EXCEL PROFESSIONAL INSTITUTE 2.1 FINANCIAL REPORTING IFRS 13, IAS 41, IAS 20, IAS 23, IAS 38, IAS 36, IAS 8, IFRS 5,, IAS 10, IAS 33 ELIKEM

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1 EXCEL PROFESSIONAL INSTITUTE 2.1 FINANCIAL REPORTING IFRS 13, IAS 41, IAS 20, IAS 23, IAS 38, IAS 36, IAS 8, IFRS 5,, IAS 10, IAS 33 ELIKEM

2 EXCEL PROFESSIONAL INSTITUTE IFRS 13 Fair Value Measurement The objective of IFRS 13 is to provide a single source of guidance for fair value measurement when it is required by a reporting standard, rather than it being spread throughout several reporting standards. Many accounting standards require or allow items to be measured at fair value. Some examples from your prior studies include: IAS 16 Property, Plant and Equipment, which allows entities to measure property, plant and equipment at fair value IFRS 3 Business Combinations, which requires the identifiable net assets of a subsidiary to be measured at fair value at the acquisition date.

3 IFRS 13 does not apply to: share-based payment transactions (IFRS 2 Share-based Payments) leases (IAS 17/IFRS 16 Leases). The definition of fair value Fair value is defined as 'the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are knowledgeable, third parties. When pricing an asset or a liability, they would take into account: '

4 Condition Location Restrictions on use. It should be assumed that market participants are not forced into transactions (i.e. they are not suffering from cash flow shortages) IFRS 13 notes that there are various approaches to determining the fair value of an asset or liability: Market approaches (valuations based on recent sales prices) Cost approaches (valuations based on replacement cost) Income approaches (valuations based on financial forecasts). Whatever approach is taken, the aim is always the same to estimate the price that would be transferred in a transaction with a market participant.

5 Fair value is a market-based measurement, not one that is entity specific. As such, when determining the price at which an asset would be sold (or the price paid to transfer a liability), observable data from active markets should be used where possible. An active market is a market where transactions for the asset or liability occur frequently. Level 1 inputs are quoted prices for identical assets in active markets. Level 2 inputs are observable prices that are not level 1 inputs. This may include: I. Quoted prices for similar assets in active markets II. Quoted prices for identical assets in less active markets III. Observable inputs that are not prices (such as interest rates).

6 Level 3 inputs are unobservable. This could include cash or profit forecasts using an entity s own data. A significant adjustment to a level 2 input would lead to it being categorized as a level 3 input. Priority is given to level 1 inputs. The lowest priority is given to level 3 inputs. Asset Example Level 1 Equity shares in a listed entity Unadjusted quoted prices in an active market Level 2 Building held and used Price per square metre for the building from observable market data, such as observed transactions for similar buildings in similar locations. Level 2 Cash-generating unit Profit or cash flow forecast using own data.

7 Baklava has an investment property that is measured at fair value. This property is rented out on short-term leases. The directors wish to fair value the property by estimating the present value of the net cash flows that the property will generate for Baklava. They argue that this best reflects the way in which the building will generate economic benefits for Baklava. The building is unique, although there have been many sales of similar buildings in the local area. Required: Discuss whether the valuation technique suggested by the directors complies with International Financial Reporting Standards.

8 The price received when an asset is sold (or paid when a liability is transferred) may differ depending on the specific market where the transaction occurs. Principal market IFRS 13 says that fair value should be measured by reference to the principal market. The principal market is the market with the greatest activity for the asset or liability being measured. The entity must be able to access the principal market at the measurement date. This means that the principal market for the same asset can differ between entities.

9 Most advantageous market If there is no principal market, then fair value is measured by reference to prices in the most advantageous market. The most advantageous market is the one that maximizes the net amount received from selling an asset (or minimizes the amount paid to transfer a liability). Transaction costs (such as legal and broker fees) will play a role in deciding which market is most advantageous. However, fair value is not adjusted for transaction costs because they are a characteristic of the market, rather than the asset.

10 Market 1 ghc Price Transaction cost (3) (1) Transport cost (2) (2) Net price received What is the fair value of the asset if: (a) market 1 is the principal market for the asset? (b) no principal market can be determined? Market 2 ghc

11 Non-financial assets include: I. Property, plant and equipment II. Intangible assets. The fair value of a non-financial asset IFRS 13 says that the fair value of a non-financial asset should be based on its highest and best use. The highest and best use of an asset is the use that a market participant would adopt in order to maximize its value. The current use of a non-financial asset can be assumed to be the highest and best use, unless evidence exists to the contrary. The highest and best use should take into account uses that are:

12 Physically possible Legally permissible Financially feasible.

13 Five Quarters has purchased 100% of the ordinary shares of Three Halves and is trying to determine the fair value of the net assets at the acquisition date. Three Halves owns land that is currently developed for industrial use. The fair value of the land if used in a manufacturing operation is Ghc5 million. Many nearby plots of land have been developed for residential use (as high-rise apartment buildings). The land owned by Three Halves does not have planning permission for residential use, although permission has been granted for similar plots of land. The fair value of Three Halves land as a vacant site for residential development is Ghc6 million. However, transformation costs of Ghc0.3 million would need to be incurred to get the land into this condition. Required: How should the fair value of the land be determined?

14 IAS 41 Agriculture applies to biological assets and to agricultural produce at the point of harvest. Definitions A biological asset is 'a living plant or animal'. Agricultural produce is 'the harvested product of the entity s biological assets'. Harvest is 'the detachment of produce from a biological asset or the cessation of a biological asset s life processes'. Application of IAS 41 definitions A farmer buys a dairy calf. The calf grows into a mature cow. The farmer milks the cow. The calf is a biological asset. Growth is a type of biological transformation. The milk has been harvested. Milk is agricultural produce

15 Recognition criteria A biological asset should be recognized if: it is probable that future economic benefits will flow to the entity from the asset the cost or fair value of the asset can be reliably measured the entity controls the asset. Initial measurement Biological assets are initially measured at fair value less estimated costs to sell. Gains and losses may arise in profit or loss when a biological asset is first recognized. For example: A loss can arise because estimated selling costs are deducted from fair value. A gain can arise when a new biological asset (such as a lamb or a calf) is born.

16 At each reporting date, biological assets are revalued to fair value less costs to sell. Gains and losses arising from changes in fair value are recognized in profit or loss for the period in which they arise. Biological assets are presented separately on the face of the statement of financial position within non-current assets.

17 IAS 41 presumes that the fair value of biological assets should be capable of being measured reliably. If market prices are not readily available then the biological asset should be measured at cost less accumulated depreciation and accumulated impairment losses. Once the asset's fair value can be measured reliably, it should be remeasured to fair value less costs to sell.

18 On 1 January 20X1, a farmer had a herd of 100 cows, all of which were 2 years old. At this date, the fair value less point of sale costs of the herd was Ghc10,000. On 1 July 20X1, the farmer purchased 20 cows (each two and half years old) for Ghc60 each. As at 31 December 20X1, three year old cows sell at market for Ghc90 each. Market auctioneers have charged a sales levy of 2% for many years. Required: Discuss the accounting treatment of the above in the financial statements for the year ended 31 December 20X1.

19 At the date of harvest, agricultural produce should be recognized and measured at fair value less estimated costs to sell. Gains and losses on initial recognition are included in profit or loss (operating profit) for the period. After produce has been harvested, it becomes an item of inventory. Therefore, IAS 41 ceases to apply. The initial measurement value at the point of harvest is the deemed 'cost' for the purpose of IAS 2 Inventories, which is applied from then onwards.

20 IAS 41 does not apply to intangible assets (such as production quotas), bearer plants, or to land related to agricultural activity. In accordance with IAS 38, intangible assets are measured at cost less amortization or fair value less amortization or subject to impairment review. Bearer plants are used to produce agricultural produce for more than one period. Examples include grape vines or tea bushes. Bearer plants are accounted for in accordance with IAS 16 Property, Plant and Equipment. However, any unharvested produce growing on a bearer plant, such as grapes on a grape vine, is a biological asset and so is accounted for in accordance with IAS 41. Land is not a biological asset. It is treated as a tangible non-current asset and accounted for under IAS 16 Property, Plant and Equipment. When valuing a forest, for example, the trees must be accounted for separately from the land that they grow on.

21 GoodWine is a company that grows and harvests grapes. Grape vines, which produce a new harvest of grapes each year, are typically replaced every 30 years. Harvested grapes are sold to wine producers. With regards to property, plant and equipment, GoodWine accounts for land using the revaluation model and all other classes of assets using the cost model. On 30 June 20X1, its grape vines had a carrying amount of Ghc300,000 and a remaining useful life of 20 years. The grapes on the vines, which are generally harvested in August each year, had a fair value of Ghc500,000. The land used for growing the grape vines had a fair value of Ghc2m. On 30 June 20X2, grapes with a fair value of Ghc100,000 were harvested early due to unusual weather conditions. The grapes left on the grape vines had a fair value of Ghc520,000. The land had a fair value of Ghc2.1m. All selling costs are negligible and should be ignored. Required: Discuss the accounting treatment of the above in the financial statements of GoodWine for the year ended 30 June 20X2.

22 IAS 20 Accounting for Government Grants and Disclosure of Government Assistance defines the following terms: Government grants are transfers of resources to an entity in return for past or future compliance with certain conditions. They exclude assistance that cannot be valued and normal trade with governments. Government assistance is government action designed to provide an economic benefit to a specific entity. It does not include indirect help such as infrastructure development.

23 IAS 20 says that government grants should not be recognized : until the conditions for receipt have been complied with and there is reasonable assurance that the grant will be received. Grants should be matched with the expenditure towards which they are intended to contribute in the statement of profit or loss: Income grants given to subsidize expenditure should be matched to the related costs. Income grants given to help achieve a non-financial goal (such as job creation) should be matched to the costs incurred to meet that goal.

24 Grants for purchases of non-current assets should be recognized over the expected useful lives of the related assets. IAS 20 provides two acceptable accounting policies for this: deduct the grant from the cost of the asset and depreciate the net cost treat the grant as deferred income and release to profit or loss over the life of the asset.

25 Repayments A government grant that becomes repayable is accounted for as a revision of an accounting estimate. (a) Income-based grants Firstly, debit the repayment to any liability for deferred income. Any excess repayment must be charged to profits immediately (b) Capital-based grants deducted from cost Increase the cost of the asset with the repayment. This will also increase the amount of depreciation that should have been charged in the past. This should be recognized and charged immediately. (c) Capital-based grants treated as deferred income Firstly, debit the repayment to any liability for deferred income. Any excess repayment must be charged against profits immediately.

26 As implied in the definition set out above, government assistance helps businesses through loan guarantees, loans at a low rate of interest, advice, procurement policies and similar methods. It is not possible to place reliable values on these forms of assistance, so they are not recognized.

27 On 1 June 20X1, Clock received written confirmation from a local government agency that it would receive a Ghc1m grant towards the purchase price of a new office building. The grant becomes receivable on the date that Clock transfers the Ghc10m purchase price to the vendor. On 1 October 20X1 Clock paid Ghc10m in cash for its new office building, which is estimated to have a useful life of 50 years. By 1 December 20X1, the building was ready for use. Clock received the government grant on 1 January 20X2. Required: Discuss the possible accounting treatments of the above in the financial statements of Clock for the year ended 31 December 20X1.

28 The definition of borrowing costs includes interest expense calculated by the effective interest method, finance charges on finance leases and exchange differences arising from foreign currency borrowings relating to interest costs. Borrowing costs should be capitalized if they relate to the acquisition, construction or production of a qualifying asset. IAS 23 defines a qualifying asset as one that takes a substantial period of time to get ready for its intended use or sale.

29 Borrowing costs should only be capitalized while construction is in progress. IAS 23 stipulates that: Capitalization of borrowing costs should commence when all of the following apply: expenditure for the asset is being incurred borrowing costs are being incurred activities that are necessary to get the asset ready for use are in progress. Capitalization of borrowing costs should cease when substantially all the activities that are necessary to get the asset ready for use are complete. Capitalization of borrowing costs should be suspended during extended periods in which active development is interrupted.

30 Where a loan is taken out specifically to finance the construction of a qualifying asset, IAS 23 says that the amount to be capitalized is the interest payable on that loan less income earned on the temporary investment of the borrowings. If construction of a qualifying asset is financed from an entity's general borrowings, the borrowing costs eligible to be capitalized are determined by applying the weighted average general borrowings rate to the expenditure incurred on the asset. IAS 23 is silent on how to arrive at the expenditure on the asset, but it would be reasonable to calculate it as the weighted average carrying amount of the asset during the period, including finance costs previously capitalized.

31 Emcee, a public limited company, is a sports organization which owns several football and basketball teams. It has a financial year end of 31 May Emcee needs a new stadium to host sporting events which will be included as part of Emcee s property, plant and equipment. Emcee therefore commenced construction on a new stadium on 1 February 2016, and this continued until its completion which was after the year end of 31 May The direct costs were Ghc20 million in February 2016 and then Ghc50 million in each month until the year end. Emcee has not taken out any specific borrowings to finance the construction of the stadium, but it has incurred finance costs on its general borrowings during the period, which could have been avoided if the stadium had not been constructed. Emcee has calculated that the weighted average cost of borrowings for the period 1 February 31 May 2016 on an annualized basis amounted to 9% per annum. Emcee needs advice on how to treat the borrowing costs in its financial statements for the year ending 31 May (6 marks)

32 Definition and recognition criteria An intangible asset is defined as 'an identifiable non-monetary asset without physical substance'. An entity should recognize an intangible asset should be recognized if all the following criteria are met: The asset is identifiable('is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or as part of a package), or it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations The asset is controlled by the entity The asset will generate future economic benefits for the entity The cost of the asset can be measured reliably.

33 Initial measurement When an intangible asset is initially recognized, it is measured at cost. Subsequent measurement After initial measurement, an entity must choose either the cost model or the revaluation model for each class of intangible asset. The cost model measures the asset at cost less accumulated amortization and impairment. The revaluation model measures the asset at fair value less accumulated amortization and impairment

34 An entity must assess whether the useful life of an intangible asset is finite or indefinite. An asset with a finite useful life must be amortized on a systematic basis over that life. Normally the straight-line method with a zero residual value should be used. Amortization starts when the asset is available for use. An asset has an indefinite useful life when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows. It should not be amortized, but be subject to an annual impairment review.

35 Research is defined as 'original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding'. Research expenditure cannot be recognized as an intangible asset. (although tangible assets used in research should be recognized as plant and equipment). Development is defined as 'the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use'.

36 IAS 38 says that development expenditure should only be recognized as an intangible asset if the entity can demonstrate that: the project is technically feasible the entity intends to complete the intangible asset, and then use it or sell it the intangible asset will generate future economic benefits it has adequate resources to complete the project it can reliably measure the expenditure on the project.

37 Definition Impairment is a reduction in the recoverable amount of an asset or cashgenerating unit below its carrying amount. IAS 36 Impairment of Assets says that an entity should carry out an impairment review at least annually if: an intangible asset is not being amortized because it has an indefinite useful life goodwill has arisen on a business combination. Otherwise, an impairment review is required only where there is an indication that impairment may have occurred.

38 IAS 36 lists the following indications that an asset is impaired: External sources of information: unexpected decreases in an asset s market value significant adverse changes have taken place, or are about to take place, in the technological, market, economic or legal environment increased interest rates have decreased an asset s recoverable amount the entity s net assets are measured at more than its market capitalization. Internal sources of information: evidence of obsolescence or damage there is, or is about to be, a material reduction in usage of an asset evidence that the economic performance of an asset has been, or will be, worse than expected.

39 An impairment occurs if the carrying amount of an asset is greater than its recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use. Fair value is defined in IFRS 13 as the price received when selling an asset in an orderly transaction between market participants at the measurement date. Costs to sell are incremental costs directly attributable to the disposal of an asset. Value in use is the present value of future cash flows from using an asset, including its eventual disposal.

40 COMPARE CARRYING AMOUNT RECOVERABLE AMOUNT: HIGHER OF FAIR VALUE LESS COST TO SELL VALUE IN USE If fair value less costs to sell is higher than the carrying amount, there is no impairment and no need to calculate value in use.

41 An impairment loss is normally charged immediately in the statement of profit or loss and other comprehensive income. If the asset has previously been revalued upwards, the impairment is recognized as a component of other comprehensive income and is debited to the revaluation reserve until the surplus relating to that asset has been reduced to nil. The remainder of the impairment loss is recognized in profit or loss. The recoverable (impaired) amount of the asset is then depreciated/amortised over its remaining useful life.

42 On 31 December 20X1, an entity noticed that one of its items of plant and machinery is often left idle. On this date, the asset had a carrying amount of Ghc500,000 and a fair value of Ghc325,000. The estimated costs required to dispose of the asset are Ghc25,000. If the asset is not sold, the entity estimates that it would generate cash inflows of Ghc200,000 in each of the next two years. The discount rate that reflects the risks specific to this asset is 10%. Required: (a) Discuss the accounting treatment of the above in the financial statements for the year ended 31 December 20X1. (b) How would the answer to part (a) be different if there was a balance of Ghc10,000 in other components of equity relating to the prior revaluation of this specific asset?

43 On 1 December 2012, Suntory acquired a trademark, Golfo, for a line of golf clothing for Ghc3 million. Initially, Suntory expected to continue marketing and receiving cash flows from the Golfo product-line indefinitely. However, because of the difficulty in determining its useful life, Suntory decided to amortize the trademark over a 10-year life, using the straight-line method. In December 2015, a competitor unexpectedly revealed a technological breakthrough which is expected to result in a product which, when launched, will significantly reduce the demand for the Golfo product-line. The demand for the Golfo product-line is expected to remain high until May 2018, when the competitor is expected to launch its new product. At 30 November 2016, the end of the financial year, Suntory assessed the recoverable amount of the trademark at Ghc500,000 and intends to continue manufacturing Golfo products until 31 May The directors of Suntory require advice as to how to deal with the trademark in the financial statements for the year ended 30 November (7 marks) Required: Discuss the advice which should be given to Suntory in the above cases with reference to relevant International Financial Reporting Standards.

44 It is not usually possible to identify cash flows relating to particular assets. For example, a factory production line is made up of many individual machines, but the revenues are earned by the production line as a whole. This means that value in use must be calculated (and the impairment review performed) for groups of assets, rather than individual assets. These groups of assets are called cash-generating units (CGUs). Cash-generating units are segments of the business whose income streams are largely independent of each other or a CGU is defined as the smallest identifiable group of assets generating cash inflows which are largely independent of the cash inflows from other assets or groups of assets In practice they are likely to mirror the strategic business units used for monitoring the performance of the business. It could also include a subsidiary or associate within a corporate group structure.

45 The carrying amount of a cash-generating unit includes the carrying amount of assets that can be attributed to the cash-generating unit and will generate the future cash inflows used in determining the cash-generating unit s value in use There are two problem areas: Corporate assets: assets that are used by several cash-generating units (e.g. a head office building or a research centre). They do not generate their own cash inflows, so do not themselves qualify as cash-generating units. Goodwill, which does not generate cash flows independently of other assets and often relates to a whole business. Corporate assets and goodwill should be allocated to cash-generating units on a reasonable and consistent basis. A cash-generating unit to which goodwill has been allocated must be tested for impairment annually.

46 If an impairment loss arises in respect of a cash-generating unit, IAS 36 requires that it is allocated among the assets in the following order: goodwill other assets in proportion to their carrying amount. However, the carrying amount of an asset cannot be reduced below the highest of: fair value less costs to sell value in use nil.

47 There was an explosion in a factory. The carrying amounts of its assets were as follows: Ghc Goodwill 100 Patents 200 Machines 300 Computers 500 Buildings 1,500 2,600 The factory operates as a cash-generating unit. An impairment review reveals a net selling price of Ghc1.2 million for the factory and value in use of Ghc1.95 million. Half of the machines have been blown to pieces but the other half can be sold for at least their carrying amount. The patents have been superseded and are now considered worthless. Required: Discuss, with calculations, how any impairment loss will be accounted for.

48 The calculation of impairment losses is based on predictions of what may happen in the future. Sometimes, actual events turn out to be better than predicted. If this happens, the recoverable amount is re-calculated and the previous writedown is reversed. Impaired assets should be reviewed at each reporting date to see whether there are indications that the impairment has reversed. A reversal of an impairment loss is recognized immediately as income in profit or loss. If the original impairment was charged against the revaluation surplus, it is recognized as other comprehensive income and credited to the revaluation reserve. The reversal must not take the value of the asset above the amount it would have been if the original impairment had never been recorded. The depreciation that would have been charged in the meantime must be taken into account.

49 The depreciation charge for future periods should be revised to reflect the changed carrying amount. An impairment loss recognized for goodwill cannot be reversed in a subsequent period. Indicators of an impairment reversal External indicators of an impairment reversal are: Increases in the asset s market value Favorable changes in the technological, market, economic or legal environment Decreases in interest rates.

50 Internal indicators of an impairment reversal are: Favorable changes in the use of the asset Improvements in the asset s economic performance. Impairment reversals and cash-generating unit If the reversal relates to a cash-generating unit, the reversal is allocated to assets other than goodwill on a pro rata basis. The carrying amount of an asset must not be increased above the lower of: its recoverable amount (if determinable) the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the asset in prior periods.

51 The amount that would otherwise have been allocated to the asset is allocated pro rata to the other assets of the unit, except for goodwill. Impairment reversals and goodwill Impairment losses relating to goodwill can never be reversed. The reason for this is that once purchased goodwill has become impaired, any subsequent increase in its recoverable amount is likely to be an increase in internally generated goodwill, rather than a reversal of the impairment loss recognized for the original purchased goodwill. Internally generated goodwill cannot be recognized.

52 Boxer purchased a non-current asset on 1 January 20X1 at a cost of Ghc30,000. At that date, the asset had an estimated useful life of ten years. Boxer does not revalue this type of asset, but accounts for it on the basis of depreciated historical cost. At 31 December 20X2, the asset was subject to an impairment review and had a recoverable amount of Ghc16,000. At 31 December 20X5, the circumstances which caused the original impairment to be recognized have reversed and are no longer applicable, with the result that recoverable amount is now Ghc40,000. Required: Explain, with supporting computations, the impact on the financial statements of the two impairment reviews.

53 Pod is a listed company specializing in the distribution and sale of photographic products and services. Pod s statement of financial position included an intangible asset which was a portfolio of customers acquired from a similar business which had gone into liquidation. Pod changed its assessment of the useful life of this intangible asset from finite to indefinite. Pod felt that it could not predict the length of life of the intangible asset, stating that it was impossible to foresee the length of life of this intangible due to a number of factors such as technological evolution, and changing consumer behavior. Pod has a significant network of retail branches. In its financial statements, Pod changed the determination of a cash generating unit (CGU) for impairment testing purposes at the level of each major product line, rather than at each individual branch. The determination of CGUs was based on the fact that each of its individual branches did not operate on a standalone basis as some income, such as volume rebates, and costs were dependent on the nature of the product line rather than on individual branches. Pod considered that cash inflows and outflows for individual branches did not provide an accurate assessment of the actual cash generated by those branches. Pod, however, has daily sales information and monthly statements of profit or loss produced for each individual branch and this information is used to make decisions about continuing to operate individual branches. Required: Discuss whether the changes to accounting practice suggested by Pod are acceptable under International Financial Reporting Standards. (8 marks)

54 Introduction IAS 8 governs the following topics: selection of accounting policies changes in accounting policies changes in accounting estimates correction of prior period errors.

55 Accounting policies are the principles, bases, conventions, rules and practices applied by an entity which specify how the effects of transactions and other events are reflected in the financial statements. IAS 8 requires an entity to select and apply appropriate accounting policies complying with International Financial Reporting Standards (IFRSs) and Interpretations to ensure that the financial statements provide information that is: relevant to the decision making needs of users reliable in that they: represent faithfully the results and financial position of the entity reflect the economic substance of events and transactions and not merely the legal form are neutral, i.e. free from bias are prudent are complete in all material respects

56 The general rule is that accounting policies are normally kept the same from period to period to ensure comparability of financial statements over time. IAS 8 requires accounting policies to be changed only if the change: is required by IFRSs or will result in a reliable and more relevant presentation of events or transactions. A change in accounting policy occurs if there has been a change in: recognition, e.g. an expense is now recognized rather than an asset presentation, e.g. depreciation is now included in cost of sales rather than administrative expenses, or measurement basis, e.g. stating assets at replacement cost rather than historical cost.

57 The required accounting treatment is that: the change should be applied retrospectively, with an adjustment to the opening balance of retained earnings in the statement of changes in equity. comparative information should be restated unless it is impracticable to do so. if the adjustment to opening retained earnings cannot be reasonably determined, the change should be adjusted prospectively, i.e. included in the current period s statement of profit or loss.

58 An accounting estimate is a method adopted by an entity to arrive at estimated amounts for the financial statements. Most figures in the financial statements require some estimation: the exercise of judgement based on the latest information available at the time at a later date, estimates may have to be revised as a result of the availability of new information, more experience or subsequent developments

59 The requirements of IAS 8 are: The effects of a change in accounting estimate should be included in the statement of profit or loss in the period of the change and, if subsequent periods are affected, in those subsequent periods. The effects of the change should be included in the same income or expense classification as was used for the original estimate. If the effect of the change is material, its nature and amount must be disclosed.

60 Examples of changes in accounting estimates are changes in: the useful lives of non-current assets the residual values of non-current assets the method of depreciating non-current assets warranty provisions, based upon more up-to-date information about claims frequency.

61 If a noncurrent asset has a depreciable amount of Ghc5,000 to be written off over five years, different depreciation methods such as straight line, reducing balance, sum of the digits, etc. all represent different estimation techniques. The choice of method of depreciation would be the estimation technique whereas the policy of writing off the cost of noncurrent assets over their useful lives would be the accounting policy.

62 Which of the following is a change in accounting policy as opposed to a change in estimation technique? (1) An entity has previously charged interest incurred in connection with the construction of tangible noncurrent assets to the statement of profit or loss. Following the revision of IAS 23, and in accordance with the revised requirements of that standard, it now capitalizes this interest. (2) An entity has previously depreciated vehicles using the reducing balance method at 40% pa. It now uses the straight-line method over a period of five years. (3) An entity has previously shown certain overheads within cost of sales. It now shows those overheads within administrative expenses. (4) (3) (4) An entity has previously measured inventory at weighted average cost. It now measures inventory using the first in first out (FIFO) method

63 Prior period errors are omissions from, and misstatements in, the financial statements for one or more prior periods arising from a failure to use information that: was available when the financial statements for those periods were authorized for issue and could reasonably be expected to have been taken into account in preparing those financial statements. Such errors include mathematical mistakes, mistakes in applying accounting policies, oversights and fraud. Current period errors that are discovered in that period should be corrected before the financial statements are authorized for issue.

64 Prior period errors are dealt with by: restating the opening balance of assets, liabilities and equity as if the error had never occurred, and presenting the necessary adjustment to the opening balance of retained earnings in the statement of changes in equity restating the comparative figures presented, as if the error had never occurred disclosing within the accounts a statement of financial position at the beginning of the earliest comparative period. In effect this means that three statements of financial position will be presented within a set of financial statements: at the end of the current year at the end of the previous year at the beginning of the previous year.

65 During 20X1 a company discovered that certain items had been included in inventory at 31 December 20X0 at a value of Ghc2.5 million but they had in fact been sold before the year end. The original figures reported for the year ending 31 December 20X0 and the figures for the current year 20X1 are given below: 20X1 20X0 Sales 52,100 48,300 Cost of sales (33,500) (30,200) Gross profit 18,600 18,100 Tax (4,600) (4,300) Net profit 14,000 13,800

66 The cost of goods sold in 20X1 includes the Ghc2.5 million error in opening inventory. The retained earnings at 1 January 20X0 were Ghc11.2 million.(assume that the adjustment will have no effect on the tax charge.) Show the 20X1 statement of profit or loss with comparative figures and the retained earnings for each year. Disclosure of other comprehensive income is not required.

67 The objectives of IFRS 5 are to set out: requirements for the classification, measurement and presentation of noncurrent assets held for sale, in particular requiring that such assets should be presented separately on the face of the statement of financial position updated rules for the presentation of discontinued operations, in particular requiring that the results of discontinued operations should be presented separately in the statement of profit or loss.

68 A noncurrent asset should be classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. For this to be the case, the following conditions must apply: The asset must be available for immediate sale in its present condition The sale must be highly probable, meaning that: management are committed to a plan to sell the asset there is an active program to locate a buyer, and the asset is being actively marketed at a reasonable price The sale is expected to be completed within 12 months of its classification as held for sale It is unlikely that the plan will be significantly changed or will be withdrawn.

69 Non-current assets that qualify as held for sale should be measured at the lower of: their carrying amount and fair value less costs to sell. Held for sale noncurrent assets should be: presented separately on the face of the statement of financial position under current assets not depreciated.

70 On 1 January 20X1, Michelle Co bought a chicken processing machine for Ghc20,000. It has an expected useful life of 10 years and a nil residual value. On 30 September 20X3, Michelle Co decides to sell the machine and starts actions to locate a buyer. The machines are in short supply, so Michelle Co is confident that the machine will be sold fairly quickly. Its market value at 30 September 20X3 is Ghc13,500 and it will cost Ghc500 to dismantle the machine and make it available to the purchaser. The machine has not been sold at the year end. At what value should the machine be stated in Michelle Co s statement of financial position at 31 December 20X3?

71 A discontinued operation is a component of an entity that has either been disposed of, or is classified as held for sale, and: represents a separate major line of business or geographical area of operations. is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations, or is a subsidiary acquired exclusively with a view to resale. Discontinued operations are required to be shown separately in order to help users to predict future performance, i.e. based upon continuing operations. An entity must disclose a single amount on the face of the statement of profit or loss, comprising the total of: the post-tax profit or loss of discontinued operations, and the post-tax gain or loss recognized on the measurement to fair value less costs to sell, or on the disposal, of the assets constituting the discontinued operation.

72 Events after the reporting period are those events, both favorable and unfavorable, which occur between the reporting date and the date on which the financial statements are approved for issue by the board of directors. Adjusting and non adjusting events Adjusting events are events after the reporting date which provide additional evidence of conditions existing at the reporting date. Non-adjusting events are events after the reporting date which concern conditions that arose after the reporting date.

73 Examples of adjusting events include: irrecoverable debts arising after the reporting date, which may help to quantify the allowance for receivables as at the reporting date allowances for inventories due to evidence of net realizable value amounts received or receivable in respect of insurance claims which were being negotiated at the reporting date the discovery of fraud or errors. Examples of non-adjusting events include: a major business combination after the reporting date the destruction of a major production plant by a fire after the reporting date abnormally large changes after the reporting date in asset prices or foreign exchange rates.

74 Adjusting events require the adjustment of amounts recognized in the financial statements. Non-adjusting events should be disclosed by note if they are of such importance that non-disclosure would affect the ability of the users of the financial statements to make proper evaluations and decisions. The note should disclose the nature of the event and an estimate of the financial effect, or a statement that such an estimate cannot be made.

75 Shortly after the reporting date a major credit customer of a company went into liquidation because of heavy trading losses and it is expected that little or none of the Ghc12,500 debt will be recoverable. Ghc10,000 of the debt relates to sales made prior to the year end; Ghc2,500 relates to sales made in the first two days of the new financial year. In the 20X1 financial statements the whole debt has been written off, but one of the directors has pointed out that, as the liquidation is an event after the reporting date, the debt should not in fact be written off but disclosure should be made by note to this year s financial statements, and the debt written off in the 20X2 financial statements. Advise whether the director is correct.

76 Equity dividends proposed before but approved and paid after the reporting date may not be included as liabilities at the reporting date. We account for dividends on a cash basis so they are non-adjusting events after the reporting date and must be disclosed by note as required by IAS 1.

77 Earnings per share (EPS) is widely regarded as the most important indicator of a company s performance. It is important that users of the financial statements: are able to compare the EPS of different entities and are able to compare the EPS of the same entity in different accounting periods. IAS 33 Earnings per Share achieves comparability by: defining earnings prescribing methods for determining the number of shares to be included in the calculation of EPS requiring standard presentation and disclosures.

78 IAS 33 applies to entities whose ordinary shares are publicly traded. Publicly traded entities which present both parent and consolidated financial statements are only required to present EPS based on the consolidated figures. Basic EPS The basic EPS calculation is simply: Earnings Shares This should be expressed as pesewas per share to 1 decimal place. Earnings: group profit after tax, less non-controlling interests and irredeemable preference share dividends. Shares: weighted average number of ordinary shares outstanding during the period.

79 Issue of shares at full market price Earnings should be apportioned over the weighted average equity share capital (i.e. taking account of the date any new shares are issued during the year). Example: A company issued 200,000 shares at full market price (Ghc3.00) on 1 July 20X8. Relevant information Profit attributable to the ordinary shareholders for the year ending 31 December 20X8 20X7 Ghc550,000 Ghc460,000 Number of ordinary shares in issue at 31 December 1,000, ,000 Required: Calculate the EPS for each of the years.

80 A bonus issue (or capitalization issue or scrip issue): does not provide additional resources to the issuer means that the shareholder owns the same proportion of the business before and after the issue. In the calculation of EPS: in the current year, the bonus shares are deemed to have been issued at the start of the year. comparative figures are restated to allow for the proportional increase in share capital caused by the bonus issue. Doing this treats the bonus issue as if it had always been in existence.

81 A company makes a bonus issue of one new share for every five existing shares held on 1 July 20X8. Profit attributable to the ordinary shareholders 20X8 20X7 for the year ending 31 December Ghc550,000 Ghc460,000 Number of ordinary shares in issue at 31 December 1,200,000 1,000,000 Calculate the EPS in 20X8 accounts.

82 Rights issues present special problems: they contribute additional resources they are normally priced below full market price. Therefore they combine the characteristics of issues at full market price and bonus issues. Calculating EPS when there has been a rights issue can be done using a four-step process. Step 1 Calculate theoretical ex-rights price (TERP) Step 2 Bonus fraction: Market price before issue Theoretical ex rights price Adjust for bonus element in rights issue, by multiplying capital in issue before the rights issue by the bonus fraction.

83 Step 3 Weighted average number of shares (WANS) Step 4 Earnings per share (EPS) You can now calculate earnings per share (PAT/WANS). It is important to note that if you're asked to restate the prior year EPS, then this is simply the prior year's EPS multiplied by the inverse of the bonus fraction.

84 Equity share capital may change in the future owing to circumstances which exist now known as dilution. The provision of a diluted EPS figure attempts to alert shareholders to the potential impact on EPS. Examples of dilutive factors are: the conversion terms for convertible bonds/convertible loans etc the exercise price for options and the subscription price for warrants. Basic principles of calculation To deal with potential ordinary shares, adjust basic earnings and number of shares assuming convertibles, options, etc. had converted to equity shares on the first day of the accounting period, or on the date of issue, if later. DEPS is calculated as follows: Earnings + notional extra earnings Number of shares + notional extra shares

85 The principles of convertible bonds and convertible preference shares are similar and will be dealt with together. If the convertible bonds/preference shares had been converted: the interest/dividend would be saved therefore earnings would be higher the number of shares would increase.

86 A company had 8.28 million shares in issue at the start of the year and made no new issue of shares during the year ended 31 December 20X4, but on that date it had in issue ghc2,300,000 convertible loan stock 20X6-20X9. The loan stock carries an effective rate of 10%. Assume an income tax rate of 30%. The earnings for the year were ghc2,208,000. This loan stock will be convertible into ordinary shares as follows. 20X6 90 shares for ghc100 nominal value loan stock 20X7 85 shares for ghc100 nominal value loan stock 20X8 80 shares for ghc100 nominal value loan stock 20X9 75 shares for ghc100 nominal value loan stock Calculate the fully DEPS for the year ended 31 December 20X4.

87 An option or warrant gives the holder the right to buy shares at some time in the future at a pre-determined price. Cash does enter the entity at the time the option is exercised, and the DEPS calculation must allow for this. The total number of shares issued on the exercise of the option or warrant is split into two: the number of shares that would have been issued if the cash received had been used to buy shares at fair value (using the average price of the shares during the period) the remainder, which are treated like a bonus issue (i.e. as having been issued for no consideration).

88 The number of shares issued for no consideration is added to the number of shares when calculating the DEPS. A formula for DEPS with an option can be used to work out the number of free shares: Fair value exercise price No. of options Fair value

89 A company had 8.28 million shares in issue at the start of the year and made no issue of shares during the year ended 31 December 20X4, but on that date there were outstanding options to purchase 920,000 ordinary shares at Ghc1.70 per share. The average fair value of ordinary shares was Ghc1.80. Earnings for the year ended 31 December 20X4 were Ghc2,208,000. Calculate the fully DEPS for the year ended 31 December 20X4.