Tuesday 5 June 2018

Exam Guidance for ACCA Paper P2

Abibu Dumbuya SEKOYEN ACCOUNTING SOLUTIONS

June 2018 Exam Guidance

©2015-2018 Sekoyen Accounting Solutions Ltd. All rights reserved

Standard/Area/guide

Study guide Examinable documents

IASB Work plan

Prepare to pass

Examining team

NEW ADDITIONS

(items added since 14/05/18 email are shaded with this

colour and listed here)

Qn

.

No

Core assessment requirements & priorities for the upcoming exam Read March 2018 Examiner’s report (annotated) Read December 2017 Examiner’s report (annotated) Read September 2017 Examiner’s report (annotated)

Read June 2017 Examiner’s report (annotated)

“…it is important to note that only a portion of the marks is allocated to

knowledge of the standard itself and the rest to application. It then becomes

obvious why candidates do not score well as many simply set out the requirements of

the IFRS without application to the scenario.” Examiner’s report, June 2013

“The Corporate Reporting examination requires a deep understanding and

knowledge of the Conceptual Framework, IFRSs and Code of Ethics. Questions at

professional level will challenge the candidate to show this knowledge and then to

apply it to a particular scenario, and this requires extensive preparation.”

Examiners report, September 2016

Anticipated question features and practice suggestions

Personal leadership

Having a clear mission for the course can be energising because it can sharpen

your focus on the contribution you can make with the tools that the course

allows you to acquire. Awakened to your self-actualisation needs, and the

means to fulfil them, you will think clearly about how to vigorously harness

your potential to master the course. Personal leadership sets some benchmarks

to consider.

Reading effectively for the professional exams Reading effectively is a prerequisite for learning effectively. Reading effectively is a skill that can be mastered by learning the principles and developing a routine for

effective regular practice. The skill development guides, reading and practice plans

aim to cover all the different types of reading challenges of the syllabus including the

language aspects which tend to be overlooked.

Critical thinking

Critical thinking is implicit in the syllabus aims because corporate reporting is a

complex process where successful outcomes depend on making a series of

active and integrated choices through structured critical thinking. These resources alert, spur and support you to develop the requisite capabilities.

Your P2 compass Managing your learning can be a difficult task especially when you have access to so

much advice and resources on the internet? Your P2 compass assists in setting your

direction, and navigating an increasingly congested resource landscape, towards

successful outcomes. The Exam guidance acts as your anchor to the syllabus – preventing you from drifting away from its aims, rationale and approach. Whether

you are studying on your own, or following a course, the compass helps you monitor

and evaluate your learning activities so that you can keep your exam preparation on

track. With such a reliable companion you can aspire to high performance in the

upcoming exams and beyond.

Effective writing skills

Effective writing is a core capability: you earn professional marks for the

“clarity and quality of presentation” of your answers.

Here you can find an assortment of practice examples as stimulus. You are

encouraged to work at these methodically to improve this essential component

of your professional skillset

How to use P2 terms and techniques (P2TT)

This document is being developed as a study and exam dictionary to support in-depth

learning required at P2 cognitive level (Level 3 – synthesis and evaluation). Reading

the dictionary can help you think about the issues in an exam focused way. E.g. part

of “Deem” relates to December 2015 q3aiii (irrecoverable gas is PPE as it is an

integral part of the plant); “Impairment” relates to March 2016 q4aii. You don’t get

these exam insights by simply googling the item.

Annotations

Annotations are provided to some of the questions and answers to help you

focus on the salient features which you might otherwise miss. Use the P2-

colour codes to annotations.

Understanding the examiner’s craft

Understanding the examiner’s distinctive craft is an advantage in learning and answering questions. Working through these examples diligently can be

rewarding.

The transition guide

Success in studying P2 requires an effective transition from F7. The transition guide

can be useful.

Real-time Exam technique

Question selection, exam time management and suggested final practice

programme: please go to the section before the last on this document for

guidance on question selection on exam day!

June 2018 Exam Guidance

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A.1 Professional behaviour and

compliance with accounting

standards

1c “The syllabus …examines professional competences within the corporate reporting

environment.” Approach to examining the syllabus, p7

The examiner’s central concerns are that candidates can discuss professional issues

and attitudes in a professional manner and reach conclusions that reflect their

commitment to professional principles. Because professional ethics are inherent to

professional conduct it is inevitable that ethics would be considered in the

application and evaluation of financial principles and practices. Refer to The

professional and ethical duties of the accountant.

Please refer to question strategy particularly q1c strategy table for a review of the

types of questions that have been asked and the learning approach that is entailed

by these requirements.

Unfortunately, candidates often perform below expectation because they fail to

recognize and develop the required competences. The discursive questions are

determined by the syllabus requirements which include the verbs “appraise”,

“assess” and “discuss”. The learning that is entailed by these verbs is explained and

the practice exercises are prescribed to support effective learning and preparation.

You are encouraged to work through the exercises carefully and extensively over a

period of time to ensure that the skills are honed.

Grant Thornton and Robert Napper fined April 2017 (lapse of professional

scepticism)

For June 2018, the following areas are prioritised:

Suggested approach:

- Learn the concept of ethics in P2 Terms and techniques.

- Pay attention to the reasoning employed e.g. see “Understanding” in P2

terms and techniques.

Additional practice questions:

1. Ethical environments can reduce misuse of management reporting

discretion and enhance accounting quality through disclosure of estimates

based on ethically compliant practices. Discuss

See below under professional ethics A.2

A.2 Ethical requirements of

corporate reporting and the

consequences of unethical

behaviour

1c The examiner’s central concerns are that candidates can discuss ethical issues and attitudes in a professional manner and reach conclusions that reflect their

understanding and commitment to ethical principles. But remember that this is not a

P1 Governance, Risk and Ethics paper (assessing the ethics of business conduct) but

a P2 paper addressing the financial effects (impact on financial performance,

financial position and cash flows) of business conduct through the ethics and

standards of the profession.

Therefore, all ethical questions must be viewed through a financial reporting prism

e.g. you should always ask: i) does the attitude or behaviour comply with

professional ethics? ii) is the accounting treatment proposed or adopted supported by

the conceptual framework? iii) if not can it be justified by the general principles of financial reporting and the guidelines of IAS 8 Hierarchy?

Please refer to question strategy particularly q1c strategy table for a review of the

types of questions that have been asked and the learning approach that is entailed

by these requirements.

“As previously reported, many candidates focus on the reporting issues to the

detriment of the ethical issues. The marks in this part of the question are often split

For June 2018, the following areas are priority:

Additional practice questions:

Attempt the past question and study the model answer.

Make sure you cover all the past questions and focus on the core themes:

- March 2018 q1c (answer): ethics of retrospective revaluation of NCI to

current fair value basis from proportional share of fair value of net assets at

time of acquisition “some years ago”.

- December 2017 q1c (answer): ethical issues in intra-group transactions

involving mark-up.

- September 2017 q1c (answer): the ethical implications of unsubstantiated

claims in integrated reports e.g. greenwashing

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equally and therefore not to discuss the ethical or accounting issues is a serious

omission by candidates.” Examiner’s report, December 2016 q1c

Unfortunately, candidates often perform below expectation because they fail to

recognize and develop the required competences. Guidance is provided on the

competences the examiner assesses and how to go about developing them. Refer to

The professional and ethical duties of the accountant.

A suggested approach

List all the key areas for professional judgement in the financial reporting process

and think about the opportunities for manipulation driven by the pressures described

in “The professional duties of the accountant.

Examples:

- IAS 2 Inventory valuation (optimistic valuation that boosts earnings and inflate rewards linked to earnings)

- IAS 7 masking borrowing/lending as operating cash flow to boost performance

and gain performance rewards as in bonus linked to level of operating cash

flows.

- IAS 16 changes in depreciation policies, asset transfers (without commercial

substance), etc. that avoid eligible costs impacting earnings.

- IAS 19 changes in accounting policy that misallocates current and past service

cost to OCI (or allow actuarial gains to be recognised in profit or loss) to allow a

favourable operating profit on which management bonus is based (December

2016 q1c - answer)

- IAS 21 making decisions to defer exchange differences in equity to stave off

losses, or to include deferrable exchange gains in profit or loss to boost

performance.

- IAS 38 classification of items as goodwill to defer impact of related expenditure

on earnings

Consequences of unethical behaviour

Tesco fined for overstating profits in 2014

- June 2017 q1c (answer): contrary to IFRS 9 treat factoring according to its

legal form (regardless of its substance) to maintain liquidity and

profitability under covenant obligations.

- March 2017 q1c: discuss the ethics of applying the average rate to translate

individual foreign transactions for consolidation purposes, causing

excessive translations and undue costs.

- December 2016 q1c (answer): Operating profit-based bonus motivates a

change in accounting policy for recognising all pension scheme gains and

losses in other comprehensive income ostensibly to achieve consistency

and fair presentation. The question requires an analysis and evaluation of

the financial reporting and ethical implications of the proposed change.

- September 2016 q1c (answer): Should the holding company of a special

purpose vehicle (SPV) consolidate it? The terms are: the holding company

owns only small interest in the SPV, participates in board and guarantees

SPV’s debt. What are the ethical issues if not consolidated?

- June 2016 q1c (answer): loan misclassified as accounts payable to

improve gearing ratio and evade severe penalty that would otherwise be

incurred for breach of covenant terms regarding gearing.

- Mar 2016 q1c (answer): ethical and professional issues arising from the

treatment of a 30% interest in an associate where the other shareholder is a

company

- Dec 2015 q1c (answer): financial reporting fraud risk involving the

possible misuse of exchange differences to boost earnings

- Sep 2015 q1c (answer): financial reporting fraud (impairment overstated

and incorrectly netted off revenue to depress profits and understate

employee share options)

- June 2015 q1c (answer): principles-based v rules-based approaches to

standard setting and their differing implications for ethical conduct

- Ethical dilemma (Dec 2014 q1c & answer; June 2014 q1c & answer; June

2010 q1c & answer management of earnings)

- Ethics denial (Dec 2013 q1c & answer; June 2013 q1c & answer)

- Ethical critique of management decisions or intentions (Dec 2012 q1c &

answer; June 2012 q1c & answer; Dec 2010 q1c & answer: the ethics of

loan proceeds presentation; June 2009 q1c & answer: the ethics of cash &

cash equivalents presentation)

- Ethics affirmation

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- Ethics misunderstanding Dec 2009 q1c & Answer should the Finance

Director consider ethics in offering credit rating for a customer he knows is having financial difficulties?

A.3 Social responsibility

(Also see G.1 and H.1)

1c,

4 What is social responsibility?

This syllabus area addresses the “growing demand for transparency in corporate

reports” and how the profession is responding to it. Part of this is fulfilling the role of

accounting as a social function (underpinned by the social contract with the

community - the legitimacy theory) providing information to all stakeholders not

just to investors and creditors. From the perspective of the business social

responsibility (or corporate social responsibility - CSR) is

“…a commitment to behave ethically and contribute to economic development; to improve the lives of its workforce and their families and to contribute to its

community and society at large.” World Business Council for Sustainable

Development.

To prepare effectively for the exams it is essential to understand the drivers for

change, the issues they raise and the profession’s ongoing response.

The drivers for change

The drivers for change include:

- Legislation e.g. the strategic report (explain strategies and progress towards

goals) to enable stakeholders to assess the businesses’ prospects and

sustainability credentials. - Increased statutory prescriptions e.g. inclusion of Directors’ Remuneration

Report in response to calls for more transparency about excessive directors’

remuneration.

- Activist investors seeking additional disclosures about the business model,

environmental compliance policy and programmes in order to better understand

the business’ environmental impact and assess the risk to earnings and financial

position. The better these risks are known the better the assurance of

sustainability, the lower the cost of capital and the more stable the share price is

expected to be.

- Environmental and social activists seeking greater disclosures about company

practices such as pollution and waste that affect the environment; supply chain e.g. disclose illegitimate practices such as the use of slave or child labour or

discriminatory practices that adversely affect minorities and other vulnerable

groups.

Issues raised

Because of the significance of the drivers for change there is increasing recognition

that CSR is a core business priority and that the issues for corporate reporting are

integral to the corporate reporting process itself. Therefore, there is a need for

In answering CSR type questions it is easy to waffle. Don’t be tempted. Be

rigorous in your preparation and practise producing clear and concise answers

to challenging discursive questions.

Be precise about the benefits of CSR reporting to the business and its

stakeholders. But be prepared to evaluate the financial implications for the

business of its CSR commitments.

Also, recognize that the IASB’s Conceptual Framework may not be adequate for certain items. Be prepared to discuss the merits and deficiencies of the

Integrated reporting framework examined in June 2015 q4aiii (answer).

According to the examiner

“…the IIRC’s Framework, which is a recent addition to the syllabus, was often

confused with the IASB’s Framework, with the result that some candidates

scored poorly on this part of the question.” Examiner’s report, June 2015

q4aiii

The risk of information overload is a current issue being addressed by the

disclosure initiative e.g. materiality considerations.

The link between employee incentives and CSR must also be considered as

there is always a potential ethical conflict which may result in financial

reporting fraud. For example, expenditure on social responsibility may be

delayed or deferred to preserve profit profit-related bonus.

Evaluate whether expenditure to comply with environmental regulations is

capital (e.g. IAS 38 Intangible assets) or revenue.

Be prepared to discuss the social implications of a corporate restructuring plan.

Be clear about relevant concepts such as - Accountability

- Assurance

- Benchmarking

- Decommissioning costs

- Environmental costs

- Externalities

- Innovation in corporate reporting

- Integrated reporting

- Legitimacy theory

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integrated reporting about how the organisation is creating value from its capital

resources, its impact on the environment and its relationships to all stakeholders.

This raises the following key issues to be considered at the transaction processing and

report production levels which should be the focus of your exam preparation:

- What is material to recognize and classify separately, involving unit of account

considerations?

- What is relevant to report?

- What is material to present and disclose?

- How can the need for comparability be satisfied?

- What measurement basis is appropriate for “value creation” and certain items

such as environmental costs and the value of human capital?

- How can trade-offs be achieved between confidentiality and useful disclosures?

- How can existing report contents and structures be modified to achieve clear and concise reporting while avoiding clutter?

- How can the benefit and costs balance be maintained?

- What form and level of assurance is required and where is it most desired?

The profession’s response

The profession’s response is evolving in partnership with organisations such as the

International Integrated Reporting Council (IIRC) which are leading the way

towards a more comprehensive and coherent reporting system that is focused on

sustainability in the long term. Evidence for this is the publication in December 2013

of the Integrated Reporting Framework which the ACCA has now included as an

examinable topic.

This topic and the issues it raises will be examined frequently at q1b, q1c and q2

having already been examined at q4a in June 2015, q4ai September 2016 (with

materiality). The questions will stretch and challenge you to think deeply about the

ethical, accounting and reporting issues raised by the need to report more

transparently and coherently.

For example, financial sustainability may conflict with environmental

sustainability unless management makes integration of the two a central goal of

strategic management. Then there is the question of incentivising staff to achieve

both, without creating ethical issues that result in financial reporting fraud. So, you should expect q1c to include sustainability dilemma - a corporate opportunity and

threat stemming from the same events or conditions. For example, management’s

intention to capitalise environmental expenditure as an intangible asset where the

conditions of incurrence and the nature of the perceived benefits do not satisfy the

requirements of IAS 38.

Work on the conceptual framework will naturally take account of emerging

requirements for defining concepts and measurement principles.

- Restructuring provisions

- Social benefits

- Social costs - Stakeholder theory

- Sustainability

- Transparency

- Value-added

Past questions for exam practice

- Dec 2011 q1c (answer): discuss the difficulties in reconciling the ethics of

corporate social responsibility with stakeholder expectations.

- Dec 2007 q1c (answer): discuss social and ethical responsibilities of the

group and assess whether a change in the social and ethical responsibilities

of the group could improve business performance.

Exam practice questions

1. Discuss the view that social responsibility is integral to the accountant’s role

in society. Hint: What are the fundamental principles of accounting practice?

Link these fundamentals to the requirements for a company to act responsibly in

accordance with corporate ethics.

2. The “emergence of nonfinancial reporting standards” presents challenges to

accountants while promoting sustainability reporting. The Global Reporting

Initiative (GRI) Guidelines are generally accepted as current best practice in

sustainability reporting.

Required

2.1 Describe the principles of the guidelines and discuss the practical

challenges of applying the principles.

2.2 Discuss whether sustainability reporting should have the same attributes as

financial reporting.

3. Discuss the reasons why traditional financial accounting may not be able to

reflect the social and environmental impact of organizations. See G.1 below

4. Discuss the key sustainability performance indicators you would expect to see in a corporate entity’s annual report. You may use the VW group’s CSR and

sustainability report as stimulus.

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The profession also works in partnership with other leading organisations to develop

strategies and introduce incentives for innovation and compliance with voluntary best

practice codes in the absence of legislation.

Examples:

ACCA awards for best practice in sustainability reporting.

ICAEW

The emergence of non-financial reporting standards

Social reporting (including environmental and sustainability reporting) includes non-

financial aspects not addressed by IFRS. Various organisations are developing

standards for reporting meaningful and comparable information to all stakeholders that provides a context and perspective on the state of current performance and

prospects for the future.

Examples include:

Global reporting initiative

Discussion of the ethics of corporate social responsibility (CSR) - last examined

December 2011 q1c & answer. But integrated reporting examined in June 2015

q4aiii expresses aspects of CSR.

Suggested approach

- Learn the concept of CSR in P2 Terms and techniques.

- What is the relevance of the Conceptual Framework (CF) to CSR? - Pay attention to the reasoning employed in the December 2011 answer.

- Focus on the benefits of CSR to the entity. Satisfying the needs of the socially

responsible investor by providing information about beneficial involvement in

the community can improve the company’s image and attract key stakeholders

such as investors, customers, employees and strategic partners.

- What can financial reporting contribute to CSR? i) financial reporting has

established a culture and framework for reporting reliable and relevant

information; this can be influential in setting up a similar culture for CSR; ii) the

CF’s enhancing characteristics e.g. comparability, verifiability, timeliness, etc.

are standards that can be applied in benchmarking. This will enable organisations

to assess their CSR performance relative to regulatory standards. iii) Published financial information and segmentation (IFRS 8) enhances transparency

necessary to allow monitoring and evaluation.

The ACCA awards for sustainability – an initiative that reflects CSR is at the

forefront of innovation in transparency and accountability reporting. Read and

critically discuss from the perspectives of the business and its stakeholders at least

one CSR report. Examples:

ACCA and sustainability

Vodafone: Sustainable business report 2015-16

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B.1 Conceptual

Framework (CF) ED

2015/3

4

WHAT IS IT FOR? Framework-based teaching materials

THE NATURE OF THE CONCEPTUAL FRAMEWORK

THE FUNCTIONS OF THE CONCEPTUAL FRAMEWORK

HOW THE CONCEPTUAL FRAMEWORK IMPACTS YOUR

DEVELOPMENT

REASONING AND PROBLEM SOLVING HOW TO THINK LIKE AN ACCOUNTANT

LAYING THE FOUNDATIONS FOR COHERENT & CRITICAL THINKING

IN THE DISCIPLINE

INFORMING THE ACCOUNTANT’S TOOLKIT

- New Conceptual Framework (CF) is required to underpin IFRS (e.g. September

2016 q4ai, aii on materiality and understandability) and to promote

international convergence.

- The assessment of the examiner’s priorities for June 2015 and the rationale

given below remain relevant - see June 2015 q4a and q4b. In addition, as the CF is still undergoing significant review, some of the core issues are still relevant

and interlinked with the issues that were examined in June – see Examiner’s

report December 2015 (general comments section) Also, see Examiner’s report

June 2016.

- Be prepared for questions involving the use of the CF to: evaluate current

practices using specific transactions involving recognition of income, expenses,

liabilities, assets and equity. Example, December 2016 q1b (answer): discuss

accounting and reporting practice for pension gains and losses.

- Be prepared also to discuss the meaning and requirements of “performance”. What is performance and does the profit or loss adequately measure the entity’s

performance? What principles should govern the classification of items between

profit or loss and OCI? Should OCI items be subsequently reclassified to profit

or loss – see June 2014 q1a & answer? Under what circumstances? Also see IAS

1 and read the technical article What differentiates profit or loss from OCI

- What is the most appropriate measurement basis for assets and liabilities?

Does IFRS 13 fair value measurement (measure of exit values) adequately

address all the measurement requirements? Can the business model be

justifiably used to determine appropriate measures? You are encouraged to

review June 2014 q1b and Sekoyen’s critique (and suggested answer) of the

examiner’s answer to this excellent question.

- According to EFRAG (European Financial Reporting Advisory Group) the

mixed measurement model, rather than a one-size fits all ideal model that

would be applied to all circumstances, seems more promising. Discuss. Also be

WHAT YOU SHOULD EXPECT

1. Explain with examples, why a Framework would be useful for

convergence (of international standard setting)

2. Address current issues around Framework: e.g. “management commentary”

(guidance published Dec 2010)

3. Address current challenges around the Framework: e.g. “measurement”, “reporting entity”, “cost constraint”, conflict between needs of “users” and

“preparers” of financial statements.

4. How can the Framework be used to address criticisms about the lack of

focus and the volume of disclosure in the standards? E.g. “…to develop

principles for presentation and disclosure” (principles-based approach) and

materiality in disclosure e.g. the disclosure initiative (Deloitte). The

Disclosure Initiative – Principles of Disclosure.

5. The quest by some for a re-introduction of the concept of prudence can be

countered by the following argument. Prudence means caution; faithful

representation based on comprehensive information inherently reflects all

conditions, including impairment. There being no permission to anticipate income on operating assets (rules for reflecting changes in asset values

resulting from market and operating conditions embedded in IAS 2, IAS

38, 36, IFRS 5, IAS 16 effectively preclude this by requiring that asset

accretions must not be recognised in profit or loss but must be reflected in

equity, as these are not performance related) and expenditure (IAS 37

requires all provisions to be based on “past” events and conditions that are

independent of the entity’s future actions) the scope for prudence to

influence judgement in terms of “anticipating no profits” and “providing

for all expenses” is removed, rendering the concept of prudence redundant.

6. Similarly, “reliability” is redundant because faithful representation

achieves that end by requiring that transactions, conditions and other events are reflected completely, neutrally and error-free so that their commercial

substance, financial effects and risk potential can be discerned and reliably

assessed.

7. New definitions of assets and liabilities are being proposed. Make sure you

can discuss the advantages of the revised definitions over the current ones

using specific examples and criteria.

8. The new definition of an asset is: a present economic resource controlled

by the entity as a result of past events. This definition emphasizes the

present resource potential of an asset (to which the entity has current

exclusive access) whereas the current definition emphasizes future

economic resource potential. This links to the measure of that potential.

Whatever the basis of measurement the present is more reliable than the future measure due to uncertainty over future estimates. Another problem

with the current definition is that the concept of control is not entirely

compatible with the future which is uncertain: e.g. how can the entity

control future asset prices subject to market forces? IFRS 13 deals with this

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prepared to discuss the standard valuation or measurement models and the

applications of each to the financial reporting of specific transactions. Refer to

The maths of valuation models.

- Should the primary purpose of financial reporting be to evaluate stewardship

(looking back) or to provide decision-useful information to potential investors

and other providers of capital such as financial institutions (looking forward)?

- Are there comprehensive underpinning concepts such as relevance,

verifiability, prudence, reliability and faithful representation to engender

confidence in the integrity of the financial statements? Are the concepts in

harmony with each other? E.g. the current conceptual framework excludes

prudence because it conflicts with neutrality which is a requirement of faithful

representation.

- The reporting entity: the aggregation (consolidated income statement) and

disaggregation (single entity e.g. parent’s income statement).

- The reporting entity is an entity that is required or volunteers to produce general

purpose financial statements.

- Be able to discuss relevant information in relation to consolidated and single

entity. Identify the relevant information for each: user perspectives. E.g.

dividends, performance, earnings, etc.

Be prepared to competently discuss the strengths (e.g. explain how the CF fosters production of rigorous and consistent standards of financial reporting) and

weaknesses (e.g. explain and illustrate inconsistencies allowed by optional

presentations e.g. IAS 7 direct and indirect method; subjectivity of standards such as

IFRS 13, IAS 16, IAS 40 produces relevant information at the expense of objectivity;

the cost of implementation), of the CF with specific examples. Read the IASB work

on CF and be prepared to evaluate to what extent the CF proposals overcome

inherent deficiencies in accounting standards and practices, particularly in relation to

measurement and recognition including goodwill and deferred tax assets.

Also, in the June 2016 Examiner’s report the examiner makes these significant

comments that you should pay attention to as you prepare for the next exam:

“…the application of the cost constraint has resulted in some IFRS being

inconsistent with the Framework. For example, there are certain underlying

definitions that are currently used in IFRS but not dealt with by the Framework. It is

important that candidates appreciate this problem with the Framework and can

identify those standards that are inconsistent with the Framework. This

knowledge is relevant to all questions in the examination.” June 2016 Examiner’s

report

Examples of definitions of significant concepts you should be prepared to discuss:

- Goodwill (IFRS 3)

problem by basing asset values on exit prices at the measurement date (the

entity’s reporting date) under current market conditions. Moreover, one is

not clear when “…future economic benefits are expected to flow to the entity.” Having a definition that makes it clear the economic resource exists

at the reporting date is an improvement.

9. The proposed definition of a liability is: “A present obligation of the

entity to transfer an economic resource as a result of past events.” In what

specific ways is this an improvement over the current definition? This

definition removes “expected” which in the current definition of a liability

is problematic as it leads some users to not recognize liabilities which in

their judgement are not expected to result in an outflow of economic

resources when in fact they will. This provides more relevant information

especially over unrecorded liabilities such as claims against the entity for

injury, warranty and consequential loss. As with asset the proposed definition of a liability conveys certainty about the existing obligation at

the reporting date rather than emphasize the transfer of future economic

resources as a criterion of the existence of an obligation (at the reporting

date). The adoption of this definition will result in the recognition of certain

liabilities that are currently only noted as contingent liabilities in the

financial statements simply because in the judgement of management it is

not certain that a transfer of economic resources would be required for their

settlement. The shorter definition is more compatible with the principles-

based approach to IFRS in that the emphasis is on determining whether an

obligation exists at the reporting date rather than seeking confirmation of

this through the evidence of transactions, and thereby risk failing to

recognise legitimate non-transaction based obligations that may exist. For example, obligations under a financial guarantee contract issued by the

entity could be understated if the debtor’s credit risk has deteriorated and

this condition has not been fully assessed as a basis for recognising an

obligation at the reporting date.

10. Overall the guidance provided by the definition will result in a more

rigorous search for liabilities (especially liabilities that are not transaction-

based) and therefore more complete statement of the financial position.

Consequently, the revised definition is an improvement.

Past questions for practice

- March 2018 q4c (answer): the entity has incurred significant foreign currency gains and losses but discloses a small net exchange gain, masking

a significant single exchange loss as a result of speculation. The economic

background to the entity’s jurisdiction: currency devalued, stock market

significantly fallen. This question was deliberately open, to assess complex

independent thinking about presentation and disclosure as a communication

tool. Candidates were expected to show knowledge of principles and

objectives of disclosure as set out in the Conceptual Framework chapter 7,

and to extend the discussion to show how specific IFRS (IFRS 7, 13, IAS

21) apply those principles to meet user needs. Critical thinking and

judgement were required: consider how disclosure alters perceptions in

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- Deferred tax assets or liabilities (IAS 12)

- Revaluation gain (not recognised in profit or loss but gain on disposal is

recognised in profit or loss when the asset to which they relate is disposed of) - Gains and losses in a cash flow hedge (IFRS 9)

- Transaction costs: issue of shares (set against equity e.g. share premium); IFRS 3

(set against profit or loss); IFRS 9 (set against profit or loss or if FVTPL or defer

if FVOCI)

- Transparency

- Substance over form (alternatives to legal form)

- Commercial substance (indicated by significant differential cash flows arising

from the transition)

- Business model

“Further, candidates should realise that some decisions on accounting issues have

been based more on expediency than on concepts. Often, candidates’ answers

appear quite naïve in terms of the practical application of the standards.” June 2016

Examiner’s report

- Development costs capitalised (IAS 38): according to the conceptual framework

(CF) derives its value as an economic resource from its existing potential to

produce future economic benefits, CF 4.15

- Capital grants (IAS 20) not recognised as capital as one would expect, instead

treated as a deferred credit to be released to profit or loss over the economic life

of the asset (IAS 20). An asset can be acquired as a grant, without incurring expenditure, CF 4.16

- Revenue (IFRS 15): the interest element may be ignored as a practical expedient

where the period of finance (between payment and performance) is twelve

months or less.

The implications of the examiner’s comment are that you should always approach

corporate reporting practice critically (see B.2 below). This requires in-depth

understanding - not basic knowledge as this would be inadequate (“quite naïve”):

- Consider the accounting policy choice and be prepared to evaluate its suitability in context

- Consider always the overall criteria of the conceptual framework: “faithful

representation” and “relevance”. Does the specific application outcome satisfy

these criteria?

- Consider the enhancing characteristics: does the application outcome satisfy the

criteria? E.g. in relation to Corporate Social Responsibility (CSR) does the

report clearly identify expenditure on sustainability programmes to allow users

to assess how the organisation is doing?

stewardship assessments. You should expect more questions of this kind in

future.

- March 2018 q4b (answer): discuss the nature and significance of

materiality and consider whether the principles of materiality apply

differently to accounting and auditing.

- March 2018 q4ai (answer): Discuss the effect of uncertainty on the

existence and recognition of assets and liabilities making reference to the

Conceptual Framework.

- March 2018 q4aii (answer): Explain how uncertainty affects the

definition, recognition, classification and disclosure criteria in IAS 37 and

IFRS 5.

- March 2018 q1b (answer): justify classification of disposal group

(proposed sale of subsidiary) as held for sale.

- December 2017 q1b (answer): apply classification criteria and assess the

whether the reclassification of a particular operating segment would

provide useful information.

- September 2017 q1b (answer): the justification for recognising

decommissioning provision as an asset at the time the obligation is incurred

- June 2017 q4ai,ii (answer): discuss the features of the concept of prudence and evaluate whether or not it is useful; the role of substance over form; the

principles that govern derecognition.

- March 2017 q4aii (answer): recognition criteria of the CF; reasons for the

ED e.g. to provide additional guidance on interpreting “probability” in

assessing the flow of economic resources of an entity as a basis for

recognition. This is at the heart of definitions of assets incorporated into

standards e.g. IAS 38, IFRS 15, and conditions for recognising liabilities as

in IAS 37; CF addresses “measurement uncertainty” (2.12 ED ED2015/3):

measures such as “fair value” may not be directly observed thereby

introducing subjectivity while enhancing the relevance of financial information.

- March 2017 q4bii (answer): going concern assumption doubtful after

directors considered ceasing trading a subsidiary and triggered an

impairment review.

Additional questions for exam practice 11. Discuss the conceptual framework’s user-needs approach to financial reporting.

Give specific examples from ED2015/3 to illustrate your points. Hint: consider the primacy of “relevance” in all financial reporting considerations, its requirements and implications.

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12. Explain how IFRS 15 applies the Conceptual framework for financial reporting ED2015/3. Give specific examples of recognition, measurement and disclosure to illustrate the qualitative characteristics of relevance, faithful representation, comparability and understandability.

13. “…introducing rigorous and consistent accounting standards” is the objective of

the conceptual framework. Discuss how IFRS 15 is a prime example of this. Give specific examples and provide clearly reasoned explanations illustrating how IFRS 15 dovetails with other key standards (such as IAS 2, IAS 8, IAS 16, IAS 36, IAS 37, IFRS 2, IFRS 8, IFRS 9) over recognition, measurement, presentation and disclosure.

14. The Conceptual Framework for financial reporting adopts a principles-based

approach to financial standard setting. Explain how the principles-based approach to IFRS enabled the FASB and IASB to converge towards a common revenue standard.

15. “To a large extent, financial reports are based on estimates, judgements and models

rather than exact depictions. The Conceptual Framework establishes the concepts that underlie those estimates, judgements and models. The concepts are the goal towards which the IASB and preparers of financial reports strive.” Paragraph 1.11, p24 Conceptual framework for financial reporting, ED2015/3

i) Describe the key concepts of revenue recognition, measurement and

presentation ii) Discuss how those concepts can be used by entities as goals of accounting and

financial reporting of IFRS 15 Revenue from contracts customers. iii) Discuss how the concepts can enable international convergence. 16. Accountants are increasingly required to exercise and disclose significant

judgement within the application guidance to achieve the objectives of standards. Discuss the requirements, effects and implications of this growing trend in financial reporting practice. What tools are available to the accountant to aid in the exercise of professional judgement? Refer in your discussion to examples from

recent standards such as IFRS 9, IFRS 13 and IFRS 15.

17. “Evaluate the valuation models adopted by standard setters” Study guide B.1.a

Refer to Conceptual Framework chapter 6: Measurement, Appendix A. Read technical article (annotated).

18. How does an organisation choose between different valuation models? Discuss the

practical requirements and benefits, citing requirements and guidance in IAS 2, IAS 16, IAS 19, IAS 36, IAS 38, IAS 40, IFRS 13 and IFRS 15.

19. Performance can be defined as the application of resources to earn returns through production and investment.

Required

Using the above definition 19.1 Explain why the comprehensive income statement is segregated into the

income statement and the other comprehensive income (OCI) statement. 19.2 Explain why transactions between owners (equity transactions) are excluded

from the income statement (and accounted for direct to equity).

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19.3 Explain why IFRS requires an entity to recognise a gain or loss on an interest in a subsidiary when the entity gains or loses control.

19.4 Explain why on the disposal of PPE any revaluation surplus may be transferred direct to retained earnings but not to the income statement.

19.5 Revaluation surplus is initially presented in OCI. Why? 19.6 Exchange gains and losses arising from the retranslation of a net investment in

a foreign operation are deferred in equity and reclassified to the income statement on disposal of the interest.

19.7 Exchange gains and losses on retranslation of goodwill relating to the acquisition of a foreign subsidiary are recognised in equity.

19.8 The gains and losses arising from a cash flow hedge are recognised in the income statement if the hedge is ineffective, and in the OCI if the hedge is effective.

19.9 Gains and losses arising from pension remeasurement are recognised in OCI and credited to or charged against retained earnings, but excluded from the

income statement. 20. On 1 2012 the carrying value of a building previously used as a school was £3.8m.

Due to adverse circumstances the building could no longer be used as a school and instead became a library. It was recorded at its depreciated replacement cost of £1.6m resulting in an impairment loss of £2.2m which was immediately recognized in income (profit or loss).

Required

20.1 Which of the following concepts is critical to determining the recognition and measurement basis of the asset? A) How the building contributes to cash flow B) How the building’s carrying value is recovered in use C) The highest and best use of the building D) The capital maintenance concept that underlies historical cost accounting.

20.2 Explain why depreciated replacement cost is an appropriate basis for estimating the building’s carrying value.

20.3 Using conceptual framework principles explain why the impairment loss was immediately recognized in profit or loss.

20.4 Discuss why value-in-use is not an appropriate basis for estimating the value of the building.

20.5 Discuss why fair value less cost to sell is not an appropriate measurement basis.

21. Explain how the concept of separability determines recognition, measurement and

presentation criteria in IFRS 3, IFRS 5, IAS 38, IAS 36 and IAS 16.

B.2 Critical evaluation of

principles and practices 1b This section addresses the part of the syllabus aims which requires candidates to

“…exercise professional judgement in the application and evaluation of financial

reporting principles and practices…” This specification reflects the following

considerations:

“…to understand a field of knowledge, including professional knowledge, we must

understand it realistically. To contribute to it productively, we must view it as an

imperfect construction. To use it effectively, we must internalize the mode of

Exam practice suggestion

To be adequately prepared to answer this question you should be able to address

all of the examiner’s central concerns by attempting case study that involves the honing of the relevant skills. In addition, you should be familiar with issues

addressed in published financial statements. Therefore, it is a good idea to read

at least one example of a model published financial statements from the big

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thinking integral to the profession, and be aware that when we or others think, we do

so with fallible human minds operating in a world of power struggles and vested

interest.” Paul & Elder, Critical Thinking, p276.

Please refer to question strategy particularly q1b & q4 strategy table for a review

of the types of questions that have been asked and the learning approach that is

entailed by these requirements.

The examiner’s central concerns are that candidates i) recognise that financial

reporting practices are contingent on context because the context sets the conditions

(e.g. performance conditions as in revenue recognition where the stage of

completion is a critical factor in what revenue gets recognised in a reporting period,

use conditions as in PPE or investment property, etc.) that determine which practice

is appropriate for a given reporting scenario; ii) are clear about the steps necessary to conduct critical evaluation competently in any business context; iii) develop the

necessary skills for problem analysis, evaluation and resolution of financial reporting

issues; iv) inculcate a lifelong learning attitude to financial reporting; v) understand

the core principles of financial reporting standards and be proficient in applying

them flexibly.

- In assessing these competences, the examiner ranges over all the standards and

prioritises the common but most contentious ones as can be seen on the

accompanying spreadsheet schedule – tab q1b, c (Past question analysis).

- The aspects of the standards most frequently examined are to do with

recognition and measurement. The questions are usually framed as enquiries

into the meaning of financial statements measures as in June 2014 q1b – fair

value or a discussion of valuation models, fair value option, (acquisition date)

measurement basis as in or full or partial goodwill, debt or equity

assessments of options to purchase further interests in an acquiree as in

June 2015 q1b (answer). It is advisable to read the examiner’s report and to be

prepared for a similar question.

- As the issues are contentious it would be necessary to refer to the Conceptual

Framework, IAS 1 and IAS 8 as foundations to build arguments upon.

However, arguments must always refer to the circumstances because of the

contingency nature of practice as explained above. Otherwise, answers would be incomplete, however sound the reasoning given.

Crafting cogent arguments would be essential as much of the answers to this type of

question entail making a claim and proving it i) as a way of countering adopted

practice that unjustifiably deviates from IFRS, or ii) to prove that IFRS compliant

recommended practice is best suited to the business model of the entity.

Read

How to Write for P2

accountancy firms and one actual (latest) published financial statements. Read

and think about how the entities justify the following

- Accounting policies (for topics under presentation below) - Disclosure notes (for topics under presentation below)

- Presentation of gains and losses: pensions, share-based payments, PPE,

effects of exchange rate movements, investments, reclassifications from

equity, financial liabilities

- Operating segments

- Guarantees

Examples of model financial statements

- Deloitte

- Ernst & Young

- Grant Thornton

Examples of published financial statements.

- Tesco plc

- Balfour Beatty

For June 2018, the following areas should be mastered

Financial guarantee contracts (IFRS 9).

- Be able to discuss whether a particular contract is a financial guarantee

(protecting against financial risk) or a provision (recognition of an

obligation that arises from operations IAS 37) or insurance (protecting

against operating risks IFRS 4). This is a high priority area because the examiner was very disappointed at candidates’ inability to apply financial

principles to identify and analyse the critical distinguishing features

between a financial guarantee and a provision in December 2014. Given the

crucial (for fair statement and disclosure of material liabilities the lack of

which could mask going concern problems) importance of this area he is

very likely to return to re-examine this area soon and several times until he

is satisfied that the required knowledge and skills have been acquired by

candidates. Examined September 2016 q1c but still examiner not happy

because answers tend to be “boiler plate”: lacking in analysis and reference

to the scenario. Therefore, it remains priority for all future exams.

- Be able to discuss the issue of a financial guarantee at a premium from the issuer’s perspective as a holding company and from the debtor’s (not

the holder) perspective being a subsidiary whose debt is guaranteed and the

group’s perspective. Recognise that where the fair value of the guarantee

(premium) exceeds the reimbursement received from the subsidiary (or if

no reimbursement is received at all) then the net premium incurred by the

parent is in effect a contribution of capital from the parent. Make sure you

are able to raise the journal entries for each perspective: parent, subsidiary,

group. This is similar to q1b December 2014 & Answer. Also, study “what

I learnt from studying exemplars”

- How is the issue of a guarantee reflected in the fair value of the underlying

liability of the debtor? Refer to IFRS 13 - be prepared to discuss this.

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- Be prepared to give advice regarding the treatment of guarantees given

under various terms: i) overcompensate for incurred loss arising from

default of a specified debtor; ii) no preconditions required for payment of incurred loss because of the debtor not making payment on the guaranteed

asset; iii) performance guarantee.

Questions for further practice are given under the relevant IFRS (q1b)

- December 2017 q2 (answer): Application of Conceptual framework

control principles to transaction recognition assessments (IFRS 9,11,15)

- June 2017 q1b (answer): reflecting the substance of factoring arrangements

over its legal form (IFRS 9).

- Mar 2017 q1b (answer): i) advise on the effect of a change to a fair value

model for a group holding a mixture of PPE and investment properties

locally, and in other countries, involving revaluation and retranslation for consolidation purposes; ii) discuss whether there should be consistency in

the treatment of exchange differences between monetary and non-

monetary assets and liabilities.

IAS 1 Presentation of

financial statements

1b,

c,4 - Performance reporting is topical due to the drive to determine what

performance really is, how it should be measured and reported.

- Naturally, in seeking answers to the above the structure and content of the profit

or loss and OCI would be reviewed. Key issues are definitions of the elements: income, expenses; what gets included in which part of the comprehensive

income statement?

- Re-measured items such as actuarial gains and losses, holding gains on PPE,

exchange differences on re-translating investment in foreign operations are

recognised in OCI and presented in other components of equity in the SOFP.

There is a presumption that information included in OCI is relevant. Be prepared

to evaluate this presumption in unfamiliar business contexts and situations.

- The corollary is that gains and losses that do not arise from re-measurement are

recognised in profit or loss. For example, gains on disposal of noncurrent

operating assets (PPE).

- When do OCI items get into profit or loss after being previously recognised in equity? What are the CF principles that govern the movement (reclassification

from equity to profit or loss or reclassification between equity accounts as in DR

Revaluation reserve, CR Retained earnings on the disposal of a related

noncurrent asset?) How relevant would the profit or loss be if the previous OCI

items come back into profit or loss on the occurrence of the trigger event? Give

many varied examples of trigger events e.g. disposal of the foreign subsidiary,

and disposal of the available-for-sale investment. Why is the treatment of these

two different from the treatment of disposal of the noncurrent operating asset

(PPE)? Read P2TT.

- Be prepared to study the performance reporting and presentation issues in

conjunction with CF and measurement standards such as IFRS 13.

- ED 2015/1 Classification of liabilities proposes a more general approach to

classification of liabilities between current and noncurrent reflecting the

WHAT YOU SHOULD EXPECT

- Be able to deal with discursive questions.

- Get familiar with the structure of model published financial statements, e.g.

Deloitte - Be able to discuss the CF in relation to the SOCI in terms of relevance,

understandability, verifiability and comparability.

- Relevance has two key components: confirmatory value (contains

feedback information that confirms assessments and expectations e.g.

actual equals forecast sales, and earnings beat predicted EPS for the quarter

– key performance data for listed companies) and predictive value (having

information that can enable future outcomes to forecast e.g. qtr1 earnings

can be used to revise and rebase predictions for qtr2 earnings; inputs to

valuation models e.g. IFRS 13 Level 3 mark-to-model).

- Notice and be able to explain how the CF principle of relevance

(specifically predictability) underpins the requirement under IFRS 5 to separately disclose discontinued operations and to identify elements of a

disposal group on the face of the SOFP and in the notes.

- Explain how principles-based approach underpins specific IFRS e.g. IFRS

13, IAS 8, IFRS 10, IAS 18, IAS 12, IAS 28 and how those standards

achieve understandability, verifiability, comparability and timeliness.

- For example, how does IFRS 13 prioritise relevance, verifiability,

comparability, understandability and timeliness in the measurement of fair

values?

Questions for practice

- March 2017 q4ai (answer): discuss how an entity determines “fair

presentation” - March 2017 q4biii (answer): a bank loan to a subsidiary the directors

intend to cease trading is shown as a non-current liability when the bank

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principles-based approach. For example, it proposes that classification should be

based on the entity’s substantive rights at the reporting date e.g. the “right to

defer settlement of the liability by rolling over the borrowing under the terms of an existing facility”. It clarifies the term settlement to include transfer to the

counterparty of cash, equity, other assets and services. For the next exam be

prepared to answer further q4 or q1b type questions (similar to December 2013

q1b (answer)) requiring you to discuss and advise how certain obligations should

be classified, citing principles and demonstrating the effects of classification on

the SOFP (March 2017 q4biii). The effects of classification may be assessed:

this would entail evaluating key financial indicators such as working capital,

solvency, liquidity, financial gearing and returns on capital employed. The effect

of classification on, and rights under, existing financing arrangements such as

loan facilities and covenants should be discussed. Keep in mind that as explained

in P2TT overdrafts can be cash and cash equivalent (current liability) or long term liability. Make sure you are clear about the definitions of these terms in

ED2015/1 (e.g. paragraph 69) so that you can apply them to the details in the

scenario.

Read the technical articles

What differentiates profit or loss from OCI?

Concepts of profit or loss and OCI

The basis of financial statement connectivity

There are five financial statements; it is essential that they are coherent to enable

users to understand them individually, and as a whole. Therefore, their links or

connectivity must be conceptually established.

Interaction with IFRS 8 Capital disclosures apply to all entities and not just those (e.g. banks and insurers)

subject to external regulation. [IAS 1 para BC87] - An entity is required to describe what it manages as capital on the basis of

information provided internally to key management personnel. This would

satisfy the requirements of IFRS 8: the CODM allocates resources to operating

segments and segment reporting is in accordance with internal management

information.

- Capital may be allocated to parts of the organisation subject to different

economic factors such as exchange rates or political risks. Evaluation of

capital efficiency (ROCE, gearing, etc) and effectiveness may therefore require

segmentation.

Interaction with IFRS 7

USEFULNESS OF CAPITAL DISCLOSURES

Disclosure aids evaluation of the nature, amount, risk and uncertainty surrounding the entity’s existing resources. FRC guidelines recommend disclosure of

had the right to call for repayment on demand; it should be reclassified as a

"current liability" as it is due on demand, and the entity has no “substantive

rights” under the terms of the loan to defer payment demanded by the bank. - September 2015 q3b: extraordinary items not permitted

- June 2015 q3b & answer: “non-recurring” measurement basis for a portion

of inventory acquired as part of a business combination under IFRS 3. The

issue is the recognition of an “extraordinary item” is prohibited under IAS

1.

- June 2013 q2d & answer

- June 2011 q3a & answer

QUESTIONS FOR FURTHER PRACTICE

Q4b Specimen paper for Strategic business reporting: reclassification

adjustment. The case for and against: Conceptual Framework 7.19-7.27 Information about financial performance.

Reclassification decisions are driven by relevance – confirmatory, predictive

and comparability value to the entity and its stakeholders.

In discussing relevance your answers, you must identify a purpose for which

the information containing the reclassification would be relevant. For example,

performance measurement is a key theme and relevant information must

reflect underlying performance to enable stewardship evaluation (CF 1.22-1.23)

and assessment of future earnings and cash flow prospects (CF 1.15-1.16).

Comparability is an essential quality of such information but reclassification of certain items from equity to the income statement (profit or loss), e.g. arising

from the sale of a controlling interest in a subsidiary can reduce comparability

while providing information that is relevant to performance measurement for

the period.

Additional disclosure about the circumstances of the trigger event and its

effects can help overcome any perceived deficiencies in information quality

stemming from the reclassification.

Elaborate on the predictive aspects of relevance including use of amounts in

measurement models as in IFRS 13 fair value measurement level 3.

Always identify the purpose to focus specifically on the impact of

reclassification on the user (e.g. investor, prospective investor, management,

lender, short-term creditor, etc.). How would an investor (existing and

prospective) evaluate the recognition of a gain on the disposal of an interest in a

foreign operation? What difference will it make if, instead of a gain, a loss was

made on disposal?

Materiality is another important consideration when assessing how to present

and disclose the reclassified amount in the income statement.

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information about changes in net debt and financing arrangements. Examples

(IFRS 7):

- Significance of financial instruments for the entity’s financial position and performance; and

- Nature and extent of risks arising from financial instruments to which the entity

is exposed during the period and at the end of the period, and how the entity

manages those risks.

Read the technical articles

Giving investors what they need

The definition and disclosure of capital

Possible exam scenarios for assessing the concepts, principles and judgements

- Initial classification of gains and losses: bifurcated between income and

OCI e.g. financial liabilities (change due to form or market prices - income; change due to credit risk – OCI except where precluded by accounting

mismatch under fair value option IFRS 9 para 42.80)

- Pension remeasurement gains losses presented in OCI and credited or

charged to retained earnings: justify.

- Reclassification triggered by the event that makes reclassification relevant.

What is it about the event?

- Discuss with the aid of conceptual framework principles e.g. accrual

transactions involving subsequent

i) reclassification to profit or loss and

ii) transfer to retained earnings bypassing the profit or loss.

IAS 7 Statement of

cash flows (part of D.1

of the study guide)

Issues of exam significance

Carillion Why did it go under? Annual report and accounts

Cash margin

Retained cash

Debt/equity

Gross gearing

Net gearing

Tesco recovers cash flow

Tesco recovers cash flow after

scandal

General Electric

Alters dividend basis to conserve

free cash flow – smart! FT, 14

November 2017

VW cash strong

VW cash flow survives emission

crisis

Take an interest

What is in the news?

What is on the IASB work plan

for cash?

Why are top five tech firms

awash with cash?

Why is cash “king”?

Published financial statements

Research highlights & academic

discussions

1a,

1b,

1c

2,4

ORIENTATION QUESTIONS YOU SHOULD ASK What is it for?

The objective of this standard is to require the provision of information about the

historical changes in cash and cash equivalents of an entity by means of a statement

of cash flows (SOCF) which classifies cash flows during the reporting period from

operating, investing and financing activities.

Syllabus extracts

D.1 “Group accounting including statements of cash flows”

D.1.l) “Prepare and discuss group statements of cash flows. [3]

D.1. f) “Outline and apply the qualifying criteria for hedge accounting and account for fair value hedges and cash flow hedges including hedge effectiveness.”

In thinking about how to study the statement of cash flows as required by the above

extracts, it is essential to consider how the objectives of decision-usefulness and

stewardship are achieved. Accordingly, you should identify the criteria by which

you can judge how the key objectives are achieved. The following preliminary

questions would be useful:

What principles govern the presentation of SOCF?

What features promote fair presentation?

What features undermine fair presentation? What features enhance fundamental and enhancing characteristics?

How the SOCF presents underlying performance better than statement of income.

Or, why is the net cash from operating activities more informative and useful than

the net profit after tax?

How do the cash flow issues in the news help me understand the significance of the

SOCF? Ascertain, analyse, appraise and apply what you learn from the news.

HOW YOU SHOULD LEARN Learning to score: a critical approach

HOW YOU WILL BE ASSESSED

You will be assessed in accordance with the syllabus extracts which require an

open mindset as discussed. The following guide might be useful in setting

objectives for practice and assessing your exam readiness.

Assessment criteria and critical learning skill guide Criteria Active (open mindset) Passive (closed

mindset)

Critical analysis of user

needs v SOCF content

and presentation

Identifies different user characteristics and needs. Explains how specific features of SOCF meet different user needs.

Has a general understanding of user needs but fails to identify distinct user characteristics and consequently lacks incisiveness.

Application of

classification principles

Can explain the classification principles

and relate major classifications coherently. Appreciates IAS 7.6 definitions but shows the practical difficulties of classifying certain cash flow transactions.

Can describe categories but unable to explain the

principles and concepts. Hence unable to provide coherent response to discursive questions.

Read in conjunction

with other financial

statements

Can conceptually and analytically trace and interpret links between performance, position and cash flow. For example, understands the relationship between operating profits and cash provided by

operations, and the

wider aspects of

liquidity.

Can refer to relationships but not with convincing analysis and interpretation because the interactions and implications are not well understood. For example, liquidity is narrowly defined resulting in failure to take account of the

entity’s ability to generate cash from asset sales, credit

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Cash flow margin Capital structure and cash flows

Cash flow based indicators

Cash flow margin

Operating cash flow

Understanding cash flows

How to score

Make a clear point about an issue

Support it with clear evidence

Comment as required

Avoid uncertainty e.g. “sort of”,

“seems like”

How to convince State a clear proposition

State a clear reason e.g. present

investment in human capital

under investing activities

Provide an example - evidence of

the effect (outcomes)

Analyse the effect

Evaluate the effect (outcomes)

How to analyse How to analyse

What to analyse

The analytic framework

Identify the key relationships

How do I identify the key

relationships?

Relationships within financial

statements (horizontal and

vertical)

Relationships between financial

statements (horizontal and

vertical)

How to connect the parts

meaningfully and coherently and

move the analysis.

Select and synthesise Identify and interpret information

Arguments from various sources

Evidence from various sources

Compare and link ideas between

IFRS

Compare and contrast ideas

between IFRS

Critical evaluation What is critical evaluation?

Basic evaluation: process, words,

situations, outcomes (frames)

Complex evaluation: process,

words, situations, outcomes

(frames). What is it about IAS 7

You should aim for quality in your answers and you should prepare by answering

case study questions to develop critical reading and writing skills appropriate for

professional exams (synthesis and evaluation – intellectual level 3). Therefore, when you start to study you should decide how to learn to be able to apply principles based

on insightful, rather than shallow understanding.

Think carefully about the exam verbs: they suggest an open, rather than a closed

mindset. An open mindset considers the subject from all sides and avoids a

minimalist approach to learning and exam preparation characterised by “I got the

answer” or “I have covered it”. That results in minimum attainment standards. An

open approach asks:

- What is fair presentation in the context of statement of cash flows?

- Where does SOCF fit within general purpose financial statements?

- How do I show that I have understood what the SOCF was designed for? - How do I explain and apply the concepts and principles of IAS 7 to SOCF?

- How do I identify and discuss the strengths and weaknesses of the SOCF?

- How do I weigh up and show that certain user needs are capable of being met,

whereas others can only be met to a lesser extent, or not at all?

- How do I critically assess whether certain transactions are suitably presented?

- What recommendations can I make to improve the SOCF and how can I justify

them?

- How do I read the SOCF in conjunction with other financial statements to

discern the links between the income effects, cash flow effects and balance sheet

effects of various transactions?

- How do I identify critical ethical issues arising from, or related to, SOCF?

- How do I evaluate the disclosures of the SOCF? E.g. what is the significance of disclosing segment cash flows (IFRS 8) and cash flows of discontinued

operations (IFRS 5)?

Consequently, the open mindset aims for ample practice for skill development such

that the critical learning success criteria focus on the skill, rather than the knowledge.

Feature and function

What features contribute towards “fair presentation”? Discuss by reference to

specific features including how interaction with other standards influence those

features. Examples, financial instruments (see below), IFRS 5, IAS 10 (dividends), IAS 16 disposal of PPE.

The structure of the SOCF enables clarity and communication of changes in cash

flow which contributes to assessing financial performance and prospects for the

future. As a critical thinker you should ask: How does a historical cash flow

statement enable assessment of future earnings and cash flow prospects?

According to IAS 7.9 cash flows on the face of the SOCF do not reflect cash

management, as they exclude movements between items that constitute cash or cash

equivalent. For example, a transfer from demand deposits to cover working capital

facilities in addition to operations.

Demonstrate

commercial awareness

in classification and

interpretation

Integrates the financial with the non-financial, technical with commercial

to provide rich blended insights for user consumption (internal and stakeholder perspectives). Insight-driven interpretation: uses financial and

organisational (e.g. strategy) understanding to discern performance drivers and their impacts. Uses ratios as back-up to the qualitative and quantitative

interpretations and insights already gained from initial assessments.

Simplistic technical awareness; not enhanced by deep commercial and

organisational understanding. Hence the assertions adduced don’t add value. Ratio-driven interpretations: calculates ratios but has limited understanding of

what they represent, and frequently fails to notice the links between related ratios and consequently fails to go beyond the obvious.

Demonstrate awareness

of the business

environment

Reflects sound grasp of the business environment and its specific impact on performance, which adds an extra dimension to the

overall quality of the response; identifies the entity’s ability to affect the timing and amount of its cash flows, enabling timely responses to optimise its growth opportunities.

Reflects basic awareness of the business environment but not integrated into the analysis and interpretation. For example, there is no

reference to the requirements of strategy, the timing of investments, the adequacy of financing, the differing obligations for dividends and interest, the causes and consequences of repayment of equity capital.

Critical reflection on

strengths and weaknesses to provide

succinct synthesis

Able to identify and evaluate for each user strengths and weaknesses of the SOCF. Can evaluate the cash-flow based performance

measures such as free operating cash flows to demonstrate their advantages and disadvantages over income-based performance measures.

Limited to making basic and general observations about the cash flow basis and accrual basis without any specific analysis and application to context or issue.

Being so limited unable to develop meaningful interpretations based on coherent understanding of the statements; unable to offer informed assessments of strengths and

June 2018 Exam Guidance

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that makes evaluations and

language use particularly critical?

Answer: multiple parts and

variables.

How do I perform a critical

evaluation of performance

indicators? Are they helpful to the

management in terms of

monitoring the right things?

How do I evaluate the SOCF?

Appropriate criteria of evaluation

How to use terminology

Identify critical points/features

They are functional

Match to their functions

Evidence of sophisticated subject

terminology: distinguishing,

explaining, evaluating, analysing,

sustained.

Acquired through critical reading

and thinking.

What is a point? Point in text response

Point in data response

Point in computations

Develop a point: affirming a

point, negating a point (it is not

financing activity because…); it

is financing activity because …

Examples of a point

What is an issue? How do I identify an issue?

How do I frame an issue?

What is context?

What is a scenario?

How do I analyse a scenario?

Issue as policy prompt

Issue identifies a gap.

What is evidence? Relevant evidence

Reliable evidence

Information and evidence

When do I assess evidence?

When do I take evidence for

granted?

What evidence should I take for

granted?

Evidence and assumptions.

What is a factor?

What is a variable?

What is fact?

What is belief?

overdraft would not be presented as financing activity because it is a cash equivalent

movement.

Fair presentation and decision-usefulness

What is “fair presentation” in the context of the statement of cash flows? In the

context of cash flows fair presentation means the provision of information that

enables users to identify the value drivers of the business – those activities that use

and provide cash and cash equivalents. Cash equivalents are short-term highly liquid

investments that are readily convertible to known amounts of cash and subject to an

insignificant risk of change in value.

The value drivers are classified as operating (making, buying and selling goods and

services), investing (expenditure on acquiring resources from which income can be

generated) and financing (obtaining equity or debt to pay for investing activities and provide temporary support for operations).

Statement of Income items whose cash flow effects are non-operating: investing and

financing are separately disclosed. In other words, the income effects of investing

and financing activities are separately disclosed.

The statement of cash flows shows how these items are related to each other, and

their effects on the historical changes in cash and cash equivalents of an entity.

This presentation satisfies user needs for information (to varying degrees) as it

enables them to

- Identify and assess the entity’s ability to generate cash to support its operations,

meet its commitments to providers of capital and invest in expansion for

sustainability.

- Evaluate the cash flow and income effects of changes in its net assets: e.g. the

effects of disposals and acquisitions of noncurrent assets, the effects on current

assets and current liabilities of levels of operations, profitability and investment

in short-term assets.

- Evaluate the relative contributions of performance, investment and financing on

the changes in its financial structure: e.g. i) what is the relationship between profitability and liquidity, working capital, solvency and stability; ii) what is the

effect on cash flow of the levels of investment activity; iii) what is the effect of

dividend policy on cash flow; iv) how does performance affect dividend policy?

- Assess the entity’s ability to affect the timing and amount of cash flows in order

to adapt to changing circumstances (needs and opportunities).

The disclosures (IAS 7. 48-52) enhance fair presentation by giving additional

information which expands on the conditions and restrictions significant to understanding cash flow generation and availability. For example, disclosure of

undrawn borrowing facilities (IAS 7.50a), disclosure of foreign subsidiaries restricted

Can compare SOCF and SOI to illustrate their relative advantages and

disadvantages and show how they each complement the other and

relate to the SOFP.

weaknesses; offers perfunctory analysis and comment.

Professional judgement Cultured in the professional ethos: able to synthesise analyses and judge competently, justifying interpretations with rigour and

circumspection.

Offers undeveloped arguments and inadequately supported conclusions about the structure and content of the SOCF. Consequently, issues are

not resolved.

Prepare and discuss

SOCF extracts

Integrates relevant extracts into the discussion: refers to specific elements as the issue demands. For example, refers to cash inflow from borrowings to

indicate potential claims on future cash flows by providers of debt capital.

Can prepare extracts but fails to apply principles to the scenario; makes basic method mistakes indicating lack of attention to learning concepts and principles.

Discuss ethical issues Explicitly focuses on the ethical issues raised by specific cash flow contexts e.g. presenting

preferred cash flow position to fraudulently comply with bank covenants or to satisfy performance reward criteria. Competently analyses and appraises the issues to

reach a justifiable conclusion.

Only general descriptive references to ethical principles without attempting to engage by

applying principles to context.

Language and style Clear, technically precise and concise; structured and coherent. A rich educational ethos

and an active approach to learning explain this student’s exemplary attitude and performance.

The grammatical errors, rudimentary analysis, vagueness and poor word choice are symptomatic of a deficient educational ethos

that causes this student to fail.

Marks scored out of 25 25/25 10/25

WHAT YOU SHOULD EXPECT

You should be able to evaluate the usefulness of the SOCF to existing and

prospective investors, lenders, and short-term creditors. As required by

June 2018 Exam Guidance

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Is management’s intention

evidence? Give examples for and

against.

When should you be

professionally sceptical about the

management’s intentions?

Evidence, detail, fact: how do

they relate?

Examples make things clear

How good should my examples

be?

How do I obtain examples?

How do I use examples in

answers?

Ask your own exam questions

Explain questions

Discuss questions

Analyse questions

Compare questions

Advise questions

Evaluate questions

Comment questions

How do I frame an argument?

The simple deductive

The complex deductive

Toulmin

PEE

Develop an argument Discourse markers

Flow and development

How do I use details?

What effect do you seek?

Identify the characteristics of

details that achieves the desired

effects.

To clarify a point

To support a point

To compare

To evaluate

To explore

To draw conclusions

Raise your commercial

awareness

What is commercial awareness?

How do I gain commercial

awareness?

How do I assess the effects of

commercial awareness on cash

flow? Example: linking customer

perceptions of product quality to

cash flows. Bad product news hits

cash flows.

Materiality

Operating cycle,

balances (IAS 7.49), the separate disclosure of cash flows that represent increases in

operating capacity and cash flows that are required to maintain operating capacity

(IAS 7.50) and the disclosure of segmental cash flows (IAS 7.52) constitute decision-useful and stewardship information.

WHAT YOU SHOULD LEARN The importance of operating cash flows

A key indicator of the entity’s ability to meet its operating, investing and financing

commitments from core internal activities routinely carried out, comprising sale of

goods and services for a consideration. From such core operations adequate cash

flow must be generated to meet core obligations for investment (to maintain

operating capability) and financing e.g. dividends, interest and repayment of capital

without recourse to external financing. When the entity is in this position it is said to

be in a sustainable position.

The operating activities section of the statement of cash flows enables an evaluation

of this ability (relevance, decision-usefulness and stewardship). By excluding the

effects of accounting policy choices through the reconciliation to cash (see below),

the cash flow from operating activities is deemed to be more reliable and comparable

than the operating profit (see below). For example, unlike the statement of income

(SOI) the SOCF, comprising only historical cash flows, is not subject to

measurement uncertainty, outcome uncertainty, estimation uncertainty, existence

uncertainty.

In accordance with the efficiency perspective an entity presents its operating,

investing and financing activities in a manner which is most appropriate to its

business IAS 7.10.

The efficiency perspective is that organizations are best served by selecting

accounting methods that best reflect their underlying performance (Positive

accounting theory).

Required

Discuss how appropriateness can be judged? Hint: Information quality: this must be

judged in terms of the conceptual framework – apply the characteristics to specific

scenarios or discuss how appropriate presentations can be achieved generally. (See

below). Functional importance: this must be judged in relation to the distinct

objectives of stewardship and decision-usefulness which are integrated into the qualities of information. Your discussion should therefore give them due prominence.

Reconciliation to cash

The operating activities section shows a reconciliation of the accrual-based profit to

the cash-based profit in two stages.

Stage 1: Calculate profit from operations (from the net profit before tax)

i) Add (or deduct) the non-current operating accruals such as depreciation,

amortization and deferred tax income and expense; ii) add (or deduct) the non-cash

integrated reporting demonstrate commercial awareness, future outlook,

business model impact when assessing cash flow generation and user needs.

You need to show that you understand what is happening in the business. This

entails considering the entity’s environment and its stage of development:

growth, maturity or decline. Also consider industry and firm characteristics

such as the operating cycle (periods to manufacture, sell, collect cash for

goods) and the implications for cash generation, working capital, investment

and financing needs when evaluating cash-based ratios and the relationship

between cash flow, operating profit and earnings. The following table sets some

user-needs benchmarks to consider.

Activity Investor Accountability &

stewardship

Lender WC creditor e.g.

bank overdraft

Operating Does the cash flow

from operating activities exceed net profit from operations? Does the entity generate sufficient surplus cash flow

from its operating activities and manage its working capital effectively? Is the relationship between operating

profit and cash

provided by operations changing? What is that due to?

Can the entity

generate surplus cash flow from its operating activities and manage its working capital effectively to enable it to meet

its financial commitments as they fall due?

Can the entity

generate surplus cash flow from its operating activities and manage its working capital effectively? Is current

investment in working capital safe and sustainable?

Investing Is the entity investing adequately and timely in noncurrent assets for future growth and

income generation?

Is the timing and amount of investment adequate to

generate cash flows at a speed and size that will enable the entity to repay the loan?

Is current investment adequate for future growth?

Financing Is financing in accordance with

current strategy? Can the entity pay interest and repay its borrowings on time?

Is financing adequate to

execute the current strategy? Is the entity paying interest

Can the entity repay the overdraft and

interest on time? Can the accounts payable be paid on time and regularly?

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Enables insightful understanding

Enables reading with discernment

Enables reading with engagement

Enables reading with a purpose

Sources

ACCA:

Commercial awareness podcast

operating gains and losses such as gains on derivatives held for trading, sale of non-

current operating assets, share-based payment and pensions; iii) eliminate the income

effects of investing and financing activities such as investment income, interest charges.

Note the type of non-cash items that are not adjusted: adjustments relating to current

items such as bad debts, working capital accruals, etc. They are not adjusted because

the later WC adjustment takes care of them. How? For example, accounts receivable

is presented net of bad debt allowance.

Stage 2: Calculate cash from operations

Convert profit from operations in Stage 1 to cash from operations by adjusting for the

timing of unrealized working capital.

Refer to cash flow template.

Examples of critical issues in classification

Cash flows do not always fit exclusively into one of the three categories: operating,

investing, financing. A scenario may be given requiring discussion of the key ethical

and financial reporting issues in classifying between:

- operating and financing (the issue is source of financing, internal or external e.g.

factoring accounts receivable or AR is external financing activity if factored

with recourse, and internal operating activity if factored without. External

financing means cash received under factoring arrangements represent

borrowings secured against AR. In this circumstance AR is not derecognised

and therefore forms part of OWC adjustment in the operating activities segment

of the SOCF).

- investing and cash and cash equivalent (the issue is liquidity: the liquid

investments are short term highly liquid investments that are readily convertible

to known amounts of cash and are subject to an insignificant risk of change in

value; the illiquid investments are current and noncurrent assets)

- investing and financing (the issue is control: e.g. buy or sell controlling interest

in a subsidiary is investing activity, but buy or sell NCI is financing activity;

invest in associate or joint venture is investing; government capital grant is

financing). According to the economic entity concept the parent and the entities

over which it has control form a single economic entity (the group) which includes the NCI. Until control is lost, transactions between members of the

group that simply reallocate ownership rights between them are equity

transactions (CF 6.69). Accordingly, they are deemed to be financing activities.

However, in accordance with IFRS 10, when control is lost, the parent

recognises the fair value of the interest in the subsidiary as consideration in

exchange for the loss. This allows the parent to recognise a return on the

investment. Hence, the loss of control is deemed to be an investing activity.

- operating and investing (the issue is performance: assess ability to pay; assess

return on investment - dividends received and paid are operating or financing;

gain on disposal which reflects the soundness of the depreciation policy over

Can the entity pay dividends and sustain its dividend policy? Is finance obtained on efficient terms?

Is financial risk being adequately managed within acceptable limits?

and repaying its borrowings on time in accordance with bank covenants?

Change in cash and cash

equivalents

Is the net change in cash and cash

equivalents in line with strategic and

operational

objectives?

Is the net change in cash and cash

equivalents in line with expectations and under control?

Is the net change in cash and cash

equivalents in line with expectations and under control?

Cash and cash equivalents

Is the total amount of cash and cash equivalents excessive, safe, sound, adequate

to meet baseline operations for the foreseeable future? Is the amount of cash and cash equivalent likely to cause agency problems? E.g. low

balances might induce unethical adaptive behaviour to mislead creditors and avoid detection of covenant violations; large balances might encourage needless

and wasteful investments such as M&A activity.

Is the total amount of cash and cash equivalents

adequate to meet outstanding obligations?

Is the total amount of cash and cash equivalents adequate to support

baseline operations?

Cash and cash equivalents reconciliation

Is the SOCF reconciled to equivalent items in the statement of financial position (SOFP)? For example, SOFP items may include an overdraft balance presented in current liabilities. This balance should be deducted from the components of cash and cash

equivalent in current assets. The net figure should be equal to the total cash and cash equivalent in the SOCF.

Noncash items Are non-cash items such as assets acquired under a finance lease, the conversion of debt to equity, equity financed business acquisitions adequately disclosed elsewhere in the financial statements?

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which management exercises discretion is operating, but the related proceeds

which are market-determined and not subject to managerial discretion are

classified as investing)

- operating and financing (the issue is performance: assess cost of financing;

assess ability to pay - interest and dividends paid)

Classification issues in past exams

The examiner is concerned about classification e.g. Dec 2013 q1b & answer. This

was a very challenging question requiring technical knowledge of cash and cash

equivalent to be used in determining how “term deposits” should be classified.

According to the examiner “classification is not always clear-cut, and the principles

have to be used to classify these items.” The examiner was disappointed that students

often did not engage in the type of discussion prompted by the question.

Classification and ethics

- Ethics q1c: manipulating the statement of cash flows e.g. structuring the sale of

securitised assets to fit a preferred presentation within the SOCF; classification

of a loan as cash and cash equivalent June 2009 q1c (answer).

- Issues in classification: explain the principles that govern the classification of

cash flows under IAS 7 and evaluate to what extent these classifications aid

understandability and decision-usefulness.

Integration and Coherence The statement of cash flows is presented as an integral part of the financial

statements for each reporting period. Accordingly, you need to understand the

relationships between the five statements and reflect this understanding by providing

integrated interpretations of financial performance, cash flow and financial position

(IAS 7.50).

The interpretations must be meaningful. Demonstrating understanding of how value

has been created (or destroyed) and the implications for the entity must be the focal point of all analysis. Thus, the effects of the interaction of the key value drivers

must be identified, evaluated and communicated in their strategic and environmental

contexts.

Therefore, while ratios may be used to provide stimulus (for leading questions), to

achieve the deeper understanding required for meaningful interpretation candidates

must consider and refer to all the key documents that provide full understanding of

the operating, strategic and financial performance of the entity in its environment.

Examples of documents include strategic report e.g. Tesco plc. Candidates are

encouraged to get familiar with the terms, techniques and data for interpretation by

reading, analysing and comparing published financial statements.

Relevance and decision-usefulness The examiner is also concerned about the usefulness of financial statements. In the

context of the drive towards improving the usefulness of financial statements (as

Disclosure Are disclosures adequate to ensure full understanding of cash flows for stewardship and decision-usefulness including risk exposure and management strategies? Is the policy for determining cash and cash equivalents adequately disclosed to allow users to understand the components?

Movement in net debt

Does the SOCF reconcile to the movement in net debt? Net debt is the total interest-bearing debts (current and non-current) less cash and other risk-free securities. Read the notes to published financial statements.

What type of transactions and issues are examined under statement of cash

flows and why?

- Discuss the benefits of classification of cash flows and the key issues that

may arise in classifying cash flows. How does the principles-based

approach help in resolving these issues?

- Explain why it matters whether cash flow arising from a transaction is classified as

a) Operating or investing activity e.g. received interest, dividend IAS

7.33

b) Operating or financing activity e.g. pay interest, dividend IAS 7.33-4

c) Investing or financing activity e.g. increase interest in subsidiary

d) Investment or cash equivalent e.g. invest in marketable securities

e) Financing or cash equivalent e.g. bank overdraft IAS 7.8

In each case give specific examples (don’t be limited to the above examples) to

show how specific user needs are satisfied when the cash flow effects are combined with the income effects and the impact on the financial position

(integrated interpretation). Hint: prepare a table. Think analytically and

critically.

- Discuss the extent to which the structure and presentation of the SOCF

attain the objectives of integrated reporting (CF1.16). Hint: adopt a

stakeholder perspective to discuss the stakeholder needs that are met and

those that are not met given the limitations of general purpose financial

statements.

- Why would you expect the amount of cash provided by operations (or cash flow from operations) to be higher than net income?

- Which aspects of the SOCF could provide comfort to an investor about the

value of the entity’s quoted shares? How would the investor corroborate the

initial assessment with other published information in the annual report?

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evidenced by integrated reporting proposals examined in June 2015 q4 & answer)

candidates should expect the statement of cash flows to be examined as a current

issue and as critical evaluation (June 2016 q1b & answer).

Free cash flow (net cash provided by operating activities less investment in

operating and investment assets) is a better basis for dividend declaration than

earnings because it ensures that the business is investing in renewal and expansion of

future sources of cash before dividends are considered for distribution to existing

shareholders.

UNDERMINES FAIR PRESENTATION

The following requirements or omissions undermine “fair presentation”:

asymmetry in presenting the income effects and cash flow effects of certain transactions.

Activity Income effects

(accrual basis)

Cash flow effects

Sale of PPE Gain or loss: Operating activity

Proceeds: Investing Activity

Interest due from others Investing Investing or operating IAS

7.33

Interest due to others Financing Financing or Operating IAS

7.33

Equity income from

unconsolidated entities

(e.g. associates)

Investing Investing

Dividend due from

others (including

dividend from

associates)

Investing Investing or operating IAS

7.33, IAS 7.33. Return on

investment; included in

profit or loss.

Dividend due to others Direct to equity:

deducted from retained earnings

(See discussion under

IAS 10)

Operating or financing IAS

7.34. Enable assessment of ability to pay dividends out

of operating cash flows; cost

of financing.

DEALING WITH INCONSISTENCIES

Aside from the timing effects the presentation of the income effects and cash flow

effects of certain transactions classified as operating, investing and financing

activities are not aligned between the statement of income and the statement of cash

flows. For example, gains and losses arising from the sale of PPE are presented in operating profits whereas the proceeds (cash flow effects) are presented in investing

activities in the SOCF. How is this fair presentation? Discuss.

- Why would an investor be tolerant of an overdraft if the entity is profitable?

Hint: think about materiality. How would materiality be judged?

- What is the amount of cash available to pay dividends (free cash flow to

equity)? Is that information readily available or does it need to be derived

from the SOCF?

- Why would an investor be cautious about predicting future cash flows

based on the firm’s current free cash flow to equity? What information in

the Management Commentary would significantly influence investor

predictions? Also refer to CF 1.13, 1.14, 1.15, 1.16, 1.18, 1.20, 1.21.

- What is the amount of cash available to invest in renewal and expansion?

Is that information readily available or does it need to be derived from the SOCF?

- What is the amount of debt that should have been repaid as opposed to the

debt repaid in the period? Is this information available on the SOCF or is it

available elsewhere in the financial statements? IAS 7.4, IAS 7.50.

- What is the role of covenants in discharging stewardship over cash flows?

- An entity reclassified $2.5 billion of software development expenditure

from operating expenses to intangible assets satisfying the criteria of IAS

38 Intangible assets. Explain the effect the reclassification would have on

the entity’s cash flows.

- To ease its financial difficulties a parent reclassified an advance to its

subsidiary from current assets to long-term receivable, as settlement is not

expected for the foreseeable future. Explain the effects of the

reclassification on the cash flows of the group, the separate financial

statements of the parent and the individual financial statements of the

subsidiary.

Entity Y’s functional currency is the euro. On 1 January 2017 it sold goods to a

US customer for $1,000,000 when the spot exchange rate was at par, and it

recognised revenue of €1,000,000. Payment was due to be received on 30 June 2017, therefore Y enters into a forward contract to exchange $1,000,000 for

€1,095,000 on 30 June 2017 but does not designate the contract as a hedge

because movements on the contract will offset the effects of retranslating the

receivable in profit or loss. On 30 June 2017 Y receives the equivalent of

€1,200,000 from its customer.

Required

- Discuss how A should present the cash flows in its statement of cash flows.

- What difference would it make if Y elects to apply hedge accounting?

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DEALING WITH AMBIGUITIES

According to IAS 7.33 interest paid (finance cost) and interest and dividend received

(finance/investing income) may be classified as operating cash flows because “they enter into the determination of profit or loss”. This reasoning is flawed because profit

or loss is “accrual basis” whereas “cash flow from operating activities” is “cash

basis”. Therefore, if this rule is applied cash flow from operating activities may be

misstated by the inclusion of dividends that relate to previous periods, thereby

undermining fair presentation. Moreover, the inclusion of dividend and interest paid

and received in cash flow from operating activities conflicts with IAS 7’s definition

of operating activities: “Operating activities are the principal revenue-producing

activities of the entity and other activities that are not investing or financing

activities.” IAS 7.6

Furthermore, according to IAS 7.13 “the amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the

entity have generated sufficient cash flows to repay loans, maintain the operating

capability of the entity (see also IAS 7.50c), pay dividends and make new

investments without recourse to external sources of finance. Information about the

specific components of historical operating cash flows is useful, in conjunction

with other information, in forecasting future operating cash flows”. This usefulness

would be limited by the distorting effects of mixing operating cash flows with other

non-operating cash flows as IAS 7.33 permits. This weakness can be removed by

revising IAS 7.33 to remove the permitted options and require all investment income

cash flows to be presented in investing activities.

COMMENTS ON OPTIONAL PRESENTATION OF DIVIDENDS AND

INTEREST PAID AS OPERATING OR FINANCING

Rationale for optional presentations

Presented in operating activities: to enable an entity to assess its ability to pay out of

its internal resources.

Presented in financing activities: to enable the entity to assess its cost of financing.

Evaluation of optional presentations

How do you evaluate the options to determine whether to use them or not? Identify a rationale or basis for evaluation: in this case it is the critical importance of

operating cash flow. The information about the entity’s ability to meet its obligations

out of its internally generated resources is crucial to performance evaluation.

Presentation of dividends and interest paid in operating activities is not appropriate as

it distorts the cash flow from operating activities which is essential information. The

ability to pay is important but it can be determined separately.

Therefore, the option should be declined. Instead, interest paid and received, and

dividend and interest paid and received, should be presented in financing and

investing activities as appropriate.

- Assess the likely impact of leasing (and the impact of IFRS 16 Leases). See

September 2016 q4b (answer). Read the examiner’s report in anticipation

of this question being asked again, as part of the assessment of the impact of the new standard.

- The effect of group transactions and balances: Dec 2013 q1a (answer)

acquisition of a (foreign) subsidiary; disposal of a subsidiary (discontinued

operation); adjustment of the purchase price for obligations (e.g.

pension, contingent liability, share-based payment, etc.). Practise answering

this question repeatedly until you are confident. Also, read the examiner’s

report December 2013 paying careful attention to comments relating to

q1a.

- Evaluate cash flows in major sections e.g. investing, financing, etc., in terms of the overall financial health of the entity and of the implications of

the information about a segment such as a subsidiary. See Dec 2012 q2b

(answer).

- Interpretation of pattern of cash flows See Dec 2010 q1b (& Answer) and

Dec 2008 q1b (& Answer). (See also section G.2)

- Relate cash flows to ethics e.g. management of earnings (June 2010 q1c

and answer) and assess whether features of the SOCF allow or prevent

ethical misconduct and manipulation e.g. i) the indirect method is more

susceptible to manipulation than the direct method because it has lines that

are entirely subjective or discretionary and management can use them to mislead (December 2010 q1bi, ii & answer); ii) an abundance of free cash

flows (disclosed using the indirect method) could induce wasteful

investment; on the other hand the indirect method provides relevant

information in terms of negative free cash flows. This highlights company

financial problems, warranting remedial action.

- Statement of changes in equity (SOCE) items e.g. dividends to equity

holders of the parent (financing); issue of shares (not share-based payment)

including rights issue (financing); equity transactions (financing if control

is not lost or investing if control is lost); purchase of NCI interests

(financing).

- Share-based payment: in the SOCE this is presented as a transaction with

owners. It is not shown as a financing cash flow as resources don’t enter or

leave the group - being equity-settled. However, the net amount is shown as

an adjustment (amount added back) in the reconciliation between “profit”

and “cash generated from operations” being the amount debited to profit

or loss in respect of the award of share options in the year to be settled in

the entity’s equity instruments. (Refer to the SOCE for Tesco plc and the

related documents given at the end of the adjacent column.) The entries to

account for the annual charge for equity-settled share-based payment are:

DR Profit or loss; DR Treasury shares, CR Share-based payment.

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HOW THE ADJUSTMENTS TO OBTAIN CASH FLOW FROM

OPERATING ACTIVITIES AFFECT RELIABILITY AND DECISION

USEFULNESS

- Adding back non-current operating accruals such as depreciation, deferred tax

and amortisation reverses the effects of matching non-current accruals to income

generated by the underlying operating assets. Thus, the SOCF does not allow for

the benefits that flow from operations to be associated with the cost of using

underlying resources. This criticism can be countered by the argument that it is

not the aim of the SOCF to support cost-benefit analysis.

- Eliminating the non-operating gains and losses (gains and losses on disposal of

PPE) limits the use of the SOCF to assess future earnings potential (not a serious

limitation as SOI can supplement SOCF) if read in conjunction with it as suggested by IAS 7.4.

- Operating working capital (OWC) adjustments reverse the timing effects of

unrealised OWC (inventory, accounts receivable, accounts payable, prepayments

and accruals) and at the same time remove the completeness attribute of faithful

representation introduced by the accrual basis.

FACTORING

Presentation of cash flows arising from factoring (securitisation of accounts

receivable) with or without recourse. Without recourse means substantially all the

risks and rewards of the receivables are transferred to the factor and there is no further managerial involvement that is normally associated with control of the

receivables. Hence the total amount of AR is derecognised by the entity and the cash

inflow is operating – included in cash and cash equivalent.

With recourse means the converse of without recourse, and the substance of the

transaction is then financing. Accordingly, the cash from the factor is shown as cash

inflow under financing activities. Full collection of the AR results in derecognition:

DR borrowings, CR AR. There is no internal cash flow when this event occurs.

However, the event may be presented as cash outflow in the financing activity

section of the SOCF.

DISCONTINUED OPERATIONS

Assessments of future cash flows (relevance) and evaluation of performance

(stewardship) must be made on comparable basis. Accordingly, due prominence is

given to the effects of discontinued operations on the ability to predict future cash

flows by requiring the separate disclosure of amounts relating to discontinued

operations on the face of the SOCF (understandability).

GROUP CASH FLOWS

Group cash flow considerations: the impact of acquisitions of subsidiaries on the

group’s balances. Adjustments to the purchase price for outstanding obligations e.g.

pension obligations, share-based payment, contingent liability, etc. according to the

- Interest paid: capitalised interest under IAS 23 must be shown as

financing cash flow; total interest paid must be shown including operating interest cash flow. Other interest paid, including finance charges under a

deferred payment scheme may be classified as operating or financing.

- Interest received may be classified as operating or investing. The choice is

the entity’s but once made must be applied consistently

- Factoring cash flow receipts: i) debt derecognised (operating cash flows);

ii) debt not derecognised due to continuing involvement e.g. invoice

discounting. (financing cash flows) June 2012 q1bii & answer

- Cash flows on derivative contracts: i) investing; ii) operating if held for trading; iii) mirror the cash flows of the hedged item if using as a hedging

instrument for an identifiable position (for recognised asset/liability,

highly probable forecast transaction, firm commitment). For example, cash

flows arising from an interest rate swap can be classified as operating or

financing activities, depending on the entity’s classification policy for

interest paid, because they are interest payments or hedges of interest

payments.

- Treasury shares: cash flows classified in financing activities even where

acquired as part of an-equity settled share-based payment transaction.

However, payments by a subsidiary to its parent or a trust that holds

treasury shares as part of an equity-settled share-based payment transaction is deemed to be a distribution of reserves and is deducted from equity.

Consequently, such payments are classified as operating or financing

depending on the entity’s policy on dividends.

- Pension adjustments: noncash and cash. The noncash element is first added

back as a reconciling item in the “operating activities”. Therefore, the cash

element (amount paid) should be deducted to match the movement in the

bank and provide the net cash generated from “operating activities”. Refer

to the extracts opposite to see how this works in the published financial

statements of Tesco plc. Also refer to December 2013 q1aiii (answer)

You may also be asked to explain the treatment of cash flows arising from

certain transactions

a) Transactions with owners: financing, e.g. sell, acquire NCI, pay dividends

b) Transaction costs incurred in raising debt finance: presented as cash

outflow in financing activities.

c) The difference between the treatment of the disposal of NCI and subsidiary

d) Rights issue pro-rata.

e) Rights issue to NCI only of subsidiary (control maintained)

f) Unrealised and realized working capital balances on acquired subsidiary.

Cash is deducted from the consideration paid or received; I, AR, AP, are

deducted from the acquirer’s OWC in calculating changes in the period.

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terms of acquisition. Refer to the spreadsheet worked example 1.5.3 pay attention to

the annotations in column I.

REFLECTING FOREIGN EXCHANGE DIFFERENCES

that arise on translation at the balance sheet date

Status Relates to Effect on reconciliation of profit or loss

to operating cash flows.

Settled Operating activities None: why? On settlement, the

movement in cash reflects the exchange

difference, and an equivalent amount is

reflected in profit or loss at that point.

Consequently, there is parity in the

effects of settlement on income and

cash flows, obviating the need for an

adjustment to reconcile the two.

Settled Investing or financing

activities

Eliminate: why? As they are not

operating items, the actual cash flow movement on settlement is not reflected

in the reconciliation of profits to

operating cash flows. For example,

remove the gain or loss relating to

dividend received from a foreign

operation. The dividend is shown as

investing cash inflow.

Unsettled Operating activities None: why? Because changes in OWC

monetary amounts include exchange

differences which are offset by the

corresponding differences recognised in

profit or loss from operations. See IAS

7 calculations.

Unsettled Investing or financing

activities

Eliminate: why? As they are not

operating items the actual movement of

long-term monetary items that include

exchange differences is not included in

the reconciliation of operating profit to

operating cash flow. See IAS 7

calculations.

PROPERTY PURCHASE CASH FLOWS

Property developer

Purchase of land and buildings by a property developer to redevelop and sell: classify

cash outflows as operating activities. This is like inventory to a manufacturer, retailer or wholesaler. At the time it is acquired management does not intend to hold

the asset permanently. This circumstance distinguishes this transaction from the

purchase of PPE IAS 16.7-8 where the cash flow is classified as investing activity.

g) Income tax paid

h) Discontinued operations

i) Bonus dividend j) Foreign currency IAS 7.28.

k) Non-cash transactions do not have a direct impact on current cash flows

although they do affect the capital and asset structure of an entity - IAS

7.43,44. Principles: consistency dictates that relevant details of these

transactions should be disclosed elsewhere in the financial statements.

Interpreting disclosure

a) SOCE extract

b) SOCF extract

c) Dividend note in the published financial statements. Discuss the

implications for the statement of cash flow. Be specific.

Definition of key terms:

a) Investment entity IAS 7.42A

b) Operating working capital (OWC)

c) Operating free cash flow

d) Free cash flow includes net borrowings and discretionary investment such

as acquisitions

e) Operating working capital requirements

f) Cash equivalent

g) Cash flow hedge

Weaknesses of the SOCF: What are the weaknesses of the statement of cash flow? Refer to IAS 7 Evaluation of the SOCF.

a) No information about working capital strategy to enable evaluation of the

soundness of level of OWC

b) No information about credit policy

c) No information about manufacturing and stockholding policy

d) No information about split of investment between renewal and innovation.

e) No information about the timing of cash inflows to determine if cash is

obtained promptly to optimise strategic advantage.

Relationships between the statements: how do they relate and how do they

complement each other? a) SOCE

b) SOCF

c) SOI

Key cash flow-based performance indicators: evaluate their strengths over

income-based financial indicators

a) Operating cash cover (operating cash/interest paid) over EBITDA interest

cover (EBITDA/interest charged)

b) Price-to-cash over price-to-earnings ratio

c) Free operating cash flow/total debt (all debts, excludes operating liabilities)

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Property investment entity

Purchase of land and buildings by a property investment entity to collect rental

income and routinely earn revenue from the sale of property: classify cash outflows as operating activities. At acquisition there was a clear intention to hold the asset to

generate revenue for a predetermined period at the end of which the asset would be

sold and replaced with an asset or assets of equivalent capacity to replicate the

service. The business model is designed solely to generate cash directly from

operating the asset; hence the cash flows must be classified as operating activities.

Manufacturer & Hotelier: Property plant and equipment

In contrast, PPE IAS 16.7-8 acquisition and disposal cash flows are classified as

investing activities because they arise indirectly from the use of the asset to produce

goods or services, provide office accommodation for the entity and to earn a return

from holding the asset as evidenced by the assessment of residual income at acquisition.

LEASING

The annual finance lease payments consist of capital (financing activities) and

interest (operating activities). Cash flows arising from a sale and leaseback are

treated as investing activities. See IFRS 16 for further discussions.

CASH FLOW HEDGING

Financial instruments held in a cash flow hedge (IAS 7.16). The effects of cash flow

hedge transactions (IFRS 9.6.5.2b, 6.5.4) should be carefully thought through from

all sides. Hedge accounting has been poorly answered in previous exams. Use the following past exams to prepare thoroughly.

- December 2013 q3b (answer) is a good guide to the examiner’s circumspective

approach.

- IFRS 9 on hedge accounting: q2c 12/14 & answer; q1a 6/14 & answer; hedge

accounting is normally poorly answered. Expect this question again in June

2018.

- June 2015 q4bi (answer): cash flow hedge; accounting for gain or loss (IFRS 9)

at period end (IAS 2) and on disposal of inventory.

OTHER KEY AREAS OF INTEREST

a) Payment of contingent consideration following acquisition: this is interesting

because according to IAS 7.16 “Only expenditures that result in a recognised

asset in the statement of financial position are eligible for classification as

investing activities.”

b) Borrowing costs i) treated as expenses; ii) capitalised. The total amount of

interest paid must be presented in the SOCF whether or not it has been

capitalised under IAS 23 or expensed. IAS 7.32

c) Provisions for warranties: changes have an impact on cash flow from operating

activities.

d) Explain why total debt in the denominator in (d) above excludes operating

liabilities such as trade payables, accrued liabilities and advances from

customers. Hint: the operating liabilities are covered by operating working capital assets.

Operating cash cover = operating cash/interest paid

Price-to-cash = Share price/Free cash flow to equity per share

HOW YOU SHOULD PREPARE Set clear practice objectives for each area and note that you will be required to

analyse, explain and evaluate – the core components of a discussion.

Therefore, your practice objectives must be focused on developing these skills

to the highest intellectual level 3 (synthesis and evaluation) alongside the

traditional computational skills.

Read past examiner’s reports to ascertain good practice and mistakes to avoid.

Get familiar with real-life examples: as you can see from the examiner’s reports

the examiner expects you to read published financial statements and the

financial press.

Be clear about how other IFRSs impact the statement of cash flows and be

prepared to demonstrate knowledge of the principles and ability to apply them

in unfamiliar situations. As a minimum make sure you are clear and can deal

with the following:

- IAS 7 and IFRS 3 (acquisition costs [operating activity], consideration [investing activity]

- IAS 7 and IFRS 5 (cash flows arising from disposal of subsidiaries

[investing activity]) - IAS 7 and IFRS 7 (liquidity risk; credit risk; cash flow hedge) - IAS 7 and IFRS 8 (segmental cash flows) - IAS 7 with IFRS 16 (sale and leaseback: sale proceeds [investing

activity]; leaseback [financing activity]) - IAS 7 with IFRS 9 (cash flow hedge and fair value hedge interaction;

purchase and sale of investments such as bonds, available-for-sale investments; returns on investments, financial guarantees)

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d) Insurance proceeds: operating cash flow if relates to inventory losses; investing

activity if relates to PPE losses.

e) NCI changes: financing cash flows/investing cash flows? f) Purchase of preference shares acquired within a short period of their maturity

and with a definite redemption date IAS 7.7 In substance these are cash

equivalent as they are readily converted into a known amounts of cash and

subject to an insignificant risk of change in value.

g) Bank overdraft: CCE or borrowing? Justify as an example of how to use

commercial circumstances to achieve “fair presentation”.

h) Interest accrued in accounts payable or WC accrual: why is it essential to

eliminate?

i) Working capital Accounts Payable and PPE expenditure: explain why PPE

invoices should not be in there.

j) Non-current accruals in working capital accruals or accounts payable. k) Government grants for revenue and capital expenditure: how should these be

presented and why?

l) Sale or purchase of derivatives held for trading v derivatives held in a cash flow

hedge (IAS 7.16).

m) Cash flows are reported gross; transaction costs of debt or equity finance are

classified separately as financing activity. Transaction costs for a business

combination are expenses and classified as operating. In some cases (e.g.

financial institutions) cash flow may be reported on a net basis IAS 7.22-24.

n) Change in accounting policy for classification of cash and cash equivalents

e.g. arising from reclassification of certain investment items.

o) Sale of PPE held for production (IAS 16: proceeds investing activity) compared

with sale of PPE held for rental (IFRS 15 – proceeds operating activity) See IAS 7.14

CASH-FLOW-BASED MEASUREMENT TECHNIQUES

Review Conceptual framework for cash-flow based measures. Remember that

cash flow-based techniques are not measurement bases but means of estimating

measures using a valuation model (mark-to-model) e.g. where those measures

cannot be directly observed (fair value hierarchy level 3) or where they are specific to

an entity (VIU): Conceptual Framework for financial reporting (2015), Appendix

A2, p81. Study appendix A of the conceptual Framework.

Is there adequate disclosure of cash-flow based estimates: value in use (VIU), fulfilment value (FIV), exit value - fair value (IFRS 13 fair value hierarchy level 3).

The worked example in The maths of IAS 37 illustrates the key issues that would

attract the examiner’s attention. These have already been examined in

- December 2012 q4b (answer). Fair value of a liability

- December 2014 q4b (answer) CGU/SBU IAS 36 impairment assessments:

- Jun 2015 q2b (answer) measurement and accounting for biological assets

- Exchange of assets: IAS 16.25 assess commercial substance (VIU); post-tax cash

flows

DISCLOSURES

- IAS 7 with IAS 1 (fair presentation of cash flows; accounting for gains and losses)

- IAS 7 with IAS 16 (additions or disposals including exchange of

assets with commercial substance IAS 16.25) - IAS 7 with IAS 19 (operating activity) - IAS 7 with IAS 21 (financing an interest in a foreign operation) - IAS 7 with IAS 23 (investing activity) - IAS 7 with IAS 28 (share of associate’s profits [eliminate in

reconciliation of net profits to cash from operations]; dividend received [investing activity]; invest in associate [investing activity]; loan to associate [investing activity])

- IAS 7 with IAS 38 (research phase [operating activity], development

phase [investing activity], production phase [IAS 2 operating activity])

You should aim to score full marks by practising applying the above principles

assiduously. You are probably best advised to listen less to lectures and to practise more! Practise repeatedly and make use of the mark scheme and

examiner’s report to identify and improve weaknesses fast! Reflect and learn!

If you are running out of time in the exam prioritise finishing the workings over

preparing the statement. Marks are not awarded for writing out the statement of

cash flows as the format is a given at this level.

- The pattern of examination for q1a has been: September 2017, June 2017

(optional) June 2016, Dec 2013, Dec 2010 and Dec 2008. The principles

and applications of SOCF are expected at other questions e.g. q1b, q2

interpretation (See also section G.2).

- The examiner can combine consolidated income statement and cash flows

June 2016 q1a (answer).

- The examiner can test interpretation and evaluation skills directly,

involving ratio analysis, EPS, etc. These have not been tested since

December 2007. This infrequency indicates that the more direct and

straightforward aspects of interpretation are examinable at F7 Financial

reporting. At P2 interpretation will be at a deeper application level

involving the evaluation of the effects of strategic decisions such as

acquisitions, reconstructions and disposals.

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Disclosures together with commentary by management aid understandability:

- Policy about cash and cash equivalents

- Restrictions over cash held by subsidiaries - Additional information that aids user understanding of liquidity and overall

financial position including adaptability to change. IAS 7.50

- Cash flows required to increase operating capacity separated from cash flows

required to maintain operating capacity enables assessment of future earnings

capacity.

- Non-cash investing and financing activities IAS 7.43-44 e.g. the conversion of

debt to equity changes the capital structure and may have a significant effect on

the prospective cash flows of the reporting entity.

REAL-LIFE EXAMPLES VW 2017 KEY ISSUES

COMMENTS ON THE FINANCIAL POSITION

QUALITATIVE FEATURES

Technically relevant to IAS 7

Fundamental characteristics

Enhancing characteristics

Effective writing

- Succinct: focused, concise and precise

- Incorporates relevant details to make meaning clear

- Comparatives with previous year

- Contextualized

- Audience focused (nontechnical language)

KEY HIGHLIGHTS

- Reclassification: disposal of PPE from operating activities to investing activities.

- Disclosure of major cash out flows to do with exceptional item – the emissions scandal’s impact on cash flows.

- Disclosure of major financing inflows

- Disclosure of dividends paid out of borrowed money: is this sound finance?

Comment means give your supported views; must be sophisticated i.e. it must

reflect the critical context features and judgment about the soundness of the

practice. So, if dividend is paid out of borrowed money a sophisticated statement

reflects the view that borrowing to pay dividends is not sound finance because

dividends are returns to providers of equity capital and so must be financed by

cash provided by operations. Moreover, borrowing long-term to finance

discretionary obligations is not sound finance. Statement is also sophisticated if

it reflects the view that other items have priority over dividends and that

borrowing increases financial risk through gearing. The statement is defensible and complex as it can be rebutted by others. This sort of analysis is very much

liked by examiners as it indicates deep understanding of how a firm should be

financed. It is a differentiator of P2 from F7 standard.

- The concepts of gross cash flow and gross liquidity are very interesting.

- According to the examiner some candidates put the wrong sign in front of

the right amount. Make sure the sign as well as the amount is correct. Don’t throw marks away. Below is a clear example of how to present investing

cash flows correctly: money going out (negative); money coming in

(positive). The same rules apply to “Financing activities.”

Investing activities

Investment in the shares of an associate (500)

Loans to associate (150)

Loans repaid by associate 15

Dividends received (from an associate) 5

Net investing cash outflow (630)

- Make sure you are completely familiar with the entire format and contents

of the statement of cash flows – the “indirect method” tends to be required

but you should also be familiar with the “direct method” format as well.

Make sure you define correctly what goes into each section. Operating

cash flows section: make sure you can describe the subtotals correctly:

“cash flow from operating activities”; “net cash flow from operating

activities”. Study the answers to past questions to ascertain the correct

structure and contents.

- Make sure you are clear about foreign currency cash flows and any

related adjustments. Refer to the spreadsheet worked example.1.5.1. Pay

attention to the notes in column F of “Non-operating cash flows.”

- Make sure you understand financial instruments cash flows. Refer to

worked examples in spreadsheet.1.5.2.

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- Gross cash flows is in accordance with IAS 7.

- However, gross liquidity (NET LIQUIDITY) is also useful: it shows the

management’s priority focus on liquidity. This concept is similar to the concept of NET DEBT.

- Presentation relates investing activities cash flows to operating activities. This

is useful to show investors that the current level of activities will be sustained

and improved through renewal and expansion. Required: Identify the other

stakeholders that would be interested in this information.

Tesco plc

2015 Tesco plc Group Statement of cash flow 1.5.4

2015 Tesco plc reconciliation of profit before tax to cash generated from operations

1.5.5

2015 Tesco plc statement of changes in equity 1.5.6 2015 Tesco plc Note 31 Business combinations and acquisitions 1.5.7

TECHNICAL ARTICLES

None about statement of cash flows but the annotated article about measurement is

relevant.

IAS 8 Accounting

policies, changes in

accounting estimates

and errors

(Also, relevant to G.1

The creation of

suitable accounting

policies)

1,

a,

b,

2,

3,4

Fundamental to financial reporting are accounting policies – the key subject of this standard. The standard provides a hierarchy of accounting guidance for selecting

accounting policies in accordance with IFRS. The accounting policy sets the basis for

measuring the amounts (carrying values) at which the elements of financial reporting

(income, expenses, assets, liabilities and equity) are carried (reported) in the financial

statements. The adoption of a new accounting policy is not a change in accounting

policy because there was no policy in existence to be replaced by the new one.

To meet the Conceptual Framework requirement for comparability IAS 8 provides

that a change in accounting policy should be reflected in the financial statements for

all prior periods presented as if the policy had always been applied unless it is

impracticable to do so. Mandatory changes to accounting policies because of the impact of a new IFRS must be accounted for in compliance with applicable

transitional arrangements.

The application of accounting policies may be affected by, or may result in, “errors”.

It is essential to be clear about the standard’s definition of “errors” which can be

paraphrased as: “omissions from”, and “misstatements in”, financial statements that

should not have occurred had the preparers been sufficiently knowledgeable and

diligent. “Errors” range from arithmetical errors through mistakes in applying IFRS

to financial reporting fraud. Errors, as with changes in accounting policies, must be

accounted for retrospectively to remove their effects on prior periods presented and

make the financial statements comparable.

The application of accounting policies requires frequent use of estimates as in the

measurement of income, provisions, expected losses, fair values and depreciation.

WHAT YOU SHOULD EXPECT This standard addresses changes that are prevalent in any accounting system; it

should be expected in every exam.

Therefore revise thoroughly and practise extensively both the computational and discursive aspects which were poorly addressed the last time the standard

was examined (as a “current issue” – December 2013 q4a,b (answer)):

“The question asked for “discussion” and examples and the marking scheme

reflected these requirements. The weighting of the marks was heavily towards

the discursive aspect of the question and many candidates failed to gain these

marks, particularly as regards the examples as very few practical examples were

given. This question demonstrates the difference in knowledge and application

between paper F7 and P2” Examiner’s report December 2013, q4a

It is essential to be clear about the critical requirements for and effects of - change in accounting policy (mandatory, voluntary)

- change in accounting estimates (new information, new development)

- errors (discovery of errors in previous periods) June 2013 q2b & Answer

Address the issues of materiality, judgement and earnings management as these

are appropriately at the forefront of the examiner’s mind:

“Any professional accountant should understand how critical the use of

judgement and materiality are. In selecting an entity’s accounting policies many

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As these estimates are based on assumptions and judgements about the outcomes of

certain variables depending on future conditions and events, there is always an

inherent risk that the estimates would need revising when new information is obtained or when new developments occur. Given that financial statements are

prepared on the basis of conditions prevailing at the end of the reporting period

retrospective restatement of prior periods would not be appropriate. Hence changes

in accounting estimates are accounted for prospectively in the current, and where

appropriate, in future periods.

Understand and apply the requirements of IAS 8 to disclose the future impact of

new IFRS e.g. IFRS 9, 15 and 16. IFRS 16 Leases is particularly important for

entities most significantly affected - operating lessees. It is relevant under the

requirements of IAS 8 for entities to disclose the effect of standards in issue but not

yet effective. Pending full adoption of IFRS 16 an entity that has material operating leases should now (in compliance with IAS 8.30) disclose in the notes to its financial

statements its total obligations under operating leases previously treated as off-

balance sheet finance, together with the amount of leased assets. When the standard

is fully adopted it would involve a major change in accounting policy the financial

effects of which are known and can be estimated reliably.

- Read 2017 Deloitte’s Model financial statements, p43

- Read examples from published financial statements: Balfour Beatty; British

Airways.

CHANGES THAT ARE NOT CHANGES IN ACCOUNTING POLICY

It is essential to be clear about those changes which according to IAS 8 are not changes in accounting policy: the substance over form principle is the guide.

Substance in this case is the determinative nature of the change i.e. whether the

change alone can determine how carrying amounts are measured (the basis of

estimating) e.g. under IFRS 13 “fair value basis” is determinative of “exit price”

whereas a “cost basis” is not, as the latter simply implements a (modified) version of

the former by determining a method for calculating fair values in certain limited

situations? Hence, a change to fair value basis is a change in accounting policy

whereas a change between valuation techniques is a change in accounting estimates.

Examples:

- If an entity changes its valuation technique or approach for measuring fair value (IFRS 13), the change (e.g. from market to cost basis) is accounted for as a

change in accounting estimate and treated on a prospective basis.

- When the entity initially adopts the revaluation model to value noncurrent assets

having previously applied the cost model the change is not a change in

accounting policy under IAS 8. Instead, the change is treated as a change in

accounting estimate and accounted for prospectively in accordance with

IAS 16 and IAS 38. However, applying the above rationale it can be argued that

a change from “cost model” to “revaluation model” is a change in accounting

policy. So why is it not recognized as such by IAS 8? Suggested answer: Current

prices, the basis of the revaluation model, do not necessarily apply to prior

issues arise in practice over the use of extant standards and IAS 8 is no

different. Understanding how a change in accounting policy or an accounting

error is dealt with and the difficulties therein is again fundamental. Similarly, if accountants cannot recognise the potential earnings management issues in this

context, then there is a major issue for the profession.” Examiner’s report

December 2013, q4a

Examined as q4a &b (answer) in December 2013 . As the above extract

suggests the examiner was not happy. Usually when the examiner is not happy

with candidates’ answers to questions on critical areas such as this one he re-

examines that area again, sometimes in the next diet. As expected this area has

since been examined

- Dec 2016 q1b, c: proposed accounting policy change to recognise all pension gains and losses in other comprehensive income for consistency

- Jun 2016

- Dec 2015 q1b, c:

However, this key area has not been examined at question 4 since December

2013; you should therefore be prepared for another similar question for the

June 2018 exams as the big topical issues of judgement and risk of earnings

management are increasing in importance.

Also, expect questions involving

- Retrospective restatement,

- Application of the IAS 8 hierarchy as in a deemed disposal of a controlling interest in a subsidiary, June 2010 q2c (answer)

- Retrospective adjustment of contingent consideration recognised at the

acquisition date in the previous period.

- Adjustment of current tax in respect of prior period December 2012 q2d &

ans. Study the answer carefully and practise answering this question.

HOW YOU SHOULD PREPARE Practise extensively with discursive and computational aspects of

- Examples of changes in accounting policies

- How to account for a change in accounting policy including its effect on

retained earnings.

- How to distinguish between changes in accounting policy and changes in

accounting estimates

- How to account for changes in accounting estimates - Correction of errors

- What determines different accounting policies for groups and their

constituents (e.g. subsidiaries) and what are the effects of such differences

on their respective users?

- Disclosure requirements

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periods. A change in accounting policy would mean restating prior periods to

incorporate current asset prices, which is clearly not valid. Using asset prices

prevailing in prior periods would not be valid either, as using those outdated prices would be in contravention of IFRS 13 “exit prices” which reflect “current

market conditions” at the “measurement date”. Thus, as far as revaluation is

concerned it is not feasible to go back in time. The apparent inconsistency within

IAS 8 has a basis in the conceptual framework in that as retrospective

restatement of asset values would not produce relevant information for users (in

this case) it is precluded. This is an example of why theory (and a conceptual

framework) is required to inform practice. In this case the requirement of

“relevance” (an essential characteristic of the conceptual framework) has

overridden the internal logic of a standard (IAS 8) resulting in a desirable

outcome (precluding the production of useless information while safeguarding

best practice in financial reporting).

- A change in the depreciation method e.g. from straight line to reducing balance

is not a change in accounting policy. However, a change to component

depreciation is a change in accounting policy as it affects the basis for (separate

components) determining depreciation amounts. This change must be accounted

for retrospectively; where this is not practical prospective application must be

done from the earliest period.

- A change in the use of an asset e.g. from PPE to investment property implies a

change in the way that re-measurement gains and losses are accounted for. This

change is accounted for prospectively because the business model for the asset

has changed. Restating previous year’s amounts to reflect investment property would be inconsistent as the asset was managed under a different business

model.

- Reclassification of a noncurrent asset as current e.g. when a fleet of vehicles is

regularly replaced and the existing fleet is classified as a current asset prior to

being sold.

Apply IAS 8 hierarchical guidance in determining accounting treatment of items for

which an accounting standard does not exist. See P2 terms and techniques.

Read Study text

Question for practice Prospective application of a change in accounting policy when retrospective application is not practicable

IAS 10 Events after

the reporting period

1a,

b,

c,

2,4

- This standard is frequently examined in connection with transactions accounted

for using another standard; it requires events after the reporting period to be

considered to determine if there are grounds for reflecting their effects in the

financial statements for the period that has ended.

- The authorization date is the date the financial statements are considered to be

legally authorized for issuance to the public. This date marks the cut-off point

up to which events after the reporting period are to be assessed against IAS 10

criteria to determine if they are adjusting or non-adjusting.

Exam technique for IAS 10 Events after the reporting period.

Keep in mind the premise of IAS 10 is that financial statements are prepared

based on conditions existing at the reporting date.

- Justify your treatment (to adjust or not to adjust) by reference to this

overarching condition.

Keep in mind the authorization date being the cut-off point:

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- Adjusting events must be reflected in the financial statements by raising journal

entries to record their effects and alter the financial statements. This is because

these events provide evidence of conditions existing at the balance sheet (or

reporting date - IAS 10 criterion). An example is a customer that is declared

bankrupt after the reporting period but before the authorization date.

- Non-adjusting events are reflected only by way of a note to the financial

statements; they remain the same in terms of the numbers. This is because non-

adjusting events do not provide evidence of conditions existing at the balance

sheet date. An example is the loss of a building by force majeure after the

reporting period but before the authorization date. Even though the building has

been lost its carrying value at the reporting date will remain in the financial

statements. However, a note will be inserted to inform users about the loss and

its consequences.

- It is essential to identify secondary adjustments - associated adjustments that must be made as a result of the primary adjusting journal entries. For example, if

an impairment is recognised there must also be a deferred tax adjustment as

the tax base now exceeds the carrying value of the asset resulting in a deductible

temporary difference.

- Events after this date are out of scope and cannot be considered for IAS 10

treatment.

- A notable example of an out of scope event is the approval of the declared

final dividend at the shareholders annual general meeting (agm) which

occurs after the authorization date. The financial statements are not altered

to include the amount of the dividend approved based on the profits for the

reporting period.

- Instead, the dividend is treated as a transaction of the period in which it is

approved.

- When the dividend is initially declared by the management (board) an

obligation does not arise under IAS 37 as management does not have the

authority to commit the company irrevocably to pay dividends. Hence the

dividend is not a financial instrument until it is approved by the

shareholders. - Note also that a constructive obligation does not arise from established

past practice of paying dividends. So if directors declare an interim

dividend and it remains unpaid at the end of the reporting period no

liability is recognised.

In this type of question you should be able to score full marks just by being

methodical. Practise with at least three examples of each of adjusting and non-

adjusting events. Make sure you use the dates and give reasons.

Past questions for practice

- September 2016 q1b (answer): restructuring ceased after the “reporting

date” due to cost pressures. Assess the accounting implications on current and future financial statements. Interacts with IAS 37: reassess the

restructuring provision.

- Dec 2015 q3c (answer)

-

IAS 12 Income taxes 1,2

,3 - A key standard that is involved in every transaction including revaluation,

impairment, business combinations and share-based payments. Therefore

examined in every diet. - Practise all the questions that have been examined.

Questions for further practice

- Mar 2016

- Dec 2015 - Sep 2015 q3b & answer: accounting treatment of deferred tax recognised

on the back of unreliable evidence of future stream of profits. Does it

work?

- Jun 2015

- Jun 2014 q2b & answer

- Dec 2012 q2d & answer

- Jun 2012 q3aiii & answer

- Dec 2010 q1a & answer

- Jun 2010 q2a & answer

IAS 16 Property, Plant

and Equipment

1a,

2,3 This is a key standard: examined frequently because of the importance of

noncurrent operating assets as a key factor of production in the business. The key

issues examined:

WHAT YOU SHOULD EXPECT

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- Initial recognition basis including decommissioning and other incidental costs

IAS 16.11

- Materiality considerations and the need to exercise judgement over the

recognition or otherwise of such items as spare parts, servicing equipment and

standby equipment. IAS 16.8, IAS 16.9.

- Initial recognition of acquired and self-constructed assets including the

capitalisation of all directly attributable expenditure, assessment of residual

value, commencement of depreciation.

- The determination of the capitalised cost, including borrowing costs capitalised

under IAS 23 Borrowing costs; admin costs; deferred payment terms; revenue

generated prior to, during and after construction or development of the asset. Make sure you can account for these correctly.

- The need to retain the asset for more than one year has specific accounting

implications that are frequently examined including depreciation, revaluation,

changes in residual value, useful life, depreciation method and enhancement

costs (component accounting). These can cause interaction with other standards

including IAS 36, IAS 37 (e.g. provision for decommissioning costs) and IFRS 5

(disposal group). Refer to See the maths of IAS 16 and the calculations of other

standards.

- Assets may be exchanged, transferred or reclassified. Gains and losses may arise

as a result. Recognition in profit or loss and OCI; reclassification of deferred gain from equity on de-recognition as PPE upon reclassification to investment

property.

- Be prepared to explain why expenditure on mandatory safety and

environmental items may be classified as PPE e.g. because they enable other

associated assets to become fully operational thereby enhancing the extraction of

economic benefits from those assets. However, the resulting carrying amount of

such an asset and related assets is reviewed for impairment in accordance IAS

36. IAS 16.11

KEY CHANGES IN ESTIMATES

IFRIC 1 addresses how changes in estimates of decommissioning and similar

liabilities DURING THE LIFE OF AN ASSET (Expected useful life, EUL)

should be accounted for. Such changes may arise from

- A change in the estimated outflow of resources embodying economic benefits

required to settle the obligation

- A change in the current market-based discount rate (due to changes in the risks

specific to the liability and the time value of money)

- An increase that reflects the passage of time (unwinding of the discount)

ASSETS AT COST

You should expect this area to be tested at the discursive cognitive level –

requiring critical thinking to go beyond the obvious in applying principles to

discern, measure, present and disclose PPE in various situations including agricultural land and bearer plants. Be prepared to explain your reasoning

using relevant criteria and judgement of the circumstances. For example,

- Explain the basic criteria for recognising PPE including bearer plants (but

not produce obtained from them).

- Discuss how an entity chooses between the cost model and the revaluation

model, IAS 16, para 29 to measure PPE after recognition. What contextual

factors determine the needs fulfilled by the entity’s chosen model, and what

are the measurement and accounting implications of the choice?

- Explain the criteria that determine which costs are capitalised at initial

recognition? How do these criteria explain what costs are charged as

expenses? - When is PPE recognised because a provision is recognised? What type of

provisions are eligible? Example: decommissioning provision. See IAS 37

Calculations

- Explain how changes in the discount rate and expenditure estimates impact

decommissioning costs. See IAS 37 Calculations.

- When should borrowing costs be recognised as part of PPE?

- When is an inventory type item recognised as PPE e.g. spare parts,

inventory required permanently to operate a refinery? Unique parts that

can only be used in an item of PPE.

- How should expenditure on major overhaul be treated?

- How should expenditure on major inspections for faults be treated? IAS

16.14

Therefore, you need to be clear about the recognition and measurement

principles in the Conceptual Framework (and amplified in IAS 16. 11, 15-20).

You should expect questions about assets related to agricultural activity. Even

though these are used for agriculture they are nevertheless accounted for as PPE

in the normal way because they are part of the infrastructure in place to produce

goods and services. Examples:

- Bearer plants

- Agricultural land and buildings

- Access roads - Vehicles

Bearer plants (biological assets) may be accounted for under the cost model or

revaluation model. However, the produce growing on the plants may still be

measured on fair value basis and accounted for under IAS 41.

You should expect questions about biological assets where there is an absence

of management of biological transformation because the assets have already

reached maturity and are in a location and condition in which they are capable

of operating in the manner intended by management. Therefore, even though

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Increase in liabilities According to IFRIC 1 if the related asset is measured using the cost model changes in

the liability shall be added to or deducted from the cost of the related asset in the

current period. However, the amount deducted from the cost of the asset shall not

exceed its carrying amount. If a decrease in the liability exceeds the carrying amount of the asset, the excess is recognised immediately in profit or loss. IFRIC 1.5

DR Asset

CR Liability

Impairment may result from increase in carrying value

An increase in the carrying amount of the asset in this circumstance may indicate that

the asset is impaired; a qualitative assessment should be done to determine if this is

the case. If it is, then a quantitative assessment should be carried out in accordance

with IAS 36. Any impairment loss should then be written off immediately in

accordance with IAS 36.

Decrease in liability DR Liability

CR Asset (up to the limit of carrying value)

CR Profit or loss (excess of the decrease over the carrying value)

EFFECT ON DEPRECIATION

The adjusted depreciable amount (including the adjustment for the increase in

liabilities) is depreciated over the assets adjusted EUL in accordance with the chosen

policy.

CHANGES IN ESTIMATES AFTER THE END OF THE EUL

Changes after the end of the EUL are charged to profit or loss as there is no further basis for deferral (or capitalisation).

DEPRECIATION CANNOT RESULT IN A NEGATIVE ASSET

ASSETS AT VALUATION

Issues to consider:

THE REVALUATION SURPLUS CANNOT EXCEED THE VALUE OF THE

ASSET

According to IFRIC 1 if the related asset is measured using the revaluation model

changes in the liability alter the revaluation surplus or deficit previously recognised

on that asset. IFRIC 6 (a).

Increase in liabilities

these are biological assets they are accounted for as separate components of

PPE. Examples:

- Animals in a game park for tourism - Animals in a zoo for recreation

You should expect questions about land where agricultural use is temporary or

incidental. You may be required to discuss how the land should be accounted

for initially, or over a period of time. Initial recognition and subsequent

reclassification to inventory, investment property and non-current asset held for

sale should only be made at the time that the relevant criteria governing

transfers are complied with. Examples:

- Land held for ultimate sale (initially recognised as PPE but reclassified as

held for sale when IFRS 5 criteria are met)

- Land held for construction of property for rental (initially recognised as PPE but subsequently reclassified as IAS 40 investment property)

DEPRECIATION

- When is depreciation chargeable?

- How should depreciation on revalued assets be accounted for?

- The impact of overhaul expenditure

- Depreciation on components

- Depreciation method changes (interacts with IAS 8)

REVALUATION

See Maths of IAS 16

- Measurement of revalued amount - Depreciation after revaluation

- Impairment of assets following revaluation.

- Interaction of depreciation, revaluation and impairment loss

- Deferred tax effects of revaluation

You should expect questions that bring depreciation, revaluation and

impairment together to assess candidates’ ability to prioritise the interaction of

these measures and to account correctly on that basis. An example is June 2012

q1aiv) (answer).

RESIDUAL VALUES See Maths of IAS 16

- Definition of residual value

- The calculation of residual value

- The role of residual value in determining depreciation amount

USEFUL LIVES

- The basis of estimating EUL

- Impact on depreciation when the residual value is reduced, EUL is

extended due to effective asset maintenance.

EXCHANGE OF ASSETS (NON-MONETARY)

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HOW DOES THE CHANGE INTERACT WITH A SURPLUS ON THE

REVALUATION ACCOUNT?

DR Profit or loss (an increase in a liability or a decrease in an asset is an expense

charged in profit or loss unless offset by a surplus on revaluation.) IFRIC 6 (a).

DR OCI (if there is a revaluation surplus on the asset: present in OCI to reduce

surplus in revaluation account at the end of the year.)

CR Liabilities (to reflect the increase in whole)

So, unlike the cost basis the carrying value of the asset is unaffected by the increase

in the liability.

Rationale: the revaluation basis implies that the asset is already stated at current

values and therefore, changes in the carrying amounts of related liabilities are

immaterial to its measurement. This is supported by IFRIC 1, para 6

Decrease in liability CAN THE CREDIT (reduction in the LIABILITY) REVERSE A PREVIOUS

REVALUATION LOSS?

Yes.

DR Liability (to reflect the reduction in whole)

CR Profit or loss (to reverse previous revaluation loss)

CR OCI (income is increase in asset or decrease in liability; but this income is

deferred in equity not being realized – backed by the immediate receipt of cash, or

the expectation of receipt of cash in the future, from a transaction.) Thus, existing

revaluation surplus is increased by the excess of the decrease in liability over the

amount credited to profit or loss to reverse a previous revaluation loss.

CHANGES IN ESTIMATES AFTER THE END OF THE UL

Changes after the end of the UL are charged to profit or loss as there is no further

basis for deferral.

Capitalise & depreciate

- Obligations arising from new legislation

- Not error as legislation has introduced “new information and development” that

did not exist previously.

- Not change in accounting policy as not previously accounted for as the condition

did not exist.

Allocate to products

The entity exchanges an asset (the asset given up) with another asset (the asset

acquired) from another entity with or without a cash settle-up (or boot) to

equalise the difference in exchange values. The essential condition is that the exchange has commercial substance – as a result of the exchange the timing,

amount and riskiness of the entity’s cash flows changed significantly from what

would have been expected without it.

Where the exchange has commercial substance, the asset acquired in the

exchange is accounted for at fair value; the carrying amount of the asset given

up is derecognised and a gain or loss is recognised in income immediately. This

is in contrast to a sale-and-leaseback where the gain is amortised over the

leaseback period. The difference in treatment is due to the fact that in this case

the entity relinquishes control over the asset exchanged; in the case of leaseback

the entity retains control over the asset.

Compared with IFRS 15

Note that whereas the exchange of PPE is accounted for under IAS 16, the gain

or loss being recognised as income (excluded from revenue), the exchange of

goods and services is accounted for under IFRS 15 (previously IAS 18) as

revenue. Note also that IAS 16 gives no indication regarding the classification

of the gain or loss other than that it is an operating item.

DERECOGNITION When the item is sold or when economic benefits cease to flow to the entity from the item

- Asset cost/value and related accumulated depreciation eliminated

- Proceeds of sale (and gains) are excluded from revenue (IFRS 15) except

for assets routinely sold (e.g. assets held for rental to others) at the end of

their UL and replaced in a planned obsolescence scheme. BC35C: “this

would better reflect the ordinary activities of such entities” than “ a net gain

or loss on the sale of the assets…”. IFRS 5 should not be applied in those circumstances.

- Revaluation surplus (if applicable) transferred to Retained earnings (direct

to equity)

- Gain/loss on disposal recognised in profit or loss.

HELD FOR SALE

- Held-for-sale classification (IFRS 5) principle

- Measurement basis if carrying value principally recovered through sale

rather than through continuing use.

TRANSFERS - Nonreciprocal transfers: recognize the transfer at fair value and recognize a

gain or loss. An example is the distribution of property as dividend.

Another example is the donation of PPE to a charity.

- Transfers of PPE (or cash to buy PPE) from customers (IFRIC 18) – this is

not a government grant (IAS 20) as the transferor is not a government; it is

not infrastructure used in service concession arrangement (IFRIC 12). Such

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- Costs (e.g. compensation) incurred as a result of damage to 3rd parties

Expense

- Cost of wear and tear: e.g. obligations to repair leased property; this may be

expensed or allocated to product costs but not capitalised as the cost does not

generate or enhance resources needed for production or distribution.

- Onerous contract: IAS 37 measured obligation (lower of: exit costs and

fulfilment costs). Exit costs: penalties, etc. Fulfilment costs: whatever it takes to

satisfy the obligations to the customer, leaseholder, etc.

FURTHER READING

ACCA Technical article

IAS Plus Deloitte IAS 16 Summary

Terms to learn

- Bearer plant IAS 16.6

- Carrying amount IAS 16.25

- Change in an accounting estimate

- Commercial substance IAS 16.24,25

- Compensation for impairment

- Cost

- Cost model

- Depreciation - Depreciable amount

- Elements of cost IAS 16.16

- Entity specific value

- Fair value

- Impairment loss

- Initial costs IAS 16.11

- Measurement at recognition

- Measurement of cost

- Recognition

- Recoverable amount

- Residual value - Revaluation model

- Subsequent costs

- Useful life

assets are received by the entity for the purpose of i) connecting the

customer to a network; ii) providing goods and services.

Initial recognition

DR Asset (at fair value if an “asset” according to CF definition) (IAS 16)

CR Obligations to customer (IAS 37)

Discharge obligations over a period of time:

DR Obligations (IFRS 9)

CR Revenue (IFRS 15)

DISCLOSURES

- What is the objective of disclosure? To provide information that enables users to evaluate the impact of PPE on financial performance, financial

position and cash flow. Be prepared to discuss what the elements of

depreciation, cost, lease obligations and capital commitment contribute

separately and in combination.

- Does the standard achieve its objectives? Discuss to what extent

disclosures of accounting policies and notes about PPE enable

understanding, comparison and decision-usefulness. Highlight limitations

in the information disclosed e.g. boiler plate approach restricts insights into

commercial, strategic and sustainability priorities; historical as opposed to

fair values; failure to reflect changes due to technological and other

advances; failure to explain the basis for decisions to invest in additions to

PPE e.g. whether driven by the need to renew or expand. See VW Key

figures and the Conceptual Framework Business activities (p19), paras

2.35.

Past questions for practice

- Mar 2018 q2b (answer): evaluate the impact on depreciation of a proposed

extension to the useful life of leased vehicles and non-depreciation of

unleased vehicles.

- Dec 2017 q1a.6 (answer): revaluation gains and deferred tax

- March 2017 q2a: transfer of PPE (IAS 16) to Investment property (IAS 40) at fair value. (Part of March/June question, answer)

- March 2017 q4bi (answer): penalty payment received for the late delivery

of an asset acquired is a reduction of the cost of the asset; however,

reimbursement for costs incurred due to failure to deliver purchased asset is

an expense as the additional cost does not enhance the capacity of the asset,

nor is it necessarily incurred in getting the asset to its location and

condition for intended use. Materiality need not be invoked.

- Dec 2016 q1a.5 (answer)

- Sep 2016

- Jun 2016

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- Mar 2016 q3a (answer): treatment of costs incurred on the acquisition of a

new business

- Dec 2015 q3a (answer): gas required permanently as part of plant is PPE (not inventory);

- Dec 2015 q3c (answer): cost of overhauling a refinery is PPE

- Sep 2015 q2a: components; change in depreciation method; impairment of

CGUs (onerous contracts) IAS 36 & IAS 37 interaction

- June 2015

- Dec 2014 q3b & answer Component accounting

- Jun 2014 q3a & answer

- Jun 2014 q3d & answer

- Jun 2014 q1a.6 & answer

- Jun 2013 q2d & answer

- Dec 2012 q3a & answer - Jun 2012 q1a.6 & answer: sale of PPE with option to buy-back in an

arrangement that is ethically questionable.

- Jun 2012 q1a.4 & answer: depreciation, revaluation and impairment

(“direct to income” and “direct to equity” – transfer of additional

depreciation on revalued PPE from revaluation surplus to retained earnings)

- Dec 2011 q1a.5 & answer

- June 2011 q1a.3 (answer)

- Jun 2011 q2a & answer

- Dec 2010 q1a.vi & answer

IAS 19 Employee

benefits

1a,

2 A key standard frequently examined due to the importance of employee costs - a

major factor of production and significant in determining operating profit (a key

managerial performance measure). As this standard has been long established the

examiner’s overall assessment objectives are well known.

Overall assessment objectives

These are distilled from a close examination of the assessment objectives since the standard was revised in June 2011. However, these objectives must be reviewed in

the light of changes or improvements in financial reporting practice. As can be seen

in (December 2016 q1b) the treatment of pension gains and losses has been

examined in the context of the conceptual framework’s fundamental characteristics

of faithful representation and relevance. Critical thinking is being assessed – the

ability to evaluate reporting practice using approved criteria. This is anticipated in the

Exam guidance for B.1 Conceptual Framework and B.2 Critical evaluation of

reporting practice above.

The examiner is looking for evidence of the learning outcomes around:

- Conceptual understanding: definition of terms; explanation of the accounting for

charges, gains and losses: SOCI, SOCE, SOCF, SOFP for DfdC and DfdB schemes.

- Funded and unfunded

Suggested exam practice approach

Start with June 2013 q1a.7 to get comprehensive practice with the calculations.

Then attempt June 2012 q2b. Attempt all past questions. Only use the linked

study text if you need more information about the learning outcomes.

Further practice questions

- December 2017 q1a.7 (answer): accounting for defined benefit pension current service cost and remeasurement.

- June 2017 q1a.6 (answer): curtailment and settlement resulting from

closure of a division

- December 2016 q1a.6 (answer): finance cost, re-measurement gains,

current service cost, discount rate.

- December 2016 q1b (answer): the impact of pension gains and losses on

performance measurement for the period. Justify the presentation of re-

measurement gains and losses in OCI and then in retained earnings. Can

deferral in equity be justified? Evaluate the soundness of the practice:

how does it meet the conceptual framework characteristics?

- December 2016 q1c (answer): discuss ethical and financial reporting

implications of a proposed change in accounting policy to report all defined benefit pension scheme gains and losses in other comprehensive income

(OCI).

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- Short-term and long-term benefits

- Vested and unvested benefits

- Current period service cost; scheme changes (past service cost, curtailments, settlements).

- Deferred tax asset on outstanding obligations if tax relief is only obtained on

actual contributions to the scheme;

- Deferred tax liabilities on actuarial gains - reported in OCI

- Presentation of pension expense in profit or loss: finance charge in finance cost

(funded schemes); other charges (current service cost and scheme changes) in

operating cost (administration cost)

- Presentation of actuarial gains and losses in other comprehensive income - OCI

- Discount rate: good quality corporate bond (in deep market) or government

bond.

- Plan assets and liabilities - Calculation of finance cost/credit on net asset or obligation

- Calculation of pension obligations and finance cost – projected unit credit

method

- Discussion of ethical and financial reporting consequences of proposed or

adopted practice

- Business combinations

- Involving allocation of gains and losses; service cost (past and current).

- Leave pay and bonus

- Injury compensation and insurance

The study text: Employee benefits addresses the salient features.

The common mistakes are also well known

Read the examiner’s reports and address common mistakes.

Examples:

“Candidates seemed to be able to show a statement reconciling the opening and

closing liability for the defined benefit scheme but then found the detailed

accounting problematical. Also, candidates often calculated the net interest cost on

the defined benefit liability using the closing instead of opening rate of interest.”

Examiner’s report, December 2015.

Technical article

There is no published technical article on the ACCA website. The requirements are

quite straightforward. If you practise the past questions under timed conditions (not

more than 1.5 minute/mark) you should be ready to score full marks.

- September 2016 NOT EXAMINED

- June 2016 q1a.iv) (answer): deferred tax on pension obligations; deferred

tax on actuarial gains; deferred tax in the calculation of the tax charge.

Calculation of amount of tax paid. SOCF adjustments for non-cash and

cash items.

- March 2016 NOT EXAMINED

- December 2015 q1a.5 (answer): purchase of an overseas subsidiary

with defined benefit pension scheme; actuarial loss, curtailment, finance

cost, current service cost.

- September 2015 q2c defined pension benefits v defined contribution.

Distinguishing features and implications for accounting, financial reporting

and disclosures. Application of knowledge to appraise key factors such as

risks.

- June 2015 q1a.4 & answer: effect of restructuring on defined benefit and

defined contribution plans; accounting for curtailment, settlement and past

service cost. Interaction with IAS 37 – constructive obligation as

implementation underway at the reporting date. Elimination of pension

obligations.

- December 2014 NOT EXAMINED

- June 2014 q1a.5 (answer): measurement and accounting for finance cost of

funded scheme, current and past service cost and re-measurement loss.

- December 2013 q1a.iii (answer): IAS 7 adjustment for non-cash current

service cost of defined benefit pension obligation (funded scheme).

- June 2013 q1a.7 & answer: comprehensive pension plan calculations

including separate re-measurements for plan assets and liabilities, net

asset/obligation presented in SOFP.

- December 2012 NOT EXAMINED

- June 2012 q2b & answer: financial accounting, measurement and

presentation of current period service cost and scheme changes of a

funded scheme.

- June 2011 q1a & answer: long-term bonus scheme

- June 2010 q1a.7 & answer: accrued leave pay

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IAS 20 Accounting

for Government grants

and Disclosure of

Government

Assistance

1a,

2 Transfer of resources (monetary and nonmonetary e.g. technical assistance and

advisory services) from the government (including agencies such as European Union,

local authorities, etc.) to an entity with conditions (about delivery to stakeholders and completion dates) attached. This raises questions of recognition (IFRS 15 is not

relevant as the grant is not income received as consideration for services rendered),

classification (revenue or capital), presentation in SOFP & SOCI, disclosures,

contingencies (if conditions are breached), cash flow presentations (operating or

financing IAS 7; no cash flow implications for nonmonetary grants such as the grant

of a building or land).

Contract income is recognised by applying the principles of IFRS 15. A government

can be the source of both contract income and grant income (revenue and capital).

Unlike grant income contract income is revenue – consideration received in exchange

for delivering goods and services to the government under contract.

There is also the possibility of interaction with IAS 10 when the grant is awarded

after the end of the reporting period but the eligibility conditions were satisfied

during the reporting period. This would be the case where the grant is awarded as

compensation for expenses and losses already incurred by the end of the reporting

period.

Be able to apply the conceptual framework principles e.g. accrual to the treatment of

grants received as subsidy for costs incurred and for acquisition of assets. The basic

principle is that the period that bears the cost of fulfilling the conditions and

requirements of the grant must be allocated a fair portion of the grant. This applies

equally to revenue and capital grants (that finance depreciable and non-depreciable assets). State this principle in your answer: it will earn you marks and set you

thinking clearly about the scenario.

Be prepared also for a “current issues” question where Research and development

expenditure credit (RDEC) (a current issue) may trigger IAS 8 prior year

adjustment to correct a classification error made when the entity treated RDEC

received under election (during the transition period for RDEC: 1 April 2013 to 31

March 2016) as a tax credit instead of as a grant to be matched against specific R&D

expenditure.

Repayment of grants is treated as prospective adjustment because it does not constitute an error, and it is not a change in accounting policy.

Standards involved: these must be applied in priority order. The priority is dictated

by the logic of the financial reporting process and the degree of relative importance

of the particular issues addressed by the standard within the reporting process:

recognition, measurement, presentation, disclosure.

- IAS 8

- IAS 10

- IAS 20

- IAS 38

- IAS 41

The questions are usually of a discursive nature requiring the application of

principles of IAS 20. However, computations may also be required but these

tend to be straightforward.

Read the case details very carefully especially the conditions for the grants and

the dates on which the entity becomes eligible for the grant. Apply basic

principles with logical method.

Know your IAS 1 formats: i) where should revenue and capital grants be

presented in the SOCI, SOCF, SOFP; ii) where should capital expenditure be

presented in the SOCF, SOFP?

When a case study requires multiple IFRS it is essential that you assess how

each IFRS applies in priority order. An example is Dec 2012 q2a & answer

Questions for practice

- Dec 2013 q1a.1 & answer & Examiner’s report

- Jun 2013 q2d & answer

- Dec 2012 q2a & answer

- Jun 2008 q2biii & answer: capital grant subject to repayment condition.

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- IFRS 9 e.g. below market interest loan by the government

The examiner frequently sets case study that requires application of multiple IFRS involving critical and divergent thinking. The opportunity for this exists in this area.

IAS 21 The effects of

changes in foreign

exchange rates

1a

1b

2,3

4

WHAT IS IT FOR? Why is it needed?

To express an entity’s activities denominated or settled in a foreign currency in terms

of another, more relevant currency and faithfully represent those activities. How is

relevance determined? According to the conceptual framework, control is a key

criterion of relevance because faithful representation means reflecting the economic

substance of those transactions and entities under the control of the reporting entity.

For example, the reporting currency of the owner of a controlling interest in a foreign

operation is relevant for reporting its consolidated results, cash flows and financial position. Moreover, combining the results, cash flows and financial positions of

different entities requires the same units of money.

What does it apply to?

- Transactions of an entity denominated or settled in a foreign currency

- Financial statements of a foreign operation (branch, associate, subsidiary)

- Results of the reporting entity in a presentation currency

WHAT YOU SHOULD LEARN Understanding key issues, concepts, principles and methods

The key issues

- Which foreign currency?

- Which exchange rates for various transactions, conditions and other events?

- How should the effects of changes in foreign exchange rates be accounted for,

presented and disclosed in the financial statements of the parent, individual

foreign operation and the group?

- How do the conceptual framework’s characteristics affect these transactions,

events and conditions?

The concepts: as listed on IAS 21.8 including net investment, monetary and non-

monetary items and the issues raised. Relate the concepts to the issues and principles.

The principles:

- Functional currency

- Translation

- Accounting for gains and losses

The methods

- Translation IAS 21.17.

HOW YOU WILL BE ASSESSED

Assessment criteria and critical learning skill guide Criteria Active (open mindset) Passive (closed mindset)

Conceptual

framework

underpinnings of IAS

21

Understands and can apply conceptual framework

principles to evaluate the principles-based practices

of IAS 21. Understands the user-needs

approach to standard setting and can evaluate how IAS 21 meets user information needs for stewardship and decision-

making.

Unable to discern and interpret the link between

the IFRS application principles and the Conceptual framework principles. Thus when asked to explain the candidate describes and gives shallow and limited range answers.

Objective, scope,

exclusions, exceptions

Thinks holistically and considers the standard’s application requirements and effects from many sides as a result of deep processing.

Creates conceptual links to establish coherence and develop insightful understanding of how the standard works in relation to other standards. For example, can explain

why “IAS 21 does not permit use of the exchange rate at the end of the reporting period (closing rate) when translating the cash flows of a foreign subsidiary.” IAS 7.27

And can also explain why IAS 21 does not apply to hedge accounting for foreign currency items, including the hedging of a

The candidate’s basic understanding of the standard’s reach and complexities reflects a limited approach to studying the standard.

Accepting without asking (how, why, what-if, why-not) characterises a passive approach to learning that is not appropriate at this level. This weakness can be

explained by problems with the transition from F7 to P2 - a lack of explicit focus on the advanced knowledge and critical thinking skill requirements of intellectual level 3

(synthesis and evaluation).

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Initial recognition, accounting for exchange differences and reporting at the ends of

subsequent reporting periods:

- Assets: acquired, sold, impaired - Debt: settled, unsettled

- Net investment

- Acquisition

- Disposal of a foreign operation

Interactions with other standards

- IFRS 2 IAS 21.16: right or obligation to receive or deliver a fixed or variable

number of the entity’s own equity instruments…

- IAS 8 IAS 21.35: change in functional currency

- IAS 16 IAS 21.24-25

- IAS 19 - IAS 28 dividends from associates

- IAS 37 e.g. provisions to be settled in cash

- IFRS 9 financial liabilities

- IFRS 16 lease liabilities

- IFRS 15 accounts receivable

Accounting for gains and losses

The disclosure requirements

Critical thinking skills:

- Concept checks: exploring the links between IAS 21 application concepts, principles and methods and the Conceptual Framework.

- Think logically and analyse the context of foreign transactions, conditions and

other events.

- Thinking with principles

- Thinking holistically

- Appraising user needs: accountability, stewardship,

- Exercise judgement

HOW YOU SHOULD LEARN Learning to score – the critical approach

Clarify the objectives of financial reporting CF 7.2, 7.16-7.25 and determine how

they are met by the objectives of IAS 21 for: functional currency, translation,

consolidation or equity accounting. Cite Conceptual framework principles and

guidance.

Clarify the issues and the concepts, principles and methods developed to deal with

them.

net investment in a foreign

operation.

Definitions and ability

to think with concepts

The candidate understands the importance of concepts

to the mastery of IFRS and has developed deep

conceptual understanding of IAS 21 which enables him to generate fluent and full answers that call for higher order thinking skills appropriate to professional

exams. For example, the candidate’s understanding of monetary and non-monetary items enables him to determine the appropriate translation

basis (temporal, closing or average) and to apply suitable exchange rates to transactions, balances and financial statements. His understanding of the requirements of accrual, prudence and capital

maintenance in determining financial performance enables him to account correctly for exchange differences between profit or loss (actual or committed cash flow at the reporting date) and other

comprehensive income (no immediate cash flow commitment at the reporting date).

Because the candidate simply memorises the

concepts as defined without thinking about what they mean and how they apply in context, their knowledge of concepts is at best inert. In an exam that requires

application of knowledge to an unfamiliar scenario the candidate’s inability to apply inert knowledge to a practical situation is a major handicap.

Functional currency Apply criteria to determine

appropriate functional

currency. Skills tested:

analysis, application of

principles and reasoning

quality. Making inferences.

Active learning and critical thinking enable this

candidate to grasp the core

issues in the scenario and apply knowledge of IAS 21 concepts and principles to determine the appropriate functional currency.

The lack of critical thinking and inert

knowledge of concepts means that the candidate is unable to undertake critical analysis of context to determine the appropriate functional currency.

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Critically appraise the criteria (what makes these criteria suitable for financial

accounting and reporting of the activities of a foreign operation?) for determining

the functional currency.

FUNCTIONAL CURRENCY

Why does IAS 21 require each entity to determine its functional currency?

IAS 21 defines a foreign currency as a currency other than the functional currency.

Therefore, it is critical to determine the functional currency in order to identify

foreign currency transactions. There may be several functional currencies in a group.

Critical thinking about the criteria that determine the functional currency?

The primary factors IAS 21.9

The currency that mainly influences

i) Sales prices for its goods and services? How does the currency in the primary economic environment predominantly influence prices? Through

market forces: domestic currency movements primarily influence consumer

buying decisions and supplier decisions to make, buy and sell. For example,

a strong domestic currency boosts consumption, imports and production,

pushing up prices of goods and inputs (labour, material and other inputs)

required to produce goods and services.

ii) Similarly, through market forces (demand and supply) competition regulates

prices to equilibrium levels in various market segments.

iii) Prices of goods and inputs are also regulated by institutions charged with

ensuring public goods such as education, water, electricity are affordable.

Additional (secondary indicators) indicators IAS 21.10

iv) Raising finance is crucial to investing and operating activities. Hence the

currency in which the entity’s financing activities are conducted is

indicative of its functional currency.

v) The currency in which the entity retains its receipts from operating activities

is indicative of the currency in which it is able to function, as receipts form

part of working capital that supports baseline operations as well as

additional investment or growth activities.

Further indicators to be considered where the above primary factors are

not clear cut evidence of the functional currency IAS 21.11

vi) Degree of autonomy: no functional currency if simply acting as agent

selling and collecting cash for remittance to reporting entity. Functional

currency in which cash is accumulated and expended for operating,

investing and financing activities.

vii) Size of operating activities is significant relative to reporting entity

viii) Effect on reporting entity’s cash flows

Candidate relies on rudimentary descriptions and makes very limited reference to the context to justify his assertions that attempt to link the

functional currency to the context.

Presentation currency Critique the use of

presentation currency.

Skills tested: critical

analysis, evaluation and

synthesis. Accounting

argumentation.

Understands the conceptual framework objectives and compliance requirements for presentation of financial statements. CF 7.19-7.25

The student is able to incorporate this knowledge into grounded critical appraisals that result in sound decisions about the presentation currency.

Due to lack of familiarity with the principles of the conceptual framework the candidate is unable to articulate supported

explanations for the chosen presentation currency.

Cash and cash equivalent

Evaluate effects of changes in foreign exchange rates on cash and cash equivalent.

Calculates the effects on closing cash balances of the closing rate. However, the wider implications of the effect on the financial statements are not understood.

Consequently, the student struggles to answer discursive questions about IAS 21’s impact on the measurement of financial performance.

Foreign loans

Net investment -

retranslating

Net investment -

financing

Risk management

Knowledge of monetary

items as part of financing strategy for the acquisition of a foreign asset or operation. Awareness of strategies for mitigating the effects of exchange rate volatility on

financial performance. Being familiar with CF 7.19-7.25 the candidate competently addresses the accounting and presentation requirements of foreign loans.

The student has not

thought about the financing principles and their accounting implications because his learning has been limited to getting familiar with the mechanics of translation.

Such procedural

understanding is not adequate to answer discursive questions because they require in-depth conceptual

understanding and insightful application.

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ix) Self-financing in functional currency without recourse to reporting entity.

The reporting entity is the entity into which the foreign operation reports; the entity

that incorporates its own and other results, financial position and cash flows into

group accounts: associates and joint ventures (equity method), subsidiary

(consolidation), joint operations (proportional consolidation).

Determine how IAS 21 reflects the principles of the conceptual framework in its:

concepts, principles and methods (concept check).

CONCEPT CHECK Explores the link between the IAS 21 concepts and the Conceptual Framework

How does the functional currency reflect the principles of the conceptual framework?

E.g. how does the functional currency faithfully represent transactions, conditions

and other events?

IFRS

Application concepts

Conceptual Framework

link

Drivers of product

and input prices

The currency of the primary

economic environment is paramount because prices of the entity’s products, and inputs that are required to make the products, are predominantly determined in that currency by domestic market forces or regulation or

both.

Because prices are fundamental to

financial performance, transactions denominated or settled in the entity’s functional currency are faithfully represented.

Financing activity Financing activity is a critical component of financial performance because the cost of finance impacts the income statement and the

servicing of finance depends on the cash generated from operations . Hence, the currency in which financial resources are raised is indicative of the functional currency in which a significant part of the entity’s

business is conducted.

Providing finance in a currency in which financial performance is measured assures consistency in accounting for, and producing relevant information for

performance reporting and evaluation.

Degree of

autonomy

The degree of autonomy is the basis for accountability, stewardship and control. Why? Because autonomy is what generates economic

The currency in which transactions are undertaken with a degree of autonomy enable faithful representation of the

Moreover, the versatility expected comes from extensive practice beyond the scope of basic calculations.

Assets - revaluation June 2011 q1.3 (answer)

March 2017 q1bi (answer)

Sep 2016 q2b (answer)

Being clear about the principles of fair value measurement the candidate appreciates the logic of IAS 21’s translation basis for revalued amounts and is consequently able to determine the accounting

implications of revaluation of PPE and investment property.

Not being grounded in the principles of IFRS the student’s calculations of the exchange rate effects of the change in the asset’s basis of

measurement are not adequately supported.

Assets – impairment

Being clear about IAS 36’s principles the student is able to determine the impairment loss in terms of the

functional currency when IAS 21’s requirements are applied.

The student’s calculations though compliant with IAS 21 are deficient because IAS 36’s

requirements have not been applied to reflect the effects of exchange rate on the carrying value of the asset.

WHAT YOU SHOULD EXPECT A little about a lot

This standard is frequently examined because increasingly, business is being

conducted across borders, generating foreign transactions - transactions

denominated in foreign currencies, or requiring settlement in foreign currencies.

You need to know the effects of exchange rate differences on a lot of things –

the entire set of financial statements and a variety of transactions that are

broadly predictable.

Functional currency

You should expect questions about foreign operations (computational and

discursive because reflecting the economic substance of a foreign operation in

the parent’s consolidated financial statements entails making a range of

decisions requiring higher order thinking skills). As a minimum you should

expect questions that require you to

- Determine an appropriate functional currency given the operational and

financial arrangements between the reporting entity and the foreign

operation. Foreign operation covers a variety of forms including branch,

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effects such as accumulating cash, incurring expenses, generating income, arranging borrowings and investing surplus cash.

Consequently, the currency of the primary economic

environment in which such autonomy is exercised is the functional currency.

economic effects of those transactions.

Proportion of the

foreign

operation’s

activities

Whether transactions with the

reporting entity are a high or a low proportion of the foreign operation’s

activities.

Materiality is a critical

consideration in determining financial reporting requirements.

Contribution of

cash flows

Where the foreign operation’s cash flows are readily available to the reporting entity, they would

directly affect the reporting entity’s cash flows, performance and financial position. That would suggest that the commercial substance of the reporting entity is not

distinguishable from that of the foreign operation. This would indicate that they share a common functional currency.

The conceptual framework uses cash flow as a surrogate of commercial substance. CF 4.54-4.55. In other words, commercial

substance is cash flow-contingent. Hence, the foreign operation’s economic substance is reflected in the entity that has full access to its cash. This makes the reporting entity’s currency the functional currency of the foreign operation. The local currency becomes

irrelevant.

Financial self-

sufficiency

Where the foreign operation is financially independent

this would indicate a high degree of autonomy over operations that generate cash flows. Thus the currency of the foreign operation’s primary economic environment would

be its functional currency.

Transactions, conditions and other events would be faithfully

represented in the currency of the primary economic environment in which the foreign operation generates adequate cash flows for servicing of finance. In addition, relevant information would be produced for making financial decisions.

Determine the matters that require judgement and identify the guidance provided by

IAS 21 to enable judgement to be exercised e.g. IAS 21.12 prioritises the primary

indicators (operating) over the secondary indicators (financing and investing).

agent, subsidiary, associate, etc. You should think holistically considering

issues from all sides:

- Determine whether a hedge of the investment in a foreign operation is appropriate or not. Explain.

Foreign operations

You should expect questions about the effects of changes in foreign exchange

rates on

- Assets: effects on changes in the carrying value of assets.

- Loans

- Goodwill

- Profit or loss

- Dividends: income effects and cash flow effects

- Cash flows - Inventory: historical cost and NRV

HOW YOU SHOULD PREPARE Practising to score - a target driven approach

Before starting to prepare

- Set skill development targets using the skill guide

- Set practice objectives e.g. cover all salient issues (see past questions

below).

- Set priorities e.g. start with Dec 2015 comprehensive questions

- Read the examiner’s reports

For special transactions (SOCF and OCI)

For common transactions (income statement and SOCF)

Examine the effects on - The income effects

- Cash flow effects

- Effects on statement of financial position e.g. impairment of assets

- How the effects of exchange rate changes affect the user e.g. investor’s

perception of risk, assessment of cash flows

THE EXAMINER’S REPORTS ARE EXAM PRACTICE RESOURCES Here are a few extracts you may find useful

Common mistakes and barriers to scoring

QUESTIONS FOR FURTHER PRACTICE

- Practise discussion type questions involving deferred tax, goodwill,

impairment & reversal of impairment and disposal.

- Consolidation: q1a 6/11 & Answer; practise this question repeatedly until you are thorough with the calculations and the principles that underpin the

calculations.

- You should be able to undertake a critical evaluation of the IAS 21

principles and practices e.g. Dec 2015 q1b (answer).

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Situation awareness: evaluate the situations that call for use of functional and

presentation currency (retranslation of transactions, translation of financial statements

for consolidation).

Disclosures: Practical examples of disclosure of real-life issues.

CONCEPTS

Thinking with concepts Show the link between specific application concepts such as Translation (measurement concepts) and the overarching (definitions and measurement concepts) conceptual framework. CONCEPT CHECK IFRS application concepts e.g. historical cash flows of IAS 7 means that IAS 21 closing rate

cannot be used to translate the cash flows of a foreign subsidiary (IAS 7.27). This achieves consistency: the information produced would be relevant and faithfully represented. Critical thinking question you would ask: how does historical information lend itself to assessing future earnings and predicting future cash flows? This advantage is claimed for the SOCF. You need to evaluate it. Conceptual framework application concepts

PRINCIPLES

Thinking with principles, analysing, judging with principles

IAS 21.18. “… it is necessary for the results and financial position of each individual entity

included in the reporting entity to be translated into the currency in which the reporting entity

presents its financial statements”.

LOGIC

Standard forms of reasoning.

Principles of accounting argumentation

Methods of accounting argumentation

HABITUATING THE CRITICAL THINKING MINDSET

What issues are raised by the standards and requirements?

What solution approaches are appropriate?

What are the success criteria? E.g. what are the success criteria for fulfilling user

needs?

- Address user expectations? How do you identify these? Generically and

specifically? Sources?

- Prioritise user expectations

What matters require judgement?

E.g. determining the presentation currency. Examine the logic of IAS 21’s criteria

for judging appropriateness of the presentation currency. How do we examine the logic? What is the essence of the logic? Means and ends, feature and function or

cause and effect relationships mediated by inherent situational (and holistic) factors

that provide the criteria by which we can evaluate the logic (or connection,

relationships). Another phrase for logic in this context is rationale.

- Also, be able to discuss the ethical issues in the treatment of exchange

differences arising on translation of specific transactions e.g. Dec 2015 q1c

(answer). - Would it be desirable to present exchange losses separately in the income

statement from other losses, such as impairment losses on operating assets

(goodwill, intangibles and Property Plant and Equipment).

Read the annotated technical article

Further practice questions:

- Mar 2018 q2a (answer): evaluate the appropriate translation currency for a

foreign subsidiary. Transactions had been denominated in the local

functional currency but a decision was taken to change the exchange rate to

government rate on the basis that this was the most appropriate currency for

the future flow of economic benefits . Was this change appropriate given

these conditions: no hyperinflation; functional currency was untraded and the two available exchange rates changed only once a year. Would an

average rate be more appropriate to translate the foreign subsidiary’s profit

or loss? You are required to give advice.

- March 2018 q4c (answer): disclosure of significant foreign exchange

losses on speculative forward contracts.

- Dec 2017 q1a.5 (answer): retranslation into presentation currency

- March 2017 q1a (answer): translation of foreign subsidiary acquired

during the year; q1bi: discuss the effect of change to fair value model

involving translation of revalued properties held as PPE and as investment;

q1bi: should exchange differences relating to monetary and non-monetary

items be treated the same? q1c: discuss ethics of application of average rate

resulting in excessive translation and undue costs. - December 2016 q2a (answer): application of the principle for determining

the functional currency

- September 2016 q2a (answer): purchase of a foreign retail operation with

a local currency loan. Translation and treatment of asset and liability to

mitigate the effects of exchange rate fluctuations.

- Dec 2015 q1a,b,c (answer)

- Jun 2014 q2b & answer: functional currency; deferred tax, goodwill,

disposal of foreign subsidiary. Examiner was not happy – read his report to

get a good steer for the likely questions to follow.

- Dec 2012 q2b (answer): acquired foreign subsidiary exchange rate effects

on statement of cash flows.

The Expert Accounting Student by Kieran Maguire

- ACCA P2 topic 5 currencies

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PRESENTATION CURRENCY

What is a presentation currency?

What factors determine presentation currency?

Why is professional judgement required to determine the presentation currency?

Translation into the presentation currency IAS 21.38-39.

What does that achieve in terms of faithful representation?

What issues need to be addressed?

Accounting for gains and losses: which gains are recognised in profit or loss and which gains are recognized in OCI? What principles determine the basis of

recognition? See CF 7.19-25

CONCEPT CHECK

How does the presentation currency requirements, application and effects reflect the

conceptual framework principles?

IFRS application

concept

Conceptual Framework link

Single presentation

currency

Common presentation currency basis is reasonable for communicating value.

Achieves consistency in measuring the economic substance of transactions, conditions and other events. Achieves faithful representation.

CONCEPT CHECK

Explore the treatment of losses due to exchange differences

IFRS application

concept

Conceptual Framework link

Monetary items Realised or unrealised recognised in profit or loss.

Accrual, prudent as cash due or held. Predictive and confirmatory.

Non-monetary items

Hold to use e.g. PPE Defer in equity Prudent

Hold for investment Realised or unrealised recognised in profit or loss.

Accrual

Hold to sell (if NRV) Realised or unrealised

recognised in profit or loss.

Accrual

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IAS 23 Borrowing

costs (Effective date

after latest revision 1

January 2009)

1a,

c,

2,3

,4

This standard applies the definition of an asset as defined by the conceptual

framework by setting the conditions for the recognition of borrowing costs to

correspond with the criteria for recognising an asset. At the same time it is essential

to be clear what constitutes an expense or finance cost to be recognised in profit or

loss. The enhancing and fundamental characteristics of the conceptual framework are

also relevant. It is essential to bear this in mind when answering questions.

For the exams, it is essential to adopt an analytical approach along the themes

suggested:

Asset issues

- What is a qualifying asset? Assets that take a substantial period of time to get

ready for their intended use or sale. Examples: i) infrastructure assets:

construction of an oil refinery, hydroelectric dam; toll bridge, nuclear power

plant; ii) Other property plant and equipment: shopping mall, property estates,

stadiums. An acquired asset can be a qualifying asset depending on how

management intends to use it. For example, where an acquired asset can only be

used with a larger group of fixed assets under construction, or was acquired as input into the construction of one specific qualifying asset. The assessment of

whether the acquired asset is a qualifying asset is made on a combined basis.

- Which assets are not eligible? Assets that are ready on acquisition for their

intended use or sale. Examples: completed and ready for use or occupation

luxury flats, networks and installations, fleet of cars or aeroplanes, computers or

furniture however expensive the cost of finance.

Financing issues

- What finance is eligible? Only external borrowings including bank borrowings

and bonds. Borrowings can be specific or general but must be incremental i.e. could have been avoided if the construction of the qualifying asset had not

occurred.

- What finance is not eligible? Internal finance – imputed cost of equity including

preferred capital not classified as a liability. IAS 23.3. Therefore the cost

(interest or dividend) of preferred capital classified as a liability is eligible to be

recognised as borrowing cost.

- Adjustments for investment income: any investment income from short term

investment of temporarily idle funds is deducted from borrowing costs.

- Adjustments for capital grant: any grant of a capital nature that reduces the cost of the qualifying asset is deducted from the total expenditure for the purpose of

calculating the borrowing cost.

WHAT YOU SHOULD EXPECT

As can be seen from the pattern of questions this has not been a high priority

standard. However, the examiner can examine IAS 23 issues in so many ways:

- IAS 12 tax on capitalised cost: borrowing costs are capitalised gross, the

tax relief is not deducted as required by the accrual concept. Instead, in accordance with the consistency concept, eligible borrowing costs are

capitalised gross as all other costs are. A deferred tax liability should be

set up where the entity’s circumstances comply with the requirements of

IAS 12. This is similar to IAS 38 capitalisation of development costs. The

taxable temporary difference (deferred tax) is then released to profit or

loss on a systematic basis to match the depreciation of the capitalised

expenditure of the qualifying asset.

- IAS 16 assets completed in parts: if construction of a qualifying asset is

carried out in parts (or phases) the borrowing relating to completed parts

can be capitalised provided those parts can be fully and independently used

as intended or sold.

- IAS 16 prepayments: borrowing costs may be capitalised on amounts paid

in advance if expenditures on the asset start when the prepayments are

made and the other conditions are satisfied (borrowing costs are being

incurred and construction activities are being carried out).

- IAS 20: expenditure is reduced by grants received before calculating

borrowing cost.

- IAS 21 exchange differences on foreign currency borrowings to the extent

they are regarded as an adjustment to interest costs.. See worked example in The maths of IAS 23.

- IAS 24 related party: interest cost must be at arm’s length.

- IAS 39/(IFRS 9): gains and losses on derivative financial instruments

(interest rate swap and foreign currency swap) not designated in a hedging

relationship are not considered a borrowing cost. As they are classified as at

fair value to profit or loss (FVTPL) such gains and losses are recognised in

profit or loss when they arise.

- IAS 39/(IFRS 9): the effect of a cash flow hedge of the variability of

interest on directly attributable expenditure on a specific project is considered an adjustment to interest cost and is eligible for capitalisation

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- Working capital borrowings: the cost of amounts (including amounts of

syndicated loans from various sources) allocated to working capital are not eligible for capitalisation as working capital expenditure is not necessarily

incurred for the creation or acquisition of a qualifying asset. See The maths of

IAS 23 [General Borrowings] tab

- Progress payments: should be deducted from the cost incurred

- Permanent overdrafts: the cost of long-term overdrafts used in financing

expenditure on qualifying assets is eligible for capitalisation.

Cost issues

Which costs are eligible for capitalisation? External borrowing costs directly attributable to the acquisition, construction or production of assets that

necessarily take a substantial period of time to get ready for their intended use or

sale.

- What do external borrowing costs include? Interest, debt issue costs,

amortisation of debt discounts and premiums (through effective interest method),

finance charges on finance leases, lenders fees, exchange differences that affect

interest cost attributable to a qualifying asset.

- Which costs are not eligible? Cost of equity: share capital (including issue cost)

and other equity elements. Imputed cost of equity is not allowed. Accrued costs

– only paid costs, assets transferred and interest-bearing liabilities assumed are eligible. IAS 37 recognised costs are not eligible to be capitalised as borrowing

costs as they are not paid. Unwinding discounts (finance costs) not eligible for

capitalisation as not directly attributable to acquisition, construction or

production of an asset.

Type of activities

Necessary activities are interpreted broadly and span the period from planning until

the qualifying asset is substantially complete. They include

- Obtaining planning permits

- Planning

- Construction - Production

- Acquisition

Capitalisation issues

Borrowing costs are capitalised when it is probable that the costs will result in future

economic benefits to the entity and the costs can be measured reliably. IAS 23.9

- When to start capitalising: i) when expenditures directly attributable to the asset

start to be incurred by acquisition, production or construction; ii) undertaking

activities necessary to prepare the asset for its intended use; iii) when borrowing

costs are being incurred to finance the expenditures in whole or in part. All these

conditions must be present before capitalisation can start.

after taking into account the requirements of hedge accounting. See The

maths of IAS 23

- IAS 36 impairment of assets: interest must be charged on the costs

incurred even if costs exceed the recoverable amount as in impairment

condition; interest added can cause further impairment.

- IAS 31 joint venture: a joint venture is normally equity financed but it

may hold qualifying assets financed by joint venturers who may have

financed their equity contributions with borrowings. In this situation, the

joint venture (jointly controlled entity) cannot capitalise interest because it

has financed the asset with equity; the joint venturers cannot capitalise

interest either because they have not constructed the asset. However, if the

individual joint venturer is using proportionate consolidation then it can capitalise the interest that relates to its share of the constructed asset in its

consolidated accounts, e.g. London & Quadrant, note 14, p106. Also see

Conceptual Framework, 4.17 (control)

- IFRS 10 consolidated financial statements: i) one company borrows

externally, another develops the asset: capitalise borrowing costs in the

group financial statements at arm’s length on borrowings from third parties;

ii) cost of company’s intra-group borrowings at arm’s length to develop an

asset can be capitalised in the individual company’s financial statements.

An interest-free loan obtained by a subsidiary from a parent to construct a

qualifying asset is initially accounted for at fair value and subsequently

measured at amortised cost with interest accrued using the effective

interest method. The interest is an element of borrowing costs eligible for

capitalisation. This can be assessed at q1a, q1c, q2, q4.

- The Ethics question

As capitalisation of borrowing costs effectively defers expenses and thereby

increases profits, there is an opportunity for exploitation where the entity’s

management may be rewarded for performance based on profits. Hence IAS 23

may be assessed as an ethics question at q1c.

For example, the management of Y has decided that borrowing costs should be

capitalised. Classification issues may be a part of the scenario: - Short-term v long-term cost of borrowing

- Misallocation of expenditure to qualifying assets

- Post construction period borrowing costs

- Pre-construction period borrowing costs

- Internally funded development expenditure

- Capital structure: equity/liability

So far the past questions have been relatively straightforward. Future questions

are expected to be more challenging given that the standard has been effective

(after the last revision) since 2009. You should expect questions that require

critical thinking to identify a qualifying asset based on management’s

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- When to suspend: during extended periods in which active development is

unexpectedly or unavoidably interrupted as when floods affect the construction of a bridge or when the extended rainy season prevents road construction.

However, capitalisation is not suspended for periods of temporary delay that are

a necessary part of preparing the asset for its intended purpose.

- When to stop: capitalisation of borrowing costs shall cease when substantially

all the activities necessary to prepare the asset for its intended use or sale are

complete. Apply critical thinking to judge “substantially all” in terms of whether

the expenditure enhances or extends the productive capacity of the asset. If

more capacity is being added, then capitalisation should continue; if capacity is

only being enhanced further through cosmetic modifications then capitalisation

should cease before modifications start and after construction is substantially complete.

- How should capitalised borrowing costs be treated? Included in the cost of the

asset and presented as a non-current asset. DR Asset, CR Borrowing costs (may

consist of several accounts).

- How should the amount of borrowing costs be determined if borrowing is from

different sources and for different purposes e.g. working capital and long-term

construction of assets? Weighted average capitalisation rate. See worked

example in The maths of IAS 23.

Your preparation would be well served by considering the difficulties of attaining the directly attributable criterion due to the factors highlighted in IAS 23.11:

a) The difficulty of establishing a direct relationship between particular

borrowings and a qualifying asset; and as a result,

b) The difficulty of determining borrowings that could otherwise have been

avoided (efficiency and performance evaluation G.2) and evaluation of

segment performance IFRS 8. See Tesco plc (2016) Note 2, p97

highlighting the difficulty of allocating net debt to segments

Causes of difficulties in identifying incremental borrowing costs (costs that could

have been avoided IAS 23.10) of constructing a qualifying asset:

- Centrally financing activities that produce a qualifying asset e.g. in a group structure with a central treasury

- Using a mixture of debt instruments with varying rates to raise funds that are

then lent to members of a group on different bases and rates

- Foreign currency denominated loans susceptible to fluctuations in foreign

currency

In such circumstances determining what is relevant and attributable to a qualifying

asset is difficult and requires estimates and judgements which introduce

measurement uncertainty.

intention. Impairment, foreign exchange differences and group accounts are

always highly examinable topics. So you should not be surprised to find

borrowing costs as part of the mix. In addition, hedge accounting is always relevant. See the Maths of IAS 23.

Calculation of weighted average capitalisation rate may also be required. See

worked examples in The Maths of IAS 23.

You should expect questions about the difficulties of attaining the directly

attributable criterion due to the factors highlighted in IAS 23.11.

- How is faithful representation achieved in compiling relevant information

about borrowing costs?

- What is the role of materiality?

- How is judgement exercised about critical events during construction? - What is the role of disclosure?

Past questions for practice

- Jun 2016 q3a (answer): application to general borrowing scenario requiring

determination of capitalisation costs by applying a weighted average

capitalisation rate to the weighted average capital expenditure.

- Dec 2013 q1a.(iv) (answer): interest to be capitalised

- Dec 2013 q4b (answer): error of omission to capitalise borrowing costs

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IAS 24 Related- party

disclosures

1b,

c,

2a

Though not frequently examined this standard is always likely to be examined

because it is integral to transparency and faithful representation - key pillars of

financial reporting, accountability and corporate governance.

What are the key issues you should address?

- Definition of the “reporting entity”

- Definition of a related party; explain the importance of disclosure of related

parties in the context of satisfying the qualitative characteristics of the

conceptual framework e.g. completeness required for faithful representation

of transactions may necessitate disclosure of related parties as in an equity

settled share-based payment transaction between the parent and its

subsidiary (December 2014 q1b & answer) non-arm’s length transactions

such as interest-free loans.

- Definition of related party transactions, balances and commitments: includes transfer of goods, services and obligations regardless of whether a price is

charged or not.

- The potential impact of related party relationships on transfer prices

(intercompany transactions) and company performance e.g. F7 June 2013 q1a, b

(answer), financial position and cash flow.

- Wherever there is a source of significant influence (e.g. associate) power and

control there is a related party issue but that does not mean that transactions are

not at arm’s length. It should not be presumed that accounting malpractice

exists just because related party relationships exist. It is normal for transactions

to be conducted at arm’s length between related parties and any presumption to

the contrary can be rebutted.

- This standard is focused on disclosure but at the same time it is essential to consider the potential effects of related parties on measurement, presentation and

non-disclosure of information. For example, how would a parent relationship to

its subsidiary affect the valuation of NCI interest in a private company?

- Employees earning significant amounts of share-based payments may be

investors who are able to exercise significant influence.

- May also be relevant in the ethics question 1c as related party transactions

may raise ethics questions.

- Be aware of scope exclusions and exemptions.

- Certain transactions between entities only occur because of the existence of

related party relationships between them. For example, a firm sells its entire

output at cost to its subsidiary. These terms enable the producing entity to survive despite not having customers to sell to at arm’s length.

- Certain transactions may not occur because of the existence of a related party

relationship. Disclose the lack of expected transactions due to the existence of

related party relationships. IAS 24 is unique in that the lack of an actual

transaction where one is expected could be deemed a material disclosure matter.

For example, where a subsidiary does not refund amounts owed to the parent in

respect of an equity-settled share-based payment made to its employees for

services rendered to the subsidiary. In effect, there is a capital contribution from

the parent to the subsidiary. This fact must be disclosed.

- There are no exceptions for the nature of transactions, their sensitivity or

confidentiality.

You can score full marks by applying basic knowledge to a scenario to identify

related parties and determine what should be disclosed (December 2016 q2c –

answer). But this is not a “list and describe” exercise.

Be prepared to explain the consequences of non-disclosure and be able to

analyse and discuss the impact of related party transactions on financial

performance and financial position.

Also, be prepared to draft a related party note to the financial statements.

Therefore, it would be a good idea to look at some examples in published

financial statements Tesco plc 2016 related party note 24; Balfour Beatty.

Some of the questions tend to be discursive in nature as some of the key issues

are not straightforward. For example, determining what is a “commitment”, the existence of “control” and “significant influence” would require the exercise of

critical thinking about the evidence and judgement about its disclosure

implications. Refer to IAS 8 study text – What is an acceptable accounting

policy para no.12?

Jumping to conclusions will be an inappropriate response. Practising analysing

case study critically can prove advantageous in terms of quality of exam

response e.g. your claims, arguments and conclusions would be based on

evidence from the case study – not on conjecture!

As a minimum practise critical thinking about IAS 24 disclosure requirements

in relation to the following - Relationships: parent, subsidiary, joint control, joint venture and associate.

- Group disclosures and separate financial statements of the parent

disclosures. Focus on the disclosure requirements of a parent that enters

into a contract with a subsidiary company.

- Transactions with directors

- Compensation issues:

- Arm’s length transaction price assertions: substantiating such assertions can

be difficult.

- Commitments: where the reporting entity has obtained or given guarantee

or collateral over the discharge of debts, capital and other commitments.

(Balfour Beatty contingent liability note 35 in 2015 financial statements: guarantees are contingent liabilities that may crystallise into actual

obligations)

- Substance over form (“principles-based” approach) e.g. when a subsidiary

leaves the group what is the disclosure implication? When a company is

commercially dependent on another (e.g. single major customer). Does that

mean they are related?

- Scope exclusions and exemptions: you may be given two scenarios where

one is a related party and the other is not. Analyse, explain and conclude.

- Government-related entities

Past questions:

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- In assessing related party relationships consideration should be given to the

substance of the relationship and not merely to its legal form (principles-based).

Substance in this case means the ability of one party to exercise significant

influence on another, and for that party to be susceptible to similar influence

from the other.

- December 2016 q2c – answer

- December 2014 q1b & answer

- June 2014 q2a & answer

IAS 36 Impairment of

assets

Transaction types and links

The nature of transactions

Distinct features of transactions

Fundamental principles of

recognition

Concept links

Economic value types

Acquired

Created

Impaired

Deferred

Accrued/Accreted

Disposed: consumed/sold

Conditions and events

Onerous provisions

Impairment triggers

Impairment indicators

Impairment response

mechanism

Impairment trigger

Impairment assessment

Impairment evaluation

Carrying value

Replacement value

VIU

Discount rate

Notable write-downs of

investments

Hewlett Packard (Autonomy)

Google (Motorola Mobility)

Capita (IFRS 15 impacts

accelerated revenue recognition)

1a,

2 ,

3

WHAT IS IT FOR? Why is it needed?

Fair presentation requires that assets are faithfully represented in accordance with the

definitions and recognition criteria of the Conceptual Framework. Therefore, the

amounts at which assets are presented in the financial statements must reflect

conditions at the measurement date that might affect the potential of an asset to

produce economic benefits. This might mean that an asset could be derecognised and

expensed in whole, or in part, if it no longer satisfies the Framework’s criteria for an asset to be recognised. This standard provides requirements and guidance to enable

entities to assess conditions at the measurement date and evaluate whether assets

should be presented on the basis of their carrying amounts or current values at the

reporting date.

“…to prescribe the procedures that an entity applies to ensure that its assets are

carried at no more than their recoverable amount (RA). An asset is carried at more

than its recoverable amount if its carrying amount (CA) exceeds the amount to be

recovered through use or sale of the asset. ” IAS 36.1

The carrying amount is the net cost of an asset after deducting depreciation and

impairment losses. The recoverable amount is the current value of the asset recoverable through use or sale.

What does it apply to?

The standard applies to the impairment process of all assets other than:

Asset IFRS Measurement basis

Inventory IAS 2 Lower of cost and NRV: adjusted in

income

Assets arising from

construction contracts

IFRS 15 Remeasurement gains and losses

recognised in income

Accounts receivable IFRS 9 Bad debt allowance ; movement

recognized in income

Investment property

measured at fair value

IAS 40 Remeasurement gains and losses

recognised in income

Biological assets IAS 41 Remeasurement gains and losses

recognised in income

Assets arising from

employee benefits

IAS 19 Remeasurement gains or losses

accounted for in OCI

HOW YOU WILL BE ASSESSED

Criteria Active (open mindset) Success trajectory

Passive (closed mindset) Failure trajectory

Appropriate orientation towards optimal learning

and development Skills assessed:

Self-management

Sense of personal responsibility for self-development necessary for professional level study

Understands the criteria of success in this area and explicitly focuses on them to build optimal

competences.

Learning to score by making active choices that match the drivers of the exam: aim, rationale

and approach. Reads and assimilates all

relevant materials from the examining team. Understanding is secure.

Does not explicitly focus on critical success criteria due to lack of awareness or appreciation of their relevance.

Uncritically follows packaged solutions and does not apply rational criteria to choose among options or to extend his study beyond the confines of the study text.

Ignores guidance from the examining team. Prefers shortcuts to exam success. Substitutes the tutor for the examiner.

Appropriate conceptual

understanding of events and conditions that trigger impairment in various contexts and situations. Skills assessed:

Appreciation of how context

affects application of

principles. Understanding of

the requirements of different

contexts and situations e.g.

social landlord (holds asset to

deliver social service) and

private landlord (holds assets

to derive cash through sale or

rent). Refer to published

financial statements to see

how the factors that drive

impairment differ, and how

Understands how events and conditions alter economic value states resulting in accretion or impairment. Such conceptual understanding complements context-

based understanding and

allows for critical assessment of contingent variables that results in coherent and complete answers. Recognises the potential for standards to interact or

converge when evaluating changes in economic

Has context-limited understanding of impairment events and conditions and is hence unable to apply the full range of IFRS necessary to provide full answers. See COMMON

MISTAKES below.

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Non-current assets or

disposal groups classified as

held for sale and

Discontinued operations.

IFRS 5 Remeasurement gains and losses

recognised in income subject to

limits.

Financial asset that are within the scope of IFRS 9

IFRS 9 FVTPL/FVOCI

Deferred tax assets IAS 12 Tax basis: changes recognised in

income

Check this table with the real life examples box. Clarify the measurement and

recognition principles at work to convince yourself that the above should not form

part of IAS 36.

LEARNING OBJECTIVES

This standard deals with a highly subjective matter of critical significance to the

measurement of performance and financial position. The measurement and disclosure

requirements and guidance are quite extensive to make up for the lack of objectivity.

Critical analysis and judgement are essential skills: you should be able to evaluate

impairment practices and assess the benefits of disclosures to stakeholders especially investors where there are significant impairment losses or potential losses. The

context is a key factor as it operationalizes the business model in which the asset is

held and managed. Above all, you need to be insightful – to think fair presentation

and bring principles, concepts, facts and insights together to resolve issues. This calls

for structured critical thinking and sound reasoning.

UNDERSTANDING THE LOGIC OF IAS 36

Logic involves setting conditions (premises), testing the conditions (reasoning with

facts or evidence) and drawing an inference (inferring the validity of the conclusion

from the premises). This is the deductive argument structure inherent to accounting

discourse because accounting is a convergent discipline – the IFRS have a common source of principles and measurement concepts (the Conceptual Framework) that are

applied to achieve predetermined ends, ultimately fair presentation of financial

statements.

True or false assessments are not logical considerations, but if the premises are true,

then the conclusion is sound – then the financial statements have integrity. The

implications can be determined from a reliable base. Hence, as well as logic,

accounting is also concerned with ethics, especially in an area where subjectivity is a

significant component of the financial reporting process.

Understanding the logic means explaining how the standard selects and justifies its

methods and prescriptions and has the following benefits - We understand how and why the rules work because we understand the

standard’s arguments and can make confident and considered interpretations

based on it;

- We can think independently, resolve issues and predict outcomes based on its

logic. For example, we can identify relevant cash flows to include in the value-

in-use (VIU) model and determine the appropriate discount rate;

the basis of measurement also

differ as a result.

value states E.g. IAS 16 and IAS 36 interact as one affects the other i) to stop depreciation; ii) to require impairment assessment; and IFRS 5 converge to

separately deal with NCA disposal group held-for-sale.

Understands impairment response mechanism Assessed competence:

professional judgement about

the appropriate approach to

take whether qualitative or

quantitative.

The candidate has used his understanding of how a business uses assets to

determine impairment conditions and their implications. Being so grounded the logic and concepts of IAS 36 are clearly understood and applied as an

appropriate mechanism of response to contingencies. The candidate’s versatility is a result of an exploratory approach to learning the methods characterised by a questioning attitude and

divergent thinking to test the method’s foundations and develop coherent insights appropriate for dealing with complex scenarios at the professional level.

The candidate may learn the procedures as an accounting device (or as

a vague accompaniment

to the accounting

process) sufficient only to carry out standard computations in basic scenarios. Even accounting for the effects is a struggle.

Critical evaluation of the methods and its application to various contexts has not been a significant part of the learning process. Devoid of the fluency of

dynamic interactions, the candidate’s inchoate capabilities are unequal to the complex task of scenario analysis and evaluation.

Able to apply impairment assessment methodology Skills assessed: can you

apply principles; evaluate alternative applications and affirm that they are non-compliant with IAS

36 (June 2012 q3aii & answer); critical evaluation of alternative pragmatic models that are context contingent but acceptable within the spirit of IAS 36.

Practical variations to the standard’s impairment assessment models can fit the standard’s recognition and measurement criteria. Being confident about the objective and logic of IAS

36 the candidate can reason about various scenarios and exercise judgement about their suitability. See Notting Hill Housing & Family Mosaic below

The candidate’s limited understanding of procedures is not adequate for assessing how these procedures apply to unfamiliar situations.

Consequently, the candidate finds “discuss” questions too challenging and loses marks by writing only shallow, generic details that don’t address particular issues in the scenario.

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- We know how to think about and evaluate special situations such as onerous

contracts;

- We can evaluate the merits of alternative models to VIU. - We can be clear about how and why the standard links with other standards.

STANDARD FORMS OF REASONING

Impairment argument

The standard prescribes procedures and principles to apply. You learn to apply the

principles to identify impairment conditions and assess their implications, giving

reasons and evidence from the scenario to support your conclusions. The assessment

to identify an impairment condition takes the form of a precise argument structure:

if…then…else…. For example, if the carrying amount is less than the recoverable

amount, then the asset is not impaired, else the asset is impaired, in which case work

out the impairment loss, being the excess of the carrying amount over the recoverable amount. IAS 36.1

The premises on which the argument is based are:

- Going concern: if this assumption did not hold impairment loss would be

irrelevant, as assets would be stated at their liquidated or break-up values.

- Accrual accounting requires all expenses for the period to be accrued and

presented in the income statement.

- An asset is an economic resource controlled by an entity that has the potential to

generate future economic benefits. To the extent this criterion is not satisfied

then the asset ceases to be an asset and it is immediately derecognised and

transformed into an expense: DR Expense, CR Asset.

Recoverable amount argument

What is the implication of the logic for how the recoverable amount is

determined? IAS 36.6 states that the recoverable amount is the higher of FVLCD

(fair value less cost of disposal) and VIU (value-in-use): what is the logic (what

reasoning supports “higher of” as opposed to “lower of”? Reasoning: if asset is not

abandoned, then “higher of” indicates its value to the business is maximized, either

through sale or use. “Lower of” minimises value to zero where FVLCD = 0 (there is

no active market for the asset). “Lower of” would return unacceptable results, as VIU

may be >0, (asset has value-in-use) even if FVLCD = 0. Similarly, when VIU = 0

(the asset is classified as held for sale by executive decision), “Lower of” would

suggest asset value = 0, which would be inconsistent as FVLCD would be >0. So, while “prudence” would lead us to select “lower of” FVLCD and VIU, analysis

suggests otherwise – “higher of” is more acceptable. Emphasizes the importance of

critical analysis of the issues in context.

Reportable amount argument

However, when considering amounts to include in the financial statements, prudence

requires that assets are stated at the lower of carrying amount and recoverable

amount. This is consistent with other IFRS:

Item Basis of financial statement

amounts

Impact of impairment

losses

See June 2012 q3aii & answer

Can account correctly for impairment conditions Skills assessed: can you

raise journal entries and account correctly and for impairment loss? Can you present the effect on the income statement?

A comprehensive approach to learning all aspects of impairment

response mechanism with examples from real life equips this candidate with the full skillset to identify, recognize, measure, present and disclose the effects of impairment losses intelligibly.

Unable to raise journal entries and determine the appropriate line for

presentation on the income statement. The student’s lack of familiarity with the structure, purpose and principles of the income statement compounds his

lack of basic knowledge of bookkeeping.

Able to develop purposeful disclosures Skills assessed: do you understand the objectives of disclosure? Can you make active choices about

what is most appropriate to disclose to stakeholders? Can you evaluate disclosures and revise faulty disclosures to make them informative and useful for stewardship and decision

making?

Understands that effective disclosures must apply Conceptual Framework principles to satisfy user needs and financial reporting objectives. This

indicates that there are standards to be met and therefore evaluates disclosures from the user-

needs perspective. Thus the candidate makes purposeful disclosures,

addressing particular circumstances of interest to stakeholders.

The student’s perfunctory approach is most evident in his attempt to answer disclosure questions. He either avoids them entirely, or when he

attempts them provides only vague descriptions and details devoid of coherence and interest in the scenario.

Discuss ethical issues

Skills assessed: ethical

reasoning; analysis of scenarios; synthesis of the

ethical with the technical.

Clear evidence that consideration of ethics is an integral part of the student’s learning process. Skill, knowledge and

professional attitude are clearly evident in the analysis and judgement about ethical issues alongside technical considerations.

Ethical issues are given little thought. Answers are vague and unfocused; particular ethical issues are unanswered. Student

consistently fails to execute clear ethical reasoning.

Language and style

Skills assessed: Effective writing: structure and coherent thinking; argument

writing, tone and style.

The student’s commitment

to developing effective communication competences is evident in the structure, clarity, style and grammatical accuracy of his writing. The student scores full

marks for clarity and

The development of

effective communication skills is obviously not a priority for the student. This is evident in the deficiencies of the script: poor grammar, poorly structured paragraphs, lack of titles, incoherent

statements and poor word

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Noncurrent Assets Lower of carrying amount and recoverable amount.

Operating expenses

Inventory Lower of cost and Net realisable value NRV

Cost of sales

Financial instruments classified as at FVTPL/FVOCI

Lower of carrying amount and fair values

Income statement/OCI

WHY DO I NEED TO BE INSIGHTFUL?

At the professional level you are expected to form independent opinions about the

subject matter and related issues, e.g. impairment, and to be able to explain and

defend your opinions – it is not enough to say “that’s what the standard says”. You should be able to interpret its meaning in context to the client. That means looking

beneath the surface and going beyond the obvious to fully understand the foundations

and application conditions of the standard. Hence the Examiner repeatedly says:

“A professional accountant advises clients, and the Corporate Reporting examination

tests the candidate’s ability to apply knowledge to a scenario. The examination tests a

candidate’s ability to explain the correct accounting treatment, the principles that

underpin the treatment, and the implications of this, in complex scenarios. Whilst the

examination contains technical material, a significant part of the exam is based

around the application of the fundamental principles within IFRS, based upon the

Conceptual Framework.” Examiner’s report, March 2018

Insights enable you to develop full answers from applied understanding that comes

from deep processing of the learning resources. Insights comprise knowledge that

(principles, concepts and context), knowledge how (methods) and knowledge why

(justify application of method to context using suitable, acceptable and practical

criteria and consider implications).

EXAMPLES OF INSIGHTS Impairment and depreciation compared and contrasted

An impaired asset represents reduced potential to generate cash flows for the entity

that controls it. Therefore, an impairment loss should be recognised as an expense,

like depreciation (bad debt, obsolete inventory and other loss in value of assets).

Recall that the Conceptual Framework defines an expense in terms of the reduction

in the value of an asset (CF4.4). Accordingly, the method that is appropriate to assess

impairment condition has to be a method that measures the asset’s independent cash flows directly (FVLCD) or indirectly (VIU).

However, unlike depreciation, which represents predetermined allocation of

expenditure in accordance with an agreed policy, impairment loss arises from an

unexpected condition, discovered after diligent assessments in accordance with due

process.

Thus, even though depreciation and impairment loss are both charges to the income

statement presented in the same income line, they can be perceived differently by

quality of discourse, evidencing application of synthesis and evaluation (intellectual level three).

choice, not using technical terms where appropriate, instead resorting to vagueness.

Marks scored out of 25 25/25 11/25

Evaluation of scores What do these scores mean for the professional education of the candidate and the support he has received?

Rich educational ethos has nurtured this student’s exemplary attitude and development.

This student’s failure can be due to poor attitude, poor circumstances. The question may be asked how does a student

with such limited skillset

present himself for a

challenging professional

exam? Was he poorly advised?

WHAT YOU SHOULD EXPECT A lot about a little

This standard has been frequently examined: scan the past questions list below

for salient issues examined in the past. A lot has been examined about a little: it

has been about measurement for faithful representation (CF 5.22, p54) of certain assets. As disclosure and ethics are increasing in importance you should

expect future exams to make ethics and disclosure prominent. Therefore,

consider the following alongside the issues in past exams.

- Critical issues in measurement and disclosure

- Restructuring provision

- Impact of synergy on measurement of VIU

- Impact of disclosure on stakeholders (how can disclosure of impairment

losses benefit stakeholders, e.g. secure creditors?)

- Ethical dimension to judgement issues: to measure or not, to conceal or to

disclose

- Test of your conceptual understanding (Conceptual Framework application

principles)

HOW YOU SHOULD PREPARE Practise to score: a target driven approach

INCULCATE THE HABIT OF ASKING WHAT IS THE ISSUE?

Issues are what we need to address. Therefore they come from all discrete

stages of the financial reporting process.

Identification issues

Measurement issues

Presentation issues

Ethical issues

Disclosure issues

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stakeholders, and must be separately disclosed. For example, disclosure of an

impairment loss may alter stakeholder’s perception of management’s stewardship

of assets, depending on the causes that underly the impairment. By contrast, accelerated depreciation charges may arise from adjustments to previous

assumptions about the expected pattern of consumption of expected benefits from an

asset. There is a significant difference in the way that these conditions are perceived

by stakeholders, even though their impacts on earnings may be comparable.

Comments

The above shows insights by i) linking impairment to the definition of an asset using

robust criteria to evaluate and justify treatment of impairment; ii) extending the link

to justify the measurement basis. Shows the examiner you have thought about what

impairment does to an asset and how you can explain and justify it to a client. Your answers will be confident and reasoned.

Further expanded insights e.g. why financing cash flows are excluded (like-for-

like); why tax receipts are excluded; why incremental OWC (operating working

capital) may be included; why day-to-day maintenance is included (VIU) but

excluded FVLCD unless sold immediately. These are discussed below.

HOW DO I LEARN TO GAIN INSIGHTS?

“Candidates’ learning should extend beyond reliance on a single textbook or revision

course; the required knowledge and understanding does not come through rote

learning but through a deeper understanding - and application - of the subject

matter. A well-prepared candidate would have reviewed relevant websites including those of the standard setters (IASB), the profession, and the ACCA to maintain their

knowledge and keep up to date with topical issues.” Examiner’s report, March 2018

Have an overall purpose for learning linked to the overall purpose of financial

reporting – think fair presentation. See CF 3.4, 3.1 and IAS 1.9

Understand how the Conceptual Framework knowledge is built: look at the content

table to get an overview of the knowledge structure. Your thinking should be

organised in the same way: purpose, requirements, method (appraise, customise and

apply methods to fit circumstances and achieve fair presentation). Think about

special cases and variations – principles-based requires application to various contexts and situations (near and far transfer).

Read the methods – don’t just accept them try and evaluate the principles on which

each method is based.

Have a hierarchy of concepts to link and evaluate the learning.

Read, analyse and reflect; reflect, connect and index for future use.

Read and critically evaluate practices included in the disclosures of several published

financial statements. See box opposite.

THE HELP YOU CAN GET FROM REAL-LIFE EXAMPLES

Accounting practice develops inductively, that means the standard setters (e.g. IASB) learn from business, academics and others to see how they address

issues. Then the standard setters try to set principles of practice based on what

they find in general application, and then seek a consensus from all the

interested parties. Hence GAAP – generally accepted accounting practice.

The standards are not set in stone: they are working documents that may need

revising to catch up to the real world. Hence the questions at this professional

level are discursive, requiring you to offer reasoned and supported opinions:

“Even if the candidate reaches the wrong conclusion, marks will be awarded for

the discussion. Candidates seem to believe that these questions possess a correct answer. Corporate reporting requires judgement and candidates should consider

that real life accounting issues provide accountants with difficulties in trying to

identify their solutions.” Examiner’s report, June 2017

You can learn a lot from published financial statements which must reflect

current events and conditions which may expose the inadequacies of the

standards themselves e.g. see Capita plc, p113. Hence you are strongly

encouraged to read the published financial statements which can give you a very

practical and insightful understanding of the issues and these issues are

examination significant. Here are a few examples you may find useful:

REAL LIFE EXAMPLES BOX You may want to review these in conjunction with Chapter 6 of the Conceptual Framework (CF)

As a minimum check with Table 6.1

Organisation Issues Manchester United FS (2017) Application of IAS 36 .67b

Impairment – note 2 e Intangibles – note 2.15

Contingent consideration – note 2 d IFRS 15

Notting hill Housing Trust p55 – onerous contract p64 – basis of estimating for impairment; notice the use of depreciated replacement cost instead of value-in-use to reflect the social service nature of the business model (interesting). Do you agree with the inference?

Capita plc Analysis of Impaired items: p112-113 Assets written-off due to obsolescence Presentation of goodwill impairment loss – separately presented to prevent earnings distortion (interesting). Operating profit presentation: p119. Note the

exclusion of goodwill. Comment on the exclusion of this significant operating expense. Is it fair presentation? Do you accept the reason given on p113?

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Compare assumptions underlying estimates – how good is the quality of the support?

Compare the bases of estimating cash flows: the periods more than or less than five

years? Study the justifications provided by each entity. Are they suitable – do they

reflect the criteria of IAS 36?

You are developing a mental model that you can use to evaluate IAS 36 issues. That

is how you learn to gain insights. Your answers will be fully developed because they

will reflect deep processing: looking at the subject from many sides. You are

habituating the critical thinking mindset.

HOW DO I APPLY INSIGHTS?

Analyse the situation to identify the structure, relationships and issues. Ascertain what you are required to do according to the question.

Respond with insight and judgement to produce a coherent response.

Be self-critical: evaluate whether your response fully matches the requirements.

TYPICAL CAUSES AND INDICATORS OF IMPAIRMENT

Contingent events and conditions

Recognizing and evaluating impairment triggers (anticipate and predict)

Recognize onerous provision triggers impairment assessment (IAS 37) of a

designated asset (IFRS 15).

Recognize borrowing costs triggers impairment assessment (IAS 23)

Recognize safety equipment triggers impairment assessment (IAS 16.11)

Recognize increase in liability triggers impairment assessment of asset carried under

the cost model (IAS 37)

If market for intangible asset no longer exists: indicates asset may be impaired –

triggers assessment (IAS 38 para 83)

Recognize costs of assets when incurred e.g. cost of major inspections for faults;

cost of regular replacement parts; cost of nonrecurring replacement; cost of

infrequently recurring replacements as in replacing an interior wall, etc.

Core technical knowledge: the assets that must be assessed annually

Intangible assets with an indefinite life

Intangible assets that are yet to be fully operational e.g. development expenditure,

software development costs

Goodwill that has been acquired in a business combination

Desirable knowledge: commercial awareness about the type of assets and

arrangements and their consequential effects. Contractual relationships and their

potential impacts.

GOODWILL AND INDEFINITE LIFE INTANGIBLE ASSETS

Family Mosaic Impairment: alternatives to FVLCD and VIU to reflect social service business model (principles-based, not rules-based). Discuss the suitability of the alternative models on p65. Investment property: fair value basis and

impairment, p66 Excluded from IAS 36. Justify. Property held for security, p66 within IAS 36’s scope. Note the difference in treatment of revaluation gain of £1,549 from the treatment in the note about investment property (also on p66). See p58: impairment is charged but revaluation gain is not credited. Explain and justify. CF Table 6.1, p

Properties for sale – NRV, p70; notice the treatment of impairment. Excluded from IAS 36: justify.

SET YOUR PRACTICE STRATEGY

Objectives

Loose ends

Common mistakes Methods

Frameworks.

Test your conceptual understanding

Test your reasoning skills design test to increase student competences and

make explicit the terms of discourse, structures of arguments and critical

analysis in the discipline.

WHERE SHOULD YOU START?

Make sure you are clear about how you will be assessed and use the guide

above to set priorities.

Review the common mistakes

Suggest start with question 4 December 2014 (see past questions section below). This comprehensive question gives you an overview and lead into all

the issues.

Then attempt all the past questions.

THE EXAMINERS REPORTS ARE EXAM PRACTICE RESOURCES Here are a few extracts you may find useful

The applicability of multiple standards

“A well-prepared candidate should be aware of situations in which more than

one accounting standard may apply. This question raised issues relating to IAS

36 Impairment of Assets and also IAS 37 Provisions, Contingent Liabilities and

Contingent Assets.”

Analyse scenarios to focus on separate components and provide full

answers

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Gross up goodwill – when? Why?

Recoverable amounts of CGUs containing goodwill and intangible assets with

indefinite useful lives: detailed information about estimates should be disclosed.

CURRENCY RETRANSLATION

Cash flows in a foreign currency are estimated in that currency and discounted at a

rate appropriate for that currency. The amount obtained is then translated using the

exchange rate at the date of the VIU computation.

DETERMINATION OF RECOVERABLE AMOUNT

Based on the lowest business unit level (CGU) – could be below segment level –

capable of generating independent cash flows.

Future cash flows used in estimating recoverable amounts

Cash flows must reflect the current operating capacity (or condition) of the asset to

be truly representative of its value-in-use (VIU) IAS 36.44. Hence cash flows arising

from future asset enhancements or reductions must be excluded. Such changes may

arise from restructuring. However, cash flows required to maintain asset IAS 36.49.

Discount rate

Explain and justify the use of the discount rate.

Discount rate must reflect risk attributable to the asset alone or group of assets and

not to the firm as a whole. For example, it would not be appropriate to use a discount

rate that reflects the way the asset is financed as this would distort the calculation, the

financing cash flows having been excluded from the cash flows to be discounted. Similarly, pre-tax rate should be used because tax receipts and payments are

excluded from the operating cash flows.

Core principle: the discount rate must reflect the time value of money (TVM) and

the risks that relate to the asset.

Value-in-use

The present value of the cash flows that an entity expects to derive from the

continuing use of an asset and from its ultimate disposal.

In addition, cash flows arising from future investing or financing activities must be excluded as only operating cash flows are relevant.

MATTERS ABOUT WHICH JUDGEMENT MUST BE EXERCISED

The critical importance of management judgement

Period of forecast cash flows for VIU (Projection period)

- Assumptions about growth rates and margins used to estimate performance:

must be reasonable and supportable reflecting the latest forecasts supporting

budgets and business plans making them as relevant as possible.

- Based on past experience of growth rates and margins achievable in key markets

as a guide. Example: “We believe that the assumptions used in estimating the

future performance of … are consistent with past performance.”

“In part b IAS 38, IAS 36 and IFRS 5 Non-Current Assets Held for Sale were

the main standards to be discussed. In this type of question, candidates should

break down the scenario into its main components and answer each component separately. In this way marks will not be lost by omitting some of the elements

of the question.” Examiner’s report, June 2016

Key factors that indicate the existence of impairment conditions

“Part a of the question required candidates to discuss the importance and

significance of certain factors when conducting an impairment test under IAS

36 Impairment of Assets . The factors were set out in the question and

included changes in circumstance in the reporting period, the market

capitalisation of the entity, the allocation of goodwill to cash generating units,

valuation issues and the nature of the disclosures. These factors have been

identified by regulators as key factors in determining whether impairment has occurred.” Examiner’s report, December 2014

Fundamental considerations in the impairment process

“Further, IAS 36 Impairment of Assets states that an entity should assess at

the end of each reporting period whether there is any indication that an asset

may be impaired. These are fundamental basic principles and if a candidate

can apply them, then high marks can be achieved. Additionally, there may be a

change in accounting policy in the question and so candidates should bear in

mind IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.”

Examiner’s report, December 2016

The importance of close analysis of the case details to discuss issues in

sufficient depth

“Part c dealt with IAS 36 and the assessment of impairment. There were

several impairment indicators set out in the question. IAS 36 states that cash

flow projections should be based on reasonable and supportable

assumptions, and presumes that budgets and forecasts should not go beyond

five years. As with any estimate, it is up to management to assess the

reasonableness of its assumptions in determining value in use. In this scenario,

the management had not taken into account certain key information in

evaluating value-in-use.

Candidates needed to discuss the information provided in the question in order to gain good marks.” Examiner’s report, December 2016

Goodwill allocation basis

“IAS 36 Impairment of Assets states that goodwill should be allocated on the

disposal of a CGU on the basis of the relative values of the operation disposed

of. Candidates answered this part of the question quite well, realising that the

part of the business disposed of was not a major line of business and that the

allocation of goodwill by the entity was inaccurate.” Examiners report,

December 2015

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- Brand obsolescence: industry experience.

- Materiality, ED2015/8 paras

- Unit of account: CGU, asset

Differences between fair value less costs of disposal and value in use

Element FVLCD VIU

Reference

standard

IFRS 13 IAS 36

Perspective Market participant’s

expectation of future cash flows from disposal discounted to present value using appropriate discount rate.

Entity’s expectation of future

cash flows from hold to use (and eventual disposal).

Basis Entity’s budgets and forecasts adjusted for market conditions. See CF 6.23. p61

Entity forecasts and budgets for five year planning horizon. Any significant differences between

the assumptions of the market participant and the entity should be justified. Example, justify if period longer than five years. See CF 6.23. p63

Discount rate Post-tax Pre-tax

Operating

working capital

(OWC)

Include Exclude if (direct) trade related to avoid duplication, being already

included in the cash flow from operating profits. But include movement if (indirect) maintenance related: required to maintain plant for production and generation of cash flows from the products and

services.

Day-to-day

maintenance

Not applicable Include as required to maintain expected economic benefits.

Enhance capacity Include if part assumed by market participants

Exclude

Financing Exclude Exclude

Residual value Not applicable Include

Disposal cost Include Include

Current and

deferred tax

Include Exclude

Tax losses Exclude Exclude

Restructuring Include if reasonable part of market participants assumptions

Include only if justified by prior inclusion of IAS 37 compliant provision confirming commitment

EFFECTS OF IMPAIRMENT

Issues are the basis of exam questions. The skill and judgement required to

implement the standard’s requirements and guidance are assessed at the

intellectual level three because they involve thesis, antithesis, analysis,

synthesis and judgement (the judgement process). Convergent thinking.

Highly discursive and computational. Illustrate with extracts from the standard:

timing, etc. Here are some examples from recent exams. They are worth a close

read and analysis.

Highly discursive

“Part b of the question required candidates to apply the principles in IAS 36 to

two scenarios. The first one dealt with the use of the correct discount rate and

the second dealt with the accuracy of cash flow projections. Both of these

issues have been identified by the IASB as being extremely judgemental and the cause of subjectivity in financial statements. The question was quite well

answered by candidates.”

Examiner’s report, December 2014

It can be argued that the subjectivity inherent in the estimation process to

determine VIU provides potential for asset distortions. Discuss. What

safeguards are there in IAS 36 to guard against asset distortions? Are they

adequate? Manage impact on earnings. Hint: the most significant assets based

on potential impact on earnings and balance sheet are required to be impairment

assessed annually. So, directors have no discretion over this, although they

exercise judgement over the existence and severity of impairment conditions.

That is what makes this area highly discursive and exam significant.

Critical evaluation

“ b (ii) It appears that the cash flow forecasts were not prepared based on the

requirements of IAS 36. IAS 36 states that cash flow projections used in

measuring value-in-use shall be based on reasonable and supportable

assumptions which represent management’s best estimate of the range of

economic conditions which will exist over the remaining useful

life of the asset. IAS 36 also states that management must assess the

reasonableness of the assumptions by examining the causes of differences

between past cash flow projections and actual cash. Management should

ensure that the assumptions on which its current cash flow projections are based are consistent with past actual outcomes. Despite the fact that the realised cash

flows for 2014 were negative and far below projected cash flows, the directors

had significantly raised budgeted cash flows for 2015 without justification.

There are serious doubts about Fariole’s ability to establish realistic budgets.”

Read the question to which this is an answer: Dec 2014 q4bii.

COMMENTS

Word choice: phrasing

“which will exist” should perhaps be rephrased “which are expected to occur”

because it is not certain that “the range of economic conditions” “will exist over

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Asset write-downs to recoverable amounts

Losses allocated systematically according to judgements about which assets have

contributed to the loss in priority order. Revisions to useful lives (worked example)

Depreciation revised (worked examples)

Residual values revised (worked example)

RECOGNITION OF AN IMPAIRMENT LOSS

Before classification as held-for-sale (IAS 36)

After classification as held-for-sale (IFRS 5)

ALLOCATION OF IMPAIRMENT LOSSES

Asset not previously revalued Asset previously revalued

RECOVERY OF AN IMPAIRMENT LOSS

Before classification as held-for-sale (IAS 16: credit income to the extent of previous

impairment loss; then credit OCI)

After classification as held-for-sale (IFRS 5: credit income to the extent of previous

impairment loss)

PRESENTATION AND DISCLOSURE

Objectives and principles of disclosure: indicates there are standards to be met;

evaluate disclosures from user-needs perspective. Therefore, identify user-needs and appraise disclosure qualities (content, timeliness and style) that would satisfy

those needs.

Communication tool: communication is only effective when the target audience

receives the communication. Standards of communication that ensures the message

is received are paramount: clarity, precision, relevance, accessibility, cost

effectiveness. Study some examples from published financial statements.

Forward looking especially about risks

MATTERS THAT SHOULD BE ADEQUATELY DISCLOSED

- Basis of estimating clearly explained

- Examples of basis of estimating

- Goodwill allocated or not

- The main classes of assets affected to be separately disclosed

- The main events and circumstances that lead to the recognition of those losses

should be disclosed.

RELATIVE SIZE OF LOSSES AND THE NEED TO DISCLOSE

The role of regulators

Accountability

A stakeholder perspective

the remaining useful life of the asset”, and the revised phrasing aptly conveys

the uncertainty.

Technical requirements at odds with practicalities

iron out the seeming inconsistency

Consistent assumptions, yet reflect changing circumstances.

Critical evaluation skill (Framing)

Establish grounds for critique

Then provide the critique

The judgement process

According to IAS 36, estimates of future cash flows should include:

(i) projections of cash inflows from the continuing use of the asset; (ii) projections of cash outflows which are necessarily incurred to generate the

cash inflows from continuing use of the

asset; and

(iii) net cash flows to be received (or paid) for the disposal of the asset at the

end of its useful life.

“IAS 36 states that projected cash outflows should include those required for

the day-to-day servicing of the asset which includes future cash outflows to

maintain the level of economic benefits expected to arise from the asset in its

current condition. It is highly unlikely that no investments in working capital or

operating assets would need to be made to maintain the assets of the CGUs in

their current condition. Therefore, the cash flow projections used by Fariole are not in compliance with IAS 36.” Read the question to which this is an answer

Dec 2014 q4bii .

COMMENT

The judgement process: components

Set the grounds for judgement (provide the premise)

Conduct analysis,

Provide evaluation (process involves making interim judgements using criteria

in the grounds or premises; assesses compliance with grounds)

Provide final conclusion (judgement)

Core skills: analysis; assessment, inference, judgement, extrapolation.

COMMON MISTAKES Barriers to scoring Overcoming barriers to scoring

“a significant number of candidates were less sure on whether a pre-tax or post-

tax cashflow and discount rate should be used as the basis for the value in use calculation” Examiner’s Report, March

2017

Following algorithms (structured procedures) for computing amounts does not necessarily result in deep understanding. To understand deeply you need to engage actively, seeking answers to relevant questions. You need to self-

explain the algorithm.

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Benefits to shareholders

Risk of concealment (temptation to conceal)

CONCEPT CHECK Explores the link between the IAS 36 concepts and the Conceptual Framework

IFRS application concept Conceptual Framework

Current values

VIU is current value as it reflects the most up-to-date estimates of the cash flow the entity expects from using the asset and from its eventual disposal. Thus, the standard makes up in subjectivity (reflecting current

conditions) what it lacks in objectivity (verifiable historical costs) over faithful representation of asset values.

Current values are relevant information that have predictive value. Suitable disclosures are necessary to enable users to assess the resulting measurement uncertainty against the enhanced decision-

usefulness of the information.

VIU is entity specific

Entity assumptions and firm characteristics can cause identical assets to be valued differently,

undermining comparability.

In practice, assumptions may be relaxed to allow VIU to reflect market participants’

assumptions CF para 6.35. Useful and comparable information would thereby be produced.

VIU of assets used in combination

with other assets See note 2

Manchester United

2017 published

financial statements

Synergy precludes VIU being determined for an individual asset

IAS 36.53Ab. This highlights the issue of separability, a critical IFRS recognition criterion. For example, intangible assets are recognized if they can be separated from goodwill.

Faithful representation: requires all conditions to be considered

for completeness. In this case the operational conditions provide relevant information.

VIU of specialised

assets

Fair value of specialised item;

VIU of specialised item may be similar, as assumptions of market participants and the entity, about the asset, may be similar. CF 6.33, p63

Measurement and presentation

that reflects similar assumptions about the conditions of the underlying asset would be consistent.

Identification The standard mandates certain intangible items to be

impairment tested on a regular basis, even where there are no impairment indicators. The items lack verifiable

economic substance there being no market prices for them. The

Such rigour ensures consistency in representing the

carrying amounts faithfully, and contributes towards fair presentation.

Therefore, when engaged in study or practice ask questions and answer them fully in writing, reviewing the notes regularly. Key questions: what is the method designed to achieve, and how does it achieve it? What principles

underpin the procedures? Can I explain and convince myself that I understand how they work? Can I check the impact of the method in published financial statements? If not why not? What practical problems are there with using the method, e.g. problems with the discount rate, assumptions about cash

flow. What are the alternatives? How do I choose among alternatives?

“Candidates at this level should have recognised some facts in the scenario as indications of impairment, however many answers overlooked this issue,

jumping directly to the issue of whether the store can be classed as a discontinued operation” Examiners report, March

2016.

The factors that cause and indicate impairment are many and varied. SEE

CAUSES AND INDICATORS OF

IMPAIRMENT.

At the professional level the syllabus approach requires you to “demonstrate personal skills such as problem solving, dealing with information and decision making.” You should be able to think methodically, know what to look for, correctly assess what you find, and support your assessments with reasoning

and evidence from scenarios. Therefore, when preparing to score high marks, you need to make enough time to reflect and think things through, and to develop the professional mindset. SEE HOW DO I LEARN TO GAIN

INSIGHTS?

Where an impairment was suggested, some incorrectly recommended impairment of a CGU beyond its carrying value, and most missed the point that where outflows exceed expected inflows, an onerous contract

exists (limited to the unavoidable future costs) under IAS 37 Provisions, Contingent Liabilities and Contingent Assets.” Examiner’s report, September 2015

You can’t afford to slip-up on the technical knowledge requirements. Maximize your scoring chances by learning the technical requirements and being able to apply them in unfamiliar situations. This calls for extensive

practice and reflection. The habit of critical reflection will help you overcome the barriers to scoring. Moreover, it will help you develop the habit of regularly considering how IFRS interlink and enable you to regularly consider how to transfer knowledge from

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standard applies rigorous criteria to identify and assess impairment conditions and ensure reliable amounts are reported for these items: goodwill, intangible assets with

indefinite useful lives and intangible assets not yet fully operational. The indicators used to test other intangible assets and assets with physical substance (e.g. PPE) are germane to the determination of

economic substance and can result in relevant information. For example, decline in market value of the asset warrants a write-down of the asset’s carrying amount by reference to cash flow based FVLCD and VIU.

Hence identification and measurement basis is logical, robust and consistent.

Recognition Impairment losses immediately recognized in income; or in OCI to offset a previous revaluation

gain.

Changes in resources to be immediately recognized in income statement in accordance

with conceptual framework.

Recovery

Recognized in income to the extent of previously recognized impairment loss. Relevant to performance measurement.

Prudence concept - anticipate no profits: lower of carrying

value and FVLCD.

Disclosure Measurement uncertainty

warrants purposeful disclosure for user understandability and confidence in the basis of estimating.

Communication tool as in

chapter 7 Presentation and

Disclosure.

one IFRS (e.g. IAS 37 onerous contract) to deal with a situation that calls for its application in connection with another or other IFRS.

DISCLOSURES

This is based on the deductive argument structure which you will use to

frame assertions about impairments. The examiner expects you to identify the

salient features that must be included in disclosures about impairment. Here

is an example of a disclosure

SENSITIVITY ANALYSIS

Framing positive assertions.

Example: “We have carried out sensitivity analysis around the base case

assumptions and have concluded that no reasonable possible changes in key

assumptions would cause the recoverable amount of the …CGU to be less

than the carrying amount.”

PRACTICE QUESTIONS

1. Explain the logic of IAS 36 setting out clearly the principles that make the

logic work.

2. Explain the logic of VIU

3. Explain why partial goodwill should be grossed up for allocating to CGU

for impairment testing.

4. Explain how the application concepts of IAS 36 are coherent with the fundamental concepts of the Conceptual Framework.

5. Evaluate the computations of VIU and FVLCD cash flows – discuss the

differences and similarities.

6. Discuss the differing views of directors about VIU, FUV and fair value: see

CF 6.-6.46

7. Explain why para 6.35 of the CF suggests that VIU may accommodate

market participants assumptions. Why and how would this promote fair

presentation? What disclosures would you expect to see?

8. Which of the following is a component of cash flows for VIU?

A) Cash inflow for Accounts receivable B) Gain on disposal of PPE

C) Expenditure to replace vital component in equipment

D) Expenditure to comply with safety regulation

E) Repayment of loan to finance the acquisition of the asset

9. Explain with the aid of conceptual framework principles how impairment

is measured, accounted for, presented and disclosed in

IAS 19

IAS 2

IFRS 9: FVTPL/FVTOCI

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IAS 36

10. Explain how the presentation and disclosure of impairment loss provides decision-useful and stewardship information to primary users of financial

information.

11. IAS 36 excludes investment property measured at fair value from its

scope. Justify the exclusion. See Family Mosaic, Financial Statements,

p66.

12. Explain how separability affects the measurement of impairment losses on

intangible assets under IAS 36. Hint: consider if it is feasible to determine

VIU for goodwill and player registration rights separately. If not, why not,

and what is the alternative?

13. Explain the concepts of faithful representation (CF 5.22) and fair

presentation (IAS 1, para 15) and use examples from IAS 36 to illustrate

the relationship between the concepts.

Past questions for further practice - September 2017 q2b (answer): quantitative impairment testing of CGU;

the requirement to include all assets

- March 2017 q2c (answer): determination of impairment of CGU based on

IAS 36 criteria, involving an evaluation of VIU and FVLCD; then

allocating impairment loss between assets within CGU. Whether pre or post

tax discount rate and cash flow should be used.

- March 2017 q4bii (answer): the directors had considered a subsidiary to

cease trading even though it had prepared its financial statements on a

“going concern basis”: this is an impairment trigger that activates an impairment review.

- December 2016 q3c (answer): cash flow projections used in impairment

assessment of value-in-use should be reasonable and supportable. The

question required candidates to discuss the quality of the evidence and

management’s use of it (or failure to use it) to support the estimate of VIU.

- September 2016 – NOT EXAMINED

- June 2016 q3b (answer): impairment of players’ registration rights

- Past q1a questions

- Refer also to IFRS 5, IAS 38

- Mar 2016 q4a (qualitative indicators of impairment e.g. slow economic

growth; discuss changes i) of intangible asset to “indefinite life”; ii) CGU reset at product level from retail branch level)

- Mar 2016 q3b (answer): business acquired in the year is impaired;

management intends to sell it. Is it eligible to be classified as “held for

sale”?

- Dec 2015 q2a (answer): Inaccurate allocation of goodwill on the disposal of

a business segment that is not a major line of business.

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- Sep 2015: Impairment process, calculation and onerous contract (cash

outflows exceed cash inflows; recognise a provision immediately up to

maximum unavoidable obligations) - June 2015 – not examined

- June 2014 – q3d (answer) after property recovered impairment loss it was

sold after the end of the year of acquisition.

- Dec 2014 q4 & answer (qualitatively evaluate impairment determinants;

quantitatively evaluate impairment)

- December 2013 – not examined

- June 2013 q1a.3 & answer

- Dec 2012 q3d & answer : Application of knowledge including calculations

- June 2012 q3aii & answer : Incorrect method for determining whether

goodwill is impaired and the amount by which it is impaired

- Dec 2011 q3aii, q3b & answer (Value in use VIU estimate does not

comply with IAS 36; IAS 36 basis of estimating cash flows not complied

with; inappropriate discount rate)

- June 2011 - not examined

- Dec 2010 – not examined

- June 2010 q2b & answer (use of non IAS 36 method to measure fair

value of an interest in shares as a basis for evaluating impairment )

IAS 37 Provisions,

contingent liabilities

and contingent assets

1a,

b,

2,3

This key measurement standard has wide application and is therefore frequently

examined. Be prepared to explain how the measurement rules help entities achieve

faithful representation of the obligation in the circumstances. A faithful

representation requires estimates that are neutral, free from any bias and that reflect all the prevailing circumstances at the reporting date. Overproviding based on undue

prudence understates results in one period and overstates results in another; neither of

these outcomes represents results faithfully.

- The accent is on application of principles to a scenario.

- Make sure you know the critical criteria for a provision to be recognised under

this standard. If in doubt read the study text : Provisions, contingent liabilities

and assets, A streamlined version is available at Deloitte.

- Evaluate the standard’s strengths and weaknesses e.g. June 2012 q4a, b &

answer.

- Distinguish IAS 37 provision from financial guarantee contracts e.g. Dec 2014

q2b & answer

- The discount rate for discounting cash flow to present value if the provision (e.g. decommissioning provision) is for more than one year is the pre-tax risk-

adjusted rate that reflects the time value of money and the risk specific to the

liability e.g. December 2012 q4b (answer). However, IAS 37 requires the

finance cost to only reflect the time value of money (risk-free rate).

WHAT YOU SHOULD EXPECT

You should expect computational and discursive questions about recognition,

measurement and disclosure, involving obligations arising from ordinary

transactions, joint ventures, joint operations, associates, changes in estimates, business restructuring and environmental policies, practices and legislation.

The examiner has had plenty of practice in setting questions about this long-

established standard. So, expect subtle variations from the previous questions.

Scenarios may consist of a mixture of issues from other standards. Therefore,

think critically about every detail - refrain from reacting automatically to a

question that looks like what you have practised before. Try to answer the

question on the paper – not the one you have practised.

This standard often interacts with IAS 10 as contingent liabilities and contingent

assets move through an uncertainty spectrum before they are resolved, and such movements don’t necessarily coincide with the reporting periods. Therefore, be

prepared to assess a variety of events after the balance sheet date, to determine

whether they are adjusting or non-adjusting.

Examples:

- A court judgement in the entity’s favour (is the inflow of economic benefits

probable, virtually certain?)

- Receipt of an unrestricted cash award from the court (is it probable that a

successful appeal will be launched?)

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- As only the increase in the provision attributable to the passage of time is to be

recognised as finance cost, the pre-tax risk-free rate should be used to unwind

the discount. See IAS 37 calculations

- Effects of changes in decommissioning provisions during the life of an asset:

prospective or retrospective? Effect on asset carrying values if i) cost model, ii)

valuation. This can be part of a CSR question at q1c or q4. Covered under IAS

16 above.

Onerous provisions

- Onerous contracts: make sure you can recognise and estimate onerous provisions

under IAS 37 where the unavoidable costs of meeting the entity’s obligations

exceed the expected economic benefits from the contract as a whole. This is a

present obligation which must be recognised in full. It is the least net cost of

exiting the contract which is the lower of i) exit costs (e.g. termination

penalties), and ii) fulfilment costs (e.g. further lease rentals). But the termination

of a contract does not prima face establish an onerous contract: it is possible for

the entity to make a profit on a terminated contract. In that case, the cost of

termination can be recognised as incurred: at the reporting date an outflow of

resources is not probable and an onerous provision is not required.

- A contract may become onerous under the terms of IFRS 15 or IFRS 16, but the

assessment of the provision may require consideration of other standards. For

example, an asset designated for use in providing promised goods and services to

customers may be impaired if the contract becomes onerous and should therefore

be impairment tested at that point in accordance with IAS 36. IAS 37 requires that any impairment loss that has occurred is recognised before making a

provision for the onerous contract. Similarly, inventories (finished goods,

work-in-progress and raw materials) may need to be assessed to determine if

they should be written down to their net realisable value (NRV).

- As with other provisions, provision for onerous contracts should be reviewed to

determine if their carrying amounts still represent best estimates at the reporting

date. A post balance sheet event would be adjusting if it materially alters the

amount of the provision favourably or unfavourably.

- Executory contracts that are not onerous fall outside the scope of this standard.

Restructuring provision

- Restructuring provision recognition principle – necessarily entailed by the

restructuring and independent of the entity’s future actions: used to i) distinguish

restructuring costs (e.g. cost of dismantling plant eligible as provision if plant is

scrapped) from ongoing expenses (cost of dismantling plant is ineligible if plant

is relocated for continuing use); ii) redundancy costs from amounts paid to retain

staff to ensure a smooth transition of operations (from one location to another).

- Recognition of recoveries e.g. insurance, reimbursements (is the inflow of

economic benefits virtually certain to occur if the entity settles the

obligation, or because of the entity’s insured loss?) - The effect of possible new legislation on conditions existing at the

reporting date (is there objective evidence that it is virtually certain to be

enacted; is there evidence that the legislation once enacted will

retroactively affect conditions existing at the balance sheet date?)

You should expect questions about the interaction between IAS 37 and IFRS 13

involving measurement of decommissioning provisions using IFRS 13

principles. See IAS 37 calculations. Key issues:

- Market participants assumptions about compensations for undertaking the

project and for assuming the risks associated with project.

- The obligation is normally not transferrable. - Market premium to compensate for the difficulty of locking in current

prices for projects that will occur in future.

- Non-performance risk

- Prevention of duplication of risks in cash flow estimates and in the discount

rate.

You should expect questions about the interaction between IAS 37 and IAS 2,

IAS 36, IAS 41, IFRS 15 involving

- Penalties

- Refund liability

- Sale of goods with right-of-return

- Onerous contracts provision - Impairment of assets designated to a contract under IFRS 15. The effect of

the contract becoming onerous.

- NRV considerations arising from onerous contract.

See IAS 37 calculations.

You should also expect questions about post reporting period events (IAS 10)

concerning

- Contracts becoming onerous after the reporting period (e.g. reduction in

revenue expected from a contract).

- Events after the reporting period (e.g. changes in estimated rentals) which

favourably or unfavourably affect a contract that was onerous at the reporting date.

You should expect questions about restructuring provision issues including

- Application of recognition principles involving the exercise of judgement

to determine whether the scope or manner of change is fundamental.

- Classification of expenses between restructuring and ongoing.

- Recognition of obligations arising from the sale of an operation.

- Treatment of gains and losses arising from sale of assets integral to the

restructuring plan

- Interaction with IAS 36 and IFRS 5 in relation to the sale of an operation.

- Recognition of constructive obligations e.g. relating to staff redundancies.

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- Another recognition principle is that the provision should not include identifiable

future operating losses up to the date of the restructuring unless they relate to an

onerous contract – ongoing operating costs are not provided for.

- The income (gains) from the sale of assets driven by the restructuring plan,

however essential to the plan’s goals, is not considered in the measurement of a

restructuring provision.

- A disposal loss would probably have been recognised as an impairment charge to

the profit or loss prior to the commencement of a restructuring. An expected sale

would have triggered an impairment review (IAS 36), crystallising a loss prior to

the asset being classified as held for sale. Hence the inclusion of an expected

loss on sale as part of the restructuring provision is not a relevant consideration.

- An obligation arising on the sale of an operation can be recognised if an outflow

of resources is probable and this would require a binding agreement of the sale

by the end of the reporting period.

- Estimation techniques

- Constructive obligations

- Environmental provisions recognition requirements: i) virtually certain

legislation will be enacted which will require the clean-up of land already

contaminated, or the rectification of some other environmental damage. The

imminence of coercive legislation means that there is a present legal obligation that will require an outflow of resources to settle it, and the amount can be

estimated with reasonable certainty. Hence a provision should be recognised. ii)

the existence of a widely publicised environmental policy in which the entity

undertakes to clean up all contamination that it causes, and has a consistent

record of honouring this policy, creates a valid expectation which can be the

basis for a present constructive obligation to rectify any environmental

damage.

- Contingent liabilities

- Joint and several liability is where the entity is jointly (together with others) and severally (individually) liable for an obligation. The issue is the fair

presentation of the obligation: the other parties have a shared present obligation

for the past event and the entity only becomes liable when they fail to honour

their commitment. Thus the entity only recognises its own share of the present

obligation and notes as a contingent liability its potential exposure to the risk of

default by the other parties.

Additional reading:

The technical article: Provisions by Martin Jones, Lecturer, London School of

Business and Finance.

You should expect questions about joint and several liability involving

- Joint arrangements (IFRS 11) - Associates (IAS 28)

- Events after the reporting period (IAS 10)

You should expect questions about the effect of changes in the discount rate on

the amount of the provision.

Past questions for practice:

- March 2018 q4aii (answer): Explain how uncertainty affects the

definition, recognition, classification and disclosure criteria in IAS 37 and

IFRS 5.

- June 2017 q4bii (answer): applying the criteria for recognition of a provision under IAS 37 and a financial liability under IFRS 9 to determine

the obligation incurred upon infringement of intellectual property. When

does an obligation arise under an executory contract and a financial

liability?

- March 2017 q4bi (answer): claim for reimbursement of expenses incurred

when purchased asset was not delivered.

- September 2016 q1b (answer): reassess restructuring provision.

- Dec 2015 q3a (answer): contingent liability to the party in a joint

arrangement re decommissioning

- Jun 2015

- Dec 2014

- Jun 2014 - Jun 2013 q2c & answer

- Dec 2012 q3c & answer

- Dec 2012 q1a.8 & answer

- Jun 2011 q2d & answer

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IAS 38 Intangible

assets

1a,

3 - Very frequently examined topic – always expect a question covering the issues

identified below. The examiner is usually concerned with recognition,

revaluation and impairment issues. Revaluation of an intangible asset is only

allowed where there is an active market for it.

- Remember the principles for recognising impairment and its reversal: i)

recognise impairment loss immediately in profit or loss to the extent it exceeds

any previous revaluation surplus on the impaired asset; ii) reverse previous

impairment losses in profit or loss up to the cumulative amount previously

recognised adjusted for “savings” in depreciation as a result of impairment. Any remaining gain must be recognised in revaluation surplus via OCI.

- Recognition issues arise in relation to business combinations (e.g. q1b June 2011

& answers). In order to be recognised intangible assets must be separately

identifiable. This condition is satisfied when a business combination takes place

as the “probability” and “reliable measurement” criteria are satisfied when a

price (the fair value offered as consideration) is set for the interest in the net

assets acquired.

- Recognition issues also arise in relation to broadcasting rights, footballer’s

contracts, franchises, fishing rights, etc. (e.g. q3c December 2011 & Answer).

Study this question carefully and practise reproducing it because it is an

exemplar of how to answer questions on this standard.

- Refer to “Development” in P2TT for a comprehensive discussion of the nature, requirements and accounting implications of development issues. Other related

terms in P2TT include: Accounting policies, Application, Deferral, Future

expenditure, Intangible assets and Management’s intention.

- In preparing for this area also consider the interaction of IAS 38 with IAS 20 in

respect of RDEC (see IAS 20) guidance.

- Be prepared to discuss why expenditure on sustainability may not be recognised

as an intangible asset under IAS 38.

Further practice questions:

- Sep 2017 q3c (answer): further tests to remove slight uncertainty over the

performance of an approved prototype in extreme weather. If converted

into a product the prototype would increase efficiencies. How should the

costs be treated given the other development cost capitalisation criteria are

met? Additional minor issue: how should the revenue generated during

the testing phase be accounted for? Refer to the conceptual framework

principles that may be relevant to consider e.g. offsetting, asset or expense.

- March 2017 q2b (answer): can legal rights acquired with 100% subsidiary be separated from the business and classified as intangible assets?

- December 2016 q2b (answer): application of basic principles about

amortisation and impairment.

- June 2016 q3b (answer)

- Mar 2016

- Dec 2015 q4b (answer)

- Sep 2015

- June 2015 q3c & answer

- June 2014 q3b & answer

- June 2014 q1a – examiner not happy because IAS 38 prohibits recognition

of internally generated goodwill. After purchased goodwill had been

eliminated recoverable amounts increased subsequently, reversing a previous impairment loss. However, this increase cannot restore purchased

goodwill previously written off as it represents internally generated

goodwill. Candidates did not know this. It should be expected to be re-

examined in June 2018 because of the critical importance of goodwill.

- Dec 2012 q2a & answer Sequential interaction

- Dec 2012 q1a.2 Computation

- Dec 2011 q3ai & answer Discuss

- Dec 2011 q3c & answer Discuss

- Jun 2011 q1b & answer Discuss

- Jun 2010 q3b & answer Discuss

IAS 40 Investment

properties

1,

2,3 A very frequently examined area of the syllabus. Make sure you practise all the

questions addressing the following issues.

- Cost v Fair value model accounting implications especially changes in carrying

values

- Interaction with leases IFRS 16 (sale and lease back) - Interaction with IFRS 5 e.g. (M Jones article)

- Fair value hierarchy (discuss how it applies to real estate)

- Adjustments to observable and unobservable data

Transfers to and from investment property when there is evidence of a change of use:

- Calculate gain or loss for part A

- Discuss treatment of sale and lease-back transaction and recognition of

gains or losses (revise)

- Discuss and account for treatment of compensation from 3rd parties e.g.

insurance - Could be part of a medley with IAS 16, IAS 17 as in the “industry

question”

Questions for practice

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- Commencement of owner occupation: IAS 40 to IAS 16

- End of owner occupation: IAS 16 to IAS 40

- Commencement of development with a view to sale: IAS 40 to IAS 2 - Commencement of an operating lease: IAS 2/IAS 16 to IAS 40

- March 2018 q3b (answer): Valuation basis of property on completion of

construction; property has unique features and was valued on level 3 basis

during construction. - March 2017 q2a: transfer of PPE (IAS 16) to Investment property (IAS

40) at fair value.

- Dec 2016 q1a.4 (answer)

- June 2013 q3b & answer

- Dec 2012 q3a & answer

- Jun 2012 q1a & answer

- Jun 2012 q3ai & answer

- Dec 2010 q1a & answer

IAS 41 Agriculture

1a,

2,3 This standard is concerned with the recognition and measurement of agricultural

activities; it applies the principles of IFRS 13 Fair values, IAS 2 Inventories and IAS

20 Government grants received in respect of biological activities. A typical example

of this is question 2 a, b (March 2016). Therefore, revise the recognition and

measurement principles of the related standards before starting to study or revise

IAS 41.

If you have mastered this standard the examiner would expect to see evidence that

- You understand what the standard covers and what it does not cover

- You can identify the recognition and measurement issues in a scenario

- You can apply IFRS principles to resolve the measurement, presentation and disclosure issues

- You understand the advantage of fair values over historical costs, in providing

balanced information about agricultural activities that enables evaluation of the

stewardship of resources invested in agricultural production, and the

performance of the organisation that uses those resources.

IAS 41’s case for adopting the fair value model Why the historical cost model is inadequate

- Under the historical cost model revenue is recognised only when the asset is sold

after production is completed or the produce is harvested. This does not reflect

the economic substance of the biological transformation that takes place in each

of the periods prior to maturity. The standard recognises that each stage of the

biological transformation process contributes to the expected economic benefits ultimately to be derived from the biological assets.

- Under the provisions of the standard costs of producing biological assets are to

be charged to expense as they are incurred in accordance with the accrual

concept.

- Recognising production costs without recognising a corresponding amount of

income does not reflect the matching concept and consequently results in

distorted operating results. When produce is harvested historical cost reports

substantial profits; prior to harvest substantial losses are reported. This is not

WHAT YOU SHOULD EXPECT

As can be seen the infrequency of assessment indicates that this is not a major

standard, as agricultural issues, the exclusive focus of the standard, are not

unique in financial reporting. However, based on the pattern of past questions

you should be prepared for a question on agriculture in June 2018. The issues

are limited and hence the questions don’t vary much. Therefore, read the

extracts of examiner’s reports below and practise answering the past and further

questions until you are confident. Don’t be surprised if a question about

agricultural produce is combined with a question about financial

instruments: derivatives, fair value hedge, cash flow hedge (effective and

ineffective hedge) or as part of a disposal group (IFRS 5).

Measurement of the fair value of produce prior to harvest

You should expect questions about the determination of the fair value of bearer

produce (produce growing on bearer plants prior to harvest). As there is no

market for these a cash flow model is the most likely valuation method. Key

factor - directly attributable cash inflows and outflows. Directly attributable

means that income tax, financing, replacement costs and other indirect cash

flows are excluded (IAS 41.24) such that only the cash flow that relates solely

to the produce is included:

- Inflows: expected price in the market of the harvested produce

- Outflows: incurred in growing the asset and getting it to market - Notional contributory asset charges for owned assets (land and bearer

plant)

Measurement on harvest and transfer of produce into inventory

The maths of IAS 41

The standard reflects the view that the fair value of agricultural produce at the

point of harvest can always be measured reliably.

On purchase for inventory

The maths of IAS 41

You should expect questions about onerous contracts. See IAS 37 Calculations where an entity is under contract to supply agricultural produce and the market

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faithful representation of the economic substance of the transformation taking

place.

Why fair value model is adequate

Because it requires measurement at each reporting date the fair value model fits the

multiple-period operating cycle of agricultural activities as the value created between

measurement dates can be determined and recognised as gains and losses for the

period since the last measurement date.

- This ensures explicit recognition of the value associated with each of the discrete

stages in biological transformation: growth, production, procreation and

degeneration.

- Consistency is achieved because operating costs are matched to the income

accruing to each completed stage and associated activities that contribute to the expected economic benefits.

- Relevant information is produced because unlike historical costs current values

reflect current conditions including price changes and growth at the

measurement date, enabling an effective evaluation to be carried out not only of

the stewardship of resources, but also of the prospects for net cash inflow from

agricultural activities.

WHAT THE STANDARD COVERS

The standard covers “agricultural activity”: the process of managing the

transformation of agricultural inputs to outputs (agricultural produce) akin to

manufacturing or construction activity.

The standard sets three criteria for agricultural activity: i) relevant plants or animals

must be alive and capable of transformation; ii) the transformation must be managed

through an active programme of development and care; iii) there must be a basis for

the measurement of change reflecting the development through distinct stages or

characteristics such as ripeness, weight and width of trees.

IAS 41 only covers assets that are unique to agriculture. They are of two basic

types:

- Agricultural produce (harvested crops); governs initial measurement applying

IFRS 13 (see below); subsequent to harvest IAS 2 governs accounting for produce inventory. The initial carrying amount is the deemed cost being the

IFRS 13 fair value less estimated costs to sell. Beyond this point, IAS 41 ceases

to apply.

- Consumable biological assets (plants and animals) that become produce

themselves such as livestock intended for meat production, annual crops and

trees to be felled for pulp.

WHAT THE STANDARD DOES NOT COVER

value declines as a result of weather and other conditions. Evaluate whether the

entity should fulfil or terminate the contract.

You should expect questions that require you to apply principles in classifying

biological assets between IAS 16 and IAS 41. Examples:

- Non-bearer plants (IAS 41.5A) cultivated to be harvested as agricultural

produce e.g. trees grown for use as lumber, annual crops. They are not

PPE (IAS 16) because they are not expected to produce for more than one

period.

- Bearer plants (IAS 16.6) cultivated to bear produce for more than one

period.

You should expect questions that require you to identify disclosures that enable

operating performance evaluation and assessment of the timing of net cash

flows from agricultural activity. Key factors include:

Statement of financial position

- The carrying amount of biological assets presented separately

- Consumable and bearer assets presented separately

- Further analysis of categories into mature and immature sub-groups

- Reconciliation of movement highlighting changes due to sale, harvest, fair

values, exchange differences, business combinations, etc.

- Measurement bases, risk management strategies.

Statement of Profit or loss and Other comprehensive income

- Gains and losses arising from changes in the fair value of consumable and

bearer assets - Detailed elements to support an analysis of operating performance

Past questions for practice - Sep 2017 NOT EXAMINED

- June 2017 NOT EXAMINED

- March 2017 NOT EXAMINED

- Dec 2016 NOT EXAMINED

- Sep 2016 NOT EXAMINED

- Jun 2016 NOT EXAMINED

- Mar 2016 q2 a, b (answer): application of IFRS 13 principles to measurement of farm land with alternative use; application of IFRS 13 to

determine fair value of farm produce at harvest based on “the principal and

most advantageous market” criterion.

“Answers to the second issue on the fair value of farm produce were quite

mixed. The question provided information from three markets for the produce,

including sales volume, price and costs.

Candidates who had practiced Q2 (a) from June 2015 would have been familiar

with the requirements of IFRS 13: the relevance of the principal market and

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The standard specifically excludes the following because they are covered by other

standards:

- Farmland accounted for as PPE (IAS 16) or as investment property (IAS 40) - Farmhouse accounted for as PPE (IAS 16) or as investment property (IAS 40)

- Farm vehicles and equipment accounted for as PPE (IAS 16)

- Intangible assets (IAS 38)

- Bearer plants reclassified to IAS 16 by IASB amendment since June 2014

effective 1 January 2016. Most firms are opting for the cost model in preference

to the valuation model also available under IAS 16.

- Produce after harvest awaiting sale (IAS 2 Inventories)

- Harvested logs used for the construction of a building (IAS 16)

- The use of produce in further processing as in agribusiness activities that are not

unique to agriculture.

For the exam, you should expect all assets and related liabilities to be examined

within an agricultural context regardless of which standard is applied to their

recognition and measurement. Your task is to apply the correct principles to the

relevant issue.

THE MAIN ISSUES YOU MUST ADDRESS

Agricultural produce

- Ideally freshly harvested produce should be valued at fair value at the point of

harvest. Fair value in this instance means “farm gate” market prices. These are

real (not hypothetical prices) that reflect the assets as they exist, where they are

located, in the condition they are in, as of the measurement (statement of

financial position date).

- Where such “farm gate” market prices are not available the measurement of

agricultural produce should be based on fair values less point-of-sale costs.

Point-of–sale costs are exclusively related to selling activity and they include

commission, levies, taxes and duties. Fair values would be market prices less

transportation costs (IFRS 13). But IAS 41 does not require the use of the most

advantageous price in accessible markets as there may be good commercial

reasons why the entity may choose to sell in different markets. Hence there may

be a variety of fair values for the same produce.

- For the purpose of measurement distinguish between agricultural produce at

harvest (March 2016 q2 – measured on the basis of market prices in the

principal and most advantageous market) and agricultural crops growing prior

to harvest (June 2015 q2b – measured using a valuation technique as there is no

active market to generate reliable prices). There should always be a fair value for

harvested produce as there will be an active market. Active market conditions:

i) same product traded throughout the market; ii) available and willing buyers

and sellers participating in accordance with custom and practice; iii) price is set

by market forces based on ample information accessible to participants; iv)

accessible and efficient market.

Commitments

most advantageous market, and what costs are included within a fair value

calculation.

Weaker candidates spent considerable time listing out workings for each market

with no accompanying explanation. The question required a discussion, and

answers without discussion or justification of calculations gained few marks.”

Examiner’s report, March 2016

- Dec 2015 NOT EXAMINED

- Sep 2015 NOT EXAMINED

- Jun 2015 q2a (answer) valuation of agricultural vehicles in the principal

and most advantageous market in accordance with IFRS 13 principles.

“Part (a) of the question required the application of IFRS 13 to agricultural vehicles. The main principles involved were the application of principal and

advantageous market definitions to a set of data. Candidates were awarded

marks based upon the principles involved and the application of those

principles. Answers were quite disappointing considering the fact that the

market definitions are the cornerstone of IFRS 13. As mentioned above, the

principles involved in this part of the question were quite basic and fundamental

to the standard.” Examiner’s report, June 2015

- Jun 2015 q2b (answer) measurement and accounting for biological assets

(short-lived crops grown on own land) using a valuation technique in

accordance with IFRS 13 where no active market exists for partly-grown

crops.

“Part b of the question required candidates to apply a valuation technique to

the valuation of short-lived crops where there was no active market for partly

grown crops.

A discounted cash flow method was used to value the crops and the entity

wished to know how they should account for the biological asset at various

quarterly dates and when the crops were sold.

Candidates needed to use discounted cash flow techniques to value the crops.

This part of the question was not well answered.

Valuation techniques are used extensively in corporate reporting and therefore

candidates must become accustomed to using such techniques in answering

questions.” Examiner’s report, June 2015

- Jun 2015 q2d (answer) “highest and best” use of (unproductive) farmland;

carrying value previously measured on revaluation model basis.

ADDITIONAL PRACTICE QUESTIONS

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- The commitments relating to agricultural produce e.g. forward contracts of sale

and their implications for measurement, especially where they may be onerous

as defined by IAS 37 (a contract is onerous when “the unavoidable costs of meeting the obligations under the contract exceed the economic benefits

expected to be received under it.” This would be the case where the forward

contracted delivery price is lower than the fair value of the produce.) However,

“the fair value of the produce is not adjusted because of the existence of a

contract”. [IAS 41.16]

- Keep in mind that a forward sales contract is scoped out of IAS 39/IFRS 9 if the

agricultural producer intends to settle the contract by physical delivery of the

produce as opposed to “settling net” as in the case of a derivative (accounted for

within IAS 39/IFRS 9). But remember it is also possible for the producer to

settle the contract net in cash or another financial instrument, or by exchanging financial instruments on terms favourable to the producer. So, read the question

carefully! This examiner always explores duality where the opportunity exists.

An example is Jun 2010 q3a (answer) which also includes hedge accounting.

See also How to answer questions about derivatives.

- When the producer chooses to settle the contract by physical delivery of the

produce the contract is an executory contract. When the producer chooses to

settle the contract net the forward sales contract is a financial instrument.

- An executory contract is one in which no obligation arises until the producer has

delivered the goods; thus this type of contract is excluded from IAS 37 unless it

is onerous as defined above. See the conceptual framework (CF) 4.40

- A financial instrument is a contract where an obligation arises at the inception of

the contract.

Part-grown consumable biological assets

- The measurement of biological assets reflects the accretion (increase in value)

of the biological asset as they are transformed into mature plants and animals

that yield marketable produce such as milk, coffee beans, meat and oil palm

fruit. During this time, there is no active market hence reliable IFRS 13 Level 1

market prices are not available for use as inputs for valuation.

- The measurement objective is the fair value of the asset is based on its present

location and condition. IFRS 13 Level 3 valuation techniques as in Jun 2015 q2b

(answer) may be used. Estimates of cash flows should reflect what a “market

participant would expect the asset to generate in its most relevant market”.

Government grants

There are two types of government grants: revenue and capital. Revenue grants

contribute to revenue expenditure as explained under IAS 20. Similarly, capital

grants contribute to capital expenditure.

1. “The IASB ultimately identified fair value as having the best combination

of attributes for the determination of agriculture-related earnings. The

IASB was particularly influenced by the market context in which agriculture takes place and the transformative characteristics of

biological assets, and it concluded that fair value would offer the best

balance of relevance, reliability, comparability and understandability.”

Required

1.1 Explain what you understand by fair value, identifying the

“combination of attributes” that makes it superior to historical cost.

Explain by reference to the Conceptual Framework for financial

reporting. E.g. paras 6.21-6.33

1.2 What are the primary features of agriculture-related earnings? How is fair value particularly suited to “the determination of agriculture-

related earnings”? Explain by reference to the Conceptual Framework

for financial reporting. E.g. para 2.21

1.3 Which characteristics of the conceptual framework are most important

in addressing the “transformative characteristics of biological assets”?

Explain by reference to the Conceptual Framework for financial

reporting. E.g. paras 2.25, 2.29

2. Discuss the applicability of materiality to the measurement and

recognition practices in IAS 41. Hint: i) when does cost approximate fair

value such that the biological asset is measured at cost? IAS 41.24; ii) re-

measurement at annual intervals; iii) if agricultural use is incidental to the

purpose for which the agricultural asset is held how should the asset be

classified?

3. Biological assets are attached to land which has been improved to enhance

biological transformation. An active market exists for the combined farm

unit and the land but there is no separate market for the biological assets.

Explain how the fair value of the biological assets may be measured.

4. Accounting for plantation initially measured at cost, subsequently measured

at fair value. How should the change in carrying value be recognised?

5. Accounting for compensation for loss due to natural disaster: combination

of insurance and government grant. Explain the principles that govern the

recognition of compensation for loss a) from insurers; b) from government

6. Accounting for produce harvested for own use. What measurement basis is

appropriate for recognising a) produce for own use as raw material in

production; b) produce for use in road construction?; c) produce for own

use in staff canteen. Explain your answers citing relevant principles of

measurement in the Conceptual Framework.

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For IAS 41 the basis of measurement (cost model or fair value model) of biological

assets is a key determinant of how grants are accounted for.

Fair value basis

Biological assets measured at fair value less cost to sell. Fair value is the “exit price”

determined from the perspective of a market participant (e.g. consumer or

manufacturer using the produce as inputs). This has significant implications for

how a grant is accounted for because the entity, not the market participant, receives

the grant.

The fair value is the price that would be received to sell the produce (or crop)

irrespective of a grant. Hence

- Where an unconditional grant e.g. a subsidy is available, the grant should be

accounted for separately in profit or loss when receivable, and not deducted from the fair value of the biological asset (produce or crop). In the case of a subsidy

apply IFRS 15 to account for the revenue and IAS 20 to account for the grant.

- A grant to compensate farmers for actual loss of fair valued produce e.g. due to

the outbreak of crop disease is an unconditional grant to be accounted for as a

grant under IAS 20.

Cost basis

In contrast to fair value the cost of an asset is the “entry price” – the amount

sacrificed by the entity to acquire the biological asset. Where a grant is received as a

contribution to the cost of acquiring an asset, in substance, the amount sacrificed by

the entity is reduced by the amount of the grant. Hence where the biological asset is

measured at cost less accumulated depreciation less impairment (to obtain the carrying value) the grant should be deducted from its carrying value.

Accounting for gains and losses

The exception to the fair value model

Biological asset Biological produce

Event Calf is born, procure livestock

Harvest, slaughter of livestock to produce meat, harvest of trees, etc.

On initial recognition at fair value less cost to sell (FVLCS); or at farm gate prices where applicable. Farm gate prices are not

applicable if harvest site is remote.

Gains and losses recognised in profit or loss

Gains and losses recognised in profit or loss

Classification after initial recognition.

IAS 41 IAS 2

Changes in FVLCS. IAS 41 requires fair value to be determined at the reporting

date.

Gains and losses recognised in profit or loss

Not applicable: assets accounted for under IAS 2 until they are sold.

7. After harvesting, produce is held for maturation over a number of periods.

How should such items be a) accounted for and b) measured initially, and

at the end of each accounting period? Identify and explain the measurement principles of the relevant IFRS.

8. What measurement basis is appropriate for produce growing on bearer

plants or short-term crops? Explain your reasoning. Hint: see June 2015

q2a (answer)

9. What measurement basis is appropriate for a) livestock (e.g. cattle) and b)

harvested livestock (carcass)? See The maths of IAS 41

10. If produce is harvested at a remote site farm gate prices are not applicable

as fair value because the goods cannot be sold at that site. Instead, market prices at an appropriate market would be determined. Where that is the case

such market prices must be reduced by the transport costs to obtain fair

value. Do you agree? Give reasons.

11. If a noncurrent biological asset is classified as held for sale and included in

a disposal group in accordance with IFRS 5 it is presumed that its fair value

can be measured reliably. Do you agree? Give reasons.

12. The change in the fair value of a biological asset consists of i) physical

change through growth and ii) price change. Separate disclosure of these

components is encouraged where the biological transformation takes place

over a number of periods. Do you agree? Why is this information useful to investors?

HOW YOU SHOULD PREPARE

Practise assiduously using the above and other questions to address all the key

issues, problems and interactions within the scope of agriculture and related

aspects. Below is a checklist of the minimum you should aim to cover to get full

marks.

1 Critical events in the biological transformation cycle

2 Issues in measurement: crops, produce, livestock. FVLCS measurement

basis should be applied consistently; cost exception is temporary. Convert to FVLCS at the earliest.

3 Relevant market for agricultural produce. If active market does not exist

how should the price be determined?

4 Issues in measurement: discount rate (pre-tax) weighted average cost of

capital; match the discount rate to the measurement period: convert to

quarterly, half yearly if given annual rates; measure accretion between

periods.

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Only at initial recognition: at cost less accumulated depreciation and impairment

losses. The scenario might be a subsidiary acquires unique or immature biological

assets (not a bearer plant) from a parent for no consideration. Subsequently a buyer is found, or the assets reach maturity such that market prices can be determined.

Disclosure objectives and principles

The objective of disclosure is to provide information that enables users to understand

the nature of agricultural activity, assess financial performance, future cash flow

prospects, and operating capacity.

Assessing the timing of future cash flows

Hence the entity discloses information that is helpful in assessing the timing, amount

and riskiness of future cash flows. This would include information that allows

assessment of the different configurations of cash flows arising from different types of biological assets at different stages of transformation

- On an understandable basis the inventory of biological assets is described,

quantified and classified into bearer and consumable, mature and immature

groups. IAS 41.43,44,45

- Any restrictions on sale due to claims by third parties secured on the biological

assets. IAS 41.49.a

- Strategies for managing cash flow risks such as hedging and any contracts that

are onerous as a result. IAS 41.16

Assessing financial performance

The entity discloses in the notes, information that allows assessment of the effects of

biological transformation, sale of biological assets and sale of produce on the income for the period.

- Aggregate gains and losses arising from initial recognition and subsequent

changes in fair value

- Gains and losses on disposals

- Impairments losses

Assessing cash generation capacity of biological assets

The entity presents separately on the face of the statement of financial position the

amounts of current and noncurrent biological assets. In addition, the entity provides

descriptions of each group of biological assets comprising the carrying amounts on

the statement of financial position. - Carrying amounts and changes due to growth and accretion

- For multi-period activities analysis of growth due to quantity and price

- Measurement bases of carrying amounts of biological assets at the end of the

period

- Decreases due to harvest

- Commitment to acquire or develop and replenish harvested and depleted assets

IAS 41. 49b

- Risks due to weather, climate change, disease and mitigating strategies such as

insurance

- Details of financial risk management strategies

- Restrictions on assets

5 Issues in classification and recognition: between IAS 16 (bearer plants,

farm land, house, vehicles, equipment) and IAS 41 (other biological assets);

between IAS 41 and IAS 2 (biological assets reclassified as inventory after harvest.)

6 Disposals: revenue arising from sales is accounted for under IFRS 15.

7 Distinguish between produce (e.g. milk, beef, sugar cane IAS 41) and

processed produce (e.g. powdered milk, processed meat, etc. IAS 2)

8 Make sure you are clear about all the terms and you are able to distinguish

between them. For example, between biological assets (e.g. crops and

animals) and non-biological assets (e.g. land)

9 Be prepared to calculate gains and losses in biological transformations e.g.

in crops, livestock using a) valuation technique, b) fair value (farm gate

prices where applicable) and c) fair value less cost to sell, but remember

that biological transformation stops after harvest.

10 Impairment losses.

11 Ethics and corporate social responsibility aspects of agriculture. Read and

analyse the relevant annual reports as suggested.

12 Prepare for various scenarios and write your own questions. Examples: fire,

disease, ravages farm; government response, insurance compensations. Implications for measurement.

13 Issues in presentation & disclosure

14 Mark your own scripts according to the marking scheme – see generic

marking guide: how to score full marks. Make sure you are scoring well

above the pass mark under timed conditions.

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- Unsustainable activities

- Reconciliations of the movements during the year including exchange rate

movements IAS 41.50

Corporate social responsibility and ethics

Agricultural activities can cause environmental hazards such as fire, waste of water

resources, degradation of natural resources and pollution. Animal welfare issues can

cause reputational risks that can be potentially costly in terms of fines and loss of

customer loyalty. You should therefore be alert to these issues when preparing for

your exams. You should read the annual reports of agriculture companies or

companies with significant agriculture components. Examples include

- Sappi (2016), Our key material issues, p33-43 (e.g. material issue: water, p43)

- Associated British foods plc (2016), p26-28 (e.g. adding value by improving the

sustainability of food production, p28)

IFRS 2 Share-based

payment

1,

2,

3

Key standard that prescribes the accounting practice for transactions, including

employee remuneration and compensation, that are measured based on the value of

the entity’s shares. Settlement options: i) equity-settled; ii) cash-settled; iii) hybrid

(part equity and part cash)

In this area, as in many others the examiner is assessing understanding of basic

principles of classification, recognition and measurement and the ability to apply basic principles to typical transactions including deciding whether transactions are

within the scope of IFRS 2. The examiner’s favourite technique is exemplified in Dec

2010 q2c, & answer. Two similar transactions are presented both involving shares.

One is a share-based payment (IFRS 2) transaction and the other is not. The surface

features are similar but the core features are different requiring critical thinking to

distinguish the two.

Be prepared to explain and advise:

- Whether IFRS 2, IFRS 3, IFRS 10 or IFRS 13 (or a combination e.g. IFRS 2

interacts with IFRS 3 Dec 2010 q2b) applies to the transactions in the case study

e.g. June 2015 q2c; Dec 2010 q2 (answer) - Whether a financial liability or equity or both should be recognised where either

the entity or the supplier has the choice of settlement of the obligation.

- When an obligation arises for a cash-settled share-based payment (e.g. SARs) it

is recognised as a financial liability (classified as at FVTPL). Why not as at

FVOCI given the obligation does not crystallize until the vesting period is over?

- Why the obligation is not accounted for as a provision under IAS 37.

- Why the obligation is not a contingent liability under IAS 37 given that the

obligation is contingent on performance criteria being satisfied during the

vesting period.

- The deferred tax consequences of share based payments

- The purchase by an entity of shares from its employees above the fair value of

the shares (the excess being treated as a share-based payment) - Why the obligation is not discounted to present value at the reporting date (as for

contingent consideration IFRS 3; long-term benefits IAS 19).

- All the calculations including deferred tax

- Distinguish between share based and normal types of payments

Attempt all the past questions noting the examiner’s approach.

Questions for further practice

- September 2017 q2a (answer): what is the difference between employees and non-employees share-based payment obligations? Compare

measurement basis with IFRS 13.

- June 2016

- March 2016

- December 2015

- September 2015 not directly examined; effect of financial reporting fraud

on share options (q1c)

- June 2015 q2c (answer) valuation of share appreciation rights (SARs)

- June 2015 q3b (answer) share-based transactions (acquisition of patent,

royalties).

- Dec 2014 q1b (answer) - June 2014 q1a (answer)

- June 2012 q2c & answer

- Dec 2010 q2a,b,c,d & answer

Terminology you should be clear about

- Cash settled

- Deferred tax

- Equity

- Equity settled

- Exercise price

- Financial liability

- Grant date - Intrinsic value

- Non-vesting

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Be prepared to compare share-based payment with share appreciation rights. For

example, June 2015 q2c: what if the award was of share options instead of SARs? How would the amounts (measurement) and classification (recognition) have been

different?

- Interacts with deferred tax (IAS 12), Financial liabilities and equity (IFRS 9)

Read the text:

IFRS 2 Share-based payment

Technical article

- Settlement options

- Share appreciation rights (SAR)

- Share-based payment - Share options

- Striking price

- Vesting

- Vesting period (or service period)

Measurement & settlement issues: basis for estimating carrying amounts

- Time apportionment of costs of awards (accrual accounting)

- Estimates of leavers prior to vesting (e.g. 5% of initially eligible

employees)

- Re-measurement of obligations at the reporting date: i) equity-settled (cost

at grant date); ii) cash-settled (e.g. SARs based on fair values at the reporting date)

- The impact of cash payments

- The impact of modifications and cancellations.

IFRS 3 Business

combinations (part of

D.1)

1a,

2,3 This core standard is frequently examined – just look at the pattern of past questions

in the box on the right. You should therefore expect IFRS 3 in every exam. This

means that you should learn and practise all the key IFRS 3 issues. The key issues

are: - The application of acquisition accounting principles to the recognition of the

business combination transaction. E.g. determining the acquirer in a merger Dec

2013 q3c; March 2017 q2b: classifying net assets into identifiable net assets

and goodwill.

- Non-acquisition costs must be separated from and separately accounted for.

Examples: transaction costs, costs of post-acquisition services, etc.

- How should post acquisition errors and transactions be treated?

- What is a business combination as opposed to an acquisition of assets? Dec 2014

q3a. This topic is on the IASB’s work plan. ED2016/1 is not an examinable

document but it is prudent to get familiar with its objectives.

- Fair value measurements – satisfaction of the “probability” and “reliable measurement” criteria for the recognition of intangible assets. For intangible

assets acquired in a business combination the “probability” criterion is always

regarded as satisfied. This is because the purchase price is determined prior to

the acquisition. June 2011 q1b

- Alternative measurements – exceptions to IFRS 13 that are essential e.g. share-

option plans acquired.

- Goodwill: full, partial and the implications of the method adopted. June 2015

q1a

- Goodwill: impairment basis for recognition and measurement.

- Contingent consideration: a clear understanding of the concept as a financial

liability (June 2015 q1b & answer) and its application in the post-acquisition

period. Questions may require candidates to: i) demonstrate understanding of the principles of recognition of financial liabilities at the inception of the contract; ii)

deal with re-measurement gains and losses; iii) distinguish between contingent

Past ACCA P2 questions for practice:

- March 2017 q2b (answer): apply recognition criteria to classify acquired

net assets between “goodwill” and “identifiable net assets”.

- December 2016 q3b (answer): fair value measurement and bargain purchase gain

- Sep 2016 q3c (answer): bargain purchase of a business with investment

property as its only asset; includes tax payment as part of the property

value.

- Sep 2016 Q2b (answer): deferred tax due to fair value and the tax base of

the acquired assets of the subsidiary being different.

- Jun 2016

- Mar 2016

- Dec 2015

- September 2015 q3a: acquisition of “shell company”, intangibles, inventory

valuation (interesting point given that IFRS 13 does not apply to inventory whereas acquisition date fair values apply – implications for other

exceptions such as IFRS 2 Share based payment could they be next?).

Nonrecurring item: IAS 1. Pay attention to this ubiquitous standard. ED

2015/1 is an examinable document

- Jun 2015 q1a & Answer partial and full goodwill; NCI valued separately on

the basis of market prices and PE ratio

- Dec 2014 q1a & Answer

- Dec 2014 q3a & Answer what is a “business”?

- Dec 2013 q3c & Answer determine the acquirer

- Jun 2013 NOT EXAMINED

- Dec 2012 NOT EXAMINED

- Jun 2012 q3ai & Answer basis of recognition of impairment of goodwill - Dec 2011 q1a & Answer: partial and full; impairment testing on both.

- Jun 2011 q1b & Answer transition to IFRS

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consideration and employment benefits where previous owner managers have a

continuing involvement with the acquired entity.

- The presentation of an acquisition in the statement of cash flows - IAS 7 Cash flow statements

- IAS 10 Events after the reporting period: twelve-month post acquisition

measurement period

- IAS 8: errors

- Treatment of negative goodwill – what is the rationale for recognising “negative

goodwill” immediately in profit or loss whereas its binary opposite, positive

goodwill, is deferred and is only recognised in profit or loss when it is assessed

as impaired in accordance with IAS 36.

- Jun 2011 q2b “probability” and “reliable measurement”

- Dec 2010 q2b & Answer IFRS 2 Share-based payment – business

combination resulted in a replacement award.

IFRS 5 Noncurrent

assets held for sale

and discontinued

operations (part of

D.2)

1a,

3 The Examiner’s central concerns in this frequently examined topic are that

- The conditions for classification as held for sale are satisfied.

- The disposal group or subsidiary is impairment tested (in accordance with IAS

36) immediately prior to it being classified as held for sale as the decision to sell

is deemed to be an impairment trigger; is assessed for impairment while

classified as held for sale in accordance with applicable IFRS; is measured at the

lower of carrying value and fair value less cost to sell at each reporting date.

- The measurement of fair value reflects any contingent liability not previously

recognised under IAS 37 because a transfer of resources embodying economic benefits was not expected to be incurred to settle the obligation.

- Any impairment loss is immediately recognised in profit or loss to the extent that

it exceeds any revaluation gain previously held on the asset. Any subsequent

revaluation gain is recognised in profit or loss to the extent it is required to offset

previous impairment losses.

- Any disposal group or discontinued operation is properly presented and

disclosed (read examiner’s report and perform q1a, b December 2012 & ans.)

- The allocation of the impairment loss is only to the operating assets (IFRS 5 assets: goodwill, intangibles, PPE). Apply the rules: eliminate goodwill entirely;

then apportion the rest to the remaining operating assets pro-rata to their carrying

values. Refer to examples in spreadsheet. The impairment loss is not allocated

against any other assets (e.g. available-for-sale investments, current assets,

deferred tax assets, etc.) in the disposal group, and it is not allocated against

related liabilities.

- That depreciation is not charged on assets “held-for-sale” as the asset’s

carrying value will be recovered through sale. Depreciation is only justified

where the carrying value of the asset will be recovered principally through

continuing use. “Continuing use” implies that the asset is classified as operating

(IAS 16) – not investing (IAS 40). Note that IAS 38 intangible assets which are also operating assets are “amortised” – not “depreciated”. Refer to P2TT for an

explanation of the differences.

Practice questions:

Read the annotated examiner’s reports. Attempt these questions and make sure

you are thorough with the discursive aspects.

- March 2018 q4aii (answer): Explain how uncertainty affects the

definition, recognition, classification and disclosure criteria in IAS 37 and

IFRS 5.

- March 2018 q1a (answer): consolidation involving subsidiary held for sale

- March 2018 q1b (answer): justify classification of disposal group

(proposed sale of subsidiary) as held for sale.

- Dec 2016 NOT EXAMINED - September 2016 q3b (answer): uncertainties regarding “binding offer”.

- June 2016 q3b (answer): disposal of players’ registration rights

- Mar 2016 q3b (answer): business acquired in the year could be impaired;

management intends to sell it. But there is insufficient evidence of active marketing: is it eligible to be classified as “held for sale”?

- Dec 2015 q2a (answer): sale of non-major line of business; goodwill incorrectly

allocated to CGU on disposal - Sep 2015 NOT EXAMINED

- Jun 2015 NOT EXAMINED

- Dec 2014 q1a.6 (answer): comprehensive IFRS regarding sale of property

involving revaluation surplus (deferred in equity) and impairment loss

recognised in profit or loss.

- Jun 2014 q3d (answer); after property recovered impairment loss it was sold

after the end of the year of acquisition.

- Dec 2013 q2b (answer): measurement of disposal group; classification of

expenses between continuing and discontinued operations.

- Jun 2013 q3c & answer: the authorised sale of the entire holding of shares in a

subsidiary did not take place within twelve months of 1 January 2012 (date of authorisation); subsidiary classified as held for sale year ended 31 May 2012; management still intends to sell but subsidiary receives more activities from the parent as part of the restructure. No concrete evidence of active marketing of shares exists at 31 May 2013 but still classified as held for sale. Is this correct? Advise the correct treatment.

- Dec 2012 q1c (answer): ethics of intended sale of property - Jun 2012

- Dec 2011

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- Candidates understand, and can determine, the two types of losses that can occur

with respect to assets classified as held for sale: i) IFRS 5 measured loss and ii) non-IFRS 5 measured loss (arises when non-IFRS 5 rules are applied to the

relevant items in the disposal group e.g. re-measured inventory, provisions and

available for sale investments): Refer to examples in spreadsheet. “…the

identification and prioritisation of issues will be a key element of the paper.”

Approach to examining the syllabus, P2-study guide, p7. This is an example of

how this approach applies. In particular, note the prioritisation of losses in the

worked example.

- Interaction with other standards is a key feature of IFRS 5 questions e.g. IAS 36,

IFRS 10, IAS 16, IAS 40

- Interpretation of performance e.g. EPS calculation following disposal

- Pay attention to the dates so that the correct amounts for depreciation (prior to

being classified as held for sale), impairment loss and subsequent gains when the

fair value increases are calculated and recognised appropriately.

- Reversals of impairment of goodwill are prohibited.

Make sure you can raise the journal entries for all the adjustments correctly: see

worked example. An impairment loss is an expense (debit) presented in the profit or

loss (income statement); the expense is set against the carrying value of the related

asset (credit) to reduce it to the recoverable amount which is presented in the statement of financial position.

- Jun 2011

- Dec 2010

- Jun 2010

See The maths of IFRS 5

IFRS 7 Financial

instruments

disclosures (effective

since 1 January 2007)

Putting IFRS 7 into

perspective Shareholder perspective

Prospective investor perspective

Creditors’ perspective

Conceptual perspective

Convergence with other IFRS

Links to other IFRS (transactions)

Practicality: what practical issues

impact IFRS 7?

Definition: the risk that the entity

may not be able to settle its

financial obligations that are

settled in cash or another

1b,

1c,

4

What is it for? The objective of this standard is to provide adequate transparency of information

about financial instruments so that users can better assess

- The significance of financial instruments for the entity’s financial position and

performance

- The nature and extent of the risks that an entity was exposed to

- How the entity manages those risks

What you should learn As well as a financial instrument topic this standard should also be studied as a

current reporting issue H.3. in connection with the other ongoing report

improvement initiatives.

- Conceptual framework for financial reporting (Ch 7: Presentation and

Disclosure)

- Integrated reporting, Elevating value by E&Y

- Better communication

- ED2015/8 IFRS Practice Statement: Application of Materiality in Financial

Statements

WHAT YOU SHOULD EXPECT You should expect this standard to be examined in every exam because of the

continuing efforts to improve the quality of information, and disclosure is a

key part of every initiative. Moreover, financial instruments are a significant

part of the entity’s capital; their inherent contractual obligations are significant

to financial risk, performance and position.

“some users would like additional disclosures to better understand the different

types of debt financing by the entity. The changes should help users in making investment decisions.” December 2016, q4aiii (answer)

Read Deloitte 2017 model financial statements, pp139-150

- Get familiar with the key practical issues that the examiner is concerned

with.

- Think about possible future questions arising from the issues highlighted

e.g. how can disclosure be made relevant and useful without being

excessive (June 2013 q4ai, answer)?

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financial asset but not in own

equity instruments.

Funding liquidity risk: is there

enough cash to cover exposures

e.g. under futures contracts?

Market liquidity risk (or asset

liquidity risk)

How does disclosure capture and reflect the difference?

The disclosure initiative

Better communication

Matters about which judgement is

required

Examples of “better

communication “

Losses on futures contracts

United and Delta Airlines $3bn in

2015

Answer quality control

Skilled reasoner about disclosures

Understand how to identify

matters of disclosure significance

Execute the entire line of

reasoning in full; not bullet points

Can recognise matters of

accounting significance

Can distinguish between

financial risk disclosures (IFRS

7) and operational risk

disclosures (IAS 37). Select

typical examples for the

upcoming exams where the two

standards converge or interact.

Examiner’s recommended model

Outline knowledge of the issue

Apply knowledge to resolve the

issue (decide the correct

treatment for true and fair view)

Exercise professional judgement

Special purpose vehicle (if not

consolidated)

- The definition and disclosure of capital (an annotated version is available under

Reading effectively for the professional exams – see lead page above).

How you should learn “This subject area lends itself to spaced learning and not massed learning. It is important to relate the learning to practical events…”. Many candidates simply set

out everything they know, hoping that some of the material is relevant. There is a

need for a broader understanding rather than rote-learnt facts. This will only arise

if candidates space out their learning and fully understand different parts of the

syllabus as they learn.” Examiner’s Report, June 2013

Therefore, in studying for the exam it is essential to keep in mind the intellectual

level at which the subject matter is to be studied (Level 3: synthesis and evaluation)

and what that implies for the approach you should take to studying the standard. For

example, you are expected to think critically and apply the conceptual framework

principles to evaluate disclosures in various contexts and situations. It is therefore essential that you study the documents listed above and adopt professional

scepticism towards disclosures.

In addition, “to relate the learning to practical events” it is essential that you study

and compare examples of financial instrument disclosures of two: lender (e.g.

Barclays, HSBC, Tesco (2016)) and borrower (e.g. Balfour Beatty, Tesco (2016))

published financial statements to get acquainted with real issues and how they are

dealt with.

The implications of the user-perspective The primary users of the current published general purpose financial information

need to be satisfied that their capital is safe, and that it has earned an acceptable

return; in addition, they need to make decisions about maintaining, withdrawing, or

increasing capital. They need assurance that future income and capital growth will be

adequate and secure. Therefore, any issues that put at risk their capital and its ability

to earn an acceptable return is of crucial importance to them. The disclosures in the

published financial statements must address those concerns while demonstrating how

financial instruments contribute towards the resources needed to meet stakeholder

expectations.

Evaluate the decision-usefulness of the required disclosures (the user-perspective)

and think about how those considerations influence the examiner’s choice of issues

(June 2013 q4bi,ii, answer). Salient issues can be found in the Management

Commentary and the guidance provided by the FRC on the Strategic report (see

G.2) which requires a “balanced and comprehensive analysis”. For example, FRC

guidelines recommend disclosure of information about changes in net debt and

financing arrangements.

Analyse and synthesise your thoughts about the issues using the following checklist

in conjunction with Deloitte’s model financial statements. To think critically keep

asking: what do users need, for what purposes and does the accounting and reporting

system (IFRS applications) provide what they need? How can management

Connectivity and integrated thinking Applying the disclosure principles of IFRS 7 brings together related

requirements and guidance in IAS 1, FRC and IFRS 9 regarding capital, its

composition, financing, allocation, measurement, evaluation and disclosure.

Separately, and in combination, this information is relevant to appraisal (G.2),

segment reporting (IFRS 8) and risk management (IFRS 9).

Assembling the information and making sense of it are complex tasks that

depend on varied and uncertain (principles-based) classifications. For example,

classifying between debt and equity, and determining what is “capital” given the diversity of capitals, are based on subjective assessments of the terms and

conditions of complex transactions such as debt with an equity conversion

option, financial assets that are debt instruments held on SPPI (solely for

payment of principal and interest) terms and measured at amortised cost.

Therefore, you should expect questions that require advice to management

about the means of recording and classifying the information to be disclosed,

particularly an explanation of classification principles and distinguishing

between financial instruments and non-financial instruments. These

requirements may be examined at q1b or q4 under IAS 39/ IFRS 9. The effects

(on carrying amounts at the reporting date) of classification may also be examined at q1a.

You should also expect questions about purposeful disclosure (as opposed to

boiler plate disclosures) that require you to critically appraise the usefulness

of disclosed information from the perspectives of primary users of financial

information. This requires knowledge of ED2015/8 IFRS Practice Statement:

Application of Materiality to Financial Statements.

You should also expect questions about gearing (capital risks) requiring you to

calculate it, and evaluate the suitability of the amount calculated given the

components of the ratio (e.g. net debt/equity, equity comprising OCE

elements – justify inclusion or exclusion).

Disclosures about liquidity allow current and future liquidity assessments, and

disclosures about the impact on the statement of comprehensive income allow

assessments of future earnings.

HOW YOU SHOULD PREPARE

The benefits of disclosures are assessed from the perspectives of specific

stakeholders. Therefore, alongside the matters referred to above you should

focus on the following matters that affect the stakeholders of specific firms.

- Relating risk to cash flow: examine certain disclosures through the eyes of

an investor and ask the sort of questions an investor would ask e.g. do we

have adequate cash to cover our exposures? Management routinely asks

this question; substantial exposures would attract shareholders attention.

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incentives determine what is disclosed and the quality of disclosure? What can go

wrong as a result? Think about the principal-agency problem.

The ethical perspective For example, there is a high degree of subjectivity in the measurement and disclosure of financial instruments particularly IFRS 13 level 3 (June 2013 q3b,

answer). Faithful representation requires an absence of bias: an absence of bias in

measurement does not mean an absence of bias in what is disclosed. What is

disclosed and how it is disclosed is largely at the discretion of the directors. The way

directors exercise discretion can be influenced by personal interests (e.g. for bonus

and promotion), contractual obligations (e.g. to maintain a strong balance sheet to

keep their job), market pressures (if the market’s perception of the entity is crucial to

its attractiveness, growth and survival). This type of issue can be examined at q1c.

1ST PRINCIPAL OBJECTIVE OF IFRS 7: FINANCIAL PERFORMANCE AND FINANCIAL POSITION SIGNIFICANCE

Statement of financial position disclosures Capital maintenance objectives

IFRS 7 disclosures facilitate the fulfilment of the requirements of the strategic

report for entities to disclose what they consider to be capital and their capital

management objectives.

IFRS 7 requires disclosure of carrying amounts of categories of financial instrument, either on the face of the SOFP or in the notes.

- Financial assets or financial liabilities at FVTPL

- Equity instruments designated at FVOCI

- Defaults and breaches

- Reclassifications

- Derecognition: disclose by class the financial assets transferred that do not

qualify for derecognition (assist users in assessing the significance of the risks

associated with transferred assets that do not qualify for derecognition)

- The management of risks through hedging

- The amount, timing and uncertainty of future cash flows.

- Allowance account for credit losses (assess adequacy of impairment allowance for impairment losses)

Disclosure of finance leases is within the scope of IFRS 7 although accounting is

within IFRS 16.

Income statement and equity disclosures The required disclosures help users assess the performance of an entity’s financial

instruments and activities. The main disclosures:

- Net gains or net losses on i) financial assets or financial liabilities at FVTPL

separating into designated at inception and held for trading sources; ii) available-

- Predicting corporate failure: is the cash flow adequate to cover all risks, if

not which risks are we most exposed to in terms of defaulting on short-term obligations, foreclosures, etc.? How do we evaluate the potential impact?

Can we borrow to cover imminent obligations? Is there enough debt

capacity?

- Report risk exposure based on internal management’s view about financial

risks and how they should be managed using data that represents the

entity’s risk exposure at the reporting date. Required: discuss the ethical

issues that arise in meeting this condition or in fulfilling this criterion of

financial reporting. Hint: disclosing exposure to risk might expose the

management to the risk of punishment or even dismissal for over-exposure

and threatening the financial viability of the entity. What are the

implications of this ethical dilemma?

- An entity’s risk management depends on its internal resource

capabilities: a firm with limited resources can only afford limited hedge

against risks. You may be required to assess the benefits of certain

disclosures given the entity’s context of financial distress. Critical

assessment criteria: i) benefits to shareholders; ii) costs to creditors; iii)

impact on current cash flow restrictions; iv) regulator’s views; v) impact of

financial distress on customers and competitors; vi) impact of financial

distress on other stakeholders; vii) how disclosure might improve the

appetite and management of risk and stewardship of resources.

- How an investor might evaluate the reported risk exposure on futures

contracts gives us an idea of why it is important to disclose risks.

- Show how the fair value option links into the IFRS’s requirements for

disclosures about credit risk. Remember that fair value option is exercised

a) to prevent an accounting mismatch and b) where the assets and liabilities

are managed and reported on together, as a group, in accordance with

documented risk management strategy.

QUESTIONS FOR PRACTICE

1. An entity has a significant portfolio of financial instruments and needs

advice as to how to comply with IFRS 7 Financial instruments: Disclosure.

Required

1.1 Advise the entity’s internal management what should be disclosed

and the reasons for the disclosure.

1.2 Explain the principles of classification and discuss in general terms

how the financial instruments should be classified in order to achieve

the objectives of disclosure. Your discussion should consider

materiality and relevance. Give specific examples.

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for-sale financial assets separately disclosing recognised in the year (OCI) and

reclassified from equity to profit or loss; iii) financial liabilities measured at

amortised cost (FVOCI). - Total interest income and total interest expense (calculated using the effective

interest method) for financial assets or financial liabilities that are not at

FVTPL.

- Fee income and expense (other than amounts included in determining the

effective interest rate)

- Interest income on impaired financial assets

- The amount of any impairment loss for each class of financial asset

The quality of the disclosures will enhance the overall quality of the information

available for appraisal as discussed under G.2

Other disclosures Accounting policies

The disclosure of accounting policies as required by IAS 1 covers the requirements of

IFRS 7. Read Tesco (2016), note 1 p92-5 to get familiar with measurement basis and

concepts used in measuring and managing risks arising from financial instruments.

Hedge accounting

Because hedge accounting is always entity-specific (the entity chooses to hedge in

accordance with restrictive conditions) disclosures of the financial effects of hedging

activities is essential to allow comparisons with other entities. Accordingly, IFRS 7

contains detailed disclosure requirements to enable users to understand the hedging

arrangements and effects of each of fair value, cash flow and net investment hedges.

Read Tesco (2016), note 21 p119

Fair value

The notes to the financial statements must reflect the measurement bases described in the accounting policies section. As financial instruments are recognised and classified

as at fair value to profit or loss (FVTPL) or other comprehensive income (FVOCI)

IFRS 7 requires fair values to be disclosed. Disclosed amounts must reconcile to the

balance sheet amounts. Read Tesco (2016), note 21 p119 and check for consistency

between the notes, the accounting policies and the financial statements (June 2013

q4bii, answer).

2ND PRINCIPAL OBJECTIVE OF IFRS 7: NATURE AND EXTENT OF RISKS

Read Tesco (2016) Note 22, pp123-127 to get acquainted with real issues the

examiner is concerned with.

1.3 Explain and discuss the significance of the following terms in relation

to the entity’s financial liabilities

A) Designated as at FVTPL upon initial recognition B) Classified as Held for trading

C) Amortised cost (SPPI items)

D) Designated at FVTPL using fair value option

F) Designated as at FVOCI

2. Calculate the gearing of the entity (net debt/equity). Evaluate the suitability

of this measure of gearing given its components. Refer to the maths of

IFRS 7.

3. Discuss the usefulness of disclosures about financial assets and financial

liabilities focusing in particular on the issues around A) Derecognition

B) Collateral

C) Reclassifications

D) Defaults and breaches

E) Allowance account for credit losses

Identify the primary user (investor, long-term creditor or short-term

creditor) for whom each of the above disclosures would be most relevant.

Give specific reasons.

4. Explain why disclosure of information about cash flow hedges would be

relevant to an investor. Give specific examples from published financial statements to highlight

A) The requirements for hedge accounting (Accounting policies).

B) The ineffectiveness recognized in profit or loss (income statement).

C) The effectiveness recognized in other comprehensive income.

D) Reclassification of gain or loss previously deferred in equity to profit

or loss (if triggered by the occurrence of a relevant event in the year).

E) The periods in which the cash flows are expected to occur.

F) The periods in which cash flows are expected to impact profit or loss

(income statement).

5. Explain how disclosure of information about the fair value hierarchy

would be useful to an investor. Give specific examples from published

financial statements to illustrate the purposes, requirements and application

issues (June 2013 q3b, answer). Evaluate the following concepts as part of

the discussion

A) Mark-to-market

B) Mark-to-model

C) Relevance

D) Faithful representation

E) Materiality

F) Comparability

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Qualitative: disclose exposure to risk at the reporting date and how they arise;

describe management’s strategies, objectives, processes and policies for managing

those risks and the methods used to measure the risk (June 2013 q4bi,ii, answer).

Quantitative: for each type of risk provide summary quantitative data about the extent

to which the entity is exposed to risk at the reporting date based on the information

provided internally to key management personnel (June 2013 q4bi, answer).

CONCEPT CHECK

Consider the conceptual link to the conceptual framework of the various

disclosures. E.g. risks are disclosed based on how management views and manages

risks i.e. the data and means of assessing risks. This is relevant to decisions about

safeguarding the interest of providers of capital. However, the reliability of the

disclosures may be doubtful because managers may decide to protect themselves from adverse criticism by not reflecting the true level of risks they have incurred.

The data on which year-end risk assessments are based must be representative i.e.

it must reflect the risk exposure during the year. If it is not, the fact must be

disclosed. This ensures that the information is free of bias, is faithfully represented

and the sources of financial risks are transparent.

How you should not attempt to learn You should not be simplistic: remember you are going to be assessed at intellectual

levels 2 and 3. Therefore, you should not adopt a shallow, hasty descriptive approach - learning by rote, or skimming for vague familiarity with lists.

Do not limit your reading to the study guide or textbook: read around the subject. At

this level depth and breadth of knowledge and versatile application ability are

expected.

Do not plan to evade this area because it could be examined as compulsory questions

(q1b,c). Spread your learning over a few weeks and you will find it is not as daunting

as it looks.

6. Explain why a combination of qualitative and quantitative disclosures is

required to enable users to understand and evaluate the nature and extent

of risks arising from financial instruments to which the entity is exposed at the reporting date. Give specific examples from published financial

statements to show how such disclosures reflect the conceptual

framework’s fundamental and enhancing characteristics. In particular,

explain how the investor’s needs would be met by:

A) Credit risk-related disclosures

B) Liquidity risk disclosures

C) Market risk disclosures

D) Sensitivity analysis to market risk

E) Capital risk management disclosures

7. Discuss the requirement that the income statement effects of financial instruments must be disclosed to show separately, the effects relating to

A) Financial assets and financial liabilities designated as at FVTPL on

initial recognition

B) Financial assets and financial liabilities classified as held for trading

C) Financial liabilities measured at amortised cost

D) Available-for-sale financial assets

8. Interaction with IAS 10: Events after the reporting period and financial

commitments (June 2013 q4bii, answer).

9. Ethical perspective: classification malpractice and financial reporting fraud

due to entity being at risk of breach of covenant conditions.

10. Information inconsistency between the notes, policies financial statements,

strategic reports (June 2013 q4bii, answer).

11. Information quality and overload considerations (June 2013 q4ai,ii;

answer): informative disclosures (provide relevant and useful information);

defensive disclosures (disclose to avoid criticism and litigation); evasive

disclosures (volunteering information that obscures and confuses in the

hope that critical questions may not be asked or to hide bad news or the

effects of bad behaviour); inefficient disclosures (failing to tailor

disclosures to entity transactions instead relying on boiler plate disclosures of what might be relevant); ineffective disclosures (out of date disclosures).

12. Discuss the view that “Disclosure of the estimated fair values of financial

instruments is better than adjusting the values in the financial statements

with the resulting volatility that affects earnings and gearing ratios.”

13. What is the benefit to shareholders and creditors of disclosures about

financial guarantee contracts?

14. “If financial liabilities can be recognised at fair value all gains and losses

arising should be reflected in profit or loss.” Discuss

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Past questions for further practice - March 2018 q4c (answer): disclosure of significant financial losses on

speculative foreign exchange forward contracts

- Dec 2017 q4a (answer): discuss investor capital information needs and the

extent to which these are met by current disclosure practices; discuss

classification of debt and equity and the impact on performance

measurement (income statement and OCI effects).

- Dec 2017 q4b (answer): discuss the treatment of certain transactions that

have an impact on capital, the measurement of gearing and capital

employed.

IFRS 8 Operating

segments (effective

since 1 January 2009)

1b,

c,

2,3

,4

Core principle The core principle is that the entity should disclose information to enable users of its

financial statements to evaluate the nature and financial effects of the business

activities in which it engages and the economic environments in which it operates.

The logic of IFRS 8 is the logic of responsibility accounting which provides

relevant information to satisfy the user’s need to understand the business at a level

where the business model materializes into concrete activities in management’s chosen operating environment. Accordingly, the effects of business activities are

segmented to reveal their respective contributions to revenue, profits, cash flow,

assets, liabilities, growth, the products they make, the risks to which they are

susceptible and their principal customers. The segment outcomes are evaluated

against the resources allocated by the CODM, using appropriate performance

measures to demonstrate accountability for the resources allocated.

Always topical because of its potential impact on performance measurement and

reporting, potential abuse of transfer pricing between segments and allocation of

common costs. The requirements of integrated reporting about resource allocation

and value creation has further enhanced the relevance and significance of this standard. In particular, this standard supports IR’s objective of clear performance

analysis and presentation as a means of communicating the entity’s attractiveness and

accountability to investors.

Segment classification and implications - The examiner’s central concern is that candidates can apply basic principles to

scenario given in the question to i) identify an operating segment (satisfy all

three qualitative criteria), ii) identify a reportable segment (satisfy one of three

quantitative criteria), iii) assess whether one or more reportable segments can be

combined and reported as one (economic criteria) and iv) where appropriate

comply with the requirements of the 75% test (external revenue test). Discuss

the issues while examining how the principles apply to the scenario details.

Past questions for practice:

- Dec 2017 q1b,c & answer: identify operating segment; ethical issues in

trading with segments

- Jun 2015 q3a & answers two operating segments: one funded entirely

internally with no direct report to CODM; the other primarily externally

financed, has a head of segment who reports directly to the CODM. Advise whether the segments should report separately, or as one reportable

segment.

- June 2013 q2a & answer analysis of segment economic characteristics to

assess which operating segments can be combined as a single operating

segment. The assessment of economic characteristics of operating

segments is based on the different levels of revenue risk exposure to

different types of customer: i) local train authority (who contracts directly

with the operating segment for fixed price tickets in the local train market)

and ii) passengers in the intercity train market where the operating segment

sells tickets directly to customers subject to demand and supply.

- Dec 2011 q1b & answer (issues in the allocation of common costs to operating segments)

- June 2008 q2a & answer: apply the principles of IFRS 8 to determine

whether operating segments exist in the scenario and whether they should

be reported separately, or as one reportable segment.

Read Deloitte 2017 model financial statements, pp63-68

- Get familiar with the key practical issues that the examiner is concerned

with.

- Relate these issues to past questions and answers

- Think about possible future questions.

QUESTIONS AND ISSUES FOR EXAM PRACTICE

How economic characteristics may affect decisions about combining operating

segments

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Economic characteristics are central to the decision to combine and report

operating segments as a single reportable segment.

- The key exam technique is to apply the salient economic features of risk, return

(growth and profitability surrogates) and control in the analysis of the

commercial context, taking into account all the facts and circumstances, and to

interpret the segment information accurately. The decision to combine or not to

combine should come down to deciding which configuration of operating

segments provides users the best opportunity to assess economic performance

quickly, accurately and completely (relevant information).

- Circumstances that may indicate an operating segment exists include the role of

the segment manager and his relationship to the CODM, e.g. direct reports to the

CODM are deemed to be operating segment managers. The priorities of the CODM e.g. where the organisation can report by geography and products, as in

matrix structure: the CODM’s priorities in making resource allocation decisions

determine the operating segment. For example, if the priority is to increase

market share over a certain region, users would consider information by

geographical market more relevant than information by product.

- Streamlining financial statements by combining operating segments is efficient

and can foster understandability but relevant information reflecting the

interaction between economic factors can be more useful at the operating

segment level. So professional judgement must be exercised through the

overall rationale for segment reporting: see June 2013 q2a & answer for an

illustration of the intellectual level at which questions should be answered.

- Consider also that identification, classification, recognition, measurement and

presentation decisions are particular to the entity. Hence the application of the

principles of this standard can be inimical to the requirements of comparability

between different entities. However, it can be argued that the standard’s

principles potentially enhance inter period comparability of segments within

entities and are perceived as adding value when segment information is

corroborated by external auditors, analysts and management commentary.

Accounting policies and ethics - IFRS 8 does not define what should be included within reportable segments but

requires an explanation of how profit or loss, assets and liabilities are measured

for each reportable segment. Wiley Insights provide succinct guidance notes for

quick revision.

- Allocation of common costs. This area has not been examined since December

2011. Be prepared to answer a question linking this with accounting policies and

ethics as it can lend itself to financial reporting fraud. See December 2011 q1c

(answer). Allocations and adjustments to revenue and profits should only be

included in segment disclosures if they are reviewed by the CODM.

- Segments operating in different currencies may not be combined because of

the differing underlying currency risk indicating different economic

characteristics. - Segments operating in different economies e.g. German segment operating

in a vastly superior economic environment cannot be combined with say a

segment operating in Greece (a relatively weaker economy), even though

they are both operating in the Eurozone. The economic characteristics are

in stark contrast.

How the basis of measurement of profits may affect decisions to combine

operating segments into single reportable segment

- Profitability measured on different basis may need to be restated to a

common basis.

- Asset test may be based on a single common asset type e.g. account receivable.

See The maths of IFRS 8 for an illustration.

The significance of other information required by the standard

The standard requires inter-segment revenue, and the basis of intersegment

pricing, to be reported. See The maths of IFRS 8 for an illustration. See also

Deloitte 2017 model financial statements, pp63-68 and VW 2014 Segment

report

1. Explain the benefits of segment reporting under IFRS 8. Use examples

from published financial statements to illustrate your points.

2. What is the “management approach” to reporting segment information?

3. Discuss the key issues in producing segment information in accordance

with IFRS 8.

4. Evaluate the contribution of IFRS 8 towards enhancing the quality of

financial information.

5. Discuss the factors that may impair the usefulness of segment information

and evaluate to what extent the standard’s disclosure requirements

ameliorate its measurement and presentation shortcomings.

6. Explain why regulators and governments may have concerns about this

standard and discuss how the regulatory infrastructure addresses these

concerns.

7. How may an entity’s segment reporting be affected by

a) The requirements of integrated reporting?

b) A significant prior year operating segment does not meet the criteria

in the current year.

c) Change in management structure as a result of the reclassification of a

business from Europe to UK, following Brexit.

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- Consider also that as segmentation is based on the perspective of management

e.g. Tesco plc 2015 Annual report and financial statements, p94: “The Group’s reporting segments are based on the Group’s internal reporting to the

Chief Operating Decision Maker (CODM)”, there is a risk that certain business

critical information might be concealed or segments might be aggregated

inappropriately to conceal loss making segments within profit making ones.

Tesco plc 2016 Segment reporting note extract. This type of issue could be

examined at q1c.

- Moreover, as IFRS 8 requires that the amounts reported for each segment should

be the measures reported to the CODM for the purposes of allocating resources

and evaluating performance, there is a risk that corporate social responsibility

issues may not be addressed within segments as discussed under syllabus Section G.1 below.

Reconciliation, presentation and disclosure - IFRS 15 requires disclosed information to be reconciled to IFRS 8 segments so

that users can understand the information and the underlying performance it

depicts; reconciliation to IFRS 8 provides a check, ensures consistency and

presentation quality: neither too detailed, nor too aggregated. Given the

importance of IFRS 15 this requirement increases the likelihood of this standard

being examined again soon (possibly in 2017). See How IFRS 15 interacts with

IFRS 8.

- As this standard is primarily concerned with the presentation and disclosure of

reported information it is a good strategy to consider how it is impacted by all

other standards dealing with presentation and disclosure e.g. IFRS 10 excludes intra group income and expenses from the consolidated financial statements but

IFRS 8 does not distinguish between intra-group and extra-group income and

expenses; IFRS 5 discontinued operations and disposal groups; IAS 7

encourages disclosure for each reportable segment of the amounts of operating,

investing and financing cash flows; IAS 36: CGU to which goodwill is allocated

for impairment testing cannot be larger than an operating segment prior to

aggregation with a similar operating segment; the requirements to disclose

impairment losses (or reversals of impairment losses) relating to individual

assets and CGU; reportable segments to disclose impairment losses and

reversals. IFRS 7 requires disclosure of information about the entity’s exposure

to credit risk including concentrations of credit risk reported internally to the CODM.

- What are the implications of a joint venture that is an operating segment? The

financial information reported to the CODM regarding the joint venture will be

disclosed and then reconciled to the corresponding amounts in the consolidated

financial statements, making the required eliminations (e.g. of revenue) to align

with the equity accounted amounts in the consolidated financial statements.

d) Designation of a joint venture or associate as an operating segment?

e) Classification of a foreign subsidiary as held-for- sale?

f) Head office costs? g) Unallocated group financing costs

h) A loss making operating segment with very distinct economic

characteristics?

i) Business acquisitions

j) Asymmetric allocations

k) The CODM using different measures to evaluate segment

performance e.g. one measure of operating profit before taxes that

includes depreciation expense and one that does not. Which measure

is appropriate for segment reporting?

l) Materiality considerations

CONCEPTS TO LEARN

Absolute amount

Alternative quantitative thresholds criteria

Business activities

Core Principle

CODM

Economic environment

Evaluate

Financial effects

Major customer Operating segment

Reconciliation

Reportable segment

Revenue

Segment information

The management approach

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IAS 32, IAS 39,

IFRS 9

1,

2,3 This area is very frequently examined and the knowledge requirements are basic –

knowledge of basic concepts and principles and how they apply to basic transactions

is assessed. Try and practise as many questions as you can repeatedly around the areas mentioned below. As well as calculations practise writing discussion answers.

- Classification of financial assets based on the business model and cash flow

characteristics e.g. March 2016 q1b. Describe the alternative accounting

treatments under IAS 27. The question was not answered well.

- Impairment of financial instruments - measurement of expected credit losses

March 2016 q3a

- Fair value option June 2012 q3b (answer)

- Financial guarantee & loan commitments: q2b 12/14 (answer); the examiner

was not happy. There may be a question about the financial guarantee of a

related party e.g. parent guarantees the subsidiary’s loan for a fee that is in

excess of the compensation from the subsidiary. What is the position? - De-recognition: examined June 2012 q1b & (answer); last examined March

2016 q3a

- Restructuring, impairment, basis of measurement and recognition e.g.

December 2011 qa.4 & answer

- IFRS 9 on hedge accounting: q2c 12/14 & answer; q1a 6/14 & answer; hedge

accounting is normally poorly answered. Expect this question again in June

2018. Read the technical article

- IFRS 9 financial liabilities: q2d 12/14 & answer; September 2015 q4b &

answer. FVTOCI debt: bifurcation of re-measurement losses; reclassification on

disposal; reclassification between amortised cost and FVTPL

- With-and-without method of measurement (not examined since June 2009) to

determine fair values for the initial recognition of the separate components of equity and financial liabilities of a convertible bond. Refer to ACCA q2bi

2009. The examiner’s central concerns are that candidates are able to: i) identify

the nature of a convertible bond and apply the principles of IAS 32 to account

for it from the inception of the contract to redemption or conversion; ii) apply the

with-and-without method to measure the liability and calculate the equity

amount as residual of the fair value of the bond; iii) apply split accounting to

account for the separate components in accordance with the principles of IAS 32;

iv) account for the transaction costs; v) prepare the amortisation schedule; vi)

use the schedule to account for the discount represented by the equity

conversion option; vi) use the fixed-for-fixed principle to account for the

conversion to equity (there should be no gain no loss); vii) early repurchase of convertible bond

Past questions for further practice

- March 2018 q2c (answer): explain the implications of the entity’s business model for the valuation of its assets.

- December 2017 q2c (answer): sale of loan with recourse; expected credit

losses; should the loan be recognised by the seller? How much?

Application of Conceptual Framework principles required.

- December 2017 q3b (answer): deposit for fixed price forward contract to

buy steel for normal usage subject to option to settle net, but no previous

experience of settling net and no forex hedge in place. Is this a derivative

within the scope of IFRS 9?

- September 2017 q3b (answer): is a fixed price forward contract a

derivative given that the contract is for the supply of commodities for own

use? Implications of fluctuations in exchange rates. - September 2017 q2c (answer): the measurement of a financial asset (fixed

rate loan) under IFRS 9; what determines the choice of measurement basis:

FVTPL, FVOCI or amortised cost. Learn and apply the principles.

“Candidates’ answers to the third issue (on the treatment of a financial asset

– a fixed-rate loan) were mixed. Whilst many answers outlined the

valuation methods of IFRS 9, including the business model test and cash

flow characteristics that permit the amortised cost treatment, many answers

did not apply these requirements correctly” Examiner’s report, September

2017

- June 2017 q1a.5 (answer): acquired bond (IFRS 9 business model hold to

collect or sell, with option to repurchase); account for events.

- June 2017 q4bi, (answer): issued B shares allow holders to request redemption; issuer has option to refuse but has never refused redemption.

No other conditions.

- June 2017 q4bii (answer): applying the criteria for recognition of a

provision under IAS 37 and a financial liability under IFRS 9 to determine

the obligation incurred upon infringement of intellectual property. When

does an obligation arise under an executory contract and a financial

liability?

- March 2017 q3b (answer): apply fair value hierarchy (IFRS 13) criteria to

evaluate the most appropriate basis for measuring changes in the carrying

value (up to disposal) of an investment in a debt instrument (held to collect,

held to collect and sell) under IFRS 9. Expected credit losses, effective interest and in-house fair values are available for the purpose of the

evaluation. Question also required the impact on income (profit or loss) and

equity (OCI) of the changes in carrying value of the investment to be

discussed.

- December 2016 q4 (answer): discuss principles for recognition,

measurement and review of expected credit losses (general approach and

simplified approach) – impairment of financial instruments.

- September 2016 q3a (answer): scrip issue with put option.

- Mar 2016 q1b (answer); q3a (answer)

June 2018 Exam Guidance

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- Dec 2015 q3b (answer): financial and executory contracts (what is the

difference; what are the differing accounting implications?) Examiner:

“…not answered well” - Sep 2015 q4a & answer: implementation of a significant IFRS

- Sep 2015 q4b & answer: impairment loss bifurcation & reclassification on

disposal; reclassification between amortised cost and FVTPL

- Jun 2015 q1b & answer: debt or equity reclassification of a call option and

payments to acquire further NCI following an acquisition. Interesting

variation to a recurring theme.

- Jun 2015 q4bi (answer): cash flow hedge; accounting for gain or loss

(IFRS 9) at period end (IAS 2) and on disposal of inventory.

- Dec 2014 q2d 12/14 & answer

- Jun 2014 q1a.2, q3b & answer signing bonus, annual payment for

continuous service, performance bonus. - Jun 2014 q4 (answer): debt or equity - general principles, share types

(rights and obligations)

- Dec 2013 q3a (answer): debt or equity – share types (rights and obligations

involving put option to buy NCI B-shares); assesses substance-over-form

where “B” shares have a determinable maturity date rendering them a

financial liability (in substance) over their legal form (equity).

- Dec 2013 q3b & answer: cash flow hedge

- Dec 2012 q1a.4 & answer

- Jun 2012 q1bi, 3c & answer debt or equity: entity obliged to pay

cumulative dividend on “B” shares and has no discretion to avoid doing so.

- Dec 2011 q11a.4 & answer

- Jun 2011 q3a & answer - Jun 2010 q3a & answer

How to answer case study questions about derivatives

IFRS 10, IAS 28, (part

of D.1)

1a,

b,

2

Because consolidation is compulsory this standard is always examined at q1a.

Aspects of the standard are also examined elsewhere in the paper. Its complexities

include changes to a critical matter such as control and related issues such as “business” that determines whether an investor should consolidate an investee. Hence

the style of question is varied:

- Case study type question (involving control and consolidation): Last examined

q3a 12/14 & answer; q2c 12/12 & answer.

- Given recent trends there is an expectation that control involving case study and

assessing whether a “business” has been acquired will be examined again soon

(possibly in September 2016 – it was, but again not answered well so expect

it again in June 2018) not least because i) students have struggled to answer

previous questions on this issue; ii) the matter of what is a “business” is still

being discussed ED 2016/1 Definition of a business and accounting for

previously held interests and iii) control is ever more complex to determine.

Read the code annotations which will guide you to learn how to analyse, interpret and respond to scenarios.

- Of course, the mechanics of consolidation are always examinable.

Past ACCA questions for practice:

- Mar 2018 q1a (answer): consolidation with subsidiary held for sale.

- Dec 2017 q1a.1-4 (answer): SOCF, SOI or SOFP with standard consolidation adjustments

- Dec 2017 q2a (answer): assessing control, significant influence issues

- June 2017 q1a (answer): standard consolidation with adjustments;

- March 2017 q1a (answer): standard consolidation adjustments; two

subsidiaries acquired during the year, including one foreign subsidiary;

partial disposal; share appreciation rights

- December 2016 q1a (answer): Consolidated SOCI with loss on disposal of

subsidiary; frequently examined adjustments

- September 2016 q1a (answer): consolidated group with two subsidiaries

acquired at the start of the year

- June 2016 q1a (answer): consolidated statement of cash flow (CSOCF)

- Mar 2016 q1c (answer): associate’s ethical accounting and professional issues

June 2018 Exam Guidance

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IAS28

- This is a very important standard. The examiner’s central concerns are that

candidates i) understand how to include the results of an associate and the investment in the consolidated financial statements of the investor in accordance

with the equity method; ii) can identify, explain and account for a “deemed

disposal” of a subsidiary that results in an associate as in June 2010 q2c (answer

to q2c); iii) can account correctly for the downstream sale of an asset by an

investor to an associate together with its tax implications; iv) can account for

cessation of the equity method of accounting; v) can account for restructure

involving a) subsidiary transforms into associate, b) associate becomes a

subsidiary, c) joint venture becomes an associate, etc. September 2015 q1a;

- Associate issues equity conversion option where the option is likely to be

exercised. What are the implications for the investor? Likely to lose associate status? Students invited to show that share ownership is not the sole determinant

of associate status. Discursive question similar to control assessment questions

(see opposite). The fact that it is in q1b underscores the above sign posted rating

of associate as a very important topic.

- An investment or a portion of an investment in an associate (or joint venture)

that meets the criteria to be classified as held for sale in accordance with IFRS 5

is initially measured according to applicable standards (IAS 28 for an associate).

Therefore, the share of profits and re-measurement of carrying amounts should

be done in accordance with normal associate and joint venture rules up to the

point of classification as held for sale. The associate (or joint venture) or the

relevant portion to be disposed of, must then be measured in accordance with IFRS 5 rules: at the lower of carrying amount and fair value less cost to sell.

- Impairment of investment in an associate.

- Dec 2015 q1 (answer): Consol SOFP with o/seas sub (IAS 21) involving

impairment of goodwill (IAS 36), purchase of foreign property (IAS 16)

and defined benefit pension (IAS 19) - September 2015: consolidated P&L, OCI; associate: step-acquisition to

subsidiary, step-down to associate from subsidiary in a partial disposal.

- June 2015:

- December 2014: q3a & answer complex “business” & “control

assessment”: IFRS 3 interacts with IFRS 10; q1a (answer): consolidated

SOFP, goodwill – positive (not impaired) and negative, property held for

sale (IFRS 5), Joint operation (IFRS 11) becomes joint venture equity

accounted (IAS 28) within the year (recognition and accounting).

- June 2014:

- December 2013: q3c & answer complex “control” assessment; merger and

possible reverse acquisition. - June 2013 q1a (answer): on 1 June 2011 Trailer acquired 14% Investment

in equity instruments (IFRS 9) and Park acquired a 70% controlling interest

in Caller. As both these investments occur on the same day, only one

goodwill should be calculated on 1 June 2012 when Trailer acquires a 60%

controlling interest in Park and effectively upgrades its IEI in Caller to a

56% controlling interest (14% + 70% x 60%). NCI valued at proportionate

share of sub’s net assets.

- December 2012 q2c & answer complex “control” assessment; q1a

(answer): consolidated SOFP, acquisition of sub-sub, restriction of sub’s

consideration to determine goodwill on acquisition of sub-sub, impairment

loss (goodwill and intangible asset), parent’s disposal group (impairment

loss), Investment in equity instrument (IFRS 9: classified FVOCI) upgraded to associate to be equity accounted IAS 28 (recognise gain on

previous IEI in OCI and transfer direct to retained earnings on upgrade to

associate status), account for share of profits and dividend from associate

(equity method), intangible asset (development costs to capitalise and

operating costs to expense).

- June 2012

- December 2011

- June 2011

- December 2010

- June 2010

Discussion (case study) involving deciding whether control exists and the

implications for consolidation.

The maths of IFRS 10

IFRS 11 Joint

arrangements (D.1)

1a,

2,

3

The previous questions were answered poorly. There has been a narrow scope

amendment recently.

Past ACCA P2 questions for practice:

- December 2017 q2a (answer): assessing control issues for consolidation

- December 2015 q3a (answer)

- September 2015 NOT EXAMINED

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The narrow scope amendment requires an entity that acquires an initial and

additional interest in a joint operation that is a business as defined by IFRS 3 to apply

all the principles of IFRS 3. The amendment applies prospectively, precluding restatement of transactions that have already taken place before the effective date of 1

January 2016.

The main consequences of the application of IFRS 3 to future transactions are: i)

premiums would be recognised as goodwill; ii) expenses (with a few exceptions) will

be charged to profit or loss in the year in which they are incurred regardless of the

acquisition date. Those expenses that will not be expensed are those that are eligible

to be deducted or capitalised under applicable standards such as IAS 32 (share issue

costs) or IAS 16 PPE (costs incurred in getting the asset to a condition or location for

its intended use); iii) deferred taxes will be recognised on initial recognition of assets

and liabilities except for goodwill. Do you understand why goodwill is not subject

to deferred tax? Answer: deferred tax arises from a difference between the tax base

and the carrying value of an asset or liability. As goodwill is not identifiable (cannot

be separated from its host assets) it cannot be sold independently of its host assets

from which it derives its value. Consequently, recognition of goodwill cannot have

deferred tax effects.

Other factors that merit examination:

- Case study involving giving advice about rights and obligations arising from

change of structure.

- Examined December 2014 q1a & answer – examiner not happy. Practise this

question until you are fully confident. Given that the examiner has recently

included a discursive question about change of structure it is prudent to practise answering this type of question.

- Dec 2014 q1a & answer

- Dec 2012 q1a.5; q1a.9 & answer

- Dec 2012 q2c & answer - Jun 2012 q1a & answer

WHAT TYPE OF QUESTION SHOULD YOU EXPECT?

1. Acquirer: expect basic questions along the lines of IFRS 3

2. Investor in the new jointly controlled business (or group of businesses):

expect a discursive q2 or 3 type question that is rather more complex

requiring you to i) identify whether a business has been transferred to be

eligible to apply the amendments; ii) how the investor should account for

the transfer. This is challenging because i) both the amendment and IFRS

11 are silent about it; ii) you will need to evoke IAS 8 hierarchy to explain

how the investor should treat the transaction. Here is an example:

Use IAS 8 hierarchy: where there is no IFRS that deals specifically with a

particular transaction refer to and consider requirements and guidance in an

IFRS or interpretation that deals with similar or related items to develop and

apply an accounting policy that provides relevant and reliable information.

Treat the transfer as a "disposal" of a (subsidiary) business; the examiner is

most likely to include a subsidiary because it is more complex than the others.

i)apply the rules of IFRS 10 to deconsolidate if the transferred business was

previously part of a group;

ii) recognise gain/loss being the difference between the fair value of the interest

acquired in the new jointly controlled business and its carrying value prior to transfer

iii) recognise the investment in the transferee’s books at the fair value of the

interest acquired in the joint operation.

DR Investment (fair value)

CR Business (carrying value of net assets)

CR Gain (recognised immediately in profit or loss)

IFRS 12 Disclosure of

interests in other

entities (effective since

1 January 2013)

1b,

c

2,3

,4

This standard brings off-balance-sheet finance items onto the entity’s financial

statements to enable users to evaluate

a) the nature of, and risks associated with, its interests in other entities

b) the effects of those interests on its financial position, financial performance

and cash flows.

Generally, the standard requires disclosure of the significant judgements and

assumptions an entity makes in determining

a) whether and how one entity controls another (IFRS 10)

b) significant influence (IAS 28)

c) the classification of joint arrangements under IFRS 11 into i) joint operations and ii) joint venture

WHAT YOU SHOULD EXPECT

This standard has not been examined since its publication. This is not surprising

given i) it is exclusively about disclosure of topics covered by other standards

and disclosure is not frequently examined; ii) it does not include measurement

which the examination questions are predominantly about; iii) off-balance sheet

finance of interests in other entities is decreasing in importance due to the

consolidation requirements of IFRS 10; iv) the effects of “interests in other

entities” on the entity’s performance, position and cash flows should be

available in its strategic report which is required to be “balanced and

comprehensive”.

However, the disclosures could be useful to investors who might need assurance

that the bases of critical accounting judgements and assumptions about certain

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Specifically, in relation to an entity’s interests in subsidiaries, associates and joint

arrangements there are specific disclosure requirements.

Interests in subsidiaries An entity shall disclose information that enables users of its consolidated financial

statements to understand

a) the composition of the group and the Non-controlling interest in the group’s

activities, net assets and cash flows

b) the nature and extent of significant restrictions on its ability to use assets,

and to settle liabilities of the group;

c) the nature of, and changes in, the risks associated with its interests in

consolidated structured entities; d) the consequences of changes in its ownership interest in a subsidiary that do

not result in a loss of control; and

e) the consequences of losing control of a subsidiary during the reporting

period.

Interests in associates and joint arrangements An entity shall disclose information that enables users of its financial statements to

evaluate:

a) the nature, extent and financial effects of its interest in joint arrangements and associates;

b) the nature of, and changes in, the risks associated with its interests in joint

ventures and associates.

- All entities are affected by the new standard

- Its benefits are linked into the requirements to improve transparency,

- It enhances the ethical position of the accountant

- It expresses IAS 1 requirement for financial statements to present information

that is relevant and useful to its users

- Reflects IFRS 13 principles on disclosure requirements and objectives.

investment classifications, and the effects changes in the interests in other

entities might have on the entity’s performance, position and cash flows are

sound. Therefore you should expect questions that require candidates to - Explain the potential benefits e.g. the reduced costs of equity capital of the

additional disclosure generally and specifically.

- Examples of critical disclosures beneficial to investors and other providers

of long-term capital.

Answers to questions on IFRS 12 will require grounding on Conceptual

framework enhancing characteristics. For example:

Understandability

- Aggregation achieves simplicity but this is at the expense of transparency

which is achieved by disaggregation. - Structure and sequence logically so that users can engage readily,

understand easily and action speedily.

- Consistency of reporting and disclosure between primary statements and

disclosure notes foster linking and understandability of the effects of

related issues that have a common cause.

- Flexibility should allow the innovation necessary to produce relevant

information.

Comparability

- Consistent disclosure of policies and their impacts on the financial

statements can have beneficial effects on users’ ability to compare and

evaluate financial performance and position. - International convergence is facilitated by the adoption of comparable

disclosure policies and practices. But of course, these should allow for

flexibility.

IFRS 13 Fair value

measurement

1a,

2,3

,

- Fundamental to and pervasive in measurement and disclosure. Has wide ranging

impact including role in international convergence and conceptual framework.

- Critical to the measurement of i) financial assets and liabilities and ii)

nonfinancial assets and liabilities

- Relevant to initial recognition under IFRS 3 q2a March 2017

- Critical to initial recognition and subsequent measurement of financial

instruments: IAS 32, IFRS 9

- Critical to measurement of non-financial assets (the new concepts of highest and

best use, valuation premise, fair value hierarchy, etc.) - It is to be expected that the examiner will continue to examine IFRS 13 for a

very long time as the areas to be covered, the many application issues to be

addressed within each of the areas, and the style of questions to be asked are

germane to the study of financial reporting at the professional level. Examples of

issues to be taken into account: related party; highest and best use; holdings

distortions; terms of sale (when does compelling external evidence

demonstrating executable exit price exist?); market participants assumptions;

SECTION A part a calculation of fair value. Part b discussion of fair valuation

issues in a case study involving the issues below.

Items expected:

This is a very important standard. It will be examined at the highest level of

application to the measurement of the Conceptual Framework elements of

financial reporting: asset, liability, income, expenses and equity.

- approach to measurement of fair value (discussion of all the features of the

definition of fair value and the requirements for fair value, including the effect of valuation premise, non-performance risk, the concept of exit price

and the implications of its requirements for transfer and settlement of

liabilities and equity: analysis, synthesis and evaluation)

- initial recognition and day one gains and losses

- case study involving “highest and best use”

- case study involving determining fair value in an advantageous or principal

market

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valuation uncertainties (lack of secondary market, long-dated nature, lack of

observable loan spreads); threats to comparability and verifiability where

bespoke valuation methodology is used, combined with assumptions about unobservable inputs (this would generate fair values that are unique); as a wide

range of valuation techniques are available, it may not be appropriate to

directly compare an entity’s fair value information to independent market or

other financial institutions”;

- calculation involving impact of IFRS 13 on liabilities e.g. the measurement

of liabilities using a valuation technique where there is no quoted price for

an identical or similar liability or corresponding asset, involving the estimation of future incidental costs of fulfilling the obligation, any

expected compensation, profits and premiums for bearing the risk; the use

of expected values. The estimate of fair value would be from the

perspective of the market participant who owes the liability or has issued a

claim for the equity instrument.

- application of the fair value hierarchy on real estate (IAS 40), liabilities

(IAS 39, IFRS 9)

- valuation technique issues (inputs to reflect market participants

assumptions, reflect characteristics of the product, level of hierarchy,

maximize observable, minimize unobservable inputs) June 2013 q3b &

answer - ED 2014/4 Measuring quoted investments in subsidiaries, joint ventures

and associates at fair value

- individual unquoted equity instruments: measurement issues using the

market-based approach March 2016 q2c (answer)

- Disclosures (benefits of additional disclosures; classification of fair value

measure is based on the lowest level input that is significant to it. Why is

this desirable? What is the accounting principle in action?)

- Other application issues: i) Adjustments for level 2 inputs e.g. to reflect in

the observed price differences in the operating capacities of the assets;

reconditioning assets for use in the location of their highest and best use; ii)

Restrictions

- Multiple valuation technique: evaluating valuation options (market, income and cost) to determine the most representative fair value. Refer to

worked examples.

-

Past ACCA P2 questions for practice:

- March 2017 q2a: transfer of PPE (IAS 16) to Investment property (IAS

40) at fair value. Which of two fair values is appropriate: i) one based

on similar properties or ii) one that is a share of disaggregated values

(consequent on a reversal of a previous valuation premise). Assess reliability by reference to the fair value hierarchy framework.

- March 2017 q3b: apply fair value hierarchy (IFRS 13) criteria to evaluate

the most appropriate basis for measuring changes in the carrying value (up

to disposal) of an investment in a debt instrument (held to collect, held to

collect and sell) under IFRS 9.

- December 2016 q3a (answer): fair value hierarchy

- September 2016

- June 2016 q2

- March 2016 q2a,b,c (answer); valuation of farmland with alternative use (IAS41); valuation of farm produce; valuation of NCI interest in a private

company

- December 2015 q2b (answer): valuation of a warranty provision

- September 2015 NOT EXAMINED

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- June 2015 q 2a,b,c & answers

- December 2014 q2b,c & answer financial guarantee & financial liability

- June 2014 q1b & answer & Sekoyen’s suggested answer

- December 2013 NOT EXAMINED

- June 2013 q3b & answer

- December 2012 q4a,b & answer

IFRS 15 Revenue from

contracts with

customers (effective 1

January 2018)

1a,

c,

2,3

This new standard which replaces IAS 18 and IAS 11 was issued in May 2014 is

effective on or after 1 January 2018.

- This is a frequently examined topic because of the pervasive influence of

revenue on the business. Operations drive everything in the business and revenue

is the lead indicator of business performance. To get an idea of what this means

in terms of financial reporting have a quick look at Tesco plc’s SOCI and SOCF.

You will find that the reports are broadly structured into operating, investing and

financing activities. These activities are known as value drivers – generating and

using cash in the business.

- The questions tend to spread around the paper reflecting the variety of issues

from recognition to measurement, current issues, ethics and risk (e.g. accounts receivable IFRS 9). The interaction with other IFRS is a salient feature of

revenue accounting and this is what is reflected in the complexity and variety of

questions. For example, the movement of inventory (IAS 2) relates to the timing

of recognition of revenue; non-cash consideration could intersect with IFRS 2

and IAS 16.

- Estimates are obviously a central issue given the production (or construction)

cycle does not necessarily match the accounting cycle and thus revenue may be

recognised based on estimates of the stage of completion at the reporting date.

For June 2018 exams, the following areas are critical as they would attract the

examiner’s attention because they are complex and can be controversial. - Be prepared to appraise and apply the IFRS 15 scope criteria (the five criteria

a contract with a customer must possess to fall within the scope of IFRS 15): i)

the parties have approved the contract and are committed to their obligations

under it; ii) the entity can identify each party’s rights regarding the transfer of

goods and services or the use of assets; iii) the entity can identify the payment

terms regarding the goods or services to be transferred or the asset to be let; iv)

that the transfer has commercial substance; v) it is probable that the entity will

receive the consideration to which it is entitled.

Think about the following examiner’s comments and respond appropriately.

“This question required a reasonable knowledge of IFRS 15 but many candidates could only recite the 5 steps to revenue recognition without being able to elaborate on

them. It is important that students read Student Accountant as articles on such topics

as IFRS 15 appear regularly.” Examiner’s report December 2015 q4a

Read the technical article Part 1

Read the technical article Part 2

This critically important IFRS will be examined frequently – computational

(q1a) and discursive (q1b, c, q2,3 and even q4). Your active learning and

practice programme should therefore reflect the diversity of the challenges

mastery of the IFRS presents. You need to be clear about the concepts and

the principles and to be able to construct deductive reasoning to justify a

treatment you recommend. It won’t suffice to perform calculations without

providing explanations. Extensive preparation is therefore recommended.

Read The Maths of IFRS 15

Past questions: - Mar 2018 q3a (answer): sale of retail park with variable consideration

relating to right to receive 10% of operating profits of the year after sale.

- Dec 2017 q2b (answer): principal or agent? - Dec 2017 q3a (answer): contract with extended warranty

- Sep 2017 q3a (answer): calculate relative standalone prices for the

components of a combined contract comprising equipment, warranty and

maintenance. Caution: don’t waste time on five-part model; get straight to

the point applying principles to the specifics of the scenario.

- March 2017 q3c (answer): Performance risk penalty clauses built-into

construction contracts to protect the customer and the contractor: account

for issues that arise involving modifications, incremental costs including

admin, material wastage and penalties.

- Dec 2016 q1a.7 (answer): variable consideration - significant revenue

reversal due to volume discount in a single performance obligation - Sep 2016 q2c (answer): uncertainty over collectability; assess

circumstances to inform accounting approach.

- June 2016 Not examined

- March 2016 not examined

- Dec 2015 q4 (answer) IFRS 15 scope criteria; five-step model; finance and

revenue mix; contract modifications.

Part (b) required the application of part (a) in terms of determining the impact of

a significant financing component on a contract and contract modifications.

Candidates did not answer this part of the question very well. It is difficult when new standards are issued but there is a wealth of information available to

tutors and students on such topics as IFRS 15, so it is important that candidates

read widely on such a topic. Examiner’s report December 2015 q4b

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- Understand and apply the principles of the other four of the five-step model for

revenue recognition. The underlying principle is that the entity will recognize revenue to depict the transfer of goods or services to customers at an amount that

the entity expects to be entitled to in exchange for those goods and services.

Prioritise the timing of transfer and the measurement of revenue when transfer

occurs.

- What criteria are used to identify a performance obligation? Critical thinking is

required to assess whether goods or services are “distinct” depending on how

benefits are derived from the separate promises to transfer goods and services to

the entity. Study the example in step 2 (IFRS 15 summary) and paras 24-28.

- Make sure you understand the definition of revenue and its accounting

implications. This is critical when accounting for revenue separately from

finance income from a sale with a significant financing component (e.g.

December 2015 q4b). Payment for revenue received in advance incurs an

expense at the incremental borrowing rate (December 2015 q4bi); payment

deferred accrues interest at the implicit contract rate of interest. See worked

examples.

- Revenue (consideration) may be different from the contract price due to

(variable consideration e.g. discounts and bonuses). This is a critical

measurement issue which you should be prepared to deal with as part of case

study or as part of q1a calculations. See worked example. Also, see worked

example for an illustration of the relationship between revenue, consideration,

transaction price, contract price. Study the example in step 3 (IFRS 15 summary)

- Be prepared to do PV calculations using appropriate discount rates to calculate

accounts receivable and revenue where payment is deferred. See worked

examples.

- Understand and apply the detailed requirements for contract modification

December 2015 q4b.

- Costs to obtain and fulfil a contract: study the worked example.

- Errors due to estimation and valuation are frequent and can be material. Make

sure you can deal with IAS 8 requirements.

- Providing for anticipated losses incurred under onerous contracts (IAS 37). The

examiner would require you to recognise an onerous contract and to be able to

make an appropriate provision for anticipated losses. Onerous contracts have

been poorly dealt with in the recent past with candidates unable to recognise

their existence because they don’t understand their features and the IAS 37 requirement to provide for anticipated losses at the reporting date including costs

yet to be incurred.

- Recognising impairments of accounts receivable - financial losses (expected and

incurred) (IFRS 9)

- Licences (Also relevant to IAS 38)

- Allocating a discount (see The maths of IFRS 15)

- Warranty: assurance type to comply with agreed-upon specifications: (accrue

a liability at point of sale IAS 37 to replace or repair) and, as a significant

component of the contract requiring, where appropriate, a split of the

transaction price, to reflect the warranty as a separate performance

obligation, Service type – allocate the price to separate promises to deliver

- Implementation issues reporting entities must attend to when a major

standard is introduced. You may take a cue from IFRS 9 which has been

reassessed at q4 (see IFRS 9 past questions above). Also, see syllabus

section F.1 below.

- Analysis of the effects of IFRS 15: how has IFRS improved the

measurement of performance? Justify the assertion that revenue measures

are more reliable under IFRS 15.

- Explain how IFRS 15 applies the conceptual framework e.g.

requirements for recognition of revenue address the qualitative

characteristics of financial reports: the five-step framework enables entities

to identify, measure, present and disclose the nature, amount, timing and

uncertainty of revenue from contracts with customers.

- Discuss the interaction of IFRS 15 with other standards through

specific transactions e.g. where noncash consideration is in the form of

shares (IFRS 2 Share-based payment) or property (IAS 16 PPE); IAS 36

impairment and amortisation of capitalised costs; IFRS 9 impairment of

contract asset or accounts receivable; IAS 37 warranties, refund liability,

etc.

- Reasoning and problem solving. This paper assesses higher order

thinking (HOT) skills and awards extra marks for “clarity and quality of

presentation”. IFRS 15 provides ample opportunities for the examiner to

assess these capabilities. Examples are given in the document linked to deductive reasoning.

“The P2 syllabus clearly states its aims and the capabilities expected of candidates; rather than merely listing the topics of which knowledge is required, these capabilities

outline the level of understanding required. The verbs used in the syllabus include discuss, evaluate, advise and appraise. The higher the level of verbs, the higher the level of attainment required. All of these verbs require a degree of understanding and application and so rote learning the subject is insufficient. The capabilities should be at the centre of the teaching and learning activities.” Examiner’s report December 2016

Terms and techniques to learn “In order to perform well in this paper candidates need to develop an understanding of the important corporate reporting concepts so that they can then apply their understanding of these concepts to the scenarios presented in the examination.” Examiner’s report December 2016

As IFRS 15 is a new standard you are encouraged to follow the examiner’s

advice.

The best way to learn a term or technique is to try and apply its parts with a real

example. Ask yourself: where are the key words; why is this term significant;

can I apply it in practice? What issues arise when I try to apply the term or

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distinct goods and services). Study Illustrations 9-1 and 9-2, pp271-2. Think

about the concepts, the principles and the business model. Also, think about the

presentation in the financial statements. Why is the contract liability not a

financial instrument under IFRS 9 but account receivable is? Is the contract

liability a current liability or a noncurrent liability or both? Why is there a

contract liability but not a contract asset?

- Fines and penalties (cash paid to customers as compensation for the supply of

defective goods) are variable consideration – not assurance-type warranties.

Like returns for compensation these are equivalent to sale with a right-of-

return. However, where the entity pays cash to a customer to reimburse third

party costs incurred (to rectify product defects), such payments are in effect

assurance-type warranties and should not be treated as variable consideration.

- Sale with a right-of-return (also relevant to IAS 37)

- Sale and repurchase agreements (put option) e.g. involving leases and securities. When is a series of transactions combined into one with a common objective?

What are the accounting implications for recognition of revenue; de-recognition

of assets; recognition of liabilities and financing costs?

- Options to acquire additional goods or services

- Customer loyalty programmes

- Disclosures: what should be disclosed (qualitative and quantitative) and for

what purpose? Study the examples

technique? What principles govern how the issues are resolved. Can I trace the

effect of the terms application in the financial statements? Can I raise double

entries if applicable? What does this term link to? How? Write out and explain examples.

“… the method of examining this paper emphasises and rewards the application

of personal understanding and so candidates who adopt a surface approach are

unlikely to succeed.” Examiner’s report, December 2016

- Contract

- Contract costs

- Contract asset

- Contract liability

- Consideration

- Customer - Customer loyalty programmes

- Distinct goods or services

- Economic or commercial substance

- Enforceable rights and obligations

- Highest quality information

- Highest ranked approach

- Material right

- Onerous contract (see also IAS 41)

- Payment to customers

- Percentage of completion method

- Performance obligation

- Refund liability - Residual approach

- Revenue

- Significant economic incentive

- Standalone selling price

- Transaction price

- Unbundling of multiple performance obligations

- Valid expectation

- Warranty

IFRS 16 Leases (released January 2016;

effective January 2019.

Early adoption permitted

provided IFRS 15 is also

early adopted) (BC: IFRS 16 Basis for

conclusion)

Q4

a,b WHAT IS IT FOR? To establish principles that will allow the effects of lease transactions to be faithfully

represented and disclosed in the financial statements with maximum transparency.

The information to be produced in complying with IFRS 16 is expected to provide a

basis for users to fully assess the financial effects of leasing assets which the

previous IAS 17 did not do adequately.

What deficiencies are to be remedied and what are the potential benefits of doing so?

WHAT YOU SHOULD EXPECT Because of the prevalence of leasing activities in the business environment

IFRS 16’s profile is high. Therefore, you should expect this standard to be

examined frequently.

In September 2017 the standard was examined as a current issue covering a limited number of topics: impact on financial information quality, the option to

combine a portfolio of similar leases and the election to treat short leases as

expenses. However, as the scope of IFRS 16 is wide, you should expect the

requirements of the standard to continue to be examined as part of a mix of

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LESSEES

Under the single lessee accounting model of IFRS 16

- The requirement to fully recognise assets and liabilities for rights and obligations created by leases ensures faithful representation of leasing transactions and

enables complete understanding of the effects of leasing activities that was not

possible under the partial accounting model of IAS 17. The inclusion of the asset

will more accurately reflect the capital employed, and the inclusion of the

liability will more fully reflect the reporting entity’s financial leverage. Both

these enrichments allow users to better evaluate the effect on financial position

of leasing activities. This is an examination priority for the upcoming exams and

must be assessed in relation to section G.2 (appraisal of financial performance)

and G.1 (creation of accounting policies) of the syllabus.

- The requirements to disclose the assets that are the subject of leasing contracts

(previously classified as operating leases under IAS 17 and excluded) enable users to assess exposure to asset risks which can be significant for organisations

that depend on the quality of their leased equipment, plant and vehicles to

maintain their competitive positions.

- The requirement to disclose outstanding financial obligations in respect of

finance leases enhances the assessment of financial risk exposures. The benefits

identified under IFRS 7 are relevant.

- Removes information asymmetry in the market between various users who used

different methods to fix the lack of transparency of IAS 17 about operating

leases and produced different measures.

- The single lessee accounting model enhances comparability in ways that IAS

17 didn’t because of the limitations of its dual accounting model.

LESSORS

- The requirement to provide enhanced disclosure by lessors of information about

their potential financial loss (exposure to credit risk) if lessees default on their

lease obligations improves the relevance of general purpose financial statements

to its users.

- The requirement to provide adequate information about the risk retained by the

lessor in assets that are the subject of operating and finance leases (exposure to

residual asset risk) enhances the relevance of the information available to users.

WHAT YOU SHOULD LEARN Learn the standard’s principles, concepts and requirements for: identification,

recognition, measurement, presentation, disclosure. These are referred to in this

guidance under appropriate sections using the recommended main source for detailed

study: Section 2 E&Y

WHAT IS CONTRACT INCEPTION?

- Terms and conditions agreed

- Commitment obtained from both parties i.e. sign and accept rights and

obligations

- Asset explicitly or implicitly identified

current issues. Therefore, consider all the current reporting issues (See H.3) in

relation to it, e.g. improving the quality of financial information (The

Disclosure Initiative).

The examples referred to below are IFRS 16 Illustrative Examples (IE). The

examples are also used in the linked documents.

The impact of IFRS 16 on the financial statements from the preparer and user

perspectives (analyst/adviser) would be among the examination priorities. The

conceptual framework principles that underpin the requirements of the standard

would be integral to the priorities. Facts and circumstances of rights and

obligations created by contracts determine substance over form in critical

assessments (principles-based). For example:

“The IASB noted that with respect to initial measurement of right-of-use assets

and lease liabilities its intentions were that the measurement would reflect the

nature of the transaction and the terms and conditions of the lease”. BC143

Therefore, your critical awareness of the role of relevant facts and

circumstances in determining the substance of the contract is likely to be

assessed at the high intellectual level 3.

SCOPE AND EXCEPTIONS

You should expect questions that require you to assess whether a contract is, or

contains, a lease. This will require you to demonstrate knowledge and

understanding of the IFRS’s core principle: that the entity’s right to use an

asset depends on the existence of decision-making rights during the period of

use under the terms of the contract. Such decision-making rights can only exist

if the contract enables the use and control of a specified asset or assets. So you

should expect scenarios that require you to apply your understanding of how an

asset can be specified for the lessee’s exclusive use within a finance lease.

Issues to look out for

CONTAINS A LEASE

- Explicitly specified which means it is physically distinct from the

remaining portion of the underlying asset p9, Illustration 4, Scenario A.

- Identified by being implicitly specified at the inception of the contract.

There is a specification by which the asset can be identified at the

commencement of the contract. Applies to asset under construction as in

this example: p8, Illustration 2

- Implicitly specified – substitution rights are not substantive, p1

Illustration 1. They may exist at the inception of the contract but the

supplier does not have the practical ability to exercise them, or the

economic incentive to benefit from their exercise. (p13, Illustration 5,

Scenario B) - Definition of scope of rights as opposed to restriction of scope of

customer’s right to use the asset. Where the supplier specifies opening

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- Commitments under the lease are Noted in the financial statements.

WHAT IS CONTRACT COMMENCEMENT? - Lessor transfers right of use asset to the lessee.

- Lessee recognises the right of use being the right to control the use of the asset

and extract substantially all the economic benefits from it and accept the risks

associated with doing so.

- Lessee recognises the lease liability being the obligation to pay for the right

obtained from the lessor.

- Consistent with the measurement date for other similar transactions e.g. PPE

Why is it significant to distinguish between lease

- Inception and

- Commencement

Give specific instances to illustrate

INCEPTION COMMENCEMENT

Earlier of date of agreement or

commitment.

Date THE LESSOR transfers right-

of-use of asset (not control of the

underlying asset as that would be a

sale under IFRS 15).

Agree to principal terms and conditions

of the lease. Has commercial

substance: identify asset, agree lease

period, agree payment terms, agree

options, residual amounts, protective

rights, substitution rights, and all other

conditions and terms that create rights and obligations under the lease.

Lessee agrees to take possession and

gain right to control use of asset.

Commitment is binding e.g. by signing

documents to confirm acceptance of

obligations and rights under the

contract.

Commencement can occur prior to

the agreed commencement date if the

lessee’s activities suggest that it has

obtained the right to control the use

of the underlying asset. Examples,

design and construction as in carrying

out substantial leasehold

improvement.

Lessee can exchange lease payments

but unlikely to have an obligation to do

so before underlying asset is made

available for its use.

Lessee recognizes lease liability

based on present value of lease

payments not paid at the

commencement date.

Can be onerous if terms are unfavourable. Recognise under IAS 37.

Thus, it is feasible to have an onerous

contract before the commencement

date.

Can be onerous after the commencement date as defined under

IAS 37.

hours and restricts goods or services to be sold in a retail unit, restricts

destinations, requires equipment to be maintained in a certain condition.

These are all only protective rights; they do not alter the right to control the use of the asset.

- Provision of services such as cleaning, security, insurance, etc. does not

give supplier the right to direct how and for what purpose the underlying

asset is used, p19 Illustration 6.

- Customer has the right to control the use of the asset throughout the

period of use.

DOES NOT CONTAIN A LEASE

- The contract does not contain a lease if only a specified portion of the

available capacity is to be used by the customer. In the fibre optics cable

Example 3 only 3/15 available fibre strands are to be used and the supplier makes all decisions about the transmission of the customer’s data. This

contract does not give the customer the right to control the use of an

identified asset. This is like, p10 Illustration 4, Scenario B. However, as

Illustration 3, p9 shows physically distinct portions of a larger asset are

identified assets if they are explicitly specified and the supplier does not

have the substantive right to substitute the asset throughout the period of

use.

- Whether substitution rights are substantive - asset can be beneficially

substituted by the lessor at any time during the period of use; in that case

the underlying asset is not specified. p12, Illustration 5, Scenario A

Allocation between lease and non-lease components

Refer to 1.3.5, p28-29

- Identifying and separating lease components, p22 Illustration 7

- Activities that are not components of a lease contract, p24 Illustration 8

- Allocating contract consideration to lease and non-lease components, p26

Illustration 9

- Identifying separate leases, allocating consideration to separate leases and

non-lease components, p28 Example 12

KEY CONCEPTS Expect questions about the difference between the dates

Inception date is earlier of

- date of lease agreement and

- date of commitment

Date of commencement

- date underlying asset made available to lessee

Lease term

The lease term is a crucial part of the calculation of the right-of-use asset. Hence you should expect questions that require candidates to analyse and

evaluate the circumstances of a lease to determine the relevant lease term: the

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Disclose as capital commitments lease

commitments not provided for

because not yet commenced. See

Balfour Beatty note 34 on capital commitments.

Recognize, present and disclose

lease payments, initial direct costs

and estimates of further costs to be

incurred to dismantle, remove and restore the underlying asset at the end

of the lease.

As a lease is not a financial instrument

the inception of the lease contract does

not trigger the recognition of assets or

liabilities. Hence no gain or loss can be

determined at that point.

No gain or loss arises because the

recognition date is coincident with

the commencement date.

How IFRS 16 is inextricably linked to IFRS 15 which explains why early adoption of

IFRS 16 requires the prior or simultaneous adoption of IFRS 15.

IFRS 15 IFRS 16

Initial measurement Fair value Cost (similar to IAS 16, IAS

38) See BC149

Additional directly attributable costs

Incremental costs Initial direct costs BC150

Performance

obligations

Goods and services

are distinct

Lease is distinct

Recognition At contract inception At contract commencement

Interaction: customer

supplies equipment

Recognize revenue

for goods produced

Recognise lease if entity

directs the use of the asset

during the period of use.

Do not recognize lease if

customer directs the use of the

equipment during “the period

of use”.

Allocating contract

consideration to one

or more lease

components

Apply paras 73-90 Refers to paras 73-90 of IFRS

15

Lease and non-lease Non-lease Lease

Sale and leaseback Paras 31-34 criteria

applied

Relies on IFRS 15 criteria to

determine whether a sale has occurred.

Sale and leaseback:

the effect of the

repurchase option.

Paras B64-B76

criteria used

Relies on IFRS 15 criteria to

determine whether a sale has

occurred.

LESSEE Refer to Section 3 E&Y

non-cancellable period plus (extend) or minus (terminate) the periods covered

by the options available to the lessee. This will depend on whether it is

reasonably certain that the lessee will exercise its option to extend or not to terminate. For example, see E&Y: 2.3.1 Lease term.

Evaluating lease term and purchase option 2.3.1.1, p34

Determining the lease term - Illustration 10

Cancellable leases – Illustration 11

Lease payments

Variable lease payment that depends on a lease – Illustration 12

Residual value guarantee included in lease payments – Illustration 13

The discount rates

Expect questions about the difference between the implicit rate and the incremental borrowing rate and to explain what influences the choice of

discount rate and how the discount rate may change as part of the reassessment

of lease liabilities and right of use asset when the terms of a lease contract are

modified.

Initial direct costs (including construction and design costs)

IFRS 16 requires initial direct costs to be accounted for appropriately. This area

could be among the examiner’s initial priorities. You should expect questions in

this area to focus on

- The timing of the expenditure which is most likely to be before the

commencement date. The expenditure may indicate that the lessee may

have gained the right to control the use of the asset even before the documented commencement date (substance over form).

- The nature of the activities, whether construction or production

- The evidence it provides for the likelihood that any option to extend will be

exercised; at the same time any option to terminate may not be exercised,

given the scale of initial direct costs.

- Whether the cost is incurred by the lessor/lessee

- Whether the lease is operating/finance

Initial direct cost of non-manufacturer lessor

- Finance lease (add to the net investment)

- Operating lease (add to the carrying value)

Initial direct cost of lessee

- Finance lease (add to the right-of-use asset)

- Operating lease (add to the right-of-use asset)

Explain and justify the treatment of initial direct costs by the lessor and the

lessee in an operating and finance lease?

You should expect questions that involve consideration of both IFRS 15 and

IFRS 16 to determine the substance of the transaction. For example, a

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Transitional reliefs: learn how the standard applies initially:

- Retrospective; simplified approach? - What are the requirements of each for operating and finance lease?

- What are the implications for reporting and disclosure?

Learn the parts of the financial statements impacted by the standard: how and why.

Seeking answers to these key questions is an efficient way to learn. Therefore, make

a note of the questions that come to mind as you read.

Learn the related contractual requirements e.g. debt covenants: how are they

impacted? Type of covenant and IFRS 16 impact.

Higher level financial performance indicators (including fair presentation): net debt calculations. How to manage capital – leasing obligations are part of capital.

Definitions. implications

Significant impact on administrative systems

IFRS 16’s scope is wide and can potentially impact many subsystems depending on

the organisation. The potential impact on accounting systems, processes and

communications and the resource implications must be carefully assessed as part of

the implementation requirements.

LESSOR Refer to Section 4 E&Y

HOW YOU SHOULD LEARN What are you learning for? According to the syllabus you are learning “to apply

knowledge, skill and exercise professional judgement in the application and

evaluation of financial reporting principles and practices in a range of business

contexts and situations.”

The study of IFRS 16 is to be undertaken at the Intellectual level 3 – synthesis and

evaluation. The sub-capabilities (see p9, syllabus and study guide) for the subject

area of leases have these verbs: - “Apply and discuss” x 4,

- “Discuss the recognition” x 1,

- “Account for and discuss” x 1.

How should you go about it efficiently? The only way to learn to apply is to learn

to apply.

You should approach the study of IFRS 16 with critical thought, analysis and

judgement in accordance with the syllabus aims. You should try to understand the

customer supplies equipment in an outsourcing arrangement. Complexities can

be introduced including

- Decision-making rights about the equipment - Decision-making rights about the price of manufactured goods

- Decision-making rights about the sale of goods manufactured with the

equipment to third parties

- Decision-making rights about leasing spare capacity to third parties

LESSEE ACCOUNTING Lessee accounting will dominate future exam questions reflecting IFRS 16’s

prime objective. Therefore be thorough about how IFRS 16 has made a

difference to lessee accounting and the benefits of the changes to users and the

capital markets.

Studying IFRS 16 for exams may seem daunting because of the standard’s

complexities. But the concepts and methods of computation are familiar.

However, don’t let familiarity breed contempt –vague familiarity could be a

hindrance, rather than an aid. You need to be at your sharpest.

So it is essential that you approach the task smartly. How?

1. Process and practise the worked examples. The E&Y document is suitable because: i) it is very well organised; ii) it includes practical examples for or

against a concept or principle in exam question style; iii) it is clear and concise;

iv) it includes extracts from IFRS 16 to support and explain the worked

examples (illustrations); v) it includes clear and concise explanations of the core

concepts in action. Exploit its strengths to maximise your scoring potential by

using these features regularly. Study the examples with questions in mind.

Refer to Studying P2 efficiently (Elaboration-rehearsal) for further explanations

as to how to use worked examples to learn effectively.

2. Habitually repeat from memory (in writing) and verify with the E&Y document the concepts, principles and explanations in the carefully chosen

words of the standard and its associated commentaries – not in your own

words. For example, para 26 says: “At the commencement date a lessee shall

measure the lease liability at the present value of the lease payments that are not

paid at that date”.

The more closely and frequently you reproduce the standard’s core texts, the

more clearly you can think and the more confident you can become.

LESSEE ACCOUNTING, p48

Initial measurement 3.2: Illustration 15, p56

Residual value guarantee included in lease payment Illustration 13, p42 Short-term lease: Illustration 14 p49

Subsequent measurement Illustration 15, p56

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reason for the practice and not just accept it. You should also try to understand how

the method of the practice works and not just memorise its steps. For example,

explain and justify how a gain arising on a sale and leaseback can be recognised.

You need to allow plenty of time for this: to learn, apply, fail, correct, examine what

you are learning, reflect on it. Try further questions, repeat the process. Take your

learning up the taxonomy – from basic understanding to synthesis and evaluation

Begin with an outline to gain an overview of the big ideas and effects before

immersing yourself in the detailed application procedures. Pace yourself – the brain

learns effectively at a certain pace in discrete steps under suitable conditions. Do not

rely on one source.

Source Overview focus

Pwc (in brief) All the salient features in brief

KPMG – slide share More transparent balance sheet

Deloitte Potential implications for lenders

KPMG Implementation issues and priorities

Deloitte Outline and news about the standard

IASB Effects analysis

Build a solid foundation by ascertaining the fundamentals

- What is a lease? How can you determine whether an arrangement contains a lease?

- What is the measurement basis?

- What is the recognition basis? At inception or commencement? Why does it

matter?

Be methodical: maintain coherent notes. No matter how good the notes you are

using you must always make your own notes by reconstructing and extending them.

Learning is an active process of reconstructing what is presented to you to fit the

questions you ask while thinking critically. Ask: what if, why not, what else, what

about.

Apply the conceptual framework principles to the elements associated with the

lease: asset, liability, income, expenses, equity.

Explain using the conceptual framework principles how and why IFRS 16 is an

improvement on IAS 17.

For example, IAS 17 “minimum lease term” has been replaced by “lease term” under

IFRS 16, reflecting the standard’s principles-based approach:

“…the lease term should reflect the entity’s reasonable expectation of the period

during which the underlying asset will be used because that approach provides the

most useful information.” BC 156 (BC: IFRS 16 Basis for conclusion)

Remeasurement of lease liability by lessors 2.4.9

Modifications 3.5, p57 Example 15 – Modification that is a separate lease

Example 16 – Modification that increases the scope by extending the lease term

Example 17 – Modification that decreases the scope of the lease

Example 18 – Modifications that increases and decreases the scope of the lease

Example 19 – Modification that is a change in the consideration only

Oher lease matters - Impairments

- Variable payments

Presentation 3.7, p65

You should expect questions on presentation to show the impact of IFRS 16 on

the financial statements. This section discusses and illustrates the effects.

Disclosure 3.8, p66

Disclosures are essential to show how the financial information has been

enriched by IFRS 16’s principles and guidance. Adopt the user perspective to

evaluate the relevance of the information to be disclosed. This section helps you to prepare effectively.

LESSOR ACCOUNTING Because IFRS 16’s priority is to remedy the deficiencies inherent in lessee

accounting under IAS 17, logically lessee-related issues will dominate future

exams. Therefore your exam preparation efforts should be allocated

accordingly. However, it is essential that you have adequate understanding of

lessor accounting, particularly in relation to sale-and-leaseback and modifications.

Key concepts 4.2, p72

Finance leases 4.3, p73

Dealer-lessor accounting Illustration 16

Operating leases

Modifications

Other matters, 4.6 p81

Presentation, 4.7 p81

Disclosure, 4.8 p82

SALE AND LEASEBACK - Assess whether the transfer of an asset is a sale in accordance with IFRS

15, 6.1, p88

- Off-market rates: Additional finance (if consideration received >Fair

Value of asset transferred)

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The above draws on the Conceptual Framework’s asset recognition criteria to

reflect substance over form in justifying the recognition as an asset of the lessee’s

rights to control the use of an asset BC 23: - Rights

- Potential to produce economic benefits

- Control

Substance in this case means that:

“the lease term used to measure a liability should include optional periods to the

extent that it is reasonably certain that the lessee will exercise its option to extend

(or not to terminate) the lease”, BC157.

Applying the concept of “reasonably certain” requires judgement and the IASB

provides application guidance.

“…when initially determining the lease term an entity should consider all relevant

facts and circumstances that create an economic incentive for the lessee to exercise

that option.” BC 157

The IASB includes guidance on the types of facts and circumstances that an entity

should consider to

- Ensure judgement is exercised on the basis of a wide range of relevant practical

and commercial circumstances: payment during the optional period, practical

ability to relocate at the end of the non-cancellable period; economics of

relocation; commercial importance of the location.

- Maintain lease terms that are economically reasonable for the lessee by reducing the risk of inserting non-substantive break clauses.

Choice for the lessee is in-substance fixed payment

- Exercise the option to extend the lease or

- Buy the underlying asset at the end of the non-cancellable period

Choice for the lessee guarantees minimum cash return or fixed payment to the

lessor regardless of whether an option is exercised. Possible practical situations:

- Extension option associated with a residual value guarantee

- Termination penalty equivalent to option period payments

Gain in-depth application knowledge by self-explaining worked examples:

Learning to deal with complications and unpredictability by attempting questions of

varying complexity. Learning in depth simulates various scenarios to enable versatile

application.

Source Focus

pwc All issues in a bit more depth (starter for learning in depth)

E&Y Illustrative examples: discussed at the required P2 learning

depth. Recommended MAIN SOURCE

ACCA IFRS 16 leases introduction with examples

- Off-market rates: Prepayment (If consideration received< Fair value of

asset transferred)

- Study example 24 - If the transaction is not a sale: consideration received is a financial liability

accounted for under IFRS 9. Frequently examined area. See section on

IFRS 9 and IFRS 7.

- Disclosure

Sale and leaseback practice questions - In a sale and leaseback when is the right-of-use asset increased by the

adjustment required to equate the selling price to the fair value?

- If the transaction qualifies to be recognized as a sale under IFRS 15 the profit recognized will be restricted to the rights transferred. Explain how

the amount is calculated. See Example 24 IFRS 16 calculations.

- If a sale is not recognized explain how the transfer proceeds are accounted

for.

BUSINESS COMBINATIONS Acquiree is a lessee

- Same rules as in 2. above Acquiree is a lessor

- Same as above

General issues germane to implementation. Consider

- Effect on systems (see F.1)

- Effect on performance measurement and evaluation (intersection with G.2)

- Effect on existing debt covenants (intersection with G.2)

- Disclosure initiative (intersection with H.3): Materiality Practice

statement

You should expect questions that require you to deal with interactions with

other IFRS as indicated.

TRANSITION

Transition from IAS 17 to IFRS 16 entails significant recognition, measurement

and presentational issues and differences between previous operating and

finance leases. You should expect questions about practical implementation

requirements including

- Distinguishing between a lease and a contract for services or products (where the customer provides operating assets)

- Basis of recognition of right-of-use asset and associated liability

- Appropriate discount rate

- Existing sale and leaseback gains and losses due to off-market terms

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Classic Technology Systems driven Illustrative examples. An illustration of

how IFRS 16 can be practically implemented on an

integrated IT system. But don’t get bogged down.

Additional reading for in-depth learning.

KPMG

Deloitte, Read for outline

Practise immediately and regularly with carefully selected problems.

Study interactions with other IFRS: understand the conceptual basis and practical

implications of interactions.

- IFRS 16 with IAS 40: conceptual basis (fair value); substitution or

complementarity? A lessor of investment property should apply IAS 40 when

accounting for investment property using the fair value model and apply IFRS 16

when accounting for the lease? This will ensure that useful information is

provided about the fair value of assets subject to operating leases and the rental

income earned by the lessor.

- IFRS 16 with IFRS 9: contractual basis (embedded derivatives: options, variable payments, residual value); impairments of lease receivable (lessor accounting);

impairments of residual value (lessor accounting).

- IFRS 16 with IAS 1: demonstrate impact on profit or loss (income statement)

- IFRS 16 with IFRS 15 (conceptual basis) & IAS 24 (practical implications)

…customer has the right to direct the use of an asset if it has the right to direct

how and for what purpose the asset is used throughout the period of use

(customer can make relevant decisions about how and for what purpose the

asset can be used throughout the period of use). An example is where equipment

is supplied by a customer who directs the production schedule (relevant

operating decisions the asset having already been financed by the customer) and

determines what can be produced and the quantity of goods to be produced up to

capacity throughout the period of use. The entity determines the price of the contract but no lease exists. The pricing of the contract is not relevant to the

financing of the equipment. The supplier-customer is a related party (IAS 24).

- IFRS 16 with IAS 24

- IFRS 16 with IFRS 7

- IFRS 16 with IFRS 11 the joint operation is the customer, not the parties sharing

control.

- IFRS 16 with IAS 7 operating cash flow now becomes financing cash flow

- IFRS 16 with IAS 10 contract inception and commencement take place before

and after reporting date

- IFRS 16 with IAS 8: the accounting policy change is a major issue

Critical thinking focal point

What connects one standard with another? What makes us consider whether one

standard is relevant to another or others? What is the nature of the connection? Is it

serial (the application of one triggers the sequential application of the other(s) e.g.

where appropriate IAS 37 is triggered by the requirement to estimate

decommissioning costs at the commencement of a lease under IFRS 16), or is it

parallel (the standards just happen to have a common context without having a

See Classic Technology: a guide to IFRS 16 Leases

TRANSITION FROM OPERATING LEASE

- Introductory table: 9.4 compares the available options

- Fully retrospective: 9.6-9.9

- Modified retrospective: Right-of-use asset …transition 9.10-9.13

- Modified retrospective: Right-of-use asset … commencement 9.14-9.20

- The methods compared 9.20

TRANSITION FROM FINANCE LEASE

- Fully retrospective 9.22

- Modified retrospective 9.23

LESSOR: TRANSITION FROM OPERATING LEASE

- Sub-leases are to be treated as new finance leases on transition to IFRS 16

9.24

THE FINAL REVISION TEST

Multiple-choice interactive feedback

HOW YOU SHOULD PREPARE The fail-safe approach to exam preparation

How to set exam practice objectives: question types that respond to the aims of

the syllabus, it’s rationale and approach. How do they fit? A key feature of this

IFRS is that it covers all aspects of financial reporting: recognition (discursive),

measurement (computations), presentation and disclosure. It intersects with

many other IFRS. So, prepare intensively for multi-part and multi-skilled

questions.

Refer to previous questions on implementation of new standards:

IFRS 15: Dec 2015 q4, answer, examiners report (Sep & Dec)

IFRS 09: Sep 2015 q4, answer, examiners report (Sep & Dec)

IFRS 13: Dec 2012 q4, answer, examiners report

- Review comments and be alert to previous weaknesses which the examiner

may revisit.

- What practical problems beset preparers? E.g. determining the rate of

interest implicit in the lease, achieving comparability.

- How would IFRS 16 affect accounting systems? What features of the

standard are systems critical? How are these systems needs to be met? See F.1

Rehearse articulating arguments and explanations; don’t just do calculations.

Use the worksheets as supports to develop structured and coherent analysis.

How to plug knowledge gaps

How to select questions for practice. Core criteria of selection.

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common objective e.g. IAS 2 production costs are not germane to obtaining and

maintaining the right to use an asset but may have been incurred as an initial cost in a

production activity)? Is the latter an interaction?

Blend with current issues:

- Materiality (CF and IAS 1): to particularize about materiality levels for specific

transactions would be inappropriate.

- Appraisal of financial performance

- Disclosure initiative

Contrast with other types of transactions

- Service contracts (e.g. Service Concession Arrangements, IFRIC 12) not a lease

because a service does not involve the transfer of “right to control the use of the

underlying asset” BC34 IFRS 16 - Sale is not a lease because a sale is a transfer of control and ownership to the

buyer, whereas a lease is a transfer of the right to use the asset for the lease

term in exchange for a consideration BC140 IFRS 16

- Purchase is not a lease because the buyer acquires the asset outright whereas

the lessee obtains the right to use an asset which may subsequently be bought but

not at the inception of the lease BC140 IFRS 16

Targeting the learning outcomes as you learn.

Understand the examiner’s assessment approach: clarify the basis for questions;

anticipate the focus of questions. Reflecting the syllabus aim, rationale and approach

in your learning.

Learning to score

Apply your exam insight to optimise scoring strategies and exploit scoring

opportunities.

Pacing yourself to allow time to think through the standard’s various application

examples: reflect on their significance, replicate their methods and simulate

alternative contexts in what-if scenarios. This is the essence of in-depth learning as

required by the syllabus.

HOW YOU SHOULD NOT LEARN Criterion of learning Shallow In-depth

Application Massed (all in last three

weeks before the

exams)

Distributed: spread across

several months to allow time

for assimilation and reflection.

Motivation to learn Wavers: limited Strong: driven by growth

mindset

Targeted learning General aim to pass. Clear focus on syllabus aims:

understands how to score full

marks. Understands how this

course fits within own overall

professional development.

How to target your practice at the core exam issues

How to practise deliberately to develop skills using metacognition and self-

regulated learning How to rehearse skill deployment for exam readiness

How candidates lose marks

How to avoid common mistakes

Practising for recall

Practising for retrieval

EXAM PRACTICE QUESTIONS Discuss the implementation requirements and financial effects from the lessor

and lessee’s perspectives.

Basic application scenarios

Scenario depicting critical measurement issues caused by variable aspects of

the lease terms causing measurement uncertainty.

Scenario depicting effect on the income statement

Scenario depicting the impact on profitability and the evaluation of covenant

and management ratios e.g. EBITDA coverage, EBIT.

Scenario depicting the impact on financial gearing ratios where on-balance

sheet finance (change from previous off-balance sheet ratios) has significant

implications for the entity’s ability to meet financial covenant agreements with

the bank.

Scenario depicting the issues of disclosure covered under IFRS 7 the lease

being treated as a financial instrument (in substance). The disclosure issues

may involve materiality considerations as part of the evaluation of what is useful to investors and creditors. The central focus of the disclosure scenario

would be to provide information about the measurement of the liability:

clarifying the elements that cause measurement uncertainty and how that

uncertainty is then mitigated by the management’s chosen policies.

Examine and demonstrate how the IASB thinking about disclosure has

improved to restrict the quantity of disclosures while enhancing its quality. E.g.

the requirement for single note; incorporation by cross reference of

information that is already presented elsewhere. This is relevant to the exam

because of the Disclosure Initiative.

The IASB has issued IFRS 16 Leases to reduce divergence in lease accounting

practice by replacing the dual accounting model under which lessees classified

a lease either as operating or finance lease with a single accounting model

under which all leases are classified as finance leases except for leases for a

period not exceeding twelve months.

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Primary medium of

learning

Passively watch video

lectures – not targeted

on specific learning

outcomes. Study texts. Ineffective.

Various: proactively selected

to achieve learning outcomes.

Not reliant on a single source.

Complexity of

learning and practice

tasks undertaken

Basic calculations. Complex analysis: covers all

learning outcomes.

Average time to study

IFRS

2 7

Average time to

practise

3 10

Average time to

revise

2 3

Average time to

prepare attempting

exam questions,

processing feedback,

repeating attempts.

2 10

How you learn Passive: no attempt to

think through the issues. Content to

accept prescriptions.

Critical knowledge

gaps and confusion.

Active: thinks through the

issues at appropriate depth and asks questions. Internalizes

ownership of the core

knowledge. Perceptive.

Sceptical. Actively seeking

meaning; therefore, clarifies

vague and confusing matters.

Application of effort

is concentrated on

Literal reading, basic

calculations; no

reflection; no level

three tasks

Critical reading; practise,

reflect, review, compare,

rehearse, evaluate, analyse,

synthesise.

Range or coverage of

issues

Limited Full

Energy and

application

Lethargic, ad hoc,

haphazard

Committed/disciplined

application

Marks aimed for 15/25 25/25

Marks likely to score 8/25 20/25

Habits you should overcome: shallow learning of IFRS (see passive reading v active

reading - contrast and warning!)

Habits you should develop: active and purposeful study of IFRS.

Concepts to learn Arrangement

Contract

Consideration

Required

Discuss the main principles of IFRS 16.

1. Discuss the effects on the lessee of the leases within the scope of IFRS 16

2. Discuss the effects on the lessor of the leases within the scope of IFRS 16

3. Discuss the transitional arrangements. Practise the worked examples: full

retrospective and modified versions.

4. Practise applying the basic principles of IFRS 16 to calculate the right-of-use

asset, lease liability, interest, depreciation. See IFRS 16 calculations.

5. Practise applying IFRS 16 principles to calculate the lease liability, right-of-use asset and related income statement amounts when the lease term changes. See Example 13

IFRS 16 calculations.

6. Practise extracting amounts for presentation in the financial statements.

Past exam questions

- March 2018 q3c (answer): accounting and financial implications of

implementing IFRS 16, particularly impact on gearing.

- September 2017 q4a (answer): impact assessment – is increased disclosure

enough to overcome the problems caused by off-balance sheet lease finance? Discuss, illustrating the standard’s potential impact on the quality,

range and usefulness of the financial information available to users.

- September 2017 q2b (answer): application of principle to leases including

materiality considerations: option to combine a portfolio of similar leases;

election to account for short leases as an expense. The examiner is very

much focused on the basic criteria of initial recognition of a transaction

with characteristics of a lease.

TO BE ADDED SOON

EXAM PRACTICE DOCUMENTS

Answer outlines Practice programmes

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Date of initial application

Executory arrangements

Identified asset

Initial direct costs – including construction period costs

Lease definition

Lease incentives

Lease modifications

Lease payments: fixed, variable, in-substance fixed.

Investment property

Market lease payments

Material right

Onerous contract

Performance obligations

Practical expedient (para 15) Protective rights

Reasonable certainty

Sale and repurchase option (interacts with IFRS 15); leaseback within option period

Residual value guarantee

Right-of-use asset

Separate lease components (distinct assets: para B32)

Unguaranteed residual value

D.3 Group

reorganisations

2 This was last examined in December 2011 q2 & answer as a separate and full

question. However, the effects of restructuring are frequently examined under IAS 19

(curtailment and termination of pension benefits plan) and IAS 37 (restructuring

provisions). The computational aspects are straightforward.

A group reorganisation is in essence changing where control of the group exists by

any of the available means including

i) Creating a new parent company to improve coordination and control

within the group or for the purpose of listing under a new integrated

identity.

ii) Operating under divisions rather than subsidiaries (divisionalization) by

transferring the assets, liabilities and equity of subsidiaries into one

operating entity and eliminating the subsidiaries. This can be the result

of an efficiency drive to save costs or to promote products more

aggressively.

iii) Demergers: splitting off parts of the group to improve the value of the separate components. This can be driven by the need to segregate the

loss-making parts from the profitable parts to ensure the stock market

values the components more fairly.

iv) Reverse acquisitions where an unlisted entity A issues shares to buy a

listed entity B resulting in B’s shareholders owning more of the

combined entity than A’s shareholders. Hence the acquired entity B

controls the combined entity A+B.

GROUP REORGANISATION

- December 2011 q2 & answer limited reorganisation involving IAS 27

Separate financial statements. A key issue is determining the cost of

acquisition of an investment in a subsidiary (subject to conditions). This is

based on the carrying amount of the parent’s share of the equity items shown in the separate financial statements of the original parent at the

reorganisation date, rather than the fair value of the subsidiary (as one

would expect in an acquisition). This is known as the “carry-over” basis.

- In the December 2011 question the parent reorganises the structure of its

group by establishing a new parent under the following conditions: i) the

new parent obtains control of the original parent by issuing its own equity

instruments in the new company to replace their existing equity

instruments; ii) the owners of the original parent maintain the same

absolute and relative interest in the net assets of the group before and after

the reconstruction; iii) the assets and liabilities of the new group and the

original group are the same. - The examiner may assess your ability to deal with situations where the

above conditions are varied. Key things to look out for in the scenario: i)

additional voting rights – these alter the absolute and relative interest

therefore the above conditions are not met, rendering the transaction out of

scope; in that eventuality, the investment in the new company cannot be

recognised at cost and must be fair valued instead, resulting in the

recognition of goodwill (positive or negative). What if the rights are

nonvoting? Then the relative interests are unaffected and if the other

conditions are satisfied then the investment can be recognised at cost. ii)

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Intermediate company – this is equivalent to a new parent company; iii)

acquisition of another subsidiary – this alters the composition of the group

rendering the investment transaction out of scope; iv) assets such as goodwill, intangibles, PPE, etc. may be impaired resulting in a write-down

which alters the net asset position breaching the conditions and making the

cost recognition basis inapplicable.

September 2016 q1b (answer): entity ceases restructuring after the year end

due to cost pressures. Discuss the current and future financial implications.

E.1 Financial reporting

in specialised, not-for-

profit and public

sector entities.

1,2

,3 WHAT YOU NEED TO KNOW This area has not been, and may not be examined frequently because the exam is primarily about listed company financial and corporate reporting practices which are

generally applicable to other sectors.

The specialised, public (central and local government) and not-for-profit sectors are

a significant component of most economies. Useful insights can be gleaned by

examining the rationale for practice in those sectors, especially where the practices

vary significantly from those of listed commercial organisations. For example,

section 6.2 of the 2017/2018 FReM (UK Government Financial Reporting Practice

Manual) gives succinct interpretations and adaptations of IFRS to the government

sector that demonstrates why it is essential to think critically and avoid the boilerplate

approach to financial reporting practice.

IFRS are produced primarily to meet the general purpose financial reporting

requirements of listed commercial organisations i.e. to enable organisations to

measure profits, the value of associated assets and liabilities and to reliably determine

returns on capital employed. The context is the key as there are various business

models to meet various stakeholder expectations. See Commercial and not-for-

profits: key similarities and differences.

In this syllabus area the examiner assesses your ability to recognize that context is

the driver of accounting practice. It is a test of your ability to think and solve

problems by transferring knowledge about IFRS to not-for-profit contexts that are

different from the commercial contexts in which the knowledge was initially gained. A clear illustration of this is given in Accounting scenarios of P2TT.

Types of not-for-profits, specialised and public sector organisations:

- Charities & NGOs (not-for-profit)

- The NHS, the Police, the Armed forces (specialised)

- Clubs & Cooperatives (not-for-profit)

- Housing associations (specialised)

- Central government and Local authorities (or local government) e.g. Southwark

Council (public sector)

- Schools, colleges and universities (specialised)

WHAT YOU SHOULD EXPECT Significant variations in practice between the commercial and not-for-profit

sectors highlighted below will be the subject of examinations.

You should expect questions about decision-usefulness: in this context

relevance is not primarily about shareholders and creditors but other stakeholders who may want to donate, to evaluate the impact of their

donations, to assess the organisation’s operating capability in order to decide

whether to donate.

Such assessments are carried out with the aid of information that has the

characteristics of the CF (May 2015). Hence there is practically no difference

in the scope of published financial statements. However, there are differences in

the treatment and presentation of similar items due to differences in financial,

mission and accountability contexts. For example, capital grant is not capital; it

is treated as deferred income (liability) in the SOFP and classified as financing

in the SOCF.

Specifically, decision-useful information supports decisions about maintaining

and renewing capability. What can enable the management to determine the

amounts required to maintain current and future capacity to deliver acceptable

quality and quantity of service?

Therefore, you should expect questions that require you to evaluate KPI

(section G.2 of the syllabus) E.g. assess the suitability of Welsh Water’s Net

debt/Regulatory capital value (RCV) KPI and EBITDA/interest cover given its

dependence on debt finance due to lack of shareholder equity contributions.

Given its financial context how sound is this indicator of the organisation’s ability to renew its operating capability with debt finance? What alternative

performance indicators would you suggest and why? See Welsh Water (2017),

The Value we bring, p16.

You should expect questions that require you to distinguish between income

(presented in the income statement) and financing (presented in the SOCF).

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Recognizing the specific ways in which generally accepted accounting practices

(GAAP) must be interpreted and adapted to fit the contexts of specialist, public sector

and not-for-profit organizations (within the public benefit sector) such as the above, designated statements of recommended practice (SORPs) are developed and

introduced under the guidance of the ASB’s Statement of Principles for financial

Reporting. This syllabus does not require knowledge of SORPs but it is essential to

understand the reasons for the differences in practice as variations can be the subject

of examinations.

Key areas you should expect the examiner to prioritise include:

- Income recognition: how does a charity (and other not-for-profits) recognize and

report on a variety of income sources including social rents (as opposed to

market rents), donations, contracts, grants, legacies, endowments, gifts in kind and shop sales? The principles of IFRS 15 and IAS 20 apply. The objectives of

both standards are the same in that the entity only recognizes what it is entitled

to expect, can measure reliably and uncertainty of collectability is assessed – the

certainty of entitlement principle. However, as observed under IAS 20 above,

whereas revenue is recognized as consideration for the transfer of goods and

services to a customer (and therefore requires the satisfaction of “performance

obligations”), grant income is recognized not as consideration for the transfer of

goods and services but as entitlement, based on fulfilling eligibility criteria such

as readiness (ability and willingness) to provide employment to apprentices in

certain deprived areas e.g. June 2013 q2d (answer). An eclectic approach is

inevitable.

- Asset recognition: for example, how does a local authority (government

organization) or housing association (social landlord) recognize expenditure on

property acquired for rent given its mission is to provide a social service to its

tenants? However, the social landlord’s property portfolio may consist of social

and non-social activities such as letting property to tenants on non-social basis

(e.g. shared ownership) or holding investment property for sale to tenants.

- Expenditure: how does a charity recognize, measure and report on volunteering

resources and the sale of donated goods such as used clothing and furniture?

Moreover, expenditure by a charity is often recognized in accordance with the

accrual or matching principle when it is incurred whereas, the related income may be generated in the future or not at all, as in the case of activities to generate

legacies and other fundraising activities. Accounting for grant financed revenue

and capital expenditures is dealt with under IAS 20.

- Liabilities: How does the charity (not-for-profit) recognize liabilities if cash is

received in advance of fulfilling obligations or obligations for which cash has

been received are unfulfilled at the end of the reporting period (IAS 20)? Valid

expectations created by not-for-profit actions e.g. promising grants. The

expectation is valid because it is logical, reasonable and achievable. This is the

case with the Student Loans Company (SLC) of the UK where the company has

an obligation to pay grants to eligible students without receiving consideration in

These differences arise from the nature of the grant: revenue grant (operating

activities), capital grant (financing activities).

Outsourcing public sector services to private sector operators are common and

you should expect questions because of the many different standards that are

applicable:

- Recognition of intangible asset (right to charge users for public services as

in obtaining a licence to operate a toll road IAS 38)

- Recognition of a financial asset (unconditional right to receive cash for

construction services IFRS 9)

- Recognition of operator’s borrowing costs (IAS 23) if intangible assets (but

not if financial asset as not qualifying asset)

- Recognition of right-of-use asset provided by the operator (subject to

finance lease conditions) under IFRS 16 - De-recognition of PPE under IFRS 16 (if infrastructure leased to or by the

private operator)

- Recognition of IFRS 15 including allocation of contract price between

construction and services

- IFRS 8 use of infrastructure is partly regulated and partly unregulated as in

ancillary activities such as hospital shop

- IAS 36 impairment of the underlying asset

- IAS 37 possible claims, onerous contracts

You should expect questions that require you to distinguish between provisions

(e.g. for outstanding claims, constructive obligations), liabilities (e.g. for

refunds of grants to the government) and contingent liabilities (e.g. the treatment of “contingencies”). To assess each obligation against the criteria of

IAS 37: present obligation as a result of past events; require transfer of

economic resources to settle it; can be measured with reasonable certainty; not

capable of being avoided by the entity’s future actions (no practical alternatives,

no discretion). For further illustration of these issues see Westminster Council,

Note 2 (2017), p040, Business rates appeals.

You should expect questions about insurance as not-for-profits can be high risk

organisations vulnerable to claims. Examples of high-risk not-for-profit

organisations:

- Care homes for the elderly - Schools

- Hospitals

You should expect questions about related parties: assessing who can control

and influence the not-for-profit and who it can be controlled and influenced by.

HOW YOU SHOULD PREPARE Be clear about the syllabus aims and keep them in focus as you prepare.

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exchange. Such constructive obligations are recognised as provisions under

IAS 37 once the not-for-profit has set up a valid expectation that it will pay

grants to eligible grantees. A valid expectation is set up when a letter or form is issued to the grantee specifying the amount of the grant the terms and conditions

of payment.

- Contingent liabilities relating to capital grants (social housing grant) repayable to

the government if the property to which the grant relates is sold; and revenue

grant refundable if the terms of entitlement are breached. For contingent

liabilities on capital grants see London & Quadrant Note 25 (2017).

- Surplus/ (deficit) determination: through the application of IFRS principles

backed by the conceptual framework principles e.g. faithful representation and

relevant information.

- Reserve accounting: essential to facilitate transparency and accountability for

funds e.g. restricted funds donated for specific uses. Demonstrating that this has

been the case. The accounting classification, control and reporting process

facilitate this e.g. IAS 1 allows flexibility in presentation and disclosure.

Equivalent to the statement of changes in equity.

- Performance effectiveness indicators based on financial measures and context

In all these considerations, it is essential to refer to and apply the principles of the

Conceptual Framework.

For example, faithful representation requires that all aspects of the context in which a

transaction takes place are reflected in the way that the transaction is represented.

Thus, property of a social landlord such as a housing association or a local

government organisation on which rent is collected is classified as PPE in accordance

with IAS 16 because its mission is a social one, being responsible for providing

social housing at affordable rents. By contrast a private landlord such as an estate

agent or freehold or leasehold landlord would classify an identical property as

investment property in accordance with IAS 40 because its mission is to maximize

profits by charging maximum rent to its tenants. This is an example of why the

business model matters.

In addition, benchmarking, a key performance evaluation technique prominent in the

not-for-profit sector necessitates comparability. Accordingly, not-for-profits should

apply IFRS principles in ways that allow comparisons to be made between

comparable charities, housing associations and local government institutions

especially where accountability for the use of public funds is central to

demonstrating their legitimacy.

Critical thinking like this and versatility in application are the hallmarks of a

professional. It requires applied understanding and efficient learning techniques.

Read examiner’s report relating to past questions in this area to identify what

the examiner is looking for and to understand why students have not met exam

requirements in past exams.

Read the accounting policies of several not-for-profits and evaluate the

variations from IFRS from the user perspective. The relevant CF principles

should be highlighted to focus the discussion. E.g. the FReM (UK Government

accounting manual) highlights certain variations.

Review all relevant technical documentation and make sure you understand

their core concepts and principles. In particular, as grants are a key financing

feature of non-commercial sectors it is essential that you are very thorough with the issues and problems associated with grants (e.g. refunds, restrictions,

potential grants arising from loans) and the principles that govern the financial

reporting practices.

Practise answering questions about

- Recognition (Income and capital)

- Presentation in the SOCI, SOFP, SOCF,

- Disclosure of contingent liabilities

- Interaction with IAS 10 where a claim exists at the balance sheet date for or

against the organisation and events after the balance sheet date warrant a

response. - Interaction with IFRS 15: where the organisation offers services to a

government body and separately, receives a grant from the same or other

government body, subject to conditions within IAS 20.

- Interaction with IFRS 16/IAS 16/IAS40: where leased property is used to

provide hostel services for homeless people. Watch out for the amount of

rent charged which indicates that the property is being used as plant to

carry out a social mission rather than as investment property to generate a

return on capital. If the charges only cover running cost, e.g. service

charges and minimum rent covered by housing benefit then the likelihood

is that the property is to be accounted for as under IAS 16 PPE.

Past questions for practice

- Dec 2012 q3 (answer) local authority as a social landlord accounts for

property rented to tenants as PPE (IAS 16) not as investment property

(IAS 40)

- June 2012 q3 (answer): local authority acquires property for use as school

which was later converted into a library, resulting in impairment loss.

Evaluate the measurement basis for the carrying value of the library and

justify the immediate recognition of an impairment loss in profit or loss.

ADDITIONAL EXAM PRACTICE QUESTIONS 1. Explain how classifications of income and expenditure reflect the

requirements of accountability in a specialised, public sector or not-for-

profit organisation you have studied.

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CONCEPTS TO LEARN Accounting boundary

Classification: revenue v capital

Contingent liability Control v regulation

Estimation uncertainty & relevance

Fair value

Going concern

Government grant & Government assistance

Materiality as it applies to other sectors, e.g. the Charities SORP (2015):3.15-3.19

Measurement uncertainty & relevance

Outcome uncertainty ED 2015/3: 6.56, p68. The unique nature of services and

assets may cause outcome uncertainty which may affect the degree of measurement

uncertainty. E.g. assessing the fair value of land in remote areas or unique assets

donated by individuals or governments. Reasonable assurance

Related party

Sensitivity analysis (Camden Council; Westminster Council)

Perspectives: user, preparer, analysts

Valuation premise: what is the “highest and best use” presumption?

Unit of account: at what level to aggregate or disaggregate an asset or liability for

recognition, measurement and presentation. E.g. IFRS 5 disposal group; IFRS 3

business unit (subsidiary); IAS 36 CGU

Unamortized deferred income:

2. Explain how the recognition and measurement bases reflects the

requirements of accountability in a specialised, public sector or not-for-profit organisation you have studied.

Required

2.1 Read Commercial and not-for-profits: key similarities and differences

to orient yourself to the principles and practices.

2.2 Compare the statement of financial activities (SOFA), p50 of The Welcome Trust, p50 with the Consolidated income statement of

Welsh Water, p116

2.3 Explain how the different structures and contents meet key user needs

for information about financial performance.

2.4 Explain why a lender will have some concerns about the financial

performance of Welsh Water based on the 2017 income statement?

Provide analysis to support your views.

2.5 Explain why some comfort is available from the statement of financial position and the statement of cash flow. Provide relevant calculations

and extracts of commentaries from the CEO and CFO’s reports.

3. Discuss how the terms of a loan may constitute a government grant to a

specialised, public sector or not-for-profit organisation.

ASSESS YOUR CONFIDENCE LEVEL

E.2 Entity

Reconstruction, (Study

guide reference E.2, p10)

2,4 A reconstruction is a process of rebuilding an organisation to improve its operating

performance and financial position.

A reconstruction is often triggered by financial information about an entity in

financial difficulty indicating going concern problems - doubts about the entity’s

ability to continue in operational existence for the foreseeable future. According to

the Conceptual Framework for financial reporting (May 2015) relevant information is

information that allows this assessment to be made in a timely manner. An

organisation in this situation has two options: i) liquidate (terminate the business,

sell its assets and pay creditors); ii) reconstruct if there is a reasonable chance of

rescuing the business (e.g. because it has viable products or services) and satisfying creditors and other parties.

A reconstruction is a problem-solving exercise that encompasses all aspects of the

business. Therefore, a wide range of IFRS would be relevant to accounting for the

effects of the proposals: i) IFRS 9 new investments in subsidiaries and financial

guarantees to improve the financial position and provide security to creditors; ii) IAS

37 restructuring provisions are always inevitable; iii) IAS 19 there is always an

Questions for practice

MAINTAIN EXISTING COMPANY

a) Evaluation of options to i) liquidate or ii) to continue

b) Reconstruction accounting: can you prepare a reconstruction account? See

worked example.

c) Impact assessment: i) prepare projected financial statements ii) and

comment on specific effects; this requires explaining critical accounting

effects e.g. gains and losses including reclassification of amounts deferred

in equity; iii) deferred tax arising or cancellation; iv) cancellation of capital

redemption reserve making it distributable; v) additional contributed capital (the excess over par or stated value).

TRANSFER OF ASSETS TO A NEW COMPANY

WORKBOOK

See worked example – reconstruction new company

Exam practice – fair values

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impact on the pension; iv) IAS 16 PPE would be revalued, transferred, sold, etc.; v)

IAS 2 stocks would be revalued; vi) IFRS 5 a business may be put on sale; vii) IAS

36 impairment may be recognised as result of persistent operating losses; this would affect intangibles (IAS 38), PPE (IAS 16) and current assets; viii) sale of investment

issues (realised profit/loss if control lost; reclassifications from equity); ix)

distributions and their cash flow implications; x) old business liquidated voluntarily

and its assets sold to another business (IFRS 3?): acquisition date fair values may not

apply given distress business condition; goodwill is unlikely to be recognised;

purchase consideration unlikely to be fair valued. IFRS 3 is not applicable. What

difference does it make? This is a case of a business acquiring assets – not another

business. You may be required to discuss this.

You would be required to evaluate the potential impact of the proposals on the

financial position and performance (interpretation: Study guide G.2, p11): i) primarily on cash flow IAS 7 (reflect deferred or reduced dividend, interest, debt

repayment, new equity, etc.); ii) impact of capital restructure on returns to investors

e.g. EPS (reflect effect on numerator and denominator); iii) gearing (e.g. reflecting

the effect of converting loans to equity); iv) earnings (reflecting the effect of

restructuring provisions, redundancy provisions, pension benefit changes, reduced

interest, reduced tax due to deferred tax effects of asset impairments, etc.). In essence

you would be extrapolating as explained in the P2 - codes to annotations (see

“making use of the scenario”).

You are strongly encouraged to answer this question whenever it is examined, as it is

likely to be within your reach consisting of many parts you will have studied

separately. Don’t forget about: i) ethics; ii) presentation (professional marks would be available); iii) clarifying the purpose of the reconstruction (this would be explicit

in the question and implicit in the scenario).

A key feature of such a reconstruction is i) distribution to existing shareholders

out of the available cash and or the proceeds of the consideration offered by the new company; ii) existing shareholders take up shares in the new company.

September 2016 q1b (answer):

F.1 The effect of

changes in accounting

standards on

accounting systems

4,2

,1b The purpose of accounting systems is to record and analyse the substance of

business transactions intelligibly and thereby facilitate reports to be produced that

enable stewardship and other managerial duties to be discharged to meet the

legitimate expectations of stakeholders.

Requirements and guidance in IFRS are core determinants of what accounting

systems recognize, measure, present and disclose to reflect the economic substance of business transactions. For example, the unit of account and the unit of valuation are

central to IFRS 13 Fair value measurement. Consequently, the introduction of IFRS

13 directly impacts the accounts structure of an entity which must be reorganized to

align with its requirements as part of the implementation of the standard. Thus, the

accounting control system, the procedures and policies of an entity that ensures full

but adaptive compliance with IFRS requirements and guidance must be responsive to

the introduction of new IFRS.

Examples of recent IFRS that have had major impacts on accounting systems:

IAS 1

Past questions for practice

- Mar 2016 q4ai (answer): general practical considerations of implementing

a new IFRS

- Sep 2015 q4 (answer): IFRS 9 implementation requirements

- Dec 2012 q4 (answer): IFRS 13 implementation

- Jun 2008 q4 (answer): a) inconsistencies between financial statements

stemming from changes in accounting practice and choice in the application of IFRS; b) effect of judgement and infrastructure on IFRS

compliant financial statements.

WHAT YOU SHOULD EXPECT

You should expect this area to be examined regularly at question 4 (and

possibly at q1b) because of its generic importance in the implementation of

new high profile IFRS (IFRS 9, IFRS 15, IFRS 16) and the related cross

cutting issues of corporate reporting significance. The requirements are broad

and you should think widely about the objectives, requirements and

implications of the IFRS. Consider this extract:

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- The requirement to classify (and reclassify) income items between profit or loss

and other comprehensive income.

- Amendments introduced as part of the disclosure initiative to improve the quality of published information e.g. guidance on the bases of aggregating and

disaggregating information have a direct impact on the accounts structure.

IAS 38

- The requirements to segregate development expenditure from expenditure on

pure research

IFRS 8

- The requirements to identify, segregate and report on operating segments

- The treatment of common costs December 2011 q1b (answer)

IFRS 9

- The requirements of hedge accounting; assessing hedge effectiveness

- The requirements of valuation unquoted financial instruments e.g. Level 3

unobservable inputs.

- Impairment requirement: to recognise always and to annually review expected

credit losses to reflect changes in credit risk

- Impact on financial reporting and covenant compliance of classification of

instruments as debt or equity

- Resource requirements including accounting systems required for

implementation

- The requirement to exercise professional judgement over expected losses

(subjective) as opposed to incurred losses (objective).

IFRS 13

- The unit of account that enables identification of asset or liability to be

measured; impact on accounts structure.

- The valuation premise that maximises the value of the asset in its “highest and

best use”.

- Accounting information is required to support the assessment of the most

appropriate valuation technique (market, income or cost method)

- Accounting input to valuation techniques e.g. published financial information

IFRS 15

Revenue-dependent billing, accounting, taxation and financial reporting systems will

need to change to cater to significant requirements including

- Performance obligations as unit of account

- The requirements to keep track of services delivered over a period of time in

order to recognize revenue when performance obligations are satisfied.

- Keeping track of contract costs; the requirement to recognise an asset from the

costs of obtaining and fulfilling a contract with a customer and to disclose the

relevant details and accounting policies.

- The requirement to distinguish between contract assets and accounts receivable

conceptually and operationally, and to monitor the associated credit and

“…it was surprising to see some candidates writing much less on the

implementation issues: comments such as (and not limited to) judgement issues,

new processes and resource requirements, and covenant requirement issues would have earned marks.” Examiner’s report September 2015 q4a

CORE ISSUES

Accounting control for effective:

- Recognition

- Measurement

- Presentation

- Disclosure

CROSS CUTTING ISSUES

Better communication Corporate social responsibility

Cost constraint

Integrated reporting

Performance measurement

Professional competence e.g. judgement and commercial awareness

TECHNOLOGY

Enabling implementation, facilitating integrated reporting

Promoting efficiency and reducing human error

Providing access to information for transparency

RELATIONSHIP MAINTENANCE

Covenant arrangements

Investor and creditor protection

INTERPRETATIONS

Always consider how the structure and content of financial reports (IAS 1) are

impacted and consequently, the financial performance indicators depicting the

relationships between them. Consider in particular the classification between

- Operating, financing and investing activities.

- Profit or loss and other comprehensive income

- Current and noncurrent assets - Current and noncurrent liabilities

- Equity and liabilities

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performance risks. Processes to enable reclassifications from contract asset to

account receivable, from contract liability to revenue.

- The requirement to analyse the deferred payment consideration for the sale of goods and services into financing and operating elements and to account for

them separately.

- Applying the requirements of non-cash consideration e.g. non-cash

consideration in the form of shares involves IFRS 2; remeasured and any

impairment (the difference between the fair value of the consideration due and

the fair value of the shares or other forms of non-cash consideration) accounted

for as a loss in accordance with IFRS 9. The requirement to disclose such

impairment separately from impairment from other contracts.

- The requirement to analyse revenue into meaningful categories in order to

present relevant information to users about the different goods and services

transferred to different types of customers. - Warranties: the requirement to distinguish between assurance-type and

service-type warranties to reflect their differing accounting implications.

Assurance-type warranties are accrued at the point of sale in accordance with

IAS 37 and the expense charged to profit or loss immediately. Systems would

need to be upgraded or introduced to handle the matching process between

claims and individual plans. Service-type warranties by contrast are separate

performance obligations and are therefore allocated a portion of the contract

price. When the performance obligation is discharged to the customer, revenue is

credited to profit or loss to match the cost incurred. So enhanced processes and

controls would be required to keep track of, and allocate, performance

obligations and to account accurately and completely for the associated revenue

and costs as those obligations are satisfied over time. - Impact on tax compliance processes and determination of taxable income

- Impact on HR systems for measuring and tracking incentive payments such as

bonuses dependent on revenue performance.

- The contract as the unit of account for assessing onerous contracts.

Thus, an integrated approach involving finance, IT, HR, taxation and sales functions

is essential for an adequate implementation and ongoing improvement of the

application requirements. The resource implications are significant and should be

planned and managed effectively.

IFRS 16

- The transitional relief provisions are significant. Their accounting implications

must be carefully considered after carrying out an assessment of how the reliefs

can be exploited to the entity’s benefit. Care should be exercised to ensure that

the transition itself does not induce oversight of material transactions that could

otherwise be classified as leases. One such area of risk is the identification and

classification of operating and service contracts discussed further below.

- The complexity of the IFRS 16 means that there must be integration between the

accounting and legal documents so that clauses about termination, extension,

variable payments, etc. can be electronically monitored to ensure the entity does

not breach the terms and conditions of the lease. This calls for investment in

EXAM PRACTICE QUESTIONS

1. Identify and discuss how the implementation of IFRS 16 would impact the

accounting systems and explain how an entity with a large volume of leases may respond, to maintain faithful representation of its significant leasing

portfolio in the financial statements.

2. “ What's proving to be more challenging is actually obtaining and assessing

all of the relevant data necessary to implement the standard.” KPMG

Required

2.1 Identify and explain the financial and non-financial data that would be

required to enable the transition into IFRS 16 by an operating lessee.

2.2 Assess how the challenges would influence the transition route.

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suitable IT systems and human resources to safeguard the integrity of the lease

records as a basis for faithful representation of leasing activities in the financial

statements.

- Initial direct costs, prepayments and other obligations must be carefully

identified and segregated to allow an assessment to be carried out to determine if

any contract is onerous prior to commencement. Initial direct costs can be

accounted for under IFRS 15 and IFRS 16 depending on the terms of the

contract. Accounting data capture and analysis should facilitate the assessment

process.

- The requirement to disclose off-balance sheet finance of transactions previously

classified as operating leases and the recognition of related noncurrent operating

assets previously excluded from the balance sheet. Accounting policy changes would be necessary under IAS 8 to allow for the correct treatment of identified

transactions including the recognition of right-of-use assets and liabilities,

depreciation, retrospective adjustments for prior year effects.

- Identified assets would need to be booked into a fixed assets register which is

maintained as a memorandum record outside the double entry system of

accounting, and hence would need to be periodically reconciled to the main

ledger.

- Allocation of consideration to separate leases and to non-leases means that the

chart of accounts and accounting controls would need to be amended and

strengthened to allow for the tracking, allocation and matching of lease transactions.

- The application of practical expedient exemptions in transition can cause

certain transactions to continue to be erroneously classified as operating leases.

For example, there is a risk that certain service contracts not previously

distinguished from operating leases under IAS 17 and IFRIC 4 may be lumped

together with operating leases and exempted from reassessment under the

transitional relief to determine whether they contain a lease. Such contracts

could be eligible as finance leases under IFRS 16 as most leases would be.

Therefore the accounting system must identify all such transactions for review in

stages: first identify and segregate transactions previously subjected to IFRIC 4 assessment and are probably eligible for classification as leases under IFRS 16;

review the rest to determine if they are eligible for classification as leases under

IFRS 16 or as service contracts under IFRS 15. The additional effort involved

would be worthwhile for those organisations that have substantial relevant

transactions.

- On an ongoing basis there will be a need for the accounting system to distinguish

between a lease and a service contract; between a lease and a purchase. Separate

units of account would be needed to identify, segregate and maintain the

distinctive nature of the transactions to achieve faithful representation and fair

presentation at the higher reporting level.

2.3 Discuss the implications for the entity’s cost and benefits and indicate

how the entity would make a trade-off, e.g. what sort of issues would influence a company to trade-off cost for comparability as highlighted

by KPMG?

3.

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- The replacement of operating lease expense with depreciation expense. Both

these items are operating expenses but are subject to different accounting

policies. Management’s judgement about their impact on performance

measurement would be different. For example, key measures of performance

such as EBIT and EBITDA are indifferent to rent but, whereas EBIT is sensitive

to depreciation EBITDA is not, as it excludes it. Refer to effect analysis for

further details.

- The impact on report production and quality (June 2013 q4ai, answer). To what

extent are new standards such as IFRS 16 more conducive to producing quality

information and reducing duplication? For example, the principles-based IFRS

may require enhanced disclosures to explain the basis of significant judgements

and estimates. While this may result in relevant information to users the production cost may be uneconomic; there is no requirement to monitor and

justify it. However, IFRS 16 permits cross referencing of information already

available elsewhere in the report as a way of preventing duplication of

information and holding production costs down.

- Evaluate whether the standard has in-built checks to require the preparer to

assess the decision-usefulness of information. This would encourage preparers to

trim disclosures to focused and lean levels.

As the implementation of IFRS often involves a change in accounting policy or a

change in accounting estimate you should consider studying this section in relation to

IAS 8 Accounting Policies, changes in accounting estimates and errors.

Also, consider reading the accounting policy sections of published financial

statements. “Adoption of new and amended IFRS” explains the effects of new IFRS

and the “Standards issued but not yet effective” explains the potential effects of new

IFRS on the entity’s financial statements.

These learning activities will help you to develop in-depth understanding and to pick

up marks available for commercial awareness of real-life applications of IFRS

implementation issues. Read the examiner’s report June 2016 (general

comments).

F.2 Proposed changes

to accounting

standards. Refer also

to H.3 Current

reporting issues

4

“Students will be examined on concepts, theories, and principles, and on their ability

to question and comment on proposed accounting treatments.” Approach to

examining the syllabus, p7

As discussed under B.2 Critical evaluation of principles and practices you are

required to apply critical thinking to determine the suitability and acceptability of

current practices underpinned by theory, IFRS and conceptual framework. This

should lead you to make suggested changes to improve practice in specific areas. The

ability to contribute to improvements in practice is a key differentiator from F7 where

WHAT YOU SHOULD EXPECT

A question(s) that requires critical thinking to be exercised in a structured way

to provide full answers that are anchored in the core corporate reporting

principles and objectives. Therefore, address the issues using a framework you

have used to study IFRS.

“It is important that candidates keep abreast of recent developments as the paper

frequently examines recent pronouncements.” Examiner’s report, June 2010

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the expectation is to apply acquired knowledge. See Transition guide on the top

page.

The IASB’s work plan and its supplements embodies its due diligence procedures in

guiding the profession to identify, analyse, evaluate and resolve issues that warrant

amendments to current IFRS and the introduction of new ones by building consensus

over what is best practice generically and specifically in certain areas.

The Exposure drafts included as examinable documents are the main evidence of

this process. They invite you to make and justify your recommendations for proposed

improvements to IFRS.

The examinable exposure drafts have been included in the relevant IFRS. However,

due to the cyclicality of financial reporting maintenance do not be limited to the EDs – review and action the work plan as suggested in the opposite box.

Read the examiner’s reports

As can be seen these reports give general guidance about what the examiner is

looking for and indicates how you should approach learning to develop the in-depth

understanding required to answer EDs effectively. Think about this:

ED 2013/6 Leases (examined June 2016 after issue of IFRS 16 in January 2016)

“The effects of new standards on business reporting would be considered a current

issue and this topic formed the basis of question 4 in the sample paper as did the

focus of regulators upon problems of impairment and deferred tax. There are certain general problems that most standards face. Consistency with the Framework is one.

Other problems would include assumptions used in estimates, judgements used by

directors, valuation issues, the use of discount rates, the age of the standard and its

current application, the nature of the evidence needed to apply the standard and lack

of clarity in the standard.

A useful source of information about a standard is the Project Summary and

Feedback statement issued by the IASB after a standard is issued. Thus, in order to

answer this question, candidates should be prepared to read around the subject

and gain an understanding of the issues involved. It is not a rote-learned area of the

syllabus.”

ED IAS 37 Non-financial liabilities examined June 2012

“…candidates were required to describe the new proposals that the IASB has

outlined in an exposure draft in the area and describe the accounting treatment of

certain events under IAS 37 and the possible outcomes of those events under the

proposed amendments in the Exposure Draft…”

“…candidates could have answered this part of the question with basic general

knowledge of the standard setting process.”

Read Deloitte’s 2017 model financial statements, (note 2.2, p32) to acquaint

yourself with the amendments of IFRS that are mandatorily effective for the

current year.

Review the IASB work plan relevant to June 2018 exams and make sure you

address

ACTIVE PROJECTS

- Research projects (RP): goodwill and impairment, share-based payment

IFRS 2 (ED2014/5) and discount rates are projects about core subject matter and are likely to be examined. The others are unlikely to be

examined as they are awaiting the publication of discussion papers (DP) to

engage the profession and other contributors.

- Standard setting and related projects: conceptual framework (ED

2015/3) and disclosure initiative (ED 2014/6) are very topical and you

should prepare for them.

MAINTENANCE OF IFRS (MP)

- Narrow scope amendments and IFRIC interpretations: these all relate

to frequently examined topics and are hence high priority for June 2018.

- IFRS Taxonomy

No examinable updates

- Post implementation reviews: completed PIRs. Hence it is unlikely that

any of the subject matter to which they relate would be examined in June

2018.

COMPLETED IFRS

- Standard setting and completed projects: examinable completed IFRS

are listed in the Examinable documents. Amendments to SMEs are not

particularly exam significant as the SME is not high priority for the reasons

given below under IFRS for SMEs. However, as this area is examinable

make sure you are clear about the SME as described below. - Narrow scope amendments. These are usually examined in the exams

prior to the effective dates e.g. IAS 16 PPE (issued May 2014, examined

September 2015 q2a effective 1 January 2016). Priority areas are

highlighted.

- Post implementation reviews (PIR): all PIRs are examinable.

Past questions for practice:

- Jun 2016 q4 (answer): ED 2013/6 Leases

- Mar 2016 q4 (answer): general practical considerations of implementing a

new IFRS

- Jun 2012 q4 (answer): ED IAS 37 Non-financial liabilities

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“…the level of knowledge required of the new proposals was in the nature of

summary knowledge and not detailed knowledge and a reading of part b of the question would have given candidates an insight into the nature of those proposals.”

“The lesson which should be learned by candidates is that the scenario is important

as it helps answer the question”

G.1 The creation of

suitable accounting

policies. Also, refer to

B.2 and IAS 8

1b,

c,3

,4

WHAT IS THE SUBSTANTIVE FOCUS OF THIS SECTION?

Accounting policies enable the entity to meet its reporting requirements. This section

is about understanding the critical factors that influence the entity’s accounting policy

choices and to determine if the adopted policies are suitable (fit for purpose) and

efficient (acceptable to all stakeholders).

Accounting policies are suitable (fit for purpose) if they enable the entity to achieve

the qualitative characteristics in its financial statements (B.1). Accounting policies

are acceptable if they satisfy user needs (e.g. present relevant information that can be

understood readily and applied effectively) and the benefits exceed the cost of their

application.

How this section relates to A.1 Professional behaviour and compliance with

accounting standards

Ethical issues (e.g. management of earnings) may arise when management makes accounting policy choices because their rewards may be based on the financial

performance and financial position which are significantly affected by the entity’s

accounting policies. These issues, their implications and the accountant’s expected

professional and ethical stance are discussed in the linked document under A.1. This

is a frequently examined area. Refer to the past questions of A.1 and IAS 8 above.

How this section relates to A.3 Social responsibility, B.2.a and H.1 Environmental

and social reporting

Accounting policies are at the core of producing general purpose financial statements

that meet the needs of different stakeholders. Therefore, it is essential to consider if

the policies of the reporting entity are “suitable” and “acceptable” from the perspective of all stakeholders. What are the criteria of “suitability” and

“acceptability”?

For the purposes of corporate social responsibility reporting stakeholder theory

is an appropriate source of criteria of suitability and acceptability. “Identify the

relationship between accounting theory and practice.” Study guide B.2.a

Stakeholder theory is a branch of legitimacy theory which posits that the entity is

under a social contract with the community in which it operates and strives

continuously to do the things the community approves of. This means that the

community will receive information about the entity which satisfies its legitimate

WHAT YOU SHOULD EXPECT

Questions in this section are assessed at intellectual level 3 - synthesis and

evaluation building on the preceding intellectual levels 2 (F7 - analysis and

application) and level 1 (F3 - knowledge and understanding). This fact is

reflected in the following extract from the syllabus rationale:

“The Paper P2 syllabus takes the subject into greater depth and contextualises

the role of the accountant as a professional steward and adviser/analyst by

initially exploring the wider professional duties and responsibilities of the

accountant to the stakeholders of an organisation.”

Thus, the questions are multifaceted, challenging and stretching, reflecting the

complexities of creating policies that produce general purpose financial

statements to meet the needs of diverse stakeholders while addressing the

entity’s regulatory and ethical requirements.

The multifaceted thematic approach

The multifaceted thematic approach is a recent trend in the examiner’s

approach to assessing this area. For example

- Dec 2016 q1b, c (answer): the theme was pensions

- Jun 2016 q1a, b, c: the theme was statement of cash flow

- Dec 2015 q1a,b, c (answer): the theme was foreign exchange

The examiner has plenty of opportunities to continue this trend with common

themes including:

- Classification of gains and losses between profit or loss and other

comprehensive income (OCI); between equity and debt. - Corporate social responsibility (CSR) reporting (A.3, H.1)

- Goodwill (classification between goodwill and intangible assets; full and

partial goodwill)

- Intangible assets (classification of research and development expenditure)

- Inventory valuation (cost or NRV; FIFO or AVCO)

- Liabilities (classification between current and non-current; financial and

non-financial; recognition of measurement gains and losses between profit

or loss and OCI; accounting for changes in estimates of decommissioning

liabilities in respect of assets measured at cost or valuation)

- Taxation (deferred tax asset recognition assessment)

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needs for social, financial and environmental accountability and sustainability.

Thus, an accounting policy is acceptable if it enables information to be produced

which meets the needs of the investors as well as other stakeholders.

There is potential for conflict: an accounting policy may be suitable for a

stakeholder group such as investors but unacceptable for others such as

environmentalists. Indeed some commentators question the suitability of financial

accounting for assisting in the disclosure of social and environmental costs caused by

the reporting entity as these costs are in principle not recognized by the entity unless

they are explicitly required by legislation. For example, the conceptual framework

defines an expense as

“Expenses are decreases in assets or increases in liabilities that result in decreases in

equity, other than those relating to distributions to holders of equity claims.”

On this basis, for the purposes of CSR, the entity may only recognize an expense it

incurs as a result of a specific statutory obligation such as a penalty for pollution but

may not recognize an expense when it consumes naturally occurring assets such as

land, trees, water, fish and air. These assets are not under the control of the entity and

are therefore not within the conceptual framework’s definition of an asset. Whereas

the entity may be increasing profits and shareholder wealth it may be doing so by

depleting certain natural assets and the accounting system is rightly criticized for

ignoring this situation (known as externalities). This is a serious limitation of

financial information and it should be considered in a question about CSR reporting

because according to the examiner

“Candidates need to come to the examination with an understanding of the

limitations of corporate reporting as well as the nature of it.” Examiner’s report,

June 2016

Read the P2TT (Accounting, Financial & Corporate reporting) to understand the

nature of corporate reporting and how it differs from related branches such as

financial reporting and financial accounting. Read the conceptual framework for

financial reporting 6.17 on the limitations of historical cost basis of measurement.

The other limitations of financial accounting that impair its usefulness for CSR

reporting are related to:

- The relative power of stakeholders: in the production of financial information the

interests of capital providers are paramount. The information produced tends to

reflect this dominance as discussed below under “financial materiality”.

However, there is a growing trend towards widening the quality and range of

information to encompass the requirements of the sustainability agenda. The

implications for financial reporting and accounting policy design are significant.

In questions about the implications of new IFRS implementation CSR

requirements must be considered as they can be significant.

- Property (classification between PPE and investment as in the case of hotel

and property portfolio to let; to capitalise or to charge as expenses to profit

or loss, certain costs e.g. borrowing costs, inventory, repairs and maintenance, changes in the carrying amounts of liabilities e.g.

decommissioning provisions; classification of gains and losses relating to

disposal, revaluation, insurance)

- Revenue (recognition, classification, measurement)

The implications are that the examiner expects you to engage with the subject

matter from a diverse perspective. That means every standard must be studied

in-depth as if it can be examined as an ethics (q1c), critical evaluation (q1b),

computational (q1a) and discursive question (2,3,4). This guide embeds

question strategy to explain and guide you through the requirements of each

type of question. You are encouraged to read it carefully and to apply it to the study of subject matter for best results.

Active learning is divergent thinking in action.

Current issues

Another approach is the current issues approach. Here the examiner requires

candidates to focus on the technical requirements of implementing a new

standard or applying an existing one. The scope of the question is usually broad

encompassing impact on the entity’s internal and external environments and

relationships with primary users of financial statements (investors and

creditors). A typical question is December 2013 q4 (answer). This question will repay diligent study and effective repeated practice at answering it.

Discuss accounting treatments

Yet another (more common) approach is to present a case study of a proposed

accounting treatment (syllabus reference G.1.b) that does not fully comply with

the requirements of IFRS. Candidates are required to discuss its suitability and

acceptability by reference to IFRS. A typical example of this is June 2012 q3

(answer)

As well as the above you may also be advised to:

- Be prepared to discuss how to set an accounting policy to implement the

requirements of a new standard such as IFRS 15. See Deloitte’s 2017

model financial statements 2.2 pages 32-38. Also see F.1, IFRS 15.

- Also, be prepared to draft notes to satisfy the core disclosure

requirements of a new standard such as IFRS 15 to show the effect of

accounting policies and the disclosure initiative amendments to IAS 1. See

Deloitte’s 2017 model financial statements pages 39-40.

- Keep in mind the word “suitable”. You need to justify the policy by

showing how it enables the entity to reflect the substance of its

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- The concept of financial materiality: an item is material if it can affect a decision

and is therefore relevant. Materiality has a quantitative focus: an item’s

materiality is assessed in relative terms by reference to the entity’s turnover, profits or net assets. If an item is not judged to be material it is not reported in

the financial statements because an accounting policy is not developed for it.

This tends to preclude the reporting of sustainability information which may be

difficult to quantify, or which may be immaterial in financial terms.

- The effect of discounting long-term liabilities: because statutory environmental

and decommissioning liabilities are discounted to their present value for the

purposes of evaluating their commercial effects and financial reporting

implications, the obligation (in terms of present value) may be relatively

insignificant compared to their future value because they will not be settled for

many years. Hence there is a risk that the obligation may be ignored, inducing further environmentally unfriendly behaviour which is at odds with the

sustainability agenda.

- The entity assumption: under the current accounting model transactions that are

not explicitly for the benefit of the entity are ignored because the corporate entity

has a separate legal personality and only recognises costs associated with those

risks that it has specifically underwritten. This situation can preclude admission

of liability arising from the consumption or use of assets produced or

manufactured by the entity. An extreme example is the arms industry. However,

IFRS 15 (paragraph B33) requires the entity to make a provision in accordance

with IAS 37 for any damage to the customer caused by using a product for its

intended purpose if the laws of the country requires it. Moreover, the entity assumption may conflict with and restrict the scope of the legitimacy theory

under which the entity promises to do only those things which the community

approves of. For example, if the entity makes redundancies or pays low wages it

only bears some of the social costs (if at all).

- The treatment of tradeable pollution permits (examined: Dec 2012 q2a (answer):

i) permits provide a perverse incentive to pollute albeit up to an approved limit;

ii) unused permits can be sold or transferred, further incentivising holders to be

active agents of pollution; iii) unsold or unused permits are recognised as

“assets” (in accordance with the conceptual framework for financial reporting)

but in terms of social responsibility permits are a threat (or liability) to the environment whether used or not.

The above may be directly or indirectly related to the creation of accounting policies.

The incentive to resolve the conflicts or ameliorate their effects is increasing due to

growing influences on Corporate entities to improve their image, manage reputational

risks, keep customers happy, attract new ones, offset the competitive advantage of

socially responsible competitors and pre-empt substantial fines. H.1 Environmental

and social reporting below discusses the financial reporting implications of these

drivers of corporate social conduct.

performance and financial position. You are the judge: decide how the

transaction should be recorded, disclosed and presented and cite the

relevant principles of the standard or the conceptual framework to justify your decision in the light of the evidence from the scenario.

- Which accounting policies should be disclosed? What determines the

choice? Read Deloitte’s 2017 model financial statements, p39

- Discuss the creation of accounting policies in relation to the objectives of

the IASB’s Better communication initiative.

PAST QUESTIONS FOR PRACTICE

- Refer to IAS 8 and other related sections opposite.

ADDITIONAL QUESTIONS FOR PRACTICE

1. “Accounting standards should be limited to disclosure requirements and

should not impose any rules on companies as to how to measure different

items in the financial statements” Discuss

2. How does the choice of measurement basis affect the measurement and

reporting of financial performance?

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How this section relates to B.2 Critical evaluation of accounting principles and

practices

“…exercise professional judgement in the application and evaluation of financial reporting principles and practices…”

How this section relates to IAS 8 Accounting policies, changes in accounting

estimates and errors

IAS 8 provides the guidance and methods for selecting and applying accounting

policies and for dealing with the effects of changes in accounting policies, estimates

and errors.

IAS 8 has the hierarchy that guides the creation of an accounting policy for the

production of relevant and reliable information where no IFRS exists for the

transaction, condition or other events.

“Standard” does not mean “uniform”. International convergence enables the creation

of accounting policies based on common converged standards that are applicable in

different countries. As a utility financial statements need to be fit for purpose

(suitable and acceptable). Hence IFRS allow options for flexibility.

The centrality of accounting policies to corporate reporting is reflected in the

prominence given to accounting policies in the published financial statements, being

Note 1 Disclosure of significant accounting policies.

Other salient considerations:

- Refer to P2TT for a detailed discussion of accounting bases, assumptions and

accounting policies

- Address the conceptual framework qualitative characteristics requirements for

- Links to reporting financial performance: references to the conceptual

framework for financial reporting.

- Implications for financial reporting of current developments

- Specialized entities: examples of policies

- Better communication

- Practical expedient (accounting policies are for the determination of all

amounts – no materiality threshold). However, disclosure is more complex: i)

generally only summary of significant accounting policies are required to be disclosed; ii) however, certain policies are significant by nature of business (not

amount) and must be disclosed.

G.2 The appraisal of

financial performance,

position and cash flow

and the measurement

of financial

performance (See also

4,

2,1

b,

c

“The final sections of the syllabus explore – in more depth – the role of the

accountant as financial analyst and adviser through the assessment of financial

performance and position of entities …” Syllabus Rationale, p5

“Professional and ethical judgement will need to be exercised, together with the

integration of technical knowledge when addressing corporate reporting issues in a

business context.” Approach to examining the syllabus, p7

WHAT YOU SHOULD EXPECT

You should expect questions that require you to consider and respond to the

decision-usefulness of financial statements from various user perspectives and

to evaluate current reporting practices and presentations, including

classifications, in relevant industry or commercial contexts. For example, you

should expect questions that require an assessment of “the prospects for future

cash inflow to the entity and management’s stewardship of the entity’s

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C.1 Prepare reports

relating to corporate

performance for external

stakeholders)

“Students will be required to adopt either a stakeholder or an external focus in

answering questions and to demonstrate personal skills such as problem solving, dealing with information and decision making.” Approach to examining the syllabus,

p7

In this section the separate parts of the financial statements are brought together as a

coherent set of interrelated parts (SOCI (profit or loss and OCI), SOFP, SOCE,

SOCF the accounting policies and notes) to appraise the entity’s financial

performance and to appraise the effects of financial performance on financial position

and cash flow. The financial statements are combined with the annual report to

form the corporate report which companies publish to fulfil their accountability

obligations, and to present a corporate image and outlook to stakeholders. It might be

worth reviewing the relevant Conceptual Framework sections: - Chapter 1 The objective of general purpose financial reporting.

- Chapter 3 Financial Statements and the Reporting Entity.

- Chapter 4 The Elements of financial statements.

Preparation of financial statements is not the focus of this section although you may

be required to prepare or use extracts from financial statements. Consider the impact

of differences in accounting policy choice, valuation models adopted, business

model, operating cycle, regulatory infrastructure and in other factors that exert the

strongest impact on recognition, classification, measurement, presentation and

disclosure.

Understanding and interpretation of information in their widest context are the primary focus of this section. This is facilitated by deep understanding of what drives

corporate reporting practice including an appreciation of commercial awareness. It is

useful therefore to get familiar with actual published financial statements so that

you can identify, appraise and apply principles of classification, presentation and

communication of real-life issues. Get a “rounded” picture and analytical

commentary from the internal management perspective. In this regard the

following could be useful exemplars:

- Debenhams 2015 Financial Review

- Tesco plc 2015 Financial Review

- VW Internal management systems and KPI

Think about the audience - how considerations of audience needs shape the message.

Read it critically and think about various stakeholders and how their information

needs are met, or not – the principal-agent (or agency) problem. What decisions

do they need to make? How does the published information cater to that? What is

missing?

- Appraisal is of critical importance, being based on the final output from the

accounting information systems and it is intended for users for whom the

preparers are acting as agents.

resources.” The objective and scope of financial statements, Conceptual

Framework, p16

You should expect questions that reflect various user needs and difficulties in

making sense of the financial statements and information. For example, fair

value measurement may induce the faulty perception that the financial

statements represent valuation of the entity at the reporting date (June 2014

q1b). Be prepared to address user scepticism as in questions about “aggressive

accounting” (e.g. Tesco scandal – the perils of aggressive accounting) and risk

assessment.

You will be required to demonstrate awareness of technical and behavioural

issues in financial performance measurement and presentation (December

2008: q1b,c answer), understanding of key performance indicators and their implications e.g. earnings multiple, interest cover, EVA, EBIT, EBITDA, gross

margin, operating return on capital, return on capital, net debt, free cash flow. In

particular, you should be prepared to discuss how measures to protect

creditors e.g. debt covenants, may influence behaviour that undermines

information quality: June 2016 q1c (answer).

You should be able to compare and evaluate the performance of different

entities (or components of entities) on the basis of sales, profits, cash flow,

working capital, asset structure (the relationship between current and noncurrent

assets), financial structure (the relationship between operating, investing and

financing activities) and capital structure (the relationship between equity and

debt) commenting on flexibility, profitability, efficiency and stability. Explain any factors that would account for outliers and other exceptional or unusual

practices and performance indicators. An accounting policy may seem unusual

until the strategic background of the entity is clearly understood.

Critical analysis is required: you should be able to explain why certain financial

statement measures are used and not others (e.g. carrying value instead of fair

value of assets in ROCE calculations), how the environment may affect

performance, how accounting policies are chosen and what effect they have in

performance measurement, evaluation and comparison.

You should be aware that financial statements are not complete representations of the economic substance and prospects of the business (e.g. strategies and

business models are not explained; certain resources are not included e.g.

employees, own-generated intangibles) and be able to identify and justify

further information required (including non-financial information) to enhance

your interpretation. Therefore, you may need to refer to the commentary in the

strategic report in the Annual report and accounts which contains additional

information and explanations relevant to an understanding and interpretation of

the financial statements.

Integrated reporting (IR), when fully developed and implemented is expected

to address many of the current deficiencies in financial statements.

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- Assessing fitness for purpose focuses attention on the entire process of

producing the information: recognition, measurement, presentation and

disclosure. Hence the importance of considering the qualitative characteristics which are substantially influenced by the choice of accounting policies and

significant judgements and assumptions of the management (IAS 8 – q4a &b in

December 2013 & answer.)

- Interpretation of the information is an essential function of the accountant. This

should not be treated as a shallow mechanical routine. It is communicating

insightfully, the key information about the results, the position of the entity’s

finances and of its cash flows. It must be approached as a creative exercise that

aims to add value to users of financial information. Therefore, it is essential to

relate the analysis and interpretation to the objectives of the users and their

respective timeframes.

- Gaining insight entails understanding the relationships between all the financial

statements and what underlies those relationships: i) How does profit or loss

relate to cash flow? ii) What determines the financing needs of the business

(long term and short term)? iii) What determines how the business is financed?

iv) How soundly is the business being financed? v) Is the business achieving its

objectives for stakeholders? vi) What financial and nonfinancial indicators best

depict the performance of the entity to satisfy the needs of users?

- The prevailing economic climate and the implications for risk management:

business risk (inherent in the way that the business model delivers value),

operational risks (inherent in the way that the value delivery is being supported e.g. through logistics), financial risks (inherent in the way that the business is

financed e.g. forex risk hedged by fwd. exchange contracts, financial leverage)

- Convergence imposes a need to reassess and define performance indicators that

are acceptable and suitable for use in international capital markets for

evaluation of alternative investment options based on predictions of future

earnings and past performance. Universal definitions of concepts, terminology

and norms used in ratio analysis would be helpful in interpretation of

performance.

- Opportunity to test a variety of standards and adjustments e.g. the impact of discontinued operations (IFRS 5), the benefits of segment performance

information (IFRS 8), share options, new pension recognition rules under IAS

19, deferred tax, provisions, etc. and to assess their impact on EPS, ROCE.

- Specific applications to financing problems: assessing gearing levels,

complying with loan covenants, assessing going concern and reconstruction

schemes. Refer also to syllabus section E.2 above.

Classification of certain items enhances fair presentation and assessment of cash

flow prospects.

Therefore, to prepare for questions that require you to suggest improvements to

current financial information, you are encouraged to assess IR’s potential for insights about how current deficiencies can be remedied e.g. the “strategic

overview” (one of the guiding principles of IR) provides the context for

evaluating current period financial performance and “future outlook” (one of

the core content elements of IR) enhances the relevance of the financial

performance report.

Further examinable points to consider:

1. Management commentary (how is the business executing its strategy and is

it succeeding or not?)

2. Presentation skills (particularly in advice questions: attention to structure,

clarity of arguments based on quality of insights evidenced by accurate knowledge of principles, business performance and appraisal issues)

3. Demonstrate awareness of the context in which the entity operates and the

impact on performance of such contextual factors as i) the economic

outlook, ii) factors affecting the sector, iii) factors specific to the business

e.g. growth, decline, competition.

4. The context determines the priorities: what would you say are the priorities

of the entity given the context? How do the financial statements figures and

narrative commentaries reflect that?

5. Demonstrate awareness of the risk of “management of earnings” June 2010

q1c & answer motivated by i) market pressures, ii) contractual performance

pressures, iii) personal motivation e.g. bonus incentives linked to earnings.

6. If there is no alignment then you should bring that out in the analysis and interpretation.

7. In execution, whether in growth, crisis management or steady state, speed

is of the essence. How does the speed of management action come through

in the figures? E.g. is cash flowing in as quickly as required to meet

obligations? Are (fixed) costs being reduced quickly enough to stem

losses? How much time has the entity got?

8. Adjusting the earnings and number of shares used in the diluted EPS

Past questions: sources of practice 9. March 2017 q4aiii (answer): the potential benefits of integrated reporting

in enhancing the richness and relevance of financial statement contents and

disclosures with respect to value creation, sustainability and completeness

(including financial and nonfinancial) of information. This will facilitate

interpretation and evaluation of performance.

QUESTIONS FOR FURTHER PRACTICE 10. Discuss how recognition and classification of gains and losses enhances the

measurement of financial performance and the assessment of cash flow

prospects. Give specific examples. Hint: consider the bifurcation of gains

and losses amounts classified as OCI; amount reclassified from equity to

profit or loss.

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Classification is the grouping of items into recognisable categories based on shared

characteristics and functions.

- Classifications in the SOFP: current, non-current (assets/liabilities); equity, net assets

- Classifications in the SOCF: operating, investing, financing

- Classifications in the SOCI (statement of income or profit or loss; and statement

of other comprehensive income, OCI) – operating, investing, financing

- Classifications in the SOCE: profit or loss, OCI, equity transactions

Matters that affect classification

- Objective (the purpose related to mission or strategy) e.g. operating, investing

and financing

- Subjective (what it is known as; its nature) e.g. revenue, PPE

- Cash v accrual - Revenue (accrues over one financial reporting period) v capital (permanent)

- Substance over form (e.g. management’s intention, commercial substance)

- Materiality

- Equity v liability

- Short-term v long-term creditors.

- Financial or non-financial asset, liability

- Determinable v contingent liability

- Identifiable v non-identifiable assets and goodwill

- Continuity: continuing and discontinued operations

- Disposal or abandonment

- Adjusting and non-adjusting events

CLASSIFICATION, SEGREGATION AND SUBTOTALLING

SOCI

Matters that affect understandability and performance management

- Structure and simplicity provide clarity about value drivers, e.g. the structure of

the SOI (profit or loss) and the SOCF (operating, investing, financing).

- Structure reveals relationships between value drivers

- Relationships enable analysis, planning and effective monitoring, control and

evaluation against targets.

- Aggregation and subtotals enable the calculation of KPI and the evaluation of

performance internally and externally e.g. EPS, PE ratio, ROCE, EVA, ROI, RI, etc.

- Key performance indicators allow assessment of profitability at appropriate

vertical levels e.g. Gross margin, EBIT margin, profit margin

- Structural types: division, CGU, segments, subsidiary, associate, branches, etc.

provide sites for assessing relative profitability, efficiency and returns.

SOFP

Matters that affect understandability and balance sheet management

- Structure enables WC calculations

- Structure enables operating WC extraction

11. Discuss the structure and classification of the elements of the statement of

cash flow (SOCF) and explain how the presentation contributes to the understanding of financial performance and the assessment of future

cash flow prospects. Evaluate whether the SOCF is more useful than the

SOCI in terms of presenting financial performance and prospects for the

future.

12. The Conceptual Framework defines income (CF para 4.48) and expenses

(CF para 4.49) by reference to changes in assets and liabilities (balance

sheet approach) but also states that “income and expenses included in the

statement of profit or loss are the primary source of information about an

entity’s financial performance for the period.” (CF paras 7.21, 7.23). This

can be interpreted as: performance is measured by the profit or loss items determined independently of the balance sheet items (income approach).

Does this apparent inconsistency present problems of interpretation of

financial performance?

13. Explain the meaning of financial performance and financial position and

the relationship between them. Illustrate your answer by reference to

transactions in property, plant and equipment (PPE) including policies and

notes in published financial statements.

14. Explain why interest expense may be a significant consideration in the

analysis of financial performance. Give examples of all aspects of the effect

of borrowing.

15. By far the most comprehensive and useful source of information is the

statement of changes in equity (SOCE). Discuss

16. Evaluate the contribution of the other comprehensive income (OCI)

statement to an understanding of financial performance. Give specific

examples including examples involving reclassification between equity and

profit or loss.

17. To achieve consistency and comparability performance measures should be

prescribed by the IASB and not by management. Discuss.

18. Syllabus ref G.2.c states: “Highlight inconsistencies in financial

information through analysis and application of knowledge.” Refer to the

syllabus extracts at the beginning of this section. What analysis is

useful? What type of knowledge is the examiner looking for? Analyse and

explain qualitatively the following inconsistencies in a set of financial

statements:

i) Operating cash flow falls v increase in profit, implying high WC

provided by operations

ii) PPE rises but sales fall

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- Structure enables assessments of solvency, liquidity, stability (gearing), going

concern, etc.

Aids and impairs performance measurement and evaluation.

Matters that affect understandability of cash inflows and outflows as a basis for

prediction of future prospects.

SOCF

Performance issues: sales trends, margins, competition.

Dividend issues; declaration, payment, out of IAS 10 scope.

Expansion and renewal: Impact of depreciation; assessing purpose of investment

through the size and trend in P&L items.

Operating cash cycle.

Industry type and cash cycle e.g. furniture retail, manufacturing, household white goods and equipment, mobile phone manufacturer, mobile phone retailer,

construction contractor, airline operator, aircraft manufacturer

Relationship between operating cash and operating profit – the influence of WC,

operating assets.

Usefulness: for what?

Segmenting cash flows yields what type of benefit?

Discontinued operations – segregated cash flows yields what type of benefit to

whom?

Long-term creditors interested in what? Why?

Short-term creditors interested in what? Why?

WC management requires what?

WC management impacts what?

Matters that affect operating segment classification

- Structure of reporting and accountability for resources

- Business activities and priorities

- Distinct reporting

- Regularly reviewed by the CODM

Matters that affect reportable segment classification

- Segment Sales

- Segment Assets

- Segment Profits

Matters that affect reportable segment combination Similarity of

- Product

- Production

- Distribution

- Customer class

- Regulation

Relationships between items enhances the potential to assess cash flow prospects

- Operating profit to cash

iii) Sales fall but COS rises, reducing margins

iv) Sales rise but gross margin falls

v) Sales rise and cost of sales fall vi) Distribution costs rise faster than sales

vii) Finance cost rises but long-term debt falls

viii) Operating profits fall but ROCE rises

ix) Market capitalisation of shares rises but carrying value of equity

unaffected

19. Identify the information you would need to provide qualitative and

quantitative analysis and explanations of the above inconsistencies.

20. Explain why the PE ratio of an entity is likely to be a more reliable

indicator of future earnings potential than its EPS.

21. Why may the results of two similar sized entities operating in the same

industry not be comparable?

22. Syllabus ref G.2.b states “Identify and evaluate significant features and

issues in financial statements.”

i) Unexpected sales trends, volumes and margins relative to industry and

level of investment

ii) Increasing sales but reducing profitability

iii) Deferrals of income (e.g. IAS 20) and expenditure (IAS 38: R&D)

iv) Negative operating working capital (WC)

v) Non-mandatory changes in accounting policies and notes vi) Errors and misstatements

vii) Significant investment in IT e.g. developing multi-channel capabilities

e.g. at Debenhams

viii) Financing difficulties e.g. increasing dependence on overdraft at

higher interest, borrowing levels rise. June 2012 q1bii (answer)

ix) Provisions for onerous contracts

x) Impairment losses, obsolescence, inventory write-downs

xi) Significant disposal of PPE, segments, subsidiaries

xii) Increasing cash dividends

xiii) Negative free cashflow

xiv) Financial guarantees xv) Transactions with related parties

xvi) Widening gap between reported profit and cash flow from operating

activities

23. Syllabus ref G.2.d refers to “analytical methods”: identify where the

following methods may be used

i) Ratio analysis (vertical and horizontal): investigate unexpected

margin changes; assess effectiveness of strategies for managing WC,

financial risk, bank covenant compliance, divisional performance, etc.

ii) Dupont analysis: drill down to identify sources of efficiency and

causes of variations in ROE/ROIC

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- Working capital provided

- Cash flow return on investment

Stakeholder type/ contractual commitments

- Equity investors

- Preference shareholder

- Long-term creditor

- Short-term creditor

SCENARIOS OF INTEREST

- The impact of the change from operating to finance lease (off balance sheet to on

balance sheet financing) due to adoption of IFRS 16

- Debt maintenance including covenant requirements for net worth, coverage of

interest and total debt, etc. q1c - Assess acquisition effects on cash flows

- Assess exchange rate effects on group cash flows: December 2012 q2a (answer)

- Errors and omissions

- Financial analysis for acquisition or disposal of a subsidiary

- An associate becomes a subsidiary: what is the effect on return on equity (ROE)?

- Intra group transactions not at arm’s length may affect performance and distort

interpretation (IAS 24: F7 June 2013 q1ii, b; answer)

- Development effects: e.g. increase in noncurrent assets and deferred tax

- Underperforming and restructuring

- Reconstruction scheme

- Going concern – break-up values

- Revaluation effects: additional depreciation - Asset sale/ transfer effects: commercial substance assessment based on

incremental cash flows to the recipient IAS 16.24,25

- Inventory valuation effects: FIFO or average cost

- Inventory loss effects: fall in gross profit margin

- Capital maintenance effects: bifurcation of gains and losses

- Effects of goodwill and other asset impairment

- Effect of impairment reversals

- Treasury shares

- Share-based payment effects: employee share options.

STRATEGIC REPORTING Statutory requirement under Section 414 UK Companies Act 2006 for listed companies to include the strategic report as part of their annual report

FRC guidelines

Advisory guidelines to help companies prepare their Strategic reports

IASB Practice statement: Management commentary

Advisory guidelines to help companies prepare narrative reports like the content

requirements of the Strategic reports.

This is a P2 Examinable document

iii) Z-scores: assess bankruptcy risk

iv) Interfirm comparisons (horizontal analysis)

v) Inter period comparisons (horizontal analysis) vi) Trend analysis (time series) (horizontal analysis)

vii) Impact of investment on costs (immediate) but impact on revenue

delayed

24. Appraise the suitability and usefulness of the method of analysis by

reference to the inherent limitations of the method (e.g. ratios only express

one figure in terms of another without explaining), its strengths (e.g. ratios

allow comparisons regardless of absolute sizes), the scope of the analysis

that can be undertaken (e.g. ratios only apply to factors expressed in

numbers), and the inferences that can be made (e.g. ratio-based inferences

can be simplistic unless set in business context and linked to corresponding ratios e.g. Dupont analysis). Hence syllabus ref G.2.c requires “…analysis

and application of knowledge.” And should add: “exercise of professional

judgement with scepticism”.

25. Performance indicators may also be limited in terms of what they focus on

(conceptual limitations). For example, coverage ratios (interest cover,

EBITDA interest coverage and cash coverage) only focus on the interest

element of borrowings. Inability to repay the principal is also a risk factor.

Alternative ratios (e.g. free operating cash flows/total debt) that relate cash

flows to borrowing levels may provide better guides to the riskiness of

borrowings and suggest improved risk management strategies. Read

Balfour Beatty (2016), p52 Financial risk factors and going concern for examples of alternative ratios. Explain why long-term creditors prefer to

use these alternatives in covenant agreements?

26. Read VW Key figures. Appraise the use of financial and non-financial

data to depict the performance of VW. How useful is the analysis for

assessing prospects? Identify and comment on features that make this

presentation attractive to investors. Hint: Think about the guiding principles

and concepts of Integrated Reporting and identify the principles and

concepts that best reflect VW’s performance reporting philosophy.

27. Discuss the view that financial statement analysis and interpretation is a “garbage in, garbage out” exercise that is only as good as the quality of the

numbers that go into it.

28. What is “underlying profit”? Why do companies publish “underlying

profit” analysis? Refer to Balfour Beatty (2016), p44 See also q4aii

Strategic business reporting specimen

29. What is the difference between return on capital and return of capital?

CF para 8.4.

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KPMG practical guide

Advisory guidelines to clients and potential clients on how to prepare Strategic Report

FURTHER READING For further reading (of the strategic report) and glossary of terms used in reports (at the

end of each report)

Debenhams Annual Report and accounts Tesco Annual report and accounts (excel version available from Tesco plc’s website) Integrated reporting EY

KPMG: a practical guide to the strategic report

CAUTION The Corporate reporting exam is concerned with how the entity measures and

communicates the effects of economic decisions through its corporate report. It is

essential to tailor your preparation and answers to the relevant assessment

requirements for P2, and avoid straying into (and substituting) the requirements of

other papers such as P4, P5 and P7 which also require candidates to analyse,

appraise and apply financial information. The following examples illustrate the

differences.

The consequences of capital structure

P2 focus is on the financial reporting aspects:

- The structure of SOI (profit or loss): presents interest expense as a separate line

(finance cost) providing the user information about the cost of financing

operations from borrowings, and how the cost fits within the overall financial

structure of the entity.

- The structure of SOFP (balance sheet): debt and equity are presented as distinct

categories, allowing gearing to be calculated and evaluated; separate categories

for current liabilities and non-current liabilities, enabling understanding of

relative contributions to capital and risk.

Advanced financial management P4 focus is on financial management aspects:

Input to capital structure decisions the effects of which are measured and reported in

P2. Financing efficiency and risk management aspects.

Advanced performance management P5 focus is on managing shareholder

maximisation:

Assess and monitor the contribution of capital structure to the maximisation of

shareholder value as in EVA calculation.

Advanced auditing and assurance P7 focus on quality of evidence to support

existence, ownership and amounts:

Verification of initial recognition of fair values; recognition and classification of re-measurement gains and losses.

30. Converting profits into cash (cash conversion) is a key indicator of

financial strength. The ratio of operating cash flow to EBITDA measures

the entity’s cash conversion ratio.

Required

30.1 Explain why EBITDA is used in the denominator instead of Operating

profit and discuss the implications for setting an accounting policy

about depreciation and amortisation.

30.2 If operating cash flow is less than EBITDA why would this be a sign

of inefficient financial management? How would you identify the

causes of the problem? Name two items from the financial statements

that would best indicate the nature of the problem.

30.3 If EBITDA is $6.5m and Operating cash flow is $6m what is the cash

conversion ratio? What factors would account for tolerance of lower

ratios in an industry? How would such tolerance affect the

management of cash balances?

THE STRATEGIC REPORT Including the guidance issued by the Financial Reporting Council (FRC).

31. Explain the principles of the strategic report showing how they are

underpinned by the qualitative characteristics of the conceptual framework.

32. Discuss how the strategic report complements the income statement and the statement of cash flows in allowing investors to assess the

performance and long-term prospects of the entity. Refer to the latest

published financial statements of Tesco plc, or any other listed company,

with which you are familiar.

33. Discuss how the strategic report may support the determination,

presentation and disclosure of the carrying amounts of long-term assets and

liabilities including

33.1 Capitalisation of development costs

33.2 Capitalisation of interest

33.3 Impairment of goodwill 33.4 Inventories

33.5 Provisions for onerous contracts

33.6 Provisions for restructuring

34. “The emphasis of the guidance is on business telling its story, with the

onus on companies to provide the information that they consider to be

relevant to their shareholders’ decisions.” KPMG: a practical guide to the

strategic report, p5.

Required:

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The extent of performance indicators (EPI descriptors)

Terms used to indicate the extent of performance attainment can be vague. To ensure

you score marks in the exam it is essential that you state precisely and illustrate concisely the effects and causes of changes in performance. Nothing should be

judged in isolation from its strategic and environmental context. Vagueness will not

be rewarded.

Examples of vague terms often used in interpretation answers:

- Good performance: what does this actually mean? An increase in profits is not

necessarily “good performance” judged in context. For example, consider how

the increase was financed. Was the financing costly, risky, short-term or long-

term? Did the increase in profits result in an increase in operating cash flows?

- Strong performance: what criteria of strength are relevant? How can they be

justified in context? - Efficient: what are the criteria e.g. speed, volume, cost? Isolate the driver factors,

innovation, investment, sales. How do the driver factors relate? Which ratios

aptly depict improvements or decline in efficiency? Is this in accordance with the

strategy outlined in the strategic report? Can you pinpoint it? Can you evaluate

to what extent current performance achieves the objectives of that growth and

efficiency strategy? Read Debenhams 2015 Financial Review and others and

practise reading critically. Debenhams uses NET DEBT/EBITDA to monitor its

ability to pay its debts. Are there alternatives you would suggest that will provide

better measures of its ability to repay its debt from cash generated from its

operations? How would you critique EBITDA? How does the net operating

cash flow overcome the weaknesses of EBITDA as a measure of operating

performance? - Effective: show how the performance is effective; is it linked to priorities?

Can you identify them? Are they appropriate to sustainable value creation?

- Sound: what is sound? Show how it is sound.

- Better: better than what? So what?

- Acceptable: what is acceptable? Why is it acceptable? What criteria are used?

34.1 Discuss the implications of this statement from the principal-agent

perspective.

34.2 Explain how the concept of “linkage”, p4 enhances the overall quality of financial information, citing conceptual framework principles to

support your arguments.

34.3 Discuss the difficulties organisations may face in seeking to provide

unified narrative reports containing financial and nonfinancial data.

35.

H.1 Environmental

and social reporting

1b,

c,4 What are the unique requirements of environmental and social reporting?

- The legal obligations: there can be severe financial penalties for breaches of

environmental protection legislation. As such these costs are not discretionary

but mandatory. Therefore they are material and must be disclosed. This has implications for the accounts structure and accounting policy. Obligations may

be recognised under IAS 37 as in environmental provisions and

decommissioning costs. In addition, contingent environmental liabilities may be

disclosed in accordance with IAS 37 if the entity’s circumstances warrant it.

Obligations of decommissioning liabilities may change over time. The effect of

increases or decreases on related assets can be significant and must be

accounted for prospectively in accordance with IAS 8. The impact on profit or

loss depends on whether the asset is measured on cost basis or on revaluation

basis. Refer to IAS 16.

Past questions for exam practice:

- Dec 2007 q1b (answer): advantages of producing a separate environmental

report

QUESTIONS FOR FURTHER PRACTICE

1. Explain how the publication of an entity’s environmental policies can

affect its obligations?

2. Study Debenham’s 2015 Sustainability report. The report states that:

“Emissions data are made more meaningful when compared to a core

business variable.” p39.

Required:

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- The ethical obligations to demonstrate corporate social responsibility (CSR) can

be financially significant, necessitating separate presentation and disclosure. For

example, the cost of embedding sustainable supply chain practices that satisfy growing public interest in sourcing can be substantial and require disclosure

alongside the outcomes of sustainability practices.

- Financial sustainability, growing while maintaining sound finance, is a

precondition of environmental sustainability. Reconciling the two is a core

challenge of the entity’s board: December 2011 q1c & answer

- Assessments must be made to determine whether the drivers of environmental

and social reporting are operational or investing activities. The associated

expenditure and income must be classified accordingly.

- Financial and nonfinancial data would be required to demonstrate the progress

being made in environmental and social dimensions.

How do these requirements affect performance measurement and why?

- The board as agents need to protect the organisation against environmental and

social risks and satisfy stakeholders that they are doing so. This means being

proactive by anticipating obligations, investing in preventative measures and

carrying out obligatory activities such as decommissioning and cleaning up

polluted waters, land and air. These additional cost drivers impose pressure on

the entity to manage profitability and maintain its competitive position. KPI

must be expanded to meet additional monitoring needs.

- Should these costs be capitalised or expensed? Being substantial expenditure

including acquisition of noncurrent assets, capitalisation assessment should be

made using IAS 16 and IAS 38 criteria. This assessment also includes

consideration of the eligibility of borrowing costs for capitalisation (IAS 23).

- IAS 16 PPE allows the capitalisation of expenditure necessarily incurred in

connection with acquiring, delivering and installing assets in a location and

condition fit for intended use. This includes expenditure on acquiring assets to

comply with environmental legislation without which the other related assets

would not be fully operational, and therefore the expected economic benefits would be limited (IAS 16, para11). Certain additional costs e.g.

decommissioning costs, may be capitalised later in the asset’s life if these costs

are IAS 37 compliant (e.g. incurred to comply with legislation in respect of

environmental damage) and related to the asset’s acquisition, installation or

construction. The recognition of these costs (as a result of new information and

development) is not a correction of an error or a change in accounting policy

(under IAS 8) and should be accounted for prospectively in accordance with

depreciation policy. Obligatory contractual costs of using the asset e.g. cost of

damage caused by using the asset which must be rectified under the terms of a

lease, or damage or injury to third parties requiring compensation (under the

law) are expenses to be charged to profit or loss as they do not generate or

2.1 According to the Conceptual Framework what is a core business

variable?

2.2 Explain how the Conceptual framework classification principles allow Debenhams plc to achieve its objective?

2.3 Using Figure 2 and Figure 3 (p39) discuss the contribution of non-

financial data to the understandability, relevance and general

usefulness of the sustainability report.

2.4 Comment on the clarity and quality of the presentation of the report:

structure, style, format, arguments, authority, evidence and

persuasiveness.

3. “We will continue to capture more emissions sources in the future.

In addition, we will continue to invest in projects that will further support

the reduction of our footprint and environmental impacts. This year we invested £739,628 across energy efficiency projects such as lighting,

heating, cooling and controls, with additional investment planned for

2015/16.” p39, Debenhams 2015 Sustainability report.

Required:

Explain with the support of IFRS principles how Debenhams should

account for the investment in sustainability projects.

4. “In order to deliver a compelling customer proposition at great value, our

sustainable ethical sourcing strategy underpins everything that we do as a

responsible retailer.” p34, Debenhams 2015 Sustainability report.

Required:

Discuss with specific examples how Debenhams has integrated business

sustainability, environmental sustainability, employment and human rights

within its supply chain.

5. The report is aimed at customers, investors, regulators and the general

public. It should be credible and persuasive.

Required:

5.1 Assess, using specific examples, how Debenhams has sought to

establish credibility for its report. 5.2 Explain why a retailer such as Debenhams would be particularly

proactive about corporate social responsibility reporting.

5.3 How is Debenham’s CSR behaviour explained by stakeholder theory?

6. The directors wish to capitalise as intangible assets, the significant

expenditure incurred on environmental compliance, claiming that it

enhances the company’s image and fulfils certain expectations of

stakeholders, both of which are expected to secure customer loyalty and

generate future sales.

Required:

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enhance an asset and are therefore not recoverable. However, under an

absorption costing system it is possible that these costs are absorbed in product

costs such as inventories (IAS 2) or constructed assets (IAS 16).

- IAS 38 criteria may be applied to assess whether other expenditure is eligible for

classification as intangible assets on account of the investment and potential

benefits over the long term e.g. in terms of reputational enhancement and brand

development. It is essential to determine if as a minimum the expenditure and the

benefits associated with it are i) identifiable, ii) controllable and iii) measurable

in accordance with the principles of IAS 38.

- As these costs are mandatory they may well be product costs recoverable from

the customer but not at the expense of pricing the product or service out of the

market.

- Thus, the classification and recoverability of environmental and social

expenditure can affect performance measurement and product pricing in the

short-term. Hence these matters must be addressed at the corporate level as they

have implications for how the business competes and adds value. The entity’s

strategic report should reflect these concerns.

Evaluate current reporting requirements for CSR including integrated

reporting

Purpose and status

Corporate social reports are discretionary – not mandatory except in some

jurisdictions such as Denmark, Norway, Sweden and the Netherlands where specific environmental statements are required from environmentally sensitive industries.

Their purpose is to provide information about how the entity is discharging its

environmental and social responsibilities. Unlike published statutory financial reports

subject to mandatory auditing the current CSR reporting requirements are contained

in a variety of Voluntary codes and frameworks such as the GRI, and IIRC and do

not include statutory requirements to audit. Consequently, a CSR report may be

significantly deficient in certain respects such that its usefulness may be called into

question. Some of the key aspects are:

Responsibility for the report

In the Integrated reporting framework published by the International Integrated Reporting Council (IIRC) there is no requirement for a report from “those charged

with governance” to acknowledge their responsibility for the report. This lack of

assurance undermines confidence in the report: on what basis should readers rely on

the report?

Uncertainty over measurement basis

According to the IIRC prescription of measurement basis is out of scope. This

reduces the reliability and usefulness of the reports as there is a risk that

measurements can be entirely subjective. This might be the case where the CSR

report is issued as a standalone report. However, where the CSR report is an adjunct

of the corporate report it would be consistent with the audited management

Discuss the directors’ intention in the light of IFRS.

7. An entity installs equipment as part of the new plant for making car engines. The installation of the equipment is required for the operation of

the plant because it is mandated by the regulators to ensure car factory

settings comply with engine emissions limits.

Required:

Discuss how the installation should be dealt with in the entity’s Financial

Statements and Annual Report for the period.

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information system because auditors would be required to attest to this. Thus despite

measurement not being specifically addressed by IIRC nevertheless corporate

governance and management systems that are being developed to assure the integrity and sustainability of the organisation should produce CSR data that are consistent,

reliable and independently verifiable.

Coverage, suitability and acceptability

The scope of CSR reports tends to cover financial and nonfinancial, quantitative and

qualitative aspects of environmental and social factors. These are suitable features of

a CSR report. However, it is acknowledged that the expertise required to deliver

suitable quality may not be available to all entities due to lack of commitment by the

board, there being no pressure to comply with legislation compelling reporting. The

acceptability of the reports may also be doubtful given the lack of generally

accepted standards of CSR reporting to drive consistency, understandability, rigour and comparability. However, the growth in benchmarking, e.g. the London

Benchmarking Group, driven by the need to demonstrate results from community

involvement should contribute to identifying best practices in allocating resources,

measuring effectiveness and establishing credibility for performance indicators.

These all point to the need for the profession to do more work to supplement various

initiatives and harmonise their recommendations. Accordingly, the ACCA, the

ICAEW have been involved in various award and other initiatives to try to influence

the development of appropriate standards of recording and reporting environmental

and social issues.

Discuss why entities might include disclosures relating to the environment and

society

- Useful for communicating with stakeholders to address their environmental

concerns. This provides an opportunity to demonstrate the impact on

performance of environmental and social compliance costs. However, the

effectiveness of the reports can be hampered by the shortcomings highlighted

above.

- Demonstrating accounting for sustainability as the key to creating an innovative

business model. The accountant can play a pivotal role in demonstrating how

CSR is integrated into business strategy and operations. This can be done

through integrated information whereby performance narratives contain fully

integrated financial and nonfinancial data to complement the narrative as in the strategic report.

- Disclosure of outstanding environmental obligations as in IAS 37 disclosure of

contingent liabilities provides useful information to potential investors and

other users. Such disclosures may adversely affect the share price but such

transparency would be welcome to shareholders. Disclosure of changes in

decommissioning liabilities during the life of a related asset and the effects of

those changes on asset values, performance and equity are relevant information

for users. See also IAS 16 PPE.

- Providing a basis for comparison (and benchmarking) with other firms that can

be beneficial in terms of rating stakeholder perception and brand quality. Hence

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the importance of standard financial and non-financial sustainability

performance indicators.

H.2 Convergence

between national and

international reporting

standards

1c,

b,4 “Global issues will be addressed via the current issues questions on the paper.”

Approach to examining the syllabus, p7

This area has not been examined since December 2007. This is probably because

work on the Conceptual framework was suspended for a long time. Now that ED

2015/3 has been issued (May 2015) it is advisable to prepare for a question about the

benefits of a CF, one of which is converging international standard setting. How? By

providing a uniform set of concepts and principles to standard setters. What issues

arise from this?

The requirements of the study guide are addressed fully in Convergence Final

Revision checklist.

Additional reading

H.2 International convergence

- Process ideas from q4 June 2008 (what do these issues mean for convergence?

how can they be overcome?) i) Think about reasons why despite IFRS adoption

and improvements in IFRS financial statements would still fall short of the

expected qualities of transparency, consistency and comparability. ii) What is a

financial reporting infrastructure? iii) Why would management judgement play a greater role when IFRS are adopted?

- Integrate green issues: how does convergence promote the green agenda? And

how does the green agenda promote convergence?

As an example of the benefits of convergence the IFRS foundation has just

announced a new cooperation agreement with the World Bank to provide greater

support to developing economies in their use of IFRS standards. Discuss what

benefits this cooperation can bring to all stakeholders.

Questions for practice

- Jun 2008 q4 (answer)

- Dec 2007 q4 (answer)

Reasons why IFRS underpinned by CF may fail to produce consistent,

comparable and transparent FS

- Financial reporting fraud. This can be facilitated by alternative forms of

presentation (as in IAS 7- indirect method susceptible to exploitation, IAS

1); different acceptable methods of accounting (as in IAS 16, IFRS 9); lack

of adequate guidance in IFRS that are open to interpretation especially under the principle-based IFRS.

- IFRS 1 exemptions can have ongoing effect on financial statements e.g.

- Lack of training and motivation to switch from national GAAP, especially

where no CPD (unintended inconsistencies)

- Lack of experience e.g. in carrying out valuations for IFRS 13 compliance

could lead to inconsistent valuations

- Lack of market information for IFRS 13 compliance could lead to

innovative methods (hypothetical markets) acceptable under IFRS 13

- Early adoption by some and failure by others to disclose potential impact of

new IFRS on initial adoption

Ways to overcome divergence from the expected outcomes through the

effective operation of the other elements of the financial reporting

infrastructure

- National regulators e.g. FRC (check website), PRA to provide effective

enforcement and oversight mechanism

- Quality of corporate governance (quality information needed to address the

agency question.)

- Audit quality underpinned by ISA

Why greater management judgement may be required to implement IFRS

- IFRS use fair values extensively; significant management judgement is

required to determine the measure that is most representative of fair value; also required is a level of expertise in valuation techniques and significant

knowledge about the nature and characteristics of the asset.

- Management have to use their judgement in selecting valuation

techniques (e.g. mathematical modelling) and in formulating

assumptions about specific areas including onerous contracts, share-

based payments, pensions, intangible assets acquired in business

combinations and impairment of assets. (See IFRS 13 workbook exercises)

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H.3 Current reporting

issues. Refer to F.1,

F.2, H.1, and H.2

1b,

c The examiner’s eclectic approach implies that you should consider starting your

examination preparation with an examination of “current issues” to gain an overview

of the area to be studied, an insight into the examiner’s approach to assessing what candidates should know, and what they should be able to do with what they know.

The examiner has advised that this is not a rote-learned area. You can take from this

that i) you are not required to tank up large amounts of data that you don’t know how

to use; ii) the emphasis is on problem solving therefore prioritise core areas that

have wide impact on financial reporting e.g. performance measurement, de-

recognition and applying the fundamental and enhancing characteristics; iii) think

critically about what the proposals aim to achieve, the methods it recommends and

practise writing discursively to evaluate whether the proposals achieve what they set

out to achieve; iv) plan and manage your time so that you read actively and write

regularly in a focused way. Use the examples provided above under effective writing

skills.

- Current issues are mainly examined at q4.

- Make sure you are clear about the nature and scope of current issues. Refer to

P2TT for a detailed explanation of the exam techniques and study approaches.

- Refer also to F.1, F.2, H.1 and H.2

- The December 2015 examiners report is also very informative.

- The June 2015 preamble to q4 is a useful stimulant. You will probably benefit

from reviewing this question, the answer and the examiner’s report in the light of

ED2015/3. In particular, consider this extract from the examiner’s report

“Historical financial statements are essential in corporate reporting, particularly for compliance purposes, but it can be argued that they do not provide meaningful

information. Preparers of financial statements seem to be unclear about the

interaction between profit or loss and other comprehensive income (OCI) especially

regarding the notion of reclassification,” Examiner’s report, June 2015 q4aiii

Reclassification of items deferred in equity to profit or loss is governed by the

relevant IFRS and underpinned by the accrual or matching concept (which requires

all income arising in the period to be matched to expenses incurred for that period

and presented in the profit or loss). The objective of accrual is to faithfully present

relevant information for the period in profit or loss. For example, in IAS 21 two

events trigger reclassification of amounts previously recognised in OCI and deferred in other components of equity:

i) A disposal of a foreign operation

ii) When a parent loses control of a subsidiary that was classified as a foreign

operation but retains an investment in that foreign operation

When these events occur a gain or loss on disposal is recognized immediately in the

consolidated profit or loss triggering a classification adjustment, in whole or in part,

of the related exchange component from equity.

WHAT YOU SHOULD EXPECT

There being no new standard to examine you should expect the examiner to

continue examining the themes in all-encompassing subjects: The Disclosure

Initiative, Better communication, the Conceptual Framework and

Integrated reporting. The specimen paper for Strategic Business Reporting

(the new title for corporate reporting) and previous questions indicate the broad

themes that engage the examiner’s attention:

- Recognition and measurement including groups (q1)

- Performance measurement, presentation and disclosure (q4)

- Measurement basis and information quality (q3): technical article

- Ethics in financial reporting (q2)

- Accounting policies, changes in accounting estimates and errors December

2013 (q4; answer).

- Impairment of assets: e.g. December 2014 q4 (answer);

Your preparation would be well served by carefully working through the above

themes using the questions in the specimen paper as prompts and for practice.

You should also diligently study the relevant parts of the conceptual framework.

For example:

- Measurement (chapter 6); Appendix A cash-flow-based techniques.

December 2012 q4b (answer).

- Presentation and disclosure objectives (7.16-7.18)

- Information about financial performance (7.19-7.24)

These are also referred to under IAS 1, section B.1 and below:

As the issues are interdependent you should expect questions that integrate the

above with ED2015/8 IFRS Practice Statement Application of Materiality in

Financial Statements.

ED 2015/8 is high priority because “…the IASB thinks that to address the need

for guidance on the application of materiality, it is useful to develop the

Practice Statement now”.

ED2015/8: what you should know and how you should prepare.

This ED expands the Conceptual Framework proposals ED2015/3 on

materiality 2.11 and proposes a non-mandatory persuasive practice statement (IFRS Practice Statement 2: Making Materiality Judgements) rather than a

mandatory enforceable standard. It is set in the context of the Disclosure

Initiative. The statement was issued in September 2017 but, as it is not part of

the examinable documents for June 2018, you should continue to refer to its

precursor ED2015/8.

You should study this ED (and the accompanying snapshot) to understand how

it proposes to improve judgement about materiality and to assess how the

quality of financial information would be improved as a result. For the exam

you must identify current reporting problems attributable to materiality and

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DR Equity (other components of equity – debit assumes a credit balance: this debit

is presented in OCI in the current year and then cleared down to the equity balance

sheet account). CR Profit or loss

Refer to the maths of IAS 21 for an illustration of this.

The practice of not reclassifying items deferred in equity to profit or loss is governed

by the principles of financial performance measurement which aim to determine

the amount of profit or loss that reflects the management’s direct impact on the assets

and liabilities of the organisation and the net income and cash flows that result from

that impact. Accordingly, the measurement of the results (performance) depend on

correct classification and measurement of income based on the capital maintenance

concept and the measurement basis adopted in the operating environment.

The clarity achieved by this practice is best illustrated by the accounting treatment of

the disposal of revalued PPE. A revaluation surplus is deferred in equity via

recognition in OCI in the year of revaluation. The surplus is never reclassified to

profit or loss except to offset an impairment loss on the same asset. The disposal of

the asset triggers the following

i) Recognition of a gain or loss arising on disposal in profit or loss. Rationale:

the disposal is deemed to be a management decision about how the

remaining carrying value is to be recovered. If management’s judgement is

to recover the carrying value through continuing use then, if the asset is

obsolete (or becoming so), they might incur a cost in terms of loss of competitive edge manifesting itself in reduced sales or higher costs relative

to competitors. The decision to retain or to replace is therefore critical to

improving or maintaining operating performance and its effects must form

part of the results upon which the management’s performance is measured

and evaluated.

ii) Transfer of any balance of surplus in equity direct to retained earnings

(movement due to form i.e. gain arose from property prices alone, without

management intervention, hence it should be excluded from profit or loss

being a performance measure or the basis for performance measurement).

Performance measures such as EBIT, EBITDA, ROCE, etc. depend on the results of

the entity as depicted in the profit or loss. Hence the conceptual framework for

financial reporting provides extensive guidance on the measurement and presentation

of results. Conceptual Framework 7.19-7.27 Information about financial

performance.

“The principles behind the use of OCI have not been fully determined by the IASB

and they are currently discussing them as part of the Conceptual Framework project.”

Examiner’s report, June 2015 q4aiii

explain how the ED’s proposals will help solve them. You may begin with the

overview on page 6 of the snapshot.

Therefore, to prepare effectively you must practise with examples

- Explain the nature of materiality p2, snapshot;

- Explain the function of materiality p3, snapshot;

- Describe the current problems p3, snapshot;

- Discuss how the ED proposes to overcome them p3, snapshot;

- Discuss how to take account of the context. ED para 12, 20 (OB3-6); 27,28,

53d (segment disclosures); 30-36

- Discuss identified misstatements ED paras 67-69

- Discuss current period errors ED paras 70-73

- Discuss omissions and misstatements ED paras

- Discuss prior period errors ED paras 74-76 - Discuss misstatements made intentionally to mislead ED paras 77-79

The best examples must identify current problem areas that continue to require

the IASB to issue guidance and why it is appropriate to issue a non-mandatory

practice statement rather than a mandatory one.

You should also consider how materiality principles (e.g. reporting boundary,

relevance, context, user perspective) can be applied to Integrated reporting to

produce reports that are meaningful in the context of the long-term outlook and

stakeholder expectations (E&Y 3.5, p22 Materiality defined). This was assessed

and poorly answered September 2016, q4aii (answer). It could be assessed at

q1b, q1c and q4. Review the examiner’s report and take on board the points raised about student deficiencies to improve your preparation. The examiner

may well revisit these areas of weakness in future exams.

To prepare effectively you need to read and practice answering similar case

study questions about areas of critical importance that require judgement.

Remember that materiality is about “fair presentation and disclosure” and “fair

presentation and disclosure” is about enabling users to understand and evaluate

the effects of decisions on the reporting entity’s economic resources and

claims on those economic resources, the environments in which the entity

operates, the uncertainties and risks it faces, who has controlling and significant

influence over its operating and financial policies, its strategies, prospects, governance and accountabilities.

EXAM PRACTICE QUESTIONS

1. Compare the Statement of cash flow (SOCF) with the Statement of Income

(SOI) and discuss the advantages of the SOCF over the SOI from the point

of view of the investor, creditor and management.

2. Discuss how the presentation of NCI as equity in the group statement of

financial position (SOFP) represents “fair presentation”.

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Classification of items between profit or loss and OCI improves the measurement of

performance for the current period. Thus, the concept of "comprehensive income"

results in an income reporting format that is functional in that it enables better communication to users about the various gains and losses. The bifurcation of

recognised income into “profits” (presented in profit or loss) and “gains” (presented

in OCI) resolves the issue of completeness by providing separately, information

about performance, and other gains to be deferred in equity (as capital maintenance

adjustments), Conceptual Framework for Financial reporting, paragraph 8.7, p79.

The OCI presentation requires separate grouping of

i) items that are expected to be subsequently reclassified to profit or loss.

ii) items such as gains and losses on re-measurement of pension plans that

will never be reclassified to profit or loss

This presentation improves the communication of financial information and the

predictive quality of financial statements. Conceptual Framework 7.19-7.27

Information about financial performance.

The P2 exam is very practical; you are encouraged to look at real-life applications of

these concepts and principles in action. Examples

Tesco plc 2013 statement of changes in equity (SOCE):

- reclassification of exchange differences on disposal of a subsidiary

- actuarial losses on defined benefit pension schemes

E&Y 2015 example statement of changes in equity (SOCE)

- presentation of re-measurement gains and losses and rationale for treatment - equity transaction

- exercise of options: share based-payment and treasury shares, share premium

- equity transactions

- Allocation of additional depreciation on revalued assets

Other current issues to keep in mind

Trade-offs may need to be made between conflicting qualitative characteristics. Be

prepared to discuss what governs how the entity makes trade-offs between qualitative

characteristics: verifiability for relevance, timeliness for reliability, comparability for

relevance, detailed disclosure for understandability, inter-firm comparability for inter-period comparability, comparability for cost, measurement uncertainty for

relevance (CF para 2.12-2.13), etc. Examples of issues to which these requirements

may apply:

- Selection of a measurement basis for recognised items 6.51, 6.53-6.63

- Assessment of amounts to include in the disclosure of unrecognised items under

IAS 37 and IAS 10 Non-adjusting events.

Decision-usefulness of information requires a context. Therefore consider the

aspects of context that are most decisive in determining the financial statement

amounts, presentation and disclosure: contractual relationships, power and control,

3. Equity transactions are accounted for “direct to equity”. Explain with

examples what this means and justify the accounting treatment by reference

to the conceptual framework. CF 4.5

4. Describe the structure of the statement of changes in equity (SOCE).

5. Discuss how the structure and content of the SOCE reflects the definitions,

measurement concepts and classification guidelines of the conceptual

framework for financial reporting.

6. Explain how the structure and content of the SOCE meets the qualitative

characteristics of the conceptual framework for financial reporting.

7. Explain why the total amount of the reserves and share capital in the statement of changes in equity (SOCE) is not a measure of the value of

the entity’s equity (or market capitalisation) at the reporting date.

(Conceptual Framework para 5.7, p51).

8. If the mixed-measurement model of IFRS is an outcome of the

application of capital maintenance concepts to reflect diverse business

models to what extent are general purpose financial statements useful?

See q3b Specimen paper (Strategic business reporting)

9. According to ED2015/3 Conceptual Framework for financial reporting

(May 2015) “…financial statements are prepared from the perspective of

the entity as a whole…” This means that the scope of the conceptual framework overlaps with that of Integrated reporting. Discuss.

10. The following terms are significant to the Conceptual Framework and

standards issued by the IASB. Explain what they mean and the principles

that underpin each of them giving examples of their application in contexts

i) Accounting mismatch

ii) Aggregation CF 7.14

iii) Asymmetric allocations

iv) Reporting boundary 3.15a (q4ai Strategic business reporting

Specimen)

v) Existence uncertainty and separability 5.15, 5.16 vi) Measurement uncertainty 6.55, 6.56; 2.12-2.13

vii) Outcome uncertainty 6.56

viii) Measurement inconsistency 6.58

ix) Entry values (e.g. historical cost, current replacement cost)

x) Exit values (fair value, NRV)

xi) Market perspective (q3aii Strategic business reporting Specimen)

xii) Commercial substance IAS 16.24,25; CF 4.54, 4.55

xiii) Derecognition 5.25-5.32

xiv) Management’s intention

xv) Measurement basis 6.40-6.47. Read technical article (annotated)

xvi) Reasonable and supportable

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benchmarking performance against competitors, uncertainty over existence and

measurement of assets and liabilities (CF 5.13-5.16), performance measurement of

segments, impairment assessment, sale of a segment, etc. Examples of issues to which these requirements may apply:

- IAS 38: the need for separately identifiable assets to distinguish them from

goodwill;

- IAS 23: identify attributable borrowing to enable allocation of the cost of

managing risks e.g. changes in the carrying value of hedging instruments in an

effective cash flow hedge.

Other CF issues to keep in mind:

- Be prepared to explain the role of capital and capital maintenance concepts; be

prepared to perform simple calculations to compare the effects of adopting different capital maintenance concepts on reported profits. Refer to examples in

The maths of B.1. What is a suitable capital maintenance concept? (Ch8)

- Another significant issue is financial performance? What is it and how should

it be measured and presented? What is the relationship between profit or loss

and other comprehensive income? Refer to paragraphs 7.92 to 7.27 and BC7.24

to BC 7.57. Use the structure of the profit or loss to organise your evaluation of

its usefulness. Justify the use of a separate statement for other comprehensive

income in terms of enhancing the relevance of the profit or loss.

- Should profit or loss be defined? What definition would be appropriate? How

useful would it be? It is only an aggregation of disparate components: operating, investing and financing (the value drivers – the drivers of cash in and out of

the business). The profit or loss statement (income statement) is structured

around these components underscoring the fact that “performance” is about

cash generation – how it is used and how it is obtained. Profit or loss is not an

independent performance marker in that it cannot be “observed” and evaluated

as correct – the precision of a definition would be inappropriate to its nature,

function and interpretation. For example, there is no benchmark for gauging

what the profit of an entity should be: a definition of “profit or loss” can do little

to rectify that. Hence it would have limited significance in terms of helping users

understand the financial performance of the business.

- In its present formulation the concept of profit or loss fulfils, within the

requirements of the accounting model, the role of indicator of whether financial

capital is maintained at the reporting date. It reflects the application of IFRS-

compliant accounting policies which have in-built safeguards to maintain

closing capital at opening amounts – an essential condition of profit

recognition at the end of a reporting period. For example, gains (and losses)

arising from assets held for sale are market-tested as a condition of their

recognition in profit or loss (IFRS 9 derivatives classified as held for sale); IFRS

5 requires assets classified as held for sale to be measured at the lower of cost (or

carrying value) and fair value less cost to sell; IAS 2 requires inventory to be

measured at the lower of cost and net realisable value (NRV); IAS 16 requires

xvii) The measurement of equity 6.78-6.80

xviii) Fair value option

xix) Substance over form 4.53 xx) Practical expedient

xxi) Faithful representation 6.57

xxii) Forward-looking information

xxiii) Rebuttal presumption

xxiv) Offsetting 7.13, 4.60

xxv) Unit of account 4.57-4.63

xxvi) Value in use (VIU) of assets 6.20, 6.34-6.46

xxvii) Fulfilment value of liabilities

References to Conceptual Framework paragraphs

11. The business model is becoming a central feature of financial reporting practice.

i) Explain the concept of business model? Use examples from IFRS 9

and IFRS 15 to clarify your understanding.

ii) Explain the role the business model plays in the recognition,

measurement, presentation and disclosure of financial information.

Give specific examples from recent IFRS.

iii) The Financial reporting council (FRC) has initiated a project about

business model reporting. Discuss what potential contributions to

financial reporting practice can be expected from this initiative.

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(market tested) revaluation gains on assets held for continuing use to be deferred

in equity.

- The goal of business activity is to obtain, use, invest and conserve cash; it is only

through cash that other rights and benefits can be obtained. Therefore, it can be

argued that “cash basis” is the fundamental measurement and reporting basis

(think about IFRS 13 Fair value measurement, IAS 38 Impairment of assets).

The accrual basis (which produces profit or loss) is simply there to enhance the

cash basis. Hence the statement of cash flow (IAS 7) adjusts the profit or loss

(before tax) for non-current accruals, non-operating gains and losses and

changes in working capital, to obtain the cash from operating activities. This is

a more reliable measure of performance as it will show whether the business is

able to meet its obligations and invest for renewal and growth, and whether it has

significant free cash flow to providers of debt and equity capital.

- The business model is becoming prominent in corporate reporting. The

Financial reporting Council (FRC) has published Business model reporting (July

2015) to encourage the development of business model reporting and related

issues. Sustainability requires integration of the business model to address

financial, environmental and social concerns. Read Pwc’s “Reporting your

business model”. Measurement uncertainty (when the carrying amounts of assets

and liabilities are not directly observed e.g. through market prices and therefore

estimates have to be used) can be reduced if measures reflect the business model

i.e. the economic substance of transactions depict how the entity creates value as

in IFRS 15 (the entity recognises revenue when performance obligations are

satisfied), IFRS 9 (measurement of financial liabilities at amortised cost). To comply with the conceptual framework “the estimate needs to be properly

described and disclosed (see paragraph 2.20)”. The entity’s business model and

its operating environment provide the necessary information to achieve that

objective. The variety of business models (reflecting the diversity of business

types) requires a mixed-measurement model to faithfully represent the effects of

the entity’s management of its assets and liabilities in its statement of financial

performance and financial position. See Concepts of capital, 8.1, Business

activities, p18 of The Conceptual framework for financial reporting (May 2015)

IFRS for SMEs 4 - This standard has not been examined since December 2010 q4a, b & answer.

The approach to this question would be replicated in future exams. E.g. explain

why this standard has been issued.

- This standard will not be frequently examined because it is a watered down

version of the main IFRS which the major entities apply.

- There is a current IFRS for SMEs. However, the IFRS has recently been

undergoing review and the period has ended. A revised IFRS has been issued in

September 2015

- It is essential to be clear about the general issues, problems and solutions

addressed in the study guide sections C.11 albic as these may be examined in relation to other requirements e.g. ethics and corporate social responsibility.

Questions will be in the nature of a critique of the usefulness of this standard.

- Has it compromised too much? Does it adequately reflect the purpose of

financial statements e.g. “fair presentation”? Does it comply with the

conceptual framework principles of faithful representation and relevance?

- You should be prepared to refer to specific aspects and to discuss their

suitability using the criteria of the conceptual framework.

- Be prepared also to evaluate whether this standard reflects the trend

towards integrated reporting.

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- Topics not relevant for SMEs are omitted. Examples: earnings per share, interim financial reporting and segment reporting.

- Where full IFRSs allow accounting policy choices, the IFRS for SMEs allows only the easier option. Examples: requiring a cost model for investment property unless fair value is readily available without undue cost or effort.

- Many principles for recognising and measuring assets, liabilities, income and expenses in full IFRSs are simplified. For example, amortise goodwill; expense all

borrowing and R&D costs; cost model for associates and jointly-controlled entities; and no available-for-sale or held-to-maturity classes of financial assets.

- Significantly fewer disclosures are required (roughly a 90 per cent reduction). - The Standard has been written in clear, easily translatable language.

- To further reduce the burden for SMEs, revisions to the IFRS are expected to be limited to once every three years.

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Final preparation is tough. There is one aspect that students tend to leave till late – which questions to answer on exam day? Your

final preparation should include deciding this matter and then applying it in practice sessions so that it becomes ingrained. I have

provided a rationale for question selection and a suggested order of answering that puts you in control of your answers and the time

it takes to produce them. I hope you agree and I hope it focusses your final preparation and guides your question selection on exam

day. You may find this supplementary practice programme useful. Question What is assessed? Assess your core strengths against the core

requirements

Rationale for selection, execution and completion

1a Ability to apply IFRS principles to

calculate amounts to be included in

published financial statements.

Structure and format of financial

statements (IAS 1). Note the Disclosure

initiative on structure of notes; OCI

elements from equity accounted

investments; IAS 7 presentation and disclosure of changes in debt financing.

HOT (higher order thinking) skills

especially interpretive thinking about

issues of accounting significance and

related financial reporting practices. E.g.

what is the method of calculation and

implication of:

Analysis of profit: owners and NCI

Analysis of profit and OCI: owners

and NCI

Capital maintenance adjustment

Changes in NCI

Changes to presentation e.g. IAS 1

Deferred tax

Disclosure initiative

Employee benefits – discount rate

Employee benefits – past service cost

adjustment

Employee benefits – re-measurement

of pension obligation

Errors, changes in accounting

estimates and policies

Factoring

Fair value adjustment,

Foreign currency adjustments and

attribution of gain or loss arising from

the retranslation of goodwill?

Goodwill on acquisition

Review the P2 question strategy to identify the core

strengths required. Verify that you have these strengths by

attempting timed mocks. Never base your assessment

solely on how you feel – always verify it. Studies show

that students as well as experts often overestimate

themselves. If you do, you will struggle in the exam.

“I would tend to approach answering this question by

starting with Parts (b) and (c)”, Corporate reporting case studies Martin Jones, Lecturer, London School of

Business and Finance (LSBF)

The examiner frequently observes that students run out of time

because they spend too long on this question. This guide aims to

help you take control through strategic preparation: set clear

practice goals, harness relevant resources to the task, practise,

reflect and articulate what you learn and decide the order in which

you are going to attempt the questions on the day of the exam.

Are you struggling to complete q1a? The particular challenge of

this section is to carry out many calculations at an average speed of

1.5mins/mark. It is essential that your practice average is within

this target otherwise you are going to struggle in the exam. You will likely overrun on this question and consequently mess up the

entire exam time allocation if you are not averaging 1.5 mins/mark.

If you are struggling, as most students are, here is the solution. Do

you remember the learning curve effect? The average time required

per mark declines with the number of repeated attempts at a

question. Apply this principle to the problem of lack of speed:

Select and practise by IFRSs repeatedly e.g. IAS 8,12, 16, 17, 19,

21, 28, 36,38,40; IFRS 2,3,5,9,10,11. These are the most commonly

examined – see relevant section in Exam guide above.

Review and reflect after each session to properly encode the

articulated IFRS principles and mental models you have learnt.

When students fail to do this due to “lack of time?” they pay for it

because they quickly forget what they have learnt through practice. CONSEQUENTLY, THEY STRUGGLE IN THE EXAM EVEN

THOUGH THEY MAY HAVE PRACTISED SOMEWHAT.

Therefore, REPEAT many times so that the mental model of the

solution is well formed AND REFLECT always to achieve speed.

If you are now feeling confident about this question because you

are averaging 1.5 mins/mark then DO THIS QUESTION FIRST

ON EXAM DAY BUT DO NOT EXCEED THE TIME

ALLOWED. Otherwise, DO THIS QUESTION LAST because the

other questions are less challenging and you can score marks on

them more quickly than on this question.

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Group restructure

Impairment adjustment and deferred

tax consequences

Inventory (w/down) e.g. q1a March

2016

Loss on disposal of a subsidiary

Negative goodwill,

Onerous contract e.g. q1a March 2016

Partial goodwill method,

Property (operating IAS

16/investment IAS 40): purchase,

disposal, impairment, revaluation

Provisions e.g. warranty,

restructuring, decommissioning (and the effect of changes in estimates of

liabilities)

Recognition of revaluation gain at

acquisition date (e.g. of investment in

associate as in q1a note1.i December

2014)

Reclassification adjustment

Retained earnings

Revaluation adjustment

Revenue recognition

Time apportionment

Ability to raise journal entries to record the effects of the above transactions,

conditions and other events.

1b Ability to carry out critical evaluation of

IFRS using HOT skills. This is the

hallmark of a professional – being able

to ask and answer questions about

practice (as indicated in the syllabus

aim, p4 of the Syllabus and study guide):

“does it work”, “how does it work”, “ to

what extent”, “under what conditions”,

“what are the alternatives?”

Writing structured arguments is an

absolute must. To this end it is essential

to pay attention to the following in

P2TT:

Accounting argumentation

Continuing involvement

Group structure

Key words & terms

Management intention

Review the P2 question strategy to identify the core

strengths required for this type of question. Also see exam

guidance above. Verify that you have these strengths by

attempting timed mocks. Refer to the Past question

analysis to identify the type of questions that have been

asked in the past.

The discursive skills that are examined require clear understanding

of core accounting concepts, principles and practices explained in

P2TT and the ability to write accounting essays. Examples:

Accounting context and situation

Accounting scenarios

Accounting policies

Accounting question

Accounting policies, changes in accounting estimates and

errors. Accounting theory

Application

Capital, equity and net assets

Conceptual framework

Heed the warning about overconfidence above.

Read:

How to write for P2

When you practise your aim should be to clarify what the financial

reporting practice is based on, what it is designed to achieve, and

whether it actually achieves it in practice.

The analysis and evaluation are qualitative. The principles of

practice apply equally as above. Make sure you know the

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Mark scheme

Nuanced

Point

Substance

Waffle

Words

“What-if” questions

Wide and Deep discussion

Writing

Also, use the P2- colour codes to

annotations that explains how to respond

to and use scenario details.

conceptual framework of financial reporting and how it applies to

specific financial transactions. A lot of work has been done recently

and you should be aware of it and be able to respond and present a critical evaluation.

DO THIS QUESTION NEXT IF YOU DECIDE TO DO

QUESTION 1A FIRST. SOMETIMES THIS QUESTION IS A

FOLLOW-UP ON Q1A. THEN FOLLOW THE QUESTION

LOGIC.

MAKE SURE YOU ATTEMPT THIS QUESTION. YOU HAVE

SOMETHING TO WRITE. JUST FOCUS ON THE KEY ISSUES.

FEAR NOT, FAIL NOT. FORTUNE FAVOURS THE BRAVE.

HAVE A GO.

Think about:

Recognition (the time, the conditions, the amount); the elements

(income, expenses, assets, liabilities, equity)

Measurement (concepts: fair value FVTPL initial recognition of

assets and liabilities; amortised cost subsequently, depending on the

business model), NRV for stocks, FVLCTS if an asset is classified

as held for sale IFRS 5)

Re-measurement (changes recognised in OCI, profit or loss)

Reclassifications (on sale, transfer or disposal)

Presentation (P&L or OCI – topical IASB CF ongoing work)

Disclosure (topical: focus on transparency, risk management, investment decisions, control, materiality and the enhancing

characteristics of the CF).

Group structures

Control lost or gained (joint operation, associate, joint venture,

reconstruction) – significant economic event warrants fair value to

recognise profits immediately in profit or loss. What are the

implications for goodwill, amounts deferred in equity, interest

retained in terms of measurement, recognition and presentation?

Significant influence.

1c Awareness of, and ability to, apply

ethical and professional principles and

deal with ethical challenges.

Pay attention to the following in P2TT

Ethics, ethical issues & dilemma

Corporate social responsibility

Interpretation

Review the P2 question strategy to identify the core

strengths required for this type of question. Also see exam

guide above. Verify that you have these strengths by

attempting timed mocks. Refer to the Past question

analysis to identify the type of questions that have been

asked in the past.

Practice should be aimed at assessing the ethical implications of the

practice being proposed.

The principles of practice apply equally as above.

DO THIS QUESTION AFTER QUESTION 1b. DON’T BE

TEMPTED TO SKIP IT. Analyse the scenario to understand what

has happened or is about to happen. Underline the key words (that

depict managerial decisions and intentions in response to

commercial needs and pressures) and consider if they (actually or

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potentially) transgress ethical principles. If they do then say so; also

explain the consequences and how and why the accountant should

respond by applying professional principles to those tasks that impact his role. For example, if he is asked to prepare a fraudulent

cash projection to secure a bank loan for the business he should

resist because that is dishonest and in conflict with the profession’s

standards of integrity.

Make sure you know the ethical and professional principles (see

relevant section of Exam guidance above). The examiner has

previously reported his alarm and disappointment at candidates’

lack of knowledge about ethical principles. Make sure this does not

apply to you. Study the exemplar

2 Knowledge and understanding of IFRS

principles and the issues they relate to.

Review the P2 question strategy to identify the core

strengths required for this type of question. Also see exam guide above. Verify that you have these strengths by

attempting timed mocks.

Exam practice should be aimed at i) identifying issues, ii) assessing

the accounting and financial reporting merits of the practice being proposed to deal with the transaction, condition or other event; iii)

recommending the best treatment through the exercise of critical

thinking and professional judgement. This can also involve raising

journal entries. So know your journal entries very well.

This might involve agreeing or disagreeing with the proposed

treatment. Don’t be tempted to automatically think that there is

something wrong with the proposed treatment and therefore feel

compelled to disagree with it. Many students fall into this trap by

default. The examiner is testing your understanding; so you can’t

simply guess that the treatment is wrong just because it appears as a

scenario. You must make good judgements based on an analysis of the issues and sound IFRS insight combined with commercial

awareness.

Ability to assess how IFRS applies to

transactions, conditions and other

events. This would involve assessing the

applicability of two or more IFRSs to

obtain convergent or divergent support.

Professional marks are available.

Pay attention to the following in P2TT

Accounting context and situation

Accounting scenarios

Accounting policies

Accounting question

Accounting policies, changes in accounting estimates

and errors.

Accounting theory

Application

Business

Capital, equity and net assets

Cash and cash equivalent

Conceptual framework

Contingent consideration

Craft

Credits

Convergent and divergent thinking compared.

As you may have noticed q1b and q2 require the same skill set and

cover the same scope of topics. As q1b is compulsory it makes

sense to answer q2 also because then you can transfer the skills

across.

See P2- colour codes to annotations for help with identifying issues

in scenarios. Also refer to “issues” in P2TT

The principles of practice apply equally as above. The standards that are examined here are the ones that are well established

already. From the Exam Guidance above you should know them by

now. For further interest check Marking scheme (for interacting

IFRS) and Core IFRS in P2TT.

ANSWER THIS QUESTION FIRST IF YOU ARE GOOD WITH

THIS TYPE OF QUESTON BUT YOU ARE NOT MEETING

THE SCORE TARGET FOR Q1A. IN THIS TYPE OF

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Debits

Duality

IAS 8 Hierarchy Issues

Journal entries

Mark scheme

QUESTION YOU ARE LESS LIKELY TO OVERRUN THE

ALLOWED TIME. THE COMPUTATIONS ARE LIKELY TO

BE VERY BASIC AND FEWER THAN FOR Q1A. IT IS MORE ABOUT EXPLANATIONS THAN COMPUTATIONS OR

PREPARATION.

3 Knowledge and understanding of IFRS

principles and the issues they relate to.

Review the P2 question strategy to identify the core

strengths required for this type of question. Also see exam

guide above. Verify that you have these strengths by

attempting timed mocks.

Same practice requirements as for q2.

Ability to assess how an IFRS applies to

transactions, conditions and other

events. This would involve assessing the

applicability of two or more IFRSs to

obtain convergent or divergent support.

For example, the question may be

exclusively focused on one topic such as

noncurrent assets but the various issues

assessed may include leases, investment

property, transfers, agriculture,

revaluations, etc. pertaining to one

industry such as telecommunications.

Specialist industrial knowledge is not

required but the requirements of

relevance and faithful representation dictate which IFRS is to applied or

which particular option of an IFRS is to

be selected.

Professional marks are available.

Pay attention to the following in P2TT to the same issues

as in 2 above.

IF YOU DECIDE TO START AT SECTION B ANSWER THIS

QUESTION second AFTER Q2 IF YOU ARE GOOD WITH THIS

TYPE OF QUESTON AND YOU ARE NOT MEETING THE

SCORE TARGET FOR Q1A. IN THIS TYPE OF QUESTION

YOU ARE LESS LIKELY TO OVERRUN THE ALLOWED TIME. THE COMPUTATIONS ARE LIKELY TO BE VERY

BASIC AND FEWER THAN FOR Q1A. IT IS MORE ABOUT

EXPLANATIONS THAN COMPUTATIONS OR

PREPARATION.

Q3 can be slightly more challenging than Q2 because the examiner

might focus on a type such as noncurrent asset to the exclusion of

others, and set all the questions on it. That is why students find this

question tougher than q2. Assess your strengths and decide between

q3 and q4. But answer q2 for the reasons given above.

4 Knowledge and understanding of

“current issues”. Gain an understanding

of the nature, scope and assessment

requirements of “current issues”

Professional marks are available.

Review the P2 question strategy to identify the core

strengths required for this type of question. Also see exam

guide above. Verify that you have these strengths by

attempting timed mocks.

Q4 has recently been a combination of computational and textual

questions about current issues. Expect this trend to continue and

consider its implications for strategic exam preparation.

There is ample opportunity to examine cash flow related current

issues that require application of Conceptual Framework within Disclosure Initiative. So, this is a prime area for q4 (full question)

because of its decision-usefulness arising from its confirmatory

and predictive qualities. Be prepared to discuss transactions and

specific features such as free cash flow, the relationship between

- operating profit and cash provided by operations,

- cash flow and gearing

- realised working capital and unrealised working capital

- financing activities and investing activities, etc.

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Be prepared for questions based on ED2015/8.

Refer also to G-H above.

IAS 1 Presentation of financial statements is topical because of the

Disclosure initiative. This standard has wide application and it

must be studied with many other standards.

The skill set for this question is the same as for q1b, q2, and q3.

Ability to identify, assess and evaluate

how current issues affect financial

reporting including current IFRS, new

IFRS and proposed IFRS.

Pay attention to the following in P2TT to the same issues

as in 1b, 2, and 3 above.

Refer to:

P2 question strategy

IASB work plan - annotated

Examinable documents - annotated

To sum up I would suggest the following order: q2, q1b (unless q1b is clearly a follow-up to q1a in which case do q1a and then q1b),

q1c, q3 (or q4 only if you have studied the IFRS), q1a (answer the parts of this question in reverse order because the later questions

are less challenging than the earlier ones).

Even if you are good at doing calculations speedily (and this could be a reason you overrun as you persevere to get everything right)

you are encouraged to follow this order because by the time you get to q1a you will have gained all the marks available from the

other questions. You will have only this question to deal with now and chances are you will have more than enough time for it

because of the time you might have saved on the other questions. Even if you run out of time on this question you will not do so at

the expense of other marks you could otherwise have earned – you already have those in the bag!

Before you start answering the paper for each question mark the start and finish times and stick to it.

Read each question carefully; always underline key words and ponder their meaning in context. Think about the whole answer

before you start writing. After you start writing read the question again to make sure you are on track. One way to check your

understanding is accurate is to always challenge yourself with a “what-if” question. So, if you initially think the transaction is a grant

(IAS 20) ask yourself: what if it is not? What else can it be? This forces you to read the question again closely. It could have been a

transfer of property by a customer in which case it is not a grant, but a transfer accounted for under IAS 16, 37, IFRS 15 (see above

under IAS 16). Likewise, you should be able to distinguish between a “transfer” and an “exchange” of PPE.

The examiner always tests understanding of concepts by requiring you to identify the distinguishing features of similar transactions.

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If you follow this advice you will be in control: that is a good frame of mind in which to approach the exam. You might need a bit of

luck; so, I wish you luck but, your success will not depend on it because luck is random, whereas you will be in control. That is what

is required for success; and if luck contributes to your success, it is only because “chance favours the prepared mind”.

June 2018 Exam Guidance

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PLEASE DO OTHERS A FAVOUR If this document has been useful to you please let others know directly or you can leave a message for them in the Guestbook or send us an email:

Sekoyensolutions@gmail.com. We intend to cover more subjects in future. Please let them know how you have benefited. Please let us know how we can improve. What would you like us to add or remove?

Did it help you to understand how the examiner approaches the exam?

Did it help you to understand the priorities of the exam? Did it help you to prioritise?

Did it point to holes in your memory?

Did it help you to understand a topic better? Did it help you to develop specific skills?

Did it help you to organise your thoughts about the answer?

Did it help you to understand that each question has distinctive characteristics and purposes? Did it help you to select the type of question to prepare for and answer? How?

Did it help you to ask more questions about topics?

Did it help you to think in a clear and structured way? How?

Did it introduce new ideas? Which ones? Did it help you to learn more efficiently?

Did it help you to manage your time for revision and practice?

Did it help you to manage your time in the exam? Did it help you to read the questions more carefully and accurately?

Did it help you to feel in control? How and why did you feel in control?

Did it help you to develop appropriate exam psychology – the mental attitude that is focused, confident and resilient?