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©2015 DeVry/Becker Educational Development Corp. All rights reserved. (i)

ACCA

PAPER P2

CORPORATE REPORTING (INTERNATIONAL)

REVISION QUESTION PRACTICE

For Examinations to June 2017

®

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REVISION QUESTION BANK – CORPORATE REPORTING (P2)

©2015 DeVry/Becker Educational Development Corp. All rights reserved. 1

Question 1 TIMBER PRODUCTS

Required:

(a) Explain briefly the concept of faithful representation. (3 marks)

(b) Explain the appropriate accounting treatment for the following transactions and the entries that would appear in the statement of comprehensive income for the year ended 31 October 2015 and statement of financial position as at 31 October 2015 for transactions (i) and (ii).

(i) Timber Products imports unseasoned hardwood and keeps it for five years under controlled conditions prior to manufacturing high quality furniture. In the year ended 31 October 2015 it imported unseasoned timber at a cost of $40 million. It contracted to sell the whole amount for $40 million and to buy it back in five years’ time for $56.10 million.

(ii) Timber Products manufactures and supplies retailers with furniture on a consignment basis such that either party can require the return of the furniture to the manufacturer within a period of six months from delivery. The retailers are required to pay a monthly charge for the facility to display the furniture. The manufacturer uses this monthly charge to pay for insurance cover and carriage costs. At the end of six months the retailer is required to pay Timber Products the trade price as at the date of delivery. No retailers have yet sent any goods back to Timber Products at the end of the six month period.

In the year ended 31 October 2015, Timber Products had supplied furniture to retailers at the normal trade price of $10 million being cost plus 331/3% and received $6 million from retailers. (7 marks)

(10 marks)

Jana

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CORPORATE REPORTING (P2) – REVISION QUESTION BANK

16 ©2015 DeVry/Becker Educational Development Corp. All rights reserved.

Question 16 KEY

(a) Key, a public limited company, is concerned about the reduction in the general availability of credit and the sudden tightening of the conditions required obtaining a loan from banks. There has been a reduction in credit availability and a rise in interest rates. It seems as though there has ceased to be a clear relationship between interest rates and credit availability, and lenders and investors are seeking less risky investments. The directors are trying to determine the practical implications for the financial statements particularly because of large write downs of assets in the banking sector, tightening of credit conditions, and falling sales and asset prices. They are particularly concerned about the impairment of assets and the market inputs to be used in impairment testing. They are afraid that they may experience significant impairment charges in the coming financial year. They are unsure as to how they should test for impairment and any considerations which should be taken into account.

Required:

Discuss the main considerations that the company should take into account when impairment testing non-current assets in the above economic climate. (8 marks)

Professional marks for clarity and expression. (2 marks)

(b) There are specific assets on which the company wishes to seek advice. The company holds certain non-current assets, which are in a development area and carried at cost less depreciation. These assets cost $3 million on 1 June 2014 and are depreciated on the straight-line basis over their useful life of five years. An impairment review was carried out on 31 May 2015 and the projected cash flows relating to these assets were as follows:

Year to 31 May 2016 2017 2018 2019 Cash flows ($000) 280 450 500 550 The company used a discount rate of 5%. At 30 November 2015, the directors used the same cash flow projections and noticed that the resultant value in use was above the carrying amount of the assets and wished to reverse any impairment loss calculated at 31 May 2015. The government has indicated that it may compensate the company for any loss in value of the assets up to 20% of the impairment loss.

Key holds a non-current asset, which was purchased for $10 million on 1 December 2012 with an expected useful life of 10 years. On 1 December 2014, it was revalued to $8·8 million. At 30 November 2015, the asset was reviewed for impairment and written down to its recoverable amount of $5·5 million.

Key committed itself at the beginning of the financial year to selling a property that is being under-utilised following the economic downturn. As a result of the economic downturn, the property was not sold by the end of the year. The asset was actively marketed but there were no reasonable offers to purchase the asset. Key is hoping that the economic downturn will change in the future and therefore has not reduced the price of the asset.

Required:

Discuss with suitable computations, how to account for any potential impairment of the above non-current assets in the financial statements for the year ended 30 November 2015. (15 marks)

Jana

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Note: The following discount factors may be relevant:

Year 1 0·9524 Year 2 0·9070 Year 3 0·8638 Year 4 0·8227

(25 marks)



A

Question 18 BRAMSHAW

The definition of a financial instrument captures a wide variety of assets and liabilities including cash, evidence of an ownership interest in an entity, or a contractual right to receive, or deliver cash or another financial instrument.

Preparers, auditors and users of financial statements have found the requirements for reporting financial assets and liabilities to be very complex, problematical and sometimes subjective. The result is that there is a need to develop new standards of reporting for financial instruments that are principle-based and significantly less complex than current requirements. It is important that a standard in this area should allow users to understand the economic substance of the transaction and preparers to properly apply generally accepted accounting principles.

Required:

(a) (i) Discuss how the measurement of financial instruments under International Financial Reporting Standards can create confusion and complexity for preparers and users of financial statements. (9 marks)

Jana

Rectangle

Jana

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(ii) Set out the reasons why using fair value to measure all financial instruments may result in less complexity in the application of IFRS 9 “Financial Instruments” but may lead to uncertainty in financial statements. (9 marks)

Professional marks will be awarded for clarity and expression. (2 marks)

(b) Bramshaw borrowed $47 million on 1 December 2014 when the market and effective interest rate was 5%. On 30 November 2015, the company borrowed an additional $45 million when the current market and effective interest rate was 7·4%. Both financial liabilities are repayable on 30 November 2019 and are single payment notes, whereby interest and capital are repaid on that date.

Required:

Discuss the accounting for the above financial liabilities under current financial reporting standards using amortised cost, and additionally using fair value as at 30 November 2015. (5 marks)

(25 marks)

Question 19 SEEJOY

Seejoy is a famous football club but has significant cash flow problems. The directors and shareholders wish to take steps to improve the club’s financial position. The following proposals had been drafted in an attempt to improve the cash flow of the club. However, the directors need advice on their implications.

(a) Sale and leaseback of football stadium (excluding the land element)

The football stadium is currently accounted for using the cost model in IAS 16 Property, Plant, and Equipment. The carrying value of the stadium will be $12 million at 31 December 2015. The stadium will have a remaining life of 20 years at 31 December 2015, and the club uses straight line depreciation. It is proposed to sell the stadium to a third party institution on 1 January 2016 and lease it back under a 20 year finance lease. The sale price and fair value are $15 million which is the present value of the minimum lease payments. The agreement transfers the title of the stadium back to the football club at the end of the lease at nil cost. The rental is $1·2 million per annum in advance commencing on 1 January 2016. The directors do not wish to treat this transaction as the raising of a secured loan. The implicit interest rate on the finance in the lease is 5·6%. (9 marks)

(b) Player registrations

The club capitalises the unconditional amounts (transfer fees) paid to acquire players.

The club proposes to amortise the cost of the transfer fees over 10 years instead of the current practice which is to amortise the cost over the duration of the player’s contract. The club has sold most of its valuable players during the current financial year but still has two valuable players under contract.

Transfer fee Amortisation to Contract Contract Player capitalised 31 December 2015 commenced expires $m $m A. Steel 20 4 1 January 2015 31 December 2019 R. Aldo 15 10 1 January 2014 31 December 2016

If Seejoy win the national football league, then a further $5 million will be payable to the two players’ former clubs. Seejoy are currently performing very poorly in the league. (5 marks)

Jana

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(c) Issue of bond

The club proposes to issue a 7% bond with a face value of $50 million on 1 January 2016 at a discount of 5% that will be secured on income from future ticket sales and corporate hospitality receipts, which are approximately $20 million per annum. Under the agreement the club cannot use the first $6 million received from corporate hospitality sales and reserved tickets (season tickets) as this will be used to repay the bond. The money from the bond will be used to pay for ground improvements and to pay the wages of players.

The bond will be repayable, both capital and interest, over 15 years with the first payment of $6 million due on 31 December 2016. It has an effective interest rate of 7·7%. There will be no active market for the bond and the company does not wish to use valuation models to value the bond. (6 marks)

(d) Player trading

Another proposal is for the club to sell its two valuable players, Aldo and Steel. It is thought that it will receive a total of $16 million for both players. The players are to be offered for sale at the end of the current football season on 1 May 2016. (5 marks)

Required:

Discuss how the above proposals would be dealt with in the financial statements of Seejoy for the year ending 31 December 2016, setting out their accounting treatment and appropriateness in helping the football club’s cash flow problems.

(Candidates do not need knowledge of the football finance sector to answer this question.)

(25 marks)



Question 30 MINNY GROUP

Minny is a company which operates in the service sector. Minny has business relationships with Bower and Heeny. All three entities are public limited companies. The draft statements of financial position of these entities are as follows at 30 November 2015:

Minny Bower Heeny $m $m $m Assets: Non-current assets Property, plant and equipment 920 300 310 Investments in subsidiaries Bower 730 Heeny 320 Investment in Puttin 48 Intangible assets 198 30 35 –––––– –––––– –––––– 1,896 650 345 –––––– –––––– –––––– Current assets 895 480 250 –––––– –––––– –––––– Total assets 2,791 1,130 595 –––––– –––––– –––––– Equity and liabilities: Share capital 920 400 200 Other components of equity 73 37 25 Retained earnings 895 442 139 –––––– –––––– –––––– Total equity 1,888 879 364 –––––– –––––– –––––– Non-current liabilities 495 123 93 –––––– –––––– –––––– Current liabilities 408 128 138 –––––– –––––– –––––– Total liabilities 903 251 231 –––––– –––––– –––––– Total equity and liabilities 2,791 1,130 595 –––––– –––––– ––––––

The following information is relevant to the preparation of the group financial statements:

1. On 1 December 2013, Minny acquired 70% of the equity interests of Bower. The purchase consideration comprised cash of $730 million. At acquisition, the fair value of the non-controlling interest in Bower was $295 million. On 1 December 2013, the fair value of the identifiable net assets acquired was $835 million and retained earnings of Bower were $319 million and other components of equity were $27 million. The excess in fair value is due to non-depreciable land.

2. On 1 December 2014, Bower acquired 80% of the equity interests of Heeny for a cash consideration of $320 million. The fair value of a 20% holding of the non-controlling interest was $72 million; a 30% holding was $108 million and a 44% holding was $161 million. At the date of acquisition, the identifiable net assets of Heeny had a fair value of $362 million, retained earnings were $106 million and other components of equity were $20 million. The excess in fair value is due to non-depreciable land.

Jana

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It is the group’s policy to measure the non-controlling interest at fair value at the date of acquisition.

3. Both Bower and Heeny were impairment tested at 30 November 2015. The recoverable amounts of both cash generating units as stated in the individual financial statements at 30 November 2015 were Bower, $1,425 million, and Heeny, $604 million, respectively. The directors of Minny felt that any impairment of assets was due to the poor performance of the intangible assets. The recoverable amount has been determined without consideration of liabilities which all relate to the financing of operations.

4. Minny acquired a 14% interest in Puttin, a public limited company, on 1 December 2013 for a cash consideration of $18 million. The investment was accounted for under IFRS 9 Financial Instruments and was designated as at fair value through other comprehensive income. On 1 June 2015, Minny acquired an additional 16% interest in Puttin for a cash consideration of $27 million and achieved significant influence. The value of the original 14% investment on 1 June 2015 was $21 million. Puttin made profits after tax of $20 million and $30 million for the years to 30 November 2014 and 30 November 2015 respectively. On 30 November 2015, Minny received a dividend from Puttin of $2 million, which has been credited to other components of equity.

5. Minny purchased patents of $10 million to use in a project to develop new products on 1 December 2014. Minny has completed the investigative phase of the project, incurring an additional cost of $7 million and has determined that the product can be developed profitably. An effective and working prototype was created at a cost of $4 million and in order to put the product into a condition for sale, a further $3 million was spent. Finally, marketing costs of $2 million were incurred. All of the above costs are included in the intangible assets of Minny.

6. Minny intends to dispose of a major line of the parent’s business operations. At the date the held for sale criteria were met, the carrying amount of the assets and liabilities comprising the line of business were:

$m Property, plant and equipment (PPE) 49 Inventory 18 Current liabilities 3 It is anticipated that Minny will realise $30 million for the business. No adjustments have been made in the financial statements in relation to the above decision.

Required:

(a) Prepare the consolidated statement of financial position for the Minny Group as at 30 November 2015. (35 marks)

(b) Minny intends to dispose of a major line of business in the above scenario and the entity has stated that the held for sale criteria were met under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. The criteria in IFRS 5 are very strict and regulators have been known to question entities on the application of the standard. The two criteria which must be met before an asset or disposal group will be defined as recovered principally through sale are: that it must be available for immediate sale in its present condition and the sale must be highly probable.



Required:

Discuss what is meant in IFRS 5 by “available for immediate sale in its present condition” and “the sale must be highly probable”, setting out briefly why regulators may question entities on the application of the standard. (7 marks)

(c) Bower has a property which has a carrying value of $2 million at 30 November 2015. This property had been revalued at the year end and a revaluation surplus of $400,000 had been recorded in other components of equity. The directors were intending to sell the property to Minny for $1 million shortly after the year end. Bower previously used the historical cost basis for valuing property.

Required:

Without adjusting your answer to part (a), discuss the ethical and accounting implications of the above intended sale of assets to Minny by Bower. (8 marks)

(50 marks)



Question 2 VERGE

(a) In its annual financial statements for the year ended 31 March 2015, Verge, a public limited company, had identified the following operating segments:

(i) Segment 1 local train operations (ii) Segment 2 inter-city train operations (iii) Segment 3 railway constructions

The company disclosed two reportable segments. Segments 1 and 2 were aggregated into a single reportable operating segment. Operating segments 1 and 2 have been aggregated on the basis of their similar business characteristics, and the nature of their products and services. In the local train market, it is the local transport authority which awards the contract and pays Verge for its services. In the local train market, contracts are awarded following a competitive tender process, and the ticket prices paid by passengers are set by and paid to the transport authority. In the inter-city train market, ticket prices are set by Verge and the passengers pay Verge for the service provided. (5 marks)

(b) Verge entered into a contract with a government body on 1 April 2013 to undertake maintenance services on a new railway line. The total revenue from the contract is $5 million over a three-year period. The contract states that $1 million will be paid at the commencement of the contract but although invoices will be subsequently sent at the end of each year, the government authority will only settle the subsequent amounts owing when the contract is completed. The invoices sent by Verge to date (including $1 million above) were as follows:

Year ended 31 March 2014 $2·8 million Year ended 31 March 2015 $1·2 million The balance will be invoiced on 31 March 2016. Verge has only accounted for the initial payment in the financial statements to 31 March 2014 as no subsequent amounts are to be paid until 31 March 2016. The amounts of the invoices reflect the work undertaken in the period.

The performance by Verge does not create an asset with an alternative use for Verge and Verge has an enforceable right to payment for performance completed to date.

Verge wishes to know how to account for the revenue on the contract in the financial statements to date.

Market interest rates are currently at 6%. (6 marks)

(c) In February 2014, an inter-city train did what appeared to be superficial damage to a storage facility of a local company. The directors of the company expressed an intention to sue Verge but in the absence of legal proceedings, Verge had not recognised a provision in its financial statements to 31 March 2014. In July 2014, Verge received notification for damages of $1·2m, which was based upon the estimated cost to repair the building. The local company claimed the building was much more than a storage facility as it was a valuable piece of architecture which had been damaged to a greater extent than was originally thought. The head of legal services advised Verge that the company was clearly negligent but the view obtained from an expert was that the value of the building was $800,000. Verge had an insurance policy that would cover the first $200,000 of such claims. After the financial statements for the year ended 31 March 2015 were authorised, the case came to court and the judge determined that the storage facility actually was a valuable piece of architecture. The court ruled that Verge was negligent and awarded $300,000 for the damage to the fabric of the facility. (6 marks)

Jana

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(d) Verge was given a building by a private individual in February 2014. The benefactor included a condition that it must be brought into use as a train museum in the interests of the local community or the asset (or a sum equivalent to the fair value of the asset) must be returned. The fair value of the asset was $1·5 million in February 2014. Verge took possession of the building in May 2014. However, it could not use the building in accordance with the condition until February 2015 as the building needed some refurbishment and adaptation and in order to fulfil the condition. Verge spent $1 million on refurbishment and adaptation.

On 1 July 2014, Verge obtained a cash grant of $250,000 from the government. Part of the grant related to the creation of 20 jobs at the train museum by providing a subsidy of $5,000 per job created. The remainder of the grant related to capital expenditure on the project. At 31 March 2015, all of the new jobs had been created. (6 marks)

Required:

Advise Verge on how the above accounting issues should be dealt with in its financial statements for the years ending 31 March 2014 (where applicable) and 31 March 2015.

Note: The mark allocation is shown against each of the four issues above.

Professional marks will be awarded for clarity and quality of presentation. (2 marks)

(25 marks)



JUNE 2014

Question 1 MARCHANT

The following draft financial statements relate to Marchant, a public limited company:

Marchant Group: Draft statements of profit or loss and other comprehensive income for the year ended 30 April 2015

Marchant Nathan Option $m $m $m Revenue 400 115 70 Cost of sales (312) (65) (36) –––– –––– –––– Gross profit 88 50 34 Other income 21 7 2 Administrative costs (15) (9) (12) Other expenses (35) (19) (8) –––– –––– –––– Operating profit 59 29 16 Finance costs (5) (6) (4) Finance income 6 5 8 –––– –––– –––– Profit before tax 60 28 20 Income tax expense (19) (9) (5) –––– –––– –––– Profit for the year 41 19 15 –––– –––– –––– Other comprehensive income – revaluation surplus 10 –––– –––– –––– Total comprehensive income for year 51 19 15 –––– –––– ––––

The following information is relevant to the preparation of the group statement of profit or loss and other comprehensive income:

1. On 1 May 2013, Marchant acquired 60% of the equity interests of Nathan, a public limited company. The purchase consideration comprised cash of $80 million and the fair value of the identifiable net assets acquired was $110 million at that date. The fair value of the non-controlling interest (NCI) in Nathan was $45 million on 1 May 2013. Marchant wishes to use the “full goodwill” method for all acquisitions. The share capital and retained earnings of Nathan were $25 million and $65 million respectively and other components of equity were $6 million at the date of acquisition. The excess of the fair value of the identifiable net assets at acquisition is due to non-depreciable land.

Goodwill has been impairment tested annually and as at 30 April 2014 had reduced in value by 20%. However at 30 April 2015, the impairment of goodwill had reversed and goodwill was valued at $2 million above its original value. This upward change in value has already been included in above draft financial statements of Marchant prior to the preparation of the group accounts.

Jana

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2. Marchant disposed of an 8% equity interest in Nathan on 30 April 2015 for a cash consideration of $18 million and had accounted for the gain or loss in other income. The carrying value of the net assets of Nathan at 30 April 2015 was $120 million before any adjustments on consolidation. Marchant accounts for investments in subsidiaries using IFRS 9 Financial Instruments and has made an election to show gains and losses in other comprehensive income. The carrying value of the investment in Nathan was $90 million at 30 April 2014 and $95 million at 30 April 2015 before the disposal of the equity interest.

3. Marchant acquired 60% of the equity interests of Option, a public limited company, on 30 April 2013. The purchase consideration was cash of $70 million. Option’s identifiable net assets were fair valued at $86 million and the NCI had a fair value of $28 million at that date. On 1 November 2014, Marchant disposed of a 40% equity interest in Option for a consideration of $50 million. Option’s identifiable net assets were $90 million and the value of the NCI was $34 million at the date of disposal. The remaining equity interest was fair valued at $40 million. After the disposal, Marchant exerts significant influence. Any increase in net assets since acquisition has been reported in profit or loss and the carrying value of the investment in Option had not changed since acquisition. Goodwill had been impairment tested and no impairment was required. No entries had been made in the financial statements of Marchant for this transaction other than for cash received.

4. Marchant sold inventory to Nathan for $12 million at fair value. Marchant made a loss on the transaction of $2 million and Nathan still holds $8 million in inventory at the year end.

5. The following information relates to Marchant’s pension scheme:

Plan assets at 1 May 2014 $48m Defined benefit obligation at 1 May 2014 $50m Service cost for year ended 30 April 2015 $4m Discount rate at 1 May 2014 10% Re-measurement loss in year ended 30 April 2015 $2m Past service cost 1 May 2014 $3m

The pension costs have not been accounted for in total comprehensive income.

6. On 1 May 2013, Marchant purchased an item of property, plant and equipment for $12 million and this is being depreciated using the straight line basis over 10 years with a zero residual value. At 30 April 2014, the asset was revalued to $13 million but at 30 April 2015, the value of the asset had fallen to $7 million. Marchant uses the revaluation model to value its non-current assets. The effect of the revaluation at 30 April 2015 had not been taken into account in total comprehensive income but depreciation for the year had been charged.

7. On 1 May 2013, Marchant made an award of 8,000 share options to each of its seven directors. The condition attached to the award is that the directors must remain employed by Marchant for three years. The fair value of each option at the grant date was $100 and the fair value of each option at 30 April 2015 was $110. At 30 April 2014, it was estimated that three directors would leave before the end of three years. Due to an economic downturn, the estimate of directors who were going to leave was revised to one director at 30 April 2015. The expense for the year as regards the share options had not been included in profit or loss for the current year and no directors had left by 30 April 2015.

8. A loss on an effective cash flow hedge of Nathan of $3 million has been included in the subsidiary’s finance costs.

9. Ignore the taxation effects of the above adjustments unless specified. Any expense adjustments should be amended in other expenses.



Required:

(a) (i) Prepare a consolidated statement of profit or loss and other comprehensive income for the year ended 30 April 2015 for the Marchant Group. (30 marks)

(ii) Explain, with suitable calculations, how the sale of the 8% interest in Nathan should be dealt with in the group statement of financial position at 30 April 2015. (5 marks)

(b) The directors of Marchant have strong views on the usefulness of the financial statements after their move to International Financial Reporting Standards (IFRSs). They feel that IFRSs implement a fair value model. Nevertheless, they are of the opinion that IFRSs are failing users of financial statements as they do not reflect the financial value of an entity.

Required:

Discuss the directors’ views above as regards the use of fair value in IFRSs and the fact that IFRSs do not reflect the financial value of an entity. (9 marks)

(c) Marchant plans to update its production process and the directors feel that technology-led production is the only feasible way in which the company can remain competitive. Marchant operates from a leased property and the leasing arrangement was established in order to maximise taxation benefits. However, the financial statements have not shown a lease asset or liability to date.

A new financial controller joined Marchant just after the financial year end of 30 April 2015 and is presently reviewing the financial statements to prepare for the upcoming audit and to begin making a loan application to finance the new technology. The financial controller feels that the lease relating to both the land and buildings should be treated as a finance lease but the finance director disagrees. The finance director does not wish to recognise the lease in the statement of financial position and therefore wishes to continue to treat it as an operating lease. The finance director feels that the lease does not meet the criteria for a finance lease, and it was made clear by the finance director that showing the lease as a finance lease could jeopardise the loan application.

Required:

Discuss the ethical and professional issues which face the financial controller in the above situation. (6 marks)

(50 marks)



Question 2 ASPIRE

Aspire, a public limited company, operates many of its activities overseas. The directors have asked for advice on the correct accounting treatment of several aspects of Aspire’s overseas operations. Aspire’s functional currency is the dollar.

(a) Aspire has created a new subsidiary, which is incorporated in the same country as Aspire. The subsidiary has issued 2 million dinars of equity capital to Aspire, which paid for these shares in dinars. The subsidiary has also raised 100,000 dinars of equity capital from external sources and has deposited the whole of the capital with a bank in an overseas country whose currency is the dinar. The capital is to be invested in dinar denominated bonds. The subsidiary has a small number of staff and its operating expenses, which are low, are incurred in dollars. The profits are under the control of Aspire. Any income from the investment is either passed on to Aspire in the form of a dividend or reinvested under instruction from Aspire. The subsidiary does not make any decisions as to where to place the investments.

Aspire would like advice on how to determine the functional currency of the subsidiary. (7 marks)

(b) Aspire has a foreign branch which has the same functional currency as Aspire. The branch’s taxable profits are determined in dinars. On 1 May 2014, the branch acquired a property for 6 million dinars. The property had an expected useful life of 12 years with a zero residual value. The asset is written off for tax purposes over eight years. The tax rate in Aspire’s jurisdiction is 30% and in the branch’s jurisdiction is 20%. The foreign branch uses the cost model for valuing its property and measures the tax base at the exchange rate at the reporting date.

Aspire would like an explanation (including a calculation) as to why a deferred tax charge relating to the asset arises in the group financial statements for the year ended 30 April 2015 and the impact on the financial statements if the tax base had been translated at the historical rate. (6 marks)

(c) On 1 May 2014, Aspire purchased 70% of a multi-national group whose functional currency was the dinar. The purchase consideration was $200 million. At acquisition, the net assets at cost were 1,000 million dinars. The fair values of the net assets were 1,100 million dinars and the fair value of the non-controlling interest was 250 million dinars. Aspire uses the full goodwill method.

Aspire wishes to know how to deal with goodwill arising on the above acquisition in the group financial statements for the year ended 30 April 2015. (5 marks)

(d) Aspire took out a foreign currency loan of 5 million dinars at a fixed interest rate of 8% on 1 May 2014. The interest is paid at the end of each year. The loan will be repaid after two years on 30 April 2016. The interest rate is the current market rate for similar two-year fixed interest loans.

Aspire requires advice on how to account for the loan and interest in the financial statements for the year ended 30 April 2015. (5 marks)

Aspire has a financial statement year end of 30 April 2015 and the average currency exchange rate for the year is not materially different from the actual rate.

Exchange rates $1 = dinars 1 May 2014 5 30 April 2015 6 Average exchange rate for year ended 30 April 2015 5·6

Jana

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Required:

Advise the directors of Aspire on their various requests above, showing suitable calculations where necessary.

Note: The mark allocation is shown against each of the four issues above.

Professional marks will be awarded in question 2 for clarity and quality of presentation. (2 marks)

(25 marks)



Answer 1 TIMBER PRODUCTS

(a) Concept of faithful representation

Faithful representation is one of the two fundamental qualitative characteristics, the other being relevance, incorporated in the IASB’s Conceptual Framework for Financial Reporting. Information should faithfully represent the events and transactions (economic phenomena) that it purports to represent.

Information should be neutral, complete and free from error if it is to faithfully represent the economic phenomena. Information can never be 100% neutral, complete and free from error; choices have to be made in selecting and applying accounting policies, for information to be complete would take too much time and there can be no absolute guarantee that information is 100% correct.

Faithful representation encapsulates the concept of substance over form. This concept was core to the previous version of the framework but is now embedded in the characteristic of faithful representation.

The objective of the substance over form principle is to ensure that the substance (i.e. the economic reality) of an entity’s transactions is reported in its financial statements. The commercial effect of transactions, and any resulting assets, liabilities, gains or losses should be faithfully represented in its financial statements. Application of this principle ensures that arrangements are not accounted for in accordance with their strict legal form in a manner that would inappropriately omit assets and liabilities from the statement of financial position.

(b) Accounting treatment and entries in the financial statements

(i) Sale and buy-back

The legal form of this transaction is that it is a sale. The issue is to decide whether this is the substance of the contract or whether it is in fact a financing transaction.

Legal form

Dr Cash Cr Sales

No inventory on the statement of financial position at the year end.

Alternative?

Dr Cash Cr Loan

Inventory retained on the statement of financial position.

Interest charged through the statement of profit or loss.

This decision requires an analysis of the terms of the contract. Usually this involves an examination of:

the main feature of the transaction to decide if it is a real sale or not (e.g. sale to a bank; banks do not buy wood they lend money); and

which party has access to the risks and benefits of ownership.

Jana

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IFRS 15 Revenue from Contracts with Customers states that where an entity is obliged to buy back the goods this is a forward contract and must be accounted for as either:

a finance lease, if the buy-back price is below the selling price; or a finance arrangement where the buy-back price is greater that the selling price.

The latter applies in the case of Timber Products.

The contract specifies that the timber will be repurchased. Therefore it is not a real sale in the first place. Timber Products has not transferred the risks and rewards of ownership of the timber and this transaction is a financing transaction. Timber products have in fact borrowed money using the timber as security. The timber will therefore appear as inventory in the statement of financial position and the loan will appear as a liability.

Carrying amount of the liability

The liability is a financial liability within the definition in IFRS 9. This standard requires that liabilities (other than those classified as fair value through profit or loss) are carried at their amortised cost using the effective interest rate method. This means that the carrying amount of the liability will be increased by the interest charge based on the rate that is inherent in the contract and reduced by any cash flows (though in this case there are none). Each year there will be an interest element charged to profit or loss and added to the liability.

Calculation of the effective interest rate

Total finance charge over the term of the loan is: $m Total repayments 56.1 Amount borrowed (40) –––– Interest 16.1 ––––

This must be spread to profit or loss using the effective rate. This is calculated as the internal rate of return of the loan as follows:

5 40/1.56 – 1 = 0.07 or 7%

The annual interest cost and the carrying amount of the loan at each year end over the life of the loan is given below. (This is not required but provided for tutorial purposes.)

Opening Interest Cash Closing Period balance @ 7% flow balance

1 40 2.8 – 42.8 2 42.8 3.0 – 45.8 3 45.8 3.2 – 49 4 49 3.4 – 52.4 5 52.4 3.7 (56.1) –

The statement of financial position as at 31 October 2015 will show: $m Inventory 40.0 Loan payable after more than one year 42.8

Note: The loan is secured by inventory of $40 million at cost.

The statement of profit or loss will show:

Interest payable (7% of $40m) $2.8m



Tutorial note: This transaction is a sale and repurchase agreement. It could be possible to include the interest cost as part of the inventory, if the inventory falls to be a qualifying asset in accordance with IAS 23 “Borrowing Costs”.

(ii) Consignment sales

The problem in this transaction is to determine at which point Timber Products should recognise the sale. Is the substance of the transaction such that it is right to recognise the sale on delivery of the furniture or at a later date?

If the sale is recognised on delivery of the furniture then the financial statements of Timber Products should recognise revenue of $10m for the year and its closing statement of financial position will show a receivable of $4m ($10m – $6m).

If the sale is not recognised at delivery, but at some later date then Timber Products should recognise revenue of $6m for the year. The inventory held by the retailers at the year-end would be treated as that of Timber products and appear in its statement of financial position at cost of $3 million ($4m × 100/1331/3)

The decision as to when the sale is recognised requires an examination of the terms of the contract. The contract contains some terms that support recognition at delivery and some that suggest a later date to be appropriate.

Factors supporting recognition at delivery

Retailer pays insurance (bears the risk of ownership). Price fixed at delivery (retailer has risks and benefits of price change).

Factors supporting recognition at a time after delivery

Retailer may return the goods (Timber Products retains risk and rewards of ownership).

However, this right has never been exercised.

On balance it seems that this sale should be recognised at delivery. In substance once the goods leave Timber products they never return.



I

Answer 16 KEY

(a) Impairment testing

IAS 36 Impairment of Assets states that an asset is impaired when its carrying amount will not be recovered from its continuing use or from its sale. An entity must determine at each reporting date whether there is any indication that an asset is impaired. If an indicator of impairment exists then the asset’s recoverable amount must be determined and compared with its carrying amount to assess the amount of any impairment. Accounting for the impairment of non-financial assets can be difficult as IAS 36 is a complex accounting standard. The turbulence in the markets and signs of economic downturn will cause many companies to revisit their business plans and revise financial forecasts. As a result of these changes, there may be significant impairment charges. Indicators of impairment may arise from either the external environment in which the entity operates or from within the entity’s own operating environment. Thus the current economic downturn is an obvious indicator of impairment, which may cause the entity to experience significant impairment charges.

Assets should be tested for impairment at as low a level as possible, at individual asset level where possible. However, many assets do not generate cash inflows independently from other assets and such assets will usually be tested within the cash-generating unit (CGU) to which the asset belongs. Cash flow projections should be based on reasonable assumptions that represent management’s best estimate of the range of economic conditions that will exist over the remaining useful life of the asset. The discount rate used is the rate, which reflects the specific risks of the asset or CGU.

The basic principle is that an asset may not be carried in the statement of financial position at more than its recoverable amount.

An asset’s recoverable amount is the higher of:

(a) the amount for which the asset could be sold in an arm’s length transaction between knowledgeable and willing parties, net of costs of disposal (fair value less costs of disposal); and

(b) the present value of the future cash flows that are expected to be derived from the asset (value in use). The expected future cash flows include those from the asset’s continued use in the business and those from its ultimate disposal. Value in use is explicitly based on present value calculations.

This measurement basis reflects the economic decisions that a company’s management team makes when assets become impaired from the viewpoint of whether the business is better off disposing of the asset or continuing to use it.

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The assumptions used in arriving at the recoverable amount need to be “reasonable and supportable” regardless of whether impairment calculations are based on fair value less costs of disposal or value in use. The acceptable range for such assumptions will change over time and forecasts for revenue growth and profit margins are likely to have fallen in the economic climate. The assumptions made by management should be in line with the assumptions made by industry commentators or analysts. Variances from market will need to be justified and highlighted in financial statement disclosures.

Whatever method is used to calculate the recoverable amount; the value needs to be considered in the light of available market evidence. If other entities in the same sector are taking impairment charges, the absence of an impairment charge have to be justified because the market will be asking the same question.

It is important to inform the market about how it is dealing with the conditions, and be thinking about how different parts of the business are affected, and the market inputs they use in impairment testing. Impairment testing should be commenced as soon as possible as an impairment test process takes a significant amount of time. It includes identifying impairment indicators, assessing or reassessing the cash flows, determining the discount rates, testing the reasonableness of the assumptions and benchmarking the assumptions with the market. Goodwill does not have to be tested for impairment at the year-end; it can be tested earlier and if any impairment indicator arises at the reporting date, the impairment assessment can be updated. Also, it is important to comply with all disclosure requirements, such as the discount rate and long-term growth rate assumptions in a discounted cash flow model, and describe what the key assumptions are and what they are based on.

It is important that the cash flows being tested are consistent with the assets being tested. The forecast cash flows should make allowance for investment in working capital if the business is expected to grow. When the detailed calculations have been completed, the company should check that their conclusions make sense by comparison to any market data, such as share prices and analysts reports. Market capitalisation below net asset value is an impairment indicator, and calculations of recoverable amount are required. If the market capitalisation is lower than a value-in-use calculation, then the value in use assumptions may require reassessment. For example, the cash flow projections might not be as expected by the market, and the reasons for this must be scrutinised. Discount rates should be scrutinised in order to see if they are logical. Discount rates may have risen too as risk premiums rise. Many factors affect discount rates in impairment calculations. These include corporate lending rates, cost of capital and risks associated with cash flows, which are all increasing in the current volatile environment and can potentially result in an increase of the discount rate.

(b) Impairment issues

An asset’s carrying amount may not be recovered from future business activity. Wherever indicators of impairment exist, a review for impairment is carried out. Where impairment is identified, a write-down of the carrying amount to the recoverable amount is charged as an immediate expense in profit or loss. Using a discount rate of 5%, the value in use of the non-current assets is:

Year to 31 May 2016 2017 2018 2019 Total Discounted cash flows ($000) 267 408 431 452 1,558 The carrying amount of the non-current assets at 31 May 2015 is $2·4 million ($3m – depreciation of $600,000). Therefore the assets are impaired by $842,000 ($2·4m – $1·558m).



IAS 36 requires an assessment at each reporting date whether there is an indication that an impairment loss may have decreased. This does not apply to goodwill or to the unwinding of the discount. In this case, the increase in value is due to the unwinding of the discount as the same cash flows have been used in the calculation. Compensation received in the form of reimbursements from governmental indemnities is recorded in the statement of comprehensive income when the compensation becomes receivable according to IAS 37 Provisions, Contingent Liabilities and Contingent Assets. It is treated as separate economic events and accounted for as such. At this time the government has only stated that it may reimburse the company and therefore credit should not be taken of any potential government receipt.

For a revalued asset, the impairment loss is treated as a revaluation decrease. The loss is first set against any revaluation surplus and the balance of the loss is then treated as an expense in profit or loss. The revaluation gain and the impairment loss would be treated as follows:

Depreciated historical Revalued carrying amount cost $m $m 1 December 2012 10 10 Depreciation (2 years) (2) (2) Revaluation 0·8 –––––– –––––– 1 December 2014 8 8·8 –––––– –––––– Depreciation (1) (1·1) Impairment loss (1·5) (2·2) –––––– –––––– 30 November 2015 after impairment loss 5·5 5·5 –––––– –––––– The impairment loss of $2·2 million is charged to equity until the carrying amount reaches depreciated historical cost and thereafter it goes to profit or loss. It is assumed that the company will transfer an amount from revaluation surplus to retained earnings to cover the excess depreciation of $0·1 million as allowed by IAS 16. Therefore the impairment loss charged to equity would be $0·7 million ($0·8m – $0·1m) and the remainder of $1·5 million would be charged to profit or loss.

Tutorial note: If the annual transfer of $0.1 million is not made then $0.8 million will be charged against equity, through other comprehensive income, and $1.4 million would be charged to profit or loss.

A plan by management to dispose of an asset or group of assets due to under-utilisation is an indicator of impairment. This will usually be well before the held for sale criteria under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations are met. Assets or cash-generating units are tested for impairment when the decision to sell is made.

The impairment test is updated immediately before classification under IFRS 5. IFRS 5 requires an asset held for sale to be measured at the lower of its carrying amount and its fair value less costs to sell. Non-current assets held for sale and disposal groups are re-measured at the lower of carrying amount or fair value less costs to sell at every reporting date from classification until disposal. The measurement process is similar to that which occurs on classification as held for sale. Any excess of carrying amount over fair value less costs to sell is a further impairment loss and is recognised as a loss in the statement of comprehensive income in the current period. Fair value less costs to sell in excess of carrying amount is ignored and no gain is recorded on classification.



The non-current assets or disposal group cannot be written up past its previous (pre-impairment) carrying amount, adjusted for depreciation, which would have been applied without the impairment. The fact that the asset is being marketed at a price in excess of its fair value may mean that the asset is not available for immediate sale and therefore may not meet the criteria for “held for sale”.



A

Answer 18 BRAMSHAW

(a) Financial instruments

(i) Measurement

Financial instruments can be measured under IFRS in a variety of ways. For example, financial assets could be measured using the equity method for associates or at fair value (with gains or losses taken either to profit or loss or other comprehensive income) or at amortised cost. Financial liabilities could be measured at fair value (e.g. derivatives) or at amortised cost, which is used for most financial liabilities outside of the financial sector. The measurement methods used under IFRS sometimes portray an estimate of current value and others portray original cost. Some of the measurements include the effect of impairment losses, which are recognised differently under IFRS. For example financial assets at fair value through profit or loss recognise changes in value in earnings, while those classified as “fair value through other comprehensive income” are measured at fair value with changes in other comprehensive income.

Also the percentage of the ownership interest acquired will determine how the holding is accounted for (associate – equity method, subsidiary – acquisition method).

The different ways in which financial instruments can be measured creates problems for preparers and users of financial statements because of the following:

The criteria for deciding which instrument can be measured in a certain way are complex and difficult to apply. It is sometimes difficult to determine whether an instrument is equity or a liability and the criteria can be applied in different ways as new types of instruments are created.

Management can choose how to account for an instrument or can be forced into a treatment that they would have preferred to avoid. For example if the instrument is an equity investment then management have a choice of either valuing the instrument at fair value through profit or loss and fair value through other comprehensive income. It should be noted that this option is only available on the initial recognition of the equity instrument, and once the option has been made it is irrevocable.

Different gains or losses resulting from different measurement methods may be combined in the same line item in the statement of comprehensive income.

It is not always apparent which measurement principle has been applied to which instrument and what the implications are of the difference. Comparability is affected and the interpretation of financial statements is difficult and time consuming.

(ii) Complexity vs uncertainty

There are several approaches that can be taken to solve the measurement and related problems. There is pressure to develop standards, which are principle-based and less complex. It has been suggested by IASB members that the long-term solution is to measure all financial instruments using a single measurement principle thus making reported information easier to understand and allowing comparisons between entities and periods.

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If fair value was used for all types of financial instrument then:

There would be no need to “classify” financial instruments;

There would be no requirement to report how impairment losses have been quantified;

There would be no need for rules as regards transfers between measurement categories;

There would be no measurement mismatches between financial instruments and the need for fair value hedge accounting would be reduced;

Identification and separation of embedded derivatives would not be required (this may be required for non-financial instruments);

A single measurement method would eliminate the confusion about which method was being used for different types of financial instruments;

Entities with comparable credit ratings and obligations will report liabilities at comparable amounts even if borrowings occurred at different times at different interest rates. The reverse is true also. Different credit ratings and obligations will result in the reporting of different liabilities;

Fair value would better reflect the cash flows that would be paid if liabilities were transferred at the re-measurement date.

Fair value would result in an entity reporting the same measure for security payment obligations with identical cash flow amounts and timing. At present different amounts are likely to be reported if the two obligations were incurred at different times if market interest rates change.

There is uncertainty inherent in all estimates and fair value measurements, and there is the risk that financial statements will be seen as more arbitrary with fair value because management has even more ability to affect the financial statements.

Accountants need to be trained to recognise biases with respect to accounting estimates and fair value measurements so they can advise entities. It is important to demonstrate consistency in how an entity has applied the fair value principles and developed valuations to ensure credibility with investors, lenders and auditors. Although entities may select which assets and liabilities they wish to value under IFRS 9, outside parties will be looking for consistency in how the standard was applied. Circumstances and market conditions change. Markets may become illiquid and the predicative models may not provide an on-going advantage for the entity.

(b) Borrowings

Using amortised cost, both financial liabilities will result in single payments, which are almost identical at the same point in time in the future ($59·9 million). ($47m × 1·05 for 5 years and $45m × 1·074 for 4 years) However, the carrying amounts at 30 November 2015 would be different. The initial loan would be carried at $47 million plus interest of $2·35 million (i.e. $49·35 million) while the new loan would be carried at $45 million even though the obligation at 30 November 2018 would be approximately the same.

If the two loans were carried at fair value, then the initial loan would be carried at $45 million thus showing a net profit of $2 million (interest expense of $2·35 million and unrealised gain of $4·35 million).



Answer 19 SEEJOY

(a) Sale and leaseback

A sale and leaseback agreement releases capital for expansion, repayment of outstanding debt or repurchase of share capital. The transaction releases capital tied up in non-liquid assets. There are important considerations. The price received for the asset and the related interest rate/rental charge should be at market rates. The interest rate will normally be dependent upon the financial strength of the “tenant” and the risk/reward ratio which the lessor is prepared to accept. There are two types of sale and leaseback agreements; one using a finance lease and the other an operating lease.

The accounting treatment is determined by IAS 17 Leases. The substance of the transaction is essentially one of financing as the title to the stadium is transferred back to the club. Thus a sale is not recognised. The excess of the sale proceeds over the carrying amount of the assets is deferred and amortised to profit or loss over the lease term. The leaseback of the stadium is for the remainder of its economic and useful life, and therefore under IAS 17, the lease should be treated as a finance lease. The stadium will remain as a non-current asset and will be depreciated. The finance lease loan will be accounted for under IFRS 9 Financial Instruments in terms of the derecognition rules in the standard. The transaction will be recognised by the club as follows in the year to 31 December 2016:

Dr Cr $m $m Receipt of cash 1 January 2016 Cash received 15 Stadium 12 Deferred income 3 ––– ––– 15 15 ––– ––– Assets held under finance lease 15 Finance lease payable 15 Depreciation (15 ÷ 20 years) 0·75 Assets held under finance lease 0·75 Year ending 31 December 2016 Statement of comprehensive income $ 000 Deferred income ($3m ÷ 20 years) 150 Depreciation (750) Finance charge ($15m – $1·2m) × 5·6% (773) Statement of financial position Non-current assets Stadium ($15m – $750,000) 14,250 –––––– Non-current liabilities Deferred income ($3m – $150,000) 2,850 Long term borrowings (15 – (1·2 × 2) + 773) 13,373 –––––– Current liabilities – rental payment 1,200 ––––––

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This form of sale and leaseback has several disadvantages. The profit for the period may decrease because of the increase in the finance charge over the deferred income. Similarly the gearing ratio of the club may increase significantly because of the increase in long term borrowings although the short term borrowings may be reduced by the inflow of cash. Unsecured creditors may have less security for their borrowings after the leasing transaction. It may be worth considering a sale and leaseback involving an operating lease as in this case the profit on disposal can be recognised immediately because the sale price is at fair value. The stadium will be deemed to be sold and will be removed from the statement of financial position. Similarly a long-term liability for the loan will not be recognised in the statement of financial position, and the sale proceeds could be used to repay any outstanding debt. This form of sale and leaseback would seem to be preferable than the one using a finance lease although any increase in the residual value of the stadium would be lost. However the secured loan approach which the directors do not wish to use may better reflect substance over form.

(b) Player registrations

The players’ transfer fees have been capitalised as intangible assets under IAS 38 Intangible Assets because it is probable that expected future benefits will flow to the club as a result of the contract signed by the player and the cost of the asset can be measured reliably, being the transfer fee. The cost model would be used because the revaluation model has to use an active market to determine fair value and this is not possible because of the unique nature of the players. IAS 38 requires intangible assets such as the player contracts to be amortised over their useful life. Intangible assets with indefinite useful lives should not be amortised and should be impairment tested annually. If the player is subsequently “held for sale” (i.e. becomes available-for-sale to other clubs and satisfies the criteria in IFRS 5 Non-current Assets Held for Sale and Discontinued Operations) then amortisation ceases.

The amortisation method should reflect the pattern of the future economic benefits. The amortisation of the contracts over 10 years does not fit this criterion. IAS 38 recommends an amortisation method which reflects the useful life of the asset and the pattern of economic benefits and, therefore, the proposed method over 10 years cannot be used as an accounting policy. The current amortisation level should be maintained and a charge of $9 million would be shown in profit or loss for the year ending 31 December 2016. This proposal in any event would only mask the poor financial state of the club. It is a book entry which may help prevent negative equity but will not give a cash benefit. The strategy for the club should be to contract players which it can afford and to spend at levels appropriate to its income.

There does not appear to be any probability that the contingent liability will crystallise. Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, a contingency is a possible obligation arising out of 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. At present the club is performing very poorly in the league and is unlikely to win the national league. Therefore, the contingent liability will not become a present obligation but will still be disclosed in the financial statements for the year ending 31 December 2016.



(c) Issue of bond

This form of financing a football club’s operations is known as “securitisation”. Often in these cases a special purpose vehicle is set up to administer the income stream or assets involved. In this case, a special purpose vehicle has not been set up. The benefit of securitisation of the future corporate hospitality sales and season ticket receipts is that there will be a capital injection into the club and it is likely that the effective interest rate is lower because of the security provided by the income from the receipts. The main problem with the planned raising of capital is the way in which the money is to be used. The use of the bond for ground improvements can be commended as long-term cash should be used for long-term investment but using the bond for players’ wages will cause liquidity problems for the club.

This type of securitisation is often called a “future flow” securitisation. There is no existing asset transferred to a special purpose vehicle in this type of transaction and, therefore, there is no off balance sheet effect. The bond is shown as a long term liability and is accounted for under IFRS 9 Financial Instruments. There are no issues of derecognition of assets as there can be in other securitisation transactions. In some jurisdictions there are legal issues in assigning future receivables as they constitute an unidentifiable debt which does not exist at present and because of this uncertainty often the bond holders will require additional security such as a charge on the football stadium.

The bond will be a financial liability and it will be classified in one of two ways:

(1) Financial liabilities at fair value through profit or loss include financial liabilities that the entity either has incurred for trading purposes or, where permitted, has designated to the category at inception. Derivative liabilities are always treated as held for trading unless they are designated and effective as hedging instruments. An example of a liability held for trading is an issued debt instrument that the entity intends to repurchase in the near term to make a gain from short-term movements in interest rates. It is unlikely that the bond will be classified in this category.

(2) The second category is financial liabilities measured at amortised cost. It is the default category for financial liabilities that do not meet the criteria for financial liabilities at fair value through profit or loss. In most entities, most financial liabilities will fall into this category. Examples of financial liabilities that generally would be classified in this category are account payables, note payables, issued debt instruments, and deposits from customers. Thus the bond is likely to be classified under this heading. When a financial liability is recognised initially in the statement of financial position, the liability is measured at fair value. Fair value is 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. Since fair value is a market transaction price, on initial recognition fair value will usually equal the amount of consideration received for the financial liability. Subsequent to initial recognition financial liabilities are measured using amortised cost or fair value. In this case the company does not wish to use valuation models nor is there an active market for the bond and, therefore, amortised cost will be used to measure the bond.

The bond will be shown initially at $47·5 million ($50m × 95%) as this is the consideration received. Subsequently at 31 December 2016, the bond will be shown as follows:

$m Initial recognition 47·5 Interest at 7·7% 3·7 Cash payment (6) ––––– Amount owing 31 December 2016 45·2 –––––



(d) Player trading

The sale of the players will introduce cash into the club and help liquidity. The contingent liability will be extinguished as the players will no longer play for Seejoy. The club, however, is not performing well at present and the sale of the players will not help their performance. This may result in the reduction of ticket sales and, therefore, cause further liquidity problems. The proceeds from the sale of players may be difficult to estimate at present as the date of sale is significantly into the future. (The players will not constitute “held for sale” non-current assets under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations at 31 December 2015 as the players are not available for immediate sale. As a loss on sale is anticipated on the players, an impairment review should be undertaken at 31 December 2015.)

If the sale proceeds are $16 million, then a loss on sale will be recorded of $2 million if the players are sold on 1 May 2016.

Transfer fee Amortisation Carrying amount $m $m $m A Steel 20 4 + 4/12 of 4 14·7 R Aldo 15 10 + 4/12 of 5 3·3 —— 18 Sale proceeds (estimate) 16 —— Loss 2 —— If the players are not sold by 31 December 2016, they may constitute non-current assets held for sale, if the conditions of IFRS 5 are met. Immediately before the initial classification of the asset as held for sale, the carrying amount of the asset will be measured in accordance with applicable IFRSs and the non-current assets if deemed to be held for sale will be measured at the lower of carrying amount and fair value less costs to sell. Impairment must be considered both at the time of classification as held for sale and subsequently. Non-current assets that are classified as held for sale are not depreciated. Thus amortisation of the transfer fees will stop if the non-current assets are held for sale. Assets classified as held for sale must be presented separately in the statement of financial position at 31 December 2016.


1078 ©2015 DeVryecker Educati onal Development Corp. All rights reserved.

( Answer 30 MINNY GROUP

(a) Consolidated Statement of Financial Position at 30 November 2015

$m Assets Non-current assets: Property, plant and equipment (W9) 1,606·00 Goodwill (W2) 190·00 Intangible assets (W8) 227·00 Investment in Puttin (W3) 50·50 –––––––– 2,073·50 –––––––– Current assets (W11) 1,607·00 –––––––– Disposal group (W12) 33·00 –––––––– Total assets 3,713·50 ––––––––

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Equity and liabilities Equity attributable to owners of parent Share capital 920·00 Retained earnings (W5) 936·08 Other components of equity (W5) 77·80 –––––––– 1,933·88 –––––––– Non-controlling interest (W7) 394·62 –––––––– 2,328·50 –––––––– Total non-current liabilities (W10) 711·00 –––––––– Disposal group (W12) 3·00 Current liabilities (W6) 671·00 –––––––– Total liabilities 1,385·00 –––––––– Total equity and liabilities 3,713·50 –––––––– WORKINGS

(1) Bower $m $m Purchase consideration 730 Fair value of non-controlling interest 295 Fair value of identifiable net assets acquired: Share capital 400 Retained earnings 319 Other components of equity 27 Fair value adjustment – land 89 ––– (835) –––– Goodwill 190 ––––

(2) Heeny $m $m Purchase consideration 320 Less: Non-controlling interest’s share (30% of $320) (96) Non-controlling interest fair value of 44% holding 161 Fair value of identifiable net assets: Share capital 200 Retained earnings 106 Other components of equity 20 Fair value adjustment – land 36

–––– (362) –––– Goodwill 23 ––––



Impairment test of Bower and Heeny Bower Heeny $m $m Goodwill 190 23 Assets 1,130 595 Fair value adjustment 89 36 ––––– ––––– Total asset value 1,409 654 Recoverable amount (1,425) (604) ––––– ––––– Impairment n/a 50 There is no impairment in the case of Bower but Heeny’s assets are impaired. Goodwill of $23 million plus $27 million of the intangible assets will be written off. The reason for the latter write down is because the directors feel that the reason for the reduction in the recoverable amount is due to the intangible assets’ poor performance.

Group reserves will be debited with $28 million and non-controlling interest with $22 million, being the loss in value of the assets split according to the profit sharing ratio.

Total goodwill is therefore ($190m + $23m – $23m impairment), i.e. $190 million.

(3) Puttin

The gain of $3 million ($21m – $18m) recorded within other components of equity (OCE) up to 1 June 2015 would not be transferred to profit or loss for the year but can be transferred within equity and hence to retained earnings under IFRS 9 Financial Instruments.

The amount included in the consolidated statement of financial position would be:

$m Cost ($21 million + $27 million) 48 Share of post-acquisition profits ($30 million × 0·5 × 30%) 4·5 Less dividend received (2·0) ––––– 50·5 ––––– The dividend should have been credited to Minny’s profit or loss and not to other comprehensive income. Dividend income as an investment and as an associate is treated in the same way as a credit to profit or loss. There is no impairment as the carrying amount of the investment in the separate financial statements does not exceed the carrying amount in the consolidated financial statements nor does the dividend exceed the total comprehensive income of the associate in the period in which the dividend is declared.

(4) Intangible assets

Minny should recognise the $10 million as an intangible asset plus the cost of the prototype of $4 million and the $3 million to get it into condition for sale. The remainder of the costs should be expensed including the marketing costs. This totals $9 million, which should be taken out of intangibles and expensed.

Dr Retained earnings $9 million Cr Intangible assets $9 million



(5) Retained earnings $m Balance at 30 November 2015: Minny 895·00 Post-acquisition reserves: Bower (70% of (442 – 319)) 86·10 Heeny (56% of (139 – 106)) 18·48 Puttin: fair value of investment at acquisition from OCE 3·00 Puttin: share of post-acquisition retained profits (W3) (4·5 – 2) 2·50 Dividend income from OCE 2·00 Intangible assets (9·00) Impairment loss on goodwill of Heeny (W2) (28·00) Impairment loss on disposal group (W11) (34·00) ––––––– Total 936·08 ––––––– Other components of equity $m Balance at 30 November 2015: Minny 73 Post-acquisition reserves: Bower (70% of (37 – 27)) 7 Heeny (56% of (25 – 20)) 2·8 Dividend income to retained earnings (2) Transfer to retained earnings (3) –––– 77·8 –––– (6) Current liabilities $m Balance at 30 November 2015 Minny 408 Bower 128 Heeny 138 –––– 674 Disposal group (3) –––– 671 –––– (7) Non-controlling interest $m Bower (W1) 295 Heeny (W2) – purchase consideration (96) Fair value 161 Post-acquisition reserves – Bower Retained earnings (30% of (442 – 319)) 36·9 Other components of equity (30% of (37 – 27)) 3 Heeny Retained earnings (44% of (139 – 106)) 14·52 Other components of equity (44% of (25 – 20)) 2·2 Impairment loss (W2) (22) –––––– 394·62 ––––––



(8) Intangibles $m $m Minny 198 Bower 30 Heeny 35 Intangible expensed (9) Impairment of intangible (27) –––– –––– 227 –––– (9) Property, plant and equipment $m $m Minny 920 Bower 300 Heeny 310 ––––– 1,530 Increase in value of land – Bower (W1) 89 Increase in value of land – Heeny (W2) 36 ––––– 1,655 Disposal group (49) ––––– 1,606 ––––– (10) Non-current liabilities $m $m Minny 495 Bower 123 Heeny 93 ––––– 711 ––––– (11) Current assets $m $m Minny 895 Bower 480 Heeny 250 ––––– 1,625 Disposal group (18) ––––– 1,607 ––––– (12) Disposal group $m Property, plant and equipment 49 Inventory 18 Current liabilities (3) Proceeds (30) ––––– Impairment loss 34 –––––



The assets and liabilities will be shown as single line items in the statement of financial position. Assets at ($67 – 34 m), i.e. $33 million and liabilities at $3 million. A plan to dispose of net assets is an impairment indicator.

(b) Non-current asset held for sale

An asset or disposal group is available for immediate sale in its present condition, if the entity has the intention and ability to transfer the asset or disposal group to a buyer. There is no guidance in the standard on what constitutes available for immediate sale but the guidance notes set out various examples. Customary terms of sale such as surveys and searches of property do not preclude the classification as held for sale. However, present conditions do not include any conditions that have been imposed by the seller of the asset or disposal group, such as if planning permission is required before sale. In this case, the asset is not held for sale. The problem is determining whether the entity truly intends to dispose of the group of assets.

A sale is “highly probable” where it is significantly more likely than probable that the sale will occur and probable is defined as “more likely than not”. IFRS 5 attempts to clarify what this means by setting out the criteria for a sale to be highly probable. These criteria are: there is evidence of management commitment; there is an active programme to locate a buyer and complete the plan; the asset is actively marketed for sale at a reasonable price compared to its fair value; the sale is expected to be completed within 12 months of the date of classification; and actions required to complete the plan indicate that it is unlikely that there will be significant changes to the plan or that it will be withdrawn.

Because the standard defines “highly probable” as “significantly more likely than probable”, this creates a high threshold of certainty before recognition as held-for-sale. IFRS 5 expands on this requirement with some specific conditions but the uncertainty still remains. Thus, a number of issues has arisen over the implementation of the standard, mainly due to the fact that there is subjectivity over the requirements of the standard.

(c) Ethical and accounting implications

A company may distribute non-cash assets. The transfer of the asset from Bower to Minny amounts to a distribution of profits rather than a loss on disposal. The shortfall between the sale proceeds and the carrying amount is $1 million and this will be treated as a distribution. Bower has retained earnings of $442 million available at the year-end plus the sale of the non-current asset will “realise” an additional amount of $400,000 from the revaluation reserve. It is likely that the sale will be legal, depending upon the jurisdiction concerned. If the transaction meets the criteria of IFRS 5 Non-current Assets Held for Sale and Discontinued Operations , then the asset would be held in the financial statements of Bower in a separate category from plant, property and equipment and would be measured at the lower of carrying amount at held-for-sale date and fair value less costs to sell. If the asset is held for sale, IAS 16 Property, Plant and Equipment does not apply.

The boundary between ethical practices and legality is sometimes blurred. Questions would be asked of the directors as to why they would want to sell an asset at half of its current value, assuming that $2 million is the current value and that $1 million is not a fair approximation of fair value. It may raise suspicion. Corporate reporting involves the development and disclosure of information, which should be truthful and neutral. Both Bower and Minny would need to make related party disclosures so that the transaction is understood by stakeholders.



The nature of the responsibility of the directors requires a high level of ethical behaviour. Shareholders, potential shareholders, and other users of the financial statements rely heavily on the financial statements of a company as they can use this information to make an informed decision about investment. They rely on the directors to present a true and fair view of the company. Unethical behaviour is difficult to control or define. However, it is likely that this action will cause a degree of mistrust between the directors and shareholders unless there is a logical business reason for their actions. Shareholders in most jurisdictions who receive an unlawful dividend are liable to repay it to the company.



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Answer 2 VERGE

(a) Operating segments

IFRS 8 Operating Segments states that reportable segments are those operating segments or aggregations of operating segments for which segment information must be separately reported. Aggregation of one or more operating segments into a single reportable segment is permitted (but not required) where certain conditions are met, the principal condition being that the operating segments should have similar economic characteristics.

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The segments must be similar in each of the following respects:

the nature of the products and services; the nature of the production processes; the type or class of customer; the methods used to distribute their products or provide their services; the nature of the regulatory environment.

Segments 1 and 2 have different customers. In view of the fact that the segments have different customers, the two segments do not satisfy one of the aggregation criteria above. The decision to award or withdraw a local train contract rests with the transport authority and not with the end customer, the passenger. In contrast, the decision to withdraw from a route in the inter-city train market would normally rest with Verge but would be largely influenced by the passengers’ actions that would lead to the route becoming economically unviable.

In the local train market, contracts are awarded following a competitive tender process, and, consequently, there is no exposure to passenger revenue risk. The ticket prices paid by passengers are set by a transport authority and not Verge. By contrast, in the inter-city train market, ticket prices are set by Verge and its revenues are, therefore, the fares paid by the passengers travelling on the trains. In this set of circumstances, the company is exposed to passenger revenue risk. This risk would affect the two segments in different ways but generally through the action of the operating segment’s customer. Therefore the economic characteristics of the two segments are different and should be reported as separate segments.

(b) Revenue recognition

The performance does not create an asset with an alternative use and Verge has an enforceable right to payment for work completed to date. Therefore the contract is one in which the performance obligation is satisfied over time. Verge should recognise revenue as the contract progresses in accordance with IFRS 15 Revenue from Contracts with Customers. When a contract contains a significant financing component, as is the case here, the transaction price must take account of the time value of money. Revenue must therefore be discounted at the rate given (i.e. 6%). Where the inflow of cash is deferred, the fair value of the consideration receivable is less than the nominal amount of cash and cash equivalents to be received, and discounting is appropriate. This would occur in this instance as, effectively, Verge is providing interest-free credit to the buyer. Recognition, as defined in the IASB’s Conceptual Framework, means incorporating an item that meets the definition of revenue in the statement of profit or loss when it meets the following criteria:

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

the amount of revenue can be measured with reliability.

Thus Verge must recognise revenue as work is performed throughout the contract life. Discounting the revenue to reflect the delay in receipt of cash from the customer ensures that the revenue is reported at its fair value. The difference between the discounted revenue and the payment received should be recognised as interest income.

The calculation of the revenue’s fair value is as follows:

In the year ended 31 March 2014, Verge should have recorded revenue of $1·6 million (i.e. $1·8 million ÷ 1·062) plus $1 million, i.e. $2·6 million. In the year ended 31 March 2015, revenue should be recorded of $1·2 million ÷ 1·06 (i.e. $1·13 million).



In addition, there will be an interest income of $1·6 million × 6% (i.e. $96,000) recorded in the year to 31 March 2015 which is the unwinding of the discount on the recognised revenue for the year ended 31 March 2014.

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

was available when financial statements for those periods were authorised for issue; and

could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.

Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts and fraud. The fact that Verge only included $1 million of the revenue in the financial statements for the year ended 31 March 2014 is a prior period error.

Verge should correct the prior period errors retrospectively in the financial statements for the year ended 31 March 2015 by restating the comparative amounts for the prior period presented in which the error occurred.

(c) Provision

Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, an entity must recognise a provision if, and only if:

a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event);

payment is probable (“more likely than not”); and

the amount can be estimated reliably.

An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation. The obligating event took place in the year to 31 March 2014. A provision should be made on the date of the obligating event, which is the date on which the event takes place that results in an entity having no realistic alternative to settling the legal or constructive obligation. Even in the absence of legal proceedings, Verge should prudently recognise an obligation to pay damages, but it is reasonable at 31 March 2014 to assess the need for a provision to be immaterial as no legal proceedings have been started and the damage to the building seemed superficial. Provisions should represent the best estimate at the financial statement date of the expenditure required to settle the present obligation and this measurement should take into account the risks and uncertainties of circumstances relevant to the obligation.

In the year to 31 March 2015, as a result of the legal arguments supporting the action, Verge will have to reassess its estimate of the likely damages and a provision is needed, based on the advice that it has regarding the likely settlement. Provisions should be reviewed at each year end for material changes to the best estimate.

Dr Profit or loss $800,000 Cr Provision for damages $800,000



The potential for reimbursements (e.g. insurance payments) to cover some of the expenditure required to settle a provision can be recognised, but only if receipt is virtually certain if the entity settles the obligation. IAS 37 requires that the reimbursement be treated as a separate asset. The amount recognised for the reimbursement cannot exceed the amount of the provision. IAS 37 permits the expense relating to a provision to be presented net of the amount. The company seems confident that it will satisfy the terms of the insurance policy and should accrue for the reimbursement:

Dr Trade receivables $200,000 Cr Profit or loss $200,000 The court case was found against Verge but as this was after the authorisation of the financial statements, there is no adjustment of the provision at 31 March 2015. It is not an adjusting event.

(d) Granted building

In accordance with IAS 1 Presentation of Financial Statements, all items of income and expense recognised in a period should be included in profit or loss for the period unless a standard or interpretation requires or permits otherwise.

IAS 16 Property, Plant and Equipment states that the recognition criteria for such assets are based on the probability that future benefits will flow to the entity from the asset and that cost can be measured reliably. The above normally occurs when the risks and rewards of the asset have passed to the entity. Normally the risks and rewards are assumed to transfer when an unconditional and irrevocable contract is put in place.

Therefore at 31 March 2014, the building would not be recognised as the “contract” is not unconditional and possession of the building has not been taken by Verge.

Once the conditions of the donated asset have been met in February 2015, the income of $1·5 million is recognised in the statement of profit or loss and other comprehensive income. The following transactions need to be made to recognise the asset in the entity’s statement of financial position as of 31 March 2015.

Dr Property, plant and equipment $2·5m Cr Profit or loss $1·5m Cr Cash/trade payable $1m Depreciation of the building should also be charged for the period according to Verge’s accounting policy.

IAS 20 Accounting for Government Grants and Disclosure of Government Assistance states that a government grant is recognised only when there is reasonable assurance that (a) the entity will comply with any conditions attached to the grant and (b) the grant will be received. Thus in this case the grant will be recognised.

The grant is recognised as income over the period necessary to match it with the related costs, for which it is intended to compensate, on a systematic basis. A grant receivable as compensation for costs already incurred or for immediate financial support, with no future related costs, should be recognised as income in the period in which it is receivable.

A grant relating to assets (capital based grant) may be presented in one of two ways:

either as deferred income; or by deducting the grant from the asset’s carrying amount.



The grant of $250,000 relates to capital expenditure and revenue. It seems appropriate to account for the grant on the basis of matching the grant to the expenditure. Therefore $100,000 (20 × $5,000) should be taken to income and the remainder ($150,000) should be recognised as a capital based grant. The double entry would be:

Dr Cash $250,000 Cr Profit or loss $100,000 Cr Deferred income or property, plant and equipment (depending on accounting policy) $150,000



JUNE 2014

Answer 1 MARCHANT

(a) Consolidated financial statements

(i) Statement of profit or loss and other comprehensive income for the year ended 30 April 2015 $m Revenue 538 Cost of sales (383) –––––– Gross profit 155 Other income 23·7 Administrative costs (30) Other expenses (51·19) –––––– Operating profit 97·51 Finance costs (10) Finance income 15 –––––– Profit before tax 102·51 Income tax expense (30·5) –––––– Profit for the year 72·01 –––––– Other comprehensive income: Items which will not be reclassified to profit or loss Changes in revaluation surplus 2·8 Remeasurements – defined benefit plan (2) –––––– Total items which will not be reclassified subsequently to profit or loss 0·8 Items which may be reclassified subsequently to profit or loss Losses on cash flow hedge (3) –––––– Other comprehensive loss for the year (2·2) –––––– Total comprehensive income for the year 69·81 –––––– Profit/loss attributable to: (W7) Owners of the parent 60·21 Non-controlling interest 11·8 –––––– 72·01 –––––– Total comprehensive income attributable to: $m Owners of the parent 59·21 Non-controlling interest 10·6 –––––– 69·81 ––––––

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WORKINGS

(1) Profit or loss

Tutorial note: This is purely a working; it does not purport to show necessarily what would be reported in the individual accounts.

Marchant Nathan Option Adjustment Total $m $m $m $m Revenue 400 115 35 (12) 538 Cost of sales (312) (65) (18) 12 (383) –––––– –––– –––– –––– –––––– Gross profit 88 50 17 155 Other income (21 – 5·3 (W2)) 15·7 7 1 23·7 Administrative costs (15) (9) (6) (30) Other expenses (35) (19) (4) Impairment of goodwill (5) Gain on sale of Option 22 Share of profits of associates 1·5 Net service cost (7·2) PPE expense (2·36) Share options (2·13) (51·19) –––––– –––– –––– –––––– Operating profit 60·51 29 8 97·51 Finance costs (5) (6) (2) (10) Cash flow hedge to OCI 3 Finance income 6 5 4 15 –––––– –––– –––– –––––– Profit before tax 61·51 31 10 102·51 Income tax expense (19) (9) (2·5) (30·5) –––––– –––– –––– –––––– Profit for the year 42·51 22 7·5 72·01 –––––– –––– –––– –––––– Other comprehensive income Remeasurements defined benefit plan (2) (2) Revaluation surplus ($10m – $5m (W2)) 5 5 Revaluation adjustment (2·2) (2·2) Cash flow hedge (finance costs reduced by same amount) (3) (3) ––––– –––––– Other comprehensive income/loss for year 0·8 (3) (2·2) –––––– –––– –––– –––––– Total comprehensive income for year 43·31 19 7·5 69·81 –––––– –––– –––– ––––––



(2) Nathan $m $m Fair value of consideration for 60% interest 80 Fair value of non-controlling interest 45 125 –––– Fair value of identifiable net assets acquired (110) –––– Goodwill 15 –––– Goodwill impairment

After goodwill has been impaired by $3m (20% × $15m), any subsequent increase in the recoverable amount is likely to be internally-generated goodwill rather than a reversal of purchased goodwill impairment. IAS 38 Intangible Assets prohibits the recognition of internally-generated goodwill, thus any reversal of impairment is not recognised.

Hence $5 million needs to be charged to profit or loss to undo the reversal.

Total impairment is still $3 million.

The gains recorded regarding the investment in Nathan will be follows:

Gain on investment in Nathan ($95m – $90m) $5m Gain on sale of holding in Nathan ($18 – (8%/60% × $95m)) $5·3m

No gain or loss is recognised in profit or loss on the sale of Nathan in the group accounts as the sale is shown as a movement in equity. Therefore it is eliminated. Additionally, the gain on the revaluation of the investment in Nathan will also be eliminated on consolidation as the calculation of goodwill will be based on the fair value of the consideration at the date of acquisition and not at the date of the current financial statements.

(3) Option $m $m Fair value of consideration for 60% interest 70 Fair value of non-controlling interest 28 98 –––– Fair value of identifiable net assets acquired (86) –––– Goodwill 12 ––––

As Marchant has sold a controlling interest in Option, a gain or loss on disposal should be calculated. Additionally, the results of Option should only be consolidated in the statement of profit or loss and other comprehensive income for the six months to 1 November 2014. Thereafter Option should be equity accounted. The gain recognised in profit or loss would be as follows:



$m Fair value of consideration 50 Fair value of residual interest to be recognised as an associate 40 Value of NCI 34 –––– 124 Less: Net assets and goodwill derecognised Net assets (90) Goodwill (12) –––– Gain on disposal to profit or loss 22 –––– The share of the profits of the associate would be $1·5 million (i.e. 20% of a half year’s profit (½ × $15m)).

(4) Defined benefit plan

Pension cost recognised for the year would be $m Current service cost 4 Net interest cost (10% × ($50m – $48m)) 0·2 Past service cost 3 –––– Net service cost recognised in profit or loss 7·2 Remeasurements in other comprehensive income 2 –––– Net cost for year recognised in total comprehensive income 9·2 –––– IAS 19 does not specify where service cost and net interest cost should be presented. Therefore it is acceptable to include the net interest cost in finance costs.

(5) Property, plant and equipment

$m Carrying amount at 1 May 2014 13 Depreciation for year ($13m ÷ 9) (1·44) –––––– Carrying amount at 30 April 2015 11·56 Fall in value charged to revaluation surplus ($13m – ($12m – ($12m ÷ 10))) (2·2) Fall in value charged to profit or loss (2·36) –––––– Carrying amount after revaluation 30 April 2015 7 ––––––

(6) Share options

Year Expense for year Cumulative expense Calculation $m $m 30 April 2014 1·07 1·07 4 directors × $100 × 8,000 × 1/3 30 April 2015 2·13 3·2 6 directors × $100 × 8,000 × 2/3

(7) Non-controlling interest (NCI)

NCI in profits for year is ((40% × $22m) + (40% × ½ × $15m)) = $11·8 million

NCI in total comprehensive income ((40% × $19m) + (40% × ½ × $15)) = $10·6 million



(8) Sale of inventory

The loss on the sale of the inventory is not eliminated from group profit or loss. Because the sale is at fair value, the inventory value must have been impaired and therefore the loss on sale must remain realised. However, the revenue and cost of sales of $12 million will be eliminated.

(ii) Treatment in the group statement of financial position

Once control has been achieved, further transactions through which the parent acquires further equity interests from non-controlling interests, or disposes of equity interests but without losing control, are accounted for as equity transactions (i.e. transactions with owners in their capacity as owners). It therefore follows that:

the carrying amounts of the controlling and non-controlling interests are adjusted to reflect the changes in their relative interests in the subsidiary;

any difference between the amount by which the non-controlling interests is adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent; and

there is no consequential adjustment to the carrying amount of goodwill, and no gain or loss is recognised in profit or loss.

Sale of equity interest in Nathan $m Fair value of consideration received 18 Amount recognised as non-controlling interest (net assets per question at year end ($120m + fair value adjustment PPE at acquisition $14m + goodwill (15 – 3)) × 8%) (11·7) –––––– Positive movement in parent equity 6·3 –––––– The fair value adjustment is $110m – ($25m + $65m + $6m). The income should be shown as a movement in equity not in income. Hence it does not affect the consolidated statement of profit or loss and other comprehensive income.

(b) IFRS and fair values

IFRSs use the “fair value” concept and “present value” more frequently than some other accounting frameworks. However, it is not a complete fair value system. The IASB has a preference for a mixed system of measurements using a combination of fair value and measurements at depreciated historical cost. IASB bases its standards on the business model of the entity and on the probability of realising the asset and liability-related cash flows through operations or transfers.

Fair values, when used in the financial statements, affect the performance measurement and the net assets position and improve the disclosure of risks and of value which may be realisable. IFRS 13 Fair Value Measurement was developed to solve the problems in the application of the fair value concept. However, IFRSs do not require that all assets and liabilities are valued at fair value.



The financial statements of many entities will measure most items at depreciated historical cost, except where entities grow through acquisition when acquired assets and liabilities are valued at fair value on the acquisition date. However, a revaluation through other comprehensive income is allowed provided it is carried out regularly under IAS 16 Property, Plant and Equipment and, in addition, IAS 40 Investment Property allows as an option the measurement of investment properties at fair value with corresponding changes in earnings as this better reflects the business model of some property companies. However, the historical cost basis is still regularly used by entities holding investment properties. IAS 38 Intangible Assets allows the measurement of intangible assets at fair value, with corresponding changes in equity, but only if there is an active market, and thus a reliable valuation, for these assets.

IFRS 9 Financial Instruments replaced the multiple classification and measurement models for financial assets in IAS 39 with a single model which has only two classification categories:

(1) amortised cost; and

(2) fair value.

Classification under IFRS 9 is driven by the entity’s business model for managing the financial assets and the contractual characteristics of the financial assets.

A financial asset is measured at amortised cost if two criteria are met:

(1) the objective of the business model is to hold the financial asset for the collection of the contractual cash flows; and

(2) the contractual cash flows under the instrument solely represent payments of principal and interest.

IFRS 9 removed the requirement to separate embedded derivatives from financial asset hosts. It requires a hybrid contract to be classified in its entirety at either amortised cost or fair value.

As regards derivative financial instruments (swaps, options, future contracts), most of these contracts do not have a cost when signed, and their historical cost is not relevant and obviously it is useless to measure the extent of the commitments undertaken. A market value measurement with matching changes in profit or loss is therefore needed to reflect the risks. This can generate some volatility. Liabilities, except for derivative financial instruments, are recorded at amortised cost. A fair value option is available for financial liabilities, to be used only when some inconsistency should be avoided. In practice, only banks make a limited use of this option for their market transactions.

The fact that IFRSs make some use of fair values in the measurement of assets and liabilities is often misunderstood as meaning that financial statements prepared under IFRSs reflect the aggregate financial value of an entity. The IASB identifies the objective of general purpose financial reporting as being the provision of financial information about the reporting entity which is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. The Conceptual Framework states that general purpose financial reports are not designed to show the value of a reporting entity. The purpose of IFRS financial statements is not to disclose the selling value of the entity, even when some of the identifiable assets and liabilities are recorded at fair value. As IFRSs do not allow an entity to recognise intangible assets generated internally by business operations, any attempt to state the aggregate value of the business would be incomplete.

An entity’s net assets are reported at market value only when it is acquired by another entity and consolidated in group accounts.



(c) Ethics relating to leased asset

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. All other leases are classified as operating leases and classification is made at the inception of the lease. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the legal form. Thus in many circumstances, the classification of a lease can be quite subjective. In the case of a lease of land, this is particularly subjective as the title to the land may not pass to the lessee at the end of the agreement but the lease may still be classed as a finance lease where the present value of the residual value of the land is negligible and the risks and rewards pass to the lessee.

Thus, it appears that at first sight this is a difference in a professional opinion, which can be solved by the financial controller seeking advice.

If the features of the lease appear to meet IAS 17 Leases criteria for classification as a finance lease and the treatment used is part of a strategy to understate the liabilities of the entity in order to raise a loan, then an ethical dilemma arises. Professional accountants are capable of making judgements, applying their skills and reaching informed decisions in situations where the general public cannot. The judgements made by professional accountants should be independent and not affected by business pressures. The code of ethics is very important because it sets out boundaries outside which accountants should not stray. The financial director should not place the financial controller under undue pressure in order to influence his decisions. If the financial controller is convinced that the lease is a finance lease, then disclosure of this fact should be made to the internal governance authority. The financial controller will have the knowledge that his actions were ethical.

Answer 2 ASPIRE

(a) Functional currency

The functional currency is the currency of the primary economic environment in which the entity operates, which is normally the one in which it primarily generates and expends cash. An entity’s management considers the following primary indicators in determining its functional currency:

the currency which mainly influences sales prices for goods and services;

the currency of the country whose competitive forces and regulations mainly determine the sales prices of goods and services; and

the currency which mainly influences labour, material and other costs of providing goods and services.

Further secondary indicators which may also provide evidence of an entity’s functional currency are the currency in which funds from financing activities are generated and in which receipts from operating activities are retained.

Additional factors are considered in determining the functional currency of a foreign operation and whether its functional currency is the same as that of the reporting entity. These are:

the autonomy of a foreign operation from the reporting entity; the level of transactions between the two; whether the foreign operation generates sufficient cash flows to meet its cash needs; and whether its cash flows directly affect those of the reporting entity.

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When the functional currency is not obvious, management uses its judgement to determine the functional currency which most faithfully represents the economic effects of the underlying transactions, events and conditions.

In the case of Aspire, the subsidiary does not make any decisions as to the investment of funds, and consideration of the currency which influences sales and costs is not relevant. Although the costs are incurred in dollars, they are not material to any decision as to the functional currency. Therefore it is important to look at other factors to determine the functional currency.

The subsidiary has issued 2 million dinars of equity capital to Aspire, which is a different currency to that of Aspire, but the proceeds have been invested in dinar denominated bonds at the request of Aspire. The subsidiary has also raised 100,000 dinars of equity capital from external sources but this amount is insignificant compared to the equity issued to Aspire. The income from investments is either remitted to Aspire or reinvested on instruction from Aspire. The subsidiary has a minimum number of staff and does not have any independent management. The subsidiary is simply a vehicle for the parent entity to invest in dinar related investments. Aspire may have set up the entity so that any exposure to the dinar/dollar exchange rate will be reported in other comprehensive income through the translation of the net investment in the subsidiary. There does not seem to be any degree of autonomy as the subsidiary is merely an extension of Aspire’s activities. Therefore the functional currency would appear to be the dollar.

In contrast, the dinar represents the currency in which the economic activities of the subsidiary are primarily carried out as is the case regarding the financing of operations and retention of any income not remitted. However, the investment of funds could have been carried out directly by Aspire and therefore the parent’s functional currency should determine that of the subsidiary.

(b) Deferred tax

Where a foreign branch’s taxable profit is determined in a foreign currency, changes in exchange rates may give rise to temporary differences. This can arise where the carrying amounts of the non-monetary assets are translated at historical rates and the tax base of those assets are translated at the rate at the reporting date. An entity may translate the tax base at the year-end rate as this rate gives the best measure of the amount which will be deductible in future periods. The resulting deferred tax is charged or credited to profit or loss.

Property Dinars (000) Exchange rate Dollars (000) Cost 6,000 5 1,200 Depreciation for year (500) (100) –––––– –––––– Net book amount 5,500 1,100 Tax base Cost 6,000 Tax depreciation (750) –––––– 5,250 6 875 Temporary difference 225 Deferred tax at 20% 45 The deferred tax arising will be calculated using the tax rate in the overseas country. The deferred tax arising is therefore $45,000, which will increase the tax charge in profit or loss. If the historical rate had been used, the tax base would have been $1·05 million ($5·25m ÷ 5) which would have led to a temporary difference of $50,000 and a deferred tax liability of $10,000, which is significantly lower than when the closing rate is used.



(c) Treatment of goodwill

The goodwill arising when a parent acquires a multinational operation with several currencies is allocated to each level of functional currency. Goodwill arising on acquisition of foreign operations and any fair value adjustments are both treated as the foreign operation’s assets and liabilities. They are expressed in the foreign operation’s functional currency and translated at the closing rate.

Exchange differences arising on the retranslation of foreign entities’ financial statements are recognised in other comprehensive income and accumulated as a separate component of equity:

Exchange rate at 1 May 2014 $1 = 5 dinars Exchange rate at 30 April 2015 $1 = 6 dinars Net assets at fair value 1,100m dinars Translated at 1 May 2014 $220m Purchase consideration $200m NCI (250m dinars @ 5) $50m Goodwill $30m Goodwill treated as foreign currency asset at 1 May 2014 ($30m × 5) 150m dinars Goodwill translated at closing rate at 30 April 2015 (150m dinars @ 6) $25m Translation adjustment for goodwill in equity ($5m) An exchange loss of $3·5 million (70% × $5m), will be charged in other comprehensive income together with any gain or loss on the retranslation of the net assets of the operations. The balance of the exchange loss of $1·5 million (30% × $5m) will be charged against the NCI.

(d) Accounting for loan

The loan balance, as a monetary item, is translated at the spot exchange rate at the year-end date. Interest is translated at the average rate because it approximates to the actual rate. Because the interest is at a market rate for a similar two-year loan, Aspire measures the loan on initial recognition at the transaction price translated into the functional currency. Because there are no transaction costs, the effective interest rate is 8%.

On 1 May 2014, the loan is recorded on initial recognition as follows:

Dr Cash $1,000,000 Cr Loan payable – financial liability $1,000,000 Year ended 30 April 2015 Aspire records the interest expense as follows:

Dr Profit or loss – interest expense $71,429 Cr Loan payable – financial liability $71,429 To recognise interest payable for the year ended 30 April 2015 (0·4 million dinars @ 5·6).

On 30 April 2015 the interest is paid and the following entry is made:

Dr Loan payable – financial liability $66,666 Cr Cash $66,666



To recognise the payment of 2015 interest on financial liability (0·4 million dinars @ 6).

At 30 April 2015 the loan is recorded at $833,333 (5 million dinars @ 6), which gives rise to an exchange gain of $166,667. In addition to this, a further exchange gain of $4,763 arises on the translation of the interest paid ($71,429 – $66,666). The total exchange gain is therefore $171,430.

acca paper p2 corporate reporting (international) … acca books...the company used a discount rate...

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