidated ﬁnancial statements of Tiger Ltd as at 30 June 2015. 2

PART 4 Economic entities

Exercise 23.13

CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, FULL GOODWILL METHOD

★★ On 1 July 2011, Cheetah Ltd acquired 75% of the share capital of Bat Ltd at a cost of $27 600. At this

date, the capital of Bat Ltd consisted of 30 000 ordinary shares each fully paid, and retained earnings were $6000. At 1 July 2011, Bat Ltd had not recorded any goodwill, and all the identiﬁable net assets of Bat Ltd were recorded at fair value. Cheetah Ltd uses the full goodwill method. The fair value of the non-controlling interest at 1 July 2011 was $9000. The trial balances of the two companies as at 30 June 2016 are as shown below.

Trial Balances as at 30 June 2016 Cheetah Ltd Dr Share capital Retained earnings (1 July 2012) Other components of equity Current tax liability Plant Accumulated depreciation — plant Shares in Bat Ltd 10% debentures in Bat Ltd Inventory Cash Financial assets Deferred tax asset Sales revenue Cost of sales Selling expenses Other expenses Financial expenses Income tax expense Interest received from debentures Dividend revenue Dividend paid 10% debentures

Bat Ltd Cr

$ 30 000 14 500 5 000 2 900

$ 40 000 19 000 — 8 500 $ 60 000

$ 30 000

30 500

17 000 27 600 2 500 12 000 14 050 — 2 000

15 500 500 11 000 5 000 80 000

50 000 58 500 6 000 1 500 2 000 5 500

34 000 4 000 1 500 1 500 5 000

2 400 $136 550

250 1 800 —

2 400

$136 550

$167 900

5 000 $167 900

Additional information (a) Intragroup sales of inventory for the year ended 30 June 2016 from Bat Ltd to Cheetah Ltd: $19 000. (b) Unrealised profits on inventory held at 1 July 2015: inventory held by Cheetah Ltd purchased from Bat Ltd at a profit before tax of $800. (c) Unrealised profits on inventory held at 30 June 2016: inventory held by Cheetah Ltd purchased from Bat Ltd at a profit before tax of $1200. (d) The Other Components of Equity account relates to financial assets held by Bat Ltd. The balance of this account at 1 July 2015 was $4000. (e) The tax rate applicable is 30c in the dollar. Required

Prepare the consolidated ﬁnancial statements for the year ended 30 June 2016.

Exercise 23.14 ★★

CONSOLIDATED WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, PARTIAL GOODWILL METHOD

On 1 July 2015, Lizard Ltd acquired 80% of the share capital of Honeyeater Ltd for $264 800. This was sufﬁcient for Lizard Ltd to gain control over Honeyeater Ltd. On that date, the statement of ﬁnancial position of Honeyeater Ltd consisted of: CHAPTER 23 Consolidation: non-controlling interest

Share capital General reserve Asset revaluation surplus Retained earnings Liabilities

$ 250 000 10 000 15 000 10 000 180 000 $ 465 000

Cash Inventories Land Plant and equipment Accumulated depreciation Trademark Goodwill

$ 35 000 70 000 65 000 300 000 (130 000) 100 000 25 000 $ 465 000

All the identiﬁable assets and liabilities of Honeyeater Ltd were recorded at fair value except for:

Inventories Land Plant and equipment (cost $200 000) Trademark

Carrying amount $ 70 000 65 000 70 000 100 000

Fair value $ 80 000 85 000 90 000 110 000

The plant and equipment had a further 5-year life and was expected to be used evenly over that time. The trademark was considered to have an indeﬁnite life. Any adjustments for differences between carrying amounts at acquisition date and fair values are made on consolidation. Lizard Ltd uses the partial goodwill method. During the year ended 30 June 2016, all inventories on hand at the beginning of the year were sold, and the land was sold on 28 February 2016 to Werst Ltd for $80 000. Any valuation reserve created in relation to the land was transferred on consolidation to retained earnings. The income tax rate is assumed to be 30%. Financial information for Lizard Ltd and Honeyeater Ltd for the year ended 30 June 2016 is shown on the following page. During the current year, Honeyeater Ltd sold a quantity of inventory to Lizard Ltd for $8000. The original cost of these items to Honeyeater Ltd was $5000. One-third of this inventory was still on hand at the end of the year. On 31 March 2016, Honeyeater Ltd transferred an item of plant with a carrying amount of $10 000 to Lizard Ltd for $15 000. Lizard Ltd treated this item as inventory. The item was still on hand at the end of the year. Honeyeater Ltd applied a 20% depreciation rate to this type of plant. Required

1. Prepare the consolidation worksheet entries necessary for preparation of the consolidated ﬁnancial statements for Honeyeater Ltd and its subsidiary for the year ended 30 June 2016. 2. Prepare the consolidated statement of proﬁt or loss and other comprehensive income and statement of changes in equity for Lizard Ltd and its subsidiary at 30 June 2016. Lizard Ltd

Honeyeater Ltd

$ 200 000 75 000

$ 172 000 30 000

275 000

202 000

162 000 53 000

128 000 31 000

215 000

159 000

Profit from trading Gain on sale of non-current assets

60 000 10 000

43 000 5 000

Profit before tax Income tax expense

70 000 20 000

48 000 18 000

Sales revenue Other income Cost of sales Other expenses

PART 4 Economic entities

Profit Retained earnings (1/7/15) Transfer from general reserve Interim dividend paid Final dividend declared

30 000 10 000 8 000

80 000

48 000

12 000 6 000

10 000 4 000

18 000

14 000 $

34 000

Asset revaluation surplus (1/7/15) Gain on revaluation of specialised plant

15 000 5 000

Asset revaluation surplus (30/6/16)

20 000

Retained earnings (30/6/16)

Exercise 23.15

50 000 30 000 —

62 000

CONSOLIDATION WORKSHEET ENTRIES

★★ On 1 July 2012, Marine Ltd acquired 75% of the shares of Iceland Whale Ltd for $40 000. The following balances appeared in the records of England Whale Ltd at this date: Share capital General reserve Retained earnings

$20 000 2 000 10 000

At 1 July 2012, all the identiﬁable assets and liabilities of Whale Ltd were recorded at fair value except for the following: Carrying amount $ 30 000 16 000 20 000

Machinery (cost $36 000) Inventory Receivables

Fair value $40 000 20 000 18 000

The machinery, which had a remaining useful life of 5 years, was adjusted to fair value after the acquisition date in the consolidation worksheet. The machinery was sold by Wombat Ltd on 1 January 2017 for $4000, with the related valuation reserve being transferred on consolidation to retained earnings. By 30 June 2013, receivables had all been collected and inventory sold. For the year ended 30 June 2017, the following information is available: (a) Intragroup sales were: Whale Ltd to Marine Ltd — $40 000. The mark-up on cost of all sales was 25%. (b) At 30 June 2017, the inventory of Marine Ltd included $2000 of items acquired from Whale Ltd. (c) At 30 June 2016, inventory of Marine Ltd included goods of $1000 resulting from a sale on 1 March 2016 of non-current assets by Whale Ltd at a before-tax proﬁt of $200. These items were sold by Marine Ltd on 1 September 2016. This class of non-current assets is depreciated using a 10% depreciation rate on a straight-line basis. (d) On 1 January 2017, Whale Ltd sold an item of plant to Marine Ltd for $2000 at a before-tax proﬁt of $800. For plant assets, Whale Ltd applies a 10% p.a. straight-line depreciation rate, and Marine Ltd uses a 2.5% p.a. straight-line method. (e) The current tax rate is 30%. (f) Financial information for the year ended 30 June 2017 includes the following: Marine Ltd $84 000 3 000 12 000

Whale Ltd $51 000 — 8 000

Total revenue

99 000

59 000

Cost of sales Other expenses: Selling and administrative (including depreciation) Financial

58 000

26 000

4 000 8 000

2 000 6 000

70 000

34 000

Sales revenue Dividend revenue Other revenue

(continued) CHAPTER 23 Consolidation: non-controlling interest

Marine Ltd 29 000 4 000

Whale Ltd 25 000 1 000

Profit before tax Income tax expense

33 000 13 200

26 000 10 400

Profit Retained earnings at 1 July 2016

19 800 40 000

15 600 20 000

Transfer to general reserve Interim dividend paid Final dividend declared

59 800 3 800 4 000 4 000

35 600 1 000 8 000 4 000

11 800

13 000

Retained earnings at 30 June 2017

$ 48 000

$ 22 600

Asset revaluation surplus (1/7/17) Gains on property revaluation

$ 3 000 1 000

$ 2 000 500

Asset revaluation surplus (30/6/17)

$ 4 000

$ 2 500

Profit from trading Gain on sale of non-current assets

Required

1. Prepare the consolidation worksheet entries for the preparation of the consolidated ﬁnancial statements of Marine Ltd at 30 June 2017 using the partial goodwill method. 2. Prepare the entries that would change in requirement 1 above if the full goodwill method were used. The fair value of the non-controlling interest at 1 July 2012 was $12 900. Exercise 23.16 ★★★

CONSOLIDATION WORKSHEET ENTRIES, RECORDED GOODWILL

At 1 July 2017, Penguin Ltd acquired 80% of the share capital of Ross Ltd for $290 000. At this date the statement of ﬁnancial position of Ross Ltd, including comparative information on fair values for assets, was as follows. Carrying amount Current assets Inventory Receivables Allowance for doubtful debts

$ 40 000 5 000

Total current assets

$ 60 000

$ 65 000

35 000

95 000

Non-current assets Plant and machinery (at cost) Accumulated depreciation

200 000 125 000

75 000

90 000

Vehicles (at cost) Accumulated depreciation

80 000 10 000

70 000

75 000

Buildings (at cost) Accumulated depreciation

120 000 5 000

115 000

100 000 40 000 20 000

100 000 40 000

Trademark (at valuation) Other assets Goodwill Total non-current assets

420 000

Total assets

$ 515 000

Equity Share capital Asset revaluation surplus Retained earnings

$ 200 000 50 000 50 000

Total equity

300 000

Current liabilities Accounts payable Dividend payable

40 000 20 000

Total current liabilities

Fair value

PART 4 Economic entities

60 000

Carrying amount Non-current liabilities Debentures

Fair value

155 000 215 000 $ 515 000

Total liabilities Total equity and liabilities

At 1 July 2017, it was expected that the depreciable assets had the following remaining useful lives: Plant and machinery Vehicles Trademark Buildings

5 years 10 years 100 years 10 years

All the inventory on hand at 1 July 2017 was sold by Ross Ltd by 30 June 2018. Adjustments for differences between fair values and carrying amounts at acquisition date are made on consolidation. The tax rate is 30%. Additional information (a) The dividend payable in the records of Ross Ltd at 1 July 2017 was paid in September 2017. (b) On 1 January 2020, one of the machines that was on hand in Ross Ltd at 1 July 2017 was sold for $6000. At 1 July 2017, the machine was recorded at cost of $50 000 with accumulated depreciation of $30 000, and had a fair value of $23 000. Any related revaluation surplus was transferred on consolidation to retained earnings. (c) During the 2019–20 period, Ross Ltd transferred $10 000 from the asset revaluation surplus (on hand at 1 July 2017) to retained earnings, and transferred $20 000 to general reserve from retained earnings. (d) Information on dividends paid and declared is as follows: 2017–18 period: paid a $5000 dividend 2018–19 period: paid a $4000 interim dividend declared, in June 2013, a $6000 dividend 2019–20 period: paid the $6000 dividend declared in the previous period paid a $5000 interim dividend declared, in June 2020, an $8000 dividend.

(e) Information on inventory sold by Ross Ltd to Penguin Ltd at cost plus 25%: • At 1 July 2019, Penguin Ltd had $10 000 of inventory on hand. • During the 2019–20 period, $50 000 worth of inventory was sold, with 10% still on hand in Penguin Ltd at 30 June 2020. (f) The retained earnings balance at 30 June 2019 in Ross Ltd was $60 000. The total comprehensive income for the year ended 30 June 2020 was $28 000, including $3000 due to revaluation of land measured using the revaluation model. The asset revaluation surplus balance at 30 June 2019 for Ross Ltd was $55 000. Required

1. Prepare consolidated worksheet journal entries for preparing the consolidated ﬁnancial statements of Penguin Ltd at 30 June 2020 using the full goodwill method. Assume the fair value of the noncontrolling interest at 1 July 2017 was $67 000. 2. Prepare the entries that would change in requirement 1 above if the partial goodwill method were used. Exercise 23.17

BARGAIN PURCHASE, CONSOLIDATION WORKSHEET ENTRIES

★★★ On 1 July 2014, Earthworm Ltd acquired (cum div.) a 70% interest in Eagle Ltd. The following balances appeared in the records of Eagle Ltd at this date: Share capital — 100 000 shares General reserve Retained earnings Dividend payable

$100 000 20 000 52 000 5 000

CHAPTER 23 Consolidation: non-controlling interest

At 1 July 2014, the carrying amounts and fair values of Eagle Ltd’s identiﬁable assets and liabilities were as shown on the following page. Any differences between carrying amounts at acquisition and fair values are adjusted on consolidation. The non-current assets were deemed to have the following remaining useful lives: Vehicles Plant Furniture and fittings

Cash Accounts receivable Inventory Vehicles (cost $25 000) Plant (cost $100 000) Furniture and fittings (cost $60 000) Dividend payable Provisions Identifiable assets and liabilities

5 years 8 years 7 years

Carrying amount $ 10 000 28 000 51 000 17 000 66 000 34 500

Fair value $ 10 000 26 000 55 000 18 000 70 000 34 500

206 500

213 500

5 000 33 000

38 000 $ 168 500

38 000 $ 175 500

In addition, Eagle Ltd had recorded goodwill of $3500 at 1 July 2014. Earthworm Ltd uses the partial goodwill method. The following events occurred between the acquisition date and 30 June 2017: (a) By 30 June 2015, 80% of the inventory on hand at 1 July 2014 had been sold, and all accounts receivable deemed to be collectable at 1 July 2014 had been received. The remaining inventory was all sold by 30 June 2016. (b) On 15 September 2014, the dividend declared as at 1 July 2014 was paid. (c) On 15 March 2015, Eagle Ltd paid a $12 000 dividend. (d) On 30 June 2016, Eagle Ltd transferred $15 000 from pre-acquisition retained earnings to the general reserve. (e) On 1 January 2017, Eagle Ltd paid a bonus share dividend from the general reserve, the dividend being one share for each ten held. (f) On 20 June 2017, Eagle Ltd declared a dividend of $5000 from proﬁts earned prior to 1 July 2014. The dividend was paid on 10 October 2017. For the year ended 30 June 2019, the following information is available: (a) Earthworm Ltd recognises dividend revenue when the dividends are declared by Eagle Ltd. (b) The transfer was from pre-acquisition reserves. (c) The balance of the Shares in Eagle Ltd account was $119 380 at 30 June 2018. (d) On 30 June 2018, vehicles on hand at the acquisition date were sold for $6500. Any related valuation reserve was transferred on consolidation to retained earnings. (e) The company tax rate is 30%. (f) Financial information for the year ended 30 June 2018 included the following: Earthworm Ltd $42 000 16 800

Eagle Ltd $ 36 000 14 400

Profit Retained earnings (1/7/17) Transfer from general reserve

25 200 55 600 —

21 600 66 800 10 000

Total available for appropriation

80 800

98 400

Dividend paid Dividend declared

15 000 10 000

8 000 16 000

25 000

24 000

Retained earnings (30/6/18)

$55 800

$ 74 400

Profit before tax Income tax expense

Required

Prepare the consolidation worksheet entries for the preparation of the consolidated ﬁnancial statements of Earthworm Ltd at 30 June 2018. 8

PART 4 Economic entities

Exercise 23.18 ★★★

CONSOLIDATION WORKSHEET, REVALUATION IN SUBSIDIARY’S RECORDS, PARTIAL GOODWILL METHOD

On 1 July 2016, Gabby Ltd acquired 80% of the share capital of Moon Ltd for $198 000. At this date, the equity of Moon Ltd consisted of: Share capital General reserve Retained earnings

$150 000 30 000 20 000

At 1 July 2016, all the identiﬁable assets and liabilities of Moon Ltd were recorded at fair value except for the following assets:

Plant (cost $120 000) Land

Carrying amount

Fair value

$90 000 80 000

$100 000 120 000

The plant had a further 5-year life, with beneﬁts expected to be received evenly over that period. The land was sold by Moon Ltd in January 2018 for $150 000. Skink Ltd had revalued both these assets in its records at 1 July 2016. Yabby Ltd uses the partial goodwill method. Financial information for these two companies at 30 June 2018 included:

Sales revenue Other income Cost of sales Other expenses

Gabby Ltd

Moon Ltd

$920 000 65 000

$780 000 82 000

985 000

862 000

622 000 223 000

580 000 162 000

845 000

742 000

Profit before tax Income tax expense

140 000 30 000

120 000 40 000

Profit Retained earnings (1/7/17) Transfer from asset revaluation surplus

110 000 80 000

80 000 60 000 28 000

190 000

168 000

20 000 25 000

15 000 15 000 20 000

45 000

50 000

$145 000

$118 000

Transfer to general reserve Dividend paid Dividend declared Retained earnings (30/6/18)

Additional information (a) In the 2016–17 period, Moon Ltd transferred $10 000 from the general reserve to retained earnings. No other transfers to or from reserves took place in that period. In the 2017–18 period, the transfer from asset revaluation surplus is as a result of Moon Ltd’s selling of the land on hand at 1 July 2016. The transfer to general reserve is from post-acquisition proﬁts. The balance of Moon Ltd’s asset revaluation surplus at 1 July 2017 was $50 000, with an increase of $5000 recognised at 30 June 2018. (b) During the 2016–17 period, Moon Ltd sold some inventory to Gabby Ltd for $8000. This had originally cost Moon Ltd $6000. At 30 June 2017, 10% of these goods remained unsold by Gabby Ltd. (c) The ending inventory of Gabby Ltd included inventory sold to it by Moon Ltd at a proﬁt of $3000 before tax. This had cost Moon Ltd $32 000. (d) On 1 January 2017, Moon Ltd sold an item of inventory to Gabby Ltd for $50 000. This had originally cost Moon Ltd $40 000. Gabby Ltd uses the item as a non-current asset (plant) and depreciates it on a straight-line basis over a 5-year period. (e) The tax rate is 30%. Required

1. Prepare the consolidation worksheet entries for the preparation of the consolidated ﬁnancial statements of Gabby Ltd at 30 June 2018. 2. Prepare the consolidated statement of proﬁt or loss and other comprehensive income and statement of changes in equity at 30 June 2018. CHAPTER 23 Consolidation: non-controlling interest

Exercise 23.19 ★★★

CONSOLIDATION WORKSHEET, CONSOLIDATED FINANCIAL STATEMENTS, FULL GOODWILL METHOD

Financial information at 30 June 2016 of Spider Ltd and its subsidiary company, Bird Ltd included that shown below. At 1 July 2013, the date Spider Ltd acquired its 80% shareholding in Bird Ltd, all the identiﬁable assets and liabilities of Lorikeet Ltd were at fair value except for the following assets:

Plant (cost $75 000) Land

Carrying amount

Fair value

$ 50 000 30 000

$55 000 38 000

The plant has an expected life of 10 years, with beneﬁts being received evenly over that period. Differences between carrying amounts and fair values are adjusted on consolidation. The land on hand at 1 July 2013 was sold on 1 February 2014 for $40 000. Any valuation reserve in relation to the land is transferred on consolidation to retained earnings. Spider Ltd uses the full goodwill method. The fair value of the non-controlling interest at 1 July 2013 was $31 500.

Spider Ltd

Bird Ltd

Sales revenue Other revenue: Debenture interest Management and consulting fees Dividend from Lorikeet Ltd

$316 000

$220 000

5 000 5 000 12 000

— — —

Total revenues

338 000

220 000

Cost of sales Manufacturing expenses Depreciation on plant Administrative Financial Other expenses

130 000 90 000 15 000 15 000 11 000 14 000

85 000 60 000 15 000 8 000 5 000 12 000

Total expenses

275 000

185 000

Profit before tax Income tax expense

63 000 (25 000)

35 000 (17 000)

Profit Retained earnings (1/7/15)

38 000 50 000

18 000 45 000

88 000

63 000

3 000 10 000 10 000

— 10 000 5 000

23 000

15 000

65 000 50 000 13 000 300 000 200 000 25 000 10 000 — 90 000

48 000 10 000 10 000 100 000 100 000 17 000 5 000 7 000 12 000

$753 000

$309 000

Transfer to general reserve Interim dividend paid Final dividend declared Retained earnings (30/6/16) General reserve Other components of equity Share capital Debentures Current tax liability Dividend payable Deferred tax liability Other liabilities

PART 4 Economic entities

Financial assets Debentures in Bird Ltd Shares in Bird Ltd Plant (cost) Accumulated depreciation — plant Other depreciable assets Accumulated depreciation Inventory Deferred tax asset Land Dividend receivable

50 000 100 000 131 600 120 000 (65 000) 76 000 (40 000) 90 000 85 400 201 000 4 000

60 000 — — 102 000 (55 000) 55 000 (25 000) 85 000 30 000 57 000 —

$ 753 000

$ 309 000

Additional information (a) At the acquisition date of 80% of its issued shares by Spider Ltd, the equity of Bird Ltd was: Share capital (100 000 shares) General reserve Retained earnings

$100 000 3 000 37 000

(b) Inventory on hand of Bird Ltd at 1 July 2015 included a quantity priced at $10 000 that had been sold to Bird Ltd by its parent. This inventory had cost Spider Ltd $7500. It was all sold by Bird Ltd during the year. (c) In Spider Ltd’s inventory at 30 June 2015 were various items sold to it by Bird Ltd at $5000 above cost. (d) During the year, intragroup sales by Bird Ltd to Spider Ltd were $60 000. (e) It was also learned that Bird Ltd had sold to Spider Ltd an item from its inventory for $20 000 on 1 January 2015. Spider Ltd had treated this item as an addition to its plant and machinery. The item was put into service as soon as received by Spider Ltd and depreciation charged at 20% p.a. The item had been fully imported by Bird Ltd at a landed cost of $15 000. (f) Management and consulting fees derived by Spider Ltd were all from Bird Ltd and represented charges made for administration $2200 and technical services $2800. The latter were charged by Bird Ltd to manufacturing expenses. (g) All debentures issued by Bird Ltd are held by Spider Ltd. (h) Other components of equity relate to movements in the fair values of the ﬁnancial assets. The balance of this account at 1 July 2015 was $10 000 (Spider Ltd) and $8000 (Bird Ltd). (i) The tax rate is 30%. Required

Prepare the consolidated ﬁnancial statements for Spider Ltd and its subsidiary, Bird Ltd, for the year ended 30 June 2016.

CHAPTER 23 Consolidation: non-controlling interest

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo and revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Chapter 24: Translation of the financial statements of foreign entities

Chapter 24: Translation of the financial statements of foreign entities Discussion questions 1.

What is the purpose of translating financial statements from one currency to another?

Para 3 of IAS 21 notes 2 areas of application: • Translation of results and financial position of foreign operations for the purpose of including those results in the consolidated financial statements of a group, or to allow an investor to equity account for these results. • Translation of an entity’s results and financial position into another currency for presentation purposes

What is meant by ‘functional currency’?

Para 8 of IAS 21 defines functional currency as “the currency of the primary economic environment in which the entity operates”.

What is the rationale behind the choice of an exchange rate as an entity’s functional currency?

One of the objectives of the translation process is to provide information that is generally compatible with the expected economic effects of an exchange rate change on an entity’s cash flows and equity. A parent entity that has an investment if a foreign subsidiary has assets under its control that are exposed to a change in the exchange rate. Capturing the extent of this exposure should be reflected in the choice of exchange rate. Where a subsidiary acts simply as a conduit for the parent’s transactions, then the consolidation approach must treat the foreign currency statements of the subsidiary as artefacts that must be translated into the currency of the parent. Where the subsidiary is not just a conduit for the parent, but the latter is dependent on its own economic environment than the choice of exchange rate must reflect the fact that the functional currency is that of the subsidiary not the parent.

What guidelines are used to determine the functional currency of an entity?

See paragraphs 9–12 of IAS 21 and section 24.4 of the text.

24.2

Solutions Manual to accompany Applying IFRS Standards 4e

How are statement of profit or loss and other comprehensive income items translated from the local currency into the functional currency?

Income and expenses: these are translated at the rate current at the date of payment. Dividends paid: these are translated at the rate current at the date of payment. Dividends declared: these are translated at the rate current at the date of declaration Transfers to/from reserves: for internal transfers, the rates applicable are those existing when the amounts transferred were originally recognised in equity.

How are statement of financial position items translated from the local currency into the functional currency?

Para 23 of IAS 21: -

foreign currency monetary items are translated using the closing rate non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction non-monetary items that are measured at fair value in a foreign currency re translated using the exchange rates at the date when the value was determined.

Assets: Classify as monetary or non-monetary. Translate monetary assets at the current rate existing at the end of reporting period. For non-monetary assets, use the rate current at the date at which the recorded amount for the asset was entered into the accounts. Liabilities: Classify liabilities into monetary and non-monetary. Use the same principles as for assets. Share capital: if on hand at acquisition, use the rate at acquisition date. If arising subsequent to acquisition, use the rate at date of issue. Other reserves: If on hand at acquisition date, use the rate at that date. For reserves created by internal transfer, use the rate at date the amounts transferred were originally recognised in equity. Retained earnings: If on hand at acquisition date, use the rate at that date. Post-acquisition profits are carried forward balances

How are foreign exchange gains and losses calculated when translating from local currency to functional currency?

Exchange differences arise from translating the foreign operation’s monetary items at current rates while the non-monetary items are translated using an historical rate. For non-monetary items exchange differences arise only when they are sold or exchanged. Hence, exchange differences are calculated by examining movements in the monetary items over the period.

What is meant by ‘presentation currency’?

Paragraph 8 of IAS 21 states that presentation currency is the currency in which the financial statements are presented. 9.

How are statement of profit or loss and other comprehensive income items translated from functional currency to presentation currency?

Income and expenses: These are translated at the rates current at the applicable transaction dates. Dividends paid: These are translated at the rates current when the dividends were paid. Dividends declared: These are translated at the rates current when the dividends are declared.

24.3

Chapter 24: Translation of the financial statements of foreign entities

10.

How are statement of financial position items translated from functional currency to presentation currency?

Assets: Current rates are used Liabilities: Current rates are used Share capital: If on hand at acquisition date, the rate at acquisition date is used Other reserves: If on hand at acquisition date, use the rate at that date. For reserves created by internal transfer, use the rate at date the amounts transferred were originally recognised in equity. Retained earnings: If on hand at acquisition date, use the rate at that date. Post-acquisition profits are carried forward balances

11.

What causes a foreign currency translation reserve to arise?

A foreign currency translation reserve will arise when the financial statements are translated into the presentation currency. It arises because income and expense items are translated at dates of the transactions and not the closing rate, and in the case of a net investment in a foreign operation where the opening net assets are translated at an exchange rate different from the closing rate.

12.

Why are gains/losses on translation taken to a foreign currency translation reserve rather than to profit and loss for the period?

According to paragraph 41 of IAS 21, these exchange differences have little or no direct effect on the present and future cash flows from operations. Movements in the foreign currency translation reserve are, however, shown as part of comprehensive income for the period.

24.4

Solutions Manual to accompany Applying IFRS Standards 4e

EXERCISES Exercise 24.1

TRANSLATION INTO FUNCTIONAL CURRENCY

1. Assuming the functional currency for Auckland Ltd is the NZ$, calculate: (a) the balances for the plant items and inventory in HK$ at 30 June 2016 (b) the depreciation and cost of sales amounts in the statement of profit or loss and other comprehensive income for 2015–16. 2. Assuming the functional currency is the HK$, calculate: (a) the balances for the plant items and inventory in HK$ at 30 June 2016 (b) the depreciation and cost of sales amounts in the statement of profit or loss and other comprehensive income for 2015–16. 3. Discuss the differences in the results achieved in requirements 1 and 2 above, and why the choice of the functional currency gives a different set of accounting numbers. 1. The functional currency for Auckland Ltd is the NZ$ a). Plant: NZ$ Tanner 40 000 Accumulated depreciation (40 000 x 1/5 x 47/12) 31 333

rate 7.8

HK$ 312 000

HK$

7.8

244 400

67 600

Benches Accumulated depreciation (20 000 x 1/8 x 28/12)

20 000

7.8

156 000

5 833

7.8

45 500

Presses Accumulated depreciation (70 000 x 1/7 x ¾)

70 000

7.8

546 000

7 500

7.8

58 500

30 000

7.8

8 000 2 500 7 500

7.5 7.5 7.5

60 000 18 750 57 250

25 000 420 000 445 000 30 000 $415 000

7.2 7.5

180 000 3 150 000 3 330 000 231 000 $3 099 000

Inventory

110 500

487 500 665 600 234 000

b). Depreciation: Tanner: 1/5 x 40 000 Benches: 1/8 x 20 000 Presses: Cost of sales: Opening stock Purchases Closing stock

7.7

136 000

24.5

Chapter 24: Translation of the financial statements of foreign entities

2. The functional currency for Auckland Ltd is the HK$ a). Plant: NZ$ Tanner 40 000 Accumulated depreciation (40 000 x 1/5 x 47/12) 31 333

rate 5.4

HK$ 216 000

HK$

5.4

169 200

46 800

Benches Accumulated depreciation (20 000 x 1/8 x 28/12)

20 000

5.8

116 000

5 833

5.8

33 832

Presses Accumulated depreciation (70 000 x 1/7 x ¾)

70 000

6.2

434 000

7 500

6.2

46 500

30 000

7.7

8 000 2 500 7 500

5.4 5.8 6.2

43 200 14 500 46 500

25 000 420 000 445 000 30 000 $415 000

7.2 7.5

180 000 3 150 000 3 330 000 231 000 $3 099 000

Inventory

82 168

337 500 516 468 231 000

b). Depreciation: Tanner: 1/5 x 40 000 Benches: 1/8 x 20 000 Presses: Cost of sales: Opening stock Purchases Closing stock

7.7

104 200

3. In requirement 1 where it is assumed that the functional currency for Auckland is the NZ$, the translation to HK$ is a translation from functional currency to presentation currency which is undertaken according to the requirements of paragraph 39 of IAS 21 ie: 39. The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures: (a) assets and liabilities for each statement of financial position presented (i.e. including comparatives) shall be translated at the closing rate at the date of that statement of financial position; (b) income and expenses for each statement presenting profit or loss and other comprehensive income (i.e. including comparatives) shall be translated at exchange rates at the dates of the transactions; and (c) all resulting exchange differences shall be recognised in other comprehensive income. Requirement 2 assumes that the functional currency is the HK$ so the translation is from the local currency to the functional currency and is done according to paragraph 23 and 28 of IAS 21 ie: 23. At each end of the reporting period: (a) foreign currency monetary items shall be translated using the closing rate; (b) non-monetary items that are measured in terms of historical cost in a foreign currency shall be translated using the exchange rate at the date of the transaction; and (c) non-monetary items that are measured at fair value in a foreign currency shall be translated using the exchange rates at the date when the fair value was determined. 28 Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition

24.6

Solutions Manual to accompany Applying IFRS Standards 4e

during the period or in previous financial statements, shall be recognised in profit or loss in the period in which they arise, except as described in paragraph 32. So a different set of accounting numbers will be achieved depending on the choice of the functional currency because different rates and rules are used depending on whether the translation is from local to functional currency or functional to presentation currency.

24.7

Chapter 24: Translation of the financial statements of foreign entities

Exercise 24.2 CURRENCY

TRANSLATION OF FINANCIAL STATEMENTS INTO FUNCTIONAL

1. Prepare the financial statements of Lantau Ltd in Singaporean dollars at 30 June 2016. 2. Verify the translation adjustment. 1. Sales Cost of sales: Opening inventory Purchases Closing inventory Gross profit Proceeds of land sold Carrying amount of land sold Gain on sale Expenses: Depreciation

Other

FC translation gain/(loss) Profit before income tax Income tax expense Profit Retained earnings (op) Retained earnings (cl) Share capital General reserve

Plant

Accumulated depreciation

Land Inventory Cash Accounts receivable Total assets Payables Deferred tax liability Current tax liability Provisions Total liabilities Net assets

HK$ 610 000

Rate 0.26

S$ 158 600

60 000 260 000 320 000 60 000 260 000 350 000

0.20 0.26

12 000 67 600 79 600 14 400 65 200 93 400

250 000 200 000 50 000 400 000

0.25 0.20

62 500 40 000 22 500 115 900

120 000 30 000 6 000 134 000 290 000 110 000

0.20 0.25 0.27 0.26

50 000 60 000 240 000 300 000 800 000 100 000 $1 200 000

0.26

24 000 7 500 1 620 34 840 67 960 47 940 31 140 79 080 13 000 66 080 48 000 114 080 160 000 20 000 $294 080

600 000 200 000 120 000 (184 000) (120 000) (30 000) (6 000) 400 000 60 000 240 000 300 000 1 580 000 160 000 120 000 20 000 80 000 380 000 $1 200 000

0.20 0.25 0.27 0.20 0.20 0.25 0.27 0.28 0.24 0.22 0.22

0.24

0.20 0.20 0.20

0.22 0.22 0.22 0.22 0.22

120 000 50 000 32 400 (36 800) (24 000) (7 500) (1 620) 112 000 14 400 52 800 66 000 377 680 35 200 26 400 4 400 17 600 83 600 $294 080

24.8

Solutions Manual to accompany Applying IFRS Standards 4e

2. Verification of translation adjustment Net monetary assets at 1/7/15 Increases: Sales Proceeds – land Decreases: Purchases Land Plant Expenses Tax Net monetary assets at 30/6/16

464 000 *

0.22 – 0.20

9 280

610 000 250 000 1 324 000

0.22 – 0.26 0.22 – 0.25

(24 400) (7 500) (22 620)

260 000 400 000 200 000 120 000 134 000 50 000 1 164 000 160 000

0.22 – 0.26 0.22 – 0.28 0.22 – 0.25 0.22 – 0.27 0.22 – 0.26 0.22 – 0.26

10 400 24 000 6 000 6 000 5 360 2 000 53 760 31 140

* opening statement of financial position was: Capital Retained earnings General reserve Plant Accumulated depreciation Land Inventory Net monetary assets

800 000 240 000 100 000 1 140 000 600 000 (184 000) 200 000 60 000 464 000 $1 140 000

24.9

Chapter 24: Translation of the financial statements of foreign entities

Exercise 24.3 ADJUSTMENTS

TRANSLATION INTO PRESENTATION CURRENCY, CONSOLIDATION

1. Translate the financial statements of Swan Ltd into Singapore dollars for inclusion in the consolidated financial statements of Dragon Ltd. 2. Verify the translation adjustment. 3. Prepare the consolidation worksheet entries necessary for the preparation of the consolidated financial statements at 30 June 2016, assuming the use of the partial goodwill method. 1. Translation of subsidiary’s accounts into S$ A$ Sales 310 000 Cost of sales 120 000 Gross profit 190 000 Depreciation – plant 40 000 Other expenses 10 000 50 000 Profit before tax 140 000 Tax expense 15 000 Profit 125 000 Retained earnings 1/7/15 170 000 295 000 Dividend paid 10 000 Dividend declared 20 000 30 000 Retained earnings 30/6/16 165 000 Share capital 350 000 Foreign Currency Translation Reserve -Provisions 30 000 Payables 40 000 $685 000 Cash 30 000 Accounts receivable 115 000 Inventory 80 000 Buildings (net) 220 000 Plant 400 000 Accumulated depreciation (160 000) $685 000 2. Verification of FCTR Opening net investment Opening net investment x opening rate Opening net investment x closing rate Exchange Loss Change in equity of subsidiary Change in equity as translated Change in equity x closing rate Exchange gain Net FCTR

= = = = = =

Rate 0.65 0.65 0.65 0.65

0.65 0.6 0.68 0.7

0.6

0.7 0/7 0.7 0.7 0.7 0.7 0.7 0.7

S$ 201 500 78 000 123 500 26 000 6 500 32 500 91 000 9 750 81 250 102 000 183 250 6 800 14 000 20 800 162 450 210 000 (42 450) 21 000 28 000 $379 000 21 000 80 500 56 000 154 000 280 000 (112 000) $379 000

A$520 000 520 000 x 0.6 S$312 000 520 000 x 0.7 S$364 000 S$52 000

= A$125 000 – (10 000 + 20 000) = A$95 000 = 81 250 – (6 800 + 14 000) = S$60 450 = 95 000 x 0.7 = S$66 500 = S$6 050 = S$(52 000) + S$6 050 =S$(42 450)

24.10

Solutions Manual to accompany Applying IFRS Standards 4e

3. Consolidation worksheet entries Net fair value of identifiable assets and liabilities of subsidiary

= = = = =

Net fair value acquired Consideration transferred Goodwill acquired

A$(350 000 + 170 000 + 60 000 (1 – 30%) (ARR-plant) + 22 000 (1 – 30%) (ARR- inventory) + 140 000 (1 – 30%) (ARR- brands) A$675 400 80% x A$675 000 A$540 320 A$560 000 A$19 680

Business combination valuation entries Plant (60 000 x 0.7) Deferred Tax Liability (18 000 x 0.7) Business Combination Valuation Reserve (42 000 x 0.6) Foreign Currency Translation Reserve

Dr Cr

Depreciation Expense (12 000 x 0.65) Accumulated Depreciation (12 000 x 0.7) Foreign Currency Translation Reserve (1/5 x A$60 000 p.a.) Deferred Tax Liability (30% x 12 000 x 0.7) Income Tax Expense (30% x 12 000 x 0.7) Foreign Currency Translation Reserve

Dr Cr Dr

7 800

Dr Cr Cr

2 520

Brands (140 000 x 0.7) Deferred Tax Liability (42 000 x 0.7) Business Combination Valuation Reserve (98 000 x 0.6) Foreign Currency Translation Reserve

Dr Cr

98 000

Cost of Sales (22 000 x 0.6) Income Tax Expense (6 600 x 0.65) Transfer from Business Combination Valuation Reserve (15 400 x 0.6) Foreign Currency Translation Reserve Pre-acquisition entry Retained earnings (op bal) (80% x 170 000 x 0.6) Transfer from Asset Revaluation Reserve (80% x 9 240) Share Capital (80% x 350 000 x 0.6) Asset Revaluation Reserve (80% (25 200 + 58 800) Goodwill (19 680 x 0.7) FCTR (19 680(0.7 – 0.6)) Shares in Swan Ltd

42 000 12 600

Cr Cr

25 200 4 200

8 400 600

2 340 180

29 400

Cr Cr Dr Cr

58 800 9 800 13 200 4 290

Cr Dr

330

81 600

Dr Dr Dr Dr Cr Cr

7 392 168 000 67 200 13 776

9 240

1 968 336 000

24.11

Chapter 24: Translation of the financial statements of foreign entities

Non-controlling Interest

(i) NCI Share at acquisition date Retained Earnings (op bal) (20% x 170 000 x 0.6) Share Capital (20% x 350 000 x 0.6) Business Combination Valuation Reserve NCI

Dr Dr Dr Cr

20 400 42 000 21 600

Dr Cr

16 250

Dr Cr

1 848

Dr Cr

1 360

Dr Cr

2 800

Dr Cr

5 348

Dividend Payable Dividend Declared (80% x 14 000)

Dr Cr

11 200

Dividend Revenue Dividend Paid (80% x 6 800)

Dr Cr

5 440

Sales (20 000 x 0.68) Cost of Sales Inventory (200 x 0.68)

Dr Cr Cr

13 600

Deferred Tax Asset (20% x 136) Income Tax Expense

Dr Cr

84 000

(ii) NCI Share of changes in equity 2015-2016 Share of Profit NCI (20% x S$81 250) Transfer from Business Combination Valuation Reserve Business Combination Valuation Reserve (20% x 9 240) NCI Dividend Paid (20% x 6 800) NCI Dividend Declared (20% x 14 000) NCI Foreign Currency Translation Reserve (20% [(42 450) + 15 710 – valuation entries])

16 250

1 848

1 360

2 800

5 348

Intra-group transactions

11 200

5 440

13 464 136

24.12

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 24.4 ENTRIES 1.

2. 3.

TRANSLATION INTO PRESENTATION CURRENCY, CONSOLIDATION

If the functional currency for Baseball Ltd is the US dollar, prepare the financial statements of Baseball Ltd at 30 June 2016 in the presentation currency of the Australian dollar. Verify the foreign currency translation adjustment. Prepare the consolidation worksheet entries to consolidate the translated financial statements of Baseball Ltd with its parent entity at 30 June 2016.

1. Translation to presentation currency US$ Sales Cost of sales: Opening stock Purchases

1 600 000

Closing inventory Gross profit Depreciation: Plant - Old Plant - New Buildings - Old Buildings -New Interest Other expenses Profit before income tax Income tax expense Profit for the period Retained earnings at 1 July 2015 Dividend paid Dividend declared Retained earnings at 30 June 2016 Share capital Foreign Currency Translation Reserve Loan from Cricket Ltd Provisions Accounts payable Inventory Accounts receivable Cash Plant Accumulated depreciation Land Buildings Accumulated depreciation

Exchange rate 1.75

140 000 840 000 980 000 280 000 700 000 900 000

2.00 1.75

38 000 12 000 32 500 7 500 21 200 21 200 227 600 360 000 540 000 200 000 340 000 200 000 540 000 60 000 60 000 200 000 320 000 220 000 720 000

1.75 1.60 1.75 1.75 1.70 1.50 1.75

530 000 500 000 320 000 $2 290 000 280 000 100 000 20 000 720 000 (130 000) 500 000 920 000 (120 000) $2 290 000

1.50 1.50 1.50

1.52

1.75 2.00 2.00 1.70 1.50 2.00 2.00

1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50

A$ 2 800 000 280 000 1 470 000 1 750 000 425 600 1 324 400 1 475 600 66 500 19 200 56 875 13 125 36 040 31 800 398 300 621 840 853 760 350 000 503 760 400 000 903 760 120 000 102 000 300 000 522 000 381 760 1 440 000 (411 760) 795 000 750 000 480 000 $3 435 000 420 000 150 000 30 000 1 080 000 (195 000) 750 000 1 380 000 (180 000) $3 435 000

24.13

Chapter 24: Translation of the financial statements of foreign entities

2. Verification of translation adjustment: = = = = = = =

US$220 000 – US$200 000 US$20 000 20 000 x 1.50 A$30 000 A$400 000 – A$381 760 A$(18 240) A$48 240

Translation loss

= = = = = =

US$920 000 920 000 x 2.00 A$1 840 000 920 000 x 1.50 A$1 380 000 A$(460 000)

Total translation loss

A$(411 760)

Movement in retained earnings Movement x closing rate Movement as translated Translation gain Net investment at 1 July 2015 Net investment x opening rate Net investment x closing rate

3: Consolidation worksheet entries Net fair value of identifiable assets and liabilities of subsidiary

Net fair value acquired

Consideration transferred Goodwill acquired

US$[720 000 + 200 000 + (20 000) (1 - 25%) ARR – plant + (24 000) (1 – 25%) ARR – land + (32 000) (1 – 25%) ARR – inventory] = 80% x US$(720 000 + 200 000 + 15 000 + 18 000 + 24 000) = 80% x A$[2.0 x(720 000 + 200 000 + 15 000 + 18 000 + 24 000)] = 80% x (1 440 000 + 400 000 + 30 000 + 36 000 + 48 000) = A$[1 152 000 + 320 000 + 24 000 + 28 800 + 38 400] = A$1 563 200 = A$1 579 200 = A$16 000 = US$8 000

(i) Business combination valuation entries Land (24 000 x 1.50) Deferred Tax Liability (6 000 x 1.50) Business Combination Valuation Reserve (18 000 x 2.0) FCTR Dr

Dr Cr

Accumulated Depreciation (80 000 x 1.50) Plant (60 000 x 1.50) Deferred Tax Liability (5 000 x 1.50) Business Combination Valuation Reserve (15 000 x 2.0) FCTR Dr

Dr Cr Cr

Depreciation Expense (1/5 x 20 000 x 1.75) Accumulated Depreciation (1/5 x 20 000 x 1.5) FCTR

Dr Cr Cr

7 000

Deferred Tax Liability (5 000 x 1/5 x 1.50) Income Tax Expense (5 000 x 1/5 x 1.75)

Dr Cr

1 500

36 000 9 000

Cr 9 000

36 000

120 000 90 000 7 500

Cr 7 500

30 000

6 000 1 000

1 750

24.14

Solutions Manual to accompany Applying IFRS Standards 4e

FCTR Dr

250

Opening inventory (32 000 x 2.00) Income Tax Expense (25% x 32 000 x 1.75) Transfer from Business Combination Valuation Reserve (3/4 x 32 000 x 2.00) FCTR

Dr Cr

64 000 14 000

Cr Cr

48 000 2 000

(ii) Pre-acquisition entry Retained Earnings (1/7/11) Dividend Paid (60 000 x 80% x 2.0) Transfer from Business Combination Valuation Reserve Share Capital Business Combination Valuation Reserve Goodwill (8 000 x 1.50) FCTR (8 000(2.0 – 1.5)) Shares in Baseball Ltd

Dr Cr

320 000

Dr Dr Dr Dr Dr Cr

38 400 1 152 000 52 800 12 000 4 000

96 000

1 483 200

(iii) Non-controlling Interest Share at acquisition date Retained earnings (1/7/11) Share Capital Business Combination Valuation Reserve (20% x 114 000) NCI (20% of balances)

Dr Dr

64 000 230 000

Dr Cr

22 800

Share 2011-12 NCI Share of Profit NCI (20%[503 760 – (7 000 –1 750) – (64 000 – 14 000)]

Dr Cr

89 702

Share of FCTR NCI Foreign Currency Translation Reserve (20% x (430 510))

Dr Cr

86 102

Dividend paid NCI Dividend Paid (20% x 222 000)

Dr Cr

44 400

Dividend declared NCI Dividend Declared (20% x 300 000)

Dr Cr

60 000

Transfer from Business Combination Valuation Reserve Transfer from Business Combination Valuation Reserve Dr Business Combination Valuation Reserve Cr (20% x 48 000)

316 800

89 702

86 102

44 400

60 000

9 600 9 600

24.15

Chapter 24: Translation of the financial statements of foreign entities

(iv) Sale of Inventory: Parent to Subsidiary Sales

Dr Cr Cr

Cost of Sales Inventory

590 400 583 360 7 040

Sales: (120 000 x 1.80) + (96 000 x 1.70) + (132 000 x 1.60) Inventory: (20% x 22 000 x 1.60) Deferred Tax Asset Income Tax Expense (25% x 7 040)

Dr Cr

1 760

Dr Cr

81 600

Dividend Payable Dividend Declared (80% x 300 000)

Dr Cr

240 000

Dividend Revenue Dividend Receivable

Dr Cr

240 000

Dr Cr

795 000

Dr Cr

67 840

1 760

(v) Dividend paid Dividend Revenue Dividend Paid (80% x 102 000)

81 600

(vi) Dividend declared

240 000

(vii) Loan Loan from Cricket Ltd Loan to Baseball Ltd

795 000

(viii) Interest on Loan Interest Revenue Interest Paid

67 840

(ix) Net investment in subsidiary adjustment As Cricket Ltd had lent US$530 000 to Baseball Ltd at acquisition date, the parent entity would recognise an exchange loss of A$265 000 as the loan that was originally equal to A$1 060 000 is now only equal to A$795 000. As this loan is a part of the net investment in the foreign operation, the exchange loss must be transferred to the translation reserve: Foreign Currency Translation Reserve Foreign Exchange Loss

Dr Cr

265 000 265 000

24.16

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 24.5

1. 2. 3. 4.

TRANSLATION INTO FOREIGN CURRENCY, CONSOLIDATION EFFECTS

If the functional currency for Baseball Ltd is the Australian dollar, prepare the financial statements of Baseball Ltd at 30 June 2016 in the functional currency. Verify the foreign currency translation adjustment. Prepare the consolidation worksheet entries to consolidate the translated financial statements of Baseball Ltd with its parent entity at 30 June 2016. Assume on 1 January 2016, Baseball Ltd sold the patent to Cricket Ltd for US$100,000 and that Cricket Ltd depreciates this asset evenly over a 20-year period. Prepare the consolidation worksheet adjustment entries at 30 June 2016.

1. Translation into functional currency of A$ US$ Sales Cost of sales: Opening stock Purchases

1 600 000

Closing inventory Gross profit Depreciation: Plant - Old Plant - New Buildings - Old Buildings -New Interest Other expenses

Foreign Exchange Gain/(Loss) Profit before income tax Income tax expense Profit for the period Retained earnings at 1 July 2015 Dividend paid Dividend declared Retained earnings at 30 June 2016 Share capital Loan from Cricket Ltd Provisions Accounts payable Inventory Accounts receivable Cash Patent Plant Accumulated depreciation Land Buildings

Exchange rate 1.75

140 000 840 000 980 000 280 000 700 000 900 000

2.00 1.75

38 000 12 000 32 500 7 500 21 200 21 200 227 600 360 000

2.00 1.70 2.00 1.80 1.70 1.50 1.75

540 000 200 000 340 000 200 000 540 000 60 000 60 000 200 000 320 000 220 000 720 000 530 000 500 000 320 000 $2 290 000 280 000 20 000 20 000 80 000 600 000 120 000 (118 000) (12 000) 300 000 200 000 820 000

1.52

1.75 2.00 2.00 1.70 1.50 2.00 2.00 1.50 1.50 1.50 1.52 1.50 1.50 2.00 2.00 1.70 2.00 1.70 2.00 1.60 2.00

A$ 2 800 000 280 000 1 470 000 1 750 000 425 600 1 324 400 1 475 600 76 000 20 400 65 000 13 500 36 040 31 800 398 300 641 040 834 560 467 140 1 301 700 350 000 951 700 400 000 1 351 700 120 000 102 000 300 000 522 000 829 700 1 440 000 795 000 750 000 480 000 $4 294 700 425 600 30 000 30 000 160 000 1 200 000 204 000 (236 000) (20 400) 600 000 320 000 1 640 000

24.17

Chapter 24: Translation of the financial statements of foreign entities

Accumulated depreciation

100 000 (112 500) (7 500) $2 290 000

1.80 2.00 1.80

180 000 (225 000) (13 500) $4 294 700

2. Verification of Translation Adjustment US$ (860 000)

Net monetary assets at 1 July 2015 Increases: Sales - inventory Decreases: Plant Land Buildings Purchases Other expenses Interest Income tax expense Dividend paid Dividend declared Net monetary assets at end

1.50 – 2.00

Gain/(loss) 430 000

1 600 000 740 000

1.50 – 1.75

(400 000) 30 000

120 000 200 000 100 000 840 000 227 600 21 200 21 200 200 000 60 000 60 000 200 000 2 050 000 (1 310 000)

1.50 – 1.70 1.50 – 1.60 1.50 – 1.80 1.50 – 1.75 1.50 – 1.75 1.50 – 1.70 1.50 – 1.50 1.50 – 1.75 1.50 – 2.00 1.50 – 1.70 1.50 – 1.50

24 000 20 000 30 000 210 000 56 900 4 240 50 000 30 000 12 000 ____437 140 467 140

3. Consolidation worksheet entries Net fair value of identifiable assets and liabilities of subsidiary

Net fair value acquired

Consideration transferred Goodwill acquired

24.18

Solutions Manual to accompany Applying IFRS Standards 4e

(i) Business combination valuation entries Land (24 000 x 2.0) Deferred Tax Liability (6 000 x 1.50) Business Combination Valuation Reserve (18 000 x 2.0) Foreign Exchange Gain

Dr Cr

48 000

Accumulated Depreciation (80 000 x 2.0) Plant (60 000 x 2.0) Deferred Tax Liability (5 000 x 1.50) Business Combination Valuation Reserve (15 000 x 2.0) Foreign Exchange Gain

Dr Cr Cr

Depreciation Expense (1/5 x 20 000 x 2.0) Accumulated Depreciation (1/5 x 40 000 x 2.0)

Dr Cr

8 000

Deferred Tax Liability (5 000 x 1/5 x 1.50) Income Tax Expense (5 000 x 1/5 x 1.75) Foreign Exchange Loss

Dr Cr Dr

1 500

Opening inventory (32 000 x 2.00) Income Tax Expense (25% x 32 000 x 1.75) Transfer from Business Combination Valuation Reserve (3/4 x 32 000 x 2.00) Foreign Exchange Gain

Dr Cr

64 000

9 000

Cr Cr

36 000 3 000 160 000 120 000 7 500

Cr Cr

30 000 2 500

8 000

1 750 250

14 000

Cr Cr

48 000 2 000

(ii) Pre-acquisition entry Retained Earnings (1/7/15) Dividend Paid (60 000 x 80% x 2.0) Transfer from Business Combination Valuation Reserve Share Capital Business Combination Valuation Reserve Goodwill (8 000 x 2.0) Shares in Baseball Ltd

Dr Cr

320 000

Dr Dr Dr Dr Cr

38 400 1 152 000 52 800 16 000

96 000

1 483 200

(iii) Non-controlling Interest Share at acquisition date (20%) Retained Earnings (1/7/15) Share Capital Business Combination Valuation Reserve (20% x 114 000) NCI

Dr Dr

64 000 230 000

Dr Cr

22 800 316 800

Share 2013-14 NCI Share of Profit Dr 179 440 NCI Cr (20%[951 700 – (8 000 -1 750 + 250) –(64 000 – 14 000 – 2 000)] Dividend paid NCI Dividend Paid (20% x 222 000)

Dr Cr

179 440

44 400 44 400

24.19

Chapter 24: Translation of the financial statements of foreign entities

Dividend declared NCI Dividend Declared (20% x 300 000)

Dr Cr

Transfer from Business Combination Valuation Reserve Transfer from Business Combination Valuation Reserve Dr Business Combination Valuation Reserve Cr (20% x 48 000)

60 000 60 000

9 600 9 600

(iv) Sale of Inventory: Parent to Subsidiary Sales

Dr Cr Cr

Cost of Sales Inventory

590 400 583 360 7 040

Sales: (120 000 x 1.80) + (96 000 x 1.70) + (132 000 x 1.60) Inventory: (20% x 22 000 x 1.60) Deferred Tax Asset Income Tax Expense (25% x 7 040)

Dr Cr

1 760

Dr Cr

81 600

Dividend Payable Dividend Declared (80% x 300 000)

Dr Cr

240 000

Dividend Revenue Dividend Receivable

Dr Cr

240 000

Dr Cr

795 000

Dr Cr

67 840

Proceeds on Sale (100 000 x 1.70) Carrying Amount of Asset Sold Patent (20 000 x 1.70)

Dr Cr Cr

170 000

Deferred Tax Asset Income Tax Expense (30% x 34 000)

Dr Cr

10 200

1 760

(v) Dividend paid Dividend Revenue Dividend Paid (80% x 102 000)

81 600

(vi) Dividend declared

240 000

(vii) Loan Loan from Cricket Ltd Loan to Baseball Ltd

795 000

(viii) Interest on Loan Interest Revenue Interest Paid

67 840

4. Consolidation worksheet entries – sale of patent (i) Sale of patent: subsidiary to parent

136 000 34 000

10 200

24.20

Solutions Manual to accompany Applying IFRS Standards 4e

(ii). NCI adjustment NCI

Dr Cr

4 760

Accumulated Depreciation Depreciation Expense (1/20 x 34 000 x ½ year)

Dr Cr

850

Income Tax Expense Deferred Tax Asset (30% x 850)

Dr Cr

255

Dr Cr

119

NCI Share of Profit (20% x (34 000 – 10 200))

4 760

(iii). Depreciation on patent

850

255

(iv) NCI adjustment NCI Share of Profit NCI (20% x (850 – 255))

119

24.21

Chapter 24: Translation of the financial statements of foreign entities

Exercise 24.6

TRANSLATION INTO PRESENTATION CURRENCY

1. Prepare the financial statements of July Ltd at 31 December 2016 in the presentation currency of Australian dollars. 2. Verify the translation adjustment. 3. Discuss the differences that would occur if the functional currency of July Ltd was the Australian dollar. 4. If the functional currency was the Australian dollar, calculate the translation adjustment. 1. Functional currency is the US$

Sales Cost of sales: Opening stock Purchases Closing stock Cost of sales Gross profit Expenses: Depreciation Other Profit for the period Retained earnings at 1/1/16 Retained earnings at 31/12/16 Share capital Foreign currency translation reserve Total equity Property, plant & equipment Accumulated depreciation Accounts receivable Inventory Cash Accounts payable Net assets

US$ 90 000

rate 1/0.56

A$ 160 714

20 000 55 000 75 000 45 000 30 000 60 000

1/0.52 1/0.56

38 462 98 214 136 676 80 357 56 319 104 395

15 000 30 000 45 000 15 000 50 000 65 000 100 000 ______ 165 000 155 000 45 000 110 000 40 000 45 000 12 000 207 000 42 000 $165 000

1/0.56 1/0.56

1/0.56

1/0.52 1/0.52

1/0.60 1/0.60 1/0.60 1/0.60 1/0.60 1/0.60

26 786 53 571 80 357 24 038 96 154 120 192 192 308 (37 500) 275 000 258 333 75 000 183 333 66 667 75 000 20 000 345 000 70 000 $275 000

24.22

Solutions Manual to accompany Applying IFRS Standards 4e

JULY LTD Statement of Profit or Loss and Other Comprehensive Income for the financial year ended 31 December 2016 Sales: Cost of Sales Opening stock Purchases

$160 714 38 462 98 214 136 376 80 357 56 319

Closing stock Cost of Sales Expenses: Depreciation Other Profit for the period

26 786 53 571 $24 038

JULY LTD Statement of Financial Position as at 31 December 2016 Current Assets Receivables Inventories Cash Total Current Assets Non-current Assets Property, plant and equipment Accumulated depreciation

$66 667 75 000 20 000 161 667 258 333 75 000 183 333 183 333 345 000

Total Non-current Assets Total Assets Current Liabilities: Payables: Accounts payable Total Liabilities Net Assets

70 000 70 000 $275 000

Equity Share capital Foreign currency translation reserve Retained earnings Total Equity

$192 308 (37 500) 120 192 $275 000

2 Verifying the foreign currency translation reserve Profit as translated Profit x closing rate: 15 000 x 1/0.60 Translation gain Opening net assets Opening net assets x opening rate Opening net assets x closing rate (150 000 x 1/0.6) Translation loss Total foreign currency translation reserve

24 038 25 000 962 150 000 288 462 250 000 (38 462) (37 500)

24.23

Chapter 24: Translation of the financial statements of foreign entities

3. Functional currency is the A$

Sales Cost of sales: Opening stock Purchases Closing stock Cost of sales Gross profit Expenses: Depreciation Other Profit Foreign currency translation loss Profit Retained earnings at 1/1/16 Retained earnings at 31/12/16 Share capital Total equity Property, plant & equipment Accumulated depreciation Accounts receivable Inventory Cash Accounts payable Net assets

US$ 90 000

rate 1/0.56

A$ 160 714

20 000 55 000 75 000 45 000 30 000 60 000

1/0.52 1/0.56

38 462 98 214 136 676 80 357 56 319 104 395

15 000 30 000 45 000 15 000

1/0.52 1/0.56

50 000 65 000 100 000 $165 000

1/0.52

155 000 45 000 110 000 40 000 45 000 12 000 207 000 42 000 $165 000

1/0.52 1/0.52

1/0.56

1/0.52

1/0.60 1/0.56 1/0.60 1/0.60

28 846 53 571 82 417 21 978 (1 877) 20 101 96 154 116 255 192 308 $308 563 298 077 86 538 211 539 66 667 80 357 20 000 378 563 70 000 $308 563

Paragraph 39 of IAS 21 states the principles for translating from the functional currency into the presentation currency: The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures: (a) assets and liabilities for each statement of financial position presented (i.e. including comparatives) shall be translated at the closing rate at the date of that statement of financial position; (b) income and expenses for each statement presenting profit or loss and other comprehensive income (i.e. including comparatives) shall be translated at exchange rates at the dates of the transactions; and (c) all resulting exchange differences shall be recognised in other comprehensive income. In this circumstance, the subsidiary’s financial statements are prepared in the local currency, and, as the parent’s currency is the functional currency, they are translated into the parent’s currency. The main difference in preparing the consolidated financial statements in this case is in the valuation entries. This is because the translation of non-monetary assets differs when the translation is for presentation purposes rather than for functional currency purposes. Under the method described in paragraph 23 of IAS 21, the non-monetary assets of the subsidiary are translated using exchange rates at the date of the transaction (i.e. historical rates). In contrast, where the translation is based on paragraph 39 of IAS 21, the non-monetary assets are translated at the closing rate. Paragraph 39 of IAS 21 applies where the presentation currency differs from the functional currency ie: if July Ltd’s functional currency is US$ then non-monetary items will be translated at closing rates. However if July Ltd’s functional currency is AUD$ then Paragraph 23 of IAS 21 applies where non-monetary items will be translated at historical rates.

24.24

Solutions Manual to accompany Applying IFRS Standards 4e

4. Verification of translation adjustment Net monetary assets at 1 January 2016 Increases: sales Decreases: Purchases Expenses Net monetary assets at 31 December 2016

US$ 5 000 90 000 95 000

rate change gain/(loss) (1/0.6 – 1/0.52) (1 282) (1/0.6 – 1/0.56) (10 714) (11 996)

55 000 30 000 85 000 10 000

(1/0.6 – 1/0.56) (1/0.6 – 1/0.56)

6 548 3 571 10 119 (1 877)

24.25

Chapter 24: Translation of the financial statements of foreign entities

Exercise 24.7

CONSOLIDATION SUBSIDIARY

WORKSHEET

ENTRIES

FOR

FOREIGN

Prepare the consolidation worksheet entries for the preparation of the consolidated financial statements of Faber Ltd at 30 June 2016. Net fair value of identifiable assets and liabilities acquired =

= = = = = = = =

Consideration transferred

Goodwill

S$[800 000 + 100 000 + 240 000) x 0.2 + (50 000 x 0.2) (1 – 20%) (BCVR – land) + (40 000 x 0.2) (1 -20%) (BCVR – plant) + (10 000 x 0.2) (1 – 20%) (BCVR - inventory) S$(160 000 + 20 000 + 48 000 + 8 000 + 6 400 + 1 600) S$244 000 HK$1 250 000 S$(1 250 000 x 0.2) S$250 000 S$6 000 HK$(6 000/0.2) HK$30 000

Business combination valuation entries at 30 June 2016 Land (5000 x 0.2) Business Combination Valuation Reserve (40 000 x 0.2) Deferred Tax Liability (10 000x 0.22) Foreign Exchange Loss

Accumulated Depreciation (200 000 x 0.2) Plant (160 000 x 0.2) Deferred Tax Liability (8 000 x 0.22) Business Combination Valuation Reserve (32 000 x 0.2) Foreign Exchange Loss

Dr Cr Cr

Depreciation Expense (1/4 x 40 000 x 0.2) Accumulated Depreciation

Dr Cr

2 000

Deferred Tax Liability (10 000 x 20% x 0.22) Income Tax Expense (10 000 x 20% x 0.26) Foreign Exchange Loss

Dr Cr Dr

440

Cost of Sales (10 000 x 0.2) Income Tax Expense (2 000 x 0.26) Transfer from Business Combination Valuation Reserve (8 000 x 0.2) Foreign Exchange Loss

Dr Cr

2 000

Cr Cr Dr

Cr Dr

10 000 8 000 2 200 200 40 000 32 000 1 760 6 400 160

2 000

520 120

520

Cr Dr

120

1 600

48 000

Dr Dr Dr Dr Dr Cr

1 600 160 000 20 000 14 400 6 000

Pre-acquisition entry at 30 June 2016 Retained Earnings (op bal) Transfer from Business Combination Valuation Reserve Share Capital General Reserve Business Combination Valuation Reserve Goodwill Shares in Lantau Ltd

250 000

24.26

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 24.8

DIFFERENT FUNCTIONAL ADJUSTMENTS

CURRENCIES,

CONSOLIDATION

Translate the accounts of the foreign subsidiary, Lund Ltd, into Australian dollars at 30 June 2016, assuming: (a) the functional currency is the Swedish krona, and the presentation currency is the Australian dollar (b) the functional currency is the Australian dollar, as is the presentation currency. 2. Verify the translation adjustments in requirement 1. 3. Prepare, for each of (a) and (b) above, the business combination valuation and preacquisition entries for the preparation of the consolidated financial statements at 30 June 2016. 1. Translation of accounts (a) Translation from functional currency (Swedish krona) to presentation currency (Australian dollar) K'000 Revenue Cost of sales: Opening stock Purchases

K'000 2 585

600 1 800 2 400 580

Closing stock Cost of sales Gross profit Depreciation Other expenses

$'000 1 344

0.54 0.52

324 936 1 260 296 964 380 65 140 205 175 104 71 343 414

0.51 1 820 765

125 270

0.52 0.52 395 370 200 170 635 805

Income tax expense Profit for the period Retained earnings as at 1/7/11 Dividend paid

50 50

Retained earnings as at 30/6/12 Share capital General reserve Foreign Currency Translation Reserve

Cash & receivables Inventory Land Buildings Accumulated depreciation Plant Accumulated depreciation

100 705 800 200

0.52 0.54 0.54 0.52 0.54 0.54

____ $1 705

53 361 432 108 (48) $853

500 580 300 700 (130) 900 (330) 2 520

0.5 0.5 0.5 0.5 0.5 0.5 0.5

250 290 150 350 (65) 450 (165) 1 260

235 580 815

0.5 0.5

117 290 407

Current liabilities Notes

Net assets

K'000 0.52

$1 705

$853

24.27

Chapter 24: Translation of the financial statements of foreign entities

2 (a) Proof of Foreign Current Translation Reserve Change in net investment Opening net assets Opening net assets x ending exchange rate Opening net assets x beginning exchange rate Translation loss Income statement items Change in retained earnings Change x ending exchange rate Change as translated Translation gain Balance of FCTR

= = = = = =

K1 635 1 635 x 0.5 $818 1 635 x 0.54 $883 $(65)

= = = = = = = = =

K705 - K635 K70 K70 x 0.5 $35 $361 - $343 $18 $17 $(65) + $17 $(48)

3 (a) Consolidation Worksheet Entries: (Solution in $'000) Net fair value of identifiable assets and liabilities acquired = = = = Consideration transferred = Goodwill = =

K[800 + 200 +635 + 100(1 -25%)] K1 710 $(1 710 x 0.54) $923.4 $977.4 $54 K100

Business combination valuation entries

Accumulated Depreciation Plant Business Combination Valuation Reserve Deferred Tax Liability FCTR

Dr Cr

Depreciation Expense Accumulated Depreciation FCTR

Dr Cr Cr

10.4

Deferred Tax Liability FCTR Income Tax Expense

Dr Dr Cr

2.5 0.1

Cr Cr Dr

117.5 67.5

(K235 x 0.5) (K135 x 0.5)

40.5 (K100 x 0.54 x 75%) 12.5 (K100 x 0.5 x 25%) 5.0

10.0 0.4

(K20 x 0.52) (K20 x 0.5)

(20% x 25 x 0.5) 2.6

(20% x 25 x 0.52)

24.28

Solutions Manual to accompany Applying IFRS Standards 4e

Pre-acquisition entry Retained Earnings (1/7/15) Dividend Paid Share Capital General Reserve Business Combination Valuation Reserve Goodwill FCTR Shares in Lund Ltd

Dr Cr Dr Dr Dr Dr Dr Cr

342.9

(K635 x 0.54) (K50 x 0.54) (K800 x 0.54) (K200 x 0.54)

27.0 432.0 108.0 40.5 50 4

(K100 x 0.5) (K100[0.54 – 0.5]) 950.4

1. (b) Translation from local currency (Swedish krona) to functional currency (Australian dollar). K'000 K'000$'000 Revenue 2 585 0.52 1 344 Cost of sales: Opening stock 600 0.54 324 Purchases 1 800 0.52 936 2 400 1 260 Closing stock 580 0.51 296 Cost of sales 1 820 964 Gross profit 765 380 Depreciation 115 0.54 62 10 0.52 5 Other expenses 270 0.52 140 395 207 370 173 Foreign Exchange Gain 15 188 Income tax expense 200 0.52 104 Profit for the period 170 84 Retained earnings as at 1/7/15 635 0.54 343 805 427 Dividend paid 50 0.54 27 50 0.52 26 100 53 Retained earnings as at 30/6/16 705 374 Share capital 800 0.54 432 General reserve 200 0.54 108 1 705 914 Cash & receivables Inventory Land Buildings Accumulated depreciation Plant Accumulated depreciation

500 580 300 700 (130) 800 100 (320) (10) 2 520

0.50 0.51 0.54 0.54 0.54 0.54 0.52 0.54 0.52

250 296 162 378 (70) 432 52 (173) (5) 1 322

235 580 815

0.5 0.5

118 290 408

Current liabilities Notes

Net Assets

$1 705

$914

24.29

Chapter 24: Translation of the financial statements of foreign entities

2. (b) Proof of exchange gain K'000 Net Monetary Assets at 1/7/15 Increases: Sales Decreases: Purchases Other Expenses Income Tax Expense Dividends Acquisition of Plant

Net Monetary Assets at 30/6/16

(430) 2 585 2155

(0.54 - 0.5) (0.52 - 0.5)

1 800 270 200 50 50 100 $2 470

(0.52 - 0.5) (0.52 - 0.5) (0.52 - 0.5) (0.54 - 0.5) (0.52 - 0.5) (0.52 - 0.5)

K'000 Gain/(loss) 17 (52) (35) 36 5 4 2 1 2 $50

(315)

Foreign Exchange Gain (Any difference is due to rounding)

3 (b) Consolidation Worksheet Entries (Solution in $'000) Net fair value of identifiable assets and liabilities acquired

Consideration transferred Goodwill

= = = = = = =

K[800 + 200 +635 + 100(1 -25%)] K1 710 $(1 710 x 0.54) $923.4 $977.4 $54 K100

Business combination valuation entries Accumulated Depreciation Plant Business Combination Valuation Reserve Deferred Tax Liability Foreign Exchange Gain

Dr Cr

127.0

Depreciation Expense Accumulated Depreciation

Dr Cr

10.8

Deferred Tax Liability Foreign Exchange Loss Income Tax Expense

Dr Dr Cr

2.5 0.1

73.0

Cr Cr Cr

(K235 x 0.54) (K135 x 0.54)

40.5 (K100 x 0.54 x 75%) 12.5 (K100 x 0.5 x 25%) 1.0

10.8

(K20 x 0.54) (K20 x 0.54)

(20% x 25 x 0.5) 2.6

(20% x 25 x 0.52)

Pre-acquisition entry Retained Earnings (1/7/15) Dividend Paid Share Capital General Reserve Business Combination Valuation Reserve Goodwill Shares in Lund Ltd

Dr Cr Dr Dr Dr Dr Cr

342.9 27.0 432.0 108.0 40.5 54.0

(K635 x 0.54) (K50 x 0.54) (K800 x 0.54) (K200 x 0.54) (54 + 40.5)

950.4

24.30

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 24.9

CONSOLIDATION OF FOREIGN CURRENCY TRANSLATION RESERVE

Translate the financial statements of Panda Ltd as at 30 June 2017 into the presentation currency of Australian dollars, assuming that the functional currency is the Hong Kong dollar.

Translated accounts of Panda Ltd as at 30 June 2017 HK$

Sales Cost of sales Expenses Tax expense Profit for the period Retained earnings (1/7/16) Dividend paid Retained earnings (30/6/17) Share capital General reserve FCTR

Current assets Property, plant & equipment (net) Patents and trademarks Liabilities

Exchange Rate

595 000 400 000 195 000 100 000 95 000 20 000 75 00 450 000 525 000 25 000 500 000 200 000 100 000 _______ $800 000

0.85 0.85

250 000 500 000 150 000 900 000 100 000 $800 000

0.78 0.78 0.78 0.78 0.78

0.85 0.85

0.8 0.8 0.8

505 750 340 000 165 750 85 000 80 750 17 000 63 750 366 000 429 750 20 000 409 750 160 000 80 000 (25 750) $624 000 195 000 390 000 117 000 702 000 78 000 $624 000

Foreign Currency Translation Reserve (FCTR) at 30 June 2017 2014-15 Opening net investment Profit for the period FCTR at 30 June 2015

= = = = =

HK$(200 000 + 100 000 + 300 000) HK$600 000 HK$100 000 600 000(0.85 - 0.8) + 100 000 (0.85 - 0.82) A$33 000 (credit)

2015-16 Opening net investment

= HK$(200 000 + 100 000 + 400 000) = HK$700 000 Profit for the period = HK$50 000 FCTR change = 700 000(0.9 - 0.85) + 50 000 (0.9 - 0.88) = $36 000 (credit) Hence at 30 June 2016, the FCTR has a credit balance of $69 000.

24.31

Chapter 24: Translation of the financial statements of foreign entities

2016-17 Opening net investment Profit for the period Dividend FCTR change

= = = = = =

HK$(200 000 + 100 000 + 450 000) HK$750 000 HK$75 000 HK$25 000 750 000(0.78 - 0.9) + 75 000 (0.78 - 0.85) – 25 000 (0.78 - 0.8) $(94 750) (debit)

The balance of the FCTR at 30 June 2017 is then $(25 750).

Retained earnings balance at 1 July 2016 Retained earnings (1/7/14) Profit 2014–15 Profit 2015–16 Retained earnings (1/7/16)

= = = = = = =

HK$300 000 x 0.8 A$240 000 HK$100 000 x 0.82 A$82 000 HK$50 000 x 0.88 A$44 000 A$366 000

24.32

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise 24.10

TRANSLATION INTO FUNCTIONAL CURRENCY, INTRAGROUP TRANSACTIONS

Translate the financial statements of Paradise Ltd into Australian dollars for inclusion in the consolidated financial statements of Surfers Ltd at 31 December 2015. Prepare the consolidation worksheet entries for adjusting for the effects of the inventory sales from the parent to the subsidiary.

1. Translation into A$ US$ Sales First half Second half Cost of sales: Purchases

Closing inventory Gross profit Expenses: Depreciation: fittings Other expenses Leases expenses

Trading loss Foreign currency translation loss Loss for the period

rate

210 000 470 000 680 000

1/0.63 1/0.65

333 333 723 077 1 056 410

50 000 60 000 40 000 80 000 230 000 20 000 210 000 470 000

1/0.63 1/0.65 1/0.66 1/0.69

79 365 92 308 60 606 115 942 348 221 28 986 319 235 737 175

102 667 18 083 60 000 90 000 100 000 120 000 490 750 (20 750

1/0.64 1/0.66 1/0.63 1/0.65 1/0.63 1/0.65

160 417 27 398 95 238 138 462 158 730 184 615 764 860 (27 685 (65 170) (92 855)

1/0.69

(20 750)

Share capital Retained earnings

500 000 (20 750) $479 250

1/0.60

833 333 (92 855) $740 478

Cash Accounts receivable Fittings

14 600 33 400 448 000 124 000 (102 667) (18 083) 20 000 519 250 40 000 $479 250

1/0.7 1/0.7 1/0.64 1/0.66 1/0.64 1/0.66 1/0.69

20 857 47 714 700 000 187 879 (160 417) (27 398) 28 986 797 621 57 143 $740 478

Accumulated depreciation Inventory Total assets Accounts payable Net assets

1/0.7

24.33

Chapter 24: Translation of the financial statements of foreign entities

Verification of translation loss Net monetary assets at 1/1/15 Increases: sales-

Decreases: Acquisition of furniture Purchases

Lease expenses Other expenses

Net monetary assets at 31/12/15

US$ 500 000 210 000 470 000 1 180 000

rate change 1/0.7 – 1/0.6 1/0.7 – 1/0.63 1/0.7 – 1/0.65

gain/(loss) (119 047) (33 333) (51 648) (204 028)

448 000 124 000 50 000 60 000 40 000 80 000 100 000 120 000 60 000 90 000 1 172 000 8 000

1/0.7 – 1/0.64 1/0.7 – 1/0.66 1/0.7 – 1/0.63 1/0.7 – 1/0.65 1/0.7 – 1/0.66 1/0.7 – 1/0.69 1/0.7 – 1/0.63 1/0.7 – 1/0.65 1/0.7 – 1/0.63 1/0.7 – 1/0.65

60 000 10 736 7 936 6 594 3 463 1 656 15 873 13 186 9 524 9 891 138 859 (65 170) (rounded)

2. Consolidation worksheet entries

Sales Cost of Sales Inventory Deferred Tax Asset (20% x 28 986) Income Tax Expense

Dr Cr Cr

348 221

Dr Cr

5 797

319 235 28 986

5 797

Sales: (50 000 x 1/0.63) + 60 000 x 1/0.65) + 40 000 x 1/0.66) + 80 000 x 1/0.69) = A$348 221 Inventory: 20 000 x 1/0.69 = 28 986

24.34

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter 24 Translation of the financial statements of foreign entities

CHAPTER 24 Translation of the financial statements of foreign entities Learning Objectives 24.1

Identify the reason for translation of financial statements and the applicable accounting standard 24.2 Explain the difference between functional and presentation currencies 24.3 Discuss the rationale underlying the choice of a functional currency 24.4 Apply the indicators in choosing a functional currency 24.5 Translate a set of financial statements from local currency into the functional currency 24.6 Account for changes in the functional currency 24.7 Translate financial statements into the presentation currency 24.8 Prepare consolidated financial statements including foreign subsidiaries where the local currency is the functional currency 24.9 Prepare consolidated financial statements including foreign subsidiaries where the functional currency is that of the parent entity 24.10 Explain what constitutes the net investment in a foreign operation 24.11 Prepare the disclosures required by IAS 21.

24.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

When an entity has an investment in a foreign domiciled entity it is necessary to translate the financial statements of the foreign operation to the currency used by the investor: Learning Objective 24.1 Identify the reason for translation of financial statements and the applicable accounting standard a. regardless of the ownership interest in the entity b. only where the entity is a wholly owned subsidiary *c. where the investor has control over the foreign entity d. where the investment is material to the investor

In order for the financial statements of a foreign operation to be included in the consolidated financial statements of the parent it is necessary to translate the foreign operation’s financial statements into: Learning Objective 24.1 Identify the reason for translation of financial statements and the applicable accounting standard *a. the presentation currency of the reporting entity; b. the functional currency of the foreign operation; c. the local currency of the foreign operation; d. the domestic currency of the foreign operation;

24.3

Chapter 24 Translation of the financial statements of foreign entities

The following information relates to question 3 and 4 Aussie Ltd acquired 100% of Sing Sing Ltd (Sing Sing) on 1 July 20X0. The statement of financial position of Sing Sing on that date was as follows: Statement of Financial Position as at 1 July 20X0 S$ Machinery at cost 280,000 Investment property 200,000 Receivables 50,000 Cash 70,000 600,000

Share capital General Reserve Retained earnings

S$ 200,000 100,000 300,000 600,000

The statement of financial position of Sing Sing as at 30 June 20X1was as follows: Statement of Financial Position as at 30 June 20X1 S$ Machinery- carrying value 150,000 Investment property 200,000 Trade receivables 250,000 Cash 300,000

Share capital General Reserve Retained earnings Trade payables Income tax payable

900,000

S$ 200,000 100,000 500,000 85,000 15,000 900,000

Relevant exchange rates are as follows:

1 July 20X0 30 June 20X1 Average 20X0-X1

A$ 1.00 1.00 1.00

= = =

S$ 1.25 1.28 1.18

If the local currency of Sing Sing is Singapore dollars and the functional currency is Australian dollars the total assets of S$900,000 would translate into Australian dollars as: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. $703 125 *b. $709 688 c. $1 141 500 d. $1 152 000

24.4

Test Bank to accompany Applying IFRS Standards 4e

If the functional currency of Sing Sing is Singapore dollars and the presentation currency is Australian dollars the total assets of S$900,000 would translate into Australian dollars as: Learning Objective 24.7 Translate financial statements into the presentation currency *a. $703 125 b. $709 688 c. $1 141 500 d. $1 152 000

Indicators pointing towards the local overseas currency as the functional currency include, that the: I. Parent’s cash flows are directly affected on a current basis. II. Cash flows are primarily in the local currency and do not affect the parent’s cash flows. III. Sales prices are primarily responsive to exchange rate changes in the short-term. IV. Production costs are determined primarily by local conditions. Learning Objective 24.4 Apply the indicators in choosing a functional currency a. I and III only; *b. II and IV only; c. I, III and IV only; d. I, II and IV only.

When translating into the functional currency foreign currency denominated nonmonetary items measured using historical cost must be translated using the: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. rate current at end of reporting period; b. average rate for the reporting period; *c. exchange rate at the date of the transaction; d. rate prevailing at the end of the last financial year.

7. Monetary items are best described as: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. plant and equipment; *b. units of currency held and assets and liabilities to be received or paid in fixed numbers of currency units; c. all intangible items including goodwill; d. all items that are contingent in nature.

24.5

Chapter 24 Translation of the financial statements of foreign entities

8. Post acquisition date retained earnings that are denominated in a foreign currency are: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. translated into the functional currency using the rate current at the latest end of reporting period; b. translated into the functional currency using the average rate since acquisition date; c. translated into the functional currency using the rates at the end of each year since acquisition date; *d. balances carried forward from translation of previous statement of comprehensive income and do not need to be translated.

9. When translating into the functional currency monetary liabilities are translated using the: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. exchange rate current at the date the item was first recorded; b. exchange rate prevailing at the end of the last reporting period; c. closing exchange rate; *d. exchange rate current at end of reporting period.

10.

When translating foreign currency denominated financial statements into the functional currency, the exchange differences are recognised: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency *a. as an item of gain or loss in the statement of profit or loss and other comprehensive income; b. directly in the retained earnings account; c. as a deferred asset or liability; d. as a separate component of equity.

11.

If foreign currency denominated non-monetary items are measured using the fair value method, they must be translated into the functional currency using the: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency *a. exchange rate at the date when the value was determined; b. exchange rate current at end of reporting period; c. closing exchange rate for the financial year; d. exchange rate at the transaction date.

24.6

Test Bank to accompany Applying IFRS Standards 4e

12. When translating the revenue and expenses in the statement of profit or loss and other comprehensive income, theoretically each item of revenue and expense should be translated using the spot exchange rate between the: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. functional currency and the foreign currency on the reporting date; b. presentation currency and the functional currency on the reporting date; *c. functional currency and the foreign currency on the date the transaction occurred; d. presentation currency and the local currency on the transaction date.

13.

By applying the definition provided in IAS 21 The Effects of Changes in Foreign Exchange Rates, the following items will be regarded as a monetary item: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. property, plant and equipment; b. land and buildings; c. inventory; *d. accounts receivable.

14.

The general rule for translating liabilities denominated in a foreign currency into the functional currency is to: Learning Objective 24.5 Translate a set of financial statements from local currency into the functional currency a. translate all liabilities using the current rate existing at end of reporting period; b. first classify the liabilities into current and non-current; *c. first classify the liabilities as monetary or non-monetary; d. translate all liabilities using the rate current on entering into the transaction.

15. Where a change in the functional currency occurs, the translation procedures as outlined in IAS 21 The Effects of Changes in Foreign Exchange Rules, apply: Learning Objective 24.6 Account for changes in the functional currency *a. prospectively, from the date of the change; b. prospectively, from the next reporting date; c. retrospectively and must be adjusted in the opening balance of retained earnings; d. retrospectively and must be adjusted directly into the current period profit or loss.

24.7

Chapter 24 Translation of the financial statements of foreign entities

16.

Differences arise in relation to the treatment of which of the following when translating from the local to functional currency as opposed to the functional to presentation currency? Learning Objective 24.7 Translate financial statements into the presentation currency a. accounts receivable b. cost of goods sold *c. depreciation expense d. share capital

17. When translating into the presentation currency the translation difference is recognised: Learning Objective 24.7 Translate financial statements into the presentation currency a. in profit or loss *b. as a separate component of equity c. in retained earnings d. as an asset or liability, depending on whether it is a debit or credit balance.

18.

Mortimer Limited has the following items in its statement of profit or loss and other comprehensive income: Revenue FC60 000, Cost of goods sold FC25 000, Interest expense FC8 000, Income tax expense FC10 000. All items arose evenly across the year. The following exchange rates applied: End of reporting period FC1 = $0.80 Average rate for year FC1 = $0.75

The net profit after tax translated into the presentation currency is: Learning Objective 24.7 Translate financial statements into the presentation currency *a. $12 750; b. $13 600; c. $21 250; d. $26 667.

24.8

Test Bank to accompany Applying IFRS Standards 4e

The following information relates to questions 19 to 21 On 1 January 20X3, Claudia Ltd, an Australian company, acquired 80% of the shares of Saskia Ltd, a New Zealand company, for A$2 498 000. At that date the share capital of Saskia was NZ$2 million and the retained earnings were NZ$1 440 000. All the assets and liabilities of Saskia were recorded at fair value except for land, for which the fair value was NZ$200 000 higher than the carrying amount and equipment, for which the fair value was NZ$80 000 higher than the carrying amount. The undervalued equipment had a further 4-year life. The tax rate in New Zealand is 25%. Exchange rates are as follows: 1 January 20X3 31 December 20X3 Average for the year

A$1.00 = NZ$1.20 A$1.00 = NZ$1.40 A$1.00 = NZ$1.30

19. The goodwill arising on Claudia’s acquisition of Saskia is: Learning Objective 24.8 Prepare consolidated financial statements including foreign subsidiaries where the local currency is the functional currency *a. NZ$77 600; b. NZ$88 800; c. A$93 120; d. A$422 000.

20.

The adjustment to the foreign currency translation reserve on 31 December 20X3 relating to the revaluation of the land if the functional currency of Saskia is New Zealand dollars is: Learning Objective 24.8 Prepare consolidated financial statements including foreign subsidiaries where the local currency is the functional currency a. 5 953 debit b. 5 953 credit *c. 17 857 debit d. 17 857 credit

21.

The adjustment to the foreign currency translation reserve on 31 December 20X3 relating to the revaluation of the land if the functional currency of Saskia is Australian dollars dollars is: Learning Objective 24.9 Prepare consolidated financial statements including foreign subsidiaries where the functional currency is that of the parent entity a. 5 953 debit *b. 5 953 credit c. 17 857 debit d. 17 857 credit

24.9

Chapter 24 Translation of the financial statements of foreign entities

22.

Yandos Limited has made a loan of A$50 000 to a foreign subsidiary in Japan, Yamuchi Limited. The loan was made when the exchange rate was A$4 = Y1. By reporting date, the exchange rate had changed to A$5 = Y1. The Australian parent will need to recognise the following as part of the entry to revalue the loan: Learning Objective 24.10 Explain what constitutes the net investment in a foreign operation a. DR Loan receivable $62 500; b. DR Loan receivable $50 000 *c. DR Loan receivable $12 500; d. DR Loan receivable $2500.

23.

A parent entity has recognised an increase of $50 000 in a Loan Receivable from a foreign subsidiary as a result of a change in exchange rates. On consolidation the following adjustment is necessary: Learning Objective 24.10 Explain what constitutes the net investment in a foreign operation *a. DR Exchange gain $50 000 CR Foreign currency translation reserve $50 000; b. c. d.

DR CR

Exchange gain Loan receivable

$50 000

DR CR

Loan receivable $50 000 Foreign currency translation reserve

$50 000;

DR CR

Foreign currency translation reserve Exchange gain

$50 000.

$50 000;

$50 000

24.10

Test Bank to accompany Applying IFRS Standards 4e

24.

Under IAS 21 The Effects of Changes in Foreign Exchange Rates, an entity must disclose: I. II.

The amount of exchange differences included in profit or loss of the period. The amount of the exchange difference included directly in share capital during the period. III. Whether a change in the functional currency has occurred. IV. The reason for using a presentation currency that is different from the functional currency. Learning Objective 24.11 Prepare the disclosures required by IAS 21 a. b. *c. d.

I, II, III and IV; II and III only; I, III and IV only; I and IV only.

24.11

Exercises Exercise 24.6 ★★

STAR RATING

★ BASIC

★★ MODER ATE

★★★ DIFFICULT

TRANSLATION INTO PRESENTATION CURRENCY

January Ltd, an Australian company, acquired all the issued shares of July Ltd, a US company, on 1 January 2016. At this date, the net assets of July Ltd are shown below.

US$ Property, plant and equipment Accumulated depreciation

155 000 (30 000) 125 000 10 000 20 000 10 000 165 000 15 000 150 000

Cash Inventory Accounts receivable Total assets Accounts payable Net assets

The trial balance of July Ltd at 31 December 2016 was: US$ Dr Share capital Retained earnings Accounts payable Sales Accumulated depreciation — plant and equipment Property, plant and equipment Accounts receivable Inventory Cash Cost of sales Depreciation Other expenses

US$ Cr 100 000 50 000 42 000 90 000 45 000

155 000 40 000 45 000 12 000 30 000 15 000 30 000 327 000

327 000

Additional information 1. No property, plant and equipment were acquired in the 2016 period. 2. All sales and expenses were acquired evenly throughout the period. The inventory on hand at the end of the year was acquired during December 2016. 3. Exchange rates were (A$1 = US$): 1-Jan-2016 31-Dec-2016 Average for December 2016 Average for 2016

0.52 0.60 0.58 0.56

4. The functional currency for July Ltd is the US dollar. Required

1. Prepare the ﬁnancial statements of July Ltd at 31 December 2016 in the presentation currency of Australian dollars. 2. Verify the translation adjustment. 3. Discuss the differences that would occur if the functional currency of July Ltd was the Australian dollar. 4. If the functional currency was the Australian dollar, calculate the translation adjustment. CHAPTER 24 Translation of the financial statements of foreign entities

Exercise 24.7

CONSOLIDATION WORKSHEET ENTRIES FOR FOREIGN SUBSIDIARY

★★ Using the information in exercise 24.2, assume that Faber Ltd acquired the shares in Lantau Ltd for

HK$1 250 000. All the identiﬁable assets and liabilities of Lantau Ltd at acquisition date were recorded at amounts equal to fair value except for the following assets: HK$ Carrying amount 60 000 200 000 600 000

Inventory Land Plant (cost HK$800 000)

HK$ Fair value 70 000 250 000 640 000

The plant is expected to have a further 4-year life. The inventory is all sold by 30 June 2016. The tax rate in Hong Kong is 20%. Required

Prepare the consolidation worksheet entries for the preparation of the consolidated ﬁnancial statements of Faber Ltd at 30 June 2016.

Exercise 24.8

DIFFERENT FUNCTIONAL CURRENCIES, CONSOLIDATION ADJUSTMENTS

★★ On 1 July 2015, an Australian company, Perth Ltd, acquired all the issued capital of a Swedish company, Lund Ltd, for $997 400. At the date of acquisition, the equity of Lund Ltd consisted of:

Krona (K) Share capital General reserve Retained earnings

800 000 200 000 635 000

All the identiﬁable assets and liabilities of Lund Ltd were recorded at fair value except for plant for which the fair value was K100 000 greater than carrying amount. The plant has a further 5-year life. The internal ﬁnancial statements of Lund Ltd at 30 June 2016 are shown below.

Statement of Profit or Loss and Other Comprehensive Income K Revenues Cost of sales: Opening stock Purchases Closing stock Gross profit Expenses: Depreciation Other Profit before income tax Income tax expense Profit for the period Retained earnings as at 1 July 2015 Dividend paid Retained earnings as at 30 June 2016

PART 4 Economic entities

K 2 585 000

600 000 1 800 000 2 400 000 580 000

125 000 270 000

1 820 000 765 000

395 000 370 000 200 000 170 000 635 000 805 000 100 000 705 000

Statement of Financial Position 1/7/15 K 500 000 600 000 1 100 000 300 000 700 000 (100 000) 800 000 (235 000) 1 465 000 2 565 000 350 000 580 000 930 000 1 635 000 800 000 200 000 635 000 1 635 000

30/6/16 K Current assets Cash and receivables Inventory Total current assets Non-current assets Land Buildings Accumulated depreciation Plant Accumulated depreciation Total non-current assets Total assets Current liabilities Non-current liabilities Notes – issued September 2015 Total liabilities Net assets Equity Share capital General reserve Retained earnings Total equity

500 000 580 000 1 080 000 300 000 700 000 (130 000) 900 000 (330 000) 1 440 000 2 520 000 235 000 580 000 815 000 1 705 000 800 000 200 000 705 000 1 705 000

Additional information 1. Exchange rates for the Swedish krona were as follows: 1 krona = $A 0.54 0.52 0.52 0.5 0.51

1-Jul-2015 Average 2015–16 1-Jan-2016 30-Jun-2016 Average for the last 4 months of the 2015–16 period

2. Lund Ltd acquired additional plant for K100 000 on 1 January 2016 by issuing a note for K80 000 and paying the balance in cash. 3. Sales, purchases and other expenses were incurred evenly through the year. 4. Depreciation for the period in krona was as follows: Buildings Plant — acquired before 1 July 2015 — acquired 1 January 2016

30 000 85 000 10 000

5. The inventory is valued on a FIFO basis. The opening stock was acquired when the exchange rate was 0.54, and the closing stock was acquired during the last 4 months of the 2015–16 period. 6. Dividends of K50 000 were paid on 2 July 2015 and 1 January 2016. 7. The tax rate for Lund Ltd is 25%. Required

1. Translate the accounts of the foreign subsidiary, Lund Ltd, into Australian dollars at 30 June 2016, assuming: (a) the functional currency is the Swedish krona, and the presentation currency is the Australian dollar (b) the functional currency is the Australian dollar, as is the presentation currency. 2. Verify the translation adjustments in requirement 1. 3. Prepare, for each of (a) and (b) above, the business combination valuation and pre-acquisition entries for the preparation of the consolidated ﬁnancial statements at 30 June 2016. CHAPTER 24 Translation of the financial statements of foreign entities

Exercise 24.9

CONSOLIDATION OF FOREIGN CURRENCY TRANSLATION RESERVE

★★ On 1 July 2014, Kangaroo Ltd, an Australian company, acquired shares in Panda Ltd, a company based in

Hong Kong. At this date, the equity of Panda Ltd was:

HK$ 200 000 100 000 300 000

Share capital General reserve Retained earnings

At 30 June 2015 and 2016, the retained earnings balances of Panda Ltd were HK$400 000 and HK$450 000 respectively. All transactions occurred evenly throughout these years. The internal ﬁnancial statements of the two companies at 30 June 2017 were as follows: Statement of Profit or Loss and Other Comprehensive Income

Sales Cost of sales Expenses Dividend revenue Profit before income tax Tax expense Profit Retained earnings as at 1/7/16 Dividend paid Retained earnings as at 30/6/17

Kangaroo Ltd A$

Panda Ltd HK$

700 000 300 000 400 000 210 200 189 800 12 000 201 800 51 800 150 000 750 000 900 000 100 000 800 000

595 000 400 000 195 000 100 000 95 000 — 95 000 20 000 75 000 450 000 525 000 25 000 500 000

Kangaroo Ltd A$

Panda Ltd HK$

311 520 288 480 700 000 100 000 1 400 000 100 000 1 300 000

250 000 — 500 000 150 000 900 000 100 000 800 000

500 000 — 800 000 1 300 000

200 000 100 000 500 000 800 000

Statement of Financial Position

Current assets Shares in Panda Ltd Property, plant and equipment (net) Patents and trademarks Total assets Liabilities Net assets Equity: Share capital General reserve Retained earnings Total equity

Additional information 1. The dividend paid by Panda Ltd was paid on 1 May 2017. 2. Some relevant exchange rates are: 1-Jul-2014 Average 2014–15 1-Jul-2015 Average 2015–16 1-Jul-2016 Average 2016–17 1-May-2017 30-Jun-2017

PART 4 Economic entities

HK$1 = $A0.80 0.82 0.85 0.88 0.9 0.85 0.8 0.78

Required

Translate the ﬁnancial statements of Panda Ltd as at 30 June 2017 into the presentation currency of Australian dollars, assuming that the functional currency is the Hong Kong dollar. Exercise 24.10

TRANSLATION INTO FUNCTIONAL CURRENCY, INTRAGROUP TRANSACTIONS

★★★ On 1 January 2015, Surfers Ltd formed a company, Paradise Ltd, in the United States to sell Australian products such as boomerangs and cuddly koalas and kangaroos. The initial capital was US$500 000. On 1 February 2015, a lease was signed on a shop for US$20 000, payable on the ﬁrst day of each month. On 15 February, store furnishings were acquired for $448 000; these were expected to have a useful life of 4 years. On 10 June 2015, more ﬁttings were acquired at a cost of $124 000, again with an expected life of 4 years.

Additional information 1. Where non-current assets are acquired during a month, a full month’s depreciation is applied. 2. The tax rate in the United States is 20%, while the tax rate in Australia is 30%. 3. The functional currency for Paradise Ltd is the Australian dollar. 4. Exchange rates for the ﬁnancial year were (A$1 = US$): 0.6 0.63 0.64 0.66 0.65 0.63 0.66 0.69 0.65 0.70

1-Jan-2015 1-Feb 15-Feb 10-Jun 30-Jun Average for first half year 30-Sep 1-Dec Average for second half year 31-Dec-2015

5. Sales in the ﬁrst half of the year amounted to $210 000. 6. Expenses, other than depreciation, leases costs and purchases, in the ﬁrst half of the year amounted to $60 000. 7. Surfers Ltd sold inventory to Paradise Ltd at cost plus 20%. Inventory transferred to Paradise Ltd during the year consisted of: 1-Feb-15 30-Jun 30-Sep 1-Dec

US$50 000 US$60 000 US$40 000 US$80 000

All the inventory was sold by Paradise Ltd except for $20 000 of the stock transferred on 1 December 2015. 8. Financial information relating to Paradise Ltd for the year ending 31 December 2015 is: US$ Sales revenue Closing inventory Accumulated depreciation — furniture and fittings Accounts payable Share capital Lease expenses Purchases Inventory Other expenses Depreciation — furniture and fittings Furniture and fittings Cash Accounts receivable

680 000 20 000 120 750 40 000 500 000 1 360 750 220 000 230 000 20 000 150 000 120 750 572 000 14 600 33 400 1 360 750

Required

1. Translate the ﬁnancial statements of Paradise Ltd into Australian dollars for inclusion in the consolidated ﬁnancial statements of Surfers Ltd at 31 December 2015. 2. Prepare the consolidation worksheet entries for adjusting for the effects of the inventory sales from the parent to the subsidiary. CHAPTER 24 Translation of the financial statements of foreign entities

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter A Exploration for and evaluation of mineral resources

CHAPTER A Exploration for and evaluation of mineral resources A.1 A.2 A.3 A.4 A.5 A.6 A.7

describe the background to IFRS 6 identify which items are in the scope of IFRS 6 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets explain how to measure exploration and evaluation assets explain the impairment procedures applicable to exploration and evaluation assets describe the presentation and disclosure requirements of IFRS 6 discuss the possible future developments for IFRS 6

A.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions

1. IFRS 6 Exploration for and Evaluation of Mineral Resources was issued by the IASB in: Learning Objective A.1 Describe the background to IFRS 6 a. 2000 *b. 2004 c. 2006 d. 2007

2. The scope of IFRS 6 is limited to: Learning Objective A.2 identify which items are in the scope of IFRS 6 *a. Exploration and evaluation expenditures b. Pre-exploration, exploration and evaluation expenditures c. Exploration, evaluation and development expenditures d. Pre-exploration, exploration, evaluation and development expenditures

3. In the context of IFRS 6, E&E stands for: Learning Objective A.2 identify which items are in the scope of IFRS 6 a. evaluation and extraction *b. exploration and evaluation c. extraction and exploration d. exploration and expenditure

Mineral resources are specifically excluded from the scope of which of the following standards? I IAS 2 Inventories II IAS 16 Property, plant & equipment III IAS 18 Revenue IV IAS 38 Intangible assets Learning Objective A.2 identify which items are in the scope of IFRS 6 a. I and III only b. II and IV only c. II, III and IV only *d. I, II, III and IV

5. Which costs are within the scope of IFRS 6? Learning Objective A.2 identify which items are in the scope of IFRS 6 a. Pre-exploration and evaluation phase expenditure *b. Exploration and evaluation phase expenditure c. Development phase expenditure d. All of the above

A.3

Chapter A Exploration for and evaluation of mineral resources

Which of the following methods is the least applied method to account for exploration and evaluation costs? Learning Objective A.3 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets a. the area of interest method b. the successful efforts method *c. the appropriation method d. the full cost method

Most large oil and gas companies use which of the following methods to account for exploration and evaluation costs? Learning Objective A.3 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets *a. the area of interest method b. the successful efforts method c. the appropriation method d. the full cost method

8. Which of the following methods best reflects the traditional concept of an asset? Learning Objective A.3 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets a. the area of interest method *b. the successful efforts method c. the appropriation method d. the full cost method

Which of the following methods involves capitalizing exploration and evaluation costs using a larger cost centre than an area of interest such as a country of region? Learning Objective A.3 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets a. the area of interest method b. the successful efforts method c. the appropriation method *d. the full cost method

10. Which of the following methods is inconsistent with historical cost accounting? Learning Objective A.3 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets a. the area of interest method b. the successful efforts method *c. the appropriation method d. the full cost method

A.4

Test Bank to accompany Applying IFRS Standards 4e

11.

Which of the following is NOT included as part of the initial cost of exploration and evaluation assets? Learning Objective A.4 explain how to measure exploration and evaluation assets a. exploratory drilling b. miming acquisition rights c. trenching *d. pre-exploration survey fees The majority of an entity’s obligations for removal and restorations costs are incurred during which phase of a project? Learning Objective A.4 explain how to measure exploration and evaluation assets a. exploration phase b. technical feasibility phase *c. development phase d. evaluation phase 12.

13.

The entry to record an obligation for removal and restoration incurred during the exploration and evaluation (E&E) phase of a mining project is: Learning Objective A.4 explain how to measure exploration and evaluation assets a. DR E&E asset xx CR E&E expense xx b.

*d.

E&E expense xx CR Provision for removal and restoration

Removal and restoration expense CR E&E asset

E&E asset xx CR Provision for removal and restoration

14.

The obligation to record a provision for removal and restoration costs arising from mining exploration and evaluation arises through the application of: Learning Objective A.4 explain how to measure exploration and evaluation assets a. IFRS 6 *b. IAS 37 c. The Framework d. IFRIC 1

A.5

Chapter A Exploration for and evaluation of mineral resources

15.

Which of the following are included in IFRS 6 as factors indicating the E&E assets may be impaired? I whether the exploration rights for the specific area have expired or are expected to expire in the near future and there is no expectation of renewal II where there is no budget or plan for the incurrence of further substantial E&E expenditure in the specific area III where the entity had decided to discontinue E&E activities in the specific area on the basis that such activities have not led to the discovery of commercially viable quantities of mineral resources IV where the entity has established that the cost of the E&E asset is unlikely to be recovered in full from the successful development or sale of the specific area Learning Objective A.5 explain the impairment procedures applicable to exploration and evaluation assets *a. I, II and III b. I, II and IV c. I, III and IV d. II, III and IV

16.

Which of the following statements in relation to assessing E&E assets for impairment is correct? Learning Objective A.5 explain the impairment procedures applicable to exploration and evaluation assets *a. The level at which and E&E asset is tested for impairment may consist of one or more cash-generating units b. IFRS 6 allows the cash-generating unit or group of cash-generating units to which an E&E asset is allocated to be larger than a segment determined in accordance with IFRS 8. c. IFRS 6 allows E&E assets to be tested for impairment at the individual asset level d. IFRS 6 does not allow the reversal of impairment write-downs made against E&E assets

17.

The journal entry required to recognise depreciation on a drilling rig that is being used in the exploration phase of a mining project is: Learning Objective A.6 describe the presentation and disclosure requirements of IFRS 6 a. DR Depreciation expense - drilling rig xx CR Accumulated depreciation – drilling rig xx *b. c. d.

DR DR DR

Intangible E&E asset xx CR Accumulated depreciation – drilling rig

Depreciation expense - drilling rig CR Intangible E&E asset

xx xx

Intangible E&E asset CR Depreciation expense - drilling rig

A.6

Test Bank to accompany Applying IFRS Standards 4e

18. IFRS 6 requires disclosure of which of the following? Learning Objective A.6 describe the presentation and disclosure requirements of IFRS 6 a. accounting policies relating to pre-exploration costs b. financing cash flows relating to E&E activities c. impairment write-downs made on E&E assets *d. accounting policies relating to E&E assets

19. Which of the following statements is correct? Learning Objective A.7 discuss the possible future developments for IFRS 6 a. The IASB extractive industries project currently underway excludes disclosure requirements from its scope *b. IFRS 6 was issued by the IASB as an interim measure pending the completion of a comprehensive project dealing with accounting for the extractive industries c. The IASB extractive industries project currently underway proposed the removal of the ‘unit of account’ concept in accounting for E&E assets d. IFRS 6 was issued by the IASB as a result of their recent comprehensive extractive industries project

20.

The IFRS Interpretations Committee issued an interpretation in relation to the accounting for surface mine stripping costs (i.e., removal of rocks, soil and other waste materials to access the relevant mineral deposits) incurred during the production phase. The interpretation proposes: Learning Objective A.7 discuss the possible future developments for IFRS 6 a. Waste removal (stripping) costs would be capitalised during the production phase of a surface mine, if certain criteria are met b. This asset would be referred to as a stripping activity asset (‘the asset’) c. The asset would initially be recognised at cost plus directly attributable overhead costs. *d. All of the options are correct

21. IFRS 6 is an example of: Learning Objective A.1 Describe the background to IFRS 6 *a. an industry specific standard b. a not-for-profit standard c. a standard applicable to disclosing entities d. a differential reporting standard based on size based criteria

A.7

Chapter A Exploration for and evaluation of mineral resources

22. Accounting policies for exploration and evaluation costs should be determined: Learning Objective A.2 identify which items are in the scope of IFRS 6 *a. in accordance with IFRS 6 b. in accordance with IAS 8 c. in accordance with IAS 6 d. in accordance with IFRS 8

Accounting for the acquisition of equipment to be used in the extraction of mineral resources is covered by: Learning Objective A.2 identify which items are in the scope of IFRS a. IFRS 6 b. IAS 8 *c. IAS 16 d. IAS 38

24.

Which of the following methods tends to be restricted to small mining companies in South Africa? Learning Objective A.3 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets a. the area of interest method b. the successful efforts method *c. the appropriation method d. the full cost method

25. Which of the following methods best reflects the volatility inherent in E&E activities? Learning Objective A.3 understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets a. the area of interest method *b. the successful efforts method c. the appropriation method d. the full cost method

26. Subsequent to initial recognition E&E assets are required to be measured: Learning Objective A.4 Explain how to measure exploration and evaluation assets: a. under the cost model b. under the revaluation model *c. either under the cost model or revaluation model d. at the lower of the cost and fair value

A.8

Test Bank to accompany Applying IFRS Standards 4e

27.

Which of the following statements in relation to the use of the revaluation model to subsequently account for E&E assets is correct? Learning Objective A.4 explain how to measure exploration and evaluation assets a. The revaluation model can only be used to account for tangible E&E assets. b. The revaluation model can be used for intangible E&E assets where the fair value can be reliably measured. c. The revaluation model can be used for tangible E&E assets only where there is an active market for the assets. *d. The revaluation model can be used for tangible E&E assets where the fair value can be reliably measured.

28. E&E assets are required to be tested for impairment: Learning Objective A.5 explain the impairment procedures applicable to exploration and evaluation assets *a. when there is an indication that the assets may be impaired b. at least annually c. only where commercially feasible reserves are not found through the E&E activities d. prior to reclassification at the end of E&E activities

29.

Which of the following E&E costs would be classified as intangibles? I drilling rights II equipment inspection costs III exploration licenses IV capitalized consumable costs Learning Objective A.6 describe the presentation and disclosure requirements of IFRS 6 a. I, II and III b. II, III and IV c. I, II and IV *d. I, III and IV

30. Which of the following is NOT within the scope of the IASB extractive activities project? Learning Objective A.7 discuss the possible future developments for IFRS 6 a. the definition of reserves and resources *b. whether to expense or capitalise costs recognised after recognition of reserves and resources as assets c. measurement of reserves and resources on initial recognition as an asset d. disclosure requirements for reserves and resources

A.9

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by John Sweeting, Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter B Agriculture

CHAPTER B Agriculture Learning objectives B.1 B.2

Explain the background to the development of IAS 41 Distinguish between agricultural activities, agricultural produce, biological assets, bearer plants and produce growing on a bearer plant B.3 Explain the different accounting treatment required before and after harvest B.4 Examine the interaction between IAS 41 and IAS 16 Property, Plant and Equipment, IAS 40 Investment Property and IAS 17 Leases B.5 Explain the recognition criteria for biological assets (including produce growing on a bearer plant) and agricultural produce B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce B.7 Describe how IFRS 13 interacts with IAS 41 B.8 Explain the practical implications of measuring these assets at fair value, including interpreting the disclosures made by entities applying the standard B.9 Examine the interaction between IAS 41 and IAS 20 Accounting for Government Grants and Disclosure of Government Assistance B.10 Describe the disclosure requirements of IAS 41.

B.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1.

Which of the following is NOT a reason as to why the IASC felt that agriculture was an industry that needed its own industry specific standard? Learning Objective B.1 Explain the background to the development of IAS 41 a. the specific exclusion of assets related to agricultural activity from other standards *b. agriculture was considered to be an emerging industry at that time c. accounting guidelines for agricultural activity previously developed by national standard setters had been piecemeal d. the nature of agricultural activity had created uncertainty or conflicts when applying traditional accounting models

IAS 41 applies to the accounting for the following when they relate to agricultural activity: I agricultural produce II biological assets III land related to agricultural activity IV government grants Learning Objective B.2 Distinguish between agricultural activities, agricultural produce, biological assets, bearer plants and produce growing on a bearer plant a. I, II and III b. II, III and IV *c. I, II and IV d. I, III and IV

3. Which of the following is NOT considered an agricultural activity? Learning Objective B.2 Distinguish between agricultural activities, agricultural produce, biological assets, bearer plants and produce growing on a bearer plant a. oyster farming *b. ocean fishing c. pearl farming d. fish farming

4. Which of the following meets the definition of agricultural produce? Learning Objective B.2 Distinguish between agricultural activities, agricultural produce, biological assets, bearer plants and produce growing on a bearer plant a. Dairy cattle *b. Milk c. Cheese d. Yoghurt

B.3

Chapter B Agriculture

IAS 41 considers that there are three common features to agricultural diversity. Which of the following is NOT one of those features? Learning Objective B.2 Distinguish between agricultural activities, agricultural produce, biological assets, bearer plants and produce growing on a bearer plant a. measurement of change b. management of change c. capability to change *d. change transformation

6. Agricultural produce is defined in IAS 41 as: Learning Objective B.2 Distinguish between agricultural activities, agricultural produce, biological assets, bearer plants and produce growing on a bearer plant a. a living animal or plant b. a living product capable of biological transformation *c. the harvested product of the entity’s biological assets d. the detachment of produce from a biological asset or cessation of a biological asset’s life processes

Which of the following is NOT one of the recognition criteria contained within IAS 41 in relation to recognition of a biological asset or agricultural produce as an asset? Learning Objective B.5 Explain the recognition criteria for biological assets (including produce growing on a bearer plant) and agricultural produce *a. the asset has physical form b. the entity controls the asset as a result of past events c. it is probable that future economic benefits associated with the asset will flow to the entity d. the fair value or cost can be reliably measured

8. IAS 41 requires that biological assets be measured as follows: Learning Objective B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce a. on initial recognition and at the end of each reporting period at fair value less costs to sell *b. on initial recognition and at the end of each reporting period at its fair value less costs to sell, except where the fair value cannot be measured reliably c. at fair value-less estimated costs to sell at the point of harvest d. at fair value less costs to sell at the point of harvest

B.4

Test Bank to accompany Applying IFRS Standards 4e

9. Which of the following is NOT a cost to sell? Learning Objective B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce a. commissions to brokers b. transfer taxes and duties c. levies by regulatory agencies *d. transport costs to get assets to a market

10.

When determining the fair value of biological assets and there is no market price for that asset in its present condition IAS 41 requires that: Learning Objective B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce *a. the entity uses the present value of expected net cash flows from the asset discounted at a current market-determined pre-tax rate. b. the entity measure the asset at cost. c. the entity uses the contract prices for recent sales of similar assets adjusted for the effects of biological transformation. d. the entity uses sector benchmarks.

11.

Milko owns dairy cattle. The market value of the cattle is calculated by reference to the litres of milk able to be produced and the lactation rate of the cows. The cattle are regularly sold at auction. Costs incurred to transport the cattle to auction are €500 per truck. Each truck can transport approximately 100 cattle. Number of mature cows held at 30 June 2016 5000 Average litres of production per cow 6000 litres Lactation rate 50% Price per litre 40 cents The market value for each cow at 30 June 2016 is: Learning Objective B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce a. €1000 b. €1195 *c. €1200 d. €1205

B.5

Chapter B Agriculture

12. The entry required when an animal is born on a pig farm is: Learning Objective B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce *a. DR Biological asset xx CR Profit & Loss xx b.

13.

Agricultural produce CR Profit & Loss

Profit & Loss CR Biological asset

Profit & Loss xx CR Agricultural produce

At 30 June 2017 the fair value of WineCo’s vineyard is €2.5 million. At 30 June 2017 the following information is available: Fair value of vines prior to harvest at 31 March 2017 Fair value of grapes harvested at 31 March 2017 Estimated costs to sell – grapes Estimated costs to sell – vines

€3 100 000 €500 000 €10 000 €20 000

There have been no changes in fair values between 1 April and 30 June 2017. At 30 June 2017 the vines will be recorded in WineCo’s financial statements at an amount of: Learning Objective B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce *a. €2 580 000 b. €2 600 000 c. €2 980 000 d. €3 100 000

B.6

Test Bank to accompany Applying IFRS Standards 4e

At 30 June 2017 the fair value of WineCo’s vineyard is €2.5 million. At 30 June 2017 the following information is available: Fair value of vines prior to harvest at 31 March 2017 €3 100 000 Fair value of grapes harvested at 31 March 2017 €500 000 Estimated costs to sell – grapes €10 000 Estimated costs to sell – vines €20 000 The entry to recognise the grapes at the point of harvest is: Learning Objective B.6 Analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce a. DR Agricultural produce – grapes 500 000 CR Biological asset – vines 500 000 14.

*d.

Agricultural produce – grapes CR Cash CR Biological asset – vines

510 000

Agricultural produce – grapes CR Profit & loss

500 000

Agricultural produce – grapes CR Profit & loss

490 000

10 000 500 000

500 000

490 000

15. Fishy Co. operates a fish farm. IAS 41 requires live immature fish to be valued at: Learning Objective B.8 Explain the practical implications of measuring these assets at fair value, including interpreting the disclosures made by entities applying the standard a. cost due to the absence of an active market for such fish *b. the fair value less costs to sell based on prices of slaughtered immature fish c. either cost or fair value less estimated costs to sell d. fair value determined by applying a discount factor to the fair value of live mature fish.

16. Which of the following statements is correct in relation to government grants? Learning Objective B.9 Examine the interaction between IAS 41 and IAS 20 Accounting for Government Grants and Disclosure of Government Assistance *a. Government grants for biological assets measured at fair value are accounted for under IAS 41. b. Government grants for biological assets measured at cost are accounted for under IAS 41. c. Government grants for biological assets measured at fair value are accounted for under IAS 20. d. Government grants for biological assets measured at cost are accounted for under IAS 18.

B.7

Chapter B Agriculture

17.

Increases in fair value over cost in relation to land used for agricultural purposes is recognised in equity when the land is: Learning Objective B.4 Examine the interaction between IAS 41 and IAS 16 Property, Plant and Equipment, IAS 40 Investment Property and IAS 17 Leases a. an investment property measured at fair value and accounted for under IAS 40 b. an investment property measured at cost and accounted for under IAS 40 *c. not an investment property, is measured at fair value and accounted for under IAS 16 d. not an investment property, is measured at cost and accounted for under IAS 16

18. Which of the following require disclosures to be made under IAS 17 and IAS 41? Learning Objective B.4 Examine the interaction between IAS 41 and IAS 16 Property, Plant and Equipment, IAS 40 Investment Property and IAS 17 Leases *a. operating and financing leases by lessors and lessees b. finance leases by lessors and lessees only c. operating and finance leases by lessees only d. operating and finance leases by lessors only

19.

IAS 41 requires disclosure of which of the following? I aggregate gain or loss on initial recognition of biological assets II fair value of agricultural produce harvested during the period, at point of harvest III fair value changes attributable to physical changes IV fair value changes attributable to price changes Learning Objective B.10 Describe the disclosure requirements of IAS 41 *a. I and II only b. I, II and III only c. II, III and IV only d. I, II, III and IV

20.

Which of the following would be disclosed in the Statement of Financial Position as a biological asset under IAS 41? Learning Objective B.10 Describe the disclosure requirements of IAS 41 *a. Vines b. Picked fruit c. Cotton d. Timber

B.8

Test Bank to accompany Applying IFRS Standards 4e

21.

According to IFRS 13 Fair Value Measurement, the market used to determine fair value should be: Learning Objective B.11 Describe how IFRS 13 interacts with IAS 41 a. the principal market, or, in the absence of a principal market, the relevant market b. the most advantageous market c. the relevant market *d. either the principal market, or, in the absence of a principal market, the most advantageous market

22. Which standard was issued in 2011 that amended IAS 41? Learning Objective B.1 Explain the background to the development of IAS 41 a. IFRS 7 b. IAS 1 c. IAS 18 *d. IFRS 13

23. Which of the following is NOT considered to be agricultural produce? Learning Objective B.3 Explain the different accounting treatment required before and after harvest a. timber *b. sugar c. wool d. milk

24. Which of the following is an agricultural product? Learning Objective B.3 Explain the different accounting treatment required before and after harvest a. tea *b. milk c. coffee d. fruit juice

25. Which of the following statements is NOT correct? Learning Objective B.5 Explain the recognition criteria for biological assets (including produce growing on a bearer plant) and agricultural produce a. Management facilitates biological transformation b. Management is a key part of the definition of agricultural activity under IAS 41 c. There is a link between management and control of a biological asset *d. Management is a key part of the recognition criteria for biological assets and agricultural produce

B.9

Chapter B Agriculture

26. It is common for companies applying IAS 41 to: Learning Objective B.8 Explain the practical implications of measuring these assets at fair value, including interpreting the disclosures made by entities applying the standard a. attempt to ‘bury’ the fair value movements attributable to agricultural assets in ‘other expenses’ *b. separately disclose the fair value movements attributable to agricultural assets in the statement of profit or loss and other comprehensive income or the notes c. disclose the fair value movements attributable to agricultural assets as part of ‘abnormal’ items d. remain silent in the financial statements about the fair value movements attributable to agricultural assets, but highlight such items in ‘financial commentaries’

27.

Rural Co. received a $100 000 grant from the government on 1 July 2016. One of the conditions attached to the grant was the Rural Co had to continue farming in the same location for the following two years, otherwise the grant would have to be retuned in full. The entry to record the receipt of the grant is: Learning Objective B.9 Examine the interaction between IAS 41 and IAS 20 Accounting for Government Grants and Disclosure of Government Assistance a. DR Cash 100 000 CR Revenue 100 000 b.

*c.

Cash 100 000 CR Revenue CR Performance obligation

50 000 50 000

Cash 100 000 CR Performance obligation

100 000

No entry required as the grant is conditional and cannot be recognised until the conditions attached to the grant are met.

28. IAS 41 requires disclosure of which of the following relating to government grants? Learning Objective B.10 Describe the disclosure requirements of IAS 41 a. the nature and extent of grants recognised, unfulfilled conditions attached to the grant and significant increases expected in the level of government grants. b. the nature and extent of grants recognised, unfulfilled conditions and other contingencies attached to the grant and details of grants applied for but not yet granted c. unfulfilled conditions and other contingencies attached to the grant and details of grants applied for but not yet granted *d. the nature and extent of grants recognised, unfulfilled conditions and other contingencies attached to the grant and significant decreases expected in the level of government grants. Use the following information to answer questions 29 and 30.

B.10

Test Bank to accompany Applying IFRS Standards 4e

Cow Co. is a company that farms dairy cattle. Cow Co. owns the farmland on which the cattle are located, having purchased it for £1.5 million in 2013. The land is measured at cost under IAS 16. Details of cattle at 30 June 2015 were as follows: Cows Heifers Number 900 200 Fair value (less estimated costs to sell) £800 £320 During the year ended 30 June 2016 the following occurred: • 200 new cows were purchased at £810 each • 50 heifers matured into cows • 5 heifers died • 100 cows were sold for £830 each • The price change between a heifer and a cow at the time of maturity during the year was estimated to be £500 The following is relevant at 30 June 2016: • The land has been valued at £5.6 million • Fair value less estimated costs to sell are as follows (Cow Co. has determined that these are the appropriate fair values to use for the purposes of transfers and deaths of heifers): o Cows - £850 /head o Heifers - £350/head

29. The fair value of cows as at 30 June 2016 is: Learning Objective B.10 Describe the disclosure requirements of IAS 41 a. £943 250 *b. £892 500 c. £875 000 d. £816 500

30. The increase in fair value of livestock attributable to price change is: Learning Objective B.10 Describe the disclosure requirements of IAS 41 a. £76 000 *b. £57 000 c. £25 000 d. £6 000

B.11

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter C Associates and joint ventures

CHAPTER C Associates and joint ventures Learning Objectives C.1 Explain the nature of associates and joint ventures C.2 Discuss the concepts of significant influence and joint control C.3 Explain the rationale for the equity method and the different sets of financial statements in which it may be applied C.4 Apply the equity method in basic situations C.5 Adjust the application of the equity method for fair value-carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition C.6 Account for the effects of inter-entity transactions C.7 Account for associates and joint ventures where these entities incur losses C.8 Discuss the disclosures required in relation to associates and joint ventures.

C.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1. Which of the following statements is correct? Learning Objective C.2 Discuss the concepts of significant influence and joint control a. All joint arrangements are accounted for under IAS 28. b. Joint arrangements classified as joint ventures are accounted for under IFRS 11. *c. Joint arrangements classified as joint ventures are accounted for under IAS 28. d. Joint arrangements classified as joint operations are accounted for under IAS 28.

For the purposes of equity accounting for an investment in an associate, it is presumed that the investor has significant influence over the other entity where the investor holds: Learning Objective C.2 Discuss the concepts of significant influence and joint control a. between 1% and 5% of the voting power of the investee; b. between 5% and 10% of the voting power of the investee. *c. 20% or more of the voting power of the investee; d. 50% or more of the voting power of the investee;

The following are regarded as factors indicating the existence of significant influence over another entity: ➢ ➢ ➢ ➢

representation on the board of directors participation in decisions about dividends interchange of managerial personnel ability to control the investee’s operating policies

I Yes No No Yes

II Yes Yes No No

III Yes Yes No No

IV Yes Yes Yes No

Learning Objective C.2 Discuss the concepts of significant influence and joint control a. I; b. II; c. III; *d. IV.

For the purposes of equity accounting, significant influence is regarded as the power of an investor to: Learning Objective C.2 Discuss the concepts of significant influence and joint control a. control the financial and operating policies of an associate; *b. participate in the financial and operating policy decisions of an investee; c. participate in the day-to-day management of a joint venture interest; d. dominate the financing decisions of an entity.

C.3

Chapter C Associates and joint ventures

On 1 July 20X8 Berardo Ltd acquired 25% of the ordinary issued share capital of Ricky Ltd for €375 000. This investment gave rise to significant influence. The share capital and reserves of Ricky Ltd at 1 July 20X8 were: € Share capital 400 000 General reserve 250 000 Retained earnings 275 000 925 000 All the identifiable net assets of Ricky Ltd were stated at fair value at the date of acquisition except for a building whose carrying value was €50 000 less than the fair value. Goodwill arising on Berardo’s acquisition of Ricky was: Learning Objective C.6 Account for the effects of inter-entity transactions: Response b is correct. This is calculated as €375 000 – [(€925 000 + (€50,000 x (1-0.3))) x 25%] = €135 000. a. €131 250 *b. €135 000 c. €143 750 d. €150 000 Gunawan Limited acquired a 20% share in Juliano Limited for €18 000. Gunawan Limited has no other investments. At the date on which it became an associate, Juliano Limited had the following equity:

➢ ➢

Share capital €50 000 Retained earnings €40 000

At the end of the financial year following the investment, Juliano Limited generated a profit of €6000. After applying the equity method of accounting, Gunawan Limited will have the following carrying amount for the investment: Learning Objective C.4 Apply the equity method in basic situations *a. €9200; b. €16 800; c. €18 000; d. €19 200. Investor Limited acquired a 30% interest in Investee Limited for €27 000. Investor holds other equity investments but does not prepare consolidated financial statements. Investee Limited revalued its buildings class of assets by €10 000 during the current financial period. The balance of the investment in associate account at the end of the current financial period is: Learning Objective C.4 Apply the equity method in basic situations a. €11 100; b. €18 100; c. €27 000; *d. €30 000. 7.

C.4

Test Bank to accompany Applying IFRS Standards 4e

Codger Limited acquired a 40% investment in Lodger Limited for €50 000. Lodger declared and paid a dividend of €10 000. Codger Limited does not prepare consolidated financial statements. The appropriate entry for the investor to record this dividend is: Learning Objective C.4 Apply the equity method in basic situations *a. DR Cash €4 000 CR Investment in associate €4 000 8.

Dividends payable CR Cash

€4 000 €4 000

Cash CR Dividend revenue

€4 000 €4 000

Investment in associate CR Dividend revenue

€4 000 €4 000

The equity method of accounting for an investment in an associate includes the following steps:

Recognise the initial investment at cost Recognise the initial investment at fair value Reduce the carrying amount by any distributions Adjust the carrying amount by the investor’s share of the associate’s profit or loss

I Yes Yes No

II Yes No Yes

III No Yes No

IV No No Yes

Yes Yes No

Learning Objective C.4 Apply the equity method in basic situations a. I; *b. II; c. III; d. IV.

10. When goodwill is acquired by an investor in an associate, the amortisation of goodwill is: Learning Objective C.5 Adjust the application of the equity method for fair value-carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition a. spread evenly across the useful life of the investment; *b. not permitted; c. included in the determination of the investor’s share of the associate’s profit or loss; d. included in the revaluation of the investment.

C.5

Chapter C Associates and joint ventures

11.

Adjustments made for the purpose of calculating the incremental adjustment to the share of profit of an associate are: Learning Objective C.5 Adjust the application of the equity method for fair value-carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition a. recognised in the books of the investor; b. recognised in the books of the investee; *c. notional adjustments and not included in the books of the investee; d. relate to realised transactions and so are recognised directly by the investee.

The following information relates to questions 12 and 13 On 1 July 20X3 Alpha Ltd acquired a 25% share of Beta Ltd. At that date the following assets had carrying amounts different to their fair values in Beta’s books: Asset

Carrying amount Inventory €12 000 Machinery €24 000

Fair value €15 000 €30 000

All inventory was sold to third parties by 30 June 20X4. On 1 July 20X3, the machinery had a remaining useful life of 3 years. The tax rate is 30%. 12.

The adjustment required to the investment in associate account at 30 June 20X4 in relation to the above assets is: Learning Objective C.5 Adjust the application of the equity method for fair value-carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition *a. €875 b. €1250 c. €3500 d. €5000 13.

The adjustment required to the investment in associate account at 30 June 20X5 in relation to the above assets is: Learning Objective C.5 Adjust the application of the equity method for fair value-carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition a. €500 *b. €1225 c. €1400 d. €1750

C.6

Test Bank to accompany Applying IFRS Standards 4e

14.

Where an acquisition in an associate results in an excess the excess is accounted for in the year of acquisition as follows: Learning Objective C.5 Adjust the application of the equity method for fair value-carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition a. as a credit against the investment in associate account. *b. as a credit against the share of associate profit account. c. as a debit against the share of associates retained earnings d. no adjustment is required due to the single line method of accounting followed under the equity method.

The following information relates to questions 15 and 16 Nero Ltd purchased a 30% per cent shareholding in Bianco Ltd on 1 January 20X8 for $180,000. Bianco Ltd’s assets recorded at fair values and its owners’ equity, totalling $520,000, was represented as follows: Share capital $260,000 Reserves $120,000 Retained profits $100,000 Asset revaluation reserve $40,000 During July 20X8, Bianco Ltd paid an interim dividend of $18,000. At 31 December 20X8, Bianco Ltd reported: Profit for 20X8 $48,000 Final dividend payable $14,000 A transfer to the general reserve $10,000 Increase of the asset revaluation reserve to $70,000. 15. The equity carrying amount of the investment in Bianco Ltd at 31 December 20X8 is: Learning Objective C.5 Adjust the application of the equity method for fair value-carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition *a $199,200 b. $202,200 c. $203,400 d. $211,200 16.

Assuming that Nero Ltd applies the equity method in its own books the entry to record the dividend receivable from Bianco Ltd at 31 December 20X9 would include: Learning Objective C.6 Account for the effects of inter-entity transactions a. a credit to the dividend revenue account. *b. a credit to the investment in associate account. c. a debit to the dividend revenue account. d. a debit to the investment in associate account.

C.7

Chapter C Associates and joint ventures

17.

Where there are transactions between the investor and associate that result in an unrealised profit, the investor’s share of the associate’s profit is: Learning Objective C.6 Account for the effects of inter-entity transactions a. not affected at all regardless of whether the transaction is an upstream or downstream one; b. affected only if the transaction is an upstream one; c. affected only if the transaction is a downstream one; *d. affected regardless of whether the transaction is an upstream or downstream one.

18.

Where an investor sells inventory to an associate and the inventory is still on hand at the end of the year the investor’s share of the associate’s profits is: Learning Objective C.6 Account for the effects of inter-entity transactions a. not affected as unrealised profits are only considered to arise in a parent-subsidiary relationship; b. not affected as the unrealised profit is in the books of the investor, not the associate; c. increased by the investor’s share of the unrealised profit; *d. decreased by the investor’s share of the unrealised profit.

19.

Where an investor sells inventory to an associate in a prior year and the inventory is sold by the associate during the current year the investment in associate account is: Learning Objective C.6 Account for the effects of inter-entity transactions *a. unaffected; b. decreased by the investor’s share of the realised profit; c. increased by the investor’s share of the realised profit; d. increased by the full amount of the realised profit.

Clovelly Ltd, owns 25% of Bronte Ltd. Bronte’s profit after tax for the year ended 30 June 20X3 is £30 000. The tax rate is 30%. During the year ended 30 June 20X4, Bronte sold £5000 worth of inventory to Clovelly. These items had previously cost Bronte £3000. All the items remain unsold by the Clovelly at 30 June 20X3. Clovelly’s share of Bronte’s profit for the year ended 30 June 20X3 is: Learning Objective C.6 Account for the effects of inter-entity transactions a. £5500 b. £6250 *c. £7150 d. £7000 20.

C.8

Test Bank to accompany Applying IFRS Standards 4e

Clovelly Ltd owns 25% of Bronte Ltd. Bronte’s profit after tax for the year ended 30 June 20X5 is £30 000. The tax rate is 30%. On 1 July 20X3, Bronte Ltd sold an item of plant to Clovelly Ltd for £8000. The carrying amount of the asset on this date in Bronte Ltd’s records was £3000. The plant had a remaining useful life of 5 years. Clovelly’s share of Bronte’s profit for the year ended 30 June 20X5 is: Learning Objective C.6 Account for the effects of inter-entity transactions a. £6800 b. £7325 *c. £7675 d. £7750 21.

The following information relates to questions 22 to 24 On 1 July 2013 Joey Ltd acquired 25% of the shares of Leo Ltd for £100 000. At that date the equity of Leo Ltd was £400 000, with all identifiable assets and liabilities being measured at fair value. Profits/(losses) made since the date of acquisition are as follows: Year ended 30 June 20X5 20X6 20X7 20X8 20X9

Profit/(Loss) £ 20 000 (200 000) (250 000) 16 000 20 000

There have been no dividends paid or movements in reserves since the date of acquisition. 22. At 30 June 20X5 the equity accounted balance of the investment in Leo was: Learning Objective C.7 Account for associates and joint ventures where these entities incur losses a. £50 000 *b. £55 000 c. £100 000 d. £105 000 23. At 30 June 20X7 the equity accounted balance of the investment in Leo was: Learning Objective C.7 Account for associates and joint ventures where these entities incur losses *a. NIL b. (£3500) c. £4000 d. £16 000

C.9

Chapter C Associates and joint ventures

24. At 30 June 20X8 the equity accounted balance of the investment in Leo was: Learning Objective C.7 Account for associates and joint ventures where these entities incur losses a. NIL *b. £1500 c. £5000 d. £20 000 25. If an associate incurs losses the investor is required to: Learning Objective C.7 Account for associates and joint ventures where these entities incur losses a. ignore the losses for the purposes of equity accounting adjustments; b. recognise losses only to the point where the carrying amount is equal to the initial investment; *c. recognise losses to the point where the carrying amount of the investment is zero; d. reclassify the investment as a current asset. 26.

Where an investor has discontinued the use of the equity method because the associate has incurred losses it must disclose the: Learning Objective C.8 Discuss the disclosures required in relation to associates and joint ventures. *a. unrecognised share of current period and cumulative losses of the associate; b. reason why it has discontinued the method; c. accounting policy it has adopted in place of the equity method; d. effect on the statement of changes in equity if it had continued to use the method. 27.

Investments in associates accounted for using the equity method are presented in the statement of financial position amongst: Learning Objective C.8 Discuss the disclosures required in relation to associates and joint ventures. a. equity; b. non-current liabilities; c. current assets; *d. non-current assets.

C.10

Test Bank to accompany Applying IFRS Standards 4e

28.

When disclosing information about investments in associates, IAS 28, requires separate disclosure of which of the following? I II III IV

Shares in associates, in the statement of financial position. Share of profit or loss of associates, in the statement of profit or loss and other comprehensive income. Share of any discontinuing operations, in the statement of changes in equity. Shares of changes recognised directly in the associate’s equity, in the statement of changes in equity.

Learning Objective C.8 Discuss the disclosures required in relation to associates and joint ventures. *a. I, II, III and IV; b. I, II and IV only; c. II, II and IV only; d. I, II and III only.

C.11

Testbank to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Emma Holmes and Elisabetta Barone

John Wiley & Sons, Ltd 2016

Chapter D Joint Arrangements

CHAPTER D Joint Arrangements Learning Objectives D.1 Discuss the use of joint arrangements by companies to structure their business D.2 Explain the nature of a joint arrangement and how to classify joint arrangements into joint ventures and joint operations D.3 Explain the accounting undertaken by the joint operation itself D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation D.5 Discuss the disclosures required in relation to joint operations.

D.2

Test Bank to accompany Applying IFRS Standards 4e

Multiple Choice Questions 1. Which of the following statements is not correct? Learning Objective D.1 Discuss the use of joint arrangements by companies to structure their business a. Joint arrangements may be entered into to manage risks involved in a project. b. Joint arrangements may be entered into to provide the parties with access to new technology or new markets. *c. Joint arrangements require investors to have equal interests in the joint arrangement. d. The key feature of a joint arrangement is that the parties involved have joint control over the decision making in relation to the joint arrangement.

2. The particular relationship between parties that signifies the existence of a joint arrangement is: Learning Objective D.2 Explain the nature of a joint arrangement and how to classify joint arrangements into joint ventures and joint operations a. significant influence by one party over the other party; b. control over the operating policies of one party by another party; c. shared influence by two parties over the activities of another party; *d. joint control by the parties over the activities of an operation.

3. Which of the following statements is not true in relation to joint control? Learning Objective D.2 Explain the nature of a joint arrangement and how to classify joint arrangements into joint ventures and joint operations *a. each party must have an equal interest for joint control to exist b. joint control exists only where there is contractually agreed sharing of control c. entities over which a party has joint control are accounted for in accordance with IFRS 11 Joint Arrangements d. joint control requires the unanimous consent of the parties sharing control

The matters generally dealt with in a joint arrangement contract include the: ➢ ➢ ➢ ➢

activity, duration and reporting obligations capital contribution of the venturers sharing of the output, expenses or results voting rights of the venturers

I II Yes Yes Yes Yes Yes No No No

III IV Yes Yes Yes No Yes Yes Yes No

Learning Objective D.2 Explain the nature of a joint arrangement and how to classify joint arrangements into joint ventures and joint operations a. I; b. II; *c. III; d. IV.

D.3

Chapter D Joint Arrangements

5. IFRS 11, provides that joint control exists where: Learning Objective D.2 Explain the nature of a joint arrangement and how to classify joint arrangements into joint ventures and joint operations *a. no single party is in a position to control the activity unilaterally; b. the decisions in areas essential to the goals of the joint arrangement do not require the consent of the parties; c. no one party may be appointed as the manager of the joint arrangement; d. one party alone has power to control the strategic operating decisions of the joint arrangement.

6. Which of the following is correct? Learning Objective D.2 Explain the nature of a joint arrangement and how to classify joint arrangements into joint ventures and joint operations a. All joint arrangements which are not structured through a separate vehicle are classified as joint ventures; b. For a joint venture, the rights pertain to the rights and obligations associated with individual assets and liabilities, whereas with a joint operation, the rights and obligations pertain to the net assets. *c. In considering the legal form of the separate vehicle if the legal form establishes rights to individual assets and obligations, the arrangement is a joint operation. If the legal form establishes rights to the net assets of the arrangement, then the arrangement is a joint venture. d. Where the joint operators have designed the joint arrangement so that its activities primarily aim to provide the parties with an output it will be classified as a joint venture.

Three joint operators are involved in a joint operation that manufactures ships chandlery. At the beginning of the year the joint operation held €50 000 in cash. During the year the joint operation incurred the following expenses: Wages paid €20 000, Overheads accrued €10 000. Additionally creditors amounting to €40 000 were paid and the joint operators contributed €15 000 cash each to the joint operation. The balance of cash held by the joint operation at the end of the year is: Learning Objective D.3 Explain the accounting undertaken by the joint operation itself a. € 5000; b. €25 000; *c. €35 000; d. €75 000.

D.4

Test Bank to accompany Applying IFRS Standards 4e

Wiseye Limited and Goodbody Limited agreed to form a joint operation to offer health services. To start the operation the joint operators agreed to contribute cash of €30 000 each. The joint operation will record which of the following entries to recognise this event? Learning Objective D.3 Explain the accounting undertaken by the joint operation itself a. DR Joint operator contributions €600 000 CR Cash €600 000 b.

*d.

€600 000

DR CR

Cash

DR DR CR

Venturer’s equity – Wiseye Limited Venturer’s equity – Goodbody Limited Cash

€300 000 €300 000

DR CR CR

Cash

€600 000

Joint operator contributions

€600 000

Joint operation contribution – Wiseye Joint operation contribution – Goodbody

€300 000 €300 000

Cash contributed to a joint operation was used to purchase Equipment (€100 000) and raw materials (€70 000). The following entry would be part of the overall recording of these transactions: Learning Objective D.3 Explain the accounting undertaken by the joint operation itself *a. DR Equipment €100 000 DR Raw materials € 70 000 CR Cash €170 000 b.

DR CR

Work in progress Joint operation capital

€170 000

DR CR

Cash

€170 000

DR CR CR

Cash

€170 000 €170 000

Contribution to joint operation €170 000 Equipment Raw materials

€100 000 €70 000

D.5

Chapter D Joint Arrangements

10.

Company A Limited and Company B Limited formed a joint operation and share in the output of the joint operation 60:40. The joint operation paid a management fee of $20 000 to Company A Limited during the current period. The cost to Company A Limited of supplying the management service was $14 000. Company A Limited records the management fee revenue as follows: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation *a. DR Cash $20 000 CR Fee revenue $20 000 b.

DR CR

Cash

DR CR

Cash

DR CR

Cash

$14 000 Fee revenue

$14 000 $ 12 000

Fee revenue

$12 000 $8 000

Fee revenue

$8 000

11.

A 50:50 joint operation was commenced between two participants. Participant One contributed cash of $50 000, and Participant Two contributed a Building with a fair value of $50 000 and a carrying amount of $40 000. Using the line-by-line method of accounting, Participant Two would record: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. DR Building in JO $40 000 CR Building $40 000 b. DR

c. DR

*d. DR DR

Building in JO $50 000 CR Building CR Gain on sale of building

$40 000 $10 000

Investment in joint operation $50 000 CR Building CR Gain on sale of building

$40 000 $10 000

Cash in JO $25 000 Building in JO $20 000 CR Building CR Gain on sale of building

$40 000 $10 000

D.6

Test Bank to accompany Applying IFRS Standards 4e

12.

A joint operation holds Equipment with a carrying amount of £1 200 000. The two joint operators participating in this arrangement share control equally. They also depreciate Equipment using the straight-line method. The Equipment has a useful life of 5 years. At reporting date each joint operator must recognise the following entry, in relation to depreciation, in its records: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. DR Depreciation £240 000; *b. DR Depreciation £120 000; c. DR Investment in joint operation £240 000; d. DR Assets in joint operation £120 000.

13.

In relation to the supply of a service to a joint operation by one of the joint operators, which of the following statements is correct? Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. a joint operator can recognise 100% of the earned through the supply of services to the joint operation; b. a joint operator is entitled to recognise a profit from the supply of services to itself; *c. a joint operator cannot earn a profit on supplying services to itself; d. a joint operator is not able to recognise the service revenue or service cost for the services supplied to the joint operation.

14.

Company A Limited and Company B Limited formed a joint operation and share equally in the output of the joint operation. The joint operation paid a management fee of £20 000 to Company A Limited during the current period. The cost to Company A Limited of supplying the management service was £14 000. Company A Limited records the management fee revenue as follows: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation *a. DR Cash £20 000 CR Fee revenue £20 000 b.

DR CR

Cash

DR CR

Cash

DR CR

Cash

Fee revenue

£14 000 £14 000

Fee revenue

£ 6 000 £ 6 000

Fee revenue

£10 000 £10 000

D.7

Chapter D Joint Arrangements

15.

Three joint operators agree to an arrangement in which they have an equal share in an agricultural joint operation. The work undertaken in setting up the joint operation cost £300 000 and each operator contributed in cash. Each operator will need to recognise the following accounting entry: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. DR Cost of joint operation product £300 000 CR Cash £300 000 b.

*d.

DR CR

Inventory in JO Cash

£100 000

DR CR

Cash in JO Cash

£300 000

DR CR

Cash in JO Cash

£100 000

£300 000

£100 000

16.

A 50:50 joint operation was commenced between two participants. Participant One contributed cash of £50 000, and Participant Two contributed a Building with a fair value of £50 000. Using the line-by-line method of accounting, participant One would record: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. DR Building in JO £50 000 CR Cash £50 000 b.

*d.

DR CR

Cash in JO Cash

£50 000

DR CR

Investment in joint operation Cash

£50 000

DR DR CR

Cash in JO Building in JO Cash

£25 000 £25 000

£50 000

D.8

Test Bank to accompany Applying IFRS Standards 4e

17.

Company A Limited and Company B Limited formed a joint operation and share in the output of the joint operation 60:40. The joint operation paid a management fee of £20 000 to Company A Limited during the current period. The cost to Company A Limited of supplying the management service was £14 000. The amount of profit that Company A Limited will recognise in relation to the provision of the management fee to the joint operation is: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. NIL *b. £2 400 c. £3 600 d. £6 000

The following information relates to Questions 18 and 19 A Ltd and B Ltd have established the AB Joint Operation. A Ltd has a 60% interest in the joint operation and B Ltd has a 40% interest. A Ltd contributed an asset with a carrying amount of $90,000 and a fair value of $120,000 and B Ltd agreed to provide technical services to the joint operation over the first two years of operations. The fair value of the technical services was agreed to be $80,000 and the cost to provide the services was estimated at $65,000 at the inception of the joint operation. 18. As part of its initial contribution entry A Ltd will record a: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. Debit against the Services Receivable in JO account of $32,000; *b. Debit against the Plant in JO account of $54,000; c. Credit against the Plant of $120,000; d. Credit against the Gain on Sale of Plant of $18,000.

19. As part of its initial contribution entry B Ltd will record a: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. Debit against the Services Receivable in JO account of $32,000; b. Debit against the Plant in JO account of $36,000; *c. Credit against the Obligation to JO of $39,000; d. Credit against the Gain on Provision of Services of $6,000.

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Chapter D Joint Arrangements

20.

A 60:40 joint operation was commenced between two participants. Participant One contributed cash of $60 000, and Participant Two agreed to provide technical services to the joint operation over a period of two years. The fair value of the services was determined to be $40 000 and the cost to provide the services was estimated to be $35 000. Using the line-by-line method of accounting, participant Two would record: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. DR Cash in JO $30 000 CR Obligation to JO $30 000 *b.

DR CR CR

Cash in JO $24 000 Obligation to JO Profit on provisions of services

$21 000 $ 3 000

DR CR

Cash in JO Obligation to JO

$24 000 $24 000

DR DR CR

Cash in JO Receivable in JO Obligation to JO

$24 000 $16 000 $40 000

21.

On 1 July 20X0, the Ears & Eyes Joint Operation was established. The two joint operators participating in this arrangement, Ears Ltd and Eyes Ltd, share control equally. Both joint operators contributed cash to establish the joint operation. The joint operation holds equipment with a carrying amount of $1 200 000. Both joint operators depreciate equipment using the straight-line method and the depreciation is regarded a cost of production. The equipment has a useful life of 5 years. At 30 June 20X1 Ears Ltd had sold all inventory distributed to it and Eyes Ltd had sold 50% of the inventory distributed to it. At 30 June 20X1 Venturer Eyes must recognise the following entry, in relation to depreciation, in its records: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. DR Depreciation expense $240 000; b. DR Accumulated depreciation $120 000; *c. DR Inventory $60 000; d. DR Cost of sales $120 000.

D.10

Test Bank to accompany Applying IFRS Standards 4e

22.

When eliminating any unrealised profit arising when a joint operator provides services to a joint operation the profit is eliminated against: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. the investment in the joint operation; b. retained earnings; *c. work in progress, finished goods and other inventory related accounts; d. cost of sales.

23.

When a joint operator is accounting for an interest in joint operation it is required to recognise all of the following in its financial statements:

The assets that it controls The liabilities that it incurs Its share of income from the sale of goods by the joint operation The expenses that it incurs

I Yes Yes Yes

II Yes Yes No

III Yes No Yes

IV Yes No No

Yes

Learning Objective D.5 Discuss the disclosures required in relation to joint operations *a. I; b. II; c. III; d. IV.

D.11

Chapter D Joint Arrangements

The following information relates to Questions 24 to 26 On 1 July20X0, Abel Ltd entered into a 50:50 joint operation with Tasman Ltd to develop an oil field off the south coast of Tasmania. Each operator’s initial contribution was €2 million. Abel contributed €1 million cash and equipment with a fair value of €1 million and a book value of €500,000. Tasman’s contributed €2 million cash. Additional information: •

Production costs for the JO for the year ended 30 June 20X1 were:

Purchases Wages Management fee Total production costs Less: Work in progress Cost of production • • •

€’000 750 1,300 400 2,450 (650) 1,800

The remaining useful life of the equipment contributed by Abel is 5 years. Tasman is responsible for the day to day management of JO and has recognised the management fee received during the year as revenue. The costs of providing these management services to JO was €225,000. Tasman has sold all of the oil distributed to it and Abel has sold 50% of the oil distributed to it by 30 June 20X1. An extract of JO’s balance sheet at 30 June 20X1 shows: €’000 Assets Cash Work in progress Finished goods inventory Plant & equipment Accounts payable Net assets

650 650 100 1,000 (100) 2,300

24. Which of the following will not form part of Abel Ltd’s initial contribution entry? Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. Debit against the Cash in JO account of €1 500 000; *b. Debit against the Equipment in JO account of €500 000; c. Credit against the Cash of €1 000 000; d. Credit against the Gain on Equipment of €250 000.

D.12

Test Bank to accompany Applying IFRS Standards 4e

25. Tasman Ltd’s initial contribution entry will include a debit to the Cash in JO account of: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation a. €1 000 000; *b. €1 500 000; c. €2 000 000; d. €3 000 000. 26.

The value of inventory distributed to Abel Ltd by the joint venture and subsequently sold by 30 June 20X1 is: Learning Objective D.4 Prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation *a. €425 000; b. €850 000; c. €900 000; d. €1 700 000.

D.13

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo, revised for this edition by John Dunn

John Wiley & Sons, Ltd 2016

Solutions Manual to accompany Applying IFRS Standards 4e

Online chapter A – Exploration for and evaluation of mineral resources Discussion Questions 1.

The scope of IFRS 6 is limited to which expenditures?

Exploration and evaluation expenditures incurred by an entity in connection with the ‘exploration for and evaluation of mineral resources’. This would include expenditures incurred in the search for mineral resources, including minerals, oil, natural gas and similar non-regenerative resources after the entity has obtained the legal rights to explore in a specific area, as well as the determination of the technical feasibility and commercial viability of extracting the mineral resource. 2.

Discuss the complexities and considerations an entity involved in the extractive industries faces in determining the accounting policies to apply to expenditures it incurs that are outside of the scope of IFRS 6.

The accounting policies applicable under IFRSs, which include IFRSs for other aspects of the extractive industries activities should be determined in accordance with paragraphs 7 to 12 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors,that means: 1.

If a transaction, other event or condition is specifically covered by an existing IFRS, that standard should be applied in determining the appropriate accounting policy. For example, the acquisition of equipment to be used in the extraction of mineral resources is not covered by IFRS 6 because that extraction occurs after the technical feasibility and commercial viability of extracting that mineral resource is demonstrated. However, acquisition of property, plant and equipment is addressed by IAS 16 Property, Plant and Equipment so IAS 16 should be applied in arriving at the accounting policy to apply to the acquisition of that plant and equipment.

If there is no specific IFRS that applies to a transaction, other event or condition, the entity’s management must apply its judgement in determining an appropriate accounting policy to result in information that is: (a) relevant to the economic decision-making needs of users; and (b) reliable, in that the financial statements: (i) represents faithfully the financial position, financial performance and cash flows of the entity; (ii) reflects the economic substance of transactions, other events and conditions, and not merely the legal form; (iii) is neutral, that is, free from bias; (iv) is prudent; and (v) is complete in all material respects.

In applying this judgement, management should consider the requirements and guidance in IFRSs dealing with similar and related issues, followed by the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework for the Preparation and Presentation of Financial Statements (the Framework).

A.2

Online chapter A: Exploration for and evaluation of mineral resources

4. Management may also consider the most recent pronouncements of other standard-setting 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 IFRSs or the Framework. The difficulty for entities in the extractive industries is that mineral resources are excluded from the scope of a number of standards including: • IAS 2 Inventories • IAS 16 Property, Plant and Equipment • IAS 17 Leases • IAS 18 Revenue • IAS 38 Intangible Assets • IAS 40 Investment Property • IFRIC Interpretation 4 Determining whether an Arrangement contains a Lease. This is further complicated by the fact that these scope exclusions are not complete. For example, IAS 16 does not apply to ‘the recognition and measurement of exploration and evaluation assets’ (i.e. they are covered by IFRS 6) or ‘mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources’. However, it does apply to property, plant and equipment used to develop or maintain E&E assets, mineral rights and mineral reserves.

Discuss what entities need to consider if they want to change their accounting policies applicable to E&E costs.

Paragraph 13 of IFRS 6 allows an entity to change its accounting policies related to E&E costs on the condition that the change ‘makes the financial statements more relevant to the economic decisionmaking needs of users and no less reliable, or more reliable and no less relevant to those needs’. In assessing the relevance and reliability of the change, entities are directed to the criteria in IAS 8, although they are not expected to fully comply with those criteria. An example of an acceptable change in accounting policy following this guidance would be a change from the full cost method to the successful efforts method.

Explain how the successful efforts method of accounting for E&E expenditure compares to the full cost method.

Under the successful efforts method of accounting E & E costs are not capitalised unless they are expected to lead to finding, acquiring and developing mineral reserves. If the expectation is not bourne out, the costs are written off whereas under the full cost method, E & E costs are capitalised using a larger cost centre than an area of interest such as a country or even a group of countries.

Discuss the possible challenges in applying the revaluation models under IAS 16 or IAS 38 to E&E assets.

The revaluation model in IAS 16 requires that the fair value be reliably measurable. It is normally extremely difficult to determine the fair value of E&E assets due to the early stage of such projects and the significant degree of estimation involved in determining the fair value of an asset that only has future value to the extent a commercial quantity of resources exists and can be efficiently extracted. The revaluation model in IAS 38 requires the existence of an active market, which does not exist for E&E assets as they are not homogenous assets.

A.3

Solutions Manual to accompany Applying IFRS Standards 4e

Discuss the possible future developments related to the accounting for extractive activities.

In 1998, the International Accounting Standards Committee (IASC), the predecessor organisation of the IASB, created a Steering Committee to deal with financial reporting in the extractive industries. This resulted in the release of an issues paper Extractive Industries Issues Paper in 2000. The project was put on hold as the IASB did not believe it could complete it in time for the 2005 adoption of IFRSs by many parts of the world. As previously discussed, IFRS 6 was released by the IASB as an interim measure pending completion of a comprehensive project dealing with the accounting for extractive activities. In 2004 the IASB set up an international project team comprising staff from the national standardsetters in Australia, Canada, Norway and South Africa to undertake a detailed assessment of accounting for extractive activities. The project team’s findings and recommendations research are presented in the staff Discussion Paper Extractive Activities, which was published in April 2010. Although the Discussion Paper is a lengthy document running to some 180 pages, it is substantially narrower in scope than many commentators had predicted it would be when the project was initiated. The IASB has discussed the project team’s findings at public meetings but has not developed preliminary views on any of the project team’s recommendations or made any related technical decisions. The aim of the project is to create a single accounting and disclosure model that applies to extractive activities in both the minerals and oil and gas industries. It addresses financial reporting issues associated with exploring for and finding minerals, oil and natural gas deposits; developing those deposits; and extracting the minerals, oil and natural gas. These are referred to as either extractive activities or, alternatively, as upstream activities. The Discussion Paper includes: • • • •

Definitions of reserves and resources for use in accounting Initial recognition and measurement of extractive assets Subsequent accounting for those assets (including impairment and depreciation) Disclosure of information (including reserves and resources information)

A.4

Online chapter A: Exploration for and evaluation of mineral resources

Exercises Exercise A.1

OBLIGATIONS FOR REMOVAL AND RESTORATION

What are the implications of the above for Mining plc’s financial statements? Mining plc would be required to recognise a provision for the estimated costs of returning the environment to its original condition at the time the related damage is incurred. The provision would be recognised and measured in accordance with the requirements of IAS 37. The cost would be recognised as part of the carrying value of the E&E asset to which it relates.

Exercise A.2

IMPAIRMENT OF E&E ASSETS

What is the impact of this decision on Gas Inc.’s financial statements as at 31 December 2016? This decision would be considered an indicator of impairment. As a result, Gas Inc. will need to determine the recoverable amount of the E&E asset if any, and write the asset down to this recoverable amount. Normally this situation would result in the write-off of the full $1.2 million asset to profit or loss.

15.4 Exercise A.3

ELEMENTS OF COST OF E&E ASSETS

Which of the above items should be capitalised into the E&E asset? Items (c) – (h) would qualify for capitalisation. Items (a) and (b) would not qualify because they were incurred prior to obtaining the licence to explore.

Exercise A.4

APPLICATION OF THE REVALUATION MODEL

What might prevent Resource plc from being able to make this change in accounting policy? Resource plc would need to be able to show that there is an active market for its E&E asset as specifically defined in IAS 38. This would require that the asset be considered homogenous in nature with other assets for which there are buyers and sellers available and a publicly available market price for those assets. This would be extremely rare for E&E assets. 15.5

Exercise A.5

CHANGE IN ACCOUNTING POLICY

Discuss whether Sandy Oil plc can change its accounting policy to capitalise all of its E&E costs to match its competitor’s accounting policy. Sandy Oil plc would need to consider whether such a change in accounting policy ‘makes the financial statements more relevant to the economic decision-making needs of users and no less reliable, or more reliable and no less relevant to those needs’. The costs capitalised must also be expected to be recouped through sale or successful development and exploitation and/or at the end of the reporting period, the E&E activities in the area of interest are not at a stage that would permit assessment of the existence or otherwise of economically recoverable reserves, and active and significant operations in, or in relation to, the area are continuing.

A.5

Solutions Manual to accompany Applying IFRS Standards 4e

The extent to which the above relevance and reliability criteria is met will be a matter of judgement and will depend quite heavily on whether such a policy is applied by the majority of Sandy Oil plc’s peers.

Exercise A.6

RECOGNITION OF E&E ASSETS

Determine the amount of the E&E asset to be capitalised by Digging Inc. in relation to the property. for the area (GST exempt) Cash paid to acquire exploration rights Cash paid to acquire fencing materials to mark out the property, net of GST Contractor fees for labour to set up the fencing, net of GST Contractor fees for exploratory drilling, net of GST Hire of drilling equipment for contractor use, net of GST Salary of project manager Stationery and other office supplies, net of GST

$ 10 000 800 500 25 000 5 000 60 000 300 $101 600

330 160 000

A.6

Online chapter A: Exploration for and evaluation of mineral resources

Exercise A.7

MEASUREMENT OF E&E ASSETS

Determine what expenses would be recognised in profit or loss versus capitalised as an asset related to each property for each financial year assuming Reserves plc: (a) expenses all of its E&E costs as incurred (b) applies the full cost method (assume that each property is in a different country and represents a separate cost pool) (c) applies the successful efforts method (assume that each property represents a separate licence). (a) A

Expensed

100 000

Capitalised

150 000

220 000

180 000

30/12/2014

31/12/2015 Expensed

750 000

290 000

120 000

420 000

355 000

[280 000 + 140 000]

[175 000 + 180 000]

625 000

[600 000 + 150 000] Capitalised

31/12/2016 Expensed

Capitalised

[300000 + 325 000]

A.7

Solutions Manual to accompany Applying IFRS Standards 4e

(b) A

31/12/2014 Expensed

100 000

Capitalised

250 000

320 000

280 000

850 000

290 000

120 000

575 000

31/12/2015 Expensed

[600 000 + 250 000] Capitalised

31/12/2016 Expensed

[175 000 + 120 000 + 280 000] Capitalised

1 045 000

A.8

Online chapter A: Exploration for and evaluation of mineral resources

31/12/2014 Expensed

100 000

Capitalised

150 000

220 000

180 000

750 000

290 000

120 000

280 000

475 000

31/12/2015 Expensed

[600,000 + 150,000] Capitalised

31/12/2016 Expensed

[175 000 + 180 000 + 120 000] Capitalised

765,000

[140 000 + 300 000 + 325 000]

A.9

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ruth Picker, revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Solutions Manual to accompany Applying IFRS Standards 4e

Online chapter B: Agriculture Discussion Questions 1.

Why do you think IAS 41 was a controversial standard when it was issued?

IAS 41 was a controversial standard when it was first issued, mainly because of the requirement to measure assets related to biological activity at fair value, with movements in fair value to be recognised in the statement of comprehensive income as gains or losses. The requirement to measure biological assets poses problems in that it can be difficult to determine reliable fair values for some biological assets such as immature trees. There can also be valuation problems in distinguishing between processing after harvest of biological assets, and biological transformation. The key points can be summarised as follows: • • •

Requirement to measure biological assets at fair value through Income Statement Difficulty in determining reliable fair values for some biological assets Difficulty distinguishing between processing after harvest and biological transformation

Explain why the concept of “control” is problematic when applying the recognition criteria of IAS 41.

The concept of control can be problematic in the agricultural industry where leases or management agreements are involved. This occurs because the definition of ‘agricultural activity’ in IAS 41 deals with the ‘management’ by an entity of the biological transformation of biological assets, thus it is possible to confuse management with control. The definitions provided in IAS 41 describe ‘management’ as the facilitation of biological transformation by enhancing the conditions necessary for the process to take place. Some key points to note in the understanding of control include that: • • •

Control is a key condition in the definition of an asset Control is not defined consistently in IFRS Control may or may not be linked to risks and rewards of ownership

The scope of IAS 41 refers to “agricultural activity” which refers to the management of biological assets, not the control of such assets. Illustrative Example B.1 assists in the differentiation between management and control of biological assets.

B.2

Online chapter B: Agriculture 3.

What are the arguments for and against the use of fair value as the measurement basis for biological assets and agricultural produce? Why do you think the IASB settled on requiring fair value?

The IASB decided that fair value provided more relevant information and that this information was more comparable and understandable. It also decided that fair value could usually be reliably determined but made an exception for cases where this was not possible (IAS 41 paragraph 30). The exception recognised that fair value may not be able to be measured reliably where market prices are not available and alternative estimates of fair value are determined to be clearly unreliable. However, this exception can only be applied on initial recognition of the biological asset. The arguments for and against the use of fair value for measuring biological assets are summarised in Table B.4. The arguments for include that: many biological assets are traded in active markets and active markets provide relevant and reliable information; long production cycles mean that the change in asset value is more relevant than a period-end measure of costs incurred; valuation based on costs is arbitrary when there are joint products and joint costs; and, different sources of animals and plants (e.g. home-grown or purchased) should not be measured differently which would occur if the historic cost valuation model were used rather than the fair value model.

How does a gain or loss on initial recognition of a biological asset or agricultural produce arise?

In the case of biological assets a loss may arise on initial recognition because costs to sell (which are deducted in arriving at fair value) may exceed the fair value. A profit may arise on initial recognition when, for example, an animal is born. Gains or losses on initial recognition of agricultural produce may arise as a result of harvesting. For example, say the fair value of a tonne of grapes is $20 and the fair value of the related grape vines is $100 at the date of harvest. On initial recognition, a loss of $20 is recognised to record the fair value of the grapes removed from the vines. These gains and losses are sometimes referred to as “day one [initial] gains or losses” and arise due to the application of the fair value model of valuation.

Why is agricultural produce not remeasured to fair value during a reporting period?

Agricultural produce is not remeasured to fair value during a reporting period because it is recognised and measured only at the point of harvest (see IAS 41 paragraphs 1(b) and 13) and this amount becomes its cost for ongoing measurement. IAS 41 Paragraph 1: “This standard shall be applied to account for the following when they relate to agricultural activity: (b) agricultural produce at the point of harvest” IAS 41 Paragraph 13: “Agricultural produce harvested from an entity’s biological assets shall be measured at its fair value less costs to sell at the point of harvest. Such measurement is the cost at that date when applying IAS 2 or another applicable standard.” Thus there is no remeasurement to fair value of agricultural produce, whereas biological assets are remeasured to fair value at each end of reporting period.

B.3

Solutions Manual to accompany Applying IFRS Standards 4e 6.

Discuss the challenges with respect to measuring fair value for growing biological assets (including produce growing on a bearer plant), taking into consideration the CESR ruling in respect of immature salmon.

The Committee of European Securities Regulation (CESR) ruled that there was an active market for immature slaughtered salmon, and that an immature slaughtered salmon was “similar” (in accordance with paragraph 18(b) of IAS 41) to an immature live salmon. In the absence of observable prices in the active market for live salmon, the fair value of live salmon should be determined based on observable prices in an active market for the same category of slaughtered salmon. The implications of CESR’s ruling are that: • •

The value would need to be adjusted for the fact that one salmon was alive and the other was slaughtered but both had the same weight; and that, a company could not say that fair value of an immature live salmon could not be reliably measured when there was an active market for similar assets – i.e. immature slaughtered salmon.

B.4

Online chapter B: Agriculture

Exercises Exercise B.1

AGRICULTURAL ACTIVITY – DEFINITIONS

State which of the following meets the definition of “agricultural activity” in IAS 41. Give reasons for your answer: 1. 2. 3. 4. 5.

pig farming ocean fishing clearing forests to create farmland salmon farming managing vineyards.

The definition of “agricultural activity”, contained within IAS 41 paragraph 6, includes three components: (1) capability to change; (2) management of change; and (3) measurement of change. 1.

Pig farming: Yes – this activity meets the three components of IAS 41 paragraph 6 (capability to change, management of change, measurement of change) Ocean fishing: No – this activity does not meet the IAS 41 paragraph 6 requirement that there be conditions facilitating the management of change. Clearing forests to create farmland: No – this activity does not meet the IAS 41 paragraph criteria that there be management of change. Salmon farming: Yes – this activity meets all three components contained within the definition of agricultural activity in IAS 41 paragraph 6. Managing vineyards: Yes – this activity meets all three components contained within the definition of agricultural activity in IAS 41 paragraph 6.

Exercise B.2

AGRICULTURAL ACTIVITY – DEFINITIONS

State whether the following are (a) biological assets (excluding bearer plants), (b) bearer plants, (c) produce growing on a bearer plant (d) agricultural produce or (e) products that are as a result of processing after harvest: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

living pigs living sheep pigs’ carcasses pork sausages trees growing in a plantation forest furniture olive trees olives olive oil vines growing in a vineyard.

‘Biological assets’ are defined in IAS 41 paragraph 5 as “a living animal or plant.” ‘Agricultural produce’ is defined in IAS 41 paragraph 5 as “the harvested product of the entity’s biological assets.” ‘Harvest’ is defined in IAS 41 paragraph 5 as “the detachment of produce from a biological asset or the cessation of a biological asset’s life processes.”

B.5

Solutions Manual to accompany Applying IFRS Standards 4e See Table B.1 for examples illustrating the distinction between biological assets, bearer plants, produce growing on a bearer plant, agricultural produce and products that are a result of processing after harvest. 1. 2. 3. 4.

living pigs: living sheep: pigs’ carcasses: pork sausages:

5. 6.

Trees growing in a plantation forest: Furniture:

7. 8. 9.

Olive trees: Olives: Olive oil:

10.

Vines growing in a vineyard:

Exercise B.3

(a) biological asset (a) biological asset (b) agricultural produce (c) other products that are a result of processing after harvest (a) biological asset (c) other products that are a result of processing after harvest (a) biological asset (b) agricultural produce (c) other products that are a result of processing after harvest (a) biological asset

AGRICULTURAL ACTIVITY – MEASUREMENT

For each of the items in exercise B.2 state whether they would be measured (a) at fair value under IAS 41, (b) using either the cost or revaluation method under IAS 16 or (c) at the lower of cost and net realisable value under IAS 2: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

living pigs living sheep pigs’ carcasses pork sausages trees growing in a plantation forest furniture olive trees olives olive oil vines growing in a vineyard.

For items that are either biological assets or agricultural produce, the measurement model to be applied is fair value. For products that are a result of processing after harvest, generally IAS 12 Inventories applies. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

living pigs: living sheep: pigs’ carcasses: pork sausages: trees growing in a plantation forest: furniture: olive trees: olives: olive oil: vines growing in a vineyard:

(a) fair value (biological asset) (a) fair value (biological asset) (a) fair value (agricultural produce) (b) LCM (other products) (a) biological asset (b) LCM (other products) (a) fair value (biological asset) (a) fair value (agricultural produce) (b) LCM (other products) (a) fair value (agricultural produce)

B.6

Online chapter B: Agriculture Exercise B.4

FAIR VALUE DETERMINATION

Which of the following would likely be included in determining the fair value of a biological asset that does not have an active market and which has a 5 year production cycle? 1. 2. 3. 4. 5.

Revenue from sale in 5 years’ time Costs of growing for 5 years Financing costs on borrowings taken out to fund the growing costs Taxation on taxable income generated from sale in 5 years’ time Discount rate that reflects expected variability in cash flows.

Revenue from sale in 5 years’ time YES IAS 41 paragraph 20 includes the present value of net cash flows in the determination of fair value. Costs of growing for 5 years. YES IAS 41 paragraph 20 includes the present value of net cash flows in the determination of fair value. Financing costs on borrowings taken out to fund the growing costs NO Financing costs are specifically excluded from fair value under IAS 41 paragraph 22. Taxation on taxable income generated from sale in 5 years’ time NO Taxation is specifically excluded from the determination of fair value under IAS 41 paragraph 22 Discount rate that reflects expected variability in cash flows YES IAS 41 paragraph 23 requires the use of a discount rate that reflects the variability in expected cash flows.

3. 4.

Exercise B.5

FAIR VALUE DETERMINATION

Pine Ltd owns a plantation forest. As at the end of the reporting period the fair value of the plantation forest including the land was ¥200 million. Pine needs to measure the fair value of the trees excluding the land to comply with IAS 41 at the end of its reporting period. What will Pine need to consider when measuring the fair value of the trees?

Pine Ltd needs to measure the fair value of the land excluding the trees and then deduct that value from ¥200 million.

Exercise B.6

DISCLOSURE OF BIOLOGICAL ASSETS

State whether each of the following is true or false: 1. 2. 3. 4. 5.

Companies applying IAS 41 must disclose separately the fair value (less costs to sell) of mature and immature biological assets. A lessee of a forest that is classified as a finance lease must measure the forest (excluding the land) at fair value less costs to sell in its financial statements. Wheat planted on land that is classified as an investment property by the owner must be recognised and measured as part of that investment property. A lessor of a barley farm that is classified as a finance lease must measure the barley (excluding the land) at fair value in its financial statements. An entity availing itself of the exemption in paragraph 30 of IAS 41 for a particular biological asset must apply IAS 20 if it receives a government grant in respect of that asset.

B.7

Solutions Manual to accompany Applying IFRS Standards 4e 6.

If agricultural produce cannot be reliably measured then it may be accounted for at cost under paragraph 30 of IAS 41.

1. Companies applying IAS 41 must disclose separately the fair value (less costs to sell) of mature and immature biological assets. This is FALSE (encouraged but not required – IAS 41 paragraph 43). 2. A lessee of a forest that is classified as a finance lease must measure the forest (excluding the land) at fair value less costs to sell in its financial statements. TRUE (this is required under IAS 41 – the lessee records the forest as its own asset and measures it at fair value). 3. Wheat planted on land classified as an investment property by the owner must be recognised and measured as part of that investment property. FALSE (the land must be recognised and measured under IAS 40 and the wheat is recognised and measured under IAS 41). 4. A lessor of a barley farm that is classified as a finance lease must measure the barley (excluding the land) at fair value in its financial statements. FALSE (the lessor records a lease receivable under IAS 17). 5. An entity availing itself of the exemption in paragraph 30 of IAS 41 for a particular biological asset must apply IAS 20 if it receives a government grant in respect of that asset. TRUE (IAS 41 paragraph 37). 6. If agricultural produce cannot be reliably measured then it may be accounted for at cost under paragraph 30 of IAS 41. FALSE (paragraph 30 applies only to biological assets).

Exercise B.7

ACCOUNTING FOR ASSETS RELATING TO AGRICULTURAL ACTIVITY

Prepare the journal entries to record the above transactions in the books of each of Vintner, Lessor and Manager for the year ended 31 December 2016. Vintner 1/1/16 DR Biological asset – vineyard 2 000 000 CR Profit & Loss 2 000 000 (to record the fair value of the vineyard and the gain on initial recognition) Year ended 31/12/16 DR Operating expenses – P&L 245 000 CR Cash (to record operating expenses – fees paid to Manager)

245 000

Year ended 31/12/16 DR Biological assets – vineyard 600 000 CR Increase in Fair Value – P&L 600 000 (to record the increase in fair value of the vineyard) Lessor 1/1/16 DR Finance lease receivable 2 000 000 CR Biological assets 2 000 000 (to record the finance lease receivable from Vintner and the transfer from biological assets) Year ended 31/12/16 DR Investment property – land 1 000 000 CR Increase in fair value – P&L 1 000 000 (to record the increase in fair value of the land through P&L using the fair value model under IAS 40) Year ended 31/12/16

B.8

Online chapter B: Agriculture DR Cash 212 000 CR Finance lease receivable 200 000 CR Finance lease income – P&L 12 000 (to record the receipt of lease payments during the year and the allocation between the finance lease receivable and finance lease income) Manager Year ended 31/12/16 DR Cash 245 000 CR Income – P&L 245 000 (to record the receipt of management fees from Vintner)

Exercise B.8

ACCOUNTING FOR A GOVERNMENT GRANT

Prepare the journal entries to account for the grant by Grower for the years ended 30 June 2016 and 30 June 2017, assuming Grower complies with the conditions of the grant.

31/3/2016 Grant is notified. Nothing is recorded since the grant is effective from 1 July 2016. 15/4/2016 DR Cash 250 000 CR Performance obligation 250 000 (to record receipt of the grant and defer the full amount as the grant is not yet effective and the conditions of the grant have not yet been met) 30/6/2017 DR Performance obligation 50 000 CR Income 50 000 (to record one year’s performance under the conditions of the grant)

B.9

Solutions Manual to accompany Applying IFRS Standards 4e Exercise B.9

PREPARATION OF FINANCIAL STATEMENTS APPLYING IAS 41

Prepare the reconciliation required by paragraph 50 of IAS 41 for Shearers Ltd in accordance with IAS 41 for the year ended 30 June 2017. Show all workings. 1. Reconciliation of movements in livestock: Sheep Balance as at 1 July 2016 Purchases Sales

1 000 100 (100)

Transfer to sheep Births Deaths Balance as at 30 June 2017 Increase in fair value -

Fair Value 200 000 21 000 (24 000) 1 100

1 020

255 000

attributable to physical change attributable to price change

3 900 53 000

Lambs 200 --(20) 15 (3) 192

Fair Value 10 000

(1 100) 825 (165) 10 560

1 825

2. Reconciliation of movements in fair value - sheep Physical balance (assuming FIFO) Opening balance 1000 @ 200 Sold 100@ 240 Balance 900 @ 200 Year end 900 @ 250 Purchased 100 @ 210 Year end 100 @ 250 Total attributable to fair value changes Lambs Year end

20 @ 55 20 @ 250

Change in fair value

Total

100 @ 40

4 000

900 @ 50

45 000

100 @ 40

4 000 53 000

20 @ 195

3 900 (all attributable to physical change)

3. Reconciliation of movements in fair value – lambs Physical balance (assuming FIFO) Opening balance 200 @ 50 Transfer 20 @ 55 Balance 180 @ 50 Year end 180 @ 55 Born 15 @ 55 Total attributable to fair value changes Died 3 @ 55

Change in fair value

Total

20 @ 5

100

180 @ 5 15 @ 55

900 825

3 @ 55 (all value lost)

1,825 (165)

Total

1 660

B.10

Online chapter B: Agriculture 4. Property, plant & equipment Land measured at revalued amount through equity under the revaluation model of IAS 16. Increase in fair value is £5 600 000 – £4, 700 000 = £900,000. Plant & equipment Cost Accumulated depreciation as at 1 July 2016 Balance as at 1 July 2016

£1 000 000 £ (200 000) £ 800 000

Annual depreciation

£ 100 000

Balance as at 30 June 2016: Land Plant and equipment Total

£ 4 700 000 £ 800 000 £ 5 500 000

Balance as at 30 June 2017 Land Plant & equipment Total

£5 600 000 £ 700 000 £6 300 000

Shearers Ltd Extract from Statement of Comprehensive Income for the year ended 30 June 2017 Fair Value of wool produced Net Gains arising from changes in fair value less costs to sell of livestock (note y)

387 000 58 560

Depreciation expense Other operating expenses

(100 000) ( 34 000)

Profit from operations Income tax expense Profit after income tax

311 560 xx xx

Shearers Ltd Extract from Statement of financial position as at 30 June 2017

Notes ASSETS Non-current assets Livestock – immature Livestock – mature Subtotal – biological assets y Property, plant and equipment Note y Biological assets Reconciliation of carrying amounts of livestock

30 June 2017

30 June 2016

10 560 255 000 265 560 6 300 000

10 000 200 000 210 000 5 500 000

Carrying amount at 1 July 2016 Increases due to purchases Increase in fair value less costs to sell - attributable to price changes - attributable to physical changes Total increase in fair value less costs to sell

210 000 21 000 54 825 3 900 58 725

B.11

Solutions Manual to accompany Applying IFRS Standards 4e Decreases due to deaths Net increase in fair value

(

Decreases due to sales

(24 000)

Carrying amount as at 30 June 2017

265 560

165) 58 560

B.12

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo, revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

Applying IFRS Standards 4e Solutions Manual

Online chapter C: Associates and joint ventures Discussion questions 1. What is an associate entity? Paragraph 3 of IAS 28 Investments in Associates and Joint Ventures defines an associate as: An entity over which the investor has significant influence The key criterion is the existence of significant influence, also defined in para. 3. Note that an investor does not have to hold shares in an associate – yet the application of the equity method depends on such a shareholding. However, see the presumptions in para 5 of IAS 28.

2. Why are associates distinguished from other investments held by the investor? The suite of accounting standards provides different levels of disclosure dependent on the relationship between the investor and the investee: Subsidiaries: a control relationship Joint ventures: a joint control relationship Associates: a significant influence relationship Other investments: no relationship Where there is a relationship, it relates to the ability of the investor to influence the direction of the investee, in comparison to a simple holding of shares as an investment. Where such a relationship exists, it is argued that the investor is affected, from an accountability perspective as well as a potential receipt of benefits perspective [why get involved if there are no benefits to doing so?]. These effects result in the need for additional disclosure about the relationship.

3. Discuss the similarities and differences between the criteria used to identify subsidiaries and that used to identify associates. A subsidiary is identified where another entity controls that entity. Control is defined in IFRS 10. An associate is identified where another entity has significant influence over that entity. Control Power to govern

Significant influence Power to participate

To govern the financial and and operating policies

To participate in the financial and operating policy decisions

So as to obtain benefits

-----------

No ownership interest is necessary

C.0

Online chapter C: Associates and joint ventures

4. What is meant by ‘significant influence’? Para 2 of IAS 28 states: Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies Note:

power to participate financial and operating policy decisions

5. What factors could be used to indicate the existence of significant influence? Note paras 5 and 6 of IAS 28: 5.

If an entity holds, directly or indirectly (eg through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the entity holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the entity does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence.

The existence of significant influence by an investor is usually evidenced in one or more of the following ways: (a) representation on the board of directors or equivalent governing body of the investee; (b) participation in policy-making processes, including participation in decisions about dividends or other distributions; (c) material transactions between the investor and the investee; (d) interchange of managerial personnel; or (e) provision of essential technical information.

What is a joint venture? A joint venture is defined in paragraph 3 of IAS 28 as follows: A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.

What is meant by joint control?

Para 3 of IAS 28 contains the following definition: Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. 8.

How does joint control differ from control as applied on consolidation? Under IFRS 10, control requires dominant influence by a parent over a subsidiary. There can only be one parent of a subsidiary – control cannot be shared.

C.1

Applying IFRS Standards 4e Solutions Manual

Under IAS 28 joint control is a sharing of control by at least 2 parties such that decisions require the unanimous consent of both parties.

9. Discuss the relative merits of accounting for investments by the cost method, the fair value method and the equity method. Cost method: Advantages:

Disadvantages:

Fair value method: Advantages:

Disadvantages:

Simplicity Reliable measure No indication of changes in value since acquisition Revenue recognised only on dividend receipt

Up-to-date value, present information compared with past Information Revenue recognised as value changes rather than waiting for dividends Reliability a function of how active the market is Costs associated with regular updating, extra costs for audit and valuation fees

Equity method: Advantages: Disadvantages:

10.

Carrying amount related to change in wealth of the investee Revenue recognised prior to dividend receipt Carrying amount reliant on validity of investee information Carrying amount not based on market value Recognition of revenue prior to associate declaring dividend; no transaction has yet occurred

Outline the accounting adjustments required in relation to transactions between the investor and an associate/joint venture. Explain the rationale for these adjustments.

Note paragraph 28 of IAS 28: - adjust for profits and losses on upstream/downstream transactions - adjust to the extent of investor’s interest ie proportionate adjustment - adjust investor’s share in associate’s profits and losses Rationale IAS 28 provides no rationale. A key question is whether the equity method is used as a measurement technique to approximate fair value, or as a consolidation technique. If it is a measurement technique, then why adjust for inter-entity transactions? If it is a consolidation technique, then adjustments can be justified – however, does the method of adjustment proposed in para 28 conform with consolidation techniques? Debate: - why should investor’s share of associate’s profits be adjusted if investor sells to associate as associate’s profits are unaffected by this transaction? - Should individual accounts such as “sales”, “cost of sales” and “inventories” be adjusted? - Should downstream transactions affect different accounts than upstream transactions?

C.2

Online chapter C: Associates and joint ventures

11.

Compare the accounting for the effects of inter-entity transactions for transactions between parent entities and subsidiaries and between investors and associates/joint ventures.

See para 28 of IAS 28 Consolidation Adjust for upstream & downstream Adjust for unrealised profits/losses Adjust for inter-entity balances Adjust for 100% of effect Adjust individual accounts such as sales investment account Transactions are within group

Equity method Adjust for upstream & downstream Adjust for unrealised profits/losses No adjustment for inter-entity balances Proportionate adjustment Adjust share of profits/losses & No economic entity/group structure

12. Discuss whether the equity method should be viewed as a form of consolidation or a valuation technique.

IAS 28 does not give a clear indication whether the equity method is a consolidation technique or a measurement technique similar to fair value. Note para 26: “Many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in IFRS 10.” If a measurement method, the equity method is an extension of the accrual process within the historical cost system. Revenue is recognised in relation to the investee as the investor records profits/losses, instead of merely when the investor pays dividends. The statement of financial position is a one-line figure, being an alternative to fair value. If it is a measurement technique, why adjust for the effects of inter-entity transactions? Further, why not just use fair value if available, or reliably measurable, and equity method as a default? Why use a criterion such as significant influence to determine associates – why not apply to all material investments? If a consolidation technique, there is an expansion of the group to include the investor’s share of the associate. The group then is more than just controlled entities. Why not use proportionate consolidation? Why not properly adjust for inter-entity transactions? Why expand the group beyond controlled entities? Unfortunately, it appears that equity accounting is a hybrid between a measurement technique and consolidation. Standard-setters need to determine a conceptual basis for accounting for associates and apply an appropriate method.

13.

Explain why equity accounting is sometimes referred to as ‘one-line consolidation’.

Equity accounting is similar to consolidation in that: - both recognise the investor’s share of post-acquisition equity in the income statement. The consolidation method recognises the NCI share as well, but divides equity into parent and NCI share. - both adjust for the effects of inter-entity transactions

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Applying IFRS Standards 4e Solutions Manual

14.

in the income statement, the share of profits/losses of an associate is similar to the parent’s share of the post-acquisition equity of a subsidiary – however, under the equity method this is not taken against individual accounts but there is a one-line total. in the statement of financial position, the investment in the associate is adjusted for the increase in the investor’s share of the net assets of the associate – similar to the parent’s share of the net assets of a subsidiary. However, under equity accounting, there is no recognition of the individual assets and liabilities of the associate, rather, there is a one-line recognition.

Explain the differences in application of the equity method of accounting where the method is applied in the records of the investor compared with the application in the consolidation worksheet of the investor.

There are 2 major differences when equity accounting is applied in the consolidation worksheet rather than in the accounts of the investor. First, in relation to past periods: If the adjustments are made in the records of the investor, then in any period, there is only a need to recognise the effects of the current period changes in share of the profit/losses of the associate. If the adjustments are made on consolidation, as the worksheet is only a temporary document and has no effect on the actual accounts, in periods subsequent to the date of acquisition, there needs to be a recognition, via retained earnings, of the investor’s share of prior period profits/losses of associate. Second, in relation to dividend revenue: If the adjustments are made in the accounts of the investor, then on payment of a dividend by the associate, the adjustment is: Cash Investment in associate

Dr Cr

x x

If the adjustments are made on consolidation, the worksheet adjustment is: Dividend revenue Investment in associate

Dr Cr

x x

15. Explain the treatment of dividends from the associate under the equity method of accounting. The treatment of dividends differs dependent on whether the equity method is applied in the accounts of the investor or applied on consolidation in the consolidation worksheet. Dividends paid In the accounts of the investor: On payment of the dividend by the associate, in the accounts of the investor, the following entry is made: Cash Investment in associate

Dr Cr

x x

As the investor recognises its share of the profits/losses of the associate as income, and this profit/loss is prior to the appropriation of dividends, then to recognise dividend revenue would

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Online chapter C: Associates and joint ventures

double count the income recognised by the investor. The dividend is simply a receipt of equity already recognised via application of the equity method. Consolidation worksheet: In the year of payment of the dividend the consolidation adjustment entry is: Dividend revenue Investment in associate

Dr Cr

x x

When the dividend is paid the investor records the receipt of cash and recognises dividend revenue. The effect of the above entry is to eliminate the dividend revenue previously recognised by the investor. Because the investor recognises a share of the whole of the profit of the associate, the dividend revenue cannot also be recognised as income by the investor. Dividends declared Where revenue is recognised on declaration of the dividend, the effect is the same as for dividends paid. Where the investor does not recognise dividend revenue, then there is no entry in the investor’s accounts, nor is there any adjustment in the consolidation worksheet. In using the consolidation worksheet method, care must be taken in calculating the investor’s share of post-acquisition retained earnings where a dividend was declared at the end of the previous period. This must be added back to the closing balance of retained earnings, as the investor has not yet recognised the appropriation of profits.

C.5

Applying IFRS Standards 4e Solutions Manual

Exercises Exercise C.1

SIGNIFICANT INFLUENCE

Discuss the factors that Ms Fraulein should investigate in determining whether an investor–associate relationship exists, and what avenues are available so that the equity method of accounting does not have to be applied. The relevant paragraphs from IAS 28 are: Paragraph 3: Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies Paragraphs 5 and 6: 5.

The existence of significant influence by an entity is usually evidenced in one or more of the following ways: (a) representation on the board of directors or equivalent governing body of the investee; (b) participation in policy-making processes, including participation in decisions about dividends or other distributions; (c) material transactions between the investor and the investee; (d) interchange of managerial personnel; or (e) provision of essential technical information.

Points to discuss: 1. Why the investment is undertaken by Cornett Chocolates is irrelevant. The definition of significant influence is based on the capacity to participate, not the actual or intention to participate. 2. Whether Cornett Chocolates actually exerts influence is irrelevant. 3. The 20% is a guideline only. 4. Factors will include those in paragraph 6. Further an analysis of the 80% holding by other parties is very important. If it is closely held, then the ability for Cornett Chocolates to participate is limited.

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Online chapter C: Associates and joint ventures

Exercise C.2

ADJUSTMENTS WHERE INVESTOR PREPARES AND DOES NOT PREPARE CONSOLIDATED FINANCIAL STATEMENTS

Prepare journal entries in the records of Sarah Ltd for each of the years ended 30 June 2014 to 2015 in relation to its investment in the associate/joint venture, Madison Ltd. (Assume Sarah Ltd does not prepare consolidated financial statements.) 2. Prepare the consolidation worksheet entries to account for Sarah Ltd’s interest in the associate/joint venture, Madison Ltd. (Assume Sarah Ltd does prepare consolidated financial statements.) SARAH LTD – MADISON LTD 30% Sarah Ltd At 1 July 2013: Net fair value of identifiable assets and liabilities of Madison Ltd Net fair value acquired Cost of investment Goodwill

Madison Ltd

= = = = =

$150 000 30% x $150 000 $45 000 $50 000 $5 000

A. Journal Entries in the Accounts of Sarah Ltd 1 July 2013

2013 – 2014

Investment in Madison Ltd Cash/Payable (Acquisition of shares in Madison Ltd)

Dr Cr

50 000

Cash

Dr Cr

24 000

Investment in Madison Ltd Share of profit or loss of associates (Recognition of profit in Madison Ltd: 30% x $50 000)

Dr Cr

15 000

Cash

Dr Cr

4 500

Investment in Madison Ltd (Dividend received from Madison Ltd: 30% x $80 000) 30 June 2014

2014 – 2015

Investment in Madison Ltd (Dividend received: 30% x $15 000) 30 June 2015

Investment in Madison Ltd Share of profit or loss of associates (Recognition of profit in Madison Ltd: 30% x $45 000)

Dr Cr

50 000

24 000

15 000

4 500

13 500 13 500

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Applying IFRS Standards 4e Solutions Manual

2015– 2016

Cash Investment in Madison Ltd (Dividend from associate: 30% x $10 000) Investment in Madison Ltd * Share of profit or loss of associates (Recognition of profit in Madison Ltd: 30% x $40 000)

Dr Cr

3 000

Dr Cr

12 000

3 000

12 000

2. Consolidation Worksheet Entries 30 June 2014: Investment in Madison Ltd Share of profit or loss of associates (30% x $50 000)

Dr Cr

15 000

Dividend revenue Investment in Madison Ltd (30% x $80 000)

Dr Cr

24 000

Retained earnings (1/7/13) Investment in Madison Ltd (30% x $(30 000))

Dr Cr

9 000

Investment in Madison Ltd Share of profits or losses of associates (30% x $45 000)

Dr Cr

13 500

Dividend revenue Investment in Madison Ltd (30% x $15 000)

Dr Cr

4 500

Investment in Madison Ltd Retained earnings (1/7/14) (30% [$30 000 + $(30 000)])

Dr Cr

Investment in Madison Ltd Share of profit or loss of associates (30% x $40 000)

Dr Cr

12 000

Dividend revenue Investment in Madison Ltd (30% x $10 000)

Dr Cr

3 000

15 000

24 000

30 June 2015:

9 000

13 500

4 500

30 June 2016:

12 000

3 000

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Online chapter C: Associates and joint ventures

Exercise C.3

ACCOUNTING FOR AN ASSOCIATE/JOINT VENTURE BY AN INVESTOR

Prepare the journal entries in the records of Jasmine Ltd for the year ended 30 June 2015 in relation to its investment in the associate, Hayley Ltd. JASMINE LTD – HAYLEY LTD 40% Jasmine Ltd

Hayley Ltd

At 1 July 2014: Net fair value of identifiable assets and contingent liabilities of Hayley Ltd Net fair value acquired Cost of investment Goodwill

= = = = =

$400 000 40% x $400 000 $160 000 $170 000 $10 000

Recorded profit – Hayley Ltd Investor’s Share – 40%

$39 000 15 600

Increment in Asset Revaluation Surplus (40% x $100 000)

$40 000

Note: 1.

There is no need to adjust for differences in depreciation method. If both companies have chosen a method that best reflects the flow of benefits as the assets are consumed, then there is no policy difference.

As the general reserve is created as an appropriation from Retained Earnings, then there is no need to adjust for movements in general reserve.

The journal entries in the books of Jasmine Ltd for the year ended 30 June 2014 are:

1 July 2014

2014– 2015

Investment in Hayley Ltd Cash/Share capital

Dr Cr

170 000

Cash

Dr Cr

6 000

Investment in Hayley Ltd Share of profit or loss of associates (40% x $39 000)

Dr Cr

15 600

Investment in Hayley Ltd Asset revaluation surplus (40% x $100 000)

Dr Cr

40 000

Investment in Hayley Ltd (Dividend from associate: 40% x $15 000) 30 June 2015

170 000

6 000

15 600

40 000

C.9

Applying IFRS Standards 4e Solutions Manual

Exercise C.4

INTER-ENTITY TRANSACTIONS WHERE INVESTOR HAS NO SUBSIDIARIES

Prepare the journal entries in the records of Imogen Ltd in relation to its investment in Chelsea Ltd for the year ended 30 June 2016. IMOGEN LTD – CHELSEA LTD

Profit for the period Adjustments: Unrealised after tax profit in ending inventory (a) [$5 000 (1 – 30%)] Unrealised after tax profit in ending inventory (b) [$2 500 (1 – 30%)] Unrealised profit in opening inventory (c) [$6 000 (1 – 30%)

$100 000

(3 500) (1 750) 4 200 98 950 $19 790

Investor’s share – 20% Journal entries in books of Imogen Ltd:

Cash Investment in Chelsea Ltd (20% ($10 000 + $20 000))

Investment in Chelsea Ltd Share of profit or loss of associate

Dr Cr

6 000

Dr Cr

19 790

6 000

19 790

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Online chapter C: Associates and joint ventures

Exercise C.5

INVESTOR PREPARES CONSOLIDATED FINANCIAL STATEMENTS, MULTIPLE PERIODS

Prepare, in journal entry format, for the years ending 30 June 2013, 2014 and 2015, the consolidation worksheet adjustments to include the equity-accounted results for the associate, Lara Ltd, in the consolidated financial statements of Sophia Ltd. SOPHIA LTD – LARA LTD 30% Sophia Ltd

Lara Ltd

At 1 July 2012: Net fair value of identifiable assets and liabilities of Lara Ltd Net fair value acquired Cost of investment Goodwill Depreciation of plant p.a. after tax

= = = = = =

$195 000 (equity) + $5 000 (1 –30%) (plant) $198 500 30% x $198 500 $59 550 $60 050 $500

= =

30% x 1/5 x $3 500 $210

1. Consolidation Worksheet Entries 2012 – 2013 Profit for the period Investor’s share – 30% Pre-acquisition adjustment: Depreciation of plant

$30 000 9 000 (210) $8 790

The consolidation worksheet entries at 30 June 2013 are: Investment in Lara Ltd Share of profit or loss of associates

Dr Cr

8 790

Dividend revenue Investment in Lara Ltd (30% [$15 000 + $10 000])

Dr Cr

7 500

8 790

7 500

C.11

Applying IFRS Standards 4e Solutions Manual

2013 – 2014 Profit for the period Investor’s share – 30% Pre-acquisition adjustment: Depreciation of plant

$20 000 6 000 (210) $5 790

The consolidation worksheet entries at 30 June 2014 are: Investment in Lara Ltd Retained earnings (1/7/12) (30%[$20 000 - $15 000] - $210)

Dr Cr

1 290

Investment in Lara Ltd Share of profit or loss of associates

Dr Cr

5 790

Dividend revenue Investment in Lara Ltd (30% ($5 000 + $5 000))

Dr Cr

3 000

1 290

5 790

3 000

2014 – 2015 Profit (loss) for the period Investor’s share – 30% Pre-acquisition adjustment: Depreciation of plant

$ (5 000) (1 500) (210) $ (1 710)

The consolidation worksheet entries at 30 June 2015 are: Investment in Lara Ltd Retained earnings (1/7/14) (30%[$30 000 – $15 000] – (2 x $210))

Dr Cr

4 080

Share of profit or loss of associates Investment in Lara Ltd

Dr Cr

1 710

Dividend revenue Investment in Lara Ltd (30% [$2 000 + $1 000])

Dr Cr

900

4 080

1 710

900

C.12

Online chapter C: Associates and joint ventures

Exercise C.6

CONSOLIDATED WORKSHEET INVESTMENT IN ASSOCIATE

ENTRIES

INCLUDE

Prepare the journal entries for the consolidation worksheet of Caitlin Ltd at 30 June 2016 for the inclusion of the equity-accounted results of Alyssa Ltd. CAITLIN LTD – ALYSSA LTD 30% Caitlin Ltd

Alyssa Ltd

At 1 July 2015: Net fair value of identifiable assets and liabilities of Alyssa Ltd

Net fair value acquired Acquisition-date fair value of investment Goodwill Depreciation of machinery p.a. Adjustment for inventory

= = =

$100 000 + $60 000 + $10 000 + $40 000(equity) + $5 000 (1 – 30%)(machinery) + $2 000 (1 – 30%) (inventory)) $214 900 30% x $214 900 $64 470

= =

$70 000 $5 530

= = = =

1/5 x 30% x $3 500 $210 30% x $1 400 $420

At 1 July 2015, Caitlin Ltd would pass the following journal entry to re-measure the investment in Alyssa Ltd to fair value: Investment in Alyssa Ltd Gain on Investment (Re-measurement of investment to fair value: $70 000 - $60 000)

Dr Cr

10 000 10 000

1 July 2015 – 30 June 2016 Profit for the period Adjustments: Unrealised profit on sale of inventory (1/4 x $2 000) (1 – 30%) Unrealised profit on sale of non-current asset: Profit on sale of $10 000 (1 - 30%) less depreciation of (1/2 x 12% x $7 000) Investor’s share – 30% Pre-acquisition adjustment: Inventory Depreciation of machinery

$32 000

(350)

(6 580) $25 070 $7 521 (420) (210) $6 891

C.13

Applying IFRS Standards 4e Solutions Manual

The entries in the consolidation worksheet at 30 June 2016 are: Dividend revenue Investment in Alyssa Ltd (30% [$5 000 + $5 000])

Dr Cr

3 000

Investment in Alyssa Ltd Share of profit or loss of associates

Dr Cr

6 891

3 000

6 891

Exercise C.7 ADJUSTMENTS WHERE INVESTOR DOES AND DOES NOT PREPARE CONSOLIDATED FINANCIAL STATEMENTS 1. Assume Zara Ltd does not prepare consolidated financial statements. Prepare the journal entries in the records of Zara Ltd for the year ended 30 June 2016 in relation to the investment in Eva Ltd. 2. Assume Zara Ltd does prepare consolidated financial statements. Prepare the consolidated worksheet entries for the year ended 30 June 2016 for inclusion of the equity-accounted results of Eva Ltd. ZARA LTD – EVA LTD 30% Zara Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Eva Ltd

Eva Ltd

= = = = = =

Net fair value acquired Cost of investment Goodwill Depreciation: Non-current assets: – 20% (30% x $10 500)

$20 000 + $10 000 (equity) + $15 000 (1 – 30%) (assets) $40 500 30% x $40 500 $12 150 $13 650 $1 500

$630

1. Zara Ltd does not prepare consolidated financial statements

Profit for 2015–2016 period Adjustments: Unrealised after tax profit in ending inventory $30 000 (1 – 30%) Realised profit on opening inventory $10 000 (1 – 30%) Investor’s share – 30% Pre-acquisition adjustments: Depreciation

Increase in asset revaluation surplus Investor’s share – 30%

$180 000

(21 000) 7 000 $166 000 $49 800 (630) $49 170 $30 000 $9 000

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Online chapter C: Associates and joint ventures

The required entries in Zara Ltd’s accounts for the 2015–2016 year are: Cash

Dr Cr

15 000

Dividend receivable Investment in Eva Ltd (30% x $50 000 – dividend provided)

Dr Cr

15 000

Investment in Eva Ltd Asset revaluation surplus (30% x $30 000)

Dr Cr

9 000

Investment in Eva Ltd Share of profits or losses of associates

Dr Cr

49 170

Investment in Eva Ltd (30% x $50 000 – dividend paid)

15 000

9 000

49 170

Zara Ltd prepares consolidated financial statements Change in retained earnings balance 2014–2015 ($50 000 - $10 000) Adjustments: General reserve transfers Unrealised profit in inventory at 30/6/15 ($10 000 (1 - 30%)

$40 000 5 000 (7 000) $38 000 $11 400

Investor’s share – 30% Pre-acquisition adjustments: Depreciation

(630) $10 770

The consolidation worksheet entries at 30/6/16 are: Investment in Eva Ltd Retained earnings (1/7/15)

Dr Cr

10 770

Investment in Eva Ltd Asset revaluation surplus (30% x $30 000)

Dr Cr

9 000

Investment in Eva Ltd Share of profits or losses of associates Cr

49 170 49 170

Dividend revenue Investment in Eva Ltd (30% x $50 000 – dividend paid)

Dr Cr

15 000

Dividend revenue Investment in Eva Ltd (30% x $50 000 – dividend declared)

Dr Cr

15 000

10 770

9 000

15 000

C.15

Applying IFRS Standards 4e Solutions Manual

Exercise C.8 CONSOLIDATED FINANCIAL STATEMENTS INCLUDING INVESTMENTS IN ASSOCIATES 1. Prepare the consolidated statement of profit or loss and other comprehensive income and statement of changes in equity of Sam Ltd and its subsidiary Paige Ltd as at 30 June 2016. 2. In the consolidated statement of financial position, what would be the balance of the investment shares in Kayla Ltd? SAM LTD – PAIGE LTD – KAYLA LTD 90% Sam Ltd

Paige Ltd

25%

Kayla Ltd A: Consolidation worksheet entries – Sam Ltd – Paige Ltd At 1 July 2011: Net fair value of identifiable assets and liabilities of Paige Ltd

(a) Consideration transferred (b) Non-controlling interest Aggregate of (a) and (b) Goodwill

= = = = = =

$100 000 + $8 000 + $12 000 (equity) + $5 000 (1 – 30%) (inventory) + $10 000 (1 – 30%)(depreciable assets) $130 500 $150 750 10% x $130 500 $13 050 $163 800 $33 300

1. Business combination valuation entry Depreciation expense Income tax expense Retained earnings (1/7/15) Transfer from business combination valuation reserve

Dr Cr Dr

2 000 600 5 600

7 000

2. Pre-acquisition entries Retained earnings (1/7/15)* Dr 13 950 Share capital Dr 90 000 General reserve Dr 7 200 Business combination valuation reserve Dr 6 300 Goodwill Dr 33 300 Shares in Paige Ltd Cr * = (90% x $12 000) + 90% ($5 000 - $1 500) (BCVR - inventory) Transfer from business combination valuation reserve Business combination valuation reserve

Dr Cr

150 750

6 300 6 300

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Online chapter C: Associates and joint ventures

3. NCI in equity of Paige Ltd at 1/7/11 Retained earnings (1/7/14) Share capital General reserve Business combination valuation reserve NCI

Dr Dr Dr Dr Cr

1 200 10 000 800 1 050

Dr Cr Cr

6 240

Dr Cr

1 660

Dr Cr

700

Dr Cr

400

Dr Cr

3 600

13 050

4. NCI in equity of Paige Ltd: 1/7/11 – 30/6/15 Retained earnings (1/7/15) Business combination valuation reserve NCI (RE: 10% ($80 000 - $12 000 – $5 600) BCVR: 10% x $3 500 [inventory])

350 5 890

5. NCI in equity of Paige Ltd: 1/7/15 – 30/6/16 NCI share of profit NCI (10% ($18 000 – [$2 000 - $600])) Transfer from business combination valuation reserve Business combination valuation reserve NCI Dividend paid (10% x $4 000)

1 660

700

400

6. Dividend paid Other revenue Dividend paid (90% x $4 000)

3 600

C.17

Applying IFRS Standards 4e Solutions Manual

Equity accounting entries: Sam Ltd – Kayla Ltd At 1 July 2014: Net fair value of identifiable assets and liabilities of Kayla Ltd

Net fair value acquired Cost of investment Goodwill Inventory adjustment Depreciation p.a.

= = = = =

$10 000 + $2 150 (equity) + $500 (1 – 30%) (inventory) + $1 000 (1 – 30%) (depreciable assets) $13 200 25% x $13 200 $3 300 $3 500 $200

= = = =

25% x $350 $87.5 (round to $88) 1/5 x 25% x $700 $35

Change in Retained Earnings 2014 – 2015 ($4 000 - $2 150) Adjustments: Unrealised profit on sale of motor vehicle Profit of $800 (1 – 30%) less depreciation of ½ x 20% x $560 Increase in general reserve

$1 850

(504) 2 000 $3 346

Investor’s share – 25% Pre-acquisition adjustments: Inventory: 25% ($500 - $150) Depreciation of non-current assets

$837

Profit for the period 2015–16 Adjustments: Realised profit on motor vehicle 20% ($560 - $56) Unrealised profit on ending inventory (80% x $2 000) (1 – 30%)

$2 000

Investor’s share – 25% Pre-acquisition adjustments: Depreciation of non-current assets

(88) (35) $714

101 (1 120) $981 $245 (35) $210

The equity accounting entries are:

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Online chapter C: Associates and joint ventures

7. Equity accounting – Kayla Ltd

Financial Statements Sales revenue Other revenue

Cost of sales Depreciation Other expenses

Share of profits/losses from associates Profit before tax Tax expense Profit Retained earnings (1/7/15) Transfer from BCV reserve Dividend paid Retained earnings (30/6/16)

Dividend revenue Investment in Kayla Ltd (25% x $200)

Dr Cr

Investment in Kayla Ltd Retained earnings (1/7/15) Share of profits or losses of associates

Dr Cr Cr

924

Sam Ltd 200 000 30 000

Paige Ltd 60 000 5 000

Group

230 000 110 000 16 000 22 000

65 000 30 000 4 000 3 000

148 000 82 000 -

37 000 28 000 -

82 000

28 000

20 000 62 000 120 000

10 000 18 000 80 000

182 000 20 000 162 000

98 000 4 000 94 000

Adjustments Dr Cr 6 7

714 210

NCI Dr

Parent Cr

260 000 31 350

3 600 50

291 350 140 000 22 000 25 000

2 000

210

187 000 104 350 210

104 560 600

1 2

5 600 13 950

714

29 400 75 160 181 164

6 300

7 000

700

3 600

257 024 20 400 236 624

5 3 4

1 660 1 200 6 240

73 500 173 724

700

400

C.19

247 224 20 000 227 224

Applying IFRS Standards 4e Solutions Manual

SAM LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for the financial year ending 30 June 2016 Revenues: Sales revenue Other revenue

$260 000 31 350 $291 350

Expenses: Cost of sales Depreciation Other expenses

140 000 22 000 25 000

Share of profits/(losses) of associates Profit before income tax Income tax expense Profit for the period Comprehensive Income for the period Attributable to: Parent interest Non-controlling interest

187 000 104 350 ___210 104 560 29 400 $75 160 $75 160 $73 500 1 660 $75 160

SAM LTD Consolidated Statement of Changes in Equity for the financial year ending 30 June 2016 Comprehensive income for the period

Group $75 160

Parent $73 500

Retained earnings: Balance at 1 July 2015 Profit for the period Dividend paid Transfer from business combinations valuation reserve Balance at 30 June 2016

$181 164 75 160 (20 400) ___700 $236 624

$173 724 73 500 (20 000) ______ $227 224

$700 (700) $0

Share capital: Balance at 1 July 2015 Balance at 30 June 2016

unknown unknown

General reserve: Balance at 1 July 2015 Balance at 30 June 2016

unknown unknown

Business combination valuation reserve: Balance at 1 July 2015 Transfer to retained earnings Balance at 30 June 2016

B. Statement of Financial Position Investment in Kayla Ltd ($3 500 + $924 - $50)

$4 374

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Online chapter C: Associates and joint ventures

Exercise C.9 CONSOLIDATION WORKSHEET ENTRIES INCLUDING INVESTMENTS IN JOINT VENTURES Prepare the consolidation worksheet entries (in general journal form) needed for the consolidated statements for the year ended 30 June 2016 for Amber Ltd and its subsidiary Molly Ltd. Include the equity accounted results of Kate Ltd. AMBER LTD – MOLLY LTD – KATE LTD Amber Ltd

80%

20%

Molly Ltd

Kate Ltd

NCI 20% 1. Consolidated worksheet entries At 30 June 2014, in relation to Amber’s acquisition of Molly Ltd: Goodwill acquired (1)

Pre-acquisition entry Retained earnings (1/7/15) Goodwill Share capital Shares in Molly Ltd

(2)

Dr Dr Dr Cr

x 5 000 x

Dr Cr

2 400

NCI share of profit NCI (20% x $20 000)

Dr Cr

4 000

General reserve Transfer to general reserve (20% x $5 000)

Dr Cr

1 000

NCI

Dr Cr

1 200

Dr Cr

800

NCI in equity: 1/7/14 – 30/6/15 Retained earnings (op. bal.) NCI (20% x $12 000)

(3)

$5 000

2 400

NCI in equity from 1/7/15 – 30/6/16

Interim dividend paid (20% x $6 000) NCI Final dividend declared (20% x $4 000)

4 000

1 000

1 200

800

C.21

Applying IFRS Standards 4e Solutions Manual

(4)

Dividend paid Dividend revenue Interim dividend paid (80% x $6 000)

(5)

(6)

Dr Cr

4 800

Dividend payable Dividend declared (80% x $4 000)

Dr Cr

3 200

Dividend revenue Dividend receivable

Dr Cr

3 200

Dividend declared

Dr Dr Cr

3 500 1 500

Dr Cr

700

5 000

700

Sale of plant: Molly Ltd – Amber Ltd Retained earnings (1/7/15) Deferred tax asset Plant

(9)

3 200

NCI adjustment NCI share of profit Retained earnings (1/7/15) (20% x $3 500)

(8)

3 200

Unrealised profit in beginning inventory: Molly Ltd – Amber Ltd Retained earnings (1/7/15) Income tax expense Cost of sales

(7)

4 800

Dr Dr Cr

2 100 900

Dr Cr

420

3 000

NCI adjustment NCI Retained earnings (1/7/15) (20% x $2 100)

420

(10) Depreciation Accumulated depreciation Dr 1 100 Retained earnings (1/7/15) Cr Depreciation expense Cr (20% x 10/12 x $3 000 in previous period and 20% x $3 000 in current period) Income tax expense Retained earnings (1/7/15) Deferred tax asset

Dr Dr Cr

180 150

Dr Dr Cr

84 70

500 600

330

(11) NCI adjustment NCI share of profit Retained earnings (1/7/15) NCI

154

C.22

Online chapter C: Associates and joint ventures

(12)Equity accounted results of Kate Ltd Net fair value of identifiable assets and liabilities of Kate Ltd Net fair value acquired Cost of investment Goodwill

= = = = = =

$100 000 + $15 000 + $5 000 (equity) $120 000 20% x $120 000 $24 000 $25 000 $1 000

Change in Retained Earnings 2014 –2015 ($11 000 - $5 000) Adjustments: Increase in general reserve Unrealised profit in closing inventory $3 000 (1 – 30%)

$6 000

3 000 (2 100) 6 900 $1 380

Investor’s share – 20%

Recorded profit Adjustments: Realised profit on opening inventory Unrealised profit in ending inventory $4 000 (1 – 30%) Unrealised profit on sale of non-current assets $2 000 (1 – 30%) less depreciation of ½ x 25% x $1 400

$19 000 2 100 (2 800)

(1 225) $17 075 $3 415

Investor’s share – 20% Pre-acquisition adjustments: Increase in asset revaluation surplus [$8 000 x (1 – 30%)] Investor’s share – 20%

$5 600 1 120

The worksheet entries are: Investment in Kate Ltd Asset revaluation surplus Retained earnings (1/7/15) Share of profits or losses of associates

Dr Cr Cr

Dividend revenue Investment in Kate Ltd (20% x[$2 000 + $8 000])

Dr Cr

5 915 1 120 1 380

3 415 2 000 2 000

C.23

Online chapter D: Joint Arrangements

Solutions Manual to accompany

Applying IFRS Standards 4e

Ruth Picker, Kerry Clark, John Dunn, David Kolitz, Gilad Livne, Janice Loftus, Leo van der Tas

Prepared by Ken Leo, revised for this edition by John Dunn

John Wiley & Sons, Ltd, 2016

D.1

Solutions Manual to accompany Applying IFRS Standards 4e

Online chapter D: Joint arrangements Discussion questions 1. What is a joint arrangement? A joint arrangement is described in IFRS 11 paragraph 4 as, “an arrangement of which two or more parties have joint control.” Paragraph 5 of IFRS 11 further states that A joint arrangement has the following characteristics: (a) The parties are bound by a contractual arrangement. (b) The contractual arrangement gives two or more of those parties joint control of the arrangement. 2. How does a joint arrangement differ from an associate? The key difference is the level of control that exists within the arrangement. With an associate, the investor has significant influence over the financial and operating policies of the associate. With a joint arrangement the investor has joint control over the other entity; decisions require the unanimous consent of all parties to the contractual arrangement. Further under a joint arrangement, the parties are bound by a contractual arrangement. With an investor in an associate, the investor has no contractual arrangement with other investors in the associate. 3. What is meant by joint control? As explained in IFRS 11 paragraph 7, joint control exists when: (i) there exists a contractually agreed sharing of control and (ii) the agreement is that decisions about the relevant activities require the unanimous consent of the parties sharing control i.e. no party can make a unilateral decision about relevant activities. 4. How does joint control differ from control as used in classifying subsidiaries? Under IFRS 10: 6

An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.

Thus, an investor controls an investee if and only if the investor has all the following: (a) power over the investee; (b) exposure, or rights, to variable returns from its involvement with the investee; and (c) the ability to use its power over the investee to affect the amount of the investor’s returns.

Online chapter D: Joint Arrangements

The parent has complete control or dominant control over the subsidiary. There is only one parent – control is never shared. Under IFRS 11: 7 Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. With joint arrangements, control is shared between at least two entities. 5. How does a joint venture differ from a joint operation? In principle, they are both very similar with regard to the actual business arrangements and the cooperation between the parties to the arrangement. The main difference between a joint venture and a joint operation is that the parties to a joint venture have rights to the net assets, whereas the parties to a joint operation have rights to the assets and obligations for the liabilities. In practical terms, that suggests that a joint venture that had been incorporated as a company would be a joint venture because the parties’ equity would normally give them rights to the net assets. A joint operation would leave the parties responsible for the arrangement’s debts, which could be possible in the event that it is left unincorporated. 6. What are the key steps in classifying a joint arrangement into joint ventures and joint operations? Joint arrangements are classified into joint ventures and joint operations. - a joint operation: an arrangement in which the parties that have joint control have rights to the assets and obligations for the liabilities relating to the arrangement. These parties are called joint operators. - a joint venture: the parties that have joint control have rights to the net assets of the arrangement. These parties are called joint venturers. The key element in the classification of a joint arrangement is the rights and obligations of the parties to the arrangement (IFRS 11, para. 14). For a joint operation, the rights pertain to the rights and obligations associated with individual assets and liabilities, whereas with a joint venture, the rights and obligations pertain to the net assets, that is, the investment in net assets. The assessment of the classification of a joint arrangement is not straight-forward, it requires judgement. As outlined in IFRS 11 paragraph 17, the assessment of the rights and obligations in an arrangement involves analysing four factors: 1. the structure of the arrangement: If the joint arrangement is structured through a separate vehicle, then the arrangement can be either a joint operation or a joint venture. If the joint arrangement is not structured through a separate vehicle, then then the arrangement is classified as a joint operation 2. the legal form of the arrangement 3. the terms agreed to by the parties in the contractual arrangement, and 4. any other relevant facts and circumstances. 7. How are joint ventures accounted for? With a joint venture, the joint venturers have an interest in the investment in the joint arrangement. The accounting for this interest is done by application of the equity method in accordance with IAS 28 Investments in Associates and Joint Ventures.

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Solutions Manual to accompany Applying IFRS Standards 4e

8. How are joint operations accounted for? The key feature of a joint operation is that the joint operator has an interest in the individual assets and liabilities of the joint operation. In the situation where the joint operation produces an output which is distributed to the joint operators, the joint operator will receive a share of the output of the joint operation as well as be responsible for a share of the expenses of the operation that are not capitalised into the cost of the output. Hence each joint operator needs to recognise in its own accounts: (a) its share of any jointly held assets (b) its share of any jointly held liabilities (c) its revenue from the sale of any output received from the joint operation (d) its share of any revenue from the sale of any product that is jointly constructed by the joint operators (e) its share of any expenses incurred by the joint operation (f) its expenses incurred in construction of a joint product

Online chapter D: Joint Arrangements

Exercises Exercise D.1

CLASSIFICATION OF A JOINT ARRANGEMENT

Evaluate whether a joint arrangement exists and how it should be classified. In this case, joint control has arisen through means other than a specific written contract – although the articles of association of Tiverton Ltd may be regarded as a contract between the parties involved. The parties are then bound by a contractual arrangement. The appointment of directors and the voting rights under the articles of association require the approval of both Horsley Ltd and Benington Ltd for all strategic financial and operating decisions, thus giving each party a right of veto. Therefore, the articles of association of Tiverton Ltd result in joint control being given to the two entities involved. Tiverton Ltd is therefore a joint arrangement. The parties carry out the joint arrangement through a separate vehicle, Tiverton Ltd whose legal form confers separation between the parties and the separate vehicle. The parties have a right to the net assets in accordance with the legal form. However, by agreeing to receive a share of the output of Tiverton Ltd, they have effectively formed a joint operation and should be accounted for under IFRS 11.

Exercise D.2

EXISTENCE AND ARRANGEMENT

CLASSIFICATION

JOINT

Discuss whether a joint arrangement exists and whether it should be classified as a joint venture or a joint operation. The parties carry out the joint arrangement through a separate vehicle whose legal form confers separation between the parties and the separate vehicle. The parties have been able to reverse the initial assessment of their rights and obligations arising from the legal form of the separate vehicle in which the arrangement is conducted. They have done this by agreeing terms in the joint operating agreement that entitle them to rights to the assets (eg exploration and development permits, production, and any other assets arising from the activities) and obligations for the liabilities (eg all costs and obligations arising from the work programmes) that are held in Dragon Gold. The joint arrangement is a joint operation. Both Gold Rush Ltd and Changchun Mining Ltd recognise in their financial statements their own share of the assets and of any liabilities resulting from the arrangement on the basis of their agreed participating interest. On that basis, each party also recognises its share of the revenue (from the sale of their share of the production) and its share of the expenses.

D.5

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise D.3

CLASSIFICATION OF A JOINT ARRANGEMENT

Discuss whether a joint arrangement exists and how it should be classified. The joint arrangement is carried out through a separate vehicle whose legal form confers separation between the parties and the separate vehicle. The terms of the contractual arrangement do not specify that he parties have rights to the assets, or obligations for the liabilities, of the Overseas Bank, but it establishes that the parties have rights to the net assets of the Overseas Bank. The commitment by the parties to provide support if the Overseas Bank is not able to comply with the applicable legislation and banking regulations is not by itself a determinant that the parties have an obligation for the liabilities of the Overseas Bank. There are no other facts and circumstances that indicate that the parties have rights to substantially all the economic benefits of the assets of the Overseas Bank and that the parties have an obligation for the liabilities of the Overseas Bank. The joint arrangement is a joint venture. Both the Angkasa and Bagus banks recognise their rights to the net assets of the Overseas Bank as investments and account for them using the equity method.

Exercise D.4

ACCOUNTING FOR AN ASSET USED BY A NUMBER OF COMPANIES

Discuss how you would account for the pipeline. Raby Ltd and Bowes Ltd have entered into a joint arrangement under IFRS 11. There is a contractual arrangement between the two entities to build the pipeline, and to share its use. The pipeline is under the joint control of these two entities, as evidenced by the management agreement which requires unanimous consent in relation to management decisions. The arrangement is a cost or risk sharing arrangement of carrying out an activity where the participants have a direct right in the underlying asset. The joint arrangement is then classified as a joint operation. Both Raby Ltd and Bowes Ltd would then recognise a share of the pipeline as an asset. In relation to Allington Ltd, it is a not a part of the joint venture. It has agreed to use any excess capacity of the pipeline. Hence its use arises only when excess capacity arises. In essence a contingent asset exists. Allington Ltd would simply recognise an expense when use occurs. No asset would be raised.

Online chapter D: Joint Arrangements

Exercise D.5 1. 2.

SHARING OUTPUT

Prepare the journal entries in the records of Shapirov Ltd and London Ltd in relation to the joint operation. Prepare the journal entries in the records of London Ltd assuming that the joint operation, not the operators, had depreciated the machinery and included that expense in the cost of inventory transferred. SHAPIROV LTD – LONDON LTD

1. PART A JOURNAL ENTRIES IN RECORDS OF SHAPIROV LTD $’000

$’000

1 July 2015 Cash in JO Machinery in JO Cash

Dr Dr Cr

1 000 1 000

Cash in JO Cash

Dr Cr

3 000

Machinery in JO Supplies in JO Work in Progress in JO Inventory Operating Expenses Accrued Wages in JO Creditors in JO Cash in JO

Dr Dr Dr Dr Dr Cr Cr Cr

400 200 1 000 2 420 100

Inventory – Depreciation Expense Accum Depreciation in JO

Dr Cr

280

(2 000/2) (2 000/2) 2 000

3 000

30 June 2016

20 150 3 950

(2800/2 – 1 000) (400/2) (2 000/2) (4 840/2) (200/2) (40/2) (300/2) (100/2 – 4 000) (20% x 1 400)

280

JOURNAL ENTRIES IN THE RECORDS OF LONDON LTD $’000 1 July 2015 Cash in JO Machinery in JO Carrying Amount of Machinery Sold Proceeds – machinery sale Machinery

Dr Dr

1 000 950

Dr Cr Cr

950

Cash in JO Cash

Dr Cr

3 000

$’000

(2 000/2) (1 900/2)

1 000 1 900

(2 000/2)

3 000

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Solutions Manual to accompany Applying IFRS Standards 4e

30 June 2016 Machinery in JO Supplies in JO Work in Progress in JO Inventory Operating Expenses Accrued Wages in JO Creditors in JO Cash in JO

Dr Dr Dr Dr Dr Cr Cr Cr

400 200 1 000 2 420 100

Inventory – Depreciation Expense Accum Depreciation in JO

Dr Cr

270

20 150 3 950

(2800/2 – 1 000) (400/2) (2 000/2) (4 840/2) (200/2) (40/2) (300/2) (100/2 – 4 000) (20%(400 + 950)

270

B. PART 2 JOURNAL ENTRIES IN THE RECORDS OF LONDON LTD $’000 1 July 2015 Cash in JO Machinery in JO Carrying Amount of Machinery Sold Proceeds – machinery sale Machinery

Dr Dr

1 000 950

Dr Cr Cr

950

Cash in JO Cash

Dr Cr

3 000

Machinery in JO Supplies in JO Work in Progress in JO Inventory

Dr Dr Dr Dr

400 200 1 000 2 700

Other Expenses Accumulated Depreciation in JO Accrued Wages in JO Creditors in JO Cash in JO

Dr Cr Cr Cr Cr

100

$’000

(2 000/2) (1 900/2)

1 000 1 900

(2 000/2)

3 000

30 June 2016

280 20 150 3 950

Accumulated Depreciation in JO Dr 10 Inventory Cr Work in Progress in JO Cr (Adjustment for depreciation being based on carrying amount rather than fair value) Working Inventory Work in Progress in JV

2 700 1 000 3 700

73% 27%

7 3

7 3 10

(2800/2 – 1 000) (400/2) (2 000/2) (4 840/2) + 280 depn) (200/2) (1/2 x 20% x 2800) (40/2) (300/2) (100/2 – 4 000)

Online chapter D: Joint Arrangements

Exercise D.6

UNINCORPORATED JOINT OPERATION

Prepare the journal entries in the records of Allington Ltd in relation to the joint operation for the year ended 30 June 2016. (Round all amounts to the nearest dollar and show all relevant workings.) ALLINGTON LTD – JOULES LTD Journal Entries - Accounts of Allington Ltd (60% Interest) $'000

$'000

1 July 2015 Cash in JO Plant & Equip in JO Carrying Amount of Equipment Sold Equipment Proceeds: sale of equipment Cash

Dr Dr

1 020 420

Dr Cr Cr Cr

120

Dr Cr

600

Dr Dr Dr Dr Dr Dr

60 270 135 1 068 270 24

(1700 x .6) ((400 + 300) x .6) (300 x .4) 300 160 1 100

(400 x .4)

December Cash in JO Cash

600

30 June 2016 Raw Material in JO Work in Progress in JO Inventory in JO Inventory Plant & Equipment in JO Other Expenses in JO Accum Depreciation Plant & Equip in JO Accounts Payable in JO Accrued Expenses in JO Cash in JO Accumulated Depreciation Plant & Equip in JO Inventory in JO Inventory Work in Progress in JO

(100 x .6) (450 x .6) (225 x .6) (1 780 x .6) (450 x .6) (40 x .6)

Cr Cr Cr Cr

Dr Cr Cr Cr

123 192 54 1 458

(205 x .6) (320 x .6) (90 x .6) (1620 - (270 x .6))

12 1 9 2

Depreciation based on 60%($400 000 - $300 000) requires a $12 000 adjustment to depreciation expense which must be allocated across all forms of inventory which include the depreciation expense:

Work in Progress Inventory in JV Inventory

Total Value 270 135 1 068 1 473

% 18 9 73

Allocation 2 1 9

D.9

Solutions Manual to accompany Applying IFRS Standards 4e

Exercise D.7 1. 2.

OPERATORS SHARE OUTPUT

Prepare the journal entries in the records of Belvoir Ltd during 2016. What differences would occur if the management fee paid to Belvoir Ltd were treated as general administration costs? BELVOIR LTD – ASHTON LTD

At 1 January 2016: Investment in JO Cash

Dr Cr

1 000 000 1 000 000

During the period in relation to the supply of management services: Cash

Dr Cr

100 000

Revenue

Dr Cr

80 000

Cash

Vehicles in JO Accumulated Depreciation in JO Equipment in JO Accumulated Depreciation in JO Inventory in JO Work-in-Progress in JO Materials in JO Provisions in JO Payables in JO Inventory Expenses Investment in JO (Share of assets and liabilities of JO)

Dr Cr Dr Cr Dr Dr Dr Dr Cr Dr Dr Cr

100 000

Revenue

Dr Cr

40 000

Dr Cr Cr Cr

10 000

Expenses

100 000

80 000

At 31 December 2016:

Expenses (1/2 x cost of providing services) Revenue Inventory Inventory in JO Work-in-Progress in JO (Elimination of profit element)

25 000 410 000 30 000 40 000 160 000 105 000 40 000 20 000 200 000 100 000 1 000 000

40 000

5 000 1 000 4 000

Workings: Inventory 200 000 Inventory in JO 40 000 Work-in-Progress in JO 160 000 400 000

½ 1/10 2/5

5 000 1 000 4 000 10 000

2. If the management fee is regarded an expense by the JO, then instead of the two revenue adjustments shown under Part 1 above, the journal entry in the venturer is: Revenue

Dr 50 000 Expense Cr 50 000 This eliminates the revenue in relation to itself as well as the expense brought across from the JO.

Online chapter D: Joint Arrangements

Exercise D.8

SHARE OF OUTPUT

Prepare the journal entries in the records of Arnside Ltd for the periods ending 30 June 2016 and 2017. ARNSIDE LTD – TOWER LTD 1. JOURNAL ENTRIES IN THE ACCOUNTS OF ARNSIDE LTD Six months ended 30 June 2016 1 January 2016 $'000

$'000

Capitalised Expenses in JO Equipment in JO Cash in JO Carrying Amount of Equipment Sold Carrying Amount of Capitalised Expenses Sold Proceeds - equipment Proceeds - capitalised expenses Cash Equipment Capitalised Expenses

Dr Dr Dr

160 320 3 200

(320/2) (640/2) ((2 400 + 4 000)/2)

320

(640/2)

Dr Cr Cr Cr Cr Cr

160

Cash

Dr Cr

800

Dr Dr Cr Cr Cr

100 3 480

Cash in JO Cash

Dr Cr

1 000

Inventory Plant & Equipment in JO Accounts Payable in JO Accrued Expenses in JO Administration Expenses Cash in JO Work-in-Progress in JO

Dr Dr Dr Dr Dr Cr Cr

600 200 280 20 80

Inventory Accumulated Amortisation Capitalised Expenses in JO Accumulated Depreciation Plant & Equipment in JO

624

Bank Loan

400 400 2 400 640 320

(320/2) (800/2) (800/2)

800

30 June 2016 Work-in-Progress Plant & Equipment in JO Cash in JO Accounts Payable in JO Accrued Expenses in JO

3 080 400 100

(200/2) ((7760 - 800/2) ((240 - 6 400)/2) (800/2) (200/2)

Year ended 30 June 2017 (2 000/2) 1 000

1 080 100

600

((8 160 - 7 760/2) ((800 - 240)/2) ((200- 160)/2) (160/2) (80/2 – 1 120)

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Solutions Manual to accompany Applying IFRS Standards 4e

Calculations Cost of Inventory Work-in-Progress Materials and Supplies Wages (560 - 200 + 160)

200 480 520 1 200 x 50% = 600

Amortisation of capitalised expenses: Arnside Ltd 15% x $160 = $ 24 Depreciation of plant & equipment: Arnside Ltd Balance at 1 January 2016 Acquisitions to 30 June 2016 Acquisitions to 30 June 2017

$320 x 15% = $48 $3 480 x 15% = $522 $200 x 15% = $30 Total depreciation = $ 600

Cost of Sales Inventory (90% (600 + 624))

Dr Cr

1 101

Cash/Receivables Sales Revenue

Dr Cr

2 000

1 101

2 000

Note: the balance of inventory in Arnside Ltd is 10%(600 + 609.0) = 120.9

Online chapter D: Joint Arrangements

Exercise D.9

OPERATORS SHARE OUTPUT

Prepare the journal entries in the records of Melk Ltd and Koffie Ltd in relation to the joint operation for the year ended 30 June 2016. MELK LTD – KOFFIE LTD Journal entries in records of Melk Ltd $'000

$'000

1 July Cash in JO Plant & Equipment in JO Carrying Amount of Plant & Equipment Sold Plant & Equipment Proceeds on Sale Cash

Dr Dr

1 900 600

Dr Cr Cr Cr

200

Dr Cr

1 500

Raw Material in JO Work-in-Progress in JO Inventory in JO Inventory Plant & Equipment in JO Other Expenses in JO Accum. Depreciation in JO Accounts Payable in JO Accrued Expenses in JO Cash in JO

Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

180 1 550 290 1 000 475 220

Accum. Depreciation in JO Inventory in JO Work-in-Progress in JO Inventory

Dr Cr Cr Cr

(3 800/2) (800/2 + 400/2) (400/2) 400 300 2 000

December Cash in JO Cash

1 500

30 June

235 265 50 3 165

(360/2) (3 100/2) (580/2) (2 000/2) (950/2) (440/2) (470/2) (530/2) (100/2) (3 400 – 470/2)

2 11 7

Depreciation based on 50% ($600 000 - $400 000) requires a $20 000 adjustment to depreciation expense which must be allocated across all forms of inventory which include the depreciation cost. Calculation Total Value % Allocation Work-in-Progress 1 550 54.6 10 920 Inventory in JO 290 10.2 2 040 Inventory 1 000 35.2 7 040 2 080 20 000

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Solutions Manual to accompany Applying IFRS Standards 4e

JOURNAL ENTRIES IN THE ACCOUNTS OF KOFFIE LTD $'000 1 July Loss on Revaluation of Plant Dr 100 Plant Cr Cash in JO Plant & Equipment in JO Carrying Amount of Plant & Equipment Sold Plant & Equipment Proceeds – Plant Sale Cash

Dr Dr

1 900 700

Dr Cr Cr Cr

400

Dr Cr

1 500

Dr Dr Dr Dr Dr Dr Cr Cr Cr Cr

180 1 550 290 1 000 475 220

$'000

100 (3 800/2) (800/2 + 600/2) (800/2) 800 400 1 800

December Cash in JO Cash

1 500

30 June Raw Material in JO Work-in-Progress in JO Inventory in JO Inventory Plant & Equipment in JO Other Expenses in JO Accumulated Depreciation in JO Accounts Payable in JO Accrued Expenses in JO Cash in JV

235 265 50 3 165

(360/2) (3 100/2) (580/2) (2 000/2) (950/2) (440/2) (470/2) (530/2) (100/2) (3 400 – 470/2)

Online chapter D: Joint Arrangements

Exercise D.10 OPERATORS

UNINCORPORATED JOINT OPERATION MANAGED BY ONE OF THE

1. Prepare the journal entries in the records of Stafford Ltd and Dunster Ltd at the commencement of the joint operation. 2. Prepare the journal entries in the records of Tutbury Ltd for the financial year ending 30 June 2016. STAFFORD LTD – DUNSTER LTD – TUTBURY LTD 1.

JOURNAL ENTRIES – ENTRIES IN THE ACCOUNTS OF STAFFORD LTD AND DUNSTER LTD AT 1 JULY 2015

STAFFORD LTD (50%): Patent in JO Cash in JO Plant & Equipment in JO Carrying Amount of Asset Sold Sale Proceeds Capitalised R&D Costs

Dr Dr Dr Dr Cr Cr

$'000 700 500 500

$'000 (1400/2) (1 000/2) (1 000/2)

700 1 000 1 400

(1 400/2) (2 000/2)

DUNSTER LTD (25%): $'000 Patent in JO Cash in JO Plant & Equipment in JO Cash

Dr Dr Dr Cr

$'000

500 250 250

(2 000/4) (1 000/4) (1 000/4) 1 000

2. JOURNAL ENTRIES IN THE ACCOUNTS OF TUTBURY LTD $'000 $'000 1 July 2015 Patent in JO Cash in JO Plant & Equipment in JO Carrying Amount of Plant & Equipment Sold Sale Proceeds Plant & Equipment

Dr Dr Dr

500 250 150

Dr Cr Cr

450

(2 000/4) (1 000/4) (600/4)

750 600

(3/4 x 600) (3/4 x 1 000)

D.15

Solutions Manual to accompany Applying IFRS Standards 4e

30 June 2016 Working: Cost of output Cash Expenses Accruals Creditors Depreciation Work in Progress Cost of Inventory

792 92 136 1 020 416.8 1 456.8 40.0 1 416.8

Plant & Equipment in JO Dr Accum Depreciation P&E in JO Cr Accum Depreciation Patent in JO Cr Office Equipment in JO Dr Accum Depreciation OE in JO Cr Work in Progress in JO Dr Inventory Dr Cash in JO Cr Creditors in JO Cr Accruals in JO Cr Accumulated Depreciation P&E in JO Inventory Work in Progress in JO

Dr Cr Cr

20 52 50 22 2.2 10 354.2 240 34 28 20 19.5 0.5

(Adjustment in depreciation is $20 = 1/5 x 1/4 x ($1 000 - $600) Allocation to inventory is $19.5 = 354.2/364.2 x $20)

Cash/Accounts Receivable Sales Revenue

Dr Cr

300

Cost of Sales Inventory (80% (354.2 –19.5 – 5.0))

Dr Cr

263.8

Management Fee Receivable Fee Revenue

Dr Cr

Cost of Supplying Service Cash

Dr Cr

Fee Revenue Cost of Supplying Service (1/4 x 20)

Dr Cr

Accruals in JO Management Fee Receivable

Dr Cr

300

263.8

((1 080 - 1 000)/4) (208/4) (200/4) (88/4) (8.8/4) (40/4) (1 416.8/4) ((40 - 1 000)/4) (136/4) (112/4)

Online chapter D: Joint Arrangements

Exercise D.11

OPERATORS SHARE OUTPUT

Prepare the journal entries in the records of Cooling Ltd to record its interest in the joint operation for the years ending 31 December 2015 and 2016. COOLING LTD – DEAL LTD 2015 Cash in JO Capitalised Expenses in JO Capitalised Expenses Revenue Cash Carrying Amount

Dr Dr Cr Cr Cr Dr

Capitalised Expenses in JO Plant & Equipment in JO Accum Depreciation in JO Cash in JO Materials in JO Accrued Wages in JO Accounts Payable in JO Inventory General Admin Expenses

Cr Dr Cr Cr Dr Cr Cr Dr Dr

1 100 000 100 000

[1/2(700 000 + 1 500 000)] [1/2 x 200 000] 200 000 400 000 700 000

100 000

[1/2 x 800 000] [1/2 x200 000]

20 000 400 000 20 000 950 000 25 000 5 000 10 000 430 000 150 000

[1/2(800 000 – 760 000)] {1/2(800 000 – 0)] [1/2(40 000 – 0)] [1/2(300 000 – 1 100 000)] [1/2(50 000 – 0)] [1/2(10 000 – 0)] [1/2(20 000 – 0)] [1/2 x 860 000] [1/2 x 300 000]

As the capitalised expenses are at $100 000 for Cooling Ltd, and not $400 000, then the amortisation expense is $5 000, not $20 000. Hence a reduction in the cost of the output is required: Capitalised Expenses in JO Inventory

Dr Cr

15 000 15 000

2016 Cash in JO Cash

Dr Cr

Capitalised Expenses in JO Plant & Equipment in JOV Accum Depreciation in JO Cash in JO

Cr Dr Cr Cr

Materials in JO Accrued Wages in JO Accounts Payable in JO Inventory General Admin Expenses

Cr Cr Cr Dr Dr

600 000

[1/2 x 1 200 000] 600 000

40 000 95 000 50 000 695 000 5 000 5 000 5 000 555 000 150 000

[1/2(680 000 – 760 000)] [1/2(990 000 – 800 000)] [1/2(140 000 – 40 000)] [1/2(110 000 – 300 000 - 1 200 000)] [1/2(40 000 – 50 000)] [1/2(20 000 – 10 000)] [1/2(30 000 – 20 000)] [1/2 x 1 110 000] [1/2 x 300 000]

Capitalised expenses are at $100 000, not $400 000. Therefore, the adjustment should be $10 000 not $40 000. Capitalised Expenses in JO Inventory

Dr Cr

30 000 30 000

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for and A Exploration evaluation of mineral resources ACCOUNTING STANDARDS IN FOCUS

LEARNING OBJECTIVES

IFRS 6 Exploration for and Evaluation of Mineral Resources

After studying this chapter, you should be able to: 1

describe the background to IFRS 6

identify which items are in the scope of IFRS 6

understand the range of industry accounting policies applied to the recognition of exploration and evaluation assets

explain how to measure exploration and evaluation assets

explain the impairment procedures applicable to exploration and evaluation assets

describe the presentation and disclosure requirements of IFRS 6

discuss the possible future developments for IFRS 6.

A Exploration for and evaluation of mineral resources

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A.1

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INTRODUCTION TO IFRS 6 IFRS 6 Exploration for and Evaluation of Mineral Resources was issued by the International Accounting Standards Board (IASB®) in December 2004. Historically, the IASB has tended to avoid industry-specific standard setting. However, the extractive industries, which include industries involved in the seeking, finding and extracting of minerals, oil and gas, represent a significant economic contributor to the global economy and, due to the unique accounting issues faced by these industries, are routinely excluded from the scope of many IFRS® Standards. In November 2000, the IASB’s predecessor, the International Accounting Standards Committee (IASC), published an issues paper, Extractive Industries Issues Paper, which was meant to be the first step in the process of developing a comprehensive IFRS Standard for the extractive industries. However, the economic strength of entities in the extractive industries also gives them significant political influence and, as a result, they tend to be very effective lobbyists. This, along with the reformation of the IASC into the IASB, resulted in the issuance of IFRS 6, which merely exempts current industry practice from new rules or restrictions to a large extent. The issuance of IFRS 6 was, and still remains, a much debated political exercise. Some would say IFRS 6 reflects the significant influence the various extractive industries’ lobby groups exert. Others would say it was merely issued because something was needed in time for the 2005 wave of IFRS Standard adopters, given the extra time that development of comprehensive guidance would likely have required. The effort to develop such comprehensive guidance continues even today (see section A.7).

LO2

A.2

SCOPE OF IFRS 6 The scope of IFRS 6 is specifically limited to accounting for exploration and evaluation (E&E) expenditures incurred by an entity in connection with the ‘exploration for and evaluation of mineral resources’, which the standard defines as ‘[t]he search for mineral resources, including minerals, oil, natural gas and similar non-regenerative resources after the entity has obtained legal rights to explore in a specific area, as well as the determination of the technical feasibility and commercial viability of extracting the mineral resource’. The IASB deliberately decided not to expand the scope of IFRS 6 to avoid pre-empting the outcome of its extractive activities project, as well as to avoid any significant delay in the issuance of E&E expenditure guidance, which would have resulted from an expanded scope. Therefore, the accounting policies applicable under IFRS Standards for other aspects of extractive industries activities should be determined in accordance with paragraphs 7 to 12 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Refer to chapter 16 for discussion of these requirements. Figure A.1 illustrates the scope of IFRS 6.

Technical feasibility and commercial viability established

Acquire rights to explore

Pre-exploration and evaluation phase

Exploration and evaluation phase

Development phase

Costs outside the scope of IFRS 6

Costs within the scope of IFRS 6

Costs outside the scope of IFRS 6

FIGURE A.1 Scope of IFRS 6

As ﬁgure A.1 shows, entities engaged in the exploration for and evaluation of mineral resources should not apply IFRS 6 to expenditures incurred before the E&E phase (i.e. before the rights to explore the area have been obtained) or after the E&E phase (i.e. after the technical feasibility and commercial viability of extracting the resource are demonstrable). Rather, in these phases, management must apply appropriate judgement in determining which accounting policies should apply to such costs by considering the requirements of IAS 8, as previously noted. 2

PART 2 Elements

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A.3

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RECOGNITION OF E&E ASSETS E&E assets are merely those E&E expenditures that have been capitalised as assets in accordance with the entity’s accounting policy. IFRS 6 provides an exemption from application of the hierarchy in paragraphs 11 and 12 of IAS 8 to E&E assets and instead only requires the application of paragraph 10 of IAS 8. This exemption has the effect of allowing the accounting practices that existed prior to the issuance of IFRS 6 to continue to the extent they meet the requirements of paragraph 10 of IAS 8. This means that the entity’s accounting policy for recognition of E&E assets need not be fully compliant with the Conceptual Framework and, as a result, some costs may be capitalised earlier than would normally be allowed under the Conceptual Framework. For example, when an entity obtains the rights to explore an area, costs incurred to undertake such exploration (e.g. equipment rental, engineering costs, contractor fees) would not normally meet the asset definition and recognition criteria contained in the Conceptual Framework until the existence of probable future economic benefits has been established (i.e. until the entity has established the existence of mineral resources in the area and confirmed the probability of being able to economically benefit from those resources). However, under IFRS 6, if an entity previously had a policy of capitalising such costs, they are allowed to continue with that policy. This means entities will show more assets and less costs as a result of the application of IFRS 6 than they otherwise would be able to under the Conceptual Framework. The main issue in accounting for E&E expenditures is whether such expenditures should be expensed as incurred or capitalised and, if they are capitalised, which costs qualify for such capitalisation and at what point in the operating cycle capitalisation should commence. Two common methods used globally by entities involved in the oil and gas sector to account for E&E costs are the ‘successful efforts’ method and the ‘full cost’ method. Figure A.2 provides a description of these two methods.

FIGURE A.2 Description of common methods used to account for E&E costs in the oil and gas sector Commentary Exploration, evaluation and development costs Successful efforts method

Under the successful efforts method, only those costs that lead directly to the discovery, acquisition, or development of specific discrete mineral reserves are capitalised and become part of the capitalised costs of the cost centre. Costs that are known to fail to meet this criterion (at the time of incurrence) are generally charged to the statement of profit or loss as an expense in the period they are incurred, although some interpretations of the successful efforts method would also capitalise the cost of unsuccessful development wells. Under the successful efforts method, an entity will generally consider each individual mineral lease, concession, or production sharing contract as a cost centre. When an entity applies the successful efforts method under IFRS Standards, it will need to account for prospecting costs incurred before the E&E phase under IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets. As the economic benefits are highly uncertain at this stage of a project, prospecting costs will typically be expensed as incurred. Costs incurred to acquire undeveloped mineral rights, however, should be capitalised under IFRS Standards if an entity expects an inflow of future economic benefits. To the extent that costs are incurred within the E&E phase of a project, IFRS 6 does not prescribe any recognition and measurement rules. Therefore, it would be acceptable for such costs: (1) To be recorded as assets and written off when it is determined that the costs will not lead to economic benefits; or (2) To be expensed as incurred if the outcome is uncertain. In accordance with IFRS 6.17, once technical feasibility and commercial viability is demonstrated, the capitalised exploration costs should be transferred to property, plant and equipment or intangibles, as appropriate, after being assessed for impairment. If technical feasibility and commercial viability is uncertain, or not immediately obvious, then costs can remain capitalised while an entity is still actively engaged in the exploration or evaluation effort. If the exploration or evaluation effort has ceased, but there is potential for future benefits, e.g., through sale, although this is subject to factors outside of this particular exploration and evaluation effort, the exploration and evaluation phase is over. The capitalised exploration and evaluation costs should then be tested for impairment and reclassified into property, plant and equipment or intangible assets. If it is determined that no commercial reserves are present then the costs capitalised should be written off. Costs incurred after the E&E phase should be accounted for in accordance with the relevant IFRS Standards (i.e., IAS 16 and IAS 38). (continued) A Exploration for and evaluation of mineral resources

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FIGURE A.2 (continued) Other methods of accounting for exploration, evaluation and development costs Full cost method

The full cost method under most national GAAP requires that all costs incurred in prospecting, acquiring mineral interests, exploration, appraisal, development and construction are accumulated in large cost centres. For example, costs may be accumulated for each individual country, for groups of countries, or for the entire world. However, IFRS 6 does not permit application of the full cost method outside the E&E phase. There are several other areas in which application of the full cost method under IFRS Standards is restricted because: • While the full cost method under most national GAAP requires application of some form of ceiling test, IFRS 6 requires, when impairment indicators are present, an impairment test to be performed in accordance with IAS 36. • IFRS 6 requires E&E assets to be classified as tangible or intangible assets according to the nature of the assets, and even when an entity accounts for E&E costs in relatively large pools, it will still need to distinguish between tangible and intangible assets. • Once the technical feasibility and commercial viability of extracting mineral resources are demonstrable, IFRS 6 requires E&E assets to be assessed for impairment under IAS 36, and any impairment loss recognised (as appropriate), and then reclassified out of E&E assets in the statement of financial position and accounted for under IAS 16 or IAS 38. This means it is not possible to account for successful and unsuccessful projects within one cost centre or pool. For the reasons above. It is not possible to apply the full cost method of accounting under IFRS Standards without making very significant modifications in the application of the method. An entity may wish to use the full cost method as its starting point in developing its accounting policy for E&E assets under IFRS Standards. However, it would rarely be appropriate to describe the resulting accounting policy as a full cost method because key elements of the full cost method are not permitted under IFRS Standards. Source: Ernst & Young 2014a, Good Petroleum (International) Limited (p. 32). © 2014 EYGM Limited. All rights reserved.

In the mining sector, there are three common methods used globally to account for E&E costs and these are described in ﬁgure A.3. FIGURE A.3 Description of common methods used to account for E&E costs in the mining sector Exploration, evaluation and development costs Successful efforts type of method

Similar to the successful efforts method more commonly adopted in the oil and gas sector, only those costs that lead directly to the discovery, acquisition or development of specific discrete mineral reserves are capitalised and become part of the capitalised costs of the cost centre. Under this type of method, an entity will generally consider each individual mineral lease as a cost centre. Costs that are known to fail to meet this criterion (at the time of incurrence) are generally expensed in the period they are incurred, although some interpretations of a successful efforts type of method would capitalise the cost of unsuccessful areas of interest. When an entity applies such a method, it will need to account for prospecting costs incurred before the E&E phase under IAS 16 or IAS 38. As the economic benefits are highly uncertain at this stage, prospecting costs will typically be expensed as incurred. Costs incurred to acquire undeveloped mineral rights, however, should be capitalised if an entity expects an inflow of future economic benefits. IFRS 6 does not prescribe any recognition and measurement rules in respect of costs incurred in the E&E phase of a project. Consequently, it would be acceptable for such costs to be either recorded as assets and written off when it is determined that the costs will not lead to economic benefits or expensed when incurred if the outcome is uncertain. The capitalised costs of an undeveloped mineral right may be subject to an impairment test each period with the amount of impairment expensed, or the costs may be kept intact until it is determined whether there are any mineral reserves. However, E&E assets should no longer be classified as such when the technical feasibility and commercial viability of extracting mineral resources are demonstrable. Full cost type of method

A full cost type of method under most national GAAP requires that all costs incurred in prospecting, acquiring mineral interests, exploration, appraisal, development, and construction are accumulated in large cost centres. Costs incurred pre-licence must be expensed. However, IFRS 6 does not permit application of the full cost method outside the E&E phase. There are several other areas in which application of the full cost method under IFRS Standards is restricted because: • IFRS 6 requires, when impairment indicators are present, an impairment test in accordance with IAS 36 to be performed. 4

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FIGURE A.3 (continued)

• IFRS 6 requires E&E assets to be classified as tangible or intangible assets according to the nature of the assets. Even when an entity accounts for E&E costs in relatively large pools, it will still need to distinguish between tangible and intangible assets. • Once the technical feasibility and commerciaI viability of extracting mineral resources are demonstrable, IFRS 6 requires E&E assets to be tested for impairment under IAS 36, reclassified in the statement of financial position and accounted for under IAS 16 or IAS 38. This means it is not possible to account for successful and unsuccessful projects in one cost centre or pool For these reasons, it is not possible to apply the full cost type of method of accounting under IFRS Standards without making very significant modifications in the application of the method. An entity may wish to use the full cost method as its starting point in developing its accounting policy for E&E assets under IFRS Standards. However, it would rarely be appropriate to describe the resulting accounting policy as a ‘full cost method’ because key elements of the full cost method are not permitted under IFRS Standards. Area-of-interest type of method

Under an area-of-interest type of method, costs incurred for individual geological areas that have characteristics conducive to containing a mineral reserve are capitalised as assets pending determination of whether commercial reserves are found. If the area is found to contain commercial reserves, the accumulated costs remain expensed. Some consider such a method to be a version of a successful efforts type of method that uses an area-of-interest, rather than an individual licence, as its unit of account. Others believe that this method is more like a full cost type of method, but applied on an area-ofinterest basis. Costs incurred up to the point where an area-of-interest is identiﬁed (prospecting costs) are often expensed under the area-of-interest approach. While IFRS 6 will not permit all aspects of an area-of-interest method deﬁned by a national GAAP, an entity that uses relatively small areas-ofinterest may be able to implement the method in a meaningful way under IFRS Standards. Source: Ernst & Young 2014b, Good Mining (International) Limited (p. 35). © 2014 EYGM Limited. All rights reserved.

Reproduced in figures A.4 and A.5 are the accounting policies applied to E&E expenditure from the 2014 financial statements of two international companies in the extractive industries, Rio Tinto Group (a mining company) and BP plc (an oil and gas company). Note that both companies apply a successful efforts type of method to their E&E expenditures, with Rio Tinto Group electing not to capitalise any E&E costs until it reaches the stage of evaluation of projects with economic potential. On the other hand, BP plc initially capitalises most of its E&E costs and subsequently writes them off if it is determined that the costs will not lead to economic benefits. (f) Exploration and evaluation (note 13)

Exploration and evaluation expenditure comprises costs that are directly attributable to: – researching and analysing existing exploration data; – conducting geological studies, exploratory drilling and sampling; – examining and testing extraction and treatment methods; and/or – compiling pre-feasibility and feasibility studies. Exploration expenditure relates to the initial search for deposits with economic potential. Expenditure on exploration activity is not capitalised. Evaluation expenditure relates to a detailed assessment of deposits or other projects that have been identified as having economic potential. Capitalisation of evaluation expenditure commences when there is a high degree of confidence that the Group will determine that a project is commercially viable, ie the project will provide a satisfactory return relative to its perceived risks, and therefore it is considered probable that future economic benefits will flow to the Group. The carrying values of capitalised evaluation expenditure are reviewed for impairment twice a year by management. In the case of undeveloped mining projects (projects for which the decision to mine has not yet been approved at the appropriate authorisation level within the Group) which have arisen through acquisition, the allocation of the purchase price consideration may result in undeveloped properties being recognised at an earlier stage of project evaluation compared with organic projects. The impairment review is based on a status report summarising the Group’s intentions for development. Subsequent expenditure on acquired undeveloped projects is only capitalised if it meets the high degree of confidence threshold discussed above. In some cases, undeveloped projects are regarded as successors to ore bodies, smelters or refineries currently in production. Where this is the case, it is intended that these will be developed and go into production when the current source of ore is exhausted or to replace the output when existing smelters and/or refineries are closed. FIGURE A.4 Example of E&E expenditure accounting policy for Rio Tinto Group, a mining company Source: Rio Tinto (2014, pp. 113–14).

A Exploration for and evaluation of mineral resources

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Oil and natural gas exploration, appraisal and development expenditure

Oil and natural gas exploration, appraisal and development expenditure is accounted for using the principles of the successful efforts method of accounting. Licence and property acquisition costs

Exploration licence and leasehold property acquisition costs are capitalized within intangible assets and are reviewed at each reporting date to confirm that there is no indication that the carrying amount exceeds the recoverable amount. This review includes confirming that exploration drilling is still under way or firmly planned or that it has been determined, or work is under way to determine, that the discovery is economically viable based on a range of technical and commercial considerations and sufficient progress is being made on establishing development plans and timing. If no future activity is planned, the remaining balance of the licence and property acquisition costs is written off. Lower value licences are pooled and amortized on a straight-line basis over the estimated period of exploration. Upon recognition of proved reserves and internal approval for development, the relevant expenditure is transferred to property, plant and equipment. Exploration and appraisal expenditure

Geological and geophysical exploration costs are charged against income as incurred. Costs directly associated with an exploration well are initially capitalized as an intangible asset until the drilling of the well is complete and the results have been evaluated. These costs include employee remuneration, materials and fuel used, rig costs and payments made to contractors. If potentially commercial quantities of hydrocarbons are not found, the exploration well is written off as a dry hole. If hydrocarbons are found and, subject to further appraisal activity, are likely to be capable of commercial development, the costs continue to be carried as an asset. Costs directly associated with appraisal activity, undertaken to determine the size, characteristics and commercial potential of a reservoir following the initial discovery of hydrocarbons, including the costs of appraisal wells where hydrocarbons were not found, are initially capitalized as an intangible asset. When proved reserves of oil and natural gas are determined and development is approved by management, the relevant expenditure is transferred to property, plant and equipment. FIGURE A.5 Example of E&E expenditure accounting policy for BP plc, an oil and gas company Source: BP (2014, p. 102).

LO4

A.4 A.4.1

MEASUREMENT OF E&E ASSETS Initial recognition Regardless of the method used, E&E assets must initially be measured at cost. This raises the question of what types of E&E expenditures qualify for capitalisation as E&E assets. Paragraph 9 of IFRS 6 provides the following guidance: An entity shall determine an accounting policy specifying which expenditures are recognised as exploration and evaluation assets and apply the policy consistently. In making this determination, an entity considers the degree to which the expenditure can be associated with ﬁnding speciﬁc mineral resources. The following are examples of expenditures that might be included in the initial measurement of exploration and evaluation assets (the list is not exhaustive): (a) acquisition of rights to explore; (b) topographical, geological, geochemical and geophysical studies; (c) exploratory drilling; (d) trenching; (e) sampling; and (f) activities in relation to evaluating the technical feasibility and commercial viability of extracting a mineral resource.

IFRS 6 also indicates that costs related to activities undertaken prior to commencement of E&E activities, which is presumed to be before the entity has obtained the legal rights to explore a speciﬁc area, and costs incurred for the development of mineral resources after the E&E phase, are not covered by the standard and therefore should be accounted for in accordance with IAS 8, as previously discussed (see section A.2). In practice, this usually results in the immediate expensing of costs incurred prior to obtaining exploration licences and the treatment of development costs as intangible assets accounted for under IAS 38 or property, plant and equipment accounted for under IAS 16.

A.4.2

Subsequent measurement Subsequent to initial recognition, E&E assets must be measured using the cost model or the revaluation model. The implications of using the revaluation model will differ depending on the extent to which the components of E&E assets are classiﬁed as property, plant and equipment under IAS 16 or intangible assets under IAS 38. The classiﬁcation issue is discussed further later (see section A.6.1).

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The revaluation model in IAS 38 requires the existence of an active market, which is discussed in chapter 13, whereas the revaluation model in IAS 16 only requires that fair value be reliably measurable, which is discussed in chapter 11. Note that regardless of which model is selected, cost or revaluation, it must be applied consistently to all E&E assets. In practice, the revaluation method is rarely used.

A.4.3

Depreciation methods As explained in paragraph 62 of IAS 16, the straight-line method of depreciation results in a constant charge over the equipment’s useful life if its residual value does not change. Therefore, the straight-line method is appropriate if the economic benefits embodied in the asset are expected to be consumed evenly over the useful life of the asset. However, in the extractive industries, many items of property, plant and equipment are depreciated using the units-of-production method, which results in a charge based on the expected use or output of the asset. Basically, the straight-line method allocates an equal amount of cost to each year while the units-of-production method allocates an equal amount of cost to each unit produced. By its very nature, the units-of-production method would therefore result in no depreciation being recognised during the E&E phase because production would not have commenced. In practice, items of plant and equipment used in extractive industry activities that have an expected useful life shorter than the time expected to be necessary to extract all of the mineral resources in the area they are being used in are depreciated on a straight-line basis over the period they are expected to be used. The straight-line method is seen as easier to apply than the units-of-production method, and as not necessarily giving a materially different result where production (i.e. extraction and processing of the mineral resource) is relatively stable year on year. Alternatively, items of plant and equipment used in extractive activities with longer lives are often depreciated using the units-of-production method. This method, although not as simple as the straight-line method, is particularly useful for properties where production is expected to vary significantly over the life of the field or mine development.

A.4.4

Changes in accounting policies Paragraph 13 of IFRS 6 allows an entity to change its accounting policies related to E&E costs on the condition that the change ‘makes the ﬁnancial statements more relevant to the economic decision-making needs of users and no less reliable, or more reliable and no less relevant to those needs’. In assessing the relevance and reliability of the change, entities are directed to the criteria in IAS 8, although they are not expected to fully comply with those criteria. An example of an acceptable change in accounting policy following this guidance would be a change from the full cost method to the successful efforts method.

LO5

A.5 A.5.1

IMPAIRMENT Recognition and measurement E&E assets must be tested for impairment in accordance with IAS 36 Impairment of Assets using an indicators approach, subject to the exception explained below (see section A.5.2). This means that if facts and circumstances indicate that the book values of E&E assets might exceed their recoverable amounts, the entity is required to calculate those recoverable amounts in order to confirm the existence of any impairment. In the absence of any indication of impairment, no further work is required. IFRS 6 provides a listing of indicators specific to E&E assets that should be considered, rather than the general indicators of impairment set out in IAS 36 (discussed in section 15.2). The list in IFRS 6 is not exhaustive, although it does represent the minimum an entity should consider, and includes: • whether the exploration rights for the specific area have expired or are expected to expire in the near future and there is no expectation of renewal • where there is no budget or plan for the incurrence of further substantial E&E expenditure in the specific area • where the entity has decided to discontinue E&E activities in the specific area on the basis that such activities have not led to the discovery of commercially viable quantities of mineral resources • where the entity has established that the book value of the E&E asset is unlikely to be recovered in full from successful development or sale of the specific area. With respect to expiry of exploration rights, the term ‘near future’ is generally accepted to mean 12 months from the end of the reporting period. Other impairment indicators not listed in IFRS 6 might include changes in market prices of the applicable mineral resources, adverse regulatory or taxation changes, liquidity restrictions affecting access to funding for E&E activities, civil unrest affecting access to the specific area, and natural disasters causing damage or restricting access to the specific area. A Exploration for and evaluation of mineral resources

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An example of the reasons for impairment of E&E assets as disclosed by Goldcorp Inc. is provided in ﬁgure A.6.

Cerro Negro Economic environment

The financial consequences of the restrictions on importation of goods and services into Argentina and limitation on the exchange of Argentine pesos into US dollars as well as the continuing inflationary environment in the country are negatively impacting operations at the Cerro Negro mine. Future operating costs assumptions, which have been impacted by Argentina’s current inflationary and foreign exchange environment, included in Cerro Negro’s life-of-mine (“LOM”) are $76.10 per tonne of ore mined, $38.90 per tonne of ore milled, and general and administrative costs of $56.20 per tonne of ore milled. Additionally, the key assumption in Cerro Negro’s LOM that total operating costs increased by inflation would be offset by a devaluation of the Argentine peso has also been updated to be effective January 1, 2016, rather than following production start-up. Valuation of exploration potential of in-situ ounces

The exploration potential at Cerro Negro is included as part of the Cerro Negro CGU and is valued using a probability weighted average of the income and market transaction approaches, which estimates annuity cash ﬂows as an extension to mine life and examines market comparable information and external market risk, taking into account product mix exposure and characteristics of the property, respectively. Based on the assessment performed as at December 31, 2014, the Company concluded that the market value of the exploration potential at Cerro Negro had declined by approximately 40% to 55% resulting in a reduction of the estimated recoverable amount of that exploration potential. At December 31, 2014, the Company recorded impairment expense of $2,980 million, before tax ($2,300 million, after tax), in respect of its mining interest and goodwill in Cerro Negro. FIGURE A.6 Example of disclosure of reason for impairment of E&E assets Source: Goldcorp (2014, p. 46).

A.5.2

Identification of cash-generating units In determining the level at which to assess E&E assets for impairment, entities are required to determine an accounting policy for allocating those E&E assets to cash-generating units or groups of cash-generating units. The concept of a cash-generating unit is discussed in chapter 15. Further, IFRS 6 requires that each cashgenerating unit or group of cash-generating units to which an E&E asset is allocated must not be larger than an operating segment under IFRS 8 Operating Segments. IFRS 8 is discussed in chapter 18. As a result, the level at which an E&E asset is tested for impairment may consist of one or more cash-generating units. Those cash-generating units may contain a mix of E&E assets and other assets. It is important to note that although an impairment loss on an E&E asset is reversible under IAS 36, in practice sometimes an E&E asset is completely derecognised when an impairment is recognised because no further future economic beneﬁts are expected. See illustrative example A.1.

ILLUSTRATIVE EXAMPLE A.1 Reversal of impairment losses on E&E assets

Farzi plc is an oil and gas company, which has determined that its exploration activity for a specific property, accounted for as a separate cash-generating unit, did not result in the discovery of any oil and gas resources. As a result, the company recognises an impairment of that property and derecognises all related E&E assets for that property. Alternatively, Behran Bohrman is also an oil and gas company, which has discovered a significant quantity of oil and gas resources in a specific property, but these are located in a complex reservoir. As a result, the company determines that, at present, the costs of extraction of the resources do not justify the construction of the required infrastructure. Nevertheless, Behran Bohrman’s management believes that it is possible the required infrastructure will be constructed in the future given the pace of technology and the possibility of development of more cost-effective extraction methods. As Behran Bohrman’s management has no current intention of further exploration activity in that area, the company recognises an impairment of the related E&E assets; however, as there are expectations of possible future economic benefits, it does not derecognise those assets. The implication of the above is that Farzi plc cannot reverse the impairment as the E&E asset no longer exists while Behran Bohrman could reverse the impairment should extraction of the discovered resources become viable. Source: Adapted from Ernst & Young (2015) International GAAP 2015, Example 40.3.

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A.6 A.6.1

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PRESENTATION AND DISCLOSURE Classification IFRS 6 does not specify whether E&E assets are tangible or intangible assets; however, it does require an assessment of the nature of E&E assets to determine how they should be classiﬁed. For example, the standard notes that drilling rights are treated as intangible assets while vehicles and drilling rigs are treated as tangible assets. Table A.1 illustrates the typical components of E&E assets classiﬁed between tangible and intangible assets based on generally accepted industry practice. TABLE A.1 Typical components of E&E assets classified as tangible versus intangible assets

A.6.2

Tangible

Intangible

– Vehicles and drilling rigs – Costs of replacing major parts of equipment used in E&E activities – Costs of major inspections of equipment used in E&E activities

– Acquisition of rights to explore (e.g. drilling rights and exploration licences) – Topographical, geological, geochemical and geophysical study costs – Deferred costs associated with consumables (e.g. materials and fuel used, contractor payments, employee remuneration)

Reclassification Once the technical feasibility and commercial viability of extracting a mineral resource has been established for a particular E&E asset, IFRS 6 requires that the asset be tested for impairment and then reclassified and accounted for under IAS 16 or IAS 38 as appropriate. If no resources are found as a result of the E&E activities in a specific area, the E&E assets related to that area would be impaired and therefore written off or fully provided for. The technical feasibility and commercial viability of extracting a mineral resource is normally considered to be established once an entity has confirmed the existence of ‘economically recoverable reserves’, which IFRS 6 defines as ‘the estimated quantity of product in an area of interest that can be expected to be profitably extracted, processed and sold under current and foreseeable economic conditions’. Costs incurred after this stage are specifically scoped out of IFRS 6, IAS 16 and IAS 38, although they are generally viewed as costs associated with development of an internal project and accounted for by analogy to IAS 38, or costs associated with construction of an asset and accounted for by analogy to IAS 16. Figure A.7 provides an example of a typical accounting policy applied by BP plc to costs incurred once the existence of economically recoverable reserves has been confirmed (refer to Figure A.5 for BP plc’s accounting policy related to E&E costs). Development expenditure

Expenditure on the construction, installation and completion of infrastructure facilities such as platforms, pipelines and the drilling of development wells, including service and unsuccessful development or delineation wells, is capitalized within property, plant and equipment and is depreciated from the commencement of production as described below in the accounting policy for property, plant and equipment. FIGURE A.7 Example of accounting policy for development expenditure as applied by BP plc Source: BP (2014, p. 102).

A.6.3

Disclosure Paragraphs 23–25 of IFRS 6 contain the required disclosures relating to E&E costs, which are aimed at identifying and explaining the amounts recognised in an entity’s financial statements arising from its E&E activities. Such disclosures include: • accounting policies applicable to E&E costs and E&E assets • the amounts of assets, liabilities, income, expenses, operating cash flows and investing cash flows related to E&E activities. Further, the disclosure requirements of IAS 16 or IAS 38 must also be applied depending on whether E&E assets have been classified as tangible or intangible assets respectively. Examples of some of the disclosures have been provided throughout this chapter; however, illustrative example A.2 provides a comprehensive illustration of all disclosures required by IFRS 6. A Exploration for and evaluation of mineral resources

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ILLUSTRATIVE EXAMPLE A.2 Illustrative disclosures required by IFRS 6 Relevant note to the financial statements Note 1: Summary of accounting policies (extract) Exploration and evaluation expenditures

Exploration and evaluation expenditure is accounted for using the successful efforts method of accounting. During the geological and geophysical exploration phase, costs are charged against income as incurred. Once the legal right to explore has been acquired, costs directly associated with an exploration well are capitalised as exploration and evaluation intangible assets until the drilling of the well is complete and the results have been evaluated. These costs include employee remuneration, materials and fuel used, rig costs and payments made to contractors. If no reserves are found, the exploration asset is tested for impairment. If extractable hydrocarbons are found and, subject to further appraisal activity (e.g. by drilling further wells), are likely to be developed commercially, the costs continue to be carried as an intangible asset while sufﬁcient and continued progress is made in assessing the commerciality of the hydrocarbons. All such costs are subject to technical, commercial and management review as well as review for impairment at least once a year to conﬁrm the continued intent to develop or otherwise extract value from the discovery. When this is no longer the case, the costs are written off. When proved reserves of oil are determined and development is sanctioned, the relevant expenditure is transferred to oil and gas properties after impairment is assessed and any resulting impairment loss is recognised. 2016 $’000

2015 $’000

(146) 25 (10) 118

— (5) 94

Note 3: Exploration and evaluation assets

2016 $’000

2015 $’000

Cost as at 1 January Additions Unsuccessful exploration expenditure derecognised Disposals Transfer to oil and gas properties Cost as at 31 December

524 358 (10) (52) (101) 719

361 293 (5) (25) (100) 524

Provision for impairment as at 1 January Impairment charge for the year Reversal of previously booked impairments Provision for impairment as at 31 December

(23) (146) 25 (144)

(17) (6) — (23)

Net book value as at 31 December

575

501

Note 2: Operating (loss)/profit (extract) Operating (loss)/profit is stated after (charging)/crediting: Impairment of exploration and evaluation assets(a) Reversal of previously impaired exploration and evaluation assets(b) Exploration and evaluation costs written off Gain on sale of exploration and evaluation assets (a) The Company’s rights to explore one of its properties expired during the current reporting period and the local authority responsible for granting such rights has declined renewal of those rights on the basis that the area contains habitat considered vital to support an endangered species and no significant mineral reserves have been identified to date. As a result, the Company has fully provided for the exploration and evaluation assets associated with this property. The impairment charge is included in exploration and evaluation expenses. (b) The Company has reversed some of the previously recorded impairment charge related to the XYZ property. These reversals resulted from a positive change in the estimates used to determine the asset’s recoverable amount since the impairment losses were initially recognised. The reversal of the previously booked impairment charge is included in exploration and evaluation expenses.

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LO7

A.7

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POSSIBLE FUTURE DEVELOPMENTS In 1998, the IASC, the predecessor organisation of the IASB, created a Steering Committee to deal with financial reporting in the extractive industries. This resulted in the release of an issues paper Extractive Industries Issues Paper in 2000. The project was put on hold as the IASB did not believe it could complete it in time for the 2005 adoption of IFRS Standards by many parts of the world. As previously discussed, IFRS 6 was released by the IASB as an interim measure pending completion of a comprehensive project dealing with the accounting for extractive activities. In 2004, the IASB set up an international project team comprising staff from the national standard setters in Australia, Canada, Norway and South Africa to undertake a detailed assessment of accounting for extractive activities. The project team’s findings and recommendations research are presented in the staff discussion paper Extractive Activities, which was published in April 2010. Although the discussion paper is a lengthy document, running to some 180 pages, it is substantially narrower in scope than many commentators had predicted it would be when the project was initiated. The IASB has discussed the project team’s findings at public meetings, but has not developed preliminary views on any of the project team’s recommendations or made any related technical decisions. The aim of the project was to create a single accounting and disclosure model that applies to extractive activities in both the minerals and oil and gas industries. It addresses financial reporting issues associated with exploring for and finding minerals, oil and natural gas deposits; developing those deposits; and extracting the minerals, oil and natural gas. These are referred to as either extractive activities or, alternatively, as upstream activities. The discussion paper includes: • definitions of reserves and resources for use in accounting • initial recognition and measurement of extractive assets • subsequent accounting for those assets (including impairment and depreciation) • disclosure of information (including reserves and resources information).

Disclosure recommendations One of the more significant effects of the proposals within the discussion paper would be the extensive new disclosure requirements. For some preparers this would present a major challenge to their reporting systems and processes in order to gather the required information and provide sufficient diligence over that information for it to be disclosed by preparers. Set out below are some of the proposed disclosures that could have a significant impact on preparers. • Disclosure of reserves — The project team is proposing that the types of information that should be disclosed include: – Quantities of proved reserves and proved plus probable reserves, with the disclosure of reserve quantities presented separately by commodity and by material geographical areas, including disclosure of primary assumptions; and – A current value measurement that corresponds to reserves quantities disclosed with a reconciliation of changes in the current value measurement from year to year. • Sensitivity analysis — The discussion paper also recommends the disclosure of a sensitivity analysis for reserves. • Value-based disclosures — The discussion paper also considers various approaches to value-based disclosures. An example of a value-based disclosure is the Standardised Measure of Oil and Gas (SMOG) disclosures that are currently provided under generally accepted accounting principles in the United States, as well as the disclosure of probable reserves including a current value measurement for probable reserves. • Publish What You Pay — The final section of the discussion paper relates to the Publish What You Pay proposals. This disclosure would require companies to disclose amounts paid to host governments on a country-by-country basis.

Cost capitalisation model The discussion paper proposes that legal rights to explore and extract mineral resources should be recognised as an asset. Associated with these legal rights is information about the possible existence of mineral resources, the extent and characteristics of the deposit, and the economics of their extraction. While such information does not represent a separate asset, the project team proposes that information obtained from subsequent exploration, evaluation and development activity would be treated as enhancements of the legal rights asset. How will costs be charged to the statement of profit or loss and other comprehensive income? With more costs being capitalised than under current guidance in light of the requirement to capitalise all exploration costs, and the potential for impairment tests arising from unsuccessful exploration projects, there may be an increase in the number of impairments being recorded and increased earnings volatility as a result. Costs that previously would have been recognised by many companies in the statement of profit or loss and other comprehensive income as periodic costs would instead accumulate on the statement of financial position and would potentially have to be written off at a later date. A Exploration for and evaluation of mineral resources

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Project status As part of the IASB’s 2011 agenda consultation process, the Extractive Activities project was included in the list of projects to be considered for inclusion on the IASB’s active agenda for the following 3 years. After the outreach was completed, the IASB decided that this project would not be added to their active agenda. Instead it is a longer-term research project and was combined with intangible assets and research and development activities. The commencement of these projects was expected to be staggered over an 18-month period. At the date of writing, nothing had started on the Extractive Activities/ Intangibles/Research & Development project yet, nor have any timelines been posted on the IASB website. Given this, it is unlikely that anything signiﬁcant will happen on this project for several years.

SUMMARY The purpose of this chapter is to analyse the content of IFRS 6 and provide guidance on its implementation. The principal issues in the financial reporting for E&E expenditures are the recognition and measurement of E&E assets, assessment of impairment of E&E assets, and determining appropriate disclosures to identify and explain the amounts in the entity’s financial statements arising from the exploration for and evaluation of mineral resources (IFRS 6 Objective). The key issues in recognising and initially measuring the asset are in determining when capitalisation of costs related to E&E activities should commence and identifying which elements of that cost should be capitalised. After the initial recognition of the asset, a decision has to be made about whether to apply the cost model or the revaluation model. The revaluation model is rarely applied in practice. Regardless of which measurement basis is used, the asset must be assessed for impairment when the impairment indicators set out in IFRS 6 are present. In performing an impairment test for E&E assets, a decision has to be made about the level at which the test should be applied, this being limited to a level no larger than an operating segment as defined in IFRS 8 (see chapter 18). IFRS 6 requires specific disclosures to be made in relation to the accounting policies for E&E assets and the amounts recognised in the financial statements related to E&E activities. In addition, for E&E assets classified as tangible assets and for E&E assets classified as intangible assets, the disclosures required by IAS 16 and IAS 38 respectively must also be provided.

Discussion questions 1. The scope of IFRS 6 is limited to which expenditures? 2. Discuss the complexities and considerations an entity involved in the extractive industries faces in determining the accounting policies to apply to expenditures it incurs that are outside of the scope of IFRS 6. 3. Discuss what entities need to consider if they want to change their accounting policies applicable to E&E costs. 4. Explain how the successful efforts method of accounting for E&E expenditure compares to the full cost method. 5. Discuss the possible challenges in applying the revaluation models under IAS 16 or IAS 38 to E&E assets. 6. Discuss the possible future developments related to the accounting for extractive activities.

References BP 2014, Annual Report and Form 20-F 2014, BP plc, UK, www.bp.com. Ernst & Young 2014a, Good Petroleum (International) Limited, International GAAP Illustrative Financial Statements, www.ey.com/global. Ernst & Young 2014b, Good Mining (International) Limited, International GAAP Illustrative Financial Statements, www.ey.com/global. Ernst & Young 2015, International GAAP 2015: Generally Accepted Accounting Practice under International Financial Reporting Standards, John Wiley & Sons, New York. Goldcorp 2014, 2014 Annual Report, Goldcorp Inc., www.goldcorp.com. Rio Tinto 2014, 2014 Annual Report, Rio Tinto Group, www.riotinto.com.

Exercises Exercise A.1

STAR RATING ★ BASIC

★★ MODER ATE

★★★ DIFFICULT

OBLIGATIONS FOR REMOVAL AND RESTORATION

★ The management of Mining plc is concerned that the E&E activities it has commenced for one of its prop-

erties will cause signiﬁcant damage to the surrounding environment and the government of the country where the property is located has attached strict conditions to the exploration licence. Those conditions require that Mining plc return the environment to its original condition. Required

What are the implications of the above scenario for Mining plc’s ﬁnancial statements? 12

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Exercise A.2 ★

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IMPAIRMENT OF E&E ASSETS

During the year ended 31 December 2013, the management of Gas Inc. has been analysing its engineering reports for a specific property, which indicate that sample drilling has not resulted in any findings that confirm the existence of oil and gas. As a result, Gas Inc. is reluctant to invest any further funds in exploring the area. An E&E asset with a carrying value of $1.2 million exists in relation to that property as at 31 December 2013. Required

What is the possible impact of this decision on Gas Inc.’s ﬁnancial statements as at 31 December 2013? Exercise A.3 ★★

ELEMENTS OF COST OF E&E ASSETS

Exploration plc has acquired a licence to explore a new property and its accounting policy is to fully capitalise all of its E&E expenditures. During the period, costs have been incurred in relation to the following: (a) the acquisition of speculative seismic data in relation to the areas to be used to determine whether to apply for an exploration licence for that area (b) labour costs of engineers to analyse the seismic data obtained (c) the exploration licence fee (d) legal costs associated with obtaining the exploration licence (e) labour costs for engineers to carry out topographical, geological, geochemical and geophysical studies on the area after obtaining the exploration licence (f) payroll-related costs for that labour (g) contractors’ fees for exploratory drilling (h) hire of drilling equipment. Required

Which of the above items should be capitalised into the E&E asset? Exercise A.4 ★★

APPLICATION OF THE REVALUATION MODEL

Resource plc classiﬁes its E&E assets as intangible assets. A new accountant has just been employed and has suggested that Resource plc should change its accounting policy for E&E assets from its existing cost model to the fair value model under IAS 38 because it would provide more relevant information. Required

What might prevent Resource plc from being able to make this change in accounting policy? Exercise A.5 ★★

CHANGE IN ACCOUNTING POLICY

Sandy Oil plc is a company involved in the search for, production of and sale of oil and gas resources. The company has been following an accounting policy of expensing all of its E&E costs as incurred since adoption of IFRS 6. However, it has noted that its most significant competitor follows a policy of capitalising such costs. This makes the competitor’s profit look better in some years than Sandy Oil plc’s profit. Required

Discuss whether Sandy Oil plc can change its accounting policy to capitalise all of its E&E costs to match its competitor’s accounting policy. Exercise A.6 ★★

RECOGNITION OF E&E ASSETS

Digging Inc. has incurred the following costs during the period in relation to a speciﬁc property. Its accounting policy is to capitalise all E&E costs. Cash paid to acquire seismic study from government that is selling exploration rights for the property (GST exempt) Cash paid to acquire exploration rights for the property from the government (GST exempt) Cash paid to acquire fencing materials to mark out the property, including GST of $80 Contractor fees for labour to set up the fencing, including GST of $50 Contractor fees for exploratory drilling, including GST of $2500 Hire of drilling equipment for contractor use, including GST of $500 Salary of project manager hired specifically to manage E&E activities for the property Stationery and other office supplies used by the project manager, including GST of $30 Digging Inc. non-executive directors’ fees paid during the period

$ 3 000 10 000 880 550 27 500 5 500 60 000 330 160 000

Required

Determine the amount of the E&E asset to be capitalised by Digging Inc. in relation to the property. A Exploration for and evaluation of mineral resources

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Exercise A.7

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MEASUREMENT OF E&E ASSETS

★ ★ ★ During the year ended 31 December 2014, Reserves plc explored four different properties and spent

$100 000 in each. The results of E&E activities suggested that Properties A, B and C may contain mineral reserves so the company acquired leases over these three properties. The leases cost $170 000, $220 000 and $180 000 respectively. During the year ended 31 December 2015, Reserves plc commenced a drilling program to evaluate Properties A, B and C. Seven exploratory wells were drilled, four in Property A, two in Property B and one in Property C at a cost of $120 000 each. The five wells drilled in Property A did not result in any mineral resource findings (i.e. they were dry holes). The two wells drilled on Property B indicated that the company had discovered economically recoverable reserves. Management was uncertain about the likelihood of finding economically recoverable reserves for the well in Property C as some mineral reserves were found but not enough to be considered economically recoverable at this stage. Therefore Reserves plc decided to continue E&E activities in Property C as of 31 December 2015. Property A was abandoned, and, after incurring costs of $50 000 to confirm the technical feasibility and commercial viability of extracting the mineral resources, development of Property B commenced. During the year ended 31 December 2016, to evaluate the property further, three more wells were drilled in Property B. Of these, two were dry. Each well cost $140 000. The successful wells in Property B were developed for a total cost of $300 000. Expenditure on additional plant and equipment related to development was $325 000. After further dry wells costing $175 000 were drilled in Property C, management concluded that Property C did not contain any commercially viable quantities of mineral resources, so it was abandoned. These costs are summarised as follows:

Costs incurred for each property

31/12/2014 31/12/2015

31/12/2016

Total

Exploration Leases Dry wells Other wells Technical feasibility/ commercial viability costs Dry wells Other wells Development PPE

Total

$100 000 140 000 600 000 —

$ 100 000 220 000 — 240 000

$100 000 180 000 — 120 000

$100 000 — — —

$ 400 000 550 000 600 000 360 000

— — — — — $850 000

50 000 280 000 140 000 300 000 325 000 $165 000

— 175 000 — — — $575 000

— — — — — $100 000

50 000 455 000 140 000 300 000 325 000 $3 180 000

Required

Determine what expenses would be recognised in proﬁt or loss versus capitalised as an asset related to each property for each ﬁnancial year assuming Reserves plc: (a) expenses all of its E&E costs as incurred (b) applies the full cost method (assume that each property is in a different country and represents a separate cost pool) (c) applies the successful efforts method (assume that each property represents a separate licence).

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B Agriculture ACCOUNTING STANDARDS IN FOCUS

LEARNING OBJECTIVES

IAS 41 Agriculture IFRS 13 Fair Value Measurement

After studying this chapter, you should be able to: 1

explain the background to the development of IAS 41

distinguish between agricultural activities, agricultural produce, biological assets, bearer plants and produce growing on a bearer plant

explain the different accounting treatment required before and after harvest

examine the interaction between IAS 41 and IAS 16 Property, Plant and Equipment, IAS 40 Investment Property and IAS 17 Leases

explain the recognition criteria for biological assets (including produce growing on a bearer plant) and agricultural produce

analyse the meaning of ‘fair value’ when applied to biological assets that are within the scope of IAS 41 (including produce growing on a bearer plant) and agricultural produce

describe how IFRS 13 interacts with IAS 41

explain the practical implications of measuring these assets at fair value, including interpreting the disclosures made by entities applying the standard

examine the interaction between IAS 41 and IAS 20 Accounting for Government Grants and Disclosure of Government Assistance

describe the disclosure requirements of IAS 41.

B Agriculture

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LO1

B.1

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INTRODUCTION TO IAS 41 IAS 41 was issued by the International Accounting Standards Committee (IASC) in February 2001 and was confirmed as being included in the core set of standards to be issued by the International Accounting Standards Board (IASB®) in April 2001. (Refer to chapter 1 for the history of and distinction between the IASC and IASB.) The IASC’s project on agriculture commenced in 1994. The IASC had decided to develop a separate standard on agriculture because, although it generally developed standards that are relevant to all businesses, it regarded agriculture as an industry with a particular need for its own standard. This was for a number of reasons, one of the main ones being that diversity in accounting for agricultural activity had arisen because: • of the specific exclusion of assets related to agricultural activity from other standards (such as IAS 2 Inventories, IAS 16 and IAS 40) • accounting guidelines for agricultural activity developed by national standard setters had generally been piecemeal • the nature of agricultural activity had created uncertainty or conflicts when applying traditional accounting models (IAS 41 Basis for Conclusions paragraphs B1–B4). The IASC also regarded agriculture as an emerging industry that was seeking to attract capital from investors and this increased the need to develop standards for general purpose financial statements of the entities involved (IAS 41 Basis for Conclusions paragraphs B5–B7). IAS 41 was a controversial standard when it was first issued, mainly because of the requirement to measure assets related to agricultural activity at fair value, with movements in fair value being recognised in profit or loss as gains or losses. To this day, some entities indicate their implicit disagreement with this requirement; for example, by highlighting the fair value movements separately on the face of the financial statements so that users can clearly see and understand the impact on reported profit. Some have argued that the fair value model should not be applied to bearer biological assets that are often held to produce a flow of product (not offspring). As such, they argue that these assets are more consistent with plant and equipment. Discussions held by the IFRS® Advisory Council and the International Forum of Accounting Standard Setters (formerly, the National Standard Setters) helped highlight this concern and led the IASB to reconsider the accounting treatment of such assets. As a result, in June 2014, the IASB issued Agriculture: Bearer Plants (Amendments to IAS 16 and IAS 41), which became effective for annual periods beginning on or after 1 January 2016; however, early adoption was permitted. As a result of these amendments, a plant that meets the definition of a bearer plant (e.g. an apple tree) is treated as property, plant and equipment under IAS 16, but not the produce growing on a bearer plant (e.g. apples), which is still under IAS 41. The IASB indicated that the produce’s growth directly impacts an entity’s expected future cash flows, unlike the bearer plants, which are not regularly sold. Furthermore, the fair value model for the produce growing on a bearer plant provides useful information about those expected future cash flows (IAS 41 Basis for Conclusions paragraphs BC4A–BC4D).

LO2

B.2 B.2.1

SCOPE AND KEY DEFINITIONS Scope IAS 41 applies to the following when they relate to agricultural activity (paragraph 1): 1. biological assets, which excludes bearer plants, but includes produce growing on bearer plants 2. agricultural produce 3. government grants related to biological assets that are measured at fair value less costs to sell (see section B.6). Even if they are related to agricultural activity, IAS 41 does not apply to the following (paragraph 2): • A plant that meets the deﬁnition of a bearer plant (see section B.2.2). IAS 16 applies to these assets. • Government grants that relate to bearer plants or to biological assets that are measured using the cost model (see sections B.4.2 and B.6). • Land related to agricultural activity. Such land is recognised and measured in accordance with either IAS 16 or IAS 40, whichever is appropriate in the circumstances (see chapter 11 for further explanation). The interaction between IAS 41 and IAS 16, IAS 40 and IAS 17 is discussed below (see section B.2.4). • Intangible assets related to agricultural activity. Intangible assets are accounted for under IAS 38 Intangible Assets (see chapter 13 for further explanation).

B.2.2

Key definitions IAS 41 paragraph 5 contains the following important deﬁnitions: Agricultural activity is the management by an entity of the biological transformation and harvest of biological assets for sale or for conversion into agricultural produce or into additional biological assets. Agricultural produce is the harvested product of the entity’s biological assets. A biological asset is a living animal or plant. Biological transformation comprises the processes of growth, degeneration, production, and procreation that cause qualitative or quantitative changes in a biological asset.

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Harvest is the detachment of produce from a biological asset or the cessation of a biological asset’s life processes.

Agricultural activity covers a diverse range of activities. However, IAS 41 paragraph 6 states that there are three common features that exist within this diversity: • Capability to change. Living plants and animals are capable of biological transformation. • Management of change. Management facilitates biological transformation. For example, management of a vineyard by providing nutrients, water and protection from pests facilitates the growth of the grapes growing on the vines. This can be distinguished from unmanaged biological change such as the growth of fishes in the ocean. Thus ocean fishing is not an agricultural activity. • Measurement of change. The change in quality (e.g. ripeness, protein content or fibre strength) or quantity (e.g. weight, cubic metres or diameter) brought about by biological transformation is measured and monitored as a routine management function. As discussed in section B.2.1, the standard does not apply to a plant that meets the following definition in IAS 41 paragraph 5: A bearer plant is a living plant that: (a) is used in the production or supply of agricultural produce; (b) is expected to bear produce for more than one period; and (c) has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales.

This definition captures plants that would usually be considered bearers, for instance, grape vines. In addition, some plants that may appear to be consumed when harvested, such as the root systems of perennial plants (e.g. sugar cane or bamboo), will also be bearer plants (for more examples, see table B.1 in the following section). Annual crops and plants that are held solely to be harvested as agricultural produce (e.g. wheat, soya, trees grown for lumber) are not bearer plants. Plants that are held both to bear produce and to sell, as either a living plant or agricultural produce (beyond incidental scrap sales, e.g. as firewood at the end of its useful life), will not meet the definition of bearer plants (IAS 41 paragraphs 5A–5B). Produce growing on a bearer plant, which is in the scope of IAS 41, is a biological asset (IAS 41 paragraph 5C). LO3

B.2.3

The harvest distinction There is a very important distinction between agricultural produce, which is the harvested product of the entity’s biological assets, and products that result from processing after harvest. IAS 41 applies only to the harvested product at the point of harvest. Thereafter, IAS 2 or another applicable standard is applied. As discussed in section B.2.2, produce growing on a bearer plant is a biological asset. At the point of harvest, it becomes agricultural produce. IAS 41 includes examples to illustrate the difference between biological assets, agricultural produce and products that are the result of processing after harvest. Table B.1 is based on paragraph 4 of IAS 41, but has been modiﬁed to provide examples of possible bearer plants and produce growing on those plants. TABLE B.1 Distinction between biological assets, bearer plants, produce growing on a bearer plant, agricultural produce and products that are a result of processing after harvest Biological assets (including produce growing on a bearer plant) (IAS 41 applies)

Agricultural produce (IAS 41 applies)

Products that are a result of processing after harvest (generally IAS 2 applies)

Sheep

Wool

Yarn, carpet

Trees in a timber plantation

Felled trees

Logs, lumber

Dairy cattle

Milk

Cheese

Pigs

Carcass

Sausages, cured hams

Cotton plants

Growing cotton

Harvested cotton

Thread, clothing

Sugar cane roots

Sugar cane

Harvested cane

Sugar

Tobacco plants

Leaves on the tobacco plant

Picked leaves

Cured tobacco

Tea bushes

Leaves on the tea bush

Picked leaves

Tea

Grape vines

Grapes on the vine

Picked grapes

Wine

Fruit trees

Fruit on the trees

Picked fruit

Processed fruit

Oil palms

Growing fruit

Picked fruit

Palm oil

Rubber trees

Latex

Harvested latex

Rubber products

Possible bearer plants (IAS 16 applies)

B Agriculture

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One of the initial criticisms of IAS 41 was that it requires assets for which there is often not an active or ready market to be measured at fair value, while those assets for which there is an active or ready market are measured at cost under IAS 2. For example, it can be difficult to determine a fair value for immature trees in a plantation because there may not be an active market for trees before they are fully grown. In contrast, there would be a much more easily identifiable market value for lumber or furniture, yet this is measured at cost under IAS 2. The IASB rejected criticisms of the fair value model for biological assets and agricultural produce, but permits an exemption when fair value cannot be reliably measured (IAS 41 Basis for Conclusions paragraph B13–B21). This is discussed further in section B.4.2. Some respondents to the exposure draft that preceded IAS 41 also commented that in some cases processing after harvest was akin to biological transformation (e.g. cheese production from milk) and, therefore, there should not be a distinction at the harvest point. While acknowledging this issue, the IASB considered that it would be difficult to differentiate these circumstances from other manufacturing processes. The IASB also decided not to include a revision of IAS 2 as part of its process of approving IAS 41 (IAS 41 Basis for Conclusions paragraph B9–B11). LO4

B.2.4

The interaction between IAS 41 and IAS 16, IAS 40 and IAS 17 As noted in section B.2.1, IAS 41 does not apply to bearer plants or land related to agricultural activity. Rather, an entity applies IAS 16 to bearer plants and IAS 16 or IAS 40 to land, depending on the circumstances. Both IAS 16 and IAS 40 require an asset to be initially recognised at cost. Subsequently, both standards allow an asset to be subsequently measured using either a cost or remeasurement model, where IAS 16 uses revalued amount and IAS 40 uses fair value. Regardless of which model an entity chooses, the agricultural assets attached to a bearer plant and/or land (e.g. apples growing on an apple tree or trees in a forest) must be measured at fair value less costs to sell under IAS 41. Table B.2 summarises the accounting choices available.

TABLE B.2 Accounting policy choices available for bearer plants and land related to agricultural activity Land that is an investment property (IAS 40)

Bearer plants and land that is not an investment property (IAS 16)

Accounting policy choice

Cost model

Fair value model

Cost model

Revaluation model

Increase in fair value over cost

Not recorded

Recorded through profit or loss

Not recorded

Recorded through other comprehensive income

Decrease in fair value

Recorded through profit or loss if it is an impairment

Recorded through Recorded through profit or loss as part profit or loss if it is an impairment of the fair value measurement

Recorded through equity to the extent available with remainder through profit or loss

The accounting policy choices for bearer plants and land mean that an entity could have a mixed measurement basis for its agricultural assets. The IASB considered this issue in relation to land when the standard was being developed and noted in the Basis for Conclusions (paragraphs B56–B57): Some argue that land attached to biological assets related to agricultural activity should also be measured at its fair value. They argue that fair value measurement of land results in consistency of measurement with the fair value measurement of biological assets. They also argue that it is sometimes difﬁcult to measure the fair value of such biological assets separately from the land since an active market often exists for the combined assets (that is, land and biological assets; for example, trees in a plantation forest). The Board rejected this approach, primarily because requiring the fair value measurement of land related to agricultural activity would be inconsistent with IAS 16.

Applying different standards to assets that are physically attached may also create practical challenges when costs incurred relate to both assets (e.g. fertilising costs that beneﬁt both a fruit tree and the growing fruit). Judgement may be needed to know which standard to apply to these costs. The interaction with IAS 17 may also be challenging. When IAS 41 was issued, an amendment was made to IAS 17 to clarify that IAS 17 should not be applied to the measurement by: 1. lessees of biological assets held under ﬁnance leases (IAS 17 paragraph 2(c)), and 2. lessors of biological assets leased out under operating leases (IAS 17 paragraph 2(d)). 4

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While the recognition and measurement requirements of IAS 41 apply, the disclosure requirements of both IAS 41 and IAS 17 apply (IAS 41 paragraph B82(n)). This means that in these situations the lessee or lessor (as appropriate) must apply IAS 41 rather than IAS 17. So, for example, if a lessee leases a vineyard under a ﬁnance lease, then the grape vines would be accounted for by the lessee under IAS 16 and the grapes growing on the vines would be accounted for as biological assets of the lessee under IAS 41. The lessee would, therefore, record the grapes growing on the vines as its own assets and measure them at fair value. The lease liability would be recorded as a borrowing. The requirements are summarised in table B.3. See also illustrative example B.1 overleaf.

TABLE B.3 Lessees and lessors — application of IAS 41 and IAS 17 Finance lease Lessee

LO5

B.3 B.3.1

Operating lease Lessor

Lessee

Lessor

Biological assets

Assets recorded and measured under IAS 41

Does not record biological assets — applies IAS 17

Assets recorded and measured under IAS 41

Lease receivable

N/A

Recorded under IAS 17

N/A

Lease liability

Recorded as a borrowing to finance the biological asset

N/A

Disclosures

Made under both IAS 41 and IAS 17

Made under IAS 17

Made under both IAS 41 and IAS 17

THE RECOGNITION CRITERIA FOR BIOLOGICAL ASSETS AND AGRICULTURAL PRODUCE The recognition criteria Paragraph 10 of IAS 41 requires that an entity recognise a biological asset (which includes produce growing on a bearer plant) or agricultural produce when: (a) it controls the asset as a result of past events; (b) it is probable that future economic benefits associated with the asset will flow to the entity; and (c) the asset’s fair value or cost can be reliably measured. Note that (a) repeats one of the essential characteristics of the definition of an asset in the Conceptual Framework (control), while (b) and (c) repeat the recognition criteria in the Conceptual Framework. Determining when to initially recognise an asset may sometimes be challenging. For example, IAS 41 indicates that an entity may mark (e.g. branding) a biological asset to provide evidence of control for criterion (a) and significant physical attributes may help with assessing criterion (b) (paragraph 11). That may be difficult for seeds in the ground or latex within a rubber tree. It may also be difficult to determine whether criterion (b) is met in the early stages of development. For example, when there are only blossoms on an apple tree it may not be clear whether or not they will produce fruit. Judgement may be needed, therefore, to determine when the criteria for recognition are met. In practice, entities may use past experience to help in this assessment.

B.3.2

The problem with ‘control’ Determining whether an entity controls an asset can be problematic in the agricultural industry where leases or management agreements are involved. For example, a forest may be owned by one entity, but managed by another. Because the deﬁnition of ‘agricultural activity’ talks about ‘the management’ by an entity of the biological transformation of biological assets it is possible to confuse management with control. Therefore, it is important to distinguish between these two concepts. Illustrative example B.1 demonstrates the distinction between management and control. B Agriculture

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ILLUSTRATIVE EXAMPLE B.1 Distinguishing management from control of biological assets and agricultural produce

Company A owns Farm X, on which it grows wheat. Company A invests in many crop farms and so appoints Manager M to manage Farm X. Manager M is responsible for all the operations of the farm including daily care, regular maintenance, harvesting and threshing of the wheat, harvesting the dried stems and leaves for hay and storage of both after harvest. The wheat is then sold as grain or sent to be ground into flour by Mill W. Manager M and Mill W are not related parties of Company A. Company A pays Manager M a management fee for its services. The fee includes reimbursement of all costs incurred by Manager M, plus an agreed margin. Company A pays Mill W a fee for its services. The fee includes reimbursement of all costs incurred by Mill W, plus an agreed margin. All sales and marketing of the flour is managed by Distributor D. Distributor D is not a related party of Company A. Company A pays Distributor D a fee for its services. The fee includes reimbursement of all costs incurred by Distributor D plus an agreed margin. Who controls the biological asset (the growing wheat)? Company A or Manager M? Who controls the agricultural produce (the harvested wheat)? Company A, Manager M, Mill W or Distributor D? Unfortunately control is not defined in the Conceptual Framework and is used throughout IFRS Standards without consistency. In IFRS 10 Consolidated Financial Statements, control refers to the situation where an investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee (see chapter 23). In IFRS 15 Revenue from Contracts with Customers, control refers to the ability to direct the use of an asset and obtain substantially all of the remaining benefits. It also includes the ability to prevent others from the same (paragraph 32, see chapter 4). That standard also includes indicators that control of an asset has transferred to a customer, which include: the entity having a present right to payment and transferring physical possession; and the customer accepting the asset, having legal title and the significant risks and rewards of ownership. Other standards focus on risks and rewards of ownership, instead of control (e.g. IAS 17, see chapter 12) or may distinguish between control and risks and rewards (e.g. IAS 39, see chapter 7). To make the question of control of the biological asset in this example simpler, let’s assume that control in this case means both the legal ownership of the asset (i.e. the ability to sell or pledge the asset), as well as the exposure to the risks and rewards of ownership of the asset. What are the key rewards of the wheat? These would be the growth of the plant to be harvested and the revenues to be earned by selling the hay at a profit and by either selling the grain at a profit or by grinding it into flour to sell at a profit. Who benefits from these rewards? Manager M, Mill W and Distributor D each have a share in these rewards because they are paid a margin by Company A. This means that they recover their costs, but also benefit from increases in value of the wheat via the margin paid to them by Company A. However, because this margin is agreed upfront, it is a fixed margin. This means that Company A benefits from any increases in value over and above the recovery of costs plus the fixed margin. Manager M, Mill W and Distributor D do not share in these excess profits because their return is fixed. What are the key risks in the wheat? These would be the risks of disease, drought etc., such that the wheat fails to grow and produce a crop of adequate quality. This in turn would result in an inability to sell the produce either at all or the generation of lower returns than expected or needed to remain profitable. There are also market risks, such as an over-supply of flour in the market causing prices to fall. Who bears these risks? The majority of these risks are borne by Company A because — as we saw above — Manager M, Mill W and Distributor D are each entitled to a fixed return, even if there is no profit. This means that Company A bears all of the downside risk related to the wheat. It must pay the management fee, production fee and distribution fee even if there is no return. Who controls the wheat? While Manager M manages the daily operations of the farm, it does so on behalf of Company A. Similarly, Mill W grinds the wheat into flour on behalf of Company A and Distributor D sells the flour on behalf of Company A. Therefore, Company A has the ability to sell or pledge the wheat even though, practically, the sale of the hay, grain and flour is effected by Manager M on behalf of Company A. These entities all act as agents of Company A. So we can conclude that Company A controls the biological assets and agricultural produce under paragraph 10 of IAS 41. Therefore, Company A should recognise these assets (assuming the other requirements of paragraph 10 are met). However, the agricultural activity as defined in paragraph 5 of IAS 41 is carried out by Manager M. It is the entity that manages the transformation of the wheat from seeds to a harvested crop. Does this mean that Manager M applies IAS 41, while Company A does not? Since we have concluded that Company A controls the biological assets and agricultural produce, these assets must be recognised by Company A.

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If Manager M were to apply IAS 41, it would apply the standard to nothing since it does not control the assets in question. Therefore, it is arguably reasonable to conclude that Manager M conducts the agricultural activity on behalf of Company A and, therefore, Company A should apply IAS 41.

Variation Assume that Manager M is a lessee under a finance lease, in addition to managing the wheat farm. If this were the case, Manager M would record the wheat as its own asset because it has assumed substantially all of the risks and rewards of the farm under the finance lease. The question of control versus management would not arise in this case because Manager M both manages the farm and ‘controls’ the assets under the finance lease. Therefore, the biological assets would be recorded by Manager M and measured under IAS 41, while Company A would be the lessor and record a finance lease receivable under IAS 17 (see section B.2.4).

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B.4 B.4.1

MEASUREMENT REQUIREMENTS FOR BIOLOGICAL ASSETS AND AGRICULTURAL PRODUCE The basic requirements A biological asset (including produce growing on a bearer plant) is measured on initial recognition and at the end of each reporting period at its fair value less costs to sell, unless an entity can demonstrate at initial recognition that fair value cannot be measured reliably (IAS 41 paragraph 12).

As discussed in section B.2.2, produce growing on a bearer plant is a biological asset prior to harvest (IAS 41 paragraph 5C). As a result, produce growing on a bearer plant is measured at fair value less costs to sell from the time it is initially recognised through to the point of harvest, when it becomes agricultural produce. Agricultural produce that is harvested from an entity’s biological assets must be initially recognised at fair value less costs to sell at the point of harvest. The standard presumes that an entity can always reliably measure this amount and hence does not permit valuation at historical cost (IAS 41 paragraphs 13 and 32). The value resulting from initial measurement is subsequently used as cost in applying IAS 2 (if the agricultural produce is to be sold), IAS 16 (e.g. if harvested logs are used for the construction of a building) or other applicable IFRS Standards. ‘Fair value’ is deﬁned in IFRS 13 as (see chapter 3): The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

‘Costs to sell’ are deﬁned in paragraph 5 as: The incremental costs directly attributable to the disposal of an asset, excluding ﬁnance costs and income taxes.

Costs to sell include commissions to brokers and dealers, levies by regulatory agencies and commodity exchanges and transfer taxes and duties. Costs to sell exclude transport and other costs necessary to get assets to a market. However, such transport costs are deducted in determining fair value (IAS 41 Basis for Conclusions paragraph B22).

B.4.2

Use of the cost model when fair value cannot be measured reliably When IAS 41 was ﬁrst proposed as E65, the requirement to use fair value as the measurement basis was controversial. The arguments for and against the use of fair value are summarised in table B.4 (IAS 41 Basis for Conclusions paragraph B14–B21). TABLE B.4 Arguments for and against the use of fair value for measuring biological assets that are within the scope of IAS 41 Case for Fair Value Biological transformation has a direct relationship to changes in expectations of future economic benefits to the entity

✓

The relationship between cost incurrence and future economic benefits is weak particularly for biological assets that take a long time to mature

✓

Case against Fair Value

(continued) B Agriculture

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TABLE B.4 (continued) Case for Fair Value

Case against Fair Value

Relevance

✓ (many biological assets are traded in active markets; long production cycles mean that the change in asset value is more relevant than a period-end measured of cost incurred)

✓ (market prices at the end of the reporting period may not bear a close relationship to the prices at which the assets will be sold)

Reliability

✓ (active markets provide reliable information; allocation of costs is arbitrary when there are joint products and joint costs)

✓ (cost of historical transactions is more reliable and objective; market prices are often volatile and cyclical; active markets may not exist, particularly during periods of growth of assets that have a long growth period)

Comparability and Understandability

✓ (different sources of animals and plants — home grown or purchased — should not be measured differently, which would be the outcome under a historical cost model)

✓ (reporting of unrealised gains and losses is not useful to users)

The IASB decided to proceed with the requirement to use fair value, but was persuaded by the arguments that fair value may not always be reliably measureable. As a result, IAS 41 provides an exception in paragraph 30, which states: There is a presumption that fair value can be measured reliably for a biological asset. However, that presumption can be rebutted only on initial recognition for a biological asset for which market-determined prices or values are not available and for which alternative estimates of fair value are determined to be clearly unreliable. In such a case, that biological asset shall be measured at its cost less any accumulated depreciation and any accumulated impairment losses. Once the fair value of such a biological asset becomes reliably measurable, an entity shall measure it at its fair value less costs to sell.

Since IAS 41 requires that the fair value of a biological asset that is within its scope be measured in accordance with IFRS 13 (see chapter 3), an entity needs to consider the requirements of that standard in order to determine whether fair value can be measured reliably. When determining cost, accumulated depreciation and accumulated impairment losses an entity needs to consider the requirements of IAS 2, IAS 16 and IAS 36 (paragraph 33). The exception does not apply to agricultural produce. IAS 41 takes the view that the fair value of agricultural produce at the point of harvest can always be measured reliably (paragraph 32). IAS 41 also presumes that the fair value of a non-current biological asset that is classiﬁed as held for sale (or is included in a disposal group that is classiﬁed as held for sale) in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations can always be measured reliably. Also, an entity that previously measured a biological asset at its fair value less costs to sell cannot revert to a cost-based measurement in a later period, even if a fair value can no longer be measured reliably (IAS 41 paragraph 31).

B.4.3

Gains and losses Paragraph 26 of IAS 41 requires gains and losses arising on the initial recognition (sometimes referred to as ‘day one gains and losses’) of a biological asset that is within its scope at fair value less costs to sell to be included in proﬁt or loss for the period in which they arise. The standard warns that a loss may arise on initial recognition because costs to sell are deducted. On the other hand, a gain may arise on the initial recognition of a biological asset (e.g. when a calf is born) (paragraph 27). Subsequent to initial recognition, reported gains or losses represent the difference between two fair values. A change in fair value of a biological asset is recorded as a gain or loss at the end of each reporting period. Paragraph 28 of IAS 41 contains a similar requirement for agricultural produce except that it does not refer to a change in fair value of agricultural produce. This is because agricultural produce is recognised and measured only at the point of harvest (see IAS 41 paragraphs 1(b) and 13) and this amount becomes its cost for ongoing measurement under IAS 2 or other applicable standards.

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ILLUSTRATIVE EXAMPLE B.2 Gains or losses on initial recognition of biological assets and agricultural produce

Hogget Ltd owns and runs a sheep farm. It needs to initially recognise each lamb when it is born at its fair value less costs to sell. Assume the fair value of a new-born lamb is £50. Hogget would record the following journal entry: Biological Asset Profit or Loss (To record the acquisition of the newborn lamb)

Dr Cr

50 50

Hogget also needs to recognise wool harvested (i.e. new agricultural produce) when it shears each sheep. Assume that fair value less costs to sell of the wool at the point of harvest is £20 and the fair value less costs to sell of the related sheep is £100 at the date of harvest. On initial recognition of the wool, the following journal entries are required (ignore cost of shearing the sheep):

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B.5 B.5.1

Profit or Loss Biological Asset — Sheep (To remeasure the sheep to fair value less costs to sell — removing the fair value of the wool)

Dr Cr

Agricultural Produce — Wool Profit or Loss (To recognise the wool at fair value less costs to sell)

Dr Cr

HOW TO MEASURE FAIR VALUE The interaction between IFRS 13 and IAS 41 IFRS 13 specifies how to measure fair value whenever another standard permits or requires fair value to be measured or disclosed. However, an entity must refer to other standards to determine what must be measured at fair value and when to measure fair value. For assets in the scope of IAS 41, these requirements are discussed above (see section B.4). An entity applies IFRS 13 to measure fair value, taking into consideration the specific requirements in IAS 41 (see section B.5.2). ‘Costs to sell’, measured in accordance with IAS 41, are then deducted. Disclosures in relation to each fair value measurement need to be prepared in accordance with IFRS 13 and also IAS 41, to the extent that it requires additional agriculture-specific disclosures (see section B.7). As discussed in section B.4.1, IFRS 13 defines fair value as an exit price — the amount that would be received to sell a biological asset or agricultural produce in an orderly transaction on the measurement date (IFRS 13 paragraph 9). The requirements of IFRS 13 for measuring fair value are discussed in chapter 3 and include the following: • The hypothetical sales transaction is assumed to take place in the deepest and most liquid market for the asset to which the entity has access (the principal market). If there is no principal market, an entity can use the most advantageous market (IFRS 13 paragraph 16). • The identified market determines the market participants who would transact for the asset. The characteristics of the asset (in particular, its unit of account) and of those market participants help an entity to determine the relevant assumptions and inputs to use because fair value must be measured using market participants’ assumptions (IFRS 13 paragraphs 11 and 22). These could include the current condition and location of an asset if a market participant would consider them when pricing the asset. For example, the location of the asset may mean that it needs to be transported to a market before it can be sold. In that case, the price that would be received to sell the asset would need to be adjusted for transportation costs in order to determine fair value. Considering the condition of the asset is particularly important for biological assets. For example, would someone pay as much for a newly planted crop as one that is mature and ready for harvest? In addition, it may be more challenging to measure fair value for an immature crop because, in many instances, there will be no active market for it. So, while an entity measures an asset based on its current condition, can it consider future biological transformation? Yes, it can, provided a market participant would consider it when determining how much to pay for the asset in its immature state. That is, the fair value of a growing asset may be measured based on its potential to continue to grow and be harvested, taking into account risk factors regarding the potential growth of the asset. In B Agriculture

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practice, entities may need to work out the cash flows for a biological asset in its mature state — for example, the crop ready for harvest — and work backwards to then calculate the cash flows from the asset in its immature state (e.g. the newly planted crop). This is shown in illustrative example B.4 (see section B.5.2) and discussed further below (see section B.5.3). • The highest and best use of the asset is presumed to be its current use, but it may be something different. It may be on its own or in combination with other assets and/or liabilities. The use must be physically possible, legally permissible and financially feasible. Fair value is measured assuming the purchaser will apply the asset to that highest and best use and is sold consistent with its unit of account (IFRS 13 paragraphs 27–28 and 32). • An entity must use techniques that are appropriate to the circumstances and for which sufficient data are available, but they must be consistent with one of three approaches: the market approach, the income approach and the cost approach. Techniques are not prioritised, but an entity must prioritise the use of observable inputs over unobservable inputs. For example, the best indication of fair value is a quoted price in an active market, such as the price for a commodity on a traded exchange (IFRS 13 paragraphs 61–62 and 69).

B.5.2

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IAS 41 Specific requirements In addition to the requirements in IFRS 13 (see section B.5.1 and chapter 3), IAS 41 specifies the following when measuring the fair value of assets within its scope (paragraph 15–16, 22, 24–26): • IAS 41 does not require an entity to use an external independent valuer to determine the value of biological assets (IAS 41 Basis for Conclusions paragraph B33). • The unit of account is the individual asset. However, assets may be grouped according to significant attributes such as age or quality (e.g. grouping cattle firstly based on whether that are heifers, steers or young bulls and secondly based on their weight) to facilitate fair value measurement. This practical concession in the standard does not change the unit of account. • Contract prices are not necessarily relevant because they may not represent the current market. For example, an entity may enter into a contract to sell its cotton in 6 months’ time at a set price (known as a forward price). This forward price would not normally be the same as the current market price. IFRS 13 requires fair value be measured based on the price that would be received to sell the asset in its current condition on the measurement date, not a date in the future. Fair value is also the price between market participants generally, which may not be the same as the price in a specific contract between particular parties. • When estimating cash flows, an entity does not include any cash flows for financing the assets, taxation or re-establishing biological assets after harvest. Excluding re-establishment costs is consistent with the unit of account (i.e. the individual asset). For example, an entity that owns a forest might consider its intention, or obligation, to replace its trees in the future if it were measuring the fair value of the forest as a whole. However, the entity must measure the individual trees that are actually planted in the forest on the measurement date. It would be inconsistent to consider replanting, since removal of an existing tree (in order to plant a new tree) would be the end of that asset’s useful life. • Cost may sometimes approximate fair value, particularly when: 1. little biological transformation has taken place since initial cost incurrence (e.g. a seedling planted immediately prior to the end of a reporting period), or 2. the impact of the biological transformation on price is not expected to be material (e.g. the initial period of growth in a 30-year pine production cycle). • Where biological assets are attached to land and there is no separate market for the assets without the land, there might be an active market for the combined assets. If so, an entity may use information regarding the combined assets to derive the fair value of the biological assets (paragraph 25). Similar considerations may also be relevant for produce growing on a bearer plant, which will likely have no separate market while growing and physically attached to the bearer plant and, in turn, to the land. Illustrative examples B.3 and B.4 demonstrate the measurement of fair value — the former where there is an active market and the latter where there is no active market.

ILLUSTRATIVE EXAMPLE B.3 Measuring fair value when there is an active market

Milkman Ltd owns dairy cows. The market value of dairy cows is calculated by reference to the litres of milk able to be produced and the lactation rate of the cows. Cows are regularly sold at auction and Milkman determines this is the principal market for its cattle. Milkman has determined that, based on latest auction prices close to the end of the reporting period, the price for a mature cow is €875 (= 5000 litres × lactation rate (0.5) × price of milk (€0.35)) and the price for a heifer is €350 (= 2000 litres × 0.5 × €0.35). 10

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At the end of the reporting period, Milkman had 1000 mature cows and 400 heifers. Transportation costs are deducted in determining fair value because the cattle would need to be transported to the auction in order to sell them. Costs incurred to transport the cattle to auction are €500 per truck. The normal capacity of a truck is approximately 200 cattle. The approximate cost per cow is €2.50 (= €500/200). Therefore, the market value of each cow is €872.50 (= €875 − €2.50). The market value of each heifer is €347.50 (= €350 − €2.50). The fair value as at the end of the reporting period is, therefore: 1 000 × €872.50 = € 872 500 400 × €347.50 = € 139 000 €1 011 500

ILLUSTRATIVE EXAMPLE B.4 Measuring fair value when there is no active market for the asset in its current condition

Gala Ltd owns and manages an orchard that produces apples. In late 2016, Gala purchased an established orchard, with apple trees that had an estimated remaining fruitful life of 25 years at the date of purchase. At that time, the fair value of apples growing on the tree was estimated to be $38 000. At the end of 2016, the apples are not ready to be harvested. Gala determines that these apples will be harvested in the next month and estimates the current crop weighs approximately 30 000 kilograms in total. An observable local wholesale market exists for harvested ripe apples, but there is no observable market for immature apples. How would Gala determine the fair value of the apples growing on the trees as at the end of 2016? Gala decides to use the observable prices for ripe apples to measure the fair value of the apples that are still growing. It determines that were it to sell ripe apples at the end of the reporting period, it would receive approximately $1.70 per kilogram and pay approximately $0.10 per kilogram in transportation costs. Since the apples are not yet ripe, Gala estimates the costs that a normal market participant would incur to get the apples ready and harvested. It also considers the risk that the apples will not achieve the price of $1.70 (for example, because of potential disease or adverse weather conditions) and the fact that any market participant that acquired the apples now would want a reasonable proﬁt margin for undertaking that effort. As a result, the entity includes adjustments to reduce the value by $0.05 per kilogram. As a result, Gala measures the fair value of the growing apples to be $1.55 per kilogram. Therefore, the fair value of the estimated apples on hand at the end of the period is $46 500 (= 30 000 kilograms × $1.55). Gala would deduct estimated costs to sell before recognising this amount in its ﬁnancial statements.

B.5.3

A fishy story During 2005 and 2006, as IAS 41 was ﬁrst being implemented in Europe, there was controversy in the salmon farming industry over the measurement of immature salmon. Some were measuring live immature salmon at cost on the basis that fair value could not be reliably measured. The regulator intervened and required that the live immature salmon be measured at fair value on the basis that there was an active market for slaughtered salmon and that the fair value should be determined based on the price for similar assets. The Committee of European Securities Regulators (CESR) enforcement decision states that: . . . slaughtered salmon which is sold whole and gutted is in an accounting sense to be considered as a similar asset of live salmon . . . and . . . this also applies to so-called immature farmed salmon. Hence, the observable prices of slaughtered salmon shall be used as a basis for determining the fair value of live immature salmon . . . The adjustments should reﬂect the differences between the price of an immature salmon and the hypothetical market price in an active market for live immature salmon. Source: Committee of European Securities Regulators (2007).

While the decision was in relation to requirements that existed in IAS 41 prior to the issuance of IFRS 13, it is still relevant. As discussed in section B.5.1, an entity is required to prioritise the use of relevant observable inputs over unobservable inputs. Furthermore, when measuring fair value, an entity is required to take into consideration those things that market participants would consider when pricing the asset. When an observable price for the asset in its current location is not available, the price for the transformed asset (e.g. the slaughtered ﬁsh) may be available. An entity could determine fair value by adjusting this price for the costs a market participant would incur to transform the asset (after acquiring the asset in its current condition) and the compensation they would expect for the effort to do so. B Agriculture

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It is interesting to observe the nature of disclosures made by entities applying the fair value requirements of IAS 41 in these circumstances. For example, The Scottish Salmon Company (formerly Lighthouse Caledonia ASA), a Scottish company, reported the following (see ﬁgure B.1) in the Classiﬁcation Principles section of its 2014 annual report: FIGURE B.1 Disclosures illustrating IAS 41 practical implementation Biological assets (Biomass)

Biological assets (fish) are measured at fair value less costs to sell, in line with IAS 41 and IFRS 13. In order to estimate the fair value of live fish, management apply an income approach valuation model based on estimated revenues from the market price of harvested fish, reduced for on-growing, harvesting and freight costs to market in order to arrive at a fair value less costs to sell for the Group. This model assesses each farming region individually for the key assumptions of growth and survival. The model also reflects anticipated harvesting weight and variances in expected quality grades for each farm region. Juvenile fish under 1kg are measured at cost less losses, being the best estimate of fair value on those fish. Market prices are derived from the most recent contracts entered into by the Group and adjusted Norwegian quoted prices (from Fishpool). Future costs, growth rates, survival rates, anticipated harvest weights and quality grades are derived from the Group’s harvesting and production data and financial budgets for 2015. The change in estimated fair value is charged to the Income Statement, and is reported separately from the related cost of the biomass when harvested. Accumulated direct and indirect production costs for fish harvested are classified as costs of goods sold whereas the change in the fair value adjustment is recognised on a separate line called “fair value adjustment on biomass”. Note 17 — Biological Assets 2014 (£’000s)

2013 (£’000s)

Book value of live fish Book value of smolt

47 634 2 400

54 317 2 367

Total book value of biological assets

50 034

56 684

Scottish Salmon Company Ltd

18 103

9 441

Total fair value adjustment in the Consolidated Statement of Financial Position

18 103

9 441

Total value of biological assets in the Consolidated Statement of Financial Position

68 137

66 125

Opening fair value of live fish at 1 January

63 758

41 924

Fair value adjustment at 1 January Fair value adjustment at 31 December

9 441 18 103

(2 089) 9 441

Net fair value adjustment taken to Consolidated Statement of Comprehensive Income

8 662

7 352

Increase due to purchases and capitalisation of costs Decreases due to harvests Decreases due to mortalities and culls

86 887 (84 520) (9 050)

78 763 (56 644) (7 637)

Fair value of live fish at 31 December

65 737

63 758

Book value of smolt Fair value of live fish

2 400 65 737

2 367 63 758

Total value of biological assets in the Consolidated Statement of Financial Position

68 137

66 125

30 183 19 499

20 825 19 537

1 498 18 001

1 479 18 058

Fair value adjustments on biological assets in the Consolidated Statement of Financial Position

Reconciliation of changes in value of live fish

Volumes of biological assets (in tonnes) Volume of biological assets harvested during the year (GWT) Volume of biological assets in the sea at year-end (LWT) Split as follows Juvenile fish < 1 kg at cost Harvestable fish > 1kg at fair value

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FIGURE B.1 (continued)

IAS 41 requires that biological assets are accounted for at estimated fair value net of selling and harvesting costs. Fair value is measured using the income approach, in accordance with IFRS 13, and is categorised into level 3 in the fair value hierarchy as the inputs include unobservable inputs. The valuation under the income approach is completed based on a valuation model. This begins with forecasting revenues by estimating the fair value of ready to harvest fish, based on market prices. Whilst there is no clear defined published market price for Scottish farmed salmon, the Company considers the development in its contract and spot prices, and utilises future published prices for Norwegian salmon as a base price and applies an uplift to cover the average historic Scottish premium. The valuation model is then completed for each region individually taking into account the following unobservable inputs on forecasted costs: • volume of fish in the sea • growth rates • survival rates • on-growing costs including feed costs and feed conversion ratios • harvesting costs • freight costs These inputs also take into account any specific factors (such as disease) on a regional basis. The forecasted costs are then deducted from the forecasted revenues after allowing for a regional adjustment for quality and size distribution, to calculate an expected cashflow for each region at farm gate. This is then discounted using the WACC to a Net Present Value per region. Sensitivity analysis is then performed on the valuation model with changes to sales price, survival rates and on-growing costs taken into account. These are considered by the Group to be the key unobservable inputs which would impact the valuation model significantly. The weighted average results from the model are then taken to determine the estimated fair value of biological assets. In the Financial Statements, the gains and losses from the change in estimated fair value are recorded separately in the Income Statement in the line “Fair Value Adjustment on Biomass”. No fair value adjustment is made for juvenile fish, less than 1kg, or for smolt. The valuation model by its nature is based upon uncertain assumptions on sales price, quality growth, survival etc., and whilst the Group has a degree of expertise in these assumptions they are subject to change. Interrelationships exist between all unobservable inputs. For example, a change in the volume of fish in the sea would impact the volume of fish harvested and thus estimated harvesting and freight costs. Furthermore, relatively small changes in assumptions have a significant impact on the valuation. For example, a 10p per kg rise in sales price would increase the valuation of biological assets by £882 000. Source: The Scottish Salmon Company (2014, pp. 29, 45–6).

The extract in figure B.1 highlights a few key points: 1. The company has disclosed separately the ‘live fish’ and the ‘smolt’. Smolt is immature live salmon. 2. The company makes the point that the valuation model is based on uncertain assumptions and that relatively small changes in these assumptions could have a material impact on the valuation of the biological assets. The company’s approach is consistent with the CESR determination. 3. The company discloses the significant assumptions used in determining the fair value of live fish. This is in accordance with the disclosure requirements of IFRS 13 (see chapter 3). 4. The company also discloses the reconciliation required by paragraph 50 of IAS 41. It has elected to separate the book value from the fair value in the reconciliation and to indicate the cumulative effect of fair value adjustments over time on the statement of financial position, which is not required by the standard. It is common practice for some companies applying IAS 41 to separately disclose the fair value movements attributable to agricultural assets, either in the statement of profit or loss and other comprehensive income or in the notes, and in information reported outside the financial statements to investors such as in ‘investor packs’ or ‘financial commentaries’. This is because companies want to highlight the fair value movements as being separate from other forms of income. To some extent, the separate disclosure also reflects an implicit disagreement with the requirements of the standard, particularly where it is difficult to measure fair value.

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B.6

GOVERNMENT GRANTS Sometimes entities receive government grants in respect of agricultural activity. IAS 41 prescribes how these should be accounted for when biological assets within its scope are measured at fair value less costs to sell and distinguishes between conditional and unconditional government grants. 1. Unconditional government grants are recognised as income when the grant becomes receivable (paragraph 34). B Agriculture

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2. Conditional government grants are recognised as income when the conditions attaching to the grant are met (paragraph 35). The accounting takes into consideration the interaction between recognising the grant and the change in fair value of the related biological assets. Note that if biological assets within the scope of IAS 41 are not measured at fair value (i.e. where the exemption in paragraph 30 applies) then IAS 20 applies. Unlike IAS 41, IAS 20 allows a choice in the accounting for government grants between deferring the revenue and permitting the grant to be offset against the cost of the asset. Illustrative example B.5 demonstrates how conditional and unconditional government grants are accounted for when biological assets are measured at fair value.

ILLUSTRATIVE EXAMPLE B.5 Conditional and unconditional government grants

AgriCo engages in agricultural activities and measures its biological assets at fair value in accordance with IAS 41. In 2016, AgriCo received two grants from the government. The company was notiﬁed about Grant A, of ¥100 000, on 7 January 2016. No conditions were attached to it. The grant was received on 14 March 2016. The company was notiﬁed about Grant B, of ¥500 000, on 31 January 2016. Grant B had the following condition attached to it: ‘AgriCo must continue to operate its agricultural activities in the Zone Z Area until at least 31 January 2026. If AgriCo discontinues all or part of its operations in the Zone Z Area before that date then AgriCo shall immediately repay Grant B in full.’ Grant B was received on 14 April 2016. The end of AgriCo’s reporting period is 30 June. The journal entries for AgriCo for the year ended 30 June 2016 would be as follows: Receivables Income (To recognise the unconditional Grant A when it became receivable on 7 January)

Dr Cr

100 000

Cash Receivables (To recognise receipt of the cash on 14 March)

Dr Cr

100 000

Cash Performance Obligation (To recognise the cash received on 14 April and the corresponding obligation to comply with the conditions of Grant B)

Dr Cr

500 000

100 000

500 000

Grant B is, therefore, recorded as a liability until the conditions are met. If the conditions attaching to Grant B had permitted AgriCo to retain some of the grant based on the passing of time (e.g. by means of a formula), then AgriCo would be able to recognise the grant as income over that period of time.

LO10

B.7

DISCLOSURE REQUIREMENTS Paragraphs 40–57 set out the disclosure requirements of IAS 41. An overview of the requirements is discussed below. Students should refer to the standard for full details. The general disclosure requirements are contained in paragraphs 40–53 and are illustrated in Example 1 of IAS 41. These requirements are intended to provide users of ﬁnancial statements with information about: • An entity’s agricultural activities and assets it holds — for example, a description of each group of biological assets (namely, consumable (e.g. crops) versus bearer (e.g. dairy cows) biological assets). Entities are encouraged to distinguish between mature versus immature biological assets — and physical quantities at the end of the period and output during the period. • Risks and how they are managed — for example, any restrictions on title, assets pledged as security, commitments for development or acquisition of assets and ﬁnancial risk management strategies related to agricultural activity.

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• Changes in the carrying value during the period — for example, the aggregate gain or loss as a result of changes in fair value and a reconciliation of changes in the carrying amount during the period. Note 3 of Example 1 of IAS 41 illustrates this reconciliation. Figure B.2 provides selected extracts from biological assets note disclosure in the 2014 Annual Report of Olam International Limited, a Singaporean agricultural company. While these disclosures are prior to adoption of the bearer plants amendments, they illustrate the disclosures required by IAS 41. FIGURE B.2 Disclosures required by IAS 41

2. Summary of significant accounting policies 2.11 Biological assets Biological assets mainly include plantations, annual crops and livestock. Plantations and annual crops Immature plantations are stated at acquisition cost which includes costs incurred for field preparation, planting, fertilising and maintenance, capitalisation of borrowing costs incurred on loans used to finance the developments of immature plantations and an allocation of other indirect costs based on planted hectares. Mature plantations are stated at fair value less estimated point-of-sale costs, with any resultant gain or loss recognised in the profit or loss. Point-of-sale costs include all costs that would be necessary to sell the assets. The fair value of the mature plantations is estimated by reference to independent professional valuations using the present value of expected net cash flows of the underlying biological assets. The valuations are determined using the market price, discount rates used, annual rate of inflation and the estimated yield of the agricultural produce, net of maintenance and harvesting costs and any costs required to bring the plantations to maturity. The estimated yield of the various plantations is dependent on the age of the trees, the location of the plantations, soil type and infrastructure. The market price of the agricultural produce is largely dependent on the prevailing market prices of the products after harvest. The annual crops have been valued using adjusted cost, which is the estimate of the yield and cost of the crop at harvest discounted for the remaining time to harvest, which approximate fair value. Livestock Livestock are stated at fair value less estimated point-of-sale costs, with any resultant gain or loss recognised in the profit or loss. Point-of-sale costs include all costs that would be necessary to sell the assets. The fair value of livestock is determined based on valuations by an independent professional value using the market prices of livestock of similar age, breed and generic merit. 12. Biological assets Group

Plantations and annual crops $’000

Livestock $’000

Total $’000

As at 1 July 2012 Net additions (1) Capitalisation of expenses Net change in fair value less estimated costs to sell Foreign currency translation adjustments

485 177 19 569 41 942 105 234

146 162 16 878 18 668 (8 948)

631 339 36 447 60 610 96 286

(42 986)

(42 940)

As at 30 June 2013 and 1 July 2013 Net additions (1) Capitalisation of expenses Written off during the year Net change in fair value less estimated costs to sell Foreign currency translation adjustments

608 936 263 202 43 785 (25 926) 18 630

172 806 8 875 30 295 − (4 462)

781 742 272 077 74 080 (25 926) 14 168

(3 516)

(4 463)

(7 979)

As at 30 June 2014

905 111

203 051

1 108 162

(1) Net additions include purchases, growths and harvests in the various biological assets categories.

Plantations and annual crops Plantations consist of almonds, coffee, cocoa, palm and rubber. The almond orchards and coffee plantations presently consist of trees aged between 1 and 25 years and 1 and 13 years respectively (2013: 1 and 24 years and 1 and 12 years respectively). The cocoa plantations presently consist of trees aged between 11 and 13 years (2013: 10 and 12 years). (continued) B Agriculture

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FIGURE B.2 (continued) Biological assets written off during the year relates to the coffee plantations in Laos that were cleared and replanted to achieve optimal yields. Immature plantations consist of palm and rubber trees aged between 1 and 3 years amounting to $193 396 000. During the financial year, the Group harvested approximately 34 679 metric tonnes (2013: 40 152 metric tonnes) of almonds, which had a fair value less estimated point-of-sale costs of approximately $333 565 000 (2013: $353 483 000). The fair value of almonds was determined with reference to the market prices at the date of harvest. Annual crops consist of various commodities such as cotton, onions, tomatoes and other vegetables, rice and grains. For cotton, onions, tomatoes and other vegetables, the Group provides seeds to farmers to sow and grow, while for rice and grains, the Group manages its own farms. For annual crops where seeds are provided, the farmers take all the harvest risks and bear all the farming costs. However, the Group has the first right to buy the produce from these farmers, when these annual crops are harvested. At the end of the financial year, the Group’s total planted area of plantations and annual crops is approximately 37 324 (2013: 27 774) hectares and 35 577 (2013: Nil) hectares respectively, excluding hectares for those commodities whose plantations are not managed by the Group. Livestock Livestock relates mainly to dairy cattle in Uruguay and Russia. At the end of the financial year, the Group held 55 512 (2013: 48 988) cows, which are able to produce milk (mature assets) and 37 103 (2013: 38 394) heifers and calves, being raised to produce milk in the future (immature assets). The cows produced 229 million litres (2013: 216 million litres) of milk with a fair value less estimated point-of-sale costs of $127 237 000 (2013: $109 647 000) during the financial year. Financial risk management strategies related to agricultural activities The Group is exposed to financial risk in respect of agricultural activity. The agricultural activity of the Group consists of the management of biological assets to produce marketable output. The primary financial risk associated with this activity occurs due to the length of time between expending cash on the purchase or planting and maintenance of biological assets and on harvesting and ultimately receiving cash from the sale of the marketable output. The Group plans for cash flow requirements for such activities and manages its debt and equity portfolio actively. Source: Olam International Limited (2014, pp. 121, 148–149).

In addition to the above requirements, for any assets measured at fair value less costs to sell, an entity must also comply with the disclosure requirements of IFRS 13. These are discussed in chapter 3. If an entity rebuts the presumption that fair value can be reliably measured on initial recognition of a biological asset and measures the asset using the cost model (see section B.4.2) it is required to disclose additional information about the biological asset (paragraphs 54–56). These disclosures include an explanation of why fair value cannot be measured reliably and the range of estimates within which fair value is likely to lie. Additional disclosures are also required if the fair value of the biological asset becomes reliably measurable during the period. For government grants within the scope of IAS 41, paragraph 57 requires disclosure of the nature and extent of government grants recognised, unfulﬁlled conditions and other contingencies and signiﬁcant decreases expected in the level of government grants.

SUMMARY IAS 41 was a controversial standard when it was first issued, mainly because of its requirement to measure assets related to agricultural activity at fair value, with movements in fair value being taken to the statement of profit or loss and other comprehensive income as gains or losses. To this day, entities applying the standard indicate their implicit disagreement with this requirement, for example, by highlighting the fair value movements separately in their statements of profit or loss and other comprehensive income so that users can clearly see and understand the impact on reported profit. The IASB rejected criticisms of the fair value model for biological assets (including produce growing on a bearer plant) and agricultural produce, but conceded by permitting an exemption when fair value cannot be reliably measured and by excluding bearer plants from the scope of the standard. The Board has provided guidance in the standard, in addition to that in IFRS 13, to assist entities measuring fair value. 16

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IAS 41 distinguishes between biological assets, bearer plants, produce growing on a bearer plant, agricultural produce and products that are the result of processing after harvest. It prescribes different accounting treatments for each category, except for bearer plants, which are within the scope of IAS 16. The interaction between IAS 41 and IAS 16, IAS 17 and IAS 40 is very important to understand and apply, particularly since, in the agricultural industry, it is common to ﬁnd different parties involved in owning, leasing and managing agricultural assets.

Discussion questions 1. Why do you think IAS 41 was a controversial standard when it was issued? 2. Explain why the concept of ‘control’ is problematic when applying the recognition criteria of IAS 41. 3. What are the arguments for and against the use of fair value as the measurement basis for biological assets and agricultural produce? Why do you think the IASB settled on requiring fair value? 4. How does a gain or loss on initial recognition of a biological asset or agricultural produce arise? 5. Why is agricultural produce not remeasured to fair value during a reporting period? 6. Discuss the challenges with respect to measuring fair value for growing biological assets (including produce growing on a bearer plant), taking into consideration the CESR ruling in respect of immature salmon.

References Committee of European Securities Regulators 2007, extract from EECS’s database of enforcement decisions, Ref: 07–120. Olam International Limited 2014, Annual Report 2014, www.olamgroup.com. The Scottish Salmon Company 2014, Annual Report 2014, www.scottishsalmon.je.

Exercises Exercise B.1 ★

Exercise B.2

STAR RATING ★ BASIC

★★ MODER ATE

★★★ DIFFICULT

AGRICULTURAL ACTIVITY — DEFINITIONS

State which of the following meets the deﬁnition of ‘agricultural activity’ in IAS 41. Give reasons for your answer: 1. pig farming 2. ocean ﬁshing 3. clearing forests to create farmland 4. salmon farming 5. managing vineyards. AGRICULTURAL ACTIVITY — DEFINITIONS

★ State whether the following are (a) biological assets (excluding bearer plants), (b) bearer plants, (c) produce growing on a bearer plant (d) agricultural produce or (e) products that are as a result of processing after harvest: 1. living pigs 2. living sheep 3. pigs’ carcasses 4. pork sausages 5. trees growing in a plantation forest 6. furniture 7. olive trees 8. olives 9. olive oil 10. vines growing in a vineyard. Exercise B.3

AGRICULTURAL ACTIVITY — MEASUREMENT

★ For each of the items in exercise B.2 state whether they would be measured (a) at fair value under IAS 41 (b) using either the cost or revaluation method under IAS 16 or (c) at the lower of cost and net realisable value under IAS 2: 1. living pigs 2. living sheep B Agriculture

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3. pigs’ carcasses 4. pork sausages 5. trees growing in a plantation forest 6. furniture 7. olive trees 8. olives 9. olive oil 10. vines growing in a vineyard. Exercise B.4 ★★

Exercise B.5 ★

Exercise B.6 ★★

Exercise B.7 ★★

FAIR VALUE DETERMINATION

Which of the following would likely be included in measuring the fair value of a biological asset that does not have an active market and which has a 5-year production cycle? 1. Revenue from sale in 5 years’ time 2. Costs of growing for 5 years 3. Financing costs on borrowings taken out to fund the growing costs 4. Taxation on taxable income generated from sale in 5 years’ time 5. Discount rate that reﬂects expected variability in cash ﬂows. FAIR VALUE DETERMINATION

Pine Ltd owns a plantation forest. As at the end of the reporting period, the fair value of the plantation forest including the land was ¥200 million. Pine needs to measure the fair value of the trees excluding the land to comply with IAS 41 at the end of its reporting period. What will Pine need to consider when measuring the fair value of the trees? DISCLOSURE OF BIOLOGICAL ASSETS

State whether each of the following is true or false: 1. Entities applying IAS 41 must disclose separately the fair value (less costs to sell) of mature and immature biological assets. 2. A lessee of a forest that is classified as a finance lease must measure the forest (excluding the land) at fair value less costs to sell in its financial statements. 3. Wheat planted on land that is classified as an investment property by the owner must be recognised and measured as part of that investment property. 4. A lessor of a barley farm that is classified as a finance lease must measure the barley (excluding the land) at fair value in its financial statements. 5. An entity availing itself of the exemption in paragraph 30 of IAS 41 for a particular biological asset must apply IAS 20 if it receives a government grant in respect of that asset. 6. If agricultural produce cannot be reliably measured then it may be accounted for at cost under paragraph 30 of IAS 41. ACCOUNTING FOR ASSETS RELATING TO AGRICULTURAL ACTIVITY

Vintner entered into a lease agreement in respect of a vineyard with Lessor on 1 January 2016. The lease was classified as a finance lease as it transferred substantially all the risks and rewards of the vineyard to Vintner. The lease was for a period of 10 years, with annual lease payments of €212 000. The vineyard was established on land owned by Lessor. The vines were recorded as bearer plants at cost under IAS 16 and the grapes growing on the vines as biological assets at fair value less costs to sell under IAS 41 in the books of Lessor prior to the lease agreement. Lessor, using the fair value model under IAS 40, classifies the land as an investment property. Vintner engaged Manager to manage the vineyard on its behalf. Lessor acquired the land for €5 million in 2006. As at 31 December 2016, the fair value of the land was independently assessed to be €14 million (€13 million as at 31 December 2015). The fair value of the minimum lease payments under the finance lease was €2 million as at 1 January 2016. This was determined to be substantially the same as the fair value of the vineyard as at that date. Lessor determined that the amount of finance lease income for the year ended 31 December 2016 was €12 000. The fair value less costs to sell the vines and the grapes growing on the vines was independently assessed to be €1.9 million and €700 000, respectively, as at 31 December 2016. Vintner paid Manager €245 000 to manage the vineyard for the year ended 31 December 2016. The end of the reporting period for Vintner, Lessor and Manager is 31 December. Required

Prepare the journal entries to record the above transactions in the books of each of Vintner, Lessor and Manager for the year ended 31 December 2016. 18

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Exercise B.8

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ACCOUNTING FOR A GOVERNMENT GRANT

★★★ Grower engages in agricultural activities and measures its biological assets at fair value in accordance with

IAS 41. In 2016, Grower received a grant of $250 000 from the government. The grant was notiﬁed to the company on 31 March 2016. The terms and conditions of the grant were as follows. This grant is effective from 1 July 2016. Grower must continue to employ staff from Area A in its agricultural activities until at least 30 June 2021. If Grower ceases to employ staff from Area A before that date then Grower shall immediately repay the grant. The amount to be repaid shall be calculated according to the following formula: A = B − (C × D) Where: A = amount to be repaid B = amount of initial grant C = number of years the company has employed staff in Area A D = $50 000. The end of Grower’s reporting period is 30 June. The grant was received on 15 April 2016. Required

Prepare the journal entries to account for the grant by Grower for the years ended 30 June 2016 and 30 June 2017, assuming Grower complies with the conditions of the grant.

Exercise B.9

PREPARATION OF FINANCIAL STATEMENTS APPLYING IAS 41

★★★ Shearers Ltd owns sheep and the end of its reporting period is 30 June. The sheep are held to produce

wool. At 1 July 2016, Shearers had 1000 sheep and 200 lambs, with a fair value (less costs to sell) of £200 per sheep and £50 per lamb. During the year ended 30 June 2017 the following occurred: 1. 100 new sheep were purchased at £210 each 2. 20 lambs matured into sheep 3. 3 lambs died 4. 15 lambs were born 5. 100 sheep were sold for £240 each 6. Salaries and other operating costs were £34 000. Shearers owns the farmland, which was purchased for £1.5 million. The land is measured at fair value using the revaluation model under IAS 16. As at 30 June 2017, the fair value of the land was assessed at £5.6 million (£4.7 million as at 30 June 2016). Shearers also has plant and equipment, which was purchased for £1 million and is depreciated over its expected useful life of 10 years. As at 1 July 2016, the plant and equipment was 2 years old. As at 30 June 2017, the fair value (less costs to sell) is determined as £250 per sheep and £55 per lamb. Shearers has determined that these are the appropriate fair values to use for the purposes of transfers, births and deaths of lambs. The price change between a lamb and a sheep at the time of maturity during the year was estimated to be £195. During the year, Shearers produced wool with a fair value less costs to sell of £387 000. Required

Prepare the reconciliation required by paragraph 50 of IAS 41 for Shearers in accordance with IAS 41 for the year ended 30 June 2017. Show all workings.

B Agriculture

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and joint C Associates ventures ACCOUNTING STANDARDS IN FOCUS

IAS 28 Investments in Associates and Joint Ventures

LEARNING OBJECTIVES

After studying this chapter, you should be able to: 1

explain the nature of associates and joint ventures

discuss the concepts of significant influence and joint control

explain the rationale for the equity method and the different sets of financial statements in which it may be applied

apply the equity method in basic situations

adjust the application of the equity method for fair value/carrying amount differences of identifiable assets and liabilities at acquisition date, and account for goodwill at acquisition

account for the effects of inter-entity transactions

account for associates and joint ventures where these entities incur losses

discuss the disclosures required in relation to associates and joint ventures.

C Associates and joint ventures

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LO1

C.1

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INTRODUCTION AND SCOPE In chapters 20–23, a group was described as a parent plus all of its subsidiaries, with a subsidiary being an entity that is controlled by the parent. The subsidiaries are accounted for using the consolidation method and the consolidated financial statements contain the financial picture of the group as a single economic entity. However, it is possible to own shares without having control. Sometimes investments are insufficient to grant control, but do offer a degree of influence. The relationship with such entities cannot be accounted for by consolidation because there is no control, but they cannot be viewed as simple investments either. With some investments, an investor has a special relationship with its investees, which requires disclosure of more information about those investments. These investees are referred to as ‘associates’ and ‘joint ventures’ and they are accounted for by the application of the equity method of accounting. The purpose of this chapter is to detail the nature of associates and joint ventures and to set out how they are accounted for. The appropriate accounting standard is IAS 28 Investments in Associates and Joint Ventures, which was issued by the International Accounting Standards Board (IASB®) in 2011. Prior to the issue of this standard, the accounting for joint ventures was detailed in a different accounting standard from that used for associates. The accounting for joint ventures was covered in an accounting standard that dealt with both joint ventures and joint arrangements. Under IAS 28 as issued in 2011, the equity method is applied to both associates and joint ventures. The accounting for joint arrangements is covered by IFRS 11 Joint Arrangements, also issued in 2011 — see online chapter D.

LO2

C.2

IDENTIFYING ASSOCIATES AND JOINT VENTURES Just as a subsidiary has a special relationship with its parent requiring a particular accounting method to be used, the relationship between an investor and its associates and joint ventures is seen as being of special signiﬁcance so that a speciﬁc accounting method — the equity method of accounting — is required to provide information about the investor and its investments in associates and joint ventures.

C.2.1

Associates An associate is defined as an entity over which the investor has significant influence. The key characteristic determining the existence of an associate is that of significant influence. This is defined in paragraph 3 of IAS 28 as ‘the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies’. The key features of this definition are: • The investor has the power or the capacity to affect the decisions made in relation to the investee. As with the concept of control used in determining the parent–subsidiary relationship, an investor is not required to actually exercise the power to influence. It is only necessary that an investor have the ability to do so. • The specific power is that of being able to participate in the financial and operating policy decisions of the investee. Note that the investor cannot control the investee, just significantly influence the investee. • There is no requirement that the investor holds any shares, or has any beneficial interest in the associate. However, as discussed later, the application of the equity method is possible only where the investor holds shares in the associate. In other cases, the investor is required to make specific disclosures in its financial statements. The assessment of the existence of significant influence requires the application of judgement by the accountant. To assist in this determination, the following guidance is useful: • Where an investor holds, directly or indirectly, 20% or more of the voting power of an investee, it is presumed that the investor has significant influence over the investee (IAS 28 paragraph 5). • Similarly, where an investor holds less than 20% of another entity, there is a presumption that the investee is not an associate. Note that it is possible for an investee to be an associate of more than one investor. • Paragraph 6 of IAS 28 provides a list of factors that may provide evidence of the existence of significant influence. These factors include: (a) representation on the board of directors or equivalent governing body of the investee (b) participation in policy-making processes, including participation in decisions about dividends or other distributions (c) material transactions between the investor and the investee (d) interchange of managerial personnel (e) provision of essential technical information. The most common form of participation is that of representation on the board of directors of the investee, this being because of the size of the shareholding that the investor has in the investee. • The assessment of significant influence should also take into account any options or convertible securities that the investor holds in the investee (IAS 28 paragraph 7). The assessment takes into

PART 4 Economic entities

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account the terms of exercise of the potential voting rights including the investor’s intentions to exercise its rights and its financial ability to do so. Note that the investor must have the current ability to exercise significant influence.

C.2.2

Joint ventures A joint arrangement is defined in paragraph 3 of IAS 28 as an arrangement between two or more entities whereby two or more entities have joint control of another entity. The key feature of a joint arrangement is that of joint control. The most obvious example of joint control is where two entities each hold 50% of the shares of a third entity. Joint control is defined as ‘the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control’ (IAS 28 paragraph 3). The key element of joint control is the sharing of control. In other words, there are at least two investors who have shared control of the investee. Where a joint arrangement exists, the arrangement must be classified as either a joint operation or a joint venture. The classification depends on the rights and obligations of the parties to the arrangement. Joint ventures are accounted for under IAS 28 while joint operations are accounted for under IFRS 11. The concept of joint control and the classification of joint arrangements are covered in IFRS 11 rather than IAS 28. Hence, in this book, these two topics are covered in detail in online chapter D. In this chapter, it is sufficient to note that a joint venture is an arrangement where the investor has a right to an investment in the investee. The investee will have the following features: • the legal form of the investee and the contractual arrangements are such that the investor does not have rights to the assets and obligations for the liabilities of the investee • the investee has been designed to have a trade of its own and as such must directly face the risks arising from the activities it undertakes, such as demand, credit or inventory risks. In the examples used in this chapter an investor will hold between 20% and 50% of the shares in an investee and the classification of that investment as an investor–associate relationship or a joint venture will be dependent on whether the investor has significant influence over or joint control of the investee. The subsequent accounting for either structure is the same.

LO3

C.3

THE EQUITY METHOD OF ACCOUNTING: RATIONALE AND APPLICATION The method of accounting used to account for an investor’s interest in an associate or joint venture is known as the equity method of accounting. The equity method is deﬁned in paragraph 3 of IAS 28 as a method whereby the investment in an investee is initially recognised at cost and adjusted thereafter for the investor’s share of the post-acquisition equity of the investee. The post-acquisition equity includes both movements in proﬁt or loss and other comprehensive income of the investee.

C.3.1

Rationale for the equity method Because the investor does not control the associate, it cannot be accounted for by applying the consolidation method used for subsidiaries. However, because the investor has a special relationship with an associate via the investor having significant influence over the associate, it is argued that the cost method does not provide sufficient information about the associate in the records of the investor. Under the cost method, the only information provided about the associate would be in relation to dividends received or receivable from the associate. Hence the equity method is designed to provide more information than that provided by the cost method, but less than that given under the consolidation method. As noted in paragraph 26 of IAS 28, many of the procedures used under the equity method are similar to the consolidation method. The concepts applied in the procedures for accounting for the acquisition of a subsidiary are also adopted in accounting for an investment in an associate. Because of the similarity with the principles and procedures used in applying the consolidation method to subsidiaries, the equity method has sometimes been described as ‘one-line consolidation’. However, the equity method as applied under IAS 28 does not consistently use the consolidation principles in its application. The standard setters do not explain why the equity method is preferred to the fair value method. Further, where there is a departure from consolidation principles, IAS 28 does not supply a justification for the departure. This makes it difficult to evaluate the equity method on the basis of its being a one-line consolidation method or simply another measurement method competing with fair value. C Associates and joint ventures

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C.3.2

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Application of the equity method: consolidation worksheet or investor’s accounts An entity that has joint control in a joint venture or has significant influence over an associate must apply the equity method to account for these investments (IAS 28 paragraph 16). Where the equity method is applied depends upon whether the investor is also a parent. (a) Where the investor is a parent and prepares consolidated financial statements. If the parent or any subsidiaries have investments in associates, the equity method is applied in the consolidated financial statements to account for these investments in associates. Where consolidated financial statements are prepared, a parent does not have to prepare separate financial statements for the parent entity. Hence the equity accounting information appears only in the consolidated financial statements. No adjustments are made in the records of the investor who applies the cost method to its investments in associates. The accounting entries applying the equity method are made in the consolidation worksheet. The adjustment entries are made on a year-to-year basis as no permanent entries for the equity accounting of the associates are made in the records of the investor. (b) Where the investor is not a parent and does not prepare consolidated financial statements. In such cases, the investor applies the equity method to its associates in its own accounting records. The accounts of the investor are then affected by the application of the equity method. The investor in either of the above situations may also prepare separate financial statements (as defined in paragraph 4 of IAS 27 Separate Financial Statements) in which the investments in subsidiaries, associates and joint ventures are accounted for at cost or in accordance with IAS 39 Financial Instruments: Recognition and Measurement. In such circumstances, in relation to (b) above, a worksheet could be used to adjust for the equity accounting of associates and joint ventures. In this book, it is assumed that no separate financial statements are prepared and, where no consolidated financial statements are prepared, the equity method is applied in the records of the investor.

C.4

LO4

APPLYING THE EQUITY METHOD: BASIC PRINCIPLES The investor applies the equity method in accounting for its investment in the investee, being either an associate or a joint venture investee. There are four key steps in the application of the equity method (IAS 28 paragraph 10): 1. Recognise the initial investment in the investee at cost. If the investment is recorded at fair value, an adjustment must be made to return the investment back to original cost. 2. Increase or decrease the carrying amount of the investment by the investor’s share of the profit or loss of the investee after the acquisition date — post-acquisition profit or loss. 3. Reduce the carrying amount of the investment by distributions, such as dividends, received from the investee. 4. Increase or decrease the carrying amount of the investment for changes in the investor’s share of the changes in the investee’s other comprehensive income. This applies to reserves where changes in the investee’s equity are not recognised in profit or loss but in other comprehensive income. This includes movements in reserves such as the asset revaluation surplus. Although potential voting rights may be used in the assessment of significant influence, they are not used in any of the above calculations.

ILLUSTRATIVE EXAMPLE C.1 Basic application of the equity method

In this example, the investor owns 25% of the shares of the investee. Assuming this investment is sufficient to give the investor significant influence over the investee, the investee is then an associate of the investor. The equity method is applied to account for the investment. The same journal entries are used if there were four investors in the investee, each having a 25% interest in the investee and the investors had joint control over the investee; that is, the investee is a joint venture.

Part A: Investor does not prepare consolidated financial statements On 1 July 2015, Ella Ltd acquired 25% of the shares of Leenah Ltd for $42 500. At this date, all the identiﬁable assets and liabilities of Leenah Ltd were recorded at amounts equal to fair value, and the equity of Leenah Ltd consisted of: Share capital General reserve Asset revaluation surplus Retained earnings

PART 4 Economic entities

$100 000 30 000 20 000 20 000

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During the 2015–16 year, Leenah Ltd reported a profit of $25 000. As reported in other comprehensive income, the asset revaluation surplus increased by $5000. Leenah Ltd paid a $4000 dividend and transferred $3000 to general reserve. Step 1: Recognition of the initial investment At 1 July 2015, Ella Ltd would record the investment in Leenah Ltd at a cost of $42 500. Step 2: Recognition of the share of profit or loss of associate/joint venture At 30 June 2016, the investee has recorded a profit for the year of $25 000. The investor is entitled to a 25% share of this profit. The journal entry passed in the records of the investor at 30 June 2015 recognises as income a share of the investee’s profit and increases the investment in the associate/joint venture. The journal entry is: June 30

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures (Share of profit or loss of associate/joint venture: 25% × $25 000)

6 250

The share of proﬁt or loss of associates and joint ventures is disclosed as a separate line item in the statement of proﬁt or loss and other comprehensive income (IAS 1 Presentation of Financial Statements paragraph 82(c)). Step 3: Recognition of share of other comprehensive income: increase in asset revaluation surplus The asset revaluation surplus has increased by $5000, with this also being reported by the investee in other comprehensive income. This is post-acquisition equity and the investor is entitled to a 25% share. The investment in the associate/joint venture is increased, and the share of other comprehensive income is recognised, this being then accumulated in equity. The journal entries in the records of the investor at 30 June 2016 are:

June 30

Investments in Associates and Joint Ventures Share of Other Comprehensive Income of Associates and Joint Ventures (Share of revaluation increase: 25% × $5000)

Share of Other Comprehensive Income of Associates and Joint Ventures Asset Revaluation Surplus (Accumulation of revaluation increase in equity)

1 250

Dr Cr

1 250

1 250 1 250

The share of other comprehensive income of associates and joint ventures is required to be disclosed separately in the other comprehensive income section of the statement of profit or loss and other comprehensive income (IAS 1 paragraph 82A). The general reserve has also been increased by $3000. However, there is no need to pass any journal entries relating to this transfer from current profits to reserves. The investor, under Step 2 above, recognised its share of the investee’s profit. This includes a share of the amount transferred to general reserve. To recognise a share of the general reserve as well as a share of the profit would double count the investor’s share of equity. Step 4: Adjustment for dividend paid by associate/joint venture In the current period, the investee paid a dividend of $4000. However, the investor has already recognised its share of the equity of the investee via Step 2 above; therefore the dividend is not revenue to the investor. The investor has a reduced share of the equity of the investee. Hence, the investor passes a journal entry to recognise the receipt of cash on payment of the dividend and reduces its investment in the investee. The entry at 30 June 2016 is: June 30

Cash Investments in Associates and Joint Ventures (Adjustment for dividend paid by associate/joint venture: 25% × $4000)

Dr Cr

1 000 1 000

C Associates and joint ventures

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Note that if the dividend had been declared by the investee but not paid, the investor would recognise a dividend receivable instead of cash and still reduce its investment in the investee. At 30 June 2016, the investment in the associate is measured at $49 000 (i.e. $42 500 + $6250 + $1250 − $1000). The equity of Leenah Ltd consists of:

Share capital Asset revaluation surplus ($20 000 + $5000) General reserve ($30 000 + $3000) Retained earnings ($20 000 + $25 000 − $4000 − $3000)

$100 000 25 000 33 000 38 000 $196 000

The investor’s share of the equity of the associate is 25% of $196 000 (i.e. $49 000), which is the same as the recorded amount of the investment in the associate. In other words, the equity method, in this case, is designed to show the investment in the associate at an amount equal to the investor’s share of the reported equity of the associate. As explained later in this chapter, this relationship is not always achieved because of the effects of pre-acquisition equity, the existence of goodwill, and adjustments made for the effects of inter-entity transactions.

Part B: Investor prepares consolidated financial statements In this circumstance, the entries are not made in the accounting records of the entities themselves but in the consolidation worksheet instead. The journal entries shown in Steps 2 and 3 in Part A above are also used where the investor prepares consolidated ﬁnancial statements. These entries are passed in the consolidation worksheet at 30 June 2016. The entry that differs where the investor prepares a consolidation worksheet is that for the dividend paid. Step 4: Adjustment for dividend paid by associate The investor recorded the receipt of cash and recognised dividend revenue on payment of the dividend by the investee. However the investor, in Step 2, has recognised a share of the proﬁt of the investee. It cannot also recognise dividend revenue as this would double count the share of investee equity. Hence a worksheet entry is required that eliminates the dividend revenue recorded by the investor and reduces the investor’s investment in the investee. The consolidation worksheet entry at 30 June 2016 is:

June 30

Dividend Revenue Investments in Associates and Joint Ventures (Adjustment for dividend paid by associate/joint venture: 25% × $4000)

Dr Cr

1 000 1 000

If the dividend had been declared but not paid, the adjustment entry would be the same as above.

LO5

C.5

APPLYING THE EQUITY METHOD: GOODWILL AND FAIR VALUE ADJUSTMENTS The equity method requires that an investor recognise its share of the post-acquisition equity of the investee. When the investor acquired its interest in the investee, it paid a consideration based on an assessment of the fair value of the investee at that date. As noted in IAS 28 paragraph 32, the consideration paid took into account: • the recorded equity of the investee, equal to the recorded carrying amounts of the assets and liabilities of the investee • the differences between the carrying amounts of the assets and liabilities of the investee and the fair values of these assets and liabilities • the fair values of any unrecorded assets and liabilities of the investee • any goodwill existing in the investee.

PART 4 Economic entities

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The initial carrying amount of the investor’s interest in the investee reﬂects all of these amounts. The pre-acquisition equity of the investee effectively equals the sum of the fair values of the assets and liabilities of the investee (recorded and unrecorded) and the cost of any goodwill acquired. The investee does not record all the pre-acquisition equity at acquisition date, but recognises some of it subsequent to acquisition date. For example, assume the investee’s sole asset at acquisition date was land that was recorded at acquisition date at $100 000 but had a fair value at that date of $120 000. Although the investee’s recorded equity at acquisition date is $100 000 the real pre-acquisition equity is $120 000. If in the year following the acquisition date the investee sold the land for $120 000, the gain on sale of $20 000 is pre-acquisition equity not post-acquisition equity. Under the application of the equity method, the carrying amount of the investor’s investment in the investee should not be increased by a share of this gain. To determine the real post-acquisition equity of the investee, at acquisition date an acquisition analysis is undertaken. This is done in the same way as demonstrated in chapters 22 and 23 when accounting for a parent’s acquisition in a subsidiary. The acquisition analysis involves comparing the cost of the investment in the associate/joint venture with the net fair value of the identiﬁable assets and liabilities of the investee, determining whether any goodwill or excess arose at acquisition date. In applying the equity method, the share of recorded profit or loss is adjusted for differences between carrying amounts and fair values of identifiable assets and liabilities at acquisition date as for any impairment of goodwill. These adjustments are only notional adjustments; that is, they are not made in the records of the investee but are simply used in the calculation of the investor’s share of post-acquisition equity of the investee. Because the investor’s share of post-acquisition profit or loss of the investee is made on an after-tax basis, these adjustments are also calculated on an after-tax basis. Illustrative example C.2 shows the accounting where there are fair value/carrying amount differences at acquisition date and goodwill is acquired by the investor. Illustrative example C.3 shows the accounting where an excess occurs.

ILLUSTRATIVE EXAMPLE C.2 Goodwill and fair value adjustments

On 1 July 2015, Mia Ltd acquired 25% of the shares of Chloe Ltd for $49 375. At this date, the equity of Chloe Ltd consisted of: Share capital General reserve Retained earnings

$100 000 50 000 20 000

At the acquisition date, all the identiﬁable assets and liabilities of Chloe Ltd were recorded at fair value, except for plant for which the fair value was $10 000 greater than its carrying amount, and inventory whose fair value was $5000 greater than its cost. The tax rate is 30%. The plant has a further 5-year life. The inventory was all sold by 30 June 2016. In the reporting period ending 30 June 2016, Chloe Ltd reported a proﬁt of $15 000. The acquisition analysis at 1 July 2015 is as follows:

Net fair value of the identifiable assets and liabilities of Chloe Ltd = ($1 00 000 + $50 000 + $20 000) (equity) + $10 000(1 − 30%) (plant) + $5 000(1 − 30%) (inventory) = $180 500 Net fair value acquired by Mia Ltd = 25% × $180 500 = $45 125 Cost of investment = $49 375 Goodwill = $4 250

As the plant is used up, proﬁts are earned by the investee. However, these are not all post-acquisition proﬁts as the investor paid the fair value for the plant, not the carrying amount recorded by the investee. The proportion that is pre-acquisition equity is measured by reference to the depreciation C Associates and joint ventures

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of the plant based upon the difference between fair value and carrying amount of the plant at acquisition date: Depreciation adjustment = 20% × [$10 000(1 − 30%)] = $1 400

Similarly, on sale of the inventory in the 2015–16 year, the post-acquisition proﬁt on sale is adjusted for the difference between carrying amount and fair value of the inventory at acquisition date: Inventory adjustment = $5 000(1 − 30%) = $3 500

Hence, the investor’s share of post-acquisition equity at 30 June 2016 is: Recorded profit of Chloe Ltd Pre-acquisition adjustments: Depreciation of plant Sale of inventory

$15 000 $(1 400) (3 500)

Investor’s share of post-acquisition profit (25%)

(4 900) 10 100 $ 2 525

The journal entry to reﬂect the application of the equity method to the investment in the investee is: Investments in Chloe Ltd Share of Profit or Loss of Associates and Joint Ventures (Recognition of share of post-acquisition profit of investee)

Dr Cr

2 525 2 525

This entry is the same regardless of whether the investor prepares consolidated ﬁnancial statements or the entries are made in the records of the investor.

ILLUSTRATIVE EXAMPLE C.3 Excess — income

Any excess of the investor’s share of the net fair value of an investee’s identiﬁable assets and liabilities over the cost of the investment is recognised as income in the determination of the investor’s share of the investee’s proﬁt or loss in the period in which the investment is acquired (IAS 28 paragraph 32). Assume in illustrative example C.2 that the cost of the investment was $45 000. The acquisition analysis would then show: Net fair value acquired by Mia Ltd = 25% × $180 500 = $45 125 Cost of investment = $45 000 Excess = $125

The amount of the adjustment needed in applying equity accounting to the investment in the associate at 30 June 2016 is then as follows: Recorded profit of Chloe Ltd Pre-acquisition adjustments: Depreciation of plant Sale of inventory Investor’s share of post-acquisition profit (25%) Adjustment for excess on acquisition

PART 4 Economic entities

$15 000 (1 400) (3 500)

(4 900) 10 100 2 525 125 $ 2 650

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Note that the excess relates to the investor’s 25% investment in the investee and so is added on after the pre-acquisition adjustments are made to the recorded proﬁt. The journal entry to reﬂect the application of the equity method to the investment in the investee is: Investments in Chloe Ltd Share of Profit or Loss of Associates and Joint Ventures (Recognition of share of post-acquisition profit of investee)

C.5.1

Dr Cr

2 650 2 650

Applying the equity method across multiple years In the above illustrative examples, the journal entries are determined for the year following the investor’s acquisition of shares in the associate/joint venture. In subsequent years the entries required will differ, dependent on whether the investor prepares consolidated financial statements. • If the investor does not prepare consolidated financial statements. There are no extra issues to consider in this situation. As the journal entries passed by the investor are recorded in the accounts of the investor, then each year the investor records the annual share of increases/decreases in equity accounts. • If the investor prepares consolidated financial statements. The complication that arises here is that the journal entries are passed in the consolidation worksheet and not in the records of the investor. Hence, in years subsequent to the acquisition year, the worksheet journal entries need to recognise a share of prior years’ movements in equity as well as a share of the current year’s movements in equity. This involves recognising a share of retained earnings as well as a share of reserves.

ILLUSTRATIVE EXAMPLE C.4 Multiple periods

On 1 July 2013, Fatima Ltd acquired 40% of the shares of Najem Ltd for $122 400. The equity of Najem Ltd at acquisition date consisted of: Ordinary share capital Retained earnings

$200 000 80 000

At 1 July 2013, all the identiﬁable assets and liabilities of Najem Ltd were recorded at fair value except for the following:

Machinery Inventory

Carrying amount $140 000 60 000

Fair value $160 000 70 000

By 30 June 2014, the inventory on hand at 1 July 2013 had been sold by Najem Ltd. The machinery was expected to provide future beneﬁts evenly over the next 2 years and then be scrapped. The tax rate is 30%. Dividends declared at 30 June are paid within the following 3 months, with liabilities being raised at the date of declaration. In January 2016, Najem Ltd revalued furniture upwards by $6000, affecting the asset revaluation surplus. The ﬁnancial statements of Najem Ltd over three periods contained the following information:

Profit or loss Retained earnings (opening balance) Dividend paid Dividend declared Transfer to general reserve Retained earnings (closing balance)

30 June 2014

30 June 2015

30 June 2016

$ 40 000 80 000 120 000 5 000 7 000 10 000 22 000 $ 98 000

$ 60 000 98 000 158 000 10 000 15 000 10 000 35 000 $123 000

$ 70 000 123 000 193 000 15 000 20 000 0 35 000 $158 000

C Associates and joint ventures

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Required

Prepare the entries in the consolidation worksheet of Fatima Ltd to apply the equity method to its investment in Najem Ltd for each of the 3 years ending 30 June 2014, 2015 and 2016. Solution

Acquisition analysis Net fair value of identifiable assets and liabilities of Najem Ltd = $200 000 + $80 000 (equity) + $20 000(1 − 30%) (machinery) + $10 000(1 − 30%) (inventory) = $301 000

Net fair value acquired by Fatima Ltd = 40% × $301 000 = $120 400 Cost of investment = $122 400 Goodwill = $2 000 Pre-acquisition effects: Depreciation of machinery p.a. after tax = 50% × $20 000(1 − 30%) = $7 000 After-tax profit on sale of inventory = $10 000(1 − 30%) = $7 000

Consolidation worksheet 30 June 2014 Workings: Recorded profit of investee Pre-acquisition adjustments: Inventory Depreciation of machinery

$ 40 000 (7 000) (7 000)

(14 000) 26 000 $ 10 400

Investor’s share — 40%

The journal entries in the consolidation worksheet of Fatima Ltd at 30 June 2014 are:

June 30

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures (Recognition of equity-accounted profit of Najem Ltd) Dividend Revenue Investments in Associates and Joint Ventures (Adjustments for dividends from Najem Ltd: 40% × [$5000 + $7000])

10 400

Dr Cr

10 400

4 800 4 800

Note that the net increase in equity and the investment account for the year equals $5600 (i.e. $10 400 − $4800). Consolidation worksheet 30 June 2015 Share of prior period’s equity The ﬁrst journal entry in the consolidation worksheet recognises the investor’s share of the movement in equity of the investee in the prior period. The only account affected by prior period movements is retained earnings. Note that the movement in the general reserve has to be added back to retained earnings as this was effectively a transfer from proﬁt. The calculation of the investor’s share of prior period movements in equity is shown below, followed by the consolidation worksheet entry at 30 June 2016: 10

PART 4 Economic entities

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Movement in retained earnings since acquisition date: ($98 000 − $80 000) Movement in general reserve Pre-acquisition adjustments: Depreciation Inventory

$ 18 000 10 000 (7 000) (7 000)

(14 000) 14 000 $ 5 600

Investor’s share — 40%

June 30

Investments in Associates and Joint Ventures Retained Earnings (1/7/14) (Recognition of equity-accounted prior period profit of Najem Ltd)

Dr Cr

5 600 5 600

Note that the above entry is necessary because the equity accounting entries are made in the consolidation worksheet and not in the actual records of the investor. Share of current period equity The next set of entries relates to the investor’s share of equity for the 2014–15 year. Workings: Recorded profit of investee Pre-acquisition adjustments: Depreciation of machinery

$60 000 (7 000)

Investor’s share — 40%

(7 000) 53 000 $21 200

The entries in the consolidation worksheet at 30 June 2015 reﬂecting the effects of the proﬁt generated and the dividends declared/paid are: June 30

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures (Recognition of equity-accounted profit of Najem Ltd)

Dividend Revenue Investments in Associates and Joint Ventures (Adjustments for dividends from Najem Ltd: 40% × [$10 000 + $15 000])

Dr Cr

21 200 21 200

10 000 10 000

Note that the net increase in equity and in the investment account as a result of applying the equity method is $16 800 (i.e. $5600 + $21 200 − $10 000). Consolidation worksheet 30 June 2016 Share of prior period equity The ﬁrst journal entry in the consolidation worksheet recognises the investor’s share of the movement in equity of the investee in the prior period. The calculation of the investor’s share of prior period movements in equity is: Movement in retained earnings since acquisition date: ($123 000 − $80 000) Movement in general reserve Pre-acquisition adjustments: Depreciation: 2 × $7000 Inventory

$ 43 000 20 000 (14 000) (7 000)

(21 000) 42 000

Investor’s share — 40%

$ 16 800

C Associates and joint ventures

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The consolidation worksheet entry at 30 June 2016 is: June 30

Investments in Associates and Joint Ventures Retained Earnings (1/7/15) (Recognition of equity-accounted prior period profit of Najem Ltd)

Dr Cr

16 800 16 800

Share of current period equity The next set of entries relates to the investor’s share of equity for the 2015–16 year. Workings: Recorded profit of investee Pre-acquisition adjustments: Depreciation of machinery

$70 000 (7 000)

(7 000) 63 000

Investor’s share — 40%

$25 200

Other comprehensive income of investee: $6000(1 – 30%) Investor’s share — 40%

$ 4 200 $ 1 680

The entries in the consolidation worksheet at 30 June 2016 reﬂecting the effects of the proﬁt and other comprehensive income generated and the dividends declared/paid are:

June 30

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures (Recognition of equity-accounted profit of Najem Ltd)

Investments in Associates and Joint Ventures Share of Other Comprehensive Income of Associates and Joint Ventures (Share of revaluation increase)

Share of Other Comprehensive Income of Associates and Joint Ventures Asset Revaluation Surplus (Accumulation of revaluation increase in equity) Dividend Revenue Investments in Associates and Joint Ventures (Adjustment for dividends from Najem Ltd: 40% × [$15 000 + $20 000])

LO6

C.6

25 200 25 200

1 680 1 680

Dr Cr

1 680

Dr Cr

14 000

1 680

14 000

APPLYING THE EQUITY METHOD — INTER-ENTITY TRANSACTIONS As detailed earlier (see chapter 22), in the preparation of consolidated ﬁnancial statements, adjustments are made to eliminate the effects of transactions between a parent and its subsidiaries, and between the subsidiaries themselves. The rationale for these adjustments is that the consolidated ﬁnancial statements show only the results of transactions between the group and entities external to the group. The group is regarded as a single economic entity. The adjustment procedure requires the full effect of the transaction to be eliminated and the adjustments are made against the particular accounts affected by the transactions. Where a parent or its consolidated subsidiaries undertake transactions with an associate or a joint venture, adjustments must be made for gains and losses on those transactions.

PART 4 Economic entities

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The principles for adjusting the effects of inter-entity transactions under equity accounting are as follows (IAS 28 paragraph 28): • Adjustments are made for transactions between an associate/joint venture and the investor that give rise to unrealised profits and losses. Such transactions include the sale of inventory from the investor to the investee. Realisation of the profits or losses on these transactions occurs when the asset on which the profit or loss accrued is sold to an external entity, or as the future benefits embodied in the asset are consumed. Unlike consolidation, there is no need to adjust for all transactions between the investor and the investee — only those transactions where a profit or loss is earned require adjustment. Therefore, transactions such as a loan between the entities, or the payment of interest on the loan, do not require an adjustment under equity accounting. • Adjustments for transactions between an investor and an investee are done on a proportional basis, determined in accordance with the investor’s ownership interest in the investee. This differs from consolidation adjustments where the adjustments are made on a 100% basis, and are unaffected by the parent’s ownership interest in the subsidiary. • Adjustments are made on an after-tax basis to the accounts ‘Share of Profit or Loss of Associates and Joint Ventures’ and ‘Investments in Associates and Joint Ventures’. IAS 28 does not detail which accounts should be adjusted under the equity method. For example, if an investee sells inventory to an investor at a profit, should the inventory account of the investor be adjusted? In this chapter, only the two accounts noted earlier are adjusted — no adjustments are made to specific accounts of the investor or investee. Note that the adjustments are made on an after-tax basis as the equity method recognises a share of after-tax profits only. The adjustments are the same for all transaction regardless of whether they are upstream (where an associate/joint venture sells to an investor) or downstream (where an investor sells to an associate/joint venture). The direction of the transaction is irrelevant in determining the accounts affected by the application of the equity method. It is difficult to find a rationale for the adjustments for inter-entity transactions under the equity method of accounting as applied under IAS 28. Unlike subsidiaries, associates and joint ventures are not part of the single economic entity and so the consolidation rationale is not applicable. The main argument for the method used is simplicity. However, the method does lead to some strange results. For example, where an investor sells inventory to an investee, the adjustment is to the Share of Profit or Loss of Associates and Joint Ventures account even though the profit was made by the investor and not the investee. The incremental change to the investment account does not therefore reflect only changes in the equity of the investee, but includes unrealised profits made by the investor.

Examples of inter-entity transactions In the following examples, assume: • The reporting period is for the year ending 30 June 2016. • The investor, Jessica Ltd, owns 25% of Ava Ltd. Jessica Ltd acquired its ownership interest in Ava Ltd 2 years prior on 1 July 2014, when the retained earnings balance of Ava Ltd was $100 000. At this date, all the identiﬁable assets and liabilities of Ava Ltd were recorded at fair value. • At 30 June 2015, the retained earnings balance in Ava Ltd is $140 000, and the proﬁt recorded for the 2015–16 period is $30 000. The tax rate is 30%. The adjustment entries may differ according to whether they are made in the consolidation worksheet or in the accounting records of the investor. Differences in particular arise where the effects of a transaction occur across 2 or more years. Example 1: Sale of inventory from associate to investor in the current period During the 2015–16 period, Ava Ltd sold $5000 worth of inventory to Jessica Ltd. These items had previously cost Ava Ltd $3000. All the items remain unsold by the investor at 30 June 2016. The calculations for applying the equity method are as follows: 2014–15 period Change in retained earnings since acquisition date: $140 000 − $100 000 Investor’s share — 25% 2015–16 period Current period profit Adjustments for inter-entity transactions: Unrealised after-tax profit in ending inventory: $2000(1 – 30%)

$40 000 $10 000 $30 000

(1 400) 28 600

Investor’s share — 25%

$ 7 150

C Associates and joint ventures

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If the investor prepares consolidated ﬁnancial statements, the entries in the consolidation worksheet at 30 June 2016 to apply the equity method to its associate/joint venture are:

Investments in Associates and Joint Ventures Retained Earnings (1/7/15)

Dr Cr

10 000

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures

Dr Cr

7 150

10 000 7 150

If the investor does not prepare consolidated ﬁnancial statements, the entries are made in the records of the investor. The only entry made at 30 June 2016 is the same as the second entry above:

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures

Dr Cr

7 150 7 150

Example 2: Sale of inventory from investor to associate in the current period Details are the same as in example 1, except that Jessica Ltd sells the inventory to Ava Ltd. The calculations and journal entries are exactly the same as in example 1. The flow of the transaction, whether upstream or downstream, does not affect the accounting for the transaction. Example 3: Sale of inventory in the current period, part remaining unsold During the 2015–16 period, Ava Ltd sold $5000 worth of inventory to Jessica Ltd. These items had previously cost Ava Ltd $3000. Half of the items remain unsold by Jessica Ltd at 30 June 2016. The increment to the investment account is calculated in a similar way to example 1, but the adjustment is based only on the profit remaining in inventory on hand at the end of the period because it is this inventory that contains the unrealised profit. The calculations are as follows:

2014–15 period As for example 1: Investor’s share — 25%

$10 000

2015–16 period Current period’s recorded profit Adjustment for inter-entity transactions: Unrealised after-tax profit in ending inventory: $1000(1 – 30%)

$30 000

(700) 29 300 $ 7 325

Investor’s share — 25%

If the investor prepares consolidated ﬁnancial statements, at 30 June 2016, the entries in the consolidation worksheet to apply the equity method to its associate are:

Investments in Associates and Joint Ventures Retained Earnings (1/7/15)

Dr Cr

10 000

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures

Dr Cr

7 325

10 000 7 325

If the investor does not prepare consolidated ﬁnancial statements, in the 2015–16 period only the second of the above two entries is required.

PART 4 Economic entities

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Example 4: Sale of inventory in the previous period During the 2014–15 period, Jessica Ltd sold $5000 worth of inventory to Ava Ltd. These items had previously cost Jessica Ltd $3000. All the items remain unsold by Ava Ltd at 30 June 2015. These were all sold to other entities by 30 June 2016. The calculations for applying the equity method are as follows:

2014–15 period Change in retained earnings since acquisition date: $140 000 − $100 000 Adjustment for inter-entity transactions: Unrealised after-tax profit in ending inventory: $2000(1 – 30%)

$40 000

(1 400) 38 600 $ 9 650

Investor’s share — 25% 2015–16 period Current period’s profit Adjustment for inter-entity transactions: Realised after-tax profit in opening inventory: $2000(1 – 30%)

$30 000

1 400 31 400 $ 7 850

Investor’s share — 25%

In the 2015–16 period, the profit that was unrealised in the previous period becomes realised. Hence, the amount is added back in the calculation of the 2015–16 share of equity. The addition of the 2014–15 and the 2015–16 increments results in the inter-entity transaction having a zero effect since, by 30 June 2016, the profit on the sale is realised. If the investor prepares consolidated financial statements at 30 June 2016, the entries in the consolidation worksheet to apply the equity method to its associate are:

Investments in Associates and Joint Ventures Retained Earnings (1/7/15)

Dr Cr

9 650

Investment in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures

Dr Cr

7 850

9 650 7 850

If the investor does not prepare consolidated statements, the only entry passed at 30 June 2016 is the second entry above. Example 5: Sale of depreciable non-current asset On 1 July 2014, Ava Ltd sold an item of plant to Jessica Ltd for $8000. The carrying amount of the asset on this date in Ava Ltd’s records was $3000. The plant had a remaining useful life of 5 years. The calculations for applying the equity method are as follows: 2014–15 period Change in retained earnings since acquisition date Adjustments for inter-entity transactions: Unrealised after-tax profit on sale of plant: $5000(1 – 30%) Realised after-tax profit on sale of plant: 1/5 × $3500 Investor’s share — 25%

$40 000 (3 500) 700 37 200 $ 9 300

Note that at the time of sale of the plant the profit on the sale is unrealised. The profit is realised as the asset is consumed or used by the entity holding the asset. The consumption of benefits is measured by the depreciation of the asset. Hence, as the plant is depreciated on a straight-line basis over a 5-year period, one-fifth of the profit is realised in each year after the inter-entity transfer.

C Associates and joint ventures

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2015–16 period Current period’s recorded profit Adjustment for inter-entity transactions: Realised after-tax profit on sale of plant: 1/5 × $3500

$30 000 700 30 700 $ 7 675

Investor’s share — 25%

A further one-fifth of the unrealised profit is realised in the 2015–16 period as the benefits from the asset are further consumed. At the end of the 5-year period, the whole of the profit is realised. If the investor prepares consolidated financial statements at 30 June 2016, the entries in the consolidation worksheet to apply the equity method to its associate/joint venture are:

Investments in Associates and Joint Ventures Retained Earnings (1/7/15)

Dr Cr

9 300

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures

Dr Cr

7 675

9 300 7 675

If the investor does not prepare consolidated statements, only the second of the above entries is passed at 30 June 2016. Example 6: Payment of interest On 1 July 2014, Jessica Ltd lent $10 000 to Ava Ltd. Interest of $1000 p.a. was paid by Ava Ltd. Although the profit of Ava Ltd includes the interest expense from this transaction, no adjustment is required because the revenue/expense on the transaction is assumed to be realised. Profits are considered to be unrealised only when there remains an asset in the investor/associate transferred at a profit or loss from the associate/investor.

ILLUSTRATIVE EXAMPLE C.5 Equity method of accounting

On 1 July 2015, Georgia Ltd paid $2 696 000 for 40% of the shares of Emma Ltd, a company involved in the manufacture of garden equipment. At that date, the equity of Emma Ltd consisted of: Share capital — 3 000 000 shares Retained earnings

$ 3 000 000 3 000 000

At 1 July 2015, all the identiﬁable assets and liabilities of Emma Ltd were recorded at fair value except for:

Inventory Plant (cost $3 200 000)

Carrying amount $ 1 000 000 2 500 000

Fair value $ 1 200 000 3 000 000

The inventory was all sold by 30 June 2016. The plant had a further expected useful life of 5 years. Additional information (a) On 1 July 2016, Georgia Ltd held inventory sold to it by Emma Ltd at a profit before income tax of $200 000. This was all sold by 30 June 2017. (b) In February 2017, Emma Ltd sold inventory to Georgia Ltd at a profit before income tax of $600 000. Half of this was still held by Georgia Ltd at 30 June 2017. (c) On 30 June 2017, Emma Ltd held inventory sold to it by Georgia Ltd at a profit before income tax of $200 000. This had been sold to Emma Ltd for $2 000 000. (d) On 2 July 2015, Emma Ltd sold some equipment to Georgia Ltd for $1 500 000, with Emma Ltd recording a profit before income tax of $400 000. The equipment had a further 4-year life, with benefits expected to occur evenly in these years. 16

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(e) In June 2016, Emma Ltd provided for a dividend of $1 000 000. This dividend was paid in August 2016. Dividend revenue is recognised when the dividend is provided for. (f) The balances in the general reserve have resulted from transfers from retained earnings. (g) The tax rate is 30%. (h) Each share in Emma Ltd has a fair value at 30 June 2017 of $4. The consolidated financial statements of Georgia Ltd, not including the equity-accounted figures, and the financial statements of Emma Ltd at 30 June 2017, are as follows: Statements of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2017

Revenue Expenses Profit before tax Income tax expense Profit for the period Other comprehensive income: revaluation gains Total comprehensive income

Georgia Ltd $’000 25 000 19 200 5 800 2 200 3 600 0 3 600

Emma Ltd $’000 18 600 13 600 5 000 1 100 3 900 400 4 300

Georgia Ltd $’000 3 600 4 000 3 600 7 600 — 3 000 1 500 4 500 3 100

Emma Ltd $’000 4 300 4 000 3 900 7 900 1 000 1 500 1 000 3 500 4 400

Statements of Changes in Equity for the year ended 30 June 2017

Total comprehensive income Retained earnings as at 1/7/16 Profit Transfer to general reserve Dividend paid Dividend provided Retained earnings as at 30/6/17 Asset revaluation surplus as at 1/7/16 Increase in 2016–17 Asset revaluation surplus as at 30/6/17 General reserve as at 1/7/16 Increase in 2016–17 General reserve at 30/6/17

—

1 000 — 1 000

200 400 600 1 500 1 000 2 500

Georgia Ltd $’000

Emma Ltd $’000

8 000 — 1 000 3 100 12 100 1 500 13 600

3 000 600 2 500 4 400 10 500 1 400 11 900

Statements of Financial Position as at 30 June 2017

EQUITY AND LIABILITIES Equity Share capital Asset revaluation surplus General reserve Retained earnings Total equity Total liabilities Total equity and liabilities

C Associates and joint ventures

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Georgia Ltd $’000

Emma Ltd $’000

5 904 2 696 8 600

9 000

4 000 1 000 5 000 13 600

2 000 900 2 900 11 900

ASSETS Non-current assets Property, plant and equipment Investment in Emma Ltd Current assets Inventory Receivables Total assets

9 000

Required

Prepare the consolidated ﬁnancial statements of Georgia Ltd at 30 June 2017, applying the equity method of accounting to the investment in Emma Ltd. Solution

The first step is to prepare an acquisition analysis which compares at acquisition date, 1 July 2015, the cost of the investment in Emma Ltd and the share of the net fair value of the identifiable assets and liabilities of Emma Ltd. This analysis is the same as the acquisition analysis used in preparing consolidated financial statements, and results in the determination of any goodwill or income on acquisition. Acquisition analysis At 1 July 2015: Net fair value of identifiable assets and liabilities of Emma Ltd

= ($3 000 000 + $3 000 000) (equity) + $200 000(1 – 30%) (inventory) + $500 000(1 – 30%) (plant) = $6 490 000

Net fair value acquired by Emma Ltd = 40% × $6 490 000 = $2 596 000 Cost of investment = $2 696 000 Goodwill = $100 000

As a result of the analysis, the effects of the adjustments to assets on hand at acquisition date can be calculated. In relation to the plant, there is a $500 000 difference between the fair value and the carrying amount at acquisition date. As a result, the recorded proﬁts of the associate after acquisition date will include amounts that were paid for by the investor at acquisition date. The equity method recognises a share of post-acquisition equity only. The plant is being depreciated by the associate at 20% p.a. straight-line. The after-tax effect of the depreciation each year is calculated as: Depreciation of plant p.a. = 20% × $500 000(1 − 30%) = $70 000

In each of the 5 years subsequent to the acquisition date, the recorded profit of the associate is reduced by $28 000 p.a. prior to calculating the investor’s share of post-acquisition equity. In relation to inventory, there is a $200 000 difference between fair value and carrying amount at acquisition date. When the associate sells the inventory, it will record a profit that includes pre-acquisition equity to the investor. The after-tax effect on profit on sale of the inventory is: Pre-acquisition inventory effect = $200 000(1 − 30%) = $40 000

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In the year of sale of the inventory, the investor’s share of the recorded proﬁt of the group is reduced by $140 000 prior to calculating the investor’s share of post-acquisition equity. Consolidation worksheet entries — 30 June 2017 The investor’s share of the post-acquisition equity of the associate to be recognised on consolidation is calculated in two steps: a share of post-acquisition equity between the acquisition date and the beginning of the current period, and a share of the current period’s post-acquisition equity. A third step is necessary to adjust for dividends paid/payable by the investee. (1) Share of changes in post-acquisition equity in previous periods The calculation is based on post-acquisition movements in the Retained Earnings account and other reserve accounts created by transfers from retained earnings, and adjusted for the effects of inter-entity transactions. The consolidation worksheet entry for the investor’s share of the associate’s post-acquisition equity recognised between the date of acquisition and the beginning of the current period is calculated as follows: $’000 Retained earnings: Post-acquisition retained earnings from acquisition date to beginning of the current period: $4 000 000 – $3 000 000 Change in general reserve in previous periods Pre-acquisition adjustments: Depreciation of plant Sale of inventory Post-acquisition retained earnings Adjustments for inter-entity transactions: Inventory on hand at 30/6/17: $200 000(1 − 30%) Unrealised profit on sale of equipment: Original gain $400 000(1 – 30%) less depreciation p.a. of ¼ × $280 000

$’000

$ 1 000 1 500 2 500 (70) (140)

(210) 2 290

(140) (210)

Investor’s share (40%) of retained earnings at 1/7/16

(350) 1 940 $ 776

Asset revaluation surplus: Share of asset revaluation surplus in previous periods: 40% × $200 000 Total increase in equity-accounted carrying amount in previous periods

80 $ 856

The consolidation worksheet entry in relation to previous period’s equity is: Investments in Associates and Joint Ventures Retained Earnings (1/7/16) Asset Revaluation Surplus (Recognition of equity-accounted share of prior period’s equity)

Dr Cr Cr

856 000 776 000 80 000

In relation to the above entry and calculations, note the following: Retained earnings (1/7/16): • Retained earnings: The change is calculated as the difference between the recorded balance at acquisition date and the balance at the beginning of the current period. • General reserve: The change in this equity amount is calculated in the same way as for retained earnings. There was no balance at acquisition date. The balance at 30 June 2017 is $2.5 million and, given a transfer to the reserve of $1 million, the balance at the beginning of the period was $1.5 million. This can be seen in the statement of changes in equity. Hence there is an increase in postacquisition equity of $1.5 million. • Determination of post-acquisition equity: The movement in recorded retained earnings is not all postacquisition equity. The investor recognised the fair value of the assets and liabilities of the associate at acquisition date, and not the carrying amount in the associate. Where there are movements in these assets and liabilities, some of the proﬁts recognised by the associate are pre-acquisition and not post-acquisition. There were two assets at acquisition date for which the fair value differed from carrying amount: – Plant: The fair value was $500 000 greater than the carrying amount. As calculated in the acquisition analysis, since the asset has a 5-year life, in relation to the investor’s share the pre-acquisition amount included in recorded equity of the associate is $180 000 p.a. C Associates and joint ventures

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– Inventory: The fair value was $200 000 greater than carrying amount. As calculated in the acquisition analysis, since the asset was sold after the acquisition date, in relation to the investor’s share the pre-acquisition effect is $56 000. Therefore, the change in post-acquisition retained earnings between acquisition date and the beginning of the current period is $2 290 000. • Inter-entity transactions: Where either the investor or investee has recognised profits or losses on transactions with the other party, and these are not realised, adjustments are made to eliminate unrealised profits or losses. In this problem, the Additional Information details four inter-entity transactions, only two of which relate to previous periods, namely (a) and (d): (a) On 1 July 2016, the investee sold inventory to the investor at a profit before tax of $200 000. This was unrealised at 30 June 2017. The recorded change in equity is then reduced by $140 000 after-tax profit as the profit is not yet realised. (d) On 2 July 2015, the investee recognised an after-tax profit of $280 000 on the sale of equipment to the investor. This profit is realised as the benefits from the asset are consumed by use. The rate of consumption is measured via depreciation. As the asset has a 4-year life, one-quarter of the profit is realised each year. Hence, the unrealised portion at 30 June 2017 is the original after-tax profit of $280 000 less one-quarter of $280 000, namely $210 000. The investor’s share of post-acquisition retained earnings, adjusted for unrealised profits on interentity transactions is then $856 000. Asset revaluation surplus: There was no asset revaluation surplus recognised in the investee at acquisition date. As per the statement of profit or loss and other comprehensive income, the balance at 30 June 2017 was $200 000. Hence, the change over the period is $200 000. The investor’s share of this is 40%, namely $80 000. Investment in associate/joint venture — Emma Ltd: The investor’s total share of post-acquisition equity of the investee up to the beginning of the current period is, therefore, $856 000. This amount is then added to the Investment in Associates and Joint Ventures account, with increases recognised in the relevant reserve accounts. (2) Share of profit in current period In part (1), the investor’s share of the previous period’s post-acquisition equity was calculated. In this part, the calculation is of the investor’s share of the post-acquisition equity of the investee relating to the current period. In this problem, increases in equity arise owing to the investee’s earning of a profit and recording of other income as increments in the asset revaluation surplus. The calculations and required consolidation adjustment entry is shown below: $’000 Recorded profit Pre-acquisition adjustments: Depreciation of plant Post-acquisition profit Adjustments for inter-entity transactions: Realised profit in opening inventory Unrealised profit in Georgia Ltd’s ending inventory: ½ × $600 000 (1 – 30%) Unrealised profit in Emma Ltd’s ending inventory: $200 000 (1 – 30%) Realised profit on plant: ¼ × $280 000

$’000 3 900 (70) 3 830

140 (210) (140) 70

Investor’s share (40%) of associate/joint venture

(140) 3 690 1 476

Other comprehensive income Share of increment in asset revaluation surplus: 40% × $400 000 Total increase in equity-accounted carrying amount in current period

160 1 636

The consolidation worksheet entries are:

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures (Share of profit or loss of associate/joint venture)

PART 4 Economic entities

Dr Cr

1 476 000 1 476 000

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Investments in Associates and Joint Ventures Share of Other Comprehensive Income of Associates and Joint Ventures (Share of revaluation increase) Share of Other Comprehensive Income of Associates and Joint Ventures Asset Revaluation Surplus (Accumulation of revaluation increase in equity)

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160 000

Dr Cr

160 000

160 000 160 000

In relation to these calculations and entries, note the following: Profit or loss for the period • Share of profit or loss of associate: The associate records an after-tax profit for the year of $3 900 000. This profit needs to be adjusted where there have been transactions between the investor and the associate and at the end of the reporting period profits or losses on these transactions are unrealised. However, this profit is not all post-acquisition profit. Movements in assets and liabilities on hand at acquisition date when fair values differed from carrying amounts give rise to preacquisition elements in recorded profits. In the current period, because the plant on hand at acquisition date was recognised by the investor at fair value, the extra depreciation on the plant reflects pre-acquisition equity. As calculated in the acquisition analysis the pre-acquisition effect is $70 000 p.a. This is subtracted from the profit of the period profit to give the post-acquisition profit for the period. • Inter-entity transactions: In this problem there are four transactions noted in the additional information that affect the current period, namely (a)–(d). (a) The inventory on hand at 1 July 2016 is all sold by 30 June 2017. The profit on the inter-entity sale was unrealised at the beginning of the current period but is realised in the current period. The after-tax profit on sale of the inventory was $140 000. Since the profit is realised in the current period, it is added to the recorded profit of the associate. Note that $1 400 000 is subtracted in the calculation of the investor’s share of previous period equity and is added to the calculation of the investor’s share of current period profit. Since the profit is now realised, there is no need to make an adjustment in future periods. (b) In February 2017, the associate sold inventory to the investor at an after-tax profit of $420 000. Since half of the inventory is still on hand at 30 June 2017, there is unrealised profit at the end of the reporting period of $210 000. This amount is subtracted from recorded profit because the investor’s share relates to realised profit only. (c) In the current period, the investor sold inventory to the associate for an after-tax profit of $140 000. Since this inventory remains on hand at the end of the reporting period, the unrealised profit is subtracted from recorded profit. (d) The gain on sale of equipment was adjusted for in the calculation of the investor’s share of previous period equity. As noted in that calculation, the unrealised profit on sale is realised as the asset is used up and depreciated. The amount realised each year is in proportion to depreciation, namely one-quarter p.a. The amount of the gain realised in the current period is then ¼ × $280 000, that is, $70 000. Being realised profit, it is added back to recorded profit. The total post-acquisition profit of the investee adjusted for the effects of inter-entity transactions is then $3 690 000, and the investor’s share (40%) is $1 476 000. Other comprehensive income From the statement of changes in equity, note that the asset revaluation surplus has increased by $400 000 in the current period. The investor is entitled to 40% of this, that is, $160 000. This is recognised in other comprehensive income and accumulated in the asset revaluation surplus. Investment in associate/joint venture — Emma Ltd The investor’s share of current period post-acquisition equity is then $1 636 000, which increases the investor’s investment in the associate. For the profit portion, this is recognised by a separate line item in the consolidated statement of comprehensive income. (3) Dividends paid and provided for by associate/joint venture A further entry is necessary to take into account reductions in the investee’s equity in the current period because of dividends. In the current period, Emma Ltd paid a $1.5 million dividend and declared a $1 million dividend. Assuming the investor recognises dividend revenue in relation to the C Associates and joint ventures

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declared dividend, it would recognise dividend revenue of $1 million (i.e. 40% × [$1.5 million + $1 million]). The following entry eliminates, on consolidation, the dividend revenue recorded by the investor. This is because in parts (1) and (2) above, the investor’s equity has been increased by its share of the equity of the associate/joint venture from which the dividends were paid/declared. Similarly, it is also necessary to reduce the investment in the associate as the share of equity in the associate as calculated in parts (1) and (2) has been reduced by the payment/declaration of the dividend. The consolidation worksheet entry is: Dividend Revenue Investments in Associates and Joint Ventures (Adjustment for dividend paid by associate/joint venture: 40% × [$1 500 000 + $1 000 000])

Dr Cr

1 000 000 1 000 000

(4) Total investment On the basis of the above worksheet entries, the carrying amount of the investment in the associate/ joint venture, Emma Ltd, is: $4 188 000 = $2 696 000 + $856 000 + $1 636 000 − $1 000 000

The consolidated ﬁnancial statements of Georgia Ltd at 30 June 2017, including the investment in the associate/joint venture accounted for under the equity method, are as follows: GEORGIA LTD Consolidated Statement of Profit or Loss and Other Comprehensive Income for year ended 30 June 2017 $’000 Revenue [$25 000 000 – $1 000 000] Expenses Share of profit or loss of associates and joint ventures accounted for using the equity method Profit before tax Income tax expense Profit for the period Other comprehensive income: Share of other comprehensive income of associates and joint ventures accounted for using the equity method Total comprehensive income

24 000 19 200 4 800 1 476 6 276 2 200 4 076

160 4 236

GEORGIA LTD Consolidated Statement of Changes in Equity for year ended 30 June 2017 $’000 Total comprehensive income Retained earnings at 1/7/16 [$4 000 000 + $776 000] Profit or loss for the period Dividend paid Dividend provided Retained earnings at 30/6/17 Asset revaluation surplus at 1/7/16 Revaluation increases Asset revaluation surplus at 30/6/17 General reserve at 1/7/16 General reserve at 30/6/17

PART 4 Economic entities

4 236 4 776 4 076 8 852 (3 000) (1 500) 4 352 80 160 240 1 000 1 000

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GEORGIA LTD Consolidated Statement of Financial Position as at 30 June 2017 EQUITY AND LIABILITIES Equity Share capital Asset revaluation surplus General reserve Retained earnings Total equity Total liabilities Total equity and liabilities

$’000 8 000 240 1 000 4 352 13 592 1 500 15 092

ASSETS Non-current assets Property, plant and equipment Investments in associates and joint ventures

5 904 4 188 10 092

Current assets Inventories Receivables

4 000 1 000 5 000 15 092

Total assets

LO7

C.7

SHARE OF LOSSES OF AN ASSOCIATE OR JOINT VENTURE It may occur that the associate or joint venture incurs losses rather than profits. In this situation, the investor recognises losses only to the point where the carrying amount of the investment reaches zero (IAS 28 paragraph 38). The investor discontinues the use of the equity method when the share of losses equals or exceeds the carrying amount of the investment. Note that the carrying amount of the investment is not just the balance of the investment in the associate or joint venture. The investor’s interest in the associate/joint venture also includes other long-term interests in the associate/joint venture, such as preference shares or long-term receivables or loans. The base against which the losses are offset is then the investor’s net investment in the associate/joint venture. Where the associate/joint venture incurs losses, the carrying amount of the account ‘Investments in Associates and Joint Ventures’ is first reduced to zero. If losses exceed this carrying amount, they are then applied against the other components of the investor’s interest in the associate/joint venture in the reverse order of their seniority, or priority in liquidation. The logic is that, if the associate/joint venture is making losses, then the probability of the other investments in the associate/joint venture being realised is lessened. If the associate/joint venture subsequently reports profits, the investor resumes recognising its share of those profits only after its share of the profits equals the share of losses not recognised (IAS 28 paragraph 39). In other words, once the equity-accounted balance of the investment returns to a positive amount, equity accounting resumes. In situations where the associate records losses, if there are indications that the investment may be impaired, the investor should apply IAS 36 Impairment of Assets. As noted in paragraph 42 of IAS 28, in determining the value in use of the investment, an investor estimates: (a) its share of the present value of the estimated future cash flows expected to be generated by the associate, including the cash flows from the operations of the associate and the proceeds on the ultimate disposal of the investment; or (b) the present value of the estimated future cash flows expected to arise from dividends to be received from the investment and from its ultimate disposal. Under appropriate assumptions, both methods give the same result. C Associates and joint ventures

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ILLUSTRATIVE EXAMPLE C.6 Share of losses of the associate

On 1 July 2010, Grace Ltd acquired 25% of the shares of Amelia Ltd for $100 000. At that date, the equity of Amelia Ltd was $400 000, with all identifiable assets and liabilities being measured at amounts equal to fair value. Table C.1 shows the profits and losses made by the associate over the first 5 years of operations after 1 July 2010, with their effects on the carrying amount of the investment. TABLE C.1 Profits and losses made by associate over first 5 years of operations

Year

Profit/(loss)

2010–11 2011–12 2012–13 2013–14 2014–15

20 000 (200 000) (250 000) 16 000 20 000

Share of profit or loss

Cumulative share

$ 5 000 (50 000) (62 500) 4 000 5 000

Equity-accounted balance of investment

5 000 (45 000) (107 500) (103 500) (98 500)

$105 000 55 000 0 0 1 500

Table C.1 shows that the investment account is initially recorded by Grace Ltd at $100 000, and is progressively adjusted for Grace Ltd’s share of the profits and losses of Amelia Ltd. In the 2012–13 year, when the cumulative share of the losses of the associate exceeds the cost of the investment, the investor discontinues recognising its share of future losses. Even though profits are recorded by the associate in the 2013–14 year, the balance of the investment stays at zero because the profits are not sufficient to offset losses not reognised. The journal entries in the consolidation worksheets of Grace Ltd over these periods are: 30 June 2011

30 June 2012

30 June 2013

30 June 2014 30 June 2015

LO8

C.8

Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures Retained Earnings (1/7/11) Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures Retained Earnings (1/7/12) Investments in Associates and Joint Ventures Retained Earnings (1/7/13) Investments in Associates and Joint Ventures Retained Earnings (1/7/14) Investments in Associates and Joint Ventures Share of Profit or Loss of Associates and Joint Ventures

5 000

Cr Dr Cr

5 000 50 000 5 000 45 000

Cr Dr Dr Cr Dr Cr Dr Cr Cr

55 000 45 000 100 000 100 000 100 000 100 000 98 500 1 500

DISCLOSURE Requirements in relation to disclosure of information about investments in associates are not found in IAS 28. IFRS 12 Disclosure of Interests in Other Entities was issued in 2011 and included in the ‘other entities’ that the standard applies to are associates and joint ventures. This standard applies to annual reporting periods beginning on or after 1 January 2013. As stated in paragraph 1 of IFRS 12, the key objective of this standard is to require an entity to disclose information that enables users of its financial statements to evaluate: (a) the nature of, and risks associated with, its interests in other entities (b) the effects of those interests on its financial position, financial performance and cash flows. Notice the emphasis on the ability of users of financial statements to be able to evaluate risks. In the introduction to IFRS 12, in paragraph IN5, the IASB noted that the global financial crisis that started

PART 4 Economic entities

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in 2007 highlighted a lack of transparency about the risks to which a reporting entity was exposed from its involvement with structured entities. As a result, IFRS 12 (see paragraphs 2(a), 7 and 9) requires an entity to disclose the significant judgements and assumptions it has made in determining the nature of its interest in another entity, and in particular judgements, assumptions and changes in these. The following are examples of situations where it is necessary for an investor to disclose significant judgements and assumptions in relation to associates: • where it does not have significant influence even though it holds 20% or more of the voting rights of another entity • where it has significant influence even though it holds less than 20% of the voting rights of another entity. An entity is required to disclose information that enables users to evaluate the nature, extent and financial effects of its interest in associates and joint ventures, including the nature and effects of its contractual relationship with other investors (IFRS 11 paragraph 20). To achieve this, the following disclosures are required by paragraph 21 of IFRS 12: (a) for each joint arrangement and associate that is material to the reporting entity: (i) the name of the joint arrangement or associate. (ii) the nature of the entity’s relationship with the joint arrangement or associate (by, for example, describing the nature of the activities of the joint arrangement or associate and whether they are strategic to the entity’s activities). (iii) the principal place of business (and country of incorporation, if applicable and different from the principal place of business) of the joint arrangement or associate. (iv) the proportion of ownership interest or participating share held by the entity and, if different, the proportion of voting rights held (if applicable). (b) for each joint venture and associate that is material to the reporting entity: (i) whether the investment in the joint venture or associate is measured using the equity method or at fair value. (ii) summarised financial information about the joint venture or associate as specified in paragraphs B12 and B13. (iii) if the joint venture or associate is accounted for using the equity method, the fair value of its investment in the joint venture or associate, if there is a quoted market price for the investment. (c) financial information as specified in paragraph B16 about the entity’s investments in joint ventures and associates that are not individually material: (i) in aggregate for all individually immaterial joint ventures and, separately, (ii) in aggregate for all individually immaterial associates.

The summarised information in paragraph (b)(ii) above consists of: 1. For each joint venture and associate that is material to the reporting entity, an entity shall disclose: (a) dividends received from the joint venture or associate. (b) summarised financial information for the joint venture or associate including, but not necessarily limited to: (i) current assets (ii) non-current assets (iii) current liabilities (iv) non-current liabilities (v) revenue (vi) profit or loss from continuing operations (vii) post-tax profit or loss from discontinued operations (viii) other comprehensive income (ix) total comprehensive income. 2. In addition to the summarised financial information above, an entity has to disclose for each joint venture that is material to the reporting entity the amount of: (a) cash and cash equivalents (b) current financial liabilities (excluding trade and other payables and provisions) (c) non-current financial liabilities (excluding trade and other payables and provisions) (d) depreciation and amortisation (e) interest income (f) interest expense (g) income tax expense or income. Further required disclosures, as detailed in IFRS 12 paragraph 22 are those relating to: • significant restrictions on the ability of associates to transfer funds to the investor — these transfers could relate to dividend payments or repayment of loans • different reporting dates used by the investor and an associate — the disclosure consists of stating the date at the end of the reporting period for the associate as well the reason for using a different period or date

C Associates and joint ventures

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• losses made by an associate — an investor must disclose the unrecognised share of losses made by an associate both for the reporting period and cumulatively where the equity method has been discontinued. Where the interest in an associate or joint venture is immaterial, an entity must disclose aggregated information for all immaterial investments (IFRS 12 paragraph B16). In particular, an entity must disclose the aggregated amount of its share of the joint venture’s or associate’s: (a) proﬁt or loss from continuing operations (b) post-tax proﬁt or loss from discontinued operations (c) other comprehensive income (d) total comprehensive income.

SUMMARY This chapter has covered the principles of accounting for investments in associates and joint ventures as contained in IAS 28 Investments in Associates and Joint Ventures. Some of the key principles are: • Besides subsidiaries, an entity may have investments in other entities, known as associates and joint ventures, with which the entity has a special relationship. • An entity over which an investor has significant influence in the determination of financial and operating policy decisions is referred to as an associate. • Where an investor is involved in an investment where there is a contractually agreed sharing of control such that decisions require the unanimous consent of the parties sharing control, the investor has joint control over the investee. • The equity method is designed to provide more information about an investment than generally supplied under the cost method, but less information than supplied under the consolidation method. • Under the equity method, an investor recognises an increase in equity as well as an increase in the investment in an investee based upon the investor’s proportionate interest in the investee. • In applying the equity method, adjustments to equity balances recorded by the investee are made to eliminate any pre-acquisition equity. • Adjustments are also made to eliminate the effects of inter-entity transactions. These are made for both upstream and downstream transactions with amounts being calculated based on the investor’s proportional interest in the investee. • Where an investee incurs losses, an investment in an investee cannot be reduced below zero, with the application of the equity method being discontinued.

Discussion questions 1. What is an associate entity? 2. Why are associates distinguished from other investments held by the investor? 3. Discuss the similarities and differences between the criteria used to identify subsidiaries and those used to identify associates. 4. What is meant by ‘significant influence’? 5. What factors could be used to indicate the existence of significant influence? 6. What is a joint venture? 7. What is meant by joint control? 8. How does joint control differ from control as applied on consolidation? 9. Discuss the relative merits of accounting for investments by the cost method, the fair value method and the equity method. 10. Outline the accounting adjustments required in relation to transactions between the investor and an associate/joint venture. Explain the rationale for these adjustments. 11. Compare the accounting for the effects of inter-entity transactions for transactions between parent entities and subsidiaries and between investors and associates/joint ventures. 12. Discuss whether the equity method should be viewed as a form of consolidation or a valuation technique. 13. Explain why equity accounting is sometimes referred to as ‘one-line consolidation’. 14. Explain the differences in application of the equity method of accounting where the method is applied in the records of the investor compared with the application in the consolidation worksheet of the investor. 15. Explain the treatment of dividends from the associate under the equity method of accounting.

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Exercises Exercise C.1 ★

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STAR RATING ★ BASIC

★★ MODER ATE

★★★ DIFFICULT

SIGNIFICANT INFLUENCE

The accountant of Cornett Chocolates Ltd, Ms Fraulein, has been advised by her auditors that the entity’s investment in Concertina’s Milk Ltd should be accounted for using the equity method of accounting. Cornett Chocolates Ltd holds only 20.2% of the voting shares currently issued by Concertina’s Milk Ltd. Since the investment was undertaken purely for cash flow reasons based on the potential dividend stream from the investment, Ms Fraulein does not believe that Cornett Chocolates Ltd exerts significant influence over the investee. Required

Exercise C.2 ★

ADJUSTMENTS WHERE INVESTOR PREPARES AND DOES NOT PREPARE CONSOLIDATED FINANCIAL STATEMENTS

Sarah Ltd acquired a 30% interest in Madison Ltd for $50 000 on 1 July 2013. The equity of Madison Ltd at the acquisition date was: Share capital Retained earnings

$ 30 000 120 000

All the identiﬁable assets and liabilities of Madison Ltd were recorded at fair value. Proﬁts and dividends for the years ended 30 June 2014 to 2016 were as follows:

2014 2015 2016

Profit before tax $80 000 70 000 60 000

Income tax expense $30 000 25 000 20 000

Dividends paid $80 000 15 000 10 000

Required

1. Prepare journal entries in the records of Sarah Ltd for each of the years ended 30 June 2014 to 2015 in relation to its investment in the associate/joint venture, Madison Ltd. (Assume Sarah Ltd does not prepare consolidated ﬁnancial statements.) 2. Prepare the consolidation worksheet entries to account for Sarah Ltd’s interest in the associate/joint venture, Madison Ltd. (Assume Sarah Ltd does prepare consolidated ﬁnancial statements.)

Exercise C.3 ★

ACCOUNTING FOR AN ASSOCIATE/JOINT VENTURE BY AN INVESTOR

Jasmine Ltd acquired a 40% interest in Hayley Ltd for $170 000 on 1 July 2014. The share capital, reserves and retained earnings of Hayley Ltd at the acquisition date and at 30 June 2015 were as follows:

Share capital Asset revaluation surplus General reserve Retained earnings

1 July 2014

30 June 2015

$300 000 — — 100 000 $400 000

$300 000 100 000 15 000 109 000 $524 000

At 1 July 2014, all the identiﬁable assets and liabilities of Hayley Ltd were recorded at fair value. The following is applicable to Hayley Ltd for the year to 30 June 2015: (a) Proﬁt (after income tax expense of $11 000): $39 000 (b) Increase in reserves – General (transferred from retained earnings): $15 000 – Asset revaluation (revaluation of freehold land and buildings at 30 June 2015): $100 000 C Associates and joint ventures

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(c) Dividends paid to shareholders: $15 000 (d) The tax rate is 30%. (e) Jasmine Ltd does not prepare consolidated ﬁnancial statements. Required

Prepare the journal entries in the records of Jasmine Ltd for the year ended 30 June 2015 in relation to its investment in the associate, Hayley Ltd.

Exercise C.4 ★

INTER-ENTITY TRANSACTIONS WHERE INVESTOR HAS NO SUBSIDIARIES

Imogen Ltd acquired 20% of the ordinary shares of Chelsea Ltd on 1 July 2014. At this date, all the identifiable assets and liabilities of Imogen Ltd were recorded at fair value. An analysis of the acquisition showed that $2000 of goodwill was acquired. Imogen Ltd has no subsidiaries, and records its investment in the associate, Chelsea Ltd, in accordance with IAS 28. In the 2015–16 period, Chelsea Ltd recorded a profit of $100 000, paid an interim dividend of $10 000 and, in June 2015, declared a further dividend of $15 000. In June 2011, Chelsea Ltd had declared a $20 000 dividend, which was paid in August 2015, at which date it was recognised by Imogen Ltd. The following transactions have occurred between the two entities (all transactions are independent unless specified): (a) In January 2016, Chelsea Ltd sold inventory to Imogen Ltd for $15 000. This inventory had previously cost Chelsea Ltd $10 000, and remains unsold by Imogen Ltd at the end of the period. (b) In February 2016, Imogen Ltd sold inventory to Chelsea Ltd at a before-tax profit of $5000. Half of this was sold by Chelsea Ltd before 30 June 2016. (c) In June 2015, Chelsea Ltd sold inventory to Imogen Ltd for $18 000. This inventory had cost Chelsea Ltd $12 000. At 30 June 2015, this inventory remained unsold by Imogen Ltd. However, it was all sold by Imogen Ltd before 30 June 2016. The tax rate is 30%. Required

Prepare the journal entries in the records of Imogen Ltd in relation to its investment in Chelsea Ltd for the year ended 30 June 2016.

Exercise C.5 ★

INVESTOR PREPARES CONSOLIDATED FINANCIAL STATEMENTS, MULTIPLE PERIODS

On 1 July 2012, Sophia Ltd purchased 30% of the shares of Lara Ltd for $60 050. At this date, the ledger balances of Lara Ltd were: Capital Other reserves Retained earnings

$150 000 30 000 15 000 $195 000

Assets Less: Liabilities

$225 000 30 000 $195 000

At 1 July 2012, all the identiﬁable assets and liabilities of Lara Ltd were recorded at fair value except for plant whose fair value was $5000 greater than carrying amount. This plant has an expected future life of 5 years, the beneﬁts being received evenly over this period. Dividend revenue is recognised when dividends are declared. The tax rate is 30%. The results of Lara Ltd for the next 3 years were:

Profit/(loss) before income tax Income tax expense Profit/(loss) Dividend paid Dividend declared

30 June 2013

30 June 2014

30 June 2015

$ 50 000 20 000 30 000 15 000 10 000

$40 000 20 000 20 000 5 000 5 000

$ (5 000) — (5 000) 2 000 1 000

Required

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Exercise C.6 ★★

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CONSOLIDATED WORKSHEET ENTRIES TO INCLUDE INVESTMENT IN ASSOCIATE

On 1 July 2013, Caitlin Ltd acquired 30% of the shares of Alyssa Ltd for $60 000. At this date, the equity of Alyssa Ltd consisted of: Share capital (100 000 shares) Asset revaluation surplus Retained earnings

$ 100 000 50 000 20 000

On 1 July 2015, the ownership interest of 30%, together with board representation and a diverse spread of remaining shareholders, was sufficient for the investor to demonstrate significant influence, and accordingly to begin accounting for the investment as an associate. The fair value of the 30% interest in Alyssa Ltd at 1 July 2013 was $70 000. At this date, the equity of Alyssa Ltd consisted of: Share capital (100 000 shares) Asset revaluation surplus General reserve Retained earnings

$ 100 000 60 000 10 000 40 000

At this date, all the identiﬁable assets and liabilities of Alyssa Ltd were recorded at fair value except for the following assets:

Machinery Inventory

Carrying amount $20 000 10 000

Fair value $25 000 12 000

The machinery was expected to have a further 5-year life, benefits being received evenly over this period. The inventory was all sold by 30 June 2016. Dividends paid by Alyssa Ltd in the 2013–14 period were $10 000, and $12 000 was paid in the 2014–15 period. In June 2015, Alyssa Ltd declared a dividend of $10 000. Dividend revenue is recognised when dividends are declared. During the period ending 30 June 2015, the following events occurred: (a) Alyssa Ltd sold to Caitlin Ltd some inventory, which had previously cost Alyssa Ltd $8000, for $10 000. Caitlin Ltd still had one-quarter of these items on hand at 30 June 2016. (b) On 1 January 2016, Caitlin Ltd sold a non-current asset to Alyssa Ltd for $50 000, giving a profit before tax of $10 000 to Caitlin Ltd. Alyssa Ltd applied a 12% p.a. on cost straight-line depreciation method to this asset. (c) On 31 December 2015, Alyssa Ltd paid an interim dividend of $5000. (d) At 30 June 2016, Alyssa Ltd calculated that it had earned a profit of $32 000, after an income tax expense of $8000. Alyssa Ltd then declared a $5000 dividend, to be paid in September 2016, and transferred $3000 to the general reserve. (e) The tax rate is 30%. Required

Prepare the journal entries for the consolidation worksheet of Caitlin Ltd at 30 June 2016 for the inclusion of the equity-accounted results of Alyssa Ltd. Exercise C.7 ★★

ADJUSTMENTS WHERE INVESTOR DOES AND DOES NOT PREPARE CONSOLIDATED FINANCIAL STATEMENTS

On 1 July 2014, Zara Ltd acquired a 30% interest in one of its suppliers, Eva Ltd, at a cost of $13 650. The directors of Zara Ltd believe they exert ‘signiﬁcant inﬂuence’ over Eva Ltd. The equity of Eva Ltd at acquisition date was: Share capital (20 000 shares) Retained earnings

$ 20 000 10 000

All the identiﬁable assets and liabilities of Eva Ltd at 1 July 2014 were recorded at fair values except for some depreciable non-current assets with a fair value of $15 000 greater than carrying amount. These depreciable assets are expected to have a further 5-year life. Additional information (a) At 30 June 2016, Zara Ltd had inventory costing $100 000 (2013: $60 000) on hand which had been purchased from Eva Ltd. A proﬁt before tax of $30 000 (2015: $10 000) had been made on the sale. C Associates and joint ventures

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(b) All companies adopt the recommendations of IAS 12 regarding tax-effect accounting. Assume a tax rate of 30% applies. (c) Information about income and changes in equity of Eva Ltd as at 30 June 2016 is: Profit before tax Income tax expense Profit Retained earnings at 1/7/15

$360 000 180 000 180 000 50 000 230 000

Dividend paid Dividend declared Retained earnings at 30/6/16

$50 000 50 000

100 000 $130 000

(d) All dividends may be assumed to be out of the proﬁt for the current year. Dividend revenue is recognised when declared by directors. (e) The equity of Eva Ltd at 30 June 2016 was: Share capital Asset revaluation surplus General reserve Retained earnings

$ 20 000 30 000 5 000 130 000

The asset revaluation surplus arose from a revaluation of freehold land made at 30 June 2016. The general reserve arose from a transfer from retained earnings in June 2015. Required

1. Assume Zara Ltd does not prepare consolidated ﬁnancial statements. Prepare the journal entries in the records of Zara Ltd for the year ended 30 June 2016 in relation to the investment in Eva Ltd. 2. Assume Zara Ltd does prepare consolidated ﬁnancial statements. Prepare the consolidated worksheet entries for the year ended 30 June 2016 for inclusion of the equity-accounted results of Eva Ltd. Exercise C.8 ★★

CONSOLIDATED FINANCIAL STATEMENTS INCLUDING INVESTMENTS IN ASSOCIATES

Sam Ltd acquired 90% of the ordinary shares of Paige Ltd on 1 July 2011 at a cost of $150 750. At that date the equity of Paige Ltd was: Share capital (100 000 shares) Reserve Retained earnings

$ 100 000 8 000 12 000

At 1 July 2011, all the identiﬁable assets and liabilities of Paige Ltd were at fair value except for the following assets:

Inventory Depreciable assets

Carrying amount $10 000 25 000

Fair value $15 000 35 000

The inventory was all sold by 30 June 2012. Depreciable assets have an expected further 5-year life, with depreciation being calculated on a straight-line basis. Valuation adjustments are made on consolidation. Sam Ltd uses the partial goodwill method. On 1 July 2014, Sam Ltd acquired 25% of the capital of Kayla Ltd for $3500 entering into a joint venture with three other venturers. All the identiﬁable assets and liabilities of Kayla Ltd were recorded at fair value except for the following:

Inventory Depreciable assets

Carrying amount $1 000 6 000

Fair value $1 500 7 000

All this inventory was sold in the 12 months after 1 July 2014. The depreciable assets were considered to have a further 5-year life. 30

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Information on Kayla Ltd’s equity position is as follows:

Share capital General reserve Retained earnings

1 July 2014 $10 000 — 2 150

30 June 2015 $10 000 2 000 4 000

For the year ended 30 June 2016, Kayla Ltd recorded a profit before tax of $2600 and an income tax expense of $600. Kayla Ltd paid a dividend of $200 in January 2016. Sam Ltd regards Kayla Ltd as a joint venture investee. During the year ended 30 June 2016, Kayla Ltd sold inventory to Paige Ltd for $6000. The cost of this inventory to Kayla Ltd was $4000. Paige Ltd has resold only 20% of these items. However, Paige Ltd made a profit before tax of $500 on the resale of these items. On 1 January 2015, Sam Ltd sold Kayla Ltd a motor vehicle for $4000, at a profit before tax of $800 to Sam Ltd. Both companies treat motor vehicles as non-current assets. Both companies charge depreciation at 20% p.a. on the reducing balance. Assume a tax rate of 30%. Information about income and changes in equity for Sam Ltd and its subsidiary, Paige Ltd, for the year ended 30 June 2016 is as follows: Sam Ltd $200 000 110 000 90 000 16 000 22 000 38 000 52 000 30 000 82 000 20 000 62 000 120 000 182 000 20 000 $ 162 000

Sales revenue Less: Cost of sales Gross profit Less: Depreciation Other expenses

Plus: Other revenue Profit before income tax Less: Income tax expense Profit Plus: Retained earnings (1/7/15) Less: Dividend paid Retained earnings (30/6/16)

Paige Ltd $60 000 30 000 30 000 4 000 3 000 7 000 23 000 5 000 28 000 10 000 18 000 80 000 98 000 4 000 $94 000

Required

1. Prepare the consolidated statement of proﬁt or loss and other comprehensive income and statement of changes in equity of Sam Ltd and its subsidiary Paige Ltd as at 30 June 2016. 2. In the consolidated statement of ﬁnancial position, what would be the balance of the investment shares in Kayla Ltd? Exercise C.9

CONSOLIDATION WORKSHEET ENTRIES INCLUDING INVESTMENTS IN JOINT VENTURES

★★★ You are given the following details for the year ended 30 June 2016:

Profit before tax Income tax expense Profit Retained earnings at 1 July 2015 Dividend paid Dividend declared Transfer to general reserve (from current period’s profit) Retained earnings at 30 June 2016

Amber Ltd

Molly Ltd

Kate Ltd

$100 000 31 000 69 000 20 000 89 000 14 000 15 000

$30 000 10 000 20 000 12 000 32 000 6 000 4 000

$25 000 6 000 19 000 11 000 30 000 2 000 8 000

10 000 39 000 $ 50 000

5 000 15 000 $17 000

6 000 16 000 $14 000

C Associates and joint ventures

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Additional information (a) Amber Ltd owns 80% of the participating shares in Molly Ltd and 20% of the shares in Kate Ltd. Amber Ltd has entered into a contractual arrangement with four other venturers in relation to Kate Ltd, and the ﬁve investors have a joint control arrangement in relation to Kate Ltd (b) On 1 July 2014, all identiﬁable assets and liabilities of Molly Ltd were recorded at fair value. Amber Ltd purchased 80% of Molly Ltd’s shares on 1 July 2014, and paid $5000 for goodwill, none of which had been recorded on Molly Ltd’s records. Amber Ltd uses the partial goodwill method. (c) At the date Amber Ltd acquired its shares in Kate Ltd, Kate Ltd’s recorded equity was: Share capital General reserve Retained earnings

$ 100 000 15 000 5 000

All the identifiable assets and liabilities of Kate Ltd were recorded at fair value. Amber Ltd paid $25 000 for its shares in Kate Ltd on 1 July 2014. There was $3000 transferred to general reserve by Kate Ltd in the year ended 30 June 2013, out of equity earned since 1 July 2014. (d) Included in the beginning inventory of Amber Ltd were profits before tax made by Molly Ltd: $5000; Kate Ltd: $3000. (e) Included in the ending inventory of Molly Ltd were profits before tax made by Kate Ltd: $4000. (f) Kate Ltd had recorded a profit (net of $500 tax) of $2000 in selling certain non-current assets to Amber Ltd on 1 January 2016. Amber Ltd treats the items as non-current assets and charges depreciation at the rate of 25% p.a. straight-line from that date. (g) Amber Ltd purchased for $10 000 an item of plant from Molly Ltd on 1 September 2014. The carrying amount of the asset at that date was $7000. The asset was depreciated at the rate of 20% p.a. straightline from 1 September 2014. (h) During the year ended 30 June 2016, Kate Ltd has revalued upwards one of its non-current assets by $8000. There had been no previous downward revaluations. (i) Dividend revenue is recognised when dividends are declared. (j) The tax rate is 30%. Required

Prepare the consolidation worksheet entries (in general journal form) needed for the consolidated statements for the year ended 30 June 2016 for Amber Ltd and its subsidiary Molly Ltd. Include the equityaccounted results of Kate Ltd.

PART 4 Economic entities

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D Joint arrangements ACCOUNTING STANDARDS IN FOCUS

LEARNING OBJECTIVES

IFRS 11 Joint Arrangements

After studying this chapter, you should be able to: 1

discuss the use of joint arrangements by companies to structure their business

explain the nature of a joint arrangement and how to classify joint arrangements into joint ventures and joint operations

explain the accounting undertaken by the joint operation itself

prepare the journal entries required by a joint operator to recognise its share of the assets, liabilities, revenues and expenses of the joint operation

discuss the disclosures required in relation to joint operations.

D Joint arrangements

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LO1

D.1

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INTRODUCTION AND SCOPE This chapter is concerned with situations where companies join together to achieve a common goal. These companies sign contracts which require all companies involved to act together, to agree on the major decisions involving what the companies do in relation to specified projects. The purpose of joining together may be for varied reasons. Sometimes it is to share costs, or to manage the risk involved in the project. Alternatively it may be done to provide the parties with access to new technology or new markets. These contractual arrangements, if they meet certain conditions, are described as joint arrangements, the key feature of which is that the parties involved have joint control over the decision making in relation to the joint arrangement. Joint arrangements are particularly useful when developing new technologies as there are often major risks in terms of eventual success. Further, entities may prefer to join together to interrelate research findings and knowledge in relation to their new technology developments. For example, Perrin (2011) wrote that: Australian renewable energy company CBD Energy has disclosed to the ASX it would finalise its joint venture with two of China’s largest renewable companies and pursue A$6 billion worth of renewable energy products in the coming years. The joint venture will form the AusChina Energy Group which plans to develop renewable projects, both wind and solar, over eight years and become a significant participant in the Australian energy market.

There are three companies involved in this project: Datang Corp Renewable Power Co Ltd, China’s second largest wind power producer, has a 63.75% interest in the company; Baoding Tianwei Baobian Electric Co, which makes power transformers in China, has a 12.5% interest; and, ﬁnally, Australia’s power storage company CBD Energy Ltd has a 23.75% interest (CBD Energy 2012). As Australia has set a national target of 20% renewable energy generation by 2020, this new company plans to develop new technologies useful in both the Australian and overseas markets. Note that joint arrangements do not need to have investors that have equal interests in the project. As explained later in this chapter, decision making of the arrangement on a joint control basis is a key element of a joint arrangement and requires the unanimous agreement of all parties involved. This chapter examines accounting standard IFRS 11 Joint Arrangements, issued by the International Accounting Standards Board (IASB®) in May 2011. IFRS 11 deals with both joint ventures and joint operations. While accounting for joint ventures has been discussed previously (see online chapter C), this chapter focuses on accounting for joint operations.

LO2

D.2

D.2.1

JOINT ARRANGEMENTS: CHARACTERISTICS AND CLASSIFICATION The characteristics of a joint arrangement The term ‘arrangement’ describes an activity or an operation or a specific grouping of assets and liabilities, which may or may not form a legal entity such as a company. A joint arrangement arises where two or more entities have an arrangement between each other such that these entities have joint control of the arrangement (IFRS 11 paragraph 4). For example, Entity A and Entity B may agree to form Entity C and the management of Entity C is under the joint control of both Entity A and Entity B. A joint arrangement has two main characteristics (IFRS 11 paragraph 5). 1. The parties are bound by a contractual arrangement. The agreement between the parties is in the form of a contract which would generally be in writing. The contractual arrangement may be written into the articles of association or constitution of the entities themselves. The agreement sets out the terms under which the parties agree to participate in relation to the joint activity. As explained in IFRS 11 paragraph B4, it would contain such matters as: (a) the purpose, activity and duration of the joint arrangement (b) how the members of the board of directors are appointed (c) the decision-making process, the matters requiring decisions, the voting rights of the parties and the required level of support for these matters (d) the capital or other contributions required of the parties (e) how the parties share assets, liabilities, revenues, expenses or profit or loss relating to the joint arrangement. An example of where a contractual arrangement is necessary in order for a joint arrangement to exist is shown in figure D.1.

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Assume an arrangement in which A and B each have 35% of the voting rights in the arrangement with the remaining 30% being widely dispersed. Decisions about the relevant activities require approval by a majority of the voting rights. If there is a contractual arrangement between A and B which specifies that decisions about the relevant activities of the arrangement require both A and B agreeing, then A and B have joint control over the arrangement. No decision about the relevant activities can be made without the agreement of both A and B. In the absence of such an agreement, no entity has any form of control over the arrangement as a decision can be made about the relevant activities if any combination of either A, B or C agree to it. In such a case, A and B may be considered to have significant influence over the arrangement, but not control or joint control. FIGURE D.1 Contractual arrangements Source: Adapted from IFRS 11 — Example 3.

2. The contractual arrangement gives two or more parties joint control of the arrangement. The criterion that identifies a contractual arrangement as a joint arrangement is that of joint control. As explained in IFRS 11 paragraph 7, joint control exists when: (a) there exists a contractually agreed sharing of control (b) the agreement is that decisions about the relevant activities require the unanimous consent of the parties sharing control (i.e. no party can make a unilateral decision about relevant activities). Each party that has joint control is referred to as a joint venturer or a joint operator. Other parties in the joint arrangement are a party to a joint arrangement. In the example in figure D.1, if there is a contractual agreement between A and B, then A and B are joint venturers or joint operators while the holders of the widely dispersed 30% of voting interests are parties to the joint arrangement. Where a joint arrangement exists there is no single party that has control. The joint venturers/operators must act together to manage the affairs of the arrangement. In assessing whether joint control exists judgement will need to be exercised, and all facts and circumstances will need to be examined. If the facts and circumstances change, then a reassessment of the existence of joint control is necessary (IFRS 11 paragraph 13). Note that the agreement may not use the term ‘joint control’ but the existence of joint control may be implicit in the arrangement. For example, consider a situation where A and B each have 50% of the voting interest in an arrangement and under the terms of the contract any decision about relevant activities requires at least 51% of the votes. In such a case, decisions can be made only where A and B agree. The terms of the contract require A and B to act jointly even if the contractual agreement does not refer to joint control. There are two steps in the assessment of the existence of joint control: 1. Assess whether the parties to the arrangement have control. Control is defined in IFRS 10 Consolidated Financial Statements and exists in a joint arrangement when two or more investors in the arrangement are exposed, or have rights, to variable returns from their involvement with the arrangement, and have the ability to affect those returns through their power over the arrangement. Control must be over the ‘relevant’ activities. These are also defined in IFRS 10 and refer to those activities of the arrangement that significantly affect the returns of the arrangement. 2. Assess whether two or more parties have joint control. The control over the arrangement must be in the hands of more than one party to the arrangement. This assessment requires the determination of the existence of a contractual arrangement requiring the unanimous consent of the parties sharing control in relation to the relevant activities.

D2.2

The classification of a joint arrangement Having determined that a joint arrangement exists, it is then necessary to classify it. There are two types of joint arrangements, namely joint ventures and joint operations (IFRS 11 paragraphs 15, 16): • Joint operation: an arrangement in which the parties that have joint control have rights to the assets and obligations for the liabilities relating to the arrangement. These parties are called joint operators. • Joint venture: the parties that have joint control have rights to the net assets of the arrangement. These parties are called joint venturers. Note in particular that the key element in the classiﬁcation of a joint arrangement is the rights and obligations of the parties to the arrangement (IFRS 11 paragraph 14). For a joint operation, the rights pertain to the rights and obligations associated with individual assets and liabilities, whereas with a joint venture, the rights and obligations pertain to the net assets; that is, the investment in net assets. D Joint arrangements

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The assessment of the classification of a joint arrangement is not straightforward; it requires judgement. As outlined in IFRS 11 paragraph 17, the assessment of the rights and obligations in an arrangement involves analysing four factors: 1. the structure of the arrangement 2. the legal form of the arrangement 3. the terms agreed to by the parties in the contractual arrangement 4. any other relevant facts and circumstances. Consider each of these factors separately. 1. Structure of the arrangement The main factor here is whether or not the arrangement is or is not structured through a ‘separate vehicle’. A separate vehicle is defined in Appendix A of IFRS 11 as ‘a separately identifiable financial structure, including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality’. A separate vehicle would include a company. For example, if the airlines Singapore Airlines and Cathay Pacific formed a company, Scandinavian Airlines, to manage flights between countries such as Sweden, Finland, Norway and Denmark, then Scandinavian Airlines would be a separate vehicle. If the joint arrangement is not structured through a separate vehicle, then the arrangement is classified as a joint operation (IFRS 11 paragraph B16). The contractual arrangement would establish the parties’ rights to the assets and obligations for the liabilities of the arrangement as well as the rights to revenues and obligations for expenses of the arrangements. For example, the government may put out tenders to build a fighter aircraft for the German air force. Three companies put in a joint tender which is successful. The three companies establish a joint arrangement under which Company A builds the engines for the aircraft, Company B builds the aircraft itself, while Company C is responsible for the computer software for the aircraft. Each company is then responsible for a specific task and uses its own assets and incurs its own liabilities in relation to the agreed task. If the joint arrangement is structured through a separate vehicle, then the arrangement can be either a joint operation or a joint venture. This determination is based on an analysis of the remaining three factors noted above. This classification process may be expressed in the form of a decision tree as shown in figure D.2. 2. The legal form of the separate vehicle In considering the legal form of the separate vehicle the main area of interest is how the legal form affects the rights to the assets and obligations for the liabilities. If the legal form establishes rights to individual assets and obligations, the arrangement is a joint operation. If the legal form establishes rights to the net assets of the arrangement, then the arrangement is a joint venture. To establish the arrangement as a joint operation, the legal form of the separate vehicle must not confer separation between the parties and the separate vehicle. The assets and liabilities of the separate vehicle must be the parties’ assets and liabilities, and not those of the separate vehicle itself. Note, however, that an assessment of the legal form may not be sufficient. The terms of the contractual arrangement may override the legal form. In other words, just because the legal form of the separate vehicle is a company does not mean that the arrangement is a joint venture. 3. The terms of the contractual arrangement Generally the choice of the legal form of the arrangement would be such as to reflect the rights and obligations of the parties to the arrangement. However, in other cases, the terms of the contractual arrangement may override the rights and obligations conferred by the legal form chosen. For example, the form of the structured vehicle may be an incorporated entity. Being an incorporated entity, the entity is separate from the owners of the entity. Incorporation establishes that the assets and liabilities of the entity are separate from those of the owners of the entity. The legal form is such that the owners have rights to the net assets of the entity. However, the contractual arrangement could be written such that the owners are given an interest in the individual assets of the incorporated entity and are responsible for the liabilities of the incorporated entity. The legal form would have suggested that a joint venture exists; however, the terms of the contractual arrangement have modified the legal form such that the arrangement is a joint operation. 4. Other facts and circumstances The terms of the contractual arrangement may not specify the rights and obligations of the parties to the assets and liabilities of the joint arrangements. An assessment of other facts and circumstances of the arrangement may assist in classifying the arrangement. One fact to consider is whether the arrangement is designed to provide output to the parties to the arrangement. In the example used above where the airlines Singapore Airlines and Cathay Pacific established Scandinavian Airlines, it would be usual for Scandinavian Airlines to be managed with the objective of producing a profit for the company with dividends being paid to the owners of that company.

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Structure of the joint arrangement

Not structured through a separate vehicle

Structured through a separate vehicle

An entity shall consider: (i) the legal form of the separate vehicle (ii) the terms of the contractual arrangement, and (iii) when relevant, other facts and circumstances

Joint operation

Joint venture

FIGURE D.2 Classification of a joint arrangement — assessment of the parties’ rights and obligations arising from the arrangement Source: IFRS 11, Appendix B.

However, in other situations, a joint arrangement may be established with the objective of producing a product that is distributed to the owners of the company who then decide on how to use or sell that product. The profit is then generated by the owners of the company subsequent to receipt of the output from the joint arrangement. For example, two companies may agree to work together to produce bottled water from a mountain spring. The agreement is that the output from the arrangement, namely bottled water, is then distributed to each of the joint operators. Each operator is then responsible for distributing the bottled water under its own label for sale and marketing purposes. The joint operation manufactures the product and determines a cost of the output to the joint operators. The parties to the joint arrangement have a right to substantially all the economic benefits of the assets held by the arrangement. Another feature of such arrangements is, as a result of the decision to supply the output of the joint arrangement to the parties themselves, there is no cash inflow to the joint arrangement from the sale of the product. The joint arrangement relies solely on the parties to the arrangement for the supply of cash to continue the operations of the arrangement as well as to pay for the liabilities incurred by the arrangement. The parties themselves are then responsible for the liabilities of the arrangement as the latter has no facility to be able to generate cash for the settlement of liabilities. Figure D.3 contains an example of where the structured vehicle is an incorporated entity. The assets and liabilities of the incorporated entity are those of the entity. However, the facts and circumstances are such that the incorporated entity produces output that is distributed to the owners of the incorporated entity. Note the form of the arrangement given in figure D.3 leads to the conclusion that the incorporated entity is a joint operation, not a joint venture.

D Joint arrangements

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Assume that two parties structure a joint arrangement in an incorporated entity (Entity C) in which each party has a 50% ownership interest. The purpose of the arrangement is to manufacture materials required by the parties for their own individual manufacturing processes. The arrangement ensures that the parties operate the facility that produces the materials to the quantity and quality specifications of the parties. The legal form of Entity C (an incorporated entity) through which the activities are conducted initially indicates that the assets and liabilities held in Entity C are the assets and liabilities of Entity C. The contractual arrangement between the parties does not specify that the parties have rights to the assets or obligations for the liabilities of Entity C. Accordingly, the legal form of Entity C and the terms of the contractual arrangement indicate that the arrangement is a joint venture. However, the parties also consider the following aspects of the arrangement: • The parties agreed to purchase all the output produced by Entity C in a ratio of 50:50. Entity C cannot sell any of the output to third parties, unless this is approved by the two parties to the arrangement. Because the purpose of the arrangement is to provide the parties with output they require, such sales to third parties are expected to be uncommon and not material. • The price of the output sold to the parties is set by both parties at a level that is designed to cover the costs of production and administrative expenses incurred by Entity C. On the basis of this operating model, the arrangement is intended to operate at a break-even level. From the fact pattern above, the following facts and circumstances are relevant: • The obligation of the parties to purchase all the output produced by Entity C reflects the exclusive dependence of Entity C upon the parties for the generation of cash flows and, thus, the parties have an obligation to fund the settlement of the liabilities of Entity C. • The fact that the parties have rights to all the output produced by Entity C means that the parties are consuming, and therefore have rights to, all the economic benefits of the assets of Entity C. These facts and circumstances indicate that the arrangement is a joint operation. The conclusion about the classification of the joint arrangement in these circumstances would not change if, instead of the parties using their share of the output themselves in a subsequent manufacturing process, the parties sold their share of the output to third parties. If the parties changed the terms of the contractual arrangement so that the arrangement was able to sell output to third parties, this would result in Entity C assuming demand, inventory and credit risks. In that scenario, such a change in the facts and circumstances would require reassessment of the classification of the joint arrangement. Such facts and circumstances would indicate that the arrangement is a joint venture. FIGURE D.3 Facts and circumstances affecting classification of joint arrangements Source: IFRS 11, Appendix B — Example 5.

The classiﬁcation of a joint arrangement structured through a separate vehicle may be seen as a decision tree as shown in ﬁgure D.4.

LO3

D.3

ACCOUNTING FOR JOINT ARRANGEMENTS The accounting for joint ventures is different from that of joint operations. Regarding a joint venture, the joint venturers have an interest in the investment in the joint arrangement. The accounting for this interest is done by application of the equity method in accordance with IAS 28 Investments in Associates and Joint Ventures. The details of accounting for joint ventures are given in online chapter C.

D3.1

Accounting by the joint operation itself Where the joint operation is undertaken outside a formal structure, such as a corporation or partnership, separate accounting records do not need to be kept for the joint operation. However, for accountability reasons it is expected that the joint operation agreement would require these records. IFRS 11 does not provide standards on accounting for the joint operation itself. If the joint operation does not sell the output produced, but rather distributes it to the operators, there is no proﬁt or loss account raised by the operation. In preparing accounts for the joint operation, the main purpose is to accumulate costs as incurred. These are capitalised into a work in progress account, which is transferred to the operators as inventory. Further, the joint operation accounts provide information about the assets and

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Legal form of the separate vehicle

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Does the legal form of the separate vehicle give the parties rights to the assets, and obligations for the liabilities, relating to the arrangement?

Yes

Terms of the contractual arrangement

Do the terms of the contractual arrangement specify that the parties have rights to the assets, and obligations for the liabilities, relating to the arrangement?

Yes

Joint operation

Other facts and circumstances

Have the parties designed the arrangement so that: (a) its activities primarily aim to provide the parties with an output (i.e. the parties have rights to substantially all the economic benefits of the assets held in the separate vehicle) and (b) it depends on the parties on a continuous basis for settling the liabilities relating to the activity conducted through the arrangement?

Yes

Joint venture FIGURE D.4 Classification of a joint arrangement structured through a separate vehicle Source: IFRS 11, Appendix B.

liabilities relating to the joint operation as well as the contributions from the operators. Hence, a statement of ﬁnancial position is the joint operation’s main ﬁnancial statement. Illustrative example D.1 demonstrates the accounting system within the joint operation. The journal entries represent the establishment of the joint operation and its activities throughout the year. Transactions that occur regularly throughout the year, such as payment of wages, are accumulated into one entry. From this example, we can see that the costs of producing the output are accumulated in the joint operation, and the inventory, at cost, distributed to the joint operators. In this example, all costs are capitalised into inventory. In some cases, the costs may be transferred to the operators’ accounts as expenses and matched in the records of the operators with the revenue from sale of the output. For example, if the joint operation involved exploring for minerals, it may be desirable to expense the costs of exploration and evaluation rather than capitalise them for allocation to future inventory. Similarly, where depreciation is charged on non-current assets, the depreciation expense may not, as in this example, be charged in the accounts of the joint operation itself. Instead, a charge for depreciation may be made in the records of each operator.

D Joint arrangements

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ILLUSTRATIVE EXAMPLE D.1 Accounting by an unincorporated joint operation

On 1 July 2015, Witte Ltd and Evertsen Ltd signed an agreement to form a joint operation to manufacture a product called Plasboard. This product is used in the packaging industry and has the advantages of the strength and protection qualities of cardboard as well as the ﬂexibility and durability of plastic. To commence the operation, both operators contributed $1 500 000 in cash. In the example it is assumed that not all the raw materials are used during the period, and not all ﬁnished goods have been transferred to the operators. The journal entries in the joint operation’s accounts for the year ended 30 June 2016 are as follows: • Contributions of cash by the operators Cash Witte Ltd — Contribution Evertsen Ltd — Contribution (Contributions by operators)

Dr Cr Cr

3 000 000

Equipment Cash Loan — Equipment (Acquisition of equipment)

Dr Cr Cr

800 000

Raw Materials Trade Creditors (Acquisition of materials)

Dr Cr

650 000

Dr Dr Cr Cr

200 000 520 000

Dr Cr

500 000

Loan — Equipment Cash (Part-payment for loan on equipment)

Dr Cr

100 000

Trade Creditors Cash (Payment of trade creditors)

Dr Cr

420 000

Overhead Expenses Cash (Payment of manufacturing expenses such as electricity)

Dr Cr

1 300 000

1 500 000 1 500 000

• Use of cash and loan to buy equipment and raw materials

500 000 300 000

650 000

• Payment of wages Wages — Management Wages — Other Cash Accrued Wages (Annual wages)

700 000 20 000

• Borrowing from the bank

Cash Bank Loan (Amount borrowed)

500 000

• Repayment of loan and other expenses

PART 4 Economic entities

100 000

420 000

1 300 000

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• Depreciation of equipment Depreciation Expense Accumulated Depreciation (Depreciation of equipment)

Dr Cr

80 000

Dr Cr Cr Cr Cr

2 580 000

Dr Cr

1 800 000

Dr Dr Cr

800 000 800 000

80 000

• Transfer of expenses to work in progress Work in Progress Wages Raw Materials Overhead Expenses Depreciation Expense (Allocating of costs to work in progress)

720 000 480 000 1 300 000 80 000

• Transfer from work in progress to inventory

Inventory Work in Progress (Allocation to finished goods)

1 800 000

• Transfer of inventory to operators throughout the year

Witte Ltd Evertsen Ltd Inventory (Delivery of output to operators)

1 600 000

The major ledger accounts of interest in relation to the joint operation are as follows: Cash Contribution — Witte Ltd Contribution — Evertsen Ltd Bank Loan

$ 1 500 000 1 500 000 500 000

Balance b/d

3 500 000 480 000

Equipment Wages Loan — Equipment Trade Creditors Overhead Expenses Balance c/d

$ 500 000 700 000 100 000 420 000 1 300 000 480 000 3 500 000

Work in Progress Wages Raw Materials Overhead Depreciation Balance b/d

$ 720 000 480 000 1 300 000 80 000 2 580 000 780 000

Inventory

Balance c/d

$ 1 800 000

780 000 2 580 000

D Joint arrangements

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The statement of ﬁnancial position of the joint operation at 30 June 2016 would be: Statement of Financial Position as at 30 June 2016 Current assets Raw materials Inventory Work in progress Cash Total current assets Non-current assets Equipment Accumulated depreciation Total assets

$ 170 000 200 000 780 000 480 000

Current liabilities Trade creditors Accrued wages Total current liabilities Non-current liabilities Bank loan Loan — equipment Total non-current liabilities Total liabilities Net assets Joint operators’ equity Witte Ltd: Contributions — at 1/7/15 Cost of inventory distributed Evertsen Ltd: Contributions — at 1/7/15 Cost of inventory distributed Total joint operators’ equity

LO4

D.4

$ 1 630 000 800 000 (80 000)

720 000 2 350 000

230 000 20 000 250 000 500 000 200 000 700 000 950 000 $ 1 400 000 1 500 000 (800 000) 1 500 000 (800 000)

700 000 700 000 $ 1 400 000

ACCOUNTING BY A JOINT OPERATOR The key feature of a joint operation is that the joint operator has an interest in the individual assets and liabilities of the joint operation. In the situation where the joint operation produces an output which is distributed to the joint operators, the joint operator will receive a share of the output of the joint operation as well as be responsible for a share of the expenses of the operation that are not capitalised into the cost of the output. Hence, each joint operator needs to recognise in its own accounts: (a) its share of any jointly held assets (b) its share of any jointly held liabilities (c) its revenue from the sale of any output received from the joint operation (d) its share of any revenue from the sale of any product that is jointly constructed by the joint operators (e) its share of any expenses incurred by the joint operation (f) its expenses incurred in construction of a joint product. So, in accounting for a joint operation where output is distributed to the joint operators, each joint operator will view the accounts of the joint operation as shown above (see section D.3.1) and calculate its share of each of the relevant accounts. At the end of each period, each venturer will analyse and account for movements in those accounts.

D.4.1

Contributions of cash to a joint operation Illustrative example D.2 demonstrates the entries required when joint operators’ contribute cash to a joint operation.

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ILLUSTRATIVE EXAMPLE D.2 Contribution of cash by a joint operator

On 1 July 2015, Lim Ltd and Wan Ltd establish a joint operation to manufacture a product. Each company has a 50% interest in the operation and shares output equally. To commence the operation, both companies contribute cash of $1 500 000 on 1 July 2015. Each operator depreciates equipment at 10% p.a. on cost. The following information was extracted from the accounts and ﬁnancial statements of the joint operation as at 30 June 2016: Statement of Financial Position (extract) as at 30 June 2016 Assets Cash Raw materials Work in progress Inventory Equipment Total assets

$ 420 000 100 000 650 000 200 000 1 500 000 2 870 000

Liabilities Accounts payable (raw materials) Accrued expenses (wages) Bank loan Total liabilities Net assets

120 000 150 000 1 000 000 1 270 000 $ 1 600 000

Cash Receipts and Payments for the year ended 30 June 2016 Payments Contributions Bank loan Equipment (purchased 3/7/15) Wages Accounts payable (raw materials) Overhead expenses

$ 1 500 000 500 000 380 000 1 200 000 $ 3 580 000

Receipts $ 3 000 000 1 000 000

$ 4 000 000

Costs Incurred for the year ended 30 June 2016 Wages Raw materials Overhead expenses

$ 650 000 400 000 1 200 000 2 250 000 1 600 000 $ 650 000

Less: Cost of inventory Work in progress at 30/6/16 Required

Prepare the journal entries in the records of Lim Ltd and Wan Ltd for the year ended 30 June 2016. Solution

Records of Lim Ltd At 1 July 2015, Lim Ltd records its interest in the joint operation, the asset cash being distinguished as an asset in a joint operation by the use of (JO): Cash in Joint Operation (JO) Cash (Contribution of cash to joint operation)

Dr Cr

1 500 000 1 500 000

D Joint arrangements

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At 30 June 2016, the joint operation has used the cash to acquire various assets, undertake loans, incur expenses and manufacture inventory. As a contributor of 50% of the cash into the joint operation, Lim Ltd is entitled to 50% of all the assets, liabilities, expenses and output of the joint operation. From the statement of financial position of the joint operation, it should be noted that the net assets of the joint operation amount to $1 600 000 (i.e. $2 870 000 − $1 270 000). The inventory in the statement of financial position is $200 000. From the costs incurred information, it can be seen that the joint operation has produced $1 600 000 worth of inventory. If only $200 000 is still on hand in the joint operation, then $1 400 000 worth of inventory must have been transferred to the joint operators (i.e. $700 000 each). On transfer of inventory to the joint operators, the joint operation reduces the inventory balance and reduces the equity contribution of the joint operators. The contributions section of the statement of financial position of the joint operation at the end of the period, after the transfer of inventory, is as follows. Lim Ltd: Initial contribution Less: Inventory transferred Wan Ltd: Initial contribution Less: Inventory transferred

$ 1 500 000 (700 000) 1 500 000 (700 000)

$ 800 000 800 000 $ 1 600 000

At 30 June 2016, Lim Ltd makes the following entry in its records to replace ‘Cash in JO’ with a 50% share of each of the accounts — assets and liabilities — in the statement of ﬁnancial position of the joint operation at 30 June 2016. The entry also recognises the inventory of $700 000 transferred to Lim Ltd from the joint operation. Raw Material in JO [$100 000/2] Work in Progress in JO [$650 000/2] Inventory in JO [$200 000/2] Equipment in JO [$1 500 000/2] Inventory [$1 400 000/2] Accounts Payable in JO [$120 000/2] Accrued Expenses in JO [$150 000/2] Bank Loan in JO [$1 000 000/2] Cash in JO [$1 500 000 − ($420 000/2)]

Dr Dr Dr Dr Dr Cr Cr Cr Cr

50 000 325 000 100 000 750 000 700 000 60 000 75 000 500 000 1 290 000

Note that Lim Ltd’s share of cash in the joint operation is calculated by ﬁnding the difference between the share at the beginning of the period, the initial contribution in this example, and the share at the end of the period. Lim Ltd depreciates the equipment in its own records. Therefore, having recognised an asset at $750 000, Lim Ltd would also pass the following entry at 30 June 2016: Depreciation Expense [10% × $750 000] Accumulated Depreciation (Depreciation on equipment in the joint operation)

Dr Cr

75 000 75 000

Records of Wan Ltd As Wan Ltd contributed the same asset (cash of $1 500 000) to the joint operation as Lim Ltd, the journal entries in the records of Wan Ltd would be the same as those for Lim Ltd.

D.4.2

Contributions of assets to a joint operation In illustrative example D.2, the joint operators contributed cash to the joint operation. However, in some cases, a joint operator may contribute assets other than cash to the joint operation. For example, one of the joint operators in a mining arrangement may also manufacture mining equipment. This joint operator may contribute equipment to the joint operation while the other operators may contribute cash. Where an operator contributes a non-current asset to the joint operation, the value of the contribution is effectively the fair value of that non-current asset. Therefore, if one operator contributed $100 000 cash

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and the other operator a non-current asset, then for both parties to agree to join there would have to be agreement that the non-current asset being contributed had a fair value of $100 000. If all operators contributed non-current assets, then some form of valuation of the contributions would need to be made by the parties involved. However, as the transaction is not an arm’s length transaction, a joint operator contributing assets other than cash cannot transfer the asset at fair value to the joint operation and recognise a full proﬁt on the transaction (IFRS 11 paragraph B34). The joint operator can only recognise gains and losses on such transactions to the extent of the other parties’ interests in the joint operation. Assume Oasis carries a non-current asset at fair value in its accounts; for example, an item of plant for $100 000. If this asset is contributed to a joint operation whereas the other operator, Bhutan, contributes cash of $100 000, the journal entry to record the contribution in the records of Oasis is as follows. Cash in JO [$100 000/2] Plant in JO [$100 000/2] Plant

Dr Dr Cr

50 000 50 000

Dr Dr Cr

50 000 50 000

100 000

In the records of Bhutan, the entry is: Cash in JO [$100 000/2] Plant in JO [$100 000/2] Cash

100 000

Note that in the records of both operators the plant in the joint operation is recorded at the same amount, namely $50 000. However, the accounting records of an operator that contributes a non-current asset are more complicated when the operator carries the contributed asset in its records at an amount less than fair value. In contributing an asset to the joint operation, the operator is effectively selling a proportion of that asset to the other joint operators, and retaining a proportion for itself. Where the carrying amount of the asset is lower than the fair value, the operator makes a profit on selling the proportion of the asset to the other operators. The profit is the difference between the fair value and carrying amount of the proportion of the asset sold. Assume Oasis contributed a non-current asset with a fair value of $100 000, and a carrying amount of $80 000, while Bhutan contributed cash of $100 000. Oasis can then recognise a profit on sale of half the non-current asset, namely $10 000 (being ½ ($100 000 − $80 000)). The entry in the records of Oasis is: Cash in JO [$100 000/2] Plant in JO [$80 000/2] Gain on Sale of Plant [$20 000/2] Plant

Dr Dr Cr Cr

50 000 40 000 10 000 80 000

The whole of the plant is given up by the operator, with half being sold to the other operator at a proﬁt and the other half being the asset held in the joint operation. Note that Oasis has recognised the plant in the joint operation at half of the carrying amount and not at half of the fair value. For Bhutan, the entry in its records is different from Oasis, being: Cash in JO [$100 000/2] Plant in JO [$100 000/2] Cash

Dr Dr Cr

50 000 50 000 100 000

Note that Bhutan has recognised the non-current asset in its records at half of fair value. Hence, Oasis and Bhutan have their equal share of the plant in the joint operation recognised in their records at different amounts. The fact that the operators have the non-current asset recorded at different amounts in their records affects the calculation of the cost of the inventory distributed to the operators from the joint operation. If the asset is depreciated, and the depreciation included in the cost of inventory, then, as the operators have the asset recorded at different amounts, the depreciation expense for each of the operators differs and so does the cost of inventory transferred. Where the asset is depreciated in the joint operation’s records, this depreciation is based on the fair value of the asset. For Bhutan, the depreciation charge is then the appropriate one and no adjustment is D Joint arrangements

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necessary. However, for Oasis, an adjustment is necessary, as the depreciation charged by the joint operation is too great. As the depreciation is capitalised into inventory and work in progress in the records of the joint operation, when Oasis recognises its share of the assets of the joint operation in its accounts, a further entry is necessary to reduce the balances of the inventory-related accounts. This extra entry in Oasis’ records is demonstrated in illustrative example D.3.

ILLUSTRATIVE EXAMPLE D.3 Contribution of a non-current asset by an operator

On 1 July 2015, Occidental Ltd and Middle East Ltd established a joint operation to manufacture a product. Each company has a 50% interest in the operation and shares output equally. To commence the operation, on 1 July 2015, Occidental Ltd contributed cash of $1 500 000 and Middle East Ltd contributed equipment which had a carrying amount of $1 000 000 and a fair value of $1 500 000. The equipment is depreciated in the joint operation’s accounts at 10% p.a. on cost. The following information was extracted from the joint operation’s ﬁnancial statements as at 30 June 2016: Statement of Financial Position (extract) as at 30 June 2016 Assets Cash Raw materials Work in progress Inventory Equipment Accumulated depreciation — equipment Total assets Liabilities Accounts payable Accrued expenses (wages) Bank loan Total liabilities Net assets

420 000 100 000 800 000 200 000 1 500 000 (1 500 000) $ 2 870 000 $

120 000 150 000 1 000 000 1 270 000 $ 1 600 000

Cash Receipts and Payments for the year ended 30 June 2016 Payments Contributions Bank loan Wages Accounts payable (raw materials) Overhead expenses

$ 500 000 380 000 1 200 000 $ 2 080 000

Receipts $ 1 500 000 1 000 000

$ 2 500 000

Costs Incurred for the year ended 30 June 2016 Wages Raw materials Depreciation Overhead expenses Less: Cost of inventory Work in progress at 30 June 2016

$ 650 000 400 000 150 000 1 200 000 2 400 000 1 600 000 $ 800 000

Required

Prepare the journal entries in the records of each of the operators for the year ended 30 June 2016. 14

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Solution

Records of Occidental Ltd In this example, Occidental Ltd contributes cash to the joint operation, and Middle East Ltd contributes equipment. At 1 July 2015, Occidental Ltd gives up the cash contribution and recognises a share of the cash and the equipment in the joint operation. Occidental Ltd will recognise a share of the fair value of the asset. The entry is: Cash in JO [$1 500 000/2] Equipment in JO [$1 500 000/2] Cash

Dr Dr Cr

750 000 750 000 1 500 000

At 30 June 2016, Occidental Ltd recognises a share of the assets and liabilities in the statement of ﬁnancial position of the joint operation. Note that the joint operation has produced inventory of $1 600 000, of which $1 400 000 has been transferred to the operators. Further, the joint operation has depreciated the equipment, the depreciation being based on the fair value of the equipment. The entry at 30 June 2016 in Occidental Ltd’s accounts is shown as follows. Raw Material in JO [$100 000/2] Work in Progress in JO [$800 000/2] Inventory in JO [$200 000/2] Inventory [$1 400 000/2] Accum. Depreciation − Equipment in JO [$150 000/2] Accounts Payable in JO [$120 000/2] Accrued Expenses in JO [$150 000/2] Bank Loan in JO [$1 000 000/2] Cash in JO [$750 000 − ($420 000/2)]

Dr Dr Dr Dr Cr Cr Cr Cr Cr

50 000 400 000 100 000 700 000 75 000 60 000 75 000 500 000 540 000

As depreciation has been based on fair value in the joint operation, and Occidental Ltd has its share of the equipment in the joint operation recorded at fair value, the correct amount of depreciation has been capitalised into the cost of inventory. No adjusting entry is necessary. Records of Middle East Ltd At 1 July 2016, Middle East Ltd contributes equipment to the joint operation, this having a carrying amount in Middle East Ltd different from the fair value of the asset. In recording its contribution to the joint operation, Middle East Ltd therefore recognises a gain on selling half of the equipment to Occidental Ltd. Occidental Ltd’s share of the equipment in the joint operation is then based on the original carrying amount of the asset. The entry is: Cash in JO [$1 500 000/2] Equipment in JO [$1 000 000/2] Gain on Sale of Equipment [$500 000/2] Equipment

Dr Dr Cr Cr

750 000 500 000 250 000 1 000 000

At 30 June 2016, Middle East Ltd recognises its share of the accounts in the statement of ﬁnancial position of the joint operation as well as its share of the inventory transferred from the joint operation. The entry is: Raw Material in JO [$100 000/2] Work in Progress in JO [$800 000/2] Inventory in JO [$200 000/2] Inventory [$1 400 000/2] Accum. Depreciation − Equipment in JO [$150 000/2] Accounts Payable in JO [$120 000/2] Accrued Expenses in JO [$150 000/2] Bank Loan in JO [$1 000 000/2] Cash in JO [$750 000 − ($420 000/2)]

Dr Dr Dr Dr Cr Cr Cr Cr Cr

50 000 400 000 100 000 700 000 75 000 60 000 75 000 500 000 540 000

D Joint arrangements

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Note that this entry is the same as that for Occidental Ltd. The depreciation recognised by Occidental Ltd is $75 000, which is based on the fair value of the asset. However, the equipment in the joint operation has been recognised by Middle East Ltd at only $500 000, which is half of the original carrying amount. Middle East Ltd would want to recognise only $50 000 depreciation, which is 10% of $500 000. Hence, whereas the work in progress and inventory recognised by Middle East Ltd includes depreciation of $75 000, the real cost of these assets to Middle East Ltd is less, to the amount of $25 000. A further entry is necessary to reduce the accumulated depreciation recognised by Middle East Ltd and to reduce the cost of the work in progress and inventory relating to the joint operation. This means that the cost of these assets to Middle East Ltd is different from that recognised by Occidental Ltd. This is because the cost of the equipment in the joint operation is less for Middle East Ltd than for Occidental Ltd. As the depreciation is capitalised into work in progress and inventory (both that amount still on hand in the joint operation as well as that transferred to Middle East Ltd), the adjustment to depreciation is proportionately allocated across these accounts: Share of $25 000 Work in Progress Inventory in JO Inventory

$ 400 000 100 000 700 000 $ 1 200 000

1/3 1/12 7/12

$ 8 333 2 083 14 584 $ 25 000

The entry in the records of Middle East Ltd to adjust the accumulated depreciation and the cost of the inventory-related accounts is then: Accumulated Depreciation − Equipment in JO [10% x ($750 000 − $500 000)] Work in Progress in JO Inventory in JO Inventory

D.4.3

Dr Cr Cr Cr

25 000 8 333 2 083 14 584

Management fees paid to a joint operator It is common for one of the joint operators to act in a management position for the joint operation. In such circumstances, the joint operation will pay a management fee to the joint operator for its management services. In accounting for these payments, the joint operation pays cash to a joint operator, with the cost of the service being capitalised into work in progress and inventory produced by the joint operation. For a joint operator that does not supply the service there are no accounting adjustments necessary because of the transaction. For the joint operator that does supply the service, normally it would incur a cost to supply the service and earn a proﬁt on the supply of that service. In accounting for its interest in the joint operation, the operator supplying the service has to consider the following: • As with supplying assets other than cash as part of the initial contribution, a joint operator cannot earn a proﬁt on supplying services to itself. • As the joint operation capitalises the amount paid to the operator into the cost of work in progress and inventory, an adjustment is necessary to the inventory-related accounts of that operator because the cost of these items to the operator supplying the services is less than that to the other operator(s).

ILLUSTRATIVE EXAMPLE D.4 Management fees paid to a joint operator

Taiwan Ltd and Irdina Ltd have formed a joint operation and share equally in the output of that operation. During the current period ending 30 June 2016, the joint operation pays a management fee of $400 000 to Taiwan Ltd. The cost to Taiwan Ltd of supplying management services to the joint operation is $320 000. At the end of the current period, Taiwan Ltd’s share of the inventory-related assets from the joint operation as recorded for Taiwan Ltd is: Work in progress in JO Inventory in JO Inventory

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$300 000 200 000 500 000

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The joint operation has capitalised the management services fee of $400 000 into the cost of these assets. In the records of Taiwan Ltd at 30 June 2016, the following entries are required:

Cash Fee Revenue (Revenue on payment of the service fee by the joint operation)

Dr Cr

400 000

Cost of Supplying Services Cash (Cost of supplying the services)

Dr Cr

320 000

400 000

320 000

The total profit to Taiwan Ltd on supplying the management service is $80 000. Half this profit is made on supplying services to Irdina Ltd and the other $40 000 on supplying services to itself. An adjustment is necessary to eliminate the revenue and the expense on supplying services to itself. The following entry eliminates from the fee revenue only the amount of the expense — the profit element in the revenue is eliminated in the next entry:

Fee Revenue [$320 000/2] Cost of Supplying Services (Adjustment for the profit on Taiwan Ltd supplying services to itself)

Dr Cr

160 000 160 000

The proﬁt element on supplying services to itself, $40 000, is proportionately adjusted across the inventory-related assets as follows:

Share of $40 000 Inventory in JO Inventory Work in Progress in JO

$ 200 000 500 000 300 000 $ 1 000 000

20% 50% 30%

$ 8 000 20 000 12 000 $ 40 000

The journal entry is:

Fee Revenue Inventory in JO Inventory Work in Progress in JO

Dr Cr Cr Cr

40 000 8 000 20 000 12 000

Note that the combination of this entry and the immediately preceding one results in adjusting fee revenue for a total of $200 000, which is half the revenue paid by the joint operation to Taiwan Ltd. If Taiwan Ltd had provided the services but the joint operation had not yet paid the fee by the end of the period, the liabilities of the joint operation need to be adjusted. Further, the Fee Receivable account of $400 000 raised by Taiwan Ltd needs to be adjusted. The entry is:

Accruals in JO Fee Receivable

Dr Cr

200 000 200 000

D Joint arrangements

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LO5

D.5

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DISCLOSURE IFRS 12 Disclosure of Interests in Other Entities contains the disclosures required for interests in joint arrangements. Paragraph 20 of IFRS 12 requires an entity to disclose sufficient information about joint operations to enable users of its financial statements to evaluate the nature, extent and financial effects of its interests in joint arrangements, including the nature of its contractual relationship with other investors with joint control over joint arrangements. For each joint arrangement, the following must be disclosed (IFRS 12 paragraph 21): • the name of the joint arrangement • the nature of the entity’s relationship with the joint arrangement (by, for example, describing the nature of the activities of the joint arrangement and whether it is strategic to the entity’s activities) • the principal place of business (and country of incorporation, if applicable and different from the principal place of business) of the joint arrangement • the proportion of ownership interest or participating share held by the entity and, if different, the proportion of voting rights held (if applicable). In regards to joint operations, each joint operator includes the relevant amounts for assets, liabilities, revenues and expenses in its own records. The assets are actual assets of the joint operator, and the operator is responsible for the liabilities recognised. There is no specific requirement to show the items associated with a joint operation separately from other assets and liabilities of the operator. However, some entities may consider these to be a separate class of assets and provide information in the notes to the financial statements regarding assets and liabilities associated with joint operations.

SUMMARY This chapter has covered the principles of accounting for joint arrangements, particularly joint operations, as contained in IFRS 11 Joint Arrangements. Some of the key principles are: • A joint arrangement is an arrangement between a number of parties in which two or more parties have joint control. • A joint arrangement has two key characteristics, namely the parties are bound by a contractual agreement, and this agreement gives two or more parties joint control over the arrangement. • Joint control exists when decisions about relevant activities require the unanimous consent of the parties sharing control. • There are two types of joint arrangement, namely joint ventures and joint operations. • The classiﬁcation of a joint arrangement is dependent on the rights and obligations of the parties to the arrangement. • With a joint arrangement the parties that have joint control have rights to the assets and obligations for the liabilities relating to the arrangement. • With a joint venture, the parties that have joint control have rights to the net assets of the arrangement. • Where a joint arrangement is not structured through a separate vehicle it is a joint operation. • Where a joint arrangement is structured through a separate vehicle, its classiﬁcation depends on an analysis of the legal form of the separate vehicle, the terms of the contractual arrangement and other relevant facts and circumstances. • For a joint operation, a joint operator must recognise its share of the assets and liabilities of the arrangement, as well as its revenues and expenses associated with the arrangement.

Discussion questions 1. What is a joint arrangement? 2. How does a joint arrangement differ from an associate? 3. What is meant by joint control? 4. How does joint control differ from control as used in classifying subsidiaries? 5. How does a joint venture differ from a joint operation? 6. What are the key steps in classifying a joint arrangement into joint ventures and joint operations? 7. How are joint ventures accounted for? 8. How are joint operations accounted for?

References CBD Energy 2012, AusChina Energy, www.cbdenergy.com.au. Perrin, C.J. 2011, ‘Australia’s CBD Energy forms joint venture with Chinese ﬁrms’, International Business Times, 13 April, http://au.ibtimes.com. 18

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Exercises Exercise D.1

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STAR RATING ★ BASIC

★★ MODER ATE

★★★ DIFFICULT

CLASSIFICATION OF A JOINT ARRANGEMENT

★ Horsley Ltd and Benington Ltd decide to jointly undertake the manufacture of an electric car. They form

Tiverton Ltd, which undertakes the manufacture of the car. Horsley Ltd and Benington Ltd provide the various parts for the manufacture of the car, which is assembled by Tiverton Ltd. Horsley Ltd and Benington Ltd each hold 50% of the voting rights in Tiverton Ltd and receive 50% of the cars produced by Tiverton Ltd. Horsely Ltd and Benington Ltd then sell the cars in their own geographic region. The constitution of Tiverton Ltd requires that the operations of the company must be in accordance with a business plan prepared annually, and to which both Horsley Ltd and Benington Ltd both agree. Tiverton Ltd has six directors, with three being appointed by Horsley Ltd and three by Benington Ltd. Required

Evaluate whether a joint arrangement exists and how it should be classiﬁed.

Exercise D.2

EXISTENCE AND CLASSIFICATION OF A JOINT ARRANGEMENT

★ The Chinese mining company Changchun Mining Ltd and the South African mining company Gold Rush

Ltd have agreed to set up a separate company, Dragon Gold Ltd, to mine for gold in South Africa. The South African government has issued permits to the South African company to mine for gold in speciﬁed areas of South Africa. The companies have set up a joint operating agreement which contains the following provisions: • The assets and liabilities of Dragon Gold Ltd are those of that company and not of the parties owning shares in Dragon Gold Ltd. • Dragon Gold Ltd has a board of directors that will consist of six persons, three provided by each of Changchun Mining Ltd and Gold Rush Ltd. Each of these companies has a 50% ownership in Dragon Gold Ltd. For any resolution to be passed by the board, there has to be unanimous consent of all directors. • Gold Rush Ltd will provide the management team for Dragon Gold Ltd for which a management fee will be paid by Dragon Gold Ltd. However, all budget matters and work programmes have to be approved by the board of Dragon Gold Ltd. • The rights and obligations arising from the exploration development and production activities of Dragon Gold Ltd are to be shared by all parties to the agreement. In particular, the parties will share in the production obtained from the mining activities and all costs associated with the work undertaken. • If cash is required for ongoing mining activities, the board of Dragon Gold Ltd may make calls on the parties owning shares in that company. Required

Discuss whether a joint arrangement exists and whether it should be classiﬁed as a joint venture or a joint operation.

Exercise D.3

CLASSIFICATION OF A JOINT ARRANGEMENT

★ Two smaller banks that operate in Indonesia are the Angkasa Bank and the Bagus Bank. These have in

the past primarily offered domestic banking services to their customers. However, in recent times, these customers have made increasing demands for international currency transactions and access to offshore banking arrangements. As both banks individually are not prepared to undertake the risks associated with international operations on their own, they have decided to join together to provide these services to their customers. To this end, they have formed the Overseas Bank. This bank is regarded as a separate vehicle in its own right, with the assets and liabilities of the Overseas Bank being those of the bank itself. The Angkasa Bank and Bagus Bank will each hold a 50% interest in the Overseas Bank. These two banks have signed an agreement such that all major decisions in relation to the Overseas Bank require the unanimous agreement of the two banks. The board of the Overseas Bank will consist of an equal number of representatives of these two banks. The Angkasa Bank and the Bagus Bank have agreed to provide initial funding to establish the Overseas Bank and have also agreed on a mechanism for further cash inﬂows if required. Required

Discuss whether a joint arrangement exists and how it should be classiﬁed. D Joint arrangements

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Exercise D.4 ★

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ACCOUNTING FOR AN ASSET USED BY A NUMBER OF COMPANIES

Raby Ltd and Bowes Ltd are companies that have newly discovered oil wells in a Middle-Eastern country. There is some distance to the nearest port and, rather than build separate pipelines, they have agreed to jointly build a pipeline to the port and share the use of the pipeline for transporting oil. The management of the pipeline is conducted in accordance with an agreement between Raby Ltd and Bowes Ltd which requires unanimous agreement in relation to such issues as maintenance and future expansion or contraction of the pipeline. Allington Ltd also has oil wells in the area and has agreed to use any excess capacity of the pipeline. Required

Discuss how you would account for the pipeline.

Exercise D.5 ★★

SHARING OUTPUT

On 1 July 2015, Shapirov Ltd entered into a joint agreement with London Ltd to form an unincorporated entity to produce a new type of widget. It was agreed that each party to the agreement would share the output equally. Shapirov Ltd’s initial contribution consisted of $2 000 000 cash and London Ltd contributed machinery that was recorded in the records of London Ltd at $1 900 000. During the ﬁrst year of operation both parties contributed a further $3 000 000 each. On 30 June 2016, the venture manager provided the following statements (in $’000):

Costs incurred for the year ended 30 June 2016 Wages Supplies Overheads

$ 1 840 2 800 2 200 6 840 4 840 $ 2 000

Cost of inventory Work in progress at 30 June 2016

Receipts and Payments for year ended 30 June 2016 Receipts Original contributions Additional contributions Payments Machinery (2/7/15) Wages Supplies Overheads Operating expenses Closing cash balance

$2 000 6 000 8 000 $ 800 1 800 3 000 2 100 200

7 900 $ 100

Assets and Liabilities at 30 June 2016 Assets Cash Machinery Supplies Work in progress Total assets Liabilities Accrued wages Creditors Total liabilities Net assets

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$ 100 2 800 400 2 000 5 300 40 300 340 $4 960

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Each joint operator depreciates machinery at 20% p.a. on cost in its own records. Required

1. Prepare the journal entries in the records of Shapirov Ltd and London Ltd in relation to the joint operation. 2. Prepare the journal entries in the records of London Ltd assuming that the joint operation, not the operators, had depreciated the machinery and included that expense in the cost of inventory transferred.

Exercise D.6

UNINCORPORATED JOINT OPERATION

★★ On 1 July 2015, Allington Ltd entered into a joint agreement with Joules Ltd to establish an unincorporated joint operation to manufacture timber-felling equipment. It was agreed that the output of the operation would be shared: Allington Ltd 60% and Joules Ltd 40%. To commence the operations, contributions were as follows: • Allington Ltd: cash of $1 100 000 and equipment having a carrying amount of $300 000 and a fair value of $400 000. • Joules Ltd: cash of $600 000 and plant having a carrying amount of $450 000 and a fair value of $400 000. Joules Ltd revalued the plant it contributed to the joint operation to fair value prior to its transfer to the joint operation. Plant and equipment was depreciated (to the nearest month) in the joint operation’s books at 20% p.a. on cost. During December 2015, an additional $1 000 000 cash was contributed by the operators in the same proportion as their initial contributions. The following information, in relation to the joint operations for the year ended 30 June 2016, was provided by the operation manager:

(a) Costs incurred for the year ended 30 June 2016 $ 400 000 1 200 000 650 000 205 000 2 455 000 2 005 000 $ 450 000

Wages Raw materials Overheads Depreciation Less: Cost of inventory Work in progress at 30 June 2016

(b) Receipts and payments for year ended 30 June 2016 Payments Contributions Plant (3 January 2016) Wages Accounts payable Overhead costs Operating expenses

$ 450 000 350 000 980 000 610 000 40 000 $ 2 430 000

Receipts $ 2 700 000

$ 2 700 000

Cash Raw materials Work in progress Inventory Plant and equipment Accumulated depreciation — plant and equipment Accounts payable Accrued expenses — wages and overheads

Dr $ 270 000 100 000 450 000 255 000 1 250 000

$205 000 320 000 90 000

Required

Prepare the journal entries in the records of Allington Ltd in relation to the joint operation for the year ended 30 June 2016. (Round all amounts and show all relevant workings.) D Joint arrangements

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Exercise D.7 ★★

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OPERATORS SHARE OUTPUT

Belvoir Ltd enters into an arrangement with another operator, Ashton Ltd, to establish an unincorporated joint operation to produce a drug that assists both hay fever sufferers and those with sinus problems. To produce the drug requires a combination of the technical and pharmaceutical knowledge of both companies. Each company will receive an equal share of the output of the drug, which they will retail through their own preferred outlets, potentially under different names. Belvoir Ltd agrees to manage the project for a fee of $100 000 p.a. Belvoir Ltd estimates that it will cost $80 000 to provide the service. The management fee is capitalised into the cost of inventory produced. The operation commences on 1 January 2016, with each operator providing $1 000 000 cash. At the end of the ﬁrst year, the statement of ﬁnancial position of the joint operation showed: Assets Vehicles Accumulated depreciation Equipment Accumulated depreciation Inventory Work in progress Materials Total assets Liabilities Provisions Payables

$ 200 000 (50 000) 820 000 (60 000) 80 000 320 000 210 000 1 520 000

Net assets

80 000 40 000 120 000 $ 1 400 000

Operators’ equity Initial contributions Inventory delivered General administration costs Total equity

2 000 000 (400 000) (200 000) $ 1 400 000

Required

1. Prepare the journal entries in the records of Belvoir Ltd during 2016. 2. What differences would occur if the management fee paid to Belvoir Ltd were treated as general administration costs?

Exercise D.8

SHARE OF OUTPUT

★★★ During 2015, a group of academics was undertaking a bonding exercise in the Portadown hills. While

tracking through the hills, they came across a spring of pure sweet water. They formed a company called Arnside Ltd and decided to establish the extent of their find. In the process they expended funds, obtained from teaching overseas students, on equipment and employing geologists and mining experts. The general conclusion was that the find was significant and a commercially profitable business selling mineral water was feasible. As they were academics, and had little practical experience of business, they decided to establish a joint operation with Tower Ltd who would establish a factory to produce bottled water. The joint operation agreement was signed on 1 January 2016, with Arnside Ltd and Tower Ltd having a 50% share in the unincorporated joint operation. The initial contributions by the two operators were as follows: Arnside Ltd: Capitalised expenses Equipment Cash Tower Ltd: Cash

$ 800 000 800 000 2 400 000 $ 4 000 000

The capitalised expenses were recorded in the books of Arnside Ltd at $320 000, while the equipment was recorded at a carrying amount of $640 000. In order to supply the cash, Arnside Ltd borrowed $800 000 of its required contribution. It is expected that the reserves of water will be depleted within 10 years, and the equipment is expected to have a similar useful life. 22

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On 1 June 2016, the joint operation was ready to start producing bottles of water. The joint operation’s accounts at 30 June 2017 contained the following information: Statement of Financial Position (extract) 2016 Work in progress Capitalised costs Plant and equipment Cash Accounts payable — plant Accrued expenses — wages etc.

$ 800 000 8 360 000 80 000 (240 000) (160 000)

2017 $ 200 000 800 000 7 760 000 240 000 (800 000) (200 000)

Cash Receipts and Payments (extract) Materials and supplies Administration Wages Accounts payable — plant Contributions from joint operators

Payments $480 000 160 000 560 000 960 000

Receipts

$ 2 000 000

The output of the ﬁrst year’s operations was distributed equally to the joint operators. Production in the ﬁrst year was estimated to be 15% of the reserves. At 30 June 2017, Arnside Ltd held 10% of its share of output in inventory, having sold the rest to its customers for $2 000 000. Expenses of the joint operation incurred up to 30 June 2017 were allocated to the operators. At 30 June 2017, the joint operation had ordered new plant and equipment of $300 000 that had not yet arrived. Because of some damage to the environment caused by the establishment of the pumping station to extract the water, there is a potential restoration cost to be incurred at closure of the joint operation. Whether this will be required will depend on the result of current legal inquiries. Required

Prepare the journal entries in the records of Arnside Ltd for the periods ending 30 June 2016 and 2017.

Exercise D.9

OPERATORS SHARE OUTPUT

★★★ On 1 July 2015, Melk Ltd entered into a joint operation agreement with Kofﬁe Ltd to manufacture steve-

doring equipment. It was agreed that each party to the agreement would share the output equally. To commence the operation, contributions were as follows: • Melk Ltd: cash of $2 000 000 and equipment having a $400 000 carrying amount and a fair value of $600 000 • Kofﬁe Ltd: cash of $1 800 000 and plant having a carrying amount of $900 000 and a fair value of $800 000. Kofﬁe Ltd revalued the plant it contributed to the joint operation prior to its transfer to the joint operation. Plant and equipment is depreciated (to the nearest month) in the joint operation’s books at 20% p.a. on cost. During December 2015, both parties contributed an additional $1 500 000 cash. The following information, in relation to the joint operation’s operations for the year ended 30 June 2016, was provided by the operation manager. (a) Costs incurred for the year ended 30 June 2016 Wages Raw materials Overheads Depreciation Less: Cost of inventory Work in progress at 30 June 2016

$ 1 200 000 2 150 000 1 860 000 470 000 5 680 000 2 580 000 $ 3 100 000

D Joint arrangements

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(b) Receipts and payments for the year ended 30 June 2016 Payments Contributions Plant (10 July 2015) Wages Accounts payable Overhead costs Operating expenses

$ 950 000 1 150 000 1 980 000 1 810 000 440 000 $ 6 330 000

Receipts $ 6 800 000

$ 6 800 000

Cash Raw materials Work in progress Inventory Plant and equipment Accumulated depreciation — plant and equipment Accounts payable Accrued expenses

$ 470 000 530 000 100 000

Required

Prepare the journal entries in the records of Melk Ltd and Kofﬁe Ltd in relation to the joint operation for the year ended 30 June 2016.

Exercise D.10

UNINCORPORATED JOINT OPERATION MANAGED BY ONE OF THE OPERATORS

★★★ During 2014, discussions took place between Stafford Ltd, a company concerned with the design of spe-

cialised tools and machines, and two companies, Dunster Ltd and Tutbury Ltd, which could potentially assist in the manufacture of a new tool. The new tool is called SmartTool and is to be used in the making of high-grade mining instruments. On 1 June 2015, the three companies agreed to form an unincorporated joint operation to achieve this purpose. It was agreed that the relative interests in the joint operation would be: Stafford Ltd Dunster Ltd Tutbury Ltd

50% 25% 25%

It was further agreed that Tutbury Ltd would undertake a management role in relation to the new operation, being responsible for operating decisions and for record keeping. Tutbury Ltd would be paid a management fee by the joint operation of $20 000. In establishing the joint operation, the various parties agreed to provide the following assets as their initial contribution: • Stafford Ltd was to provide the patent to SmartTool, which was being recorded by Stafford Ltd at a capitalised development cost of $1 400 000. The operators agreed that this asset had a fair value of $2 000 000, with an expected useful life of 10 years. • Dunster Ltd was to provide cash of $1 000 000. • Tutbury Ltd was to provide the basic plant and equipment to manufacture the new tool. The plant and equipment was recorded in the books of Tutbury Ltd at $600 000, but the operators agreed that it had a fair value of $1 000 000. The plant and equipment was estimated to have a further useful life of 5 years. During the ﬁrst period of its operation, the output of the joint operation was distributed to each of the operators in proportion to their agreed interests. By 30 June 2016, Tutbury Ltd had sold 80% of the output received from the joint operation for $300 000. The joint operation had not paid the management fee to Tutbury Ltd by 30 June 2016. 24

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Information from the ﬁnancial statements of the joint operation as at 30 June 2016 is as follows: Assets Cash Plant and equipment Accumulated depreciation Patent Accumulated depreciation Office equipment Accumulated depreciation Work in progress Liabilities Creditors — for materials Accruals — salaries etc, including the management fee Cash payments Salaries Materials Operating expenses

40 000 1 080 000 (208 000) 2 000 000 (200 000) 88 000 (8 800) 40 000

$ 136 000 112 000 $ 220 000 488 000 84 000

Required

OPERATORS SHARE OUTPUT

★★★ After prospecting unsuccessfully for a number of years for gold, in November 2014 Cooling Ltd ﬁnally found an economically viable deposit. Realising that it did not have sufﬁcient expertise to operate a gold mine successfully, Cooling Ltd formed an unincorporated joint operation with Deal Ltd, agreeing to share the output of the mine equally. It was agreed that the two operators would initially contribute the following assets: Cooling Ltd: Capitalised exploration costs, including permits licences, and mining rights, currently recorded by Cooling Ltd at $200 000 Cash Deal Ltd: Cash

$ 800 000 700 000 1 500 000

The joint operation commenced on 1 January 2015. By 31 December 2015, the mine had been operating successfully. It was reliably estimated at the commencement of the project that the mine had expected reserves of 100 000 tonnes. In the first year following commencement, 5000 tonnes of gold was extracted, while in 2016, 10 000 tonnes was extracted. This output was distributed to the operators equally. All costs except general administration costs were capitalised into the cost of the output, with depreciation of equipment and capitalised exploration costs being written off in proportion to the depletion of the reserves. General administration expenses were allocated to the operators equally. The financial statements of the joint operation over the first 2 years of operation showed the following information: Cash Receipts and Payments 2015 Balance at 1 January Contributions from operators Plant and equipment Wages Materials General administration Balance at 31 December

— $ 2 200 000 2 200 000 800 000 600 000 200 000 300 000 1 900 000 $ 300 000

2016 $ 300 000 1 200 000 1 500 000 190 000 660 000 240 000 300 000 1 390 000 $ 110 000

D Joint arrangements

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Statement of Financial Position Capitalised exploration costs Plant and equipment Accumulated depreciation Cash Materials Accrued wages Accounts payable (materials) Net assets Operators’ equity: Contributions as at 1 January Additional contributions Less: Output distributed Allocation: General administration Balance at 31 December

2015 $ 760 000 800 000 (40 000) 300 000 50 000 1 870 000 10 000 20 000

2016 $ 680 000 990 000 (140 000) 110 000 40 000 1 680 000 20 000 30 000

30 000

50 000 $ 1 630 000

$ 1 840 000 3 000 000 3 000 000 860 000 300 000 1 160 000 $ 1 840 000

1 840 000 1 200 000 3 040 000 1 110 000 300 000 1 410 000 $ 1 630 000

Required

Prepare the journal entries in the records of Cooling Ltd to record its interest in the joint operation for the years ending 31 December 2015 and 2016.

PART 4 Economic entities