Part I. Basics of accounting 1 fin vs management accounting Correction of errors and suspense accounts: 2 accounting cycle and double entry book keeping preparation of fin statements "transactions recorded in subledger accounts (e.g. customer accounts, vendor accounts)" "subledger accounts are balanced and closed off into control/general ledger (GL) accounts (e.g. debtor account, creditor account etc.)" https://kfknowledgebank.kaplan.co.uk/acca/chapter-8-systems-and-controls trial balance extracted from GL accounts year-end adjustments made and GL accounts closed off A simple system can be illustrated as follows: trial balance used to prepare financial statements books of primary entry (records in subledgers) - are used to update GL accounts sales day book purchases day book "cash book (cash receipts, cash paymens, petty cash)" journals control accounts (records in general ledger) - are used to prepare trial balance reconciliation (rec) recs - means of checking that balancee on the control (GL) account agrees with balance on the ledger account how to prepare a rec: take breakdowns at transaction level of all records from related subledger accounts compare total amount from breakdown and GL cummulative balance "if two total amount do not reconcile, investigate the variance" suspense accounts (incomplete records) end-to-end period close includes: 3 accounting documents 5 accruals and prepayments arises when moment of impact on P/L and moment of actual cas are not the same: Cash flow now Cash flow later Income statement now Accrual Expense Income Income statement later Prepayment accrued prepaid accrued prepaid profit reduction currentliability profit increase current asset profit increase current asset profit reduction currentliability Accrued expense release Db Expense (P/L) Db Accued expense (B/S) Cr Accued expense (B/S) Cr Invoice received or credit note issued to customer (payable) (B/S) Accrued income 0 impact on P/L when actual expense/income is received Db Accued income (B/S) Db Invoice issued or debit note issued to vendor (receivable) (B/S) Cr Income (P/L) Cr Accued income (B/S) Prepaid expense Db Prepaid expense (B/S) Db Expense (P/L) Cr Expense (P/L) Cr Prepaid expense (B/S) Prepaid income (aka deferred income) release of amounts from B/S into P/L Db Income (P/L) Db Deferred income (B/S) Cr Deferred income (B/S) Cr Income (P/L) ##### Sheet/List 2 ##### Part II. Conceptual framework 1 Conceptual framework (evidence from IFRS) Role of Conceptual framework Conceptual framework can be seen as frame for evaluation of existing accounting practices and development of new ones. It forms theoretical basis for determining how transactions should be measured (historcial value or current value) and reported - i.e. how transactions are presented and communicated to users of fin statements Past history of standard setting bodies thoughout the world indicates that absence of conceptual framework results in production of accounting standards that have serios drawbacks: such standards were often not consistent with each other particularly in questions of prudence vs accruals basis such standards were intenrally not consistent and often prioritized effect of transaction on P/L in compariosn with effect on B/S "standards were produced on 'fire fighting' basis, often reacting on corporate scandals rather than being proactive in determining best pracice" the same theoretical issues were revised many times in successive standards (e.g. R&D expenses) Lack of conceptual framework resulted in creation of rules-based system of accounting according to which atment of all accounting transactions shuld be delt with by detailed specific rules or requirements. Such system is very prescriptive and inflexible but has the attraction of fin statements being more comparable and consistent. Aims of conceptual framework are: being a basis for evaluation of existing accounting practices and development of new ones promotion of harmonization if accounting standards by reducing the number of permitted alternative accounting treatments assist acountants in dealing with accounting transactions for which there is not (yet) an accounting standard 2 IFRS "IFRS - can be seen as common language for financial reporting which first firat created for EU-member states, but soon received wide-world adoption." Advantages of adoption of IFRS IFRS are widely accepted as a set of high-quality and transparent global standards intented to achieve consistency and comparability across the globe They were produced in cooperation with other internationally renowned standard setters with aim of achiving consesnsu and global convergence Companies using IFRS have an enhanced status and reputation International Organization for Securities Commissions (IOSCO) recognizes IFRS for listing purposes. This makes it easier and cheaper tp raise finance in international markets. Companies that own foreign subsidiaries will find it easier to consolidate fin stataments of all members of tho group if all subsidiaries use IFRS. Companies that use IFRS will find their results are ore easily compared with those of other companies that use IFRS. "Note! Accounting standards alone cannot provide regulatory framework, particulary since in many countries they (IFRS) do not have legal standing. Thus regulatory framework of juresdiction may include all of the following:" IFRS themselves local company law local securities exchange regulations EU directives local GAAP Structure of IFRS IFRS Foundation IFRS Advisory Council International Accounting Standards Board (IASB) IFRS Interpretations Committee (IFRIC) Standard setting process setting the agenda - IASB will add projects to its agenda on requests of IASB staff members and practicing accountants project planning - working party is established "development and publication of discussion paper (DP) - it is not mandatory step, but it is oftenly used, especially in case if project addresses a major issue. DP explains the issue and possible accounting solutions and invites to comment" development and publication of exposure draft (ED) - it is mandatory step. It is a draft of future standard. Comments on it are collected and analyzed and if required ED is amended and re-exposed. "development and publication of IFRS - when al issues from ED are resolved, final standard is subject to approval by IASB." procedures after IFRS is issued - IASB monitors the application of new standard and any areas that may need clarification and addresses these when standard is revised. Conceptual framework 3 Fin statements IFRS information presented in fin statements - quality characteristics Fin statements Information presented in FS should be useful quality characteristics of information it should be able to influence economic decision of users of such fin statements (relevance) underlying assumptions for preparation of fin statements "it should be faithful - complete, neutral, free from error and reflect economic substance of the transaction rather than its legal form (reliability)" elements of fin statetments Usefulness of information presented in FS is enhanced by if such info is also reporting of elements of fin statements(recognition and measurement) comparable types of fin statatments verifiable consolidation of fin statements provided on timely basis events after reporting period and in compehesive way principles/assumptions for preparation of fin statements going concern - company will continue its business activity in the foreseable future accrual/matching - expenses and incomes should be recorded in PL in the period when they actually happened regardless of recipt/issue of invoice or cash payments consistency - methodology for preparation of fin statements cannot change fro period to period (otherwise information presented in such statements will not be comparable between periods) materiality - correct level of aggregation of transactions and items should be applied substance over form - items recorded in fin stataments should be recorded according to their economic substance and never according to their legal form. Examples "where assets are 'sold' at prices that are greater or less than their fair values, substance is applied. Ofthen it is really a secured loan." "when an asset is leased and used by lessee despite the fact that the lessor is still the legal owner until fully paid, the lessee behaves like owner. So in case of such lease - fin lease - lessee is user of leased asset during the assets economic life: lessee capitalizes it at cash price, depreciates etc." "in consolidations despite the fact that the parent owns only 51% of subsidiary, the entire subsidiary is consolidated (i.e. 100% of subsidiary's assets are added to parent's assets). Legally the parent may own 51% only but in day-to-day economic reality the parent can control the entire subsidiary." in case of consignment inventory if risks and rewards of for example motor vehicle despatched from manufacturer to show-room owner are substantially with the showroom owner then the showroom owner must treat it as of it is its inventory even though legally they belong to manufacturer until paid for "a sale and repurchase of maturing goods - where the inventory doesn't leave the premise of the seller and sale is to a bank - it is considered a seured loan. Legally title mayhave passed to the bank but linking the two transactions together, it is inventory of seller." sale and lease back transaction - prudence - expenses recorded in fin statements shuld not be underestimated and incomes recorded should not be overestimated. This is often called 'assymetric prudence'. elements of fin statements asset - resource controlled by the entity as a result of past event and from which future economic benefits are expected (i.e. there are potencial economic benefits) liability - present obligation arising from past events and settlement of which is certain and will result in (potencial) outflow of resources embodying economic benfits equity - residual interest in assets after deducting from them liabilities => equity = net assets income - increases in economic benefits in form of enhancements of assets or decreases of liabilities that result in increase in equity other than by controbution from equity participants. Note: some types of ncome are required tobe directly recognized in equity (not through P/L first) e.g. revaluation gains on assets go straight to reserves which are part of equity. expense - decreases in economic benefits in form of decreases of assets or increases of liabilities that result in decrease in equity other than by distributions to equity participants reporting of elements of fin statements recognition criteria for elements - an item can be recognized as element of fin statements (i.e. recorded in fin statements as such) if it: meets the definition of particular element it is probable that any future economic benefits associated with such item will inflow or otflow from the entity item's cost or value can be measured reliably recognition of such items (i.e. assets or liabilities) provides users of fin statements with information "that is relevant - If the probability of the event is low, this may not be the most relevant information. The most relevant information may be about the potential magnitude of the item, the possible timing and the factors affecting the probability." that results in benefits exceeding the cost of providing that information measurement basis for elements (i.e. amounts at which elements are recorded in fin statements): according to methodology how to calculate and economic substance at cost (historical evaluation) - all input info is available but it can be outdated current cost - what the asset cost to purchase less any depreciation or amortization. "at value (current evaluation) - not all input info may be available (thus actuals can be substituted with estimates), but up to date" fair value (aka market value) - it is an estimate of what the asset could be sold for (if certain conditions are met). Thus it is exit value focusing on the values which will be gained from the item. Methogology how it should be determined: info input of level 1 - quoted price: identical items at active market info input of level 2 - observable inputs: similar items at active/inactive market info input of level 3 - unobservable inputs: best info available e.g. valuation models "value in use (or fulfilment value for liabilities) - it is present value, which is an estimate of discounted future cash flow which is expected to be generated by the asset" "current cost - it is replacement cost, which is an estimated cost to buy an identical item or construct/produce it at current prices. It is entry value." according to application carrying amount (book value) - amount at which item is recorded in evidence "recoverable amount - amount higher of either the asset's future value for the company or the amount it can be sold for, minus any transaction costs. It is used for comparison with carrying amount in cases of impairment testing" "revalued amount - amount higher of either the asset's present value for the company or the amount it can be sold for, minus any transaction costs. It is used for comparison with carrying amount in cases of revaluations (write downs or write ups)" types of statements statement of financial position (balance sheet) current/non-current distinction it will be realized/settled within 12 months of the reporting date or it is held for the purpose of trading or it is part of entity's normal operating cycle statement of P/L ad other comprehensive income (income statement) other comprehensive income may include movements in revaluation surplus gains and losses on equity instruments classified as financial assets measured at FV through othercomprehensive income FX differences exceptional items "certain material income or expense items, known as exceptional items, may be listed on the face of income statetemnts before profit from operations" "smaller exceptional items are not disclosed in income statement but instead within notes to accounts, normally the operating profit note." statement of change in equity reflects changes in components of company's equity due to net incomes (profits) or net expenses (losses) generated during business activity of the company direct contribution or distributions of equity components by/to business owners reclasses (transfers) between different components of equity statement of cash flow it highlights the key areas where a business has generated and spent cash. Good cash management ensures a business has sufficient cash to run its day to day operations. Advantages of cash flow statement "cash flow balances are a matter of fact and are not distorted by accounting policies (adjustments, estimates, accruals etc.)" "cash flow balances are objective, unlike profit which is subjective." users of fin statements can establish how business has generated cash. users can identify exactly how cash has been spent. users can assess the ability of business to generate cash in the future. Operating cash flow Methods for calculating operating cash flow "direct - information is extracted from ledger accounts (not just fin statements), mainly from bank accounts (cash flow picture is actual) => used by internal users who has access to management accounts" Cash sales Cash received from credit customers Cash purchases Cash paid to credit suppliers Cash expenses cash wages and salaries indirect - information is extracted from fin statements (cash flow picture is reconciled from fin stataments) => used by external users who do not have access to management accounts Profit before tax Adjustment for non-cash items depreciation/amortization loss/(profit) on disposal of non-current assets finance costs - it needs to be added here because it will be deducted in the part of Financing cash flow; otherwise it will be double counted: (1) as per of Profit before tax; (2) as part of Financing cash flow (investment income) - it needs to be dedcuted here because it will be adde back in part of Investing cash flow' otherwise it will be double counted: (1) as per of Profit before tax; (2) as part of Investing cash flow (Increase)/decrease in inventory (Increase)/decrease in receivables Increase/(decerase) in payables Investment cash flow (Purchase of non-current assets) Proceeds from sale of non-current assets Interest received Dividends received (if in cash) Financing cash flow Funds raised - through issue of financial instruments Borrowings received (Borrowings repaid) (Redemption of issued financial instruments) (finance costs) Dividends paid (if in cash) consolidated financial instruments basic terms "parent - a company that has a controlling interest in another company, giving it control of its operations." Amount of investment: Classification of investment Method of accounting to be applied "subsidiary - a company that belongs to another company, which is usually referred to as the parent company. Subsidiary's fin statatments are consolidated with fin statements of the parent." <20% of ordinary shares of acquired entity cost method. Cost is measured at fair value control 20-50% of ordinary shares of acquired entity associate equity method of accounting for such investment. Use of equity method is based on assumption that investor can exert a significant influence over the investee (purchased company). Two companes - investing company and associate - become together a joint venture what is control? =50% of ordinary shares of acquired entity and acquired entity keeps cntrol over another 50% of its ordinary shares joint venture same like for associate i.e. equity method "one company has power over another when it has the ability to direct that company's business activities, which significantly affect investee's returns" >50% of ordinary shares of acquired entity subsidiary consolidation method of accounting for such investment. Use of consolidation method is based on assumption that investor exerts a full control over the investee (purchased company). Two companes - parent company and subsidiary - become together a group. it can be achieved simply by owning a majority or voting shares or it may come from contractual arrangements "it is irrelevant wether a parent company uses its ability to direct business activity of subsidiary, what is important is that it has the ability to do so." if 50% by both sides => join venture non-controlling interest (NCI) - a minority interest; it is an ownership position wherein a shareholder owns less than 50% of outstanding shares and has no control over decisions. 0% 20% 50% 100% "associate - a company in which another company owns a significant portion of voting shares (aka 'significant nterest'), usually 20–50%. In this case, parent company does not consolidate the associate's financial statement" "significant influence - when a company holds approximately 20% to 50% of a company's stock, it is considered to have significant influence" investment consolidation adjustments associate or affiliate general rules: subsidiary the legal form here is two separate companies but the economic reality is single entity and that must be reflected in the method of consolidation. "fin statements of parent and subsidiary used in the consolidation should have the same year end. If subsidiary has different year end date within 3 months of that of the parent then the fin statements can be used with adjustment for any significant transactions in the 3 month period. if the period is greater than 3 months, then the draft fin statements for the subsidiary must be prepared for the purpose of consolidation" all group companies should have the same accounting policies. This may require adjustments to subsidiary's figures. there is a single entity concept: all intergroup transactions between the parent and subsidiary should be cancelled out because they took place within the same entity and only transactions with the outside world must be recorded in the consolidated accounts. there are some exceptions from consolidation: a parent shouldn't prepare consolidated fin stataments if it itself is wholly-owned subsidiary parent's securities are not publicly traded and it is not in the process of issuing secutiries consolidated statement of financial position steps in consolidation cost of investment into subsidiary shown in parent's BS is canceleld against subsidiary's share capital and pre-acquisition retained earnings. Any difference between the two offseting amounts (i.e. balancing figure) is recognized as goodwill "if difference is positive, then goodwill is recognized as intangible asset, which is not amortized but measured at its historical cost and tested for impairment annualy." "if difference is negative, then goodwill is credited to consolidated income statement. " Note! Inherent (non-purchased) goodwill should never be included into BS "if parent is not purchasing 100% of subsidiary, then NCI is recognized " assets and liabilities of parent and subsidiary are combined on line-by-line basis (except group receivables and payables) share capital presented in BS is only that of parent (because the one of subsidiary wqas already cancelled at prior step against parent's investment into subsidiary) retained earnings are parent's retained earnings plus subsidiary's post-acquisition retained earnings proforma Adjustments to BS non-current assets 1 Goodwill adjustments - net total value acquired Substance of adjusting entries: PPE 100% P + S investment at cost price paid for consolidation goodwill see adjustments No. 1 NCI at FV at acquisition date price paid for consolidation current assets (Net assets at FV at acquisition date) value acquired from consolidation stock 100% P + S receivables 100% P + S (BUT except intra-group balances) 2 NCI adjustments - total value bank and cash 100% P + S NCI at FV at acquisition date amount before consolidation total assets NCI % in post acquisition reserves of subsidiary impact of consolidation equity share capital (parent only) 100% P 3 Consolidated reserves - net total value acquired retained earnings see adjustments No. 3 100% of reserves of parent at year-end amount before consolidation NCI see adjustments No.2 group % of post acquisition reserves in subsidiary impact of consolidation non-current liabilities 100% P + S (PUP adjustment (P sells to S)) remove double counting current liabilities 100% P + S (BUT except intra-group balances) total equity and liabilities Notes: Elimination of intra-group balances group accounts should only show balances with parties outside the group. If intra-group balance exists between parent and subsidiary then an adjustment should be made in group accounts in order to cancel the respective balance. Db Group payable Cr Group receivable Provision for unrealized profit (PUP) "companies within a group have made sales to one another at a profit, yet the goods traded between such companies remain within the group at the reporting date, this creates 'unrealized profit'. " "If there is intra-group sales but all goods have subsequently been sold outside the group i.e. nothing is in the inventory at the year-end, there is no PUP" "If there is intra-group sales and not all goods have subsequently been sold outside the group i.e. some inventories acquired in IC transaction are left is in the inventory of the Group at the year-end, there is PUP and adjustments to IC accounts are needed. The type of adjustment depends on direction of original IC sale of inventory: from P to S (downstream IC transaction), from S to P (upstream IC transaction), from S to S (horizontal IC transaction)" "from P to S - debit Group sale (where such reversal of Group sale is apportioned between controlling and NCI), credit Group COS of such inventory, credit subsidiary inventory" "from S to P - debit subsidiary sale, credit subsidiary COS of such inventory, credit Group inventory" "from S to S - debit Selling entity's sale, credit Selling entity's COS of such inventory, credit Purchasing entity's inventory (at difference between market price and transfer price if transfer price was higher i.e. profit)" Cost of investment ways how to structure the deal: to purchase shares in subsidiary for cash to purhase shares in subsidiary and give them paranet's own sahers in return (known as share exchange) "if share exchange is the case how transaction price is paid, then the cost of investment is determined in the following way:" work out number of shares acquired in the subsidiary calculate how many parent's shares will be issued in return (what is the ration between shares subsidiary's share acquired and parent's shares given away) calculate the value of parent's shares by multiplying by the parent share price at acquisition consolidated income statement steps in consolidation group income = parent's income + subsidiary's income (as all income is controlled by the group) group expenses = parent's expenses + subsidiary's expenses (as all expenses are ontrolled by the group) "dividend income from subsidiary which is shown in parent's income statement, should be cancelled in consolidated income statement (because single entity doesn't pay income to itself)" profit attributable to NCI is calculated as: NCI% * subsidiary's profit after tax adjusted for consolidation purposes goodwill recognized as result of business combination in consolidated balance sheet should be tested for impairment annually. if full goodwill is impaired - loss is shared between the NCI and the group in the same ratio as subsidiary's profit for the year if proportionate goodwill is impaired - loss is assigned only to the group reservesin group's share on subsidiary's profit for the year proforma Notes: Mid-year acquisitions of subsidiary "we must include into consolidated business result only that part of subsidiary's business result that arose after acquisition i.e. whilest under the control of the parent. If the acquisition occurred in the middle of the year, we should only include the second half of the subsidiary's result for the year" Elimination of intra-group trading an adjustment shuld be made to reflect intra-group sales revenue: such revenue should be deducted from total consolidated revenue. The same should be done for COS: they need to be deducted from total COS. Db Group sales Cr Group COS "If there is intra-group sales but all goods have subsequently been sold outside the group i.e. nothing is in the inventory at the year-end, show only cancellation of intra-group tarding (i.e. cancelation of intra-goup sales and COS) but nort PUP." Accounting treatment of associate (equity methond) investment into associate is initially recognized at cost in the group BS and the carrying amount is increased/decerased to recognize the investor's share of profit or loss of investee after date of acquisition. investor;s share of profit or loss of investee is recognized in the group income statements as a single line entry. product till revenue Adjustement: less intra-group sales (reversal; if it is vertical IC transaction) product direct COS transaction margin Adjustement: less intra-group purchases (reversal; if it is vertical IC transaction) Transaction margin product non-direct COS supplier rebates product non-direct COS product WOFs/WONs non-transaction margin product non-direct COS product returns Product margin non-product services sold to customers non-product direct COS non-product margin non-product bad debt expense non-product credit cards commissions other marketing costs operating expenses before gross margin other distribution costs Extra line: less unralized profit in inventory Non-product margin Product margin + Non-product = Gross margin other property costs operating expenses after gross margin other payroll costs other overheads Extra line: plus admin expenses Operating profit (EBIT) Db BS - as getting new resource for the business Finance costs Cr CF statement - as outflow of cash Profit before tax Db CF statement - as inflow of cash Cr BS - as taking out an existing resource from the business Income tax expense Cr/Db P/L - as result on disposal Profit after tax Discontinued operations Extra line: less unralized profit in non-current assets Profit for the year Other comprehensive income/expenses Total profit for the year events after the reporting period (i.e. after year-end) an event after the reporting period is the event that occurs between the accounting year end and the date on which the fin statements are authorized for issue types of events and their impact on fin statements adjusting events - provide additional evidence of conditions that existed before/at year-end date => fin statements need to be adjusted to include the impact of such event non-adjusting events - conditions that did not exist before/at year-end date => fin statements shouldn't be adjusted to include the impact of such event. EXCEPTION: going concern is the only exception accounting policy and accounting estimates accounting policy - a set of rules (methodologies) for fin reporting applied by business change in accounting policy should be applied retrospectively i.e. adjustment should be done to at least one period (fin year) from the past. change in policy should be caused by change in environment of the business (external or internal) "Note! When company applies new accounting policy for the first time, it is not a change in exisitng policy, but first-time adoption of new one. Thus no retrospective adjustments are needed for this new policy." "accounting estimate - professional judgement done by accountant when actual amount is not available e.g. duration of useful life of non-current asset, likelihood of collection of aged debt from customer, expected amount of delivery costs from 3d party (cost accrual)" change in estimate should be always based on new information which was not available before (i.e. in the moment when original estimate was done) change in estimate should be accounted prospectively i.e. starting from the current period correction of prior period error correction of prior period error is always based on information which was available before (i.e. when original estimate was done or actual was calculated) correction should be done restrospectively i.e. in the period when the error happened. ##### Sheet/List 3 ##### Part III. Assets 1 PPE - IAS 16 and IFRS for SME section 17 PPE definition "Intangible assets (incl. R&D, Goodwill)" "it is held for use in the production or supply of goods or services, for rental to others, or for admin purposes" Right-to-use it is expected to be used during more than one period (year) or during one operating cycle if it is longer than 1 year Stock recognition - for an item to be recognized as PPE it needs: to meet definition of PPE to meet general recognition criteria set by Conceptual framework (i.e measurability and probability of generating of future/potencial economic benefit) derecognition - item of PPE is derecognized from evidence when: there occur circumstances as the ones stated in Framework for derecognition to happen when asset of PPE stopes meeting its definition as asset of PPE. It happens when purpose of holding an asset stops meeting the criteria of using an asset as PPE (e.g. item was consumed within one operating cycle) measurement assets of PPE are intially measured at cost initial cost includes: costs which are directly attributable to getting asset into working condition for its intended use: purchase price transportation and handling non-refundable purchase taxes and duties site preparation installation professional fees direct labor borrowing costs future dismantling Note: future dismantling and restoration costs are included as part of initial cost only when the company had an obligation to incure these costs and reliable measurement is possible initial cost excludes: costs incurred after asset is ready for use but not being used repair maintenace costs early settlement discounts Borrowing costs (IAS 23) as part of initial cost of PPE: it is interest and other costs that an entity incurs in connection with the borrowing of funds they deal with question of whether finance costs incurred in the construction of the building can be capitalized. "Borrowing costs must be capitalized as part of the cost of asset, if asset is one which necessarily takes a substantial time to get ready for its intended use or sale i.e. it is a quilifying asset. It can be PPE during the construction period, intangible assets during the development period, or ""made-to-order"" inventories (i.e. a production technique in which producers start manufacturing a product only after the customer places an order for it). An asset that normally takes more than a year to be ready for use will usually be a qualifying asset." Commence capitalization of borrowing costs when: expeniture being incurred borrowing being incurred work commenced "If capitalized, borrowing costs are calculated using effective interest method. The calculation includes fees, transaction costs and amortisation of discounts or premiums relating to borrowings" assets of PPE are subsequently measured through either cost model or through revaluation model cost model - assets are held at historical cost less accumulated depreciation and impairment losses "if cost model is chosen, then asset needs to be tested regularly for impairment" Impairment test PPE should be tested for impairment when indicators of impairment exist: internal evidence of obsolescence (moral aging) or damage of asset current period operating loss or net cash outflow from operating activities a commitment by management to undergo a significant reorganization a major loss of key employees external a significant decline in the market value of an asset during the period a significant adverse change in the commercial environment in which the entity operates. Impairment occurs when: carrying value > recoverable amount recoverable amlount is higher of Net selling price (i.e. fair value less costs to sell) and Value in use (present value of future cash inflow generated by this item of PPE) Reversal of previously recognized impairment loss after asset's impairment the new carrying amount will be depreciated over asset's remaining useful economic life (i.e. recalculation of depreciaton schedule) revaluation model - assets are held at revalued amount less accumulated depreciation and impairment losses "if revaluation model is chosen, then asset needs to be revalued regularly" Revaluation it must be applied consistently to all assets in the same class of PPE assets should be revalued with sufficient regularity so that their carrying amount is not significantly different from their fair value "upwards revaluations are recognized in OCI (i.e. BS, particularly in revaluation reserve)" Db PPE - difference between valuation and original cost/valuation Db Accumulated depreciation Cr OCI: gain on revaluation aka revaluation reserve downward revaluations are recognized in OCI and charged against the revaluation reserve to the extent that is exists in relation to the relevant asset; otherwise downward revaluations are recognized in PL. Db Revaluation reserve - to max of original gain Db P/L - any residual amount (if balance at revaluation reserve is not enough to cover the amount of calculated loss) Cr PPE - loss on revaluation the revalued amount should be depreciated over asset's remaining useful economic life depreciation it is a systematic allocation of depreciable amount of an asset over its useful lifetime depreciation begins when an asset is available for normal use. "when an asset is made of two or more significant components, each with their own useful economic lifetime, each component is depreciated separately. When component is replaced, the cost of replacement part is capitalized." "if depreciation method or rate is adjusted, the adjustment is made prospectively (i.e. forward looking)." methods of depreciation: straight-line % on cost or (Cost - residual value) / useful economic life (years) reducing balance % on carrying value carrying value = net book value CAPEX (capitalization) any subsequent expenditure on existing assets of PPE should only be capitalized if it imporves an asset's revenue earning capacity i.e. capitalize an extension to a building but not decoration costs. Capitalization should be stopped when asset is ready for use or if construction is susspensed. 2 Intangible assets - IAS 38 and IFRS for SME section 18 definition it has identifiable non-monetary form separable: is separable = it can be sold as single item is not separable but arises from contactual rights non-monetary any asset other than cash or an asset to be settled ina fxed amount of cash recognition - for an item to be recognized as intangible asset it needs: to meet definition of intangible asset to meet general recognition criteria set by Conceptual framework (i.e measurability and probability of generating of future economic benefit) "because of intangible assets have towo components - purchased items and internally genaretd items, both general recognition criteria need to be evaluated very carefully for internally generated items:" "because it is impossible to measure pricisely initial cost of some itmes, they cannot be recognized as assets e.g. internally generated goodwill" "only when initial cost can be measured reliably, items can be recognized => R&D costs " research - should be expensed immediately (i.e. should be recorded as costs in PL) development - should be capetalized (i.e. recorded as intangible assets in BS) if: it is separte project all expenditures are identifiable it is commercially viable it is technically feasible it is overall profitable there are resources available to complete it "Note: if item is recognized as development, it nees to be reviewed annually to ensure criteria still met; if not - expense immediately." derecognition - see rules for item of PPE measurement intangible assets are intially measured at cost or at fair value "if cost basis is chosen, cost includes all costs incurred in bringing such assets to their present location and condition (see PPE initial costs). If cost basis is chosen, such assets cannot be revalued." "If fair value basis if chosen, it needs to be reviewed every period and amortization of such asset is allowed, Fair value model can be chosen only if ther can be made a refernce to active market i.e.:" identical items are traded between willing buyers and sellers (not a single buyer or a single seller) with prices available to public subsequent measurement of intangible assets chosen model needs to be applied consistently to all assets in the same class of intangible or investment assets and change from one model to another is not allowed unless it results in more appropriate presentation. amortization (is calculated on monthly basis) if an assset has finite useful lifetime (e.g asset which has infinite useful life is goodwill) Impairment test "Goowill, intangible assets with an indefinite life and intangible assets that are not yet ready for use are tested for impairment annually (i.e. even when there are no external or internal indicvators that impairment loss exisis)" Impairment loss on goodwill can never be reversed. Impairment loss on other assets can be reversed where the recoverable amount has increased because of a change in economic conditions or expected use of asset. Busness combinations "all acquisition costs incl. those directly related to acquisition such as professional fees (legal, accounting, valuation etc.) must be expensed." goodwill and NCI - there are two ways how to measure them: at FV (aka full goodwill method) e.g. Consideration paid by Parent 100 NCI 25 FV of net assets -75 GW 50 at NCI's proportionate share of acquiree's (subsidiary's) net assets (aka proportionate goodwill method) e.g. Consideration paid by Parent 100 Share of net assets acquire at FV 80% FV of net assets -60 GW 40 3 Right-to-use asset (lease) - IFRS 16 and IFRS for SME … classification of lease "full IFRS: IFRS 16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value." IFRS for SME: old approach to classification of lease contracts: recognition A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments. The depreciation would usually be on a straight-line basis. " In the statement of cash flows, a lessee separates the total amount of cash paid into principal (presented within financing activities) and interest (presented within either operating or financing activities) in accordance with IAS 7." measurement Assets and liabilities arising from a lease are initially measured on a present value basis. The initial lease asset equals the lease liability in most cases. presentation in BS: "The lease asset is the right to use the underlying asset and is presented in the statement of financial position either as part of property, plant and equipment or as its own line item." Balance sheet PPE or Right-to-use asset (Financial liability) (Accumulated deprecition on PPE or Right-to-use asset) Business result i.e. depreciation charge and interest charge for Right-to-se asset (Bank i.e. as outgoing lease payment) lease payments advance payments (payments at the beginning of the period): b/f amount of lease liability - payment + interest charge = c/d amount of lease liability payments in arrears (payments at the end to the period): b/f amount of lease liability + interest charge - payment = c/d amount of lease liability 4 Stock - IAS 2 and IFRS for SME par. … definition it is property intended for consumption or sale in the ordinary course of business activity recognition - for an item to be recognized as current asset it needs: to meet definition of current asset to meet general recognition criteria set by Conceptual framework (i.e measurability and probability of generating of future economic benefit) dereconition - see rules for PPE measurement initially stock is measured at cost general rule: cost includes all costs incurred in bringing such assets to their present location and condition (see PPE initial costs) specific rule for inventories: costs include: purchase price import duties (non-refundable) carriage in (delivery inwards) manufacturing costs cost of conversion (for unfinished products) - direct costs e.g. material and production overheads e.g. factory heat and light costs exclude abnormal costs storage costs selling costs carriage out (delivery outwards) subsequently carrying amount of stock is subsequently estimated by one of the following three approaches depending on the type of accounting applied to company's stock: year-end accounting with valuation of stock in actual amounts - mainly used by sole trader who has detailed listing of all stock with actual unit costs identified for each item of stock (small number of units which are not interchangeable) During the year: At the year-end: Db Purchases (PL) Db Stock Cr Trade payables Cr Purchases continuous accounting with valuation of stock through estimates - mainly used by companies which do not have unit costs identified for each item of stock (high volumes of interchangeable units). Estimates are used instead of actuals. Types of estimates used - weighted average and FIFO (first-in first-out) During the year: At the year-end: Db Stock (BS) Db Purchases (P/L) Cr Trade payables Cr Stock Impairment test Inventories should be tested for impairment when indicators of impairment exist (same like for PPEand intangible assets): internal evidence of obsolescence or damage of asset current period operating loss or net cash outflow from operating activities a commitment by management to undergo a significant reorganization a major loss of key employees external a significant decline in the market value of an asset during the period a significant adverse change in the commercial environment in which the entity operates. Impairment occurs when: carrying value > recoverable amount recoverable amlount is Net selling price (i.e. fair value less costs to sell and to finish (for WIP)) 5 Impairment of assets impairment loss is the amount by which the carrying amount of asset or cash-generating unit exceeds its recoverable amount objective of impairment testing: assets are recorded in fin statements at no more than their recoverable amount any resulting impairment loss is measured and recognized on a consistent basis sufficient informatin is disclosed in fin statements impairment testing is required: for all assets when there is an indication of impairment at the reporting date annually for certain other assets goodwill acquired in a business combination "intangible assets with indefinite useful life (trademark, perpetual franchise)" intangible assets which are not yet available for use (development) impairment loss arises where: carrying value > recoverable amount recoverable amlount is higher of Net seplling price (i.e. fair value less costs to sell) and Value in use where value in use is present value of future cash flows generated by the asset. Present cash flows should be based on the most recent budgets and generally for a maximum of 5 years. cash-generating unit (CGU) "the value in use of non-current asset should be estimated individually where reasonable practicable. Where it is not possible to identify cash flows arising from an individdual non-current asset, value in use should be calculated at the level of cash-generating unit." "when impairment loss is recognized for CGU, fist item which is impaired (written off) is goodwill." accounting for impairment loss for assets held at historcial cost Db P/L Cr Non-current asset for revalued assets Db Revaluation surplus (other comprehensive income) to the extent that a revaluation surplus relating to the asset exists Db P/L with any excess impairment Cr Non-current asset reversal of previously recognized impairment loss reversal of past impairment losses should be recognized when the recoverable amount of asset (except goodwill) has increased because of a change in economic conditions or in the intended use of asset ##### Sheet/List 4 ##### Part IV. "Financial instruments - IAS 32, IFRS 9, IAS 36 and IFRS for SME par. 11" "see ""Fin insturments - measurement notes"" file" FI is a contract that gives rise to the fin asset of one entity and to the fin liability or equity instrument of another entity. Simpliest example of such contract (i.e. basic fin instrument) is trade receivable when company sells its goods on credit. Seller has right to receive settlement for the supply provided and buyer has liability to provide settlement for supply received at given point of time in the future at agreed amount. Most complicated examples (i.e. other fin instruments) contain structured products and derivatives. Accounting for fin instruments includes: "accounting for fin assets - investments in shares, investments in bonds abd trade receivables" "accounting for fin liabilities - long-term loans, bonds issued and trade payables" accounting for equity share capital - shares and options issued There are many issues around accounting for fin instruments: "classification - accounting for any fin instrument strats with classification (as per list above), especially when it is fin liability - it should be classified either as debt insturment or as equity instrument. This distinction is important as it will directly affect gearing ratio (debt-to-quity) - a key measure that users of fin statements use to assess fin risk of the entity. This distinction will also impact amount business result for the period as fin costs associated with debt will be charged to P/L ths reducing profit of entity, while dividends paid on shares are an appropriation (distribution) of profit rather than expense in P/L. " measurement see table from Course notes fin assets recognition fin assets are any assets that are: cash equity instrument of another entity contractual right to receive cash or another asset from another entity contractual right to exachange fin asset or liability with another entity under conditions that are potencially favourable contract that will be settled in entity's own equity instruments classification and measurement fin asset is only measured at amortized cost if the asset is held within a business model whose objactive is to hold the asset to collect contractual cash flows ('hold to collect' business test) and fin asset gives rise to cash flows on specified dates that are solely payments of principle and interest on principle outstanding ('contractual cash flow' characteristics test) fin asset is only measured at FVTOCI if the asset is held within a business model whose objactive is achieved by both collecting contractual cash flows and selling fin asset ('hold to collect and sell' business test) fin asset gives rise to cash flows on specified dates that are solely payments of principle and interest on principle outstanding ('contractual cash flow' characteristics test) fin assets are measured at FVTPL (it is default category for fin assets) when they do not meet either the business model test or contractual cash flow test fin liabilities recognition fin liabilities are any liabilities that are contractual obligation to deliver cash or another fin asset to another entity to exachange fin asset or liability with another entity under conditions that are potencially unfavourable than will or may be settled in entity's own equity instruments classification and measurement "fin liability is measured at FVTPL if such fin instruments are derivatives (e.g. share options, futures, forwards, interest rate swaps), fin instruments held for trading in short-term (repurchase agreements with floating interest rate), any fin instuments designed as FVTPL on inception (i.e. on initial recognition it is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking and embedded derivatives can sufficiently modify the cash flows of the whole liability and are not clearly closely related to underlying lianility - e.g. conversion option embedded in a convertible bond)" "fin liability is measured at amortized cost if fin liability fails to meet meausrement conditions stated above to be measured at FVTPL (e.g. held to maturity issued debt instruments quoted in an active market, that is, bonds; loans received and trade payables" equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. when preference shares issues should be classified as debt or as equity: Preference shares redeemable non-redeemable debt cumulative non-cumulative debt equity