PASS FINANCIAL ACCOUNTING TECHNICAL REVIEW IFRS/ASPE 2019 CFE

Transcription

1 PASS FINANCIAL ACCOUNTING TECHNICAL REVIEW IFRS/ASPE 2019 CFE

2 INTRODUCTION When it comes to the Financial Reporting competency, the challenge that many students face is the tremendous amount of technical knowledge included in this competency, especially in light of the fact that students are responsible for both IFRS and Accounting Standards for Private Enterprises (ASPE). The technical review notes cover the major financial accounting topics that we would expect to potentially come up on the CFE. The notes recognize that few human beings are capable of knowing every detail of every accounting standard and that fortunately this is likely not necessary, in order to pass the CFE. The summaries of the various topics are therefore condensed and do not endeavor to cover every last detail of a given topic. Rather they focus on the key aspects of each topic that we believe have the greatest probability of being examined. The notes assume that the student already has a reasonable knowledge of each of the topics and is looking for a quick way to review financial accounting. This publication will be appropriate both for both students who have chosen financial reporting as a depth area as well as those who have not. Scope of Publication The publication does not cover 100% of the topics in the CPA Canada Handbook. It, however, covers all major topics that we would expect to be potentially tested in detail on the CFE, as students can easily review the minor topics on their own by reviewing the relevant standards in the Handbook. A listing of examinable topics that are not summarized in the notes given that they are easy to learn on one s own directly from the CPA handbook, is included in the appendix at the end of this publication. The publication also includes two cases along with solutions, which provides students with an opportunity to practice applying their accounting knowledge to case scenarios.

3 TABLE OF CONTENTS TOPIC PAGE 1. Accounting Policies, Changes in Accounting Policies, Changes in Estimates 4 2. Agriculture 7 3. Asset Retirement Obligations Borrowing Costs Business Combinations Earnings Per Share Calculations (EPS) Employee Future Benefits Fair Value Measurement Financial Instruments Financial Instruments: Presentation Financial Instruments: Recognition and Measurement Foreign Currency Translation Government Assistance Impairment of Long Lived Assets Income Taxes Intangible Assets Interests in Joint Arrangements Inventory Investment in Associates Investment Property 187

4 TOPIC PAGE 21. Leases Non Current Assets Held for Sale and Discontinued Operations Non-Monetary Transactions Not-For-Profit Organizations Property, Plant and Equipment Provisions, Contingent Liabilities and Contingent Assets Related Party Transactions Revenue Recognition Stock Based Compensation Subsequent Events Appendix 316 Cases Introduction to Cases 318 Case 1: Holistic Inc. Question 319 Holistic Inc, Solution 325 Case 2: Canadian Wines Inc. Question 336 Canadian Wines Inc. Solution 343

5 INTRODUCTION Topic covered under IFRS in IAS 8 and under ASPE in HB Section 1506 Presentation is based on IFRS IFRS and ASPE are very similar in this area Any differences between IFRS and ASPE are outlined at the end of the summary Standard applies to three possible types of accounting changes: 1. Changes in accounting policies 2. Change in accounting estimate 3. Correction of prior period errors CHANGES IN ACCOUNTING POLICIES Only permitted to change accounting policy if: (i) OR (ii) it is required by a primary source of GAAP (e.g. new handbook section issued, section revised etc.) results in financial statements providing reliable and more relevant information Accounting for Change in Accounting Policy Change in accounting policy normally applied retrospectively Retrospective application means entity adjusts opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied Limitations on Retrospective Application (i) OR (ii) Change relates to initial application of a primary source of GAAP and there are specific transitional provisions state otherwise It is impracticable to determine period-specific effects of changing policy on comparative information for one or more prior periods presented

6 In case (ii) new accounting policy is applied to the carrying amounts of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable, (may be the current period), and a corresponding adjustment is made to the opening balance of equity If it is impracticable to determine cumulative effect, at the beginning of the current period, new policy applied prospectively from the earliest date practicable Impracticable means that the entity cannot apply the requirement after making every effort to do so Change in Accounting Estimate A change in an estimate occurs when changes in circumstances occur e.g. based on new trend data on collection rates for A/R revision made to ADA Sometimes difficult to determine whether a change is a change in estimate or a change between acceptable accounting policies e.g. change in method of depreciation from straight line to units of production method for machine would be a change in estimate if new information on pattern of usage suggested that units of production was more reflective, otherwise may be a change in policy If event has characteristics of both change in policy and change in estimate, change is treated as a change in estimate Changes in estimate applied prospectively (i.e. no restatement of prior periods) Errors An error can result from: A mathematical mistake in F/S Misinterpretation or misrepresentation of information Oversight of information available Misappropriation of assets (unusual) Correction of error is retrospective Prior period comparative financial statements are restated unless impracticable to do so Similar to change in accounting policies in some cases may only be able to do limited retrospective application (e.g. only adjust opening retained earnings) or may only be able to restate prospectively Accounting Standards for Private Enterprises (ASPE) HB Section 1506

7 Rules are very similar to IFRS The only significant differences are: 1. Under ASPE errors must always be corrected retrospectively by adjusting prior period F/S; no exemption where is impracticable to do so 2. There are a number of situations under ASPE when an entity may change accounting policies without meeting the regular criteria (i.e. that results in the financial statements providing reliable and more relevant information) including: To consolidate subsidiaries, to account for them using the cost or equity method To account for investments subject to significant influence using the cost or equity method To account for interests in joint interests in jointly controlled enterprises using cost or equity method or by accounting for rights to the individual assets and obligations for the individual liabilities, in accordance with INTERESTS IN JOINT ARRANGEMENTS, Section 3056; To capitalize or expense expenditures on internally generated intangible assets during the development phase To measure a defined benefit obligation for which an appropriate funding valuation has been prepared using that funding valuation or a separate actuarial valuation prepared for accounting purposes To account for income taxes using the taxes payable method or the future income taxes method To initially measure the equity component of a financial instrument that contains both a liability and an equity component at zero (see summary of Financial Instruments) INTRODUCTION Under IFRS, IAS 41 provides detailed guidance for biological assets and agricultural produce Under ASPE no specific guidance would typically be inventory or a capital asset depending on the situation. For example, cow being raised to produce milk would be a capital asset and like any other capital asset would be recorded at cost and amortized. Cow being raised for sale (i.e. for its meat) would be inventory; it would however not be subject to the rules for measuring inventory under the Inventory HB Section (3031) as it is not included in the scope of that Section

8 Instead it would be subject to industry practice which is to measure biological assets at NRV with any change in NRV from period to period being included in income. Remainder of presentation is based on IFRS. SCOPE OF IAS 41 Applies to: (a) Biological assets i.e. a living animal or plant other than bearer plants Examples: sheep, trees in a timber plantation (i.e. trees being grown for their timber) and (b) Agricultural produce at point of harvest i.e. the harvested product of the entity's biological assets Examples: wool, felled trees When these items relate to agricultural activity Agricultural activity Agricultural activity is the management by an entity of the biological transformation of biological assets (e.g. growth of plant or animal, production of new biological assets through a reproduction program) for sale, or conversion into agricultural produce, or into additional biological assets. e.g. raising livestock, forestry, fish farming etc. IAS 41 only deals with agricultural produce at the point of harvest - but not after the produce has been harvested After the produce is harvested, the standard on inventory (IAS 2) would apply Example: Once oranges are harvested would be treated as inventory Bearer Plants Bearer plant is defined as follows: (a) (b) (c) It is used in the production or supply of agricultural produce; It is expected to bear produce for more than one period; and It has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales. Based on the above definition, various types of bushes and trees that are planted with the intent that the produce which grows on it will be harvested, would be treated as bearer plants.

9 On the other hand if the tree itself is going to be harvested as agricultural produce (e.g. the tree is grown for lumber), it would not be a bearer plant and would be included in IAS 41. Annual crops like wheat or maize would also not be bearer plants. It should be noted that if the main purpose of the plant is to supply produce (e.g. the main purpose of tree is to supply fruit) would still be bearer plant even if the plan is to eventually cut down the tree and use the it for firewood once it ceases to bear fruit considered incidental scrap sale Bearer plants related to agricultural activity would be accounted for under the PPE standard (IAS 16). However, IAS 41 does apply to the produce that grows on those bearer plants. Government grants related to bearer plants should be accounted for in the Accounting for Gov t. Grants Section (IAS 20) i.e. special rules for government grants related to biological assets do not apply to bearer plants. Plants that have a dual use, (i.e., both bearing produce and the plant itself being sold as either a living plant or agricultural produce (beyond incidental scrap sales), would also not meet the definition of bearer plant. One would have to separate the bearer plant and the agricultural produce that it produces. The bearer plant would be accounted for under PPE with produce falling under IAS 41. Land Related to Agricultural Activity Standard does not apply to land related to agricultural activity Land used by an entity for agricultural purposes would be accounted for under the PPE standard (IAS 16) Land owned by a third party and rented to an entity for agricultural purposes, would be accounted for as an investment property (IAS 40) RECOGNITION AND MEASUREMENT Biological asset would be measured on initial recognition and at the end of each reporting period at its fair value less costs to sell, except in cases where fair value cannot be measured reliably No depreciation on biological assets Fair Value

10 Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (as per IFRS 13 Fair Value measurement) Fair value generally not impacted by forward contracts, unless they reflect current market prices - i.e. different than inventory May be no separate market for biological assets that are attached to the land (e.g. trees in a plantation) but an active market may exist for the raw land, and biological assets combined In this case, fair value of raw land may be deducted from the fair value of the combined asset, to arrive at the fair value of biological assets Costs to Sell Need to deduct costs to sell in measuring asset Costs to sell are the incremental costs directly attributable to the disposal of an asset, such as commissions, fees etc. Costs to sell would exclude finance costs and income taxes Situations in which it is not appropriate to use Fair Value Rebuttable Presumption Presumed that fair value can be measured reliably for a biological asset Presumption can however be rebutted only on initial recognition for a biological asset for which market-determined prices or values are not available and for which alternative estimates of fair value are clearly unreliable Would be expected to occur very rarely such as the case in which the asset is unique or of a very special nature In such a case, would measured asset at cost and take depreciation similar to PPE Cost may also be used where little biological transformation has taken place since the initial cost was incurred Example: Fruit seedling is planted immediately before the balance sheet date and therefore cost approximates fair value However, once fair value becomes reliably measurable, would measure it at its fair value less costs to sell

11 Once asset measured based on fair value less costs to sell, entity continues to use this basis until disposal similar to investment property Valuation at Time Produce is Harvested Entity always measures agricultural produce when it is harvested at fair value less costs to sell even if up to that time cost was used Would be initial cost base for the harvested produce when re-classified to inventory From that point onward asset would be valued at the lesser of cost and NRV Gains and Losses Gain or loss could arise on initial recognition of a biological asset at fair value less costs to sell and from change in fair value less costs to sell from period to period Gain may arise for example on initial recognition, when a calf is born Example Say value of a new born calf is $100 and the cost to sell is $3, entry would be: Dr Biological asset (Calf) $97 Cr. Fair value gain on initial recognition of biological asset $97 Loss on initial recognition Loss may arise because costs to sell are deducted in determining fair value of a biological asset For example, cow is purchased for $200 and the cost to sell is $7, entry as follows: Dr Biological asset (cow) $193 Dr. Fair value loss on initial recognition of biological asset $7 Cr. Cash $200 Agricultural setting came up in the legacy UFE program in 2006 Comp Government Grants Biological Asset Measured at its Fair Value Less Costs to Sell (the normal case) Grant would be recognized in profit or loss:

12 A. If the grant is unconditional, when the government grant becomes receivable; and B. If the grant is conditional only when, the conditions attaching to the government grant are met Example of conditional grant: Government grant requires an entity not to engage in specified agricultural activity for a period of 3 years and no amount will be received if the entity does not meet this condition for the full 3 years Company would not recognize the grant until 3 years have lapsed However if one third of the grant can be retained after each year has passed, then one third of the grant would be recognized each year This treatment is different than the standard rules in IAS 20 Accounting for Government Grants and Disclosure of Government Assistance. Under IAS 20, provided there is reasonable assurance that the enterprise has complied and will continue to comply with the conditions for receipt of government assistance, the accrual basis of accounting is used Biological Asset Measured at Cost (unusual situation) and Bearer Plants Would apply the standard rules for government grants under IAS 20

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14 Introduction to Cases The purpose of the cases is to provide students with an opportunity to practice applying their technical knowledge to case scenarios. The two cases provided, Holistic Inc. and Canadian Wines Inc., are not intended to be reflective of a CFE case in terms of competencies covered, as the cases cover only one competency, Financial Reporting. The following should also be noted with regard to the cases: 1) A larger number of issues are tested than would typically be tested in a CFE case in order to give students the opportunity to apply their technical skills to many accounting topics. 2) The cases are intended to simulate the types of issues that can come up in a multi or comp. Some of the shorter issues would be more reflective of an issue in a CFE multi while other issues are far more reflective of a typical CFE comp issue in terms of the amount of information provided to deal with the issue, as well as the complexity of qualitative and quantitative analysis required. We hope that you will find the cases useful both in terms of reinforcing your technical knowledge and mastering the important skill of applying case knowledge to case facts.

15 CANADIAN WINES INCORPORATED Canadian Wines Incorporated (CWI) is a 70% owned subsidiary of a public corporation International Wines Incorporated (IWI). The remainder of the company is owned by 20 investors. IWI has a number of subsidiaries operating around the world that manufacture wine for sale. To facilitate the consolidation process IWI requires their subsidiaries to prepare their financial statements according to international accounting standards (IFRS). IWI and all of its subsidiaries have a June 30 year end. Financing is raised locally and the maximum operating line of credit available to CWI is based on the assets in its financial statements. More specifically, the bank covenant stipulates that the line of credit can not exceed the aggregate of 60% of current assets and 20% of non-current assets. It is now September You CPA have been hired by CWI as the new controller. John Smatt, the company s CFO meets with you and gives you your first assignment. He explains that the draft financial statements for the year ended June 30, 2019 have already been prepared by the former controller but he is concerned that some of the accounting treatments were not appropriate, given that the former controller did not have a background in IFRS. John therefore asks you consider whether there are any areas for which CWI s accounting treatments were not appropriate and if such situations exist, recommend a more appropriate accounting treatment and indicate the adjustment that will be needed to be made. In cases where you do not have sufficient information to determine the amount of the adjustment John asks that you still describe the impact of the GAAP deviation on the financial statements and indicate what information you require to determine the amount of the adjustments. Finally he would like you to compute the impact of applying the accounting treatments you recommend, on the amount of financing that would be available, as the company would like to obtain maximum financing in order to grow. John provides you with a draft statement of financial position (Appendix I) and other documentation, which provides background information on the company s business (Appendix II), He also provides a summary of new developments in the company that will be of relevance to you (Appendix III).

16 APPENDIX I EXTRACTS FROM CWI UNAUDITED FINANCIAL STATEMENTS CANADIAN WINES INC. DRAFT STATEMENT OF FINANCIAL POSITION as at JUNE 30, Assets Current Assets Cash $ 281,610 $ 305,190 Accounts receivable 3,298,300 2,066,890 Inventory 3,450,000 2,560,250 7,029,910 4,932,330 Vineyards 5,199,600 4,650,000 Land held for potential use 3,500,000 3,500,000 Investment in WWI Joint Venture 4,300,000 - PPE 3,456,200 2,890,810 Intangibles 2,300,730 2,356,000 18,756,530 13,396,810 $25,786,440 $18,329,140 Liabilities and Shareholders' Equity Current Liabilities Line of credit $ 7,969,252 $ 5,638,760 Accounts payable and accrued liabilities 688, ,820 Income taxes payable 40,140 44,070 8,698,182 6,147,650 Non-Current Liabilities Term loan 2,240,000 2,800,000 Deferred Taxes 568, ,000 Common Shares 1,047,000 1,047,000 Preferred Shares 1,000,000 - Retained earnings 12,232,758 7,736,490 17,088,258 12,181,490 $25,786,440 $18,329,140

17 APPENDIX II BACKGROUND INFORMATION ON CWI Vineyards CWI owns a number of vineyards primarily in the Niagara region of Canada that produce high quality grapes. Vines once planted if properly taken care of will produce fruit indefinitely. CWI has however found that the vines become less vigorous over time and that by the time they are 25 years old, they become uneconomical to maintain. The company therefore plans to utilize the vines until they are 25 years old, and then the vines are uprooted. The vines were planted at the beginning of January 2017 when the vineyard was started with the purchase of raw land. The company treats the vines and the land as biological assets and therefore has valued both items at fair value less costs to sell. The vines were initially measured at the cost incurred in producing the vines which was $1,800,000 and was assumed to be approximately equal to fair value less costs to sell. As it can take up to 3 seasons for vines to bear viable grapes the fair value less costs to sell was assumed to also be $1,800,000 at the end of both 2017 and As there is no market for vines in Canada the company based the fair value of the vines on the price of vines in the Australian market. The company did not take depreciation on the vineyard in accordance with the Handbook Section on Agriculture. The cost of the land for the vineyard was $2,600,000. The fair value of the land increased from the time of purchase to $2,800,000 by June 30, 2017, $3,000,000 by June 30, 2018 and $3,368,000 by June 30, The company assumes that the costs to sell for both the vines and land amount to 5% of fair value. The total value for the vineyards in the 2019 financial statements was based upon a value for vines and land of $2,000,000 and $3,199,600 respectively.

18 Wine Production and Inventory APPENDIX II (continued) BACKGROUND INFORMATION ON CWI The fruit is transported from the vineyards to one of the two wineries where the grapes are manufactured into a variety of wines. CWI sells many varieties of wines from the inexpensive wines to premium wines which are aged for many years and are very expensive. Depending on the type of wine, it is pressed either before or during the fermentation process. The wine is then barreled. White wine must sit for a minimum of a half a year and red wine for a year in order to age. Premium wine is aged in special oak caskets over a number of years. Approximately 375,000 ml of wine is being aged as premium wine and will not be ready for sale for 4 to 5 years. The wine which is being aged as premium wine makes up 5% of the carrying value of inventory. There are no premium wines in finished goods. Each premium bottle will hold 750ml. All of the company s inventory was measured at cost in the year-end financial statements. The premium wines are expected to make up under 10% of sales, although no premium wines were ready for sale during The prices for the premium wines can fluctuate dramatically from year to year, depending upon demand. The average price per bottle of a premium wine is $250 as at the 2019 year end. The company sees this as a blip and expects the price to rise to normal levels in Long Term Contracts CWI often enters into long term contracts with other producers to purchase a particular grape which does not grow in the Niagara region. In many instances, this turns out to be profitable as the price of the grape goes up following the signing of the contract and CWI is then able to secure the grapes at the lower price stipulated in the contract. The downside however is that on occasion the opposite situation occurs; the price of the grape declines after the contract is signed. Generally there is an escape clause and CWI can pay a penalty and cancel the contract. At year end there were a number of contracts outstanding where the price of the grape had declined after the signing of the contract. CWI did not make any accounting entry in connection with these contracts.

19 Property, Plant and Equipment APPENDIX II (continued) BACKGROUND INFORMATION ON CWI CWI owns significant property, plant and equipment which it accounts for using the cost model. At the beginning of the 2019 fiscal year, CWI was required by government regulations to purchase and install some new safety equipment in their manufacturing facilities for $85,000. As the safety equipment does not increase productivity a decision was made to expense it. The safety equipment is expected to be used for 4 years at which time it will have to be scrapped for $5,000 and replaced by new equipment.

20 APPENDIX III NEW DEVELOPMENTS IN 2019 Development of New Website and Launching of New Wine Discount Program CWI has invested during the year in the development of a web site for their winery to increase sales through a new wine discount program introduced in Customers can sign up on the website and pay an annual fee of $1,000 to be a member of the premium wine discount program. Under the program members can purchase 200 bottles of premium wines over the next 12 month period at a discounted price that is similar to the prices that the company charges its liquor stores. If customers do not take full advantage of the program, they are not entitled to a refund of any part of the fee. The program started on June 1 at which time 300 customers signed up. No additional customers signed up over the remainder of the month. By year end, 6,000 bottles in total had been ordered by the 300 members of the program. The company recognizes revenue when people sign up and pay the $1,000 fee. Therefore $300,000 of revenues from the sale of memberships for this program has been recognized in the 2019 financial statements. In developing the web site, CWI incurred the following costs: Cost Market research to evaluate consumer preferences with regard to the website $26,450 Development of software for the website 30,000 Graphic design 56,200 Creation of content 28,500 Operation of the website after its completion (on March 3, 2019) 8,500 Total costs incurred $149,650 All of the costs incurred were capitalized in the 2019 financial statements and the website was classified as an intangible and valued in the financial statements at $149,650. Joint Venture with B.C Wines Inc. Although CWI does not directly own any vineyards in Western Canada, during 2019 the company entered into a joint arrangement with another winery located in British Columbia,

21 APPENDIX III (continued) NEW DEVELOPMENTS IN 2019 B.C. Wines Inc. (BCW) to manufacture wine for sale in Western Canada. This arrangement is being carried on through a corporation, Western Wines Inc. (WWI); the two owners of the shares of the corporation are CWI and BCW. CWI owns a 60% interest while the other party owns the remaining interest. The joint venture has the same year end as CWI. The arrangement is subject to a contract which stipulates the following: 1) All major decisions involving the management of the corporation including for example the acquisition of and disposal of assets, financing, management of assets etc. must be agreed upon by both CWI and BCW. 2) CWI and BCW agree to purchase all the wine produced by WWI in a ratio of 60%/40%. WWI cannot sell any of the wine to third parties, unless this is approved by both CWI and BCW; sales to third parties are expected to be immaterial. 3) The price of the wines sold to both companies will be set by the 2 owners of the corporation at a level that is designed to cover the costs incurred by the corporation which operates at a break-even level. CWI accounts for its investment in the joint venture using the equity method. As at June 30, 2019, the assets in the joint venture amounted to $9,500,000 of which $1,250,000 were current. Preferred Shares At the end of the current year, the company issued 40,000 preferred shares at $25 per share. These shares are preferred shares, which the company is required to redeem at the option of the holder of the shares, in any fiscal year starting in 2023, in which due to poor market conditions, the company generates a loss from its operations. If the shares are redeemed they will be redeemed at their issue price.

22 Memo to: Management of CWI From: Accounting policy analyst Re: Accounting policies for issues Solution to Canadian Wines Case As requested I have considered the accounting treatments in the financial statements of CWI and identified a number of accounting treatments that I believe are inappropriate. I have recommended more appropriate treatments in these situations. In addition I have calculated the impact of my accounting recommendations on financing available. Accounting Issues I have considered the following areas: 1. Accounting treatment of the vineyards: A. Vines B. Land 2. Inventory 3. Intangible Assets - Web-site costs 4. Safety equipment 5. Revenue recognition new wine shipping program 6. Accounting for venture with B.C. Wines (Joint Arrangement) 7. Onerous contracts 8. Preferred shares

23 Discussion of Issues 1. Accounting for the Vineyard Currently the company is accounting for the whole vineyard as a biological asset and therefore valuing the vines at their fair value and not taking depreciation. This is not correct as: 1) The vines do not constitute biological assets as they are Bearer Plants which are specifically excluded from IAS 41 Agriculture in its scope and subject to IAS 16 Property, Plant and Equipment The vines would constitute bearer plants as a bearer plant is defined as follows: (a) (b) (c) It is used in the production or supply of agricultural produce; It is expected to bear produce for more than one period; and It has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales. The vines would certainly meet all of the above conditions. The vines are used to produce agricultural produce (i.e. grapes) over a number of periods (i.e. 25 years) and it is extremely unlikely that the vines would be sold as agricultural produce. The vines should therefore be classified as PPE rather than as a biological asset. (Only the grapes on the vines would however continue to be accounted for as agricultural produce under IAS 41 Agriculture) 1 The land underneath the vines would also not constitute a biological asset and would also fall under IAS 16 Property, Plant and Equipment. 2 The land underneath the vines would also not constitute a biological asset as it is specifically excluded from IAS 41 Agriculture in its scope and would fall under IAS 16 Property, Plant and Equipment (PPE). PPE is defined as follows in IAS 16.6: Property, plant and equipment are tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

24 (b) are expected to be used during more than one period. The land in the vineyard would meet this definition as it is used for the production of grapes and will be used over multiple periods. Impact on the Financial Statements Vines Because the vines constitute PPE rather than biological assets, the measurement of the vines is impacted. Since the company treated the vine as biological assets they measured them at fair value and did not depreciate them in accordance with the HB section on Agriculture, IAS 41. However if the vines had been correctly classified as PPE they would not have been valued at fair value less cost to sell. Rather in accordance with the company s accounting policy they should have been accounted for using the cost model. Under the costs model the vines should have been accounted for at cost less accumulated depreciation. The vines would have to be depreciated over their useful lives. Although the vines can produce fruit indefinitely if taken care of properly, the useful life is not indefinite given that CWI only uses the vines for 25 years and then uproots them. Therefore, they should have been depreciated over their useful life of 25 years. Adjustments to Financial Statements Vines The financial statements would have to be adjusted to reflect the following: 1) Use of cost for the vines rather than fair value less costs to sell; and 2) Depreciation of the vines Calculation of adjustment: Use of Cost versus Fair Value less Costs to Sell During 2019 the fair value of the vines increased and CWI therefore wrote up the vines by $200,000 from $1,800,000 to fair value less costs to sell of $2,000,000. Under IAS 41 Agriculture the P & L would have been credited when the vines were written up.

25 If we are to use the cost method for the vines under the PPE HB section the vines should not be written up. Therefore the following entry is required to reverse the write-up that would have taken place in 2019: Dr. Gain (P & L) $200,000 Cr. Vines $200,000 To reverse the write-up Depreciation of Vines The vines were planted at the beginning of January 2017 and the cost to plant them was $1,800,000. Had they been treated as PPE at the time they were planted and had the cost method been applied, the following amount of depreciation would have been taken historically assuming straight line depreciation: Year ended June 30, 2017: $1,800,000/25 years X ½ (i.e. for half year*) = $36,000 Year ended June 30, 2018: $1,800,000/25 years = $72,000 Year ended June 30, 2019: $1,800,000/25 years = $72,000 * Vines planted Jan and year end is June 30, 2017 Failure to treat the vines as PPE constitutes an error and the correction of the error would be subject to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. IAS 8 stipulates the following with regard to the correction of an error: 42. Subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by: (a) restating the comparative amounts for the prior period(s) presented in which the (b) error occurred; or if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented. 43. A prior period error shall be corrected by retrospective restatement except to the extent that it is impracticable to determine either the period-specific effects or the cumulative effect of the error. In this case it is possible to determine the impact of the error on each of the prior years, so the financial statements would be adjusted retroactively with prior period statements restated. If the most recent statement presented is 2018, then the opening balances in the 2018 F/S would be restated.

26 The journal entries to correct for this error are as follows: 1) Dr. Retained earnings $108,000 Cr. Accumulated depreciation $108,000 To adjust for depreciation that should have been taken in the 2017 and 2018 fiscal years 2) Dr. Depreciation expense $72,000 Cr. Accumulated depreciation $72,000 To adjust for depreciation that should have been taken in the 2019 fiscal year After taking depreciation the vines will be valued on the 2019 financial statements at $1,620,000 ($1,800,000 cost less accumulated depreciation of $180,000). Accordingly the value of the vines will be reduced by $380,000 (i.e. $2,000,000 (vines valued on the F/S - $1,620,000). It is assumed that the vines would be classified as non-current assets given that they are being used for 25 years and therefore for financing purposes non-current assets are reduced by $380,000. Land Underneath the Vines (i.e. the land used for the vineyard) As discussed above, the land used for the vineyards would be classified under property, plant and equipment in IAS 16 since it is used for production. It is the company s policy to use the cost model for PPE and accordingly had the land been correctly treated as PPE, it would have been valued at cost and not written up to fair value. Adjustments to the Financial Statements The land value went up to $2,800,000 by June 30, 2017, $3,000,000 by June 30, 2018 and $3,368,000 by June 30, As CWI in error applied IAS 41 and valued the land at fair value less costs to sell, the land would have been valued as follows at each year end: June 30, 2017: $2,660,000 ($2,800,000 x 95%*) June 30, 2018: $2,850,000 ($3,000,000 x 95%*) June 30, 2019: $3,199,600 ($3,368,000 x 95%*) *The company assumes that the costs to sell amount to 5% of fair value. Had the land been valued correctly under IAS 16 PPE and the cost model used, the land would have been valued at its purchase cost of $2,600,000. Accordingly the land has to be adjusted to reflect cost rather than fair value less costs to sell.

27 Adjustments to Prior Years Financial Statements Similar to the case of the vines by valuing the land in the vineyard at fair value less costs to sell in accordance with IAS 41 Agriculture, this constitutes an error which must be corrected retroactively with prior year financial statements re-stated. To correct for the incorrect valuation of the land, the following entries would need to be made. 1) Dr. Retained earnings $250,000 Cr. Land $250,000* To correct error by reversing the write up of the land in the 2017 and 2018 F/S to fair value less costs to sell which would have been credited to the P&L each year. *Based on the aggregate write up of the land from time of purchase to June 30, 2018 i.e. $2,850,000 - $2,600,000 (purchase cost). The land was treated as a biological asset, and the fair value was $3,000,000 and costs to sell were 5%, so the fair value less costs to sell as at June 30, 2018 was $2,850,000). Adjustment to Current Year F/S: 1) Dr. Gain (P & L) $349,600* Cr. Land $349,600 To reverse the write up of the land to fair value less costs to sell through the P&L *Based on the write up of fair value of land less costs to sell as at June 30, 2018 of $2,850,00 to $3,199,600 as at June 30, (see calculation above). The land would be classified as non-current assets; therefore for financing purposes noncurrent assets would be decreased by $599,600 as a result of using the cost model rather than valuing the land at fair value less costs to sell. (i.e. Fair value less cost to sell as at the end of 2019 is $3,199,600 compared with cost of $2,600,000). 2. Inventory There are a number of sub-issues in connection with inventory. Impairment Under IAS 2 Inventories, the inventory should be valued at lower of cost or net realizable value (NRV) at year-end. NRV is defined in IAS 2 as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

28 For the wine which is being aged as premium wine over the next 4 to 5 years we will have to take writedowns given that the NRV of the wine appears to be lower than cost given the price fluctuations. This portion of the inventory makes up 5% of the $3,450,000 of the inventory which amounts to $172,500. Approximately 375,000 ml of wine is being aged as premium wine. Based on each premium wine bottle holding 750 ml this translates into 500 bottles. The sales price per bottle is $250, so the total sales value of the bottles is $125,000 which is below cost. Assuming an NRV equal to sales value the following write down would be required in order to write down the inventory to NRV: Dr. Writedown (P&L) $47,500 Cr. Inventory $47,500 In fact, the write down is probably even greater if one takes into account that the costs to complete the wines and sell them should be deducted from the sales value in computing the NRV. For example there are costs involved in aging and bottling the wines once they are ready to be sold and there may be selling costs. I will need further information with regard to these costs before finalizing the adjustment. The fact that the company expects the price for the wine to rise in 2020 has no bearing on the need to write down the wine. It would however be possible to write the wine up in future periods if prices increase. Both the writedown and writeup of the inventory go through the P&L. Financing available will be reduced given that inventory (and hence assets) will be reduced by $47,500. Classification of Wine All of the inventory is classified as current. It may however be necessary to treat wine which is being aged as premium wine over the next 4 to 5 years, as a non-current asset, given that the aging can take a number of years. Whether it is current or non-current would depend upon the normal operating cycle of the company. As per IAS 1, Presentation of Financial Statements, par. 71, the operating cycle of an entity is the time between the acquisition of assets for processing and their realisation in cash or cash equivalents. Based on this IAS, current assets would include inventories that are sold, consumed or realised as part of the normal operating cycle, even when they are not expected to be realised within twelve months after the reporting period as long as the operating cycle is longer than 12 months. Hence if CWI s operating cycle is more than 12 months, it could be argued that the premium wine inventory is current, despite the fact that it is aged for years.

29 On the other hand if the operating cycle is the normal 12 months, this inventory would be considered non-current. Given that premium wines are expected to make up under 10% of sales and the other wines do not take over a year to age, the operating cycle for the company would likely be 12 months and hence the premium wines which are being aged over the next 4 to 5 years should be treated as non-current. This will involve the following entry: Dr. Non-Current Inventory $125,000 Cr. Current Inventory $125,000 Thus the amount of financing will be impacted by 2 factors: 1) The reduction of inventory (and hence assets) by $47,500 which decreases financing available; and 2) The reclassification of inventory from current to non-current which decreases financing available, given that the financing available on current assets is 60% versus only 20% for non-current assets. Capitalization of Borrowing Costs The wine being aged over the next over the next 4 to 5 years would constitute work in progress and would be considered a qualifying asset based on IAS 23, Borrowing Costs since it takes a substantial time to get ready (i.e. it takes a number of years to age the premium wines). Interest should be capitalized to the inventory value for any direct borrowings as well as general borrowings using a weighted average cost of capital. I will need more information on borrowings. I need to know the interest rate for the line of credit as well as the term loan. I would also need to know what debt if any relates to a specific asset. I can then compute the amount of borrowing costs that should be capitalized. Once I have the figures I can compute the adjustment. The adjustment will increase inventory and hence financing available and for the current year increase income (as amounts that were expensed as interest will be capitalized to the inventory). Assuming that there was wine being aged for multiple years in prior years financial statements, failure to capitalize interest would constitute an error. Therefore the error would have to be corrected retroactively and the F/S of prior years will have to be restated. 3. Intangible Assets - Website

30 Web site development costs that provide a probable future benefit would be capitalized based on SIC 32. SIC -32, par 8, states that in particular, an entity may be able to satisfy the requirement to demonstrate how its web site will generate probable future economic benefits when, for example, the web site is capable of generating revenues, including direct revenues from enabling orders to be placed. In this case given that the website is expected to be used for people to sign up for the new wine discount program, this would certainly be the case for CWI s website. Furthermore similar programs offered by other wineries have proven profitable which further supports a probable future benefit. Precisely which aspects of the site are capitalized depends on the stage of the website development. SIC 32, par. 2 describes the following stages of a website s development: (a) (b) (c) (d) Planning includes undertaking feasibility studies, defining objectives and specifications, evaluating alternatives and selecting preferences. Application and Infrastructure Development includes obtaining a domain name, purchasing and developing hardware and operating software, installing developed applications and stress testing. Graphical Design Development includes designing the appearance of web pages. Content Development includes creating, purchasing, preparing and uploading information, either textual or graphical in nature, on the web site before the completion of the web site's development. This information may either be stored in separate databases that are integrated into (or accessed from) the web site or coded directly into the web pages. Expenses incurred in the planning stage are similar in nature to the research phase in IAS 38 Intangibles par and should therefore be expensed. Based on SIC 32, par. 9(b), the costs relating to application & infrastructure development, graphical design and content development stages can be capitalized when the expenditure can be directly attributed and is necessary to creating, producing or preparing the web site for it to be capable of operating in the manner intended by management which is the case for CWI. As per SIC 32, par 3: Once development of a web site has been completed, the Operating stage begins. During this stage, an entity maintains and enhances the applications, infrastructure, graphical design and content of the web site. On the basis of the above, the company was not correct in capitalizing the full costs relating to the website of $149,650. The $26,450 spent on market research to evaluate consumer preferences with regard to the website should be expensed since the cost was incurred in the

31 planning stage. The costs incurred for graphic design and content as well as software for the website of $114,700 (in total) was correctly capitalized. The costs of $8,500 for operating the website must be expensed since they were incurred in the operating stage. The following entry should be made to adjust for the cost that should have been expensed: Dr. Website expense $34,950 (i.e. $26,450 + $8,500) Cr. Intangibles $34,950 To expense website costs As intangibles are classified as non-current assets, financing available will be reduced given that the intangible balance will be decreased. The company also failed to amortize the website after it was completed at the end of March. In fact it should have been amortized over the last 3 months of the year. I will need to determine the useful life of the website in order to determine the amount of amortization required. A short amortization period would be used since the lifespan of a web site is short d ue to technology changes. After amortizing the website non-current assets will be further decreased further decreasing the financing available. 4. Safety Equipment The costs associated with the purchase and installation of safety equipment was incorrectly expensed. IAS 16 states in par. 7 that the cost of PPE should be recognized as an asset if and only if: (a) (b) it is probable that future economic benefits associated with the item will flow to the entity; and the cost of the item can be measured reliably. The safety equipment should be capitalized to the cost of the equipment regardless of the fact that it does not increase productivity as its implementation was involuntary. Rather CWI was required by government regulations to install the new safety equipment and in all likelihood the company would have incurred a fine for failure to install the equipment or possibly even shut down preventing the company from earning future revenue. Accordingly there is a future economic benefit associated with the equipment. Also if accidents are prevented productivity should in fact be increased. The adjustment to the financial statements to capitalize (and depreciate) the safety equipment rather than expense it is as follows: Dr. Equipment $85,000 Cr. Expense $85,000 To capitalize equipment

32 Dr. Depreciation expense $20,000* Cr. Accumulated depreciation $20,000 To account for depreciation on the safety equipment in 2019 Depreciation was based on a cost for the equipment of $85,000 less a residual value of $5,000 and a useful life of 4 years. Straight line depreciation was taken. The net book value of the equipment at the end of 2019 will be $65,000 (i.e. $85,000 purchase price less depreciation of $20,000). The equipment is a noncurrent asset so non-current assets will be increased thus increasing financing available. 5. Revenue Recognition CWI has recognized the $1,000 non-refundable fee in income, when people pay the fee to become a member of the premium wine discount program. This has resulted in $300,000 of revenue in the 2019 financial statements. Under IFRS 15 Revenue From Contracts with Customers, it is necessary to decide if the nonrefundable fee relates to the transfer of a promised good or service. IFRS 15 par. 22 states: 22. At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer: (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer Paragraph 31 deals with the recognition of revenue upon satisfying the performance obligations and says the following: An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset. Step 2 of the revenue model is to Identify the Performance Obligation in the Contract. In this case, the customer pays the $1,000 and then will only benefit if they purchase bottles of premium wine over the next 12 months, as they will be able to purchase the bottles of wine at a discount. If the customer does not purchase bottles, they receive no refund. Therefore, it seems clear that the payment of the fee of $1,000 entitles the customers to a bundle of goods over the course of the year that is distinct, i.e. 200 bottles of wine at a discount. This creates a performance obligation for CWI. Therefore, revenue should be recognized only when CWI satisfies the performance obligation by providing the wine to the