Barry Elliott and Jamie Elliott

FIFTEENTH EDITION Barry Elliott and Jamie Elliott Financial Times Prentice Hall is an imprint of Harlow, England London New York Boston San Francisco Toronto Sydney Singapore Hong Kong Tokyo Seoul Taipei New Delhi Cape Town Madrid Mexico City Amsterdam Munich Paris Milan

Full contents Preface and acknowledgements Guided tour of MyAccountingLab xx xxv Fart I F FSNANCBAL STATEMENTS D 1 Accounting and reporting on a cash flow basis 3 1.1 Introduction 3 1.2 Shareholders 3 1.3 What skills does an accountant require in respect of external reports? 4 1.4 Managers 4 1.5 What skills does an accountant require in respect of internal reports? 5 1.6 Procedural steps when reporting to internal users 5 1.7 Agency costs. 8 1.8 Illustration of periodic financial statements prepared under the cash flow concept to disclose realised operating cash flows 8 1.9 Illustration of preparation of statement of financial position 12 1.10 Treatment of non-current assets in the cash flow model 14 1. 11 What are the characteristics of these data that make them reliable? 15 1.12 Reports to external users 16 Summary 17 Review questions 18 Exercises 18 References 20 2 Accounting and reporting on an accrual accounting basis 21 2.1 Introduction 21 2.2 Historical cost convention 22 2.3 Accrual basis of accounting 23 2.4 Mechanics of accrual accounting - adjusting cash receipts and payments 23 2.5 Subjective judgements required in accrual accounting - adjusting cash payments in accordance with the matching principle 24 2.6 Mechanics of accrual accounting - the statement of financial position 24 ' 2.7 Reformatting the statement of financial position 25 2.8 Accounting for the sacrifice of non-current assets 25

viii Full contents 2.9 Reconciliation of cash flow and accrual accounting data 29 Summary 31 Review questions 31 Exercises 32 References 33 3 Preparation of financial statements 35 3.1 Introduction 35 3.2 Preparing an internal statement of income from a trial balance 36 3.3 The format of statements of income for publication 37 3.4 Other comprehensive income 41 3.5 Accounting for current tax 42 3.6 Presentation using IAS I Alternative method (Format 2) 44 3.7 The statement of financial position 45 3.8 Statement of changes in equity 46 3.9 The accounting rules for asset valuation 47 3.10 The explanatory notes that accompany a statement of financial position 48 3.11 Has prescribing the formats meant that identical transactions are reported identically? 50 3.12 What does an investor need in addition to the financial statements to make decisions? 53 3.13 ASB review of narrative reporting 58 3.14 What is meant by a fair view? 59 Summary 61 Review questions 62 Exercises 63 References 74 4 Annual Report: additional financial statements 75 4.1 Introduction 75 4.2 The value added by segment reports 75 4.3 Detailed review and evaluation of IRFS 8 - Operating Segments 76 4.4 IFRS 5 - meaning of 'held for sale' 84 4.5 IFRS 5 - implications of classification as held for sale 84 4.6 Meaning and disclosure of 'discontinued operations' 85 4.7 IAS 10 - events after the reporting period 87 4.8 Related party disclosures 88 Summary 93 Review questions 93 Exercises 94 References 104 5 Statements of cash flows 105 5.1 Introduction 105 5.2 Development of statements of cash flows 105 5.3 Applying IAS 7 (revised) Statements of Cash Flows 107 5.4 Step approach to preparation of a statement of cash flows - indirect method I 10 5.5 Statement of cash flows - direct method I 12

5.6 5.7 5.8 5.9 Additional notes required by IAS 7 Analysing statements of cash flows Critique of cash flow accounting Summary proposal for change in presentation of the financial statements Summary Review questions Exercises References Full contents IX 113 114 118 119 121 122 123 131 IMCOME AMD ASSET VALUE MEASUREMENT SYSTEMS 6 Income and asset value measurement: an economist's approach 135 6.1 Introduction 135 6.2 Role and objective of income measurement 135 6.3 Accountant's view of income, capital and value 138 6.4 Critical comment on the accountant's measure 141 6.5 Economist's view of income, capital and value 142 6.6 Critical comment on the economist's measure 148 6.7 Income, capital and changing price levels 148 Summary 150 Review questions 150 Exercises 151 References 152 Bibliography 153 7 Accounting for price-level changes 154 7.1 Introduction / 154 7.2 Review of the problems of historical cost accounting (HCA) 154 7.3 Inflation accounting 155 7.4 The concepts in principle 155 7.5 The four models illustrated for a company with cash purchases and sales 156 7.6 Critique of each model 160 7.7 Operating capital maintenance - a comprehensive example 163 7.8 Critique of CCA statements 174 7.9 The ASB approach 176 7.10 The IASC/IASB approach 178 7.11 Future developments 179 Summary " 181 Review questions 182 Exercises 182 References 191. Bibliography 191 8 Revenue recognition 192 8.1 Introduction 192 8.2 The issues 193

Full contents 8.3 The challenge 193 8.4 Revenue defined -IAS 18 Revenue 194 8.5 Proposed IFRS 196 Summary 202 Review questions 203 Exercises 204 References 207 ULATOIfW FKAMEWOIRK - AIM ATTEMPT T1 EVE UNDF [rlmity 9 Financial reporting - evolution of global standards 211 9.1 Introduction 211 9.2 Why do we need financial reporting standards? 21 I 9.3 Why do we need standards to be mandatory? 212 9.4 Arguments in support of standards 213 9.5 Arguments against standards 214 9.6 Standard setting and enforcement in the UK under the Financial Reporting Council (FRC) 214 9.7 The Accounting Standards Board (ASB) 215 9.8 The Financial Reporting Review Panel (FRRP) 216 9.9 Standard setting and enforcement in the US 217 9.10 Why have there been differences in financial reporting? 219 9.11 Efforts to standardise financial reports 223 9.12 What is the impact of changing to IFRS? 226 9.13 Progress towards adoption by the USA of international standards 227 9.14 Advantages and disadvantages of global standards for publicly accountable entities 228 9.15 How do reporting requirements differ for non-publicly accountable entities? 229 9.16 Does the need for standards and effective enforcement still exist in the 21 st century? 233 9.17 Move towards a conceptual framework 233 Summary 234 Review questions 234 Exercises 235 References 236 10 Concepts - evolution of a global conceptual framework 238 10.1 Introduction 238 10.2 Historical overview of the evolution of financial accounting theory 239 10.3 FASB Concepts Statements 243 10.4 IASC Framework for the Presentation and Preparation of Financial Statements 246 10.5 ASB Statement of Principles 1999 247 10.6 Conceptual framework developments 255 Summary 257 Review questions 259

Full contents xi Exercises 259 References 261 I I Ethical behaviour and implications for accountants 262 I I. I Introduction 262 I 1.2 The meaning of ethical behaviour 262 11.3 The accounting standard setting process and ethics 263 11.4 The IFAC Code of Ethics for Professional Accountants 264 I 1.5 Implications of ethical values for the principles versus rules-based approaches to accounting standards 267 I 1.6 Ethics in the accountants' work environment research report 270 I 1.7 Implications of unethical behaviour for stakeholders using the financial reports 271 11.8 The increasing role of whistle blowing 276 11.9 The role of financial reporting authorities 278 11.10 Why should students learn ethics? 280 Summary 282 Review questions 282 Exercises 284 References 286 Part 4 STATEMENT F FGMANC1AL POSITION - EQUBTY, LIAHQUTY AND ASSET MEASUREMENT AND DISCLOSURE ' 289 12 Share capital, distributable profits and reduction of capital 291 12.1 Introduction 291 12.2 Common themes : 291 12.3 Total owners' equity: an overview 292 12.4 Total shareholders' funds: more detailed explanation 293 12.5 Accounting entries on issue of shares 296 12.6 Creditor protection: capital maintenance concept 297 12.7 Creditor protection: why capital maintenance rules are necessary 298 12.8 Creditor protection: how to quantify the amounts available to meet creditors' claim 298 12.9 Issued share capital: minimum share capital 299 12.10 Distributable profits: general considerations 299 12.1 I Distributable profits: how to arrive at the amount using relevant accounts 301 12.12 When may capital be reduced? 301 12.13 Writing off part of capital which has already been lost and is not represented by assets 302 12.14 Repayment of part of paid-in capital to shareholders or cancellation of unpaid share capital 307 12.15 Purchase of own shares 308 Summary 311 Review questions 311 Exercises 31 I References 316

xii Full contents 13 Liabilities 317 13.1 Introduction 317 13.2 Provisions - their impact on the statement of financial position 318 13.3 ED IAS 37 Non-financial liabilities 326 13.4 ED/2010/1 Measurement of Liabilities in IAS 37 333 Summary 333 Review questions 334 Exercises 335 References 338 14 Financial instruments 339 14.1 Introduction 339 14.2 Financial instruments -the lasb's problem child 339 14.3 IAS 32 Financial Instruments: Disclosure and Presentation 340 14.4 IAS 39 Financial Instruments: Recognition and Measurement 348 14.5 IFRS 7 Financial Statement Disclosures 358 14.6 Financial instruments developments 362 Summary 365 Review questions 366 Exercises 366 References 373 15 Employee benefits 374 15.1 Introduction 374 15.2 Greater employee interest in pensions 375 15.3 Financial reporting implications 375 15.4 Types of scheme 375 15.5 Defined contribution pension schemes 378 15.6 Defined benefit pension schemes 378 15.7 I AS 19 (revised) Employee Benefits 379 15.8 The liability for pension and other post-retirement costs 379 15.9 The statement of comprehensive income 382 15.10 Comprehensive illustration 382 15.11 Plan curtailments and settlements 385 15.12 Multi-employer plans 385 15.13 Disclosures 386 15.14 Other long-service benefits. 386 15.15 Short-term benefits 387 15.16 Termination benefits 388 15.17 Exposure draft of amendments to IAS 19 388 15.18 IFRS 2 Share-Based Payment 389 15.19 Scope of IFRS 2 390 15.20 Recognition and measurement 391 15.21 Equity-settled share-based payments 391 15.22 Cash-settled share-based payments 394 15.23 Transactions which may be settled in cash or shares 395 15.24 IAS 26 Accounting and Reporting by Retirement Benefit Plans 395 Summary 398 Review questions 399 Exercises 399 References 405

Full contents xiii 16 Taxation in company accounts 406 16.1 Introduction 406 16.2 Corporation tax 406 16.3 Corporation tax systems - the theoretical background 407 16.4 Corporation tax systems - avoidance and evasion 408 16.5 Corporation tax - the system from 6 April 1999 41 I 16.6 IFRS and taxation 412 16.7 IAS 12 - accounting for current taxation 413 16.8 Deferred tax 415 16.9 FRS 19 (the UKltandard on deferred taxation) 423 16.10 A critique of deferred taxation 424 16.1 I Examples of companies following IAS 12 427 16.12 Value added tax (VAT) 427 Summary 429 Review questions 429 Exercises 430 References 432 17 Property, plant and equipment (PPE) 434 17.1 Introduction 434 17.2 PPE - concepts and the relevant lass and IFRSs 434 17.3 What is PPE? (IAS 16) 435 17.4 How is the cost of PPE determined? 436 17.5 What is depreciation? 438 17.6 What are the constituents in the depreciation formula? 441 17.7 How is the useful life of an asset determined? 441 17.8 Residual value 442 17.9 Calculation of depreciation 442 17.10 Measurement subsequent to initial recognition 447 17.11 IAS 36 Impairment of Assets 449 17.12 IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations 454 17.13 Disclosure requirements 455 17.14 Government grants towards the cost of PPE (IAS 20) 456 17.15 Investment properties 458 17.16 Effect of accounting policy for PPE on the interpretation of the financial statements 459 Summary 461 Review questions 462 Exercises 462 References 471 18 Leasing 472 18.1 Introduction 472 18.2 Background to leasing 472 18.3 Why was the IAS 17 approach so controversial? 474 18.4 IAS 17 - classification of a lease ' 475 18.5 Accounting requirements for operating leases 476 18.6 Accounting requirements for finance leases 477 18.7 Example allocating the finance charge using the sum of the digits method 478

xiv Full contents 18.8 Accounting for the lease of land and buildings 482 18.9 Leasing - a form of off balance sheet financing 483 18.10 Accounting for leases - a new approach 484 18.11 Accounting for leases by lessors 487 Summary 488 Review questions 488 Exercises 489 References 492 19 R&D; goodwill; intangible assets and brands 493 19.1 Introduction 493 19.2 Accounting treatment for research and development 493 19.3 Research and development (IAS 38) 493 19.4 Why is research expenditure not capitalised? 494 19.5 Capitalising development costs 495 19.6 The judgements to be made when deciding whether to capitalise development costs 496 19.7 Disclosure of R&D 497 19.8 IFRS for SMEs 498 19.9 Goodwill 498 19.10 The accounting treatment of goodwill 499 19.11 Critical comment on the various methods that have been used to account for goodwill 500 19.12 Negative goodwill 502 19.13 Intangible assets 503 19.14 Brand accounting 506 19.15 Justifications for reporting all brands as assets 507 19.16 Accounting for acquired brands 509 19.17 Emissions trading 510 19.18 Intellectual property 512 19.19 Review of implementation of IFRS 3 514 Summary 516 Review questions 517 Exercises 519 References 527 20 Inventories 529 20.1 Introduction 529 20.2 Inventory defined 529 20.3 The controversy 530 20.4 IAS 2 Inventories 531 20.5 Inventory valuation 532 20.6 Work-in-progress 538 20.7 Inventory control 540 20.8 Creative accounting 541 20.9 Audit of the year-end physical inventory count 543 20.10 Published accounts. 545 20.1 I Agricultural activity 546 Summary 549 Review questions 550

Full contents xv Exercises 551 References 555 21 Construction contracts 556 21.1 Introduction 556 21.2 The need to replace IAS 11 Construction Contracts 556 21.3 Identification of contract revenue 558 21.4 Identification of contract costs 558 21.5 Proposed new accounting rules 560 21.6 Approach when a contract can be separated into components 561 21.7 Accounting for a contract 561 21.8 Illustrated - profitable contract using step approach 562 21.9 Illustrated - loss-making contract using step approach 565 21.10 Developments in accounting for revenue 566 21.11 Public-private partnerships (PPPs) 567 Summary 573 Review questions 574 Exercises 575 References 581 solbdated ACCOUNTS SS3 22 Accounting for groups at the date of acquisition 585 22.1 Introduction 585 22.2 The definition of a group 585 22.3 Consolidated accounts and some reasons for their preparation 585 22.4 The definition of control 587 22.5 Alternative methods of preparing consolidated accounts 588 22.6 The treatment of positive goodwill 590 22.7. The treatment of negative goodwill 590 22.8 The comparison between an acquisition by cash and an exchange of shares 591 22.9 Non-controlling interests 591 22.10 The treatment of differences between a subsidiary's fair value and book value 594 22.11 How to calculate fair values 595 22.12 IFRS 10 - summary of significant revisions 596 Summary 597 Review questions 597 Exercises 598 References, 604 23 Preparation of consolidated statements of financial position after the date of acquisition 605 23.1 Introduction 605 23.2 Pre- and post-acquisition profits/losses 605 23.3 Inter-company balances 608 23.4 Unrealised profit on inter-company sales 609 23.5 Provision for unrealised profit affecting a non-controlling interest 614

xvi Full contents 23.6 Uniform accounting policies and reporting dates 614 23.7 How is the investment in subsidiaries reported in the parent's own statement of financial position? 615 Summary 615 Review questions 615 Exercises 615 References 619 24 Preparation of consolidated statements of comprehensive income, changes in equity and cash flows 620 24.1 Introduction 620 24.2 Preparation of a consolidated statement of comprehensive income - the Ante Group 620 24.3 The statement of changes in equity (SOCE) 623 24.4 Other consolidation adjustments 623 24.5 Dividends or interest paid by the subsidiary out of pre-acquisition profits 624 24.6 A subsidiary acquired part of the way through the year 625 24.7 Published format statement of comprehensive income 627 24.8 Consolidated statements of cash flows 628 Summary, 629 Review questions 630 Exercises 630 References 639 25 Accounting for associates and joint ventures 640 25.1 Introduction 640 25.2 Definitions of associates and of significant influence 640 25.3 The treatment of associated companies in consolidated accounts 641 25.4 The Brill Group - the equity method illustrated 641 25.5 The treatment of provisions for unrealised profits. 643 25.6 The acquisition of an associate part-way through the year 643 25.7 Joint arrangements 645 Summary 647 Review questions 648 Exercises 648 References, 659 26 Accounting for the effects of changes in foreign exchange rates under IAS 21 660 26.1 Introduction 660 26.2 The difference between conversion and translation and the definition of a foreign currency transaction 660 26.3 The functional currency 661 26.4 The presentation currency 661 26.5 Monetary and non-monetary items 661 26.6 The rules on the recording of foreign currency transactions carried out directly by the reporting entity 662 26.7 The treatment of exchange differences on foreign currency transactions 662

Full contents xvii 26.8 Foreign exchange transactions in the individual accounts of companies illustrated Boil pic 662 26.9 The translation of the accounts of foreign operations where the functional currency is the same as that of the parent 664 26.10 The use of a presentation currency other than the functional currency 664 26.11 Granby Ltd illustration 665 26.12 Granby Ltd illustration continued 666 26.13 Implications of IAS 21 669 26.14 Critique of use of presentation currency 669 Summary 670 Review questions 670 Exercises 670 References 675 27 Earnings per share 679 27.1 Introduction 679 27.2 Why is the earnings per share figure important? 679 27.3 How is the EPS figure calculated? 680 27.4 The use to shareholders of the EPS 681 27.5 Illustration of the basic EPS calculation 682 27.6 Adjusting the number of shares used in the basic EPS calculation 683 27.7 Rights issues 685 27.8 Adjusting the earnings and number of shares used in the diluted EPS calculation 690 27.9 Procedure where there are several potential dilutions 692 27.10 Exercise of conversion rights during financial year 694 27.1 I Disclosure requirements of IAS 33 694 27.12 The Improvement Project 697 27.13 Convergence project 697 Summary 697 Review questions 698 Exercises 699 References 705 28 Review of financial ratio analysis 706 28.1 Introduction 706 28.2 Initial impressions 706 28.3 What are accounting ratios? 708 28.4 Revision of key ratios 708 28.5 Key ratios for JD Wetherspoon 710 28.6 Comment on the current ratio 713 28.7 Interpreting the key ratios-jd Wetherspoon 714 28.8 Description of subsidiary ratios ' 715 28.9 Limitations of ratio analysis 726 28.10 Earnings before interest, tax, depreciation and amortisation (EBITDA) used for management control purposes 729

Jtvii; Full contents Summary 730 Review questions 731 Exercises 732 References 739 29 Analytical analysis - selective use of ratios 740 29.1 Introduction 740 29.2 Improvement of information for shareholders 740 29.3 Disclosure of risks and focus on relevant ratios 742 29.4 Shariah compliant companies - why ratios are important 749 29.5 Ratios set by lenders in debt covenants 751 29.6 Predicting corporate failure 753 29.7 Performance related remuneration - shareholder returns 759 29.8 Valuing shares of an unquoted company - quantitative process 764 29.9 Professional risk assessors 768 Summary 770 Review questions 771 Exercises 772 References 784 30 An introduction to financial reporting on the Internet. 786 30.1 Introduction 786 30.2 The reason for the development of a business reporting language 786 30.3 Reports and the flow of information pre-xbrl 787 30.4 What are HTML, XML and XBRL? 788 30.5 Reports and the flow of information post-xbrl 789 30.6 XBRL and the IASB 790 30.7 Why should companies adopt XBRL? 790 30.8 What is needed to use XBRL for outputting information? 791 30.9 What is needed when receiving XBRL output information? 793 30.10 Progress of XBRL development for internal accounting 798 30.11 Further study 798 Summary. 799 Review questions 799 Exercises 800 References 800 Bibliography, 801 31 Corporate governance 805 31.1 Introduction 805 31.2 The concept 805 31.3 Corporate governance effect on corporate behaviour 806 31.4 Pressures on good governance behaviour vary over time 807 31.5 Types of past unethical behaviour 808 31.6 Different jurisdictions have different governance priorities 808 31.7 The effect on capital markets of good corporate governance 809 31.8 The role of accounting in corporate governance 810

Full contents «xix 31.9 External audits in corporate governance 812 31.10 Corporate governance in relation to the board of directors 816 31.11 Executive remuneration 817 31.12 Market forces and corporate governance 820 31.13 Risk management 821 31.14 Corporate governance, legislation and codes 823 31.15 Corporate governance - the UK experience 825 Summary 836 Review questions 836 Exercises 838 References 840 32 Sustainability - environmental and social reporting 842 32.1 Introduction 842 32.2 How financial reporting has evolved to embrace sustainability reporting 842 32.3 The Triple Bottom Line (TBL) 843 32.4 The Connected Reporting Framework 844 32.5 IFAC Sustainability Framework 846 32.6 The accountant's role in a capitalist industrial society 847 32.7 The accountant's changing role 848 32.8 Sustainability - environmental reporting 848 32.9 Environmental information in the annual accounts 849 32.10 Background to companies' reporting practices 849 32.11 European Commission's recommendations for disclosures in annual accounts 850 32.12 Evolution of stand-alone environmental reports 852 32.13 International charters and guidelines 854 32.14 Self-regulation schemes 855 32.15 Economic consequences of environmental reporting 857 32.16 Summary on environmental reporting 858 32.17 Environmental auditing: international initiatives 858 32.18 The activities involved in an environmental audit 859 32.19 Concept of social accounting 860 32.20 Background to social accounting 862 32.21 Corporate social responsibility reporting 864 32.22 Need for comparative data. 864 32.23 International initiatives towards Triple Bottom Line reporting 866 Summary 869 Review questions 869 Exercises 870 References 876 Bibliography 877 Index 879