All F7 (FR) Technical Articles: (Association of Chartered Certified Accountants)

ALL F7 (FR) TECHNICAL ARTICLES
(2021)
(Association of Chartered Certified Accountants)
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Financial Reporting (FR) was previously known as F7 Financial

Reporting. All technical articles listed as F7 can be used for studying FR.
Financial Reporting (FR)
Study support videos
Exam technique
Financial Reporting (FR)
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Accounting for goodwill
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Accounting for goodwill is a key part of business combinations and is therefore regularly examined
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as part of the FR exam.
Watch your step
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The preparation of consolidated fnancial statements can be an area where candidates either
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perform very well or make simple mistakes, which could prove costly in the exam. This article looks
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at the most common errors made.
Extreme makeover – IASB edition
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The International Accounting Standards Board has now published a new version of the Conceptual
Framework, and this article considers some of the more signifcant changes to the Conceptual
Framework that the Board has made.
Financial instruments
International Financial Reporting Standard (IFRS®) 9, Financial Instruments, is a complex standard,
especially for users and preparers of fnancial statements. It is relevant to the Financial
Reporting syllabus, so this article takes a high-level review of its application to fnancial assets,
fnancial liabilities, and convertibles.
The use of fair values in the goodwill calculation

A central part of the Financial Reporting syllabus is accounting for the acquisition of a subsidiary,
which will test the concept of fair value; this is the value that the consideration paid for the
subsidiary must be recorded. In addition to this, the assets, liabilities and contingent liabilities of the
subsidiary must also be consolidated at their fair value. This article considers these values in each
element of the calculation.
Analysing a statement of cash fows

A key part of the Financial Reporting exam is the ability to analyse a set of fnancial statements.
The statement of cash fows is one of the primary fnancial statements, and Financial
Reporting candidates must be able to explain the performance of an entity based on all of the
fnancial statements including the cash fows given.
IAS 37 – Provisions, contingent liabilities and contingent assets

This article considers the aims of the IAS® 37, followed by the key specifc criteria which must be
met for a provision to be recognised. Finally, it will examine some specifc issues which are often
assessed in relation to the standard.
Tell me a story
This article looks at what the Financial Reporting exam is looking for in the answer to an
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interpretation question, along with the key weaknesses that are consistently noted in candidate
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answers. It then examines some of the different types of scenario that candidates might face in the
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exam, and some key recommendations of items to consider for each.
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How to improve your answer to FR interpretation exam questions
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This article contains useful advice to help improve your answers to analysis questions whether in
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the context of a group or a single entity.
IFRS 16, Leases
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The purpose of this article is to summarise the key changes introduced by IFRS 16 from the
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perspective of the lessee and how these impact on the Financial Reporting exam.
Revenue revisited
This article considers the application of IFRS 15, Revenue from Contracts with Customers using the
fve-step model.
Accounting for property, plant and equipment

This article is designed to outline the key areas of IAS 16, Property, Plant and Equipment that you
may be required to attempt in the Financial Reporting exam.
Performance appraisal
Performance appraisal requires good interpretation and a good understanding of what the
information means in the context of the question.
Impairment of goodwill
This article discusses and shows both ways of measuring goodwill following the acquisition of a
subsidiary, and how each measurement of goodwill is subject to an impairment review.
Deferred tax
This article starts by considering aspects of deferred tax that are relevant to Financial Reporting,
before moving on to the more complicated situations that may be tested in Strategic Business
Reporting.
Property, plant and equipment – part 1: Measurement and depreciation

In the frst of two articles, we look at the main features of IAS 16, Property, Plant and Equipment
(PPE).
Property, plant and equipment – part 2: Revaluation and derecognition

In the second of two articles, we consider revaluation of property, plant and equipment and its
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derecognition.
Suspense accounts and error correction
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Suspense accounts and error correction are popular topics for examiners because they test
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understanding of bookkeeping principles so well.
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Accounting for goodwill | ACCA Global
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Accounting for goodwill is a key part of business combinations and is therefore regularly examined
as part of the Financial Reporting (FR) exam. Goodwill arises when one entity (the parent company)
gains control over another entity (the subsidiary company) and is recognised as an asset in the
consolidated statement of fnancial position. Under IFRS 3, Business Combinations, this is
classifed as an intangible asset with an indefnite life, which means it is subject to an annual
impairment review and not annual amortisation.
The calculation of goodwill is as follows:
Consideration paid X
Add: Non-controlling interest at acquisition X
Less: Net assets at acquisition (X)
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Goodwill at acquisition X
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Less: Impairment to date (X)
Goodwill at reporting date

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In the FR exam, this can be worth many marks and contain many forms of adjustment. Each of
these lines will be looked at in turn for the major elements which need to be included.
1. Consideration paid
The consideration paid for a subsidiary can take many forms. The common situations arising in the
FR exam are that the parent pays for the subsidiary in cash immediately, in cash payable in the
future (deferred consideration), in cash payable in the future but where that payment is dependent
on certain events (contingent consideration), or through an issue of its own shares to the original
shareholders of the subsidiary. In addition to this, candidates will need to know the correct
treatment for professional fees incurred as part of the acquisition.
Cash consideration
This is the simplest amount of consideration and represents the cash already paid by the parent as
part of the acquisition. You will be told this and it will usually be included in the ‘investments’ line of
the parent’s statement of fnancial position and simply needs to be moved into the goodwill
calculation.
Deferred consideration
This is cash payable in the future and needs to be recognised initially at present value. For the FR
exam, if the amount is payable in one year, the candidate will be given a discount rate (%) and be
asked to calculate this. If the amount is payable in more than one year, the candidate will be given a
discount factor as a decimal. The key is to initially recognise the amount payable at present value in
goodwill and as a liability.
As time elapses, the discount on the liability must be unwound as the payable date approaches.
The unwinding of the discount on the liability is done by increasing the liability and recording a
fnance cost. A key thing to note here is that goodwill is unaffected, as goodwill is only calculated at
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the date control is gained.
EXAMPLE 1
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Laldi Co acquired control of Bidle Co on 31 March 20X6, Laldi Co’s year end. The purchase
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consideration included $200,000 payable on 31 March 20X7. An appropriate discount rate for use is
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6%.
Required:
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Calculate the amount of deferred consideration to be recognised at 31 March 20X6 and
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explain how the unwinding of any discount should be accounted for.
Answer
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The goodwill calculation would include deferred consideration of $188,679 being $200,000 x
1/1.061. This would also be included in the consolidated statement of fnancial position at 31 March
20X6 as a current liability.
In the year ended 31 March 20X7, this discount of $11,321 ($188,679 x 6%) would then be
unwound and recorded as a fnance cost in the statement of proft or loss. The full liability of
$200,000 would be settled on 31 March 20X7, consisting of the $188,679 originally recognised plus
the $11,321 of fnance costs.
Contingent consideration
In the FR exam, this will take the form of a future cash amount payable dependent on a set of
circumstances. In accordance with IFRS 3, this must be recognised initially at fair value (which will
be given in the exam). This fair value is added to the consideration as part of the goodwill
calculation and recognised as a provision in liabilities in the consolidated statement of fnancial
position.
Any subsequent movement in the potential amount payable is treated like a movement in a
provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Any increase or
decrease in the amount payable is refected in the liability and recorded in the parent’s statement of
proft or loss. Again, it is key to note that the initial calculation of goodwill is unaffected as this is
calculated on the date control is gained.
Share consideration
This is a tricky calculation but is common in the FR exam. It is likely that this amount will not yet
have been recorded, testing the candidate’s knowledge of how the transaction is to be recorded. To
do this, a candidate needs to work out how many shares the parent company has issued to the
previous shareholders (owners) of the subsidiary as part of the acquisition. To work out the value
given to the previous owners, the number of shares issued is multiplied by the parent’s share
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price at the date of acquisition. This full amount is then added to the consideration paid total. The
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amount then also needs to be added to the parent’s share capital and other components of equity
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(share premium) to refect the shares issued (see Example 3 later in the article).
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Acquisition costs
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All acquisition costs, such as professional fees (legal fees, accountant fees etc), must be expensed
in the statement of proft or loss and not included in the calculation of goodwill. Often in the FR
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exam this will have been recorded incorrectly, perhaps included in the statement of fnancial
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position as part of the cost of investments, and you need to make a correcting adjustment.
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2. Non-controlling interest
Under IFRS 3, the parent can choose to measure any non-controlling interest at either fair value or
the proportionate share of net assets.
There are two potential ways that the fair value method will arise in the FR exam. The fair value of
the non-controlling interest at acquisition may be directly given to candidates, or they may have to
calculate the fair value by reference to the subsidiary’s share price. To do this, the candidate will
simply have to multiply the number of shares held by the non-controlling interest by the subsidiary’s
share price at the date of acquisition.
Under the proportionate share of net assets method, the value of the non-controlling interest is
simpler to calculate. This is done by calculating the net assets of the subsidiary at acquisition and
multiplying this by the percentage owned by the non-controlling interest.
Under the fair value method, the non-controlling interest at acquisition will be higher, meaning that
the goodwill fgure is higher. This is because including the non-controlling interest at fair value
incorporates an element of goodwill attributable to them. Under this method the goodwill fgure
therefore includes elements of goodwill from both the parent and the non-controlling interest.
Including the non-controlling interest at the proportionate share of the net assets is really refecting
the lowest possible amount that can be attributed to the non-controlling interest. This method shows
how much they would be due if the subsidiary company were to be closed down and all the assets
sold off, incorporating no goodwill in relation to the non-controlling interest. Under the proportionate
method, the goodwill fgure is therefore smaller as it only includes the goodwill attributable to the
parent.
3. Net assets at acquisition
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At the date of acquisition, the parent company must recognise the assets and liabilities of the
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subsidiary at fair value. This can lead to a number of potential adjustments to the subsidiary’s
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assets and liabilities.
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The most common situations in the FR exam are outlined below:
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• Tangible non-current assets – These will be held at carrying amount in the subsidiary’s
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fnancial statements but will need to remeasured to fair value in the consolidated statement of
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fnancial position. This will result in an increase to property, plant and equipment. Instead of
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recording a revaluation surplus, it will actually result in a decrease to goodwill (being the
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difference between the consideration paid and the net assets acquired in the subsidiary).
• Intangible assets – The subsidiary may have internally generated intangible assets, such as
an internally generated brand, which do not meet the recognition criteria of IAS 38 Intangible
Assets. While these cannot be capitalised in the subsidiary’s individual fnancial statements,
they must be recognised in the consolidated statement of fnancial position. This will result in an
increase in intangible assets with a corresponding decrease in goodwill.
• Inventory – The subsidiary must hold any inventory at the lower of cost and net realisable
value, but this must be refected in the consolidated statement of fnancial position at fair value.
This will result in an increase to inventory and a decrease in goodwill.
• Contingent liabilities – These will simply be disclosure notes in the fnancial statements of the
subsidiary, relating to potential future liabilities that do not have a probable outfow of resources
embodying economic benefts. In the consolidated statement of fnancial position these must be
recognised as liabilities at fair value if there is a present obligation and it can be reliably
measured. This will increase liabilities in the consolidated statement of fnancial position and
actually increase goodwill (as the net assets of the subsidiary at acquisition will be reduced).
4. Impairment of goodwill
The fnal element to consider is the impairment of goodwill. Impairment arises after the acquisition
and refects some form of decline in the expected beneft to be derived from the subsidiary. As
mentioned earlier, there is no amortisation of this fgure, so the parent must assess each year
whether there are indicators that the goodwill is impaired.
There are many indicators of impairment, ranging from loss of customers in the subsidiary to the
departure of key staff or changes in technology. If an entity decides that the goodwill is impaired, it
must be written down to its recoverable amount. Once goodwill is impaired, the impairment cannot
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be reversed.
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The cumulative impairment is always deducted in full from the goodwill fgure in the statement of
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fnancial position. If the non-controlling interest is recorded at fair value, then a percentage of
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impairment will be allocated to them (based on the percentage owned in the subsidiary), with the
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remainder being allocated to the group. If the non-controlling interest is held at the proportionate
method, then the entire impairment is allocated to the group due to the fact that no goodwill has
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been attributed to the non-controlling interest.
EXAMPLE 2
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Fifer Co acquired 80% of the equity shares of Grampian Co on 1 January 20X4 for $5,000,000. The
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fair value of Grampian Co’s net assets at the date of acquisition was $4,000,000.
At 31 December 20X4, Fifer Co has determined that goodwill is impaired by 10%.
Required:
For each of the following scenarios, calculate the value of goodwill at 31 December 20X4 and
explain how the impairment loss would be allocated between the group and non-controlling
interest:
1. Non-controlling interest is valued at its fair value of $1,000,000; and
2. Non-controlling interest is valued as a proportionate share of net assets.
Answer
1. Fair value method
$000
Consideration paid 5,000
Add: Non-controlling interest at acquisition 1,000
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Less: Net assets at acquisition (4,000)
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Goodwill at acquisition 2,000
Less: impairment to date (10% x 2,000)
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Goodwill at 31 December 20X4 1,800
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The fair value method of calculating goodwill incorporates both the goodwill attributable to the group
and to the non-controlling interest. Therefore, any subsequent impairment of goodwill should be
allocated between the group and non-controlling interest based on the percentage ownership.
Non-controlling interest will be allocated $40,000 (20% x $200,000) of the impairment loss and the
group will be allocated $160,000 (80% x $200,000).
2. Proportionate share of net assets method
$000
Consideration paid 5,000
Add: Non-controlling interest at acquisition 800
Less: Net assets at acquisition (4,000)
Less: impairment to date (10% x 1,800) (180)
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Goodwill at 31 December 20X4 1,620
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The proportionate share of net assets method calculates the goodwill attributable to the group only.
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Therefore, any impairment of goodwill should only be attributed to the group and none to the non-
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controlling interest.
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The group will be allocated the full $180,000 of impairment loss.
EXAMPLE 3
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This comprehensive example is an adaptation of a previous consolidation question looking at many
of the elements of goodwill outlined above. This is good practice for how a consolidated statement
of fnancial position question might be asked, with a common format of presenting the answer. This
question contains other adjustments, so it is important that you have read through other learning
materials on group accounting, including associate companies, before attempting it.
On 1 October 20X6, Plateau Co acquired the following non-current investments:
1. Three million equity shares in Savannah Co by an exchange of one share in Plateau Co for
every two shares in Savannah Co, plus $1.25 per acquired Savannah Co share in cash. The
market price of each Plateau Co share at the date of acquisition was $6, and the market price of
each Savannah Co share at the date of acquisition was $3.25. At 1 October 20X6 Savannah Co
had retained earnings of $6 million.
2. Thirty percent of the equity shares of Axle Co at a cost of $7.50 per share in cash. At this date
Axle Co had retained earnings of $11 million.
Only the cash consideration of the above investments has been recorded by Plateau Co. In
addition, $500,000 of professional costs relating to the acquisition of Savannah Co are included
in the cost of the investment.
The summarised draft statements of fnancial position of the three companies at 30 September
20X7 are shown here.
The following information is relevant:
(i) At the date of acquisition, Savannah Co has an unrecognised internally generated brand name.
This was deemed to have a fair value of $1m at 1 October 20X6 and has not suffered any
impairment since acquisition.
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(ii) On 1 October 20X6, Plateau Co sold an item of plant to Savannah Co at its agreed fair value of
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$2.5m. Its carrying amount prior to the sale was $2m. The estimated remaining life of the plant at
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the date of sale was fve years (straight-line depreciation).
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(iii) During the year ended 30 September 20X7, Savannah Co sold goods to Plateau Co for $2.7m.
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Savannah Co had marked up these goods by 50% on cost. Plateau Co had a third of the goods still
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in its inventory at 30 September 20X7. There were no intra-group payables/receivables at 30
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September 20X7.
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(iv) At the date of acquisition, the non-controlling interest in Savannah Co is to be valued at its fair
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value. For this purpose, Savannah Co’s share price at that date can be taken to be indicative of the
fair value of the shareholding of the non-controlling interest. Impairment tests on 30 September
20X7 concluded that neither consolidated goodwill nor the value of the investment in Axle Co had
been impaired.
(v) The fnancial asset investments are included in Plateau Co’s statement of fnancial position
(above) at their fair value on 1 October 20X6, but they have a fair value of $9m at 30 September
20X7.
Required:
Prepare the consolidated statement of fnancial position for Plateau Co
as at 30 September 20X7.
Answer
Consolidated statement of fnancial position of Plateau Co as at 30 September 20X7 (see here).
(w1) Group structure:

Plateau Co – owned 75% of Savannah Co for 1 year
Plateau Co – owned 30% of Axle Co for 1 year
(w2) Net assets of Savannah Co:
SFP Post acq’n

Acquisition date $000
$000 $000
Share capital 4,000 4,000 -
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Retained earnings 6,000 8,900 2,900
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Fair value adjustment 1,000 1,000 -
Excess depreciation (w7)
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PURP on inventories (w8) (300) (300)
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(w3) Goodwill:
$000
Consideration:
- Shares issued (3,000/2 x $6) 9,000
- Cash (3,000 x $1.25) 3,750
Non-controlling interest at acquisition (1m x $3.25) 3,250
Less: Net assets at acquisition (w2) (11,000)
Tutorial note:
The consideration given by Plateau Co for the shares of Savannah Co works out at $4.25 per share
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– ie consideration of $12.75m for 3 million shares. This is higher than the market price of Savannah
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Co’s shares ($3.25) before the acquisition and could be argued to be the premium paid to gain
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control of Savannah Co. This is also why it is (often) appropriate to value the NCI in Savannah Co’s
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shares at $3.25 each, because (by defnition) the NCI does not have control.
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The 1.5 million shares issued by Plateau Co in the share exchange, at a value of $6 each, would be
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recorded as $1 per share as capital and $5 per share as other components of equity (share
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premium), giving an increase in share capital of $1.5m and a share premium of $7.5m.
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(w4) Non-controlling interest:
A $000
Fair value at acquisition (see (w3) 3,250
NCI % x S post acq’n (25% x 2,700 (w2)) 675
3,925
(w5) Retained earnings:
$000
Plateau Co’s retained earnings 25,250
Professional fees (500)
P% x S post acq’n 75% x 2,700 (w2) 2,025
P% x A post acq’n 30% x (5,000 (16,000 – 11,000)) 1,500
Non-current asset PURP (w7)
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Investment gain (9,000 – 6,500)
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30,275
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(w6) Investment in associate:
A $000
Cost (4,000 x 30% x $7.50) 9,000
Share post-acquisition proft (see w5) 1,500
10,500
(w7) Property, plant and equipment

The transfer of the plant creates an initial unrealised proft (URP) of $500,000 being the difference
between the agreed FV ($2.5m) and the carrying amount ($2m). This should be eliminated from
Plateau Co’s retained earnings and from the carrying amount of the plant to restate as if the transfer
had not taken place.
The carrying amount of the plant is reduced by excess depreciation of $100,000 for each year
([$2.5m/ 5years] – [$2m/ 5 years]) in the post-acquisition period. Therefore, the net adjustment in
the carrying amount of property, plant and equipment is $400,000.
The excess depreciation charge should also be eliminated on consolidation and, since it will have
arisen in Savannah Co’s individual accounts, the elimination of the depreciation will have the effect
of increasing Savanah Co’s post-acquisition retained earnings and, consequently, the profts
attributable to the non-controlling interest.
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(w8) Inventory
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The unrealised proft (URP) in inventory intra-group sales are $2.7m on which Savannah Co made
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a proft of $900,000 (2,700 x 50/150). One third of these are still in the inventory of Plateau Co, thus
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there is an unrealised proft of $300,000.
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Tutorial note:
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In this question, there is no goodwill impairment. If there had been an impairment, say of $1 million,
then the full $1 million would have been deducted from goodwill. As the non-controlling interest is
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recorded at fair value, this impairment would have been split between the non-controlling interest
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and the parent based on the percentage owned. Therefore $250,000 (25% of the impairment)
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would be deducted from the non-controlling interest fgure in equity and $750,000 (75% of the
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impairment) would be deducted from retained earnings in equity.
Written by a member of the FR examining team
Watch your step | ACCA Global
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Watch your step
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Home /
Students /
Study resources /
Watch your step
The preparation of consolidated fnancial statements is a key element of the Financial Reporting
(FR) exam. It can be an area where candidates perform extremely well but can also be an area
where candidates make simple mistakes which could prove costly.
This article will not focus on the more technical, diffcult adjustments that can arise within
consolidated fnancial statements but will instead look at the most common errors that candidates
make. These are the items that the FR examining team see repeatedly. Many of these errors are
easy to make in a time-pressured exam. The good news is that they are also quite simple to fx. By
avoiding these errors, candidates will be able to signifcantly improve their mark and their chances
of progressing to the next stage.
This article also looks at equity accounting for associate accounting and is a reminder of how it
differs from consolidation.
Before we look at these errors, we need to remind ourselves of some key principles surrounding the
preparation of consolidated fnancial statements. If candidates are able to keep these key principles
in mind, then hopefully they can avoid some of the most common (and costly) errors that we will
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outline below.
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Key principles in consolidation
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Control – We show control by adding in 100% of the items of the parent and the subsidiary. There
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are no exceptions to this. Even in a mid-year acquisition in the consolidated statement of proft or
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loss (where we time-apportion the results of the subsidiary), we still bring in 100% of the
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subsidiary’s income and expenses but restrict it for the period owned.
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Ownership – We must remember that there are two owners of the group. The parent’s
shareholders own the majority of the group (owning 100% of the parent, and therefore a majority
holding in the subsidiary) and the non-controlling interest. Candidates are very good at
remembering to refect the amounts attributable to the different owners in the consolidated
statement of fnancial position, but are generally quite poor in remembering to do this in the
consolidated statement of proft or loss (see error 2)
So, here are our top fve errors. A candidate that avoids just one of these simple errors could
potentially gain up to four marks in their exam, so they are worth being aware of. We have ranked
these in order of how common they are.
An important thing to note immediately is that the top two errors noted here have big impacts on the
consolidated statement of proft or loss. Of the two types of consolidated fnancial statements
preparation questions, the marks awarded on the consolidated statement of proft or loss are
always lower and the questions less well done. By avoiding errors 1 and 2 here, you could improve
your score on this question by up to 7 marks – this is signifcant in terms of your total FR score. This
is essential and shows the importance of good technique and applying the principles of control and
ownership noted above.
Error 1 – Forgetting to time apportion the consolidated P/L in

mid-year acquisitions
When candidates have previously been asked to prepare a consolidated statement of proft or loss
(CSPL) in an exam, it has often been that the company has acquired the subsidiary during the year.
If this is the case, a fundamental principle of the CSPL is that the income and expenses are only
consolidated from the date of acquisition.
This is easy to overlook but be ready for it. Dates are given in the scenario for a reason and should
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always be considered. A key part of preparing a CSPL is to check the date of acquisition before
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you attempt the question. Be ready for it to have been acquired during the year, as this is the
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case more often than not.
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If it is a mid-year acquisition, instead of adding all of the income and expenses of the parent and
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subsidiary company, you add all of the parent’s income and expenses to the time-apportioned
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income and expenses of the subsidiary. So, if the parent acquired the subsidiary on 1 October
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20X1 and the year-end is 31 December 20X1, you should only include three months of the
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subsidiary’s results.
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This is deemed as a fundamental error. If you fail to do this, you can lose all marks for the basic
principle of consolidating the results of the parent and subsidiary. You will still be able to gain marks
for the adjustments made, but you will lose the simple ‘adding up’ marks for consolidating the
income and expenses of the parent and subsidiary.
Error 2 – Omitting the non-controlling interest (NCI) in the

CSPL
This has become increasingly common, leading to students dropping numerous marks for failing to
apply a core principle in the CSPL. The two major functions of the CSPL are:
1. It shows the total profts made by the group during the year – this is why we add all of the income
and expenses of the parent and the subsidiary (time-apportioned for the subsidiary if necessary
(see error 1); and
2. It shows who each of those profts is attributable to by splitting out the profts attributable to the
owner and the NCI at the bottom of the CSPL.
Generally, students recognise the importance of point (1) above, but increasingly neglect point (2).
This is an essential part of a CSPL and can be worth up to four marks. These marks are gained
through showing the knowledge that proft is split between the two parties, and then identifying
which adjustments impact the NCI.
A frustration noted from the FR examining team is with strong candidates who clearly know how to
process technical adjustments, producing excellent answers but then not including the split of
profts at the bottom of the CSPL. This means that even strong candidates are dropping some of
the more achievable marks available.
Error 3 – One-sided adjustments
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This error could be applied across any question where candidates are preparing fnancial
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statements, and where the principles of double entry are forgotten. In recent years it has been
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noted that fewer candidates make single entries in the preparation of single-entity accounts, but it
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has become an increasing problem in the preparation of the consolidated statement of fnancial
position (CSFP).
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Often, we see candidates calculate the correct fgure for an adjustment and place that adjustment
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into one of the correct places. This means that candidates who understand adjustments can be
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losing up to half of the marks available for that item.
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As a quick guide, here is a reminder of some of the key adjustments where this error occurs and the
candidates should identify the two correct sides to the entry. The side most commonly omitted by
candidates is shown in bold:
• Fair value adjustments – Increase non-current assets, increase subsidiary’s net assets at
acquisition
• Fair value depreciation – Decrease non-current assets, decrease subsidiary’s post
acquisition net assets
• Unrealised profts – Decrease retained earnings of the seller, decrease inventory (or non-
current assets if transfer is a non-current asset)
• Deferred consideration – Add to goodwill as part of consideration, add to liabilities
• Paying for a subsidiary in shares – Add to goodwill as part of consideration, add to the share
capital/share premium of the parent
Error 4 – Time apportioning the assets and liabilities in the

CSFP
The fourth error is the opposite of what we have seen in error 1, and it is less common. It is
essential that students note the difference between a statement of proft or loss and a statement of
fnancial position.
A statement of proft or loss has income and expenses accruing over a period, so requires time-
apportionment of the subsidiary results.
A statement of fnancial position shows the assets and liabilities controlled by the entity at the
reporting date. If the parent has control of the subsidiary at the reporting date, then ALL of the
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assets and liabilities of the subsidiary must be added in. If we consider it logically, it makes no
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sense to time-apportion receivables or cash or other assets. At the year-end, the group control
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100% of these assets and so all of them must be included.
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The golden rule is this – NEVER time-apportion the assets and liabilities in consolidation. The
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only element of time-apportioning would come with any depreciation on a fair value adjustment, but
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you would still add 100% of the assets and liabilities of the subsidiary into the CSFP.
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Error 5 – Proportionate consolidation
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Of all the errors, this is the one that frustrates the FR examining team the most as it seems to
signify a lack of practice of past questions. A few years ago, this error was in dramatic decline,
which was pleasing to see. Sadly, recent diets have shown a resurgence in this error.
A student who applies proportionate consolidation does not include 100% of the assets and
liabilities of a subsidiary in a CSFP, or income and expenses in a CSPL. Instead they only apply the
percentage that the parent owns in the subsidiary. Therefore, if the parent owns 80% in the
subsidiary, these candidates add in 80% of the subsidiary’s assets, liabilities, income or expenses.
This is never a correct way to prepare consolidated fnancial statements and any candidate doing
this is making a severe and fundamental error. Students will never have seen an example of this, as
it is not acceptable practice and so they will lose signifcant marks for doing this.
Equity accounting
It is also important to note that consolidation refers to the accounting required where the parent
company controls another entity (subsidiary). Candidates should not confuse this with equity
accounting which is related to associate companies where signifcant infuence is presumed with a
shareholding between 20-50%. The following is a summary of equity accounting but you should
refer to other learning materials for further detail.
CSPL
Do not consolidate a proportion of income and expenses line by line (common error) but present a
single ‘Share of proft of the associate’ line in the CSPL. This is presented above the consolidated
proft before tax. This is the parent’s share of the associate’s proft for the year (time apportioned if
appropriate).
CSFP
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As for the CSPL, do not consolidate a proportionate share of assets and liabilities line by line
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(common error) but instead include in the CSFP a single ‘Investment in associate’ line under non-
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current assets. This is calculated as follows:
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Cost of associate (may have to calculate) X
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Group % of post-acquisition reserves X/(X)
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Less: group % of impairment losses on associate to date (X)
Less: group % of unrealised proft X
Investment in associate X
Another common error with equity accounting relates to the adjustment for unrealised proft where
trade has occurred between the parent and the associate. The FR examining team have simplifed
the required adjustment, so that it is the same adjustment irrespective of the direction of sale
(parent to associate or associate to parent). The adjustment will always reduce the ‘Share of proft
of the associate (CSPL)’ and reduce the ‘Investment in Associate’ in CSFP. However, a common
error is to calculate and adjust the unrealised proft in the same way as you would for a subsidiary.
Candidates must remember to only adjust for the group % of the unrealised proft.
Summary
In conclusion, the preparation of consolidated fnancial statements is a key area for the Financial
Reporting exam. There are many technical aspects to these questions, and question practice is
crucial. There is no short-cut to scoring a good mark, but there are some key principles to
remember. If you keep these in mind, you will avoid dropping marks on the more basic areas:
• Time-apportion the subsidiary’s income/expenses if mid-year

• Remember to include the NCI in a CSPL
• Ensure you process a double entry for all adjustments
•
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Never time-apportion assets or liabilities
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• Never apply proportionate consolidation
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So, take those tips away and know that you are protected from some of the more costly individual
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errors. Ensure you practice the CSPL, as these questions are commonly less well done. This topic
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is important for both Financial Reporting and Strategic Business Reporting, so it is essential to lock
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in the fundamentals.
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Written by a member of the FR examining team
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Extreme makeover – IASB edition | ACCA Global
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Extreme makeover a – IASB
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edition
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Extreme makeover – IASB edition
A building renovation can be tricky and it can be overwhelming: at the beginning, you defnitely
know that some parts of the building need to be upgraded, but you can often fnd more and more
that needs to be fxed after the renovation begins. Often, the project can take longer than you ever
anticipated, and you change much more of the building than you originally planned.
In March 2018, the International Accounting Standards Board (the Board) fnished its renovation of
The Conceptual Framework for Financial Reporting (the Conceptual Framework). Much like a
renovation and its implications for the existing building, the Board needed to consider that too many
changes to the Conceptual Framework may have knock-on effects to existing International
Financial Reporting Standards (IFRS®). Despite that, the Board has now published a new version
of the Conceptual Framework, and this article considers some of the more signifcant changes to
the Conceptual Framework that the Board has made.
Chapter 1 – The objective of general purpose
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fnancial reporting
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A gentle introduction
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As with any major renovation, all issues, both signifcant and minor, need to be considered. When
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considering the objective of general purpose fnancial reporting, the Board reintroduced the concept
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of ‘stewardship’. This is a relatively minor change and, as many of the respondents to the
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Discussion Paper highlighted, stewardship is not a new concept. The importance of stewardship by
management is inherent within the existing Conceptual Framework and within fnancial reporting, so
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this statement largely reinforces what already exists.
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Chapter 2 – Qualitative characteristics of useful
fnancial information
Originally, the Board had not planned to make any changes to this chapter, however following many
comments made in responses to the Discussion Paper, there have been some.
Leaving the foundations in place

Primarily, the qualitative characteristics remain unchanged. Relevance and faithful representation
remain as the two fundamental qualitative characteristics. The four enhancing qualitative
characteristics continue to be timeliness, understandability, verifability and comparability.
Restoring the original features

Whilst the qualitative characteristics remain unchanged, the Board decided to reinstate explicit
references to prudence and substance over form.
Although these two concepts were removed from the 2010 Conceptual Framework, the Board
concluded that substance over form was not a separate component of faithful representation. The
Board also decided that, if fnancial statements represented a legal form that differed from the
economic substance, then they could not result in a faithful representation.
Whilst that statement is true, the Board felt that the importance of the concept needed to be
reinforced and so a statement has now been included in Chapter 2 that states that faithful
representation provides information about the substance of an economic phenomenon rather than
its legal form.
In the 2010 Conceptual Framework, faithful representation was defned as information that was
complete, neutral and free from error. Prudence was not included in the 2010 version of the
Conceptual Framework because it was considered to be inconsistent with neutrality. However, the
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removal of the term led to confusion and many respondents to the Board’s Discussion Paper urged
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for prudence to be reinstated.
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Therefore, an explicit reference to prudence has now been included in Chapter 2, stating that
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‘prudence is the exercise of caution when making judgements under conditions of uncertainty’.
Is that level?
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As is often the case with a building project, making one minor change may lead to others, and
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everyone wants a building that is level. The problem with adjusting the building blocks here, even
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slightly, was that by adding in the reference to prudence, the Board encountered the further issue of
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asymmetry.
Many standards, such as International Accounting Standard (IAS®) 37, Provisions, Contingent
Liabilities and Contingent Assets, apply a system of asymmetric prudence. In IAS 37, a probable
outfow of economic benefts would be recognised as a provision, whereas a probable infow would
only be shown as a contingent asset and merely disclosed in the fnancial statements. Therefore,
two sides in the same court case could have differing accounting treatments despite the likelihood
of the pay-out being identical for either party. Many respondents highlighted this asymmetric
prudence as necessary under some accounting standards and felt that a discussion of the term was
required. Whilst this is true, the Board believes that the Conceptual Framework should not identify
asymmetric prudence as a necessary characteristic of useful fnancial reporting.
The 2018 Conceptual Framework states that the concept of prudence does not imply a need for
asymmetry, such as the need for more persuasive evidence to support the recognition of assets
than liabilities. It has included a statement that, in fnancial reporting standards, such asymmetry
may sometimes arise as a consequence of requiring the most useful information.
Chapter 3 – Financial statements and the reporting

entity
Building the extension
Since the inception of the Conceptual Framework, the chapter on the reporting entity has been
classifed as ‘to be added’. Finally, this part of the extension has been built, even though it might be
described as an extension built out of practicality, rather than excitement.
This addition relates to the description and boundary of a reporting entity. The Board has proposed
the description of a reporting entity as: an entity that chooses or is required to prepare general
purpose fnancial statements.
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This is a minor terminology change and not one that many examiners could have much enthusiasm
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for. Therefore, it is unlikely to feature in many professional accounting exams!
b a statements
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Chapter 4 – The elements of fnancial
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Not to everyone’s taste
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As part of this project, the Board has changed the defnitions of assets and liabilities. To casual
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observers, it may seem like some of these changes are the decorative equivalent of ‘repainting
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cream walls as magnolia’, but to some accountants it can feel like a seismic change.
The changes to the defnitions of assets and liabilities can be seen below.
2010 defnition 2018 defnition supporting concept
Asset (of an entity) A resource controlled by A present economic

the entity as a result of resource controlled by the
past events and from entity as a result of past
which future economic events.
benefts are expected to
fow to the entity.
Economic resource A right that has the

potential to produce
economic benefts
Liability (of an entity) A present obligation of A present obligation of An entity’s obligation to

the entity arising from the entity to transfer an transfer and economic
past events, the economic resource as a resource must have the
settlement of which is result of past events. potential to require the
expected to result in an entity to transfer an
outfow from the entity of economic resource to
resources embodying another party.
economic benefts.
Obligation A duty of responsibility
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that an entity has no
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practical ability to avoid.
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The Board has therefore changed the defnitions of assets and liabilities. Whilst the concept of
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‘control’ remains for assets and ‘present obligation’ for liabilities, the key change is that the term
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‘expected’ has been replaced. For assets, ‘expected economic benefts’ has been replaced with ‘the
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potential to produce economic benefts’. For liabilities, the ‘expected outfow of economic benefts’
has been replaced with the ‘potential to require the entity to transfer economic resources’.
The reason for this change is that some people interpret the term ‘expected’ to mean that an item
can only be an asset or liability if some minimum threshold were exceeded. As no such
interpretation has been applied by the Board in setting recent IFRS Standards, this defnition has
been altered in an attempt to bring clarity.
The Board has acknowledged that some IFRS Standards do include a probability criterion for
recognising assets and liabilities. For example, IAS 37 Provisions, Contingent Liabilities and
Contingent Assets states that a provision can only be recorded if there is a probable outfow of
economic benefts, while IAS 38 Intangible Assets highlights that for development costs to be
recognised there must be a probability that economic benefts will arise from the development.
The proposed change to the defnition of assets and liabilities will leave these unaffected. The
Board has explained that these standards don’t rely on an argument that items fail to meet the
defnition of an asset or liability. Instead, these standards include probable infows or outfows as a
criterion for recognition. The Board believes that this uncertainty is best dealt with in the
recognition or measurement of items, rather than in the defnition of assets or liabilities.
Chapter 5 – Recognition and derecognition

In terms of recognition, the 2010 Conceptual Framework specifed three recognition criteria which
applied to all assets and liabilities:
• the item needed to meet the defnition of an asset or liability

• it needed to be probable that any future economic beneft associated with the asset or liability
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would fow to or from the entity
•
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the asset or liability needed to have a cost or value that could be measured reliably.
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The Board has confrmed a new approach to recognition, which requires decisions to be made by
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reference to the qualitative characteristics of fnancial information. The Board has confrmed that an
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entity should recognise an asset or a liability (and any related income, expense or changes in
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equity) if such recognition provides users of fnancial statements with:
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relevant information about the asset or the liability and about any income, expense or changes
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in equity
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• a faithful representation of the asset or liability and of any income, expenses or changes in
equity, and
• information that results in benefts exceeding the cost of providing that information
A key change to this is the removal of a ‘probability criterion’. This has been removed as different
fnancial reporting standards apply different criterion; for example, some apply probable, some
virtually certain and some reasonably possible. This also means that it will not specifcally prohibit
the recognition of assets or liabilities with a low probability of an infow or outfow of economic
resources.
This is potentially controversial, and the 2018 Conceptual Framework addresses this specifcally in
chapter 5; paragraph 15 states that ‘an asset or liability can exist even if the probability of an infow
or outfow of economic benefts is low’.
The key point here relates to relevance. If the probability of the event is low, this may not be the
most relevant information. The most relevant information may be about the potential magnitude of
the item, the possible timing and the factors affecting the probability.
Even stating all of this, the Conceptual Framework acknowledges that the most likely location for
items such as this is to be included within the notes to the fnancial statements.
Finally, a major change in chapter 5 relates to derecognition. This is an area not previously
addressed by the Conceptual Framework but the 2018 Conceptual Framework states that
derecognition should aim to represent faithfully both:
(a) the assets and liabilities retained after the transaction or other event that led to the derecognition
(including any asset or liability acquired, incurred or created as part of the transaction or other
event); and
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(b) the change in the entity’s assets and liabilities as a result of that transaction or other event.
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Chapter 6 – Measurement
b a
A new en-suite?
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The 2010 version of the Conceptual Framework did not contain a separate section on measurement
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bases as it was previously felt that this was unnecessary. However, when presented with the
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opportunity of re-drafting the Conceptual Framework, some additions which are helpful and
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practical may be considered, even if we have previously managed without them.
In the 2010 Framework, there were a brief few paragraphs that outlined possible measurement
bases, but this was limited in detail. In the 2018 version, there is an entire section devoted to the
measurement of elements in the fnancial statements.
The frst of the measurement bases discussed is historical cost. The accounting treatment of this is
unchanged, but the Conceptual Framework now explains that the carrying amount of non-fnancial
items held at historical cost should be adjusted over time to refect the usage (in the form of
depreciation or amortisation). Alternatively, the carrying amount can be adjusted to refect that the
historical cost is no longer recoverable (impairment). Financial items held at historical cost should
refect subsequent changes such as interest and payments, following the principle often referred to
as amortised cost.
The 2018 Conceptual Framework also describes three measurements of current value: fair value,
value in use (or fulflment value for liabilities) and current cost.
Fair value continues to be defned as the price in an orderly transaction between market
participants. Value in use (or fulflment value) is defned as an entity-specifc value, and remains as
the present value of the cash fows that an entity expects to derive from the continuing use of an
asset and its ultimate disposal.
Current cost is different from fair value and value in use, as current cost is an entry value. This
looks at the value in which the entity would acquire the asset (or incur the liability) at current market
prices, whereas fair value and value in use are exit values, focusing on the values which will be
gained from the item.
In addition to outlining these measurement bases, the Conceptual Framework discusses these in
the light of the qualitative characteristics of fnancial information. However, it stops short of
recommending the bases under which items should be carried, but gives some guidance in the form
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of examples to show where certain bases may be more relevant.
B o
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Relevance is a key issue here. The 2018 Conceptual Framework discusses that historical cost may
a
not provide relevant information about assets held for a long period of time, and are certainly
b
unlikely to provide relevant information about derivatives. In both cases, it is likely that some
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variation of current value will be used to provide more predictive information to users.
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Conversely, the Conceptual Framework suggests that fair value may not be relevant if items are
held solely for use or to collect contractual cash fows. Alongside this, the Conceptual Framework
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specifcally mentions items used in a combination to generate cash fows by producing goods or
C
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services to customers. As these items are unlikely to be able to be sold separately without
penalising the activities, a cost-based measure is likely to provide more relevant information, as the
cost is compared to the margin made on sales.
Chapter 7 – Presentation and disclosure

On-site discussions
This is a new section, containing the principles relating to how items should be presented and
disclosed.
The frst of these principles is that income and expenses should be included in the statement of
proft or loss unless relevance or faithful representation would be enhanced by including a change
in the current value of an asset or a liability in OCI.
The second of these relates to the recycling of items in OCI into proft or loss. IAS 1 Presentation of
Financial Statements suggests that these should be disclosed as items to be reclassifed into proft
or loss, or not reclassifed.
The wisdom of crowds?

The recycling of OCI is contentious and some commenters argue that all OCI items should be
recycled. Others argue that OCI items should never be recycled, whilst some argue that only some
items should be recycled. Sometimes the best way forward on a project isn’t necessarily to seek the
wisdom of crowds.
The foreman’s call

Luckily, the Board has managed to fnd a middle ground on recycling. The 2018 Conceptual
Framework now contains a statement that income and expenses included in OCI are recycled when
doing so would enhance the relevance or faithful representation of the information. OCI may not be
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recycled if there is no clear basis for identifying the period in which recycling should occur.
B o
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Summary
b a
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To the majority of preparers, these changes to the Conceptual Framework will have little or no
impact on the fnancial statements and they are seen as minor terminology changes which simply
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confrm what is already in existence. However, for ACCA candidates, some of these changes such
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as recognition and measurement are key and can be examined in both the Financial Reporting and
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Strategic Business Reporting exams.
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Written by a member of the Financial Reporting examining team
Financial instruments | ACCA Global
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International Financial Reporting Standard (IFRS®) 9 Financial Instruments is a complex standard,

especially for users and preparers of fnancial statements. It is therefore no surprise that ACCA
candidates also fnd it complex. Indeed, there is a well-known quote from a previous Chair of the
International Accounting Standards Board (the Board) who said: ‘If you understand this [standard],
you haven’t read it properly.’
IFRS 9 is relevant to the Financial Reporting (FR) syllabus, and so this article takes a high-level
review of its application to the following:
1. Financial assets
2. Financial liabilities
3. Convertibles
1. Financial assets
x
There are two types of fnancial asset (equity and debt instruments), which can be further split into
different categories.
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(a) Equity investments
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Equity instruments are likely to be shares that have been purchased in a company, but not enough
to give the investee signifcant infuence (associate), control (subsidiary) or joint control (joint
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venture).
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There are two options here, depending on the intention of the entity. The default category is fair
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value through proft or loss (FVPL).
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Equity instruments: fair value through proft or loss (FVPL)
FVPL is the default treatment for equity investments where transaction costs such as broker fees
are expensed and not capitalised within the initial cost of the asset. Subsequently, the investment is
revalued to fair value at each year end, with the gain or loss being taken to the statement of proft or
loss.
Alternatively, equity instruments can be classifed as fair value through other comprehensive
income (FVOCI). It is important to note that this designation must be made on acquisition and the
equity investments cannot retrospectively be treated as FVPL. This is only an option if the equity
investment is intended to be a long-term investment.
Equity instruments: fair value through other comprehensive income (FVOCI)

Using FVOCI, the alternative treatment, transaction costs can be capitalised as part of the initial
cost of the investment. Similar to FVPL, the instrument would then be revalued to fair value at the
year end. The big difference is where the gain or loss is recorded. In FVOCI, the gain or loss is
recognised within Other Comprehensive Income and held in an investment reserve. In this way it is
similar to the accounting for property, plant and equipment using the revaluation model. However
unlike the treatment for a revaluation surplus, there can be a negative FVOCI reserve.
When the FVOCI instrument is sold, the reserve can be left in equity, or transferred into retained
earnings.
(b) Debt instruments

These are usually bonds or loan notes, or other instruments which are likely to carry interest and a
capital element of repayment. The treatment of the debt instrument depends on the intention of the
entity, and there are three options for categorising debt instruments.
Debt instruments: fair value through other proft or loss (FVPL)
x
The default category is FVPL, but this is rare within ACCA exams and it is much more common to
o
apply one of the two alternative treatments, being amortised cost or FVOCI.
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a
Debt instruments: amortised cost
b
To apply this treatment, the instrument must pass two tests; frst the business model test and
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secondly the contractual cash fow characteristics test.
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• Business model test – the entity must intend to hold the instrument in order to collect the
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interest payments and receive repayment on maturity.
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Contractual cash fow characteristics test – the contractual terms give rise to cash fows
C
•
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which are solely repayments of the interest and principle amount.
In the FR exam, it will only be the frst test which may (or may not) be met, so management must
decide on their intention for holding the debt instrument. This treatment tends to be the most
common in exam scenarios, as it allows the examiner to test the principles of amortised cost
accounting.
The principles of amortised cost accounting require that interest must be recorded on the amount
outstanding. This is relatively straight forward for many instruments. For example, on a $10m 5%
loan, with $10m repayable at the end of a three-year term, interest would simply be recorded as
$500,000 a year.
The issues arise when the balance may be repaid at a premium. For example, the terms of the
$10m loan, issued on 1 January 20X1, may be that the holder receives interest of 5% a year, but
then receives $11m back at the end of the three year term, on 31 December 20X3. This means that
the holder is now earning interest in two different ways. Firstly, they are earning the 5% payment
each year. Secondly, they are earning another $1m interest over three years in the form of
receiving more money back than they invested.
IFRS 9, Financial Instruments, requires that a constant rate of interest is applied to this balance to
better refect the reality of the situation. This rate takes into account both the annual payment and
the premium payable on redemption. In the FR exam, this rate will be provided in the question. The
question will provide information about the effective rate of interest. Let’s say that in this example,
the effective rate of interest is 8.08%. This rate is applied to the outstanding balance each year in
order to calculate the interest earned on the investment, which is the amount to be recorded in
investment income in the statement of proft or loss.
The easiest way to do this is often to use a table showing the movement of the asset.

o x
Balance 1 Jan Interest 8.08% Payment Balance 31 Dec
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$’000 $’000 $’000 $’000
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b
20X1 10,000 808 -500 10,308
20X2 10,308
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833 lo -500 10,641
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20X3 10,641 859 -500 11,000
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The fgures in the interest column would be the amounts recorded as investment income in the
statement of proft or loss each year. This is increasing to refect the fact that the amount owed is
increasing as it gets closer to redemption.
The balance in the fnal column refects the amount owed to the entity at each year end, and shows
how the balance outstanding increases from $10m to $11m over the three year period.
The double entries for the asset in year one would be as follows:
1 January 20X1 – The $10m loan is given to the third party. This reduces the entity’s cash balance,
but creates a long-term receivable of $10m, meaning the entry is Dr Receivable $10m, Cr Cash
$10m.
The interest then accrues over the year at the effective rate of 8.09%. This increases the amount of
the receivable and is recorded in investment income, so the entry is Dr Receivable $808k, Cr
Investment income $808k.
31 December 20X1 – The entity receives a payment of $500,000, being 5% of the original $10m
loaned. This fgure will be the same each year. This reduces the value owed to the entity, so the
entry is Dr Cash $500k, Cr Receivable $500k.
The result of these entries is that the entity has a closing receivable of $10.308m. This will all be
held as a non-current asset, as the amount is not receivable until 31 December 20X3.
This would carry on for the next two years, until the full amount is repaid at 31 December 20X3 with
the entry Dr Cash $11m, Cr Receivable $11m.
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The total interest to be recorded in the statement of proft or loss over the three years is $2.5m,
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being the $808k + $833k + $859k. This $2.5m represents all the interest earned by the entity over
a l
the three years. This consists of the $1.5m annual payments ($500k a year), and the additional $1m
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received (the difference between loaning the $10m and receiving the $11m).
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Debt instruments: fair value through other comprehensive income (FVOCI)
The fnal possible treatment for a debt instrument is to hold it at fair value through other
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comprehensive income (FVOCI). Similar to holding the instrument at amortised cost, two tests must
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be passed in order to hold a debt instrument in this manner.
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Business model test – the entity intends to hold the instrument in order to collect the interest
payments and receive repayment on maturity, but may sell the asset if the possibility of buying
one with a greater return arises.
• Contractual cash fow characteristics test – the contractual terms give rise to cash fows
which are solely repayments of the interest and principle amount.
Again, it is only the frst of these that candidates will need to consider in the FR exam, highlighting
that the choice of category will depend on the intention of management.
If the entity chooses to hold the debt instrument under the FVOCI or FVPL category, they will still
produce the amortised cost table as above, taking the same fgure to investment income. At the
year end, the asset would then be revalued to fair value, with the gain or loss being recorded in
either the statement of proft or loss if classed as FVPL or in other comprehensive income if
classifed as FVOCI.
2. Financial liabilities
In the FR exam, fnancial liabilities will be held at amortised cost. These will be similar to the
treatment shown earlier for assets held under amortised cost. Instead of having investment income
and an asset, there will be a fnance cost and a liability. The major difference in the accounting
treatment relates to the initial treatment upon issue of the fnancial liability. Initially these are
recognised at NET PROCEEDS, being the cash received net of any issue costs.
Therefore if an entity looks to raise $10m of funding, but pays a broker $200,000 for raising the
fnance, the initial double entry is to Dr Cash $9.8m and Cr Liability with the $9.8m. Taking the
$200,000 immediately to the statement of proft or loss is incorrect because this fee must be spread
over the life of the instrument. This is effectively done by applying the effective interest rate to the
outstanding liability, which as we stated earlier will be given to the candidates in the exam.
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Here, the effective interest rate on the liability now incorporates up to three elements. It would
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incorporate the annual interest payable, any premium repayable on redemption, and any issue
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costs. This is shown in the example below.
EXAMPLE
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Oviedo Co issued $10m 5% loan notes on 1 January 20X1, incurring $200,000 issue costs. These
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loan notes are repayable at a premium of $1m on 31 December 20X3, giving them an effective
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interest rate of 8.85%.
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In the above example, the 5% relates to the coupon rate, which is the amount required as an
annual payment each year. This is always based on the face (par) value of the instrument, so
means that $500,000 will be payable annually (being 5% of $10m).
As seen in the earlier example relating to fnancial assets held at amortised cost, the effective
interest rate will be applied to the outstanding balance in each period. Again, a table is the easiest
way to calculate this, as shown below.

Balance 1 January Interest 8.85% Payment Balance 31 December

$’000 $’000 $’000 $’000
20X1 9,800 867 -500 10,167
20X2 10,167 900 -500 10,567
20X3 10,567 933 -500 11,000
The entries in 20X1 will be as follows:
1 January 20X1 – The loan is issued, meaning that Oviedo Co receives $9.8m, being the $10m less
the issue costs. Therefore the entries are Dr Cash $9.8m, Cr Liability $9.8m.
Over the year, interest on the liability is accrued at the effective interest rate of 8.85%, giving the
entry Dr Finance cost $867k, Cr Liability $867k.
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31 December 20X1 – The payment of $500k is made, giving the entry Dr Liability $500k, Cr Cash
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$500k.
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This leaves a closing liability of $10.167m. This will all be sat as a non-current liability, as none of it
b a
will be repayable until 31 December 20X3.
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If we look at the interest column, we will see that the total interest paid is $2.7m ($867k + $900k +
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$933k). This is the total which will be expensed to the statement of proft or loss over the three year
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period. This amount consists of three elements:
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$1.5m in annual payments ($500k a year)
•
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$1m premium repaid (issued $10m loan, but repaid $11m)
$200k issue costs
As we can see, the issue costs have been expensed over three years, rather than being expensed
immediately in 20X1.
3. Convertibles
Convertible instruments are instruments which give the holder the right to either demand repayment
of the principle amount or to write off the debt and instead convert the balance into shares. In the
FR exam, you will only have to deal with convertible instruments from the perspective of the issuer,
being the person who has received the cash.
Convertible instruments present a special challenge, as these could ultimately result in the issue of
shares or the repayment of the loan, but the choice will be in the hand of the holder. As we do not
know whether the holder will choose to receive the cash or convert the instrument into shares, we
must refect an element of both within the fnancial statements. Therefore these are accounted for
initially using split accounting, splitting it into the equity and liability components.
The liability component is the frst thing to calculate. We work this out by calculating the present
value of the payments at the market rate of interest (using the interest on an equivalent bond
without the conversion option). The discount rates required to do this will be given to you in the
exam.
In reality the market rate of interest will be higher than the coupon rate, being the annual amount
payable to the holder of the loan. This is because the holder of the loan is willing to accept a lower
rate of annual interest compared to the market, in exchange for the option to convert the loan into
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shares.
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Once the liability component has been calculated, the equity component is then worked out. This is
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simply a balancing fgure, and represents the difference between the cash received and the liability
b a
component.
EXAMPLE
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Oviedo Co issued $10m 5% convertible loan notes on 1 January 20X1. These will either be repaid
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at par on 31 December 20X3, or converted into shares on that date. Equivalent loan notes without
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the conversion carry an interest rate of 8%. Relevant discount rates are shown below.
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Amount payable in:

A Discount factor at 5% Discount factor at 8%
1 year 0.952 0.926
2 years 0.907 0.857
3 years 0.864 0.794
it is important to note that the 5% discount rates are a red herring . It is the discount rates for the
market rate of interest that are important, i.e. 8%. The only thing we need the 5% for is to work out
the annual payment. As these are $10m 5% loan notes, this simply means that Oviedo Co will need
to make an annual payment of $500k in relation to these.
Therefore we can work out the value that the market would place on these loan notes by looking at
the present value of all the payments, discounted at the market rate of interest. If this is a normal
loan, ignoring the conversion, Oviedo Co would pay $500k in years 20X1 to 20X3, and then make a
fnal repayment of $10m on 31 December 20X3.
As the market rate of interest is 8%, the present value of these payments can be calculated. These
are calculated in the table below.

Year Payment Present value

Discount factor 8%
$’000 $’000
20X1 500 0.926
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463
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20X2 500
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0.857
a 428.5
20X3 10,500
G lo0.794 8,337
C A
C
Total 9,229
A
The present value of all of the payments can be seen as $9.229m. This means that Oviedo Co
received $10m, but the present value of the payments to be made have an initial value of only
$9.229m. As a result, the holders of the loan notes are effectively losing $771k compared to if they
had simply given Oviedo Co a normal loan at the market rate of interest.
This $771k is the amount of interest the holders are willing to lose in order to have the option to
convert the loan into shares. This is taken as the initial value of the equity element.
On 1 January 20X1, the double entry to record the transaction in the records of Oviedo Co are as
follows:
Dr Cash $10m – refecting the full cash received from the issue of the convertibles.
• Cr Liability $9.229m – refecting the present value of the liability on 1 January 20X1
• Cr Equity $0.771m – refecting the value of the equity component.
The equity balance would be held as ‘convertible options’ within other components of equity.
Subsequently, this equity amount remains fxed until conversion, but the liability must be held at
amortised cost. This must be built back up to $10m over the next 3 years, to refect the amount
which the holder would require if they demand repayment rather than conversion of the loan notes.

Balance 1 January Interest 8.85% Payment Balance 31 December

$’000 $’000 $’000 $’000
20X1 9,229 738 -500 9,467
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20X2 9,467 757 -500 9,724
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b
20X3 9,724 776 -500 10,000
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As with the fnancial liability noted earlier, the interest column is taken to the statement of proft or
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loss each year as a fnance cost.
A C
At the end of the three years, Oviedo Co will either repay the $10m liability, or this will be turned
into shares, with the $10m balance and the option balance of $771k transferred to share capital and
share premium.
Summary
This article has considered the key issues relating to fnancial instruments. To perform well at FR, it
is essential that candidates are able to identify the potential treatments for fnancial assets, produce
amortised cost calculations and understand the accounting entries required for a convertible
instrument. This is one of the most technical areas of the syllabus, but also one of the central areas
which will be further developed in Strategic Business Reporting.
The use of fair values in the goodwill calculation | ACCA Global
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The use of fair values
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The use of fair values in the goodwill calculation
For ACCA candidates studying Financial Reporting (FR), consolidated fnancial statements are a
key topic. A central part of this syllabus area is accounting for the acquisition of a subsidiary which
will test the concept of fair value; this is the value that the consideration paid for the subsidiary must
be recorded. In addition to this, the assets, liabilities and contingent liabilities of the subsidiary must
also be consolidated at their fair value. This article considers these values in each element of the
calculation.
1. Fair value of consideration

It makes logical sense that the amount to be paid for the subsidiary must be recorded at its fair
value. Accounting for a payment of cash is simple. However, complexities arise when a parent
company pays for the subsidiary in a number of different ways. For the FR exam, it is vital that
candidates are able to account for each of these.
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(a) Payments in cash
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These are the most straight forward types of consideration to deal with, as the entry is relatively
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simple: Dr goodwill Cr Cash with the amount paid. In an FR exam, this amount is likely to have
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already been recorded in the parent company’s assets as investment in subsidiary. This means that
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candidates may need to deduct the amount of cash paid from investments and include it within the
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goodwill calculation.
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(b) Deferred cash
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In addition to cash paid immediately, there may be an element of deferred cash, being cash
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payable at a later date. For this to be accounted for as deferred cash, there must be no conditions
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attached to the payment, or this becomes contingent consideration (discussed further below). For
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deferred cash, the amount payable needs to be discounted to present value. This refects the time
value of money and represents the amount of money that the parent would have to put aside at the
date of acquisition in order to be able to pay for the subsidiary on the due date. This is then
included within goodwill and liabilities at the date of acquisition, with the entry being Dr goodwill, Cr
liabilities. As this represents the present value of the consideration, this needs to be increased to
the full amount over time. This process is called unwinding the discount. Each year the liability is
increased by the interest rate used in the discounting. This subsequent increase is taken to fnance
costs, making the double entry Dr fnance cost, Cr Liability.
EXAMPLE
Pratt Co acquired 80% of Swann Co on 1 January 20X1. As part of the deal, Pratt Co agreed to pay
the previous owners of Swann Co $10m on 1 January 20X2. Pratt Co has a cost of capital of 10%.
Solution
As Pratt Co gained control of Swann Co on 1 January 20X1, the goodwill needs to be calculated on
this date. As part of this, the $10m is payable in 1 year. The present value of $10m in one year is
$9.091m ($10m x 1/1.10). This is recorded in goodwill, with an equivalent liability set up within
current liabilities, as the amount is payable in 12 months.
By the 31 December 20X1, the amount is now payable in one day. The previous owners of Swann
Co will be contacting Pratt Co in one day requesting the payment of $10m. Therefore Pratt Co is
required to show a liability of $10m in its fnancial statements at this date. Currently, Pratt Co is
showing a liability of $9.091m. Therefore this needs to be increased by 10% (the interest). This
increase of $909k ($9091 x 10%) is added to the liability and recorded as a fnance cost.
It is important to note that this does not affect the goodwill calculation in any way. Goodwill is
calculated at the date of acquisition, and subsequent changes to the consideration payable are not
adjusted in the goodwill calculation.
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(c) Contingent consideration
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Contingent consideration also relates to amounts payable to the previous owners in the future.
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However, the key difference is that the payment of these amounts is conditional upon certain
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events, such as the subsidiary performance hitting certain targets after acquisition.
b a
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Therefore these will be recorded as a provision, as the amount payable is likely to have an element
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of uncertainty (remember that a provision is a liability of uncertain timing or amount). This is where it
is important to tread carefully. While this is recorded as a provision in the fnancial statements, the
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criteria of IAS® 37 Provisions, contingent liabilities and contingent assets does not apply here.
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When we are producing consolidated fnancial statements we must apply the principle of using the
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fair value of consideration, as stated by IFRS® 3, Business Combinations.
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The fair value of the contingent consideration payable will be a mix of the likelihood of the event,
and a refection of the time value of money. However, it is important not to overthink things. They
key here is that the fair value of the contingent consideration will be given to you in the exam. This
needs to be included in the goodwill on the date of acquisition with the double entry Dr goodwill, Cr
provision.
Again, the fair value of the consideration is likely to have changed by the year end. This is treated
as a subsequent movement in the provision, with the subsequent increase or decrease being taken
through the statement of proft or loss. Just like with the deferred consideration, this does not affect
the calculation of goodwill in any way.
EXAMPLE
Pratt Co also commits to paying $10m to Swann Co in two years if the results of Swann Co
continue to grow by 5% over that period. An external valuer has assessed that this is not likely so
estimates the fair value of this to be $4m at 1 January 20X1. At 31 December 20X1, this has
increased and now the valuer assesses the fair value to be $6m.
Solution
Many candidates fall into the trap of stating that this is not likely so no liability should be recorded.
In the individual fnancial statements, this would be true, but when there is a confict between the
treatment in consolidated fnancial statements and the individual fnancial reporting treatment, the
consolidated rules would take priority. So while the outfow may not be probable, IFRS 3 states that
the consideration must be recorded at fair value.
Therefore on 1 January 20X1 the fair value of $4m is added to the consideration in the goodwill
calculation and to provisions as a non-current liability.
At 31 December 20X1, this has increased from $4m to $6m. This increase of $2m is not added to
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goodwill, but is instead expensed to the statement of proft or loss to refect the increase in the
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provision with the double entry Dr P/L, Cr provision. As the amount is now potentially payable in
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one year, this will be moved from non-current liabilities to current liabilities.
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b
(d) Paying in shares
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In addition to the potential cash payments outlined above, the parent company may also decide to
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pay for the subsidiary by giving the subsidiary’s previous owners new shares in the parent
company. The double entry for this is similar to the double entry for a normal share issue.
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The issue of shares at market value usually results in the receipt of cash, the nominal value being
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taken to share capital and the excess being recorded in share premium/other components of equity.
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This is similar to what is happening here, but no cash is changing hands. Instead of the parent
company receiving cash for the shares, they are receiving a subsidiary.
The double entry for this is therefore to debit the full market value to goodwill, credit the share
capital fgure in the consolidated statement of fnancial position with the nominal amount and to take
the excess to share premium/other components of equity, also in the consolidated statement of
fnancial position.
EXAMPLE
Pratt Co acquired 80% of Swann Co’s $5m share capital, which consisted of $1 ordinary shares. As
part of the consideration for Swann Co, Pratt Co gave the previous owners of Swann Co 2 $1
shares in Pratt Co for every 5 shares it acquired in Swann Co. At 1 January 20X1, Pratt Co’s shares
had a market value of $3.50.
Solution
Pratt Co has acquired 80% of Swann Co’s shares, meaning it has acquired 4m shares (80% of the
5m shares in Swann Co). Therefore it issued 1.6m Pratt Co shares, being 4m x 2/5. These 1.6m
shares had a fair value of $5.6m (1.6m x $3.50).
To record this, Pratt Co must add the full fair value of the consideration of $5.6m as part of the
consideration in the calculation of goodwill. $1.6m must be added to share capital in the
consolidated statement of fnancial position, being 1.6m shares x $1 nominal value. This means that
the excess of $4m is added to share premium/other components of equity in the statement of
fnancial position.
2. Fair value of net assets

In addition to recording the consideration paid at fair value, the fair value of the net assets of the
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subsidiary at acquisition must be assessed as part of the consolidation, in order to give an accurate
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picture of the goodwill arising on the acquisition.
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a
If a parent company was to buy an individual asset from the subsidiary, say an item of property, this
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would be done at whatever the market price of the asset is, irrespective of its carrying amount in the
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selling entity’s statement of fnancial position. This same principle is applied to the acquisition of the
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entire entity. Upon selling the entity, the previous owners would base the selling price on the fair
value of the assets, rather than their carrying amounts. Therefore, the consolidated fnancial
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statements must make adjustments to consolidate the subsidiary’s assets and liabilities at fair value
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at the date of acquisition. In the Financial Reporting exam, this could occur in three different ways.
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(a) Fair value adjustments to recognised assets
Assets such as property, plant and equipment, or inventory will be recognised in the subsidiary’s
fnancial statements at their carrying amounts. Adjustments must be made to refect the fair value of
these assets.
For example, inventory must be held in the fnancial statements of the subsidiary at the lower of
cost and net realisable value, but must be recognised in the consolidated fnancial statements at fair
value on acquisition. Similarly, the subsidiary may hold property under the cost model, but this must
be accounted for at fair value in the consolidated fnancial statements.
In terms of depreciable non-current assets, a fair value adjustment is applied at the date of
acquisition, similar to applying the revaluation model under IAS 16, Property, Plant and Equipment.
However, during the consolidation process, a revaluation surplus is not created. The effect of
adding a fair value adjustment to the asset is that the value of goodwill will decrease. This is
because goodwill is the difference between the consideration paid and the identifable net assets of
the entity. Therefore as the fair value adjustment increases the net assets, it produces a lower,
more accurate picture of the actual goodwill in the subsidiary.
As the group must make these fair value adjustments at acquisition, there is also an additional
depreciation adjustment to be made to depreciable assets. The increase to fair value is not
recorded in the subsidiary’s individual fnancial statements but is a consolidation adjustment and so
the additional depreciation is a consolidation adjustment too. This means that the subsidiary’s
depreciation in its fnancial statements is based on the carrying amount of the asset before the fair
value adjustment has been made. As the fair value adjustment increases the value of the asset, the
additional depreciation on this must also be accounted for.
In the statement of proft or loss, this year’s depreciation expense on the fair value adjustment must
be included. In the statement of fnancial position, it is the cumulative depreciation in all the years
since acquisition that must be adjusted. In both cases, the subsidiary’s profts will reduce following
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the adjustment for this fair value depreciation. This means that both the parent’s share and the non-
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controlling interest’s share of the post-acquisition profts will also be affected and must be reduced.
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b
(b) Internally generated assets
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The subsidiary may also have internally generated assets that are unrecognised in its individual
fnancial statements. This is correct, particularly in relation to intangibles, as most are prohibited
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from being capitalised under IAS 38, Intangible Assets. In the consolidated fnancial statements
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these will need to be recognised at fair value if they are identifable, meaning they could either be
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separated from the subsidiary or arise from legal or contractual rights.
A C
This means that items such as internally generated brands or research expenditure could be
capitalised in the consolidated statement of fnancial position, despite not meeting the criteria for
capitalisation per IAS 38, Intangible Assets. Here, we can see again that IFRS 3, Business
Combinations, overrules the ‘usual’ rule for individual accounting treatment.
The process of recording the fair value adjustment will be almost identical to that noted above. The
only difference is that it may lead to the creation of a new intangible asset which is currently
unrecognised. It will still have the effect of increasing non-current assets and reducing goodwill. As
this asset has a limited useful life, it must be amortised over that remaining life. If it is deemed to
have an indefnite life, it will be subject to an annual impairment review.
(c) Contingent liabilities

This is probably the area that most candidates fnd diffcult in the exam. Many candidates have
correctly learned the rule per IAS 37 that contingent liabilities are only disclosed in the notes to the
fnancial statements, and are not recognised in the fnancial statements themselves as a liability.
For individual fnancial statements, this is completely true. For consolidated fnancial statements,
this is not the case. In this case, these need to be included in the consolidated statement of
fnancial position at fair value.
These contingent liabilities must be recognised in the consolidated fnancial statements at their fair
value as they will have affected the price that a parent company is willing to pay for the subsidiary,
This is because the parent company will have offered a lower price for the subsidiary knowing that
the subsidiary may have a potential payout to make in the future, even if they do not deem that to
have a high probability of being paid.
These contingent liabilities need to be consolidated at fair value as a liability at the date of
acquisition. This will reduce the net assets at acquisition, and therefore increase the goodwill. Any
subsequent fair value movements in this contingent liability are recognised in the statement of proft
or loss, rather than affecting the goodwill calculation.
Summary
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As we have seen, both the consideration paid and the net assets of the subsidiary need to be
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included at fair value at the date of acquisition. More often than not, the fair value of items will be
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provided in the Financial Reporting exam, such as the fair value adjustment required to net assets,
or the fair value of contingent consideration. For the calculation of items such as deferred cash or
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an issue of shares, the information will be given which allows candidates to calculate the entries.
CC
The key is to not confuse the rules for accounting for items in a consolidation with the rules for
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individual accounting standards. As we have seen above, the fair value adjustments will overrule
the usual accounting treatment, so this is a vital area to be aware of in order to score well within a
consolidation question. Fair value adjustments are very common in the exam, and candidates
should be able to deal with these adjustments, as it is a core area of accounting for subsidiaries.
Analysing a statement of cash flows | ACCA Qualification | Students | ACCA Global
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Analysing a statementa of cash
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Analysing a statement of cash fows
A key part of the Financial Reporting exam is the ability to analyse a set of fnancial statements.
The statement of cash fows is one of the primary fnancial statements, and Financial
Reporting candidates must be able to explain the performance of an entity based on all of the
fnancial statements including the cash fows given. To do this, candidates must understand the
different sections of the statement and the implications for the business.
One of the frst things to note is to not simply comment on the overall movement in the total cash
and cash equivalents fgure in the year. An increase in this fgure does not necessarily mean that
the entity has performed well in the year. A situation could easily arise where an entity is struggling
to generate cash in a period and is forced to sell its owned premises and rent them back in order to
continue. This may mean that the entity’s overall cash position increases in the period, but is clearly
not a sign that the entity has performed well. This would be a signifcant concern, as the entity
cannot simply sell premises again in the future. There will also be fewer assets owned the entity in
the future, meaning that its ability to secure future borrowing may be limited. Any candidate simply
commenting that the entity has performed well as the overall cash fgure has increased is unlikely to
score any marks, as they have not really understood the reasons behind the movement.
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A good analysis will examine the statement of cash fows in detail and look for the reasons behind
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the movement, commenting on how the entity’s performance is refected here. The statement of
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cash fows contains three sections, namely cash fows from operating activities, investing activities
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and fnancing activities, each of which give us useful information about an entity’s performance.
Operating activities
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The frst key fgure to address is likely to be cash generated from operations. This shows how much
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cash the business can generate from its core activities, before looking at one-off items such as
asset purchases/sales and raising money through debt or equity. The cash generated from
operations fgure is effectively the cash proft from operations. The cash generated from operations
fgure should be compared to the proft from operations to show the quality of the proft.
The closer these two are together, the better the quality of proft. If the proft from operations is
signifcantly larger than the cash generated from operations, it shows that the business is not able
to turn that proft into cash, which could lead to problems with short-term liquidity.
When examining cash generated from operations, examine the movements in working capital which
have led to this fgure. Large increases in receivables and inventories could mean problems for the
cash fow of the business and should be avoided if possible. This could mean that the company has
potential irrecoverable debts, or may be that a large customer has been taken on with increased
payment terms. Either way, the company should have enough cash to pay the payables on time.
Look for large increases in payables. If a company has positive cash generated from operations,
but a signifcant increase in the payables balance compared to everything else, it may be that the
company is delaying paying its suppliers in order to improve its cash fow position at the end of the
year.
The cash generated from operations fgure should be a positive fgure. This ensures that the
business generates enough cash to cover the day to day running of the company. The cash
generated from operations should also be suffcient to cover the interest and tax payments, as the
company should be able to cover these core payments without taking on extra debt, issuing shares
or selling assets.
Any cash left over after paying the tax and interest liabilities is thought of as ‘free cash’, and
attention should be paid as to where this is spent. Ideally, a dividend would be paid out of this free
cash, so that a frm does not have to take out longer sources of fnance to make regular payments
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to its shareholders. Other good ways of using this free cash would be to invest in further non-
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current assets (as this should generate returns into the future) and paying back loans (as this will
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reduce further interest payments).
a l
Investing activities
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This section of the cash fow focuses on the cash fows relating to non-current assets,
C A
For example, sales of assets can be a good thing if those assets are being replaced. However, as
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stated earlier, if a company is selling off its premises and is now renting somewhere, this makes the
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fnancial position signifcantly weaker, and banks will be less willing to lend as there are less assets
to secure a loan against.
The sale of assets should not be used to fnance the operating side of the business or to pay
dividends. This is poor cash management, as a company will not be able to continue selling assets
in order to survive. This is an indication that a company is shrinking and not growing.
Whilst purchases or sales of non-current assets may be relatively irregular transactions, the
presence of interest received, or dividends received may well be recurring cash fows arising from
investments the entity holds.
Financing activities
The sources of fnancing any increases in assets should also be considered. If this can be fnanced
out of operations, then this is the best scenario as it shows the company is generating signifcant
levels of excess cash. Funding these out of long term sources (ie loans or shares) is also fne, as
long-term fnances are sensible to use for long term assets.
However, when raising long term fnance, it is also useful to consider the future consequences. For
example, taking out loans will lead to higher interest charges going forward. This will increase the
level of gearing in the entity, meaning that fnance providers may charge higher interest rates due to
the increased risk. It may also mean that loan providers are reluctant to provide further fnance if the
entity already has signifcant levels of debt.
Raising funds from issuing shares will not lead to interest payments and will not increase the level
of risk associated with the entity. It must also be noted that issuing shares will lead to more
shareholders and possibly higher total dividend payments in the future.
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In summary, a well-rounded answer will absorb all of the information contained within a statement
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of cash fows, using this to produce a thorough discussion of an entity’s performance. Candidates
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who are able to do this should perform well on these tasks, and are more likely to have
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demonstrated a much greater understanding of performance than simply commenting whether the
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overall cash balance has gone up (or down).

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IAS 37 – Provisions, contingent liabilities and contingent assets
For some ACCA candidates, specifc IFRS® standards are more favoured than others. IAS® 37
appears to be less popular than other standards because, usually, answers to Financial Reporting
(FR) questions required a balanced discussion of whether criteria are met, as opposed to
calculating numbers. However, IAS 37 is often a key standard in FR exams, and candidates must
be prepared to wrestle with applying the criteria.
This article will consider the aims of the standard, followed by the key specifc criteria which must be
met for a provision to be recognised. Finally, it will examine some specifc issues which are often
assessed in relation to the standard.
The defnition of a provision is key to the standard. A provision is a liability of uncertain timing or
amount, meaning that there is some question over either how much will be paid or when this will be
paid. In the past, these uncertainties may have been exploited by companies trying to ‘smooth
profts’ in order to achieve the results they believe that their various stakeholder may want.
For example, let’s take a fctional company, Rey Co. At the start of the year, Rey Co sets a proft
o x
target of $10m for the year ended 31 December 20X8. The chief accountant of Rey Co has
reviewed the proft to date and realises they are likely to achieve profts of $13m. The accountant
l B
knows that if Rey Co reports a proft of $13m, directors will not get any more of a bonus than if they
a
reported $10m. He also knows that the proft target will be set at $14m in the next year.
lo b
To avoid this, the accountant may be tempted to make some provisions for some potential future
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expenses of $3m, with the impact of making the proft seem lower in the current period. As the
A
double entry for a provision is to debit an expense and credit the liability, this would potentially
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reduce the proft down to $10m. Then in the next year, the chief accountant could reverse this
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provision, by debiting the liability and crediting the proft or loss. This is effectively an attempt to
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move $3m proft from the current year into the next period.
Clearly this is not good for the users of the fnancial statements, as they would have been
manipulated and given a false impression of the performance of the business. This is where IAS 37
is used to ensure that companies report only those provisions that meet certain criteria.
IAS 37 stipulates the criteria for provisions, contingent liabilities and contingent assets which must
be met in order for a provision to be recognised, so that companies should be prevented from
manipulating profts. According to IAS 37, 3 criteria are required to be met before a provision can be
recognised. These are:
1. There needs to be a present obligation from past event
2. There needs to be a reliable estimate
3. There needs to be a probable outfow
These criteria will now be examined in further detail to see how they can be applied in practice.
1. Present obligation from a past event
This rule has two parts, frst the type of obligation, and second, the requirement for it to come from
a past event (something must have already have happened to create the obligation).
(a) Type of obligation
The obligation could be a legal or contractual one, arising from a court case or some kind of
contractual arrangement. Most candidates are able to spot this in exams, identifying the presence
of a potential obligation of this type.
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The second type of obligation is one called a constructive obligation. This is where a company
B
establishes an expectation through an established course of past practice.
a l
b
Example
G lo
Rey Co has a published environmental policy. In this, Rey Co explains that they always replant
trees to counter-balance the environmental damage created by their operations. Rey Co has a
A
consistent history of honouring this policy. During 20X8, Rey Co opened a new factory, leading to
C
some environmental damage. Rey Co estimate that the damage will cost $400,000 to restore.
A C
Even if the country has no legal regulations forcing Rey Co to replant trees, Rey Co will have a
constructive obligation because it has created an expectation from its publications, practice and
history.
(b) Past event
The obligation needs to have arisen from a past event, rather than simply something which may or
may not arise in the future.
Example
Rey Co would have to provide for a potential legal case arising from an employee who was injured
at work in 20X8 due to faulty equipment. This is because the event arose in 20X8 which could lead
to an obligation.
Rey Co could not provide for any possible claims which may arise from injuries in the future. That is
because there is no past event which has created the obligation. Similarly, if Rey Co has to pay to
install new safety equipment in the factory in 20X9, there is no present obligation to do this in 20X8,
so no provision is required. Rey Co could delay the work until 20X9, or sell the building.
2. Reliable estimate
In an exam, it is unlikely that there will not be a reliable estimate. Likewise it is unlikely that an entity
will be able to avoid recording a liability when there is an obligation by claiming there is no way of
producing an estimate of the amount. The main rule to follow is that if the item is a one-off item, the
best estimate will be the most likely outcome. If the item is made up of a number of items, such as a
warranty provision for repairing goods, the expected value should be calculated using the
probability of all events happening.
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B
Example – best estimate
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b
Rey Co has received legal advice that the most likely outcome of the court case from the employee
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is that they will lose the case and have to pay $10m. The legal team think there is an 80% chance
of this. They believe there is a 10% chance of having to pay $12m, and a 10% chance of paying
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nothing.
C A
In this case, Rey Co would provide $10m, being the most likely outcome. It will not be uncommon to
C
take the $12m, thinking that the worst-case scenario should be provided for. Other candidates may
A
calculate an expected value based on the various probabilities.
Example – expected value
Rey Co gives a year’s warranty with all goods sold during the year. Past experience shows that Rey
Co needs to do no repairs on 85% of the goods. On average, 10% need minor repairs, and 5%
need major repairs. Rey Co’s manufacturing manager has calculated that if minor repairs were
needed on all goods it would cost $100,000, and major repairs on all goods would cost $1m.
Here, the provision would be measured at $60k. The expected cost of minor repairs would be $10k
(10% of $100k) and the expected costs of major repairs is $50k (5% of $1m). This is because there
will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs.
3. Probable outfow
The fnal criteria required is that there needs to be a probable outfow of economic resources. There
is no specifc list of what % likelihood is required for an outfow to be probable. A probable outfow
simply means that it is more likely than not that the entity will have to pay money out.
If it appears that there is a possible outfow then no provision is recorded. In this situation, a
contingent liability would be reported. A contingent liability is simply a disclosure note shown in the
notes to the accounts. There is no double entry recorded in respect of this. Instead, a description of
the event should be given to the users with an estimate of the potential fnancial effect. In addition
to this, the expected timing of when the event should be resolved should also be included.
Similar to the concept of a contingent liability is the concept of a contingent asset. This relates to a
potential infow of economic resources which could come into the entity. Like a contingent liability, a
contingent asset is simply disclosed rather than a double entry being recorded. Again, a description
x
of the event should be recorded in addition to any potential amount related to this. The key
o
difference is that a contingent asset is only recorded if there is a probable future infow, rather than
B
a possible one. The table below shows the treatment for an entity depending on the likelihood of an
l
item happening.
b a
Likelihood
G lo
Outfow of resources Infow of resources
C A (Rey Co has to pay out) (Rey Co may receive income)
Remote
A C Do nothing Do nothing
Possible Contingent liability Do nothing
Probable Provision Contingent asset
Virtually certain Provision Asset
It can be seen here that Rey Co could only recognise an asset from a potential infow if it is virtually
certain. In reality a virtually certain infow is unlikely. For example, in the case of an insurance claim
where Rey Co can show they have cover.
Example – Likelihood
Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case
against the employee and have to pay out $10m. However, it has come to light that Rey Co may
have a counter claim against the manufacturer of the machinery. The legal advisors believe that
there is an 80% chance that the counter claim against the manufacturer is likely to succeed, and
believe that Rey Co would win $8m.
In this case, Rey Co would include a provision for the $10m loss in liabilities. Even though there is a
similar likelihood that Rey Co would win the counterclaim, this is a probably infow and therefore
only a contingent asset can be recorded. This will be disclosed in the notes to the fnancial
statements rather than being recorded as an asset in the statement of fnancial position. Whilst this
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seems inconsistent, this demonstrates the asymmetry of prudence, that losses will be recorded
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earlier than potential gains.
l B
Other issues within provisions
ba
1. The time value of money
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C A
If the time value of money is material, generally if the potential outfow is payable in one year or
C
more, the provision should be discounted to present value initially. Subsequently, the discount on
A
this provision would be unwound over time, to record the provision at the actual amount payable.
The unwinding of this discount would be recorded in the statement of proft or loss as a fnance
cost.
Example
At 31 December 20X8, the legal advisors of Rey Co now believe that the $10m payment from the
court case would be payable in one year. Rey Co has a cost of capital of 10%.
On 31 December 20X8, Rey Co should record the provision at $10m/1.10, which is $9.09m. This
should be debited to the statement of proft or loss, with a liability of $9.09m recorded.
By 31 December 20X9, when Rey Co is required to make the payment, the liability should be
showing at $10m, not $9.09m. Therefore the liability is increased by 10% over the year, giving an
increase of $910k which would be recorded in fnance costs.
2. Restructuring costs
Restructuring costs associated with reorganising divisions provide two issues. The frst is to assess
whether an obligation exists at the reporting date. The key here is whether the restructuring has
been announced to the affected employees. If the employees have been informed, then an
obligation exists and a provision must be made. If the employees have not been informed, then the
company could change its mind. Therefore there is no present obligation to incur the costs
associated with this.
The second issue consideration is which costs should be included within the provision. These
costsshould exclude any costs associated with any continuing activities. Therefore any provision
should only include items such as redundancies and closure costs. Ongoing costs such as the
costs of relocating staff should be excluded from the provision and should instead be expensed as
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they are incurred.
l B
a
3. Onerous contracts
lo b
Onerous contracts are those in which the costs of meeting the contract will exceed any benefts
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which will fow to the entity from the contract. As soon as an entity is aware that a contract is
A
onerous, the full loss should be provided for as a liability in the statement of fnancial position.
CC
4. Dismantling costs associated with assets
A
So far, all of the items considered in this article have involved the provision being recorded as a
liability with the debit being shown as an expense in the statement of proft or loss. The exception to
this is if an entity creates an obligation for future costs due to the construction of a non-current
asset. In this case, the provision should be included within the original cost of the asset, as this is
directly attributable to the construction of that asset.
Example
Rey Co constructed an oil platform in the sea on 1 January 20X8 at a cost of $150m. As part of
obtaining permission to construct the platform, Rey Co has a legal obligation to remove the asset at
the end of its useful life. This obligation has a present value of $20m.
Here, Rey Co would capitalise the $170m as part of property, plant and equipment. As only $150m
has been paid, this amount would be credited to cash, with a $20m provision set up. Over the
useful life of the asset, the $170m will be depreciated. In addition to this, the discount on the
provision will be unwound and the provision increased each year.
5. Future operating losses
Future operating losses do not meet the criteria for a provision, as there is no obligation to make
these losses. Therefore there cannot be included in the fnancial statemets.
In summary, IAS 37 is a key standard for FR candidates. Candidates are required to learn the three
key criteria for a provision, as they are likely to have to explain these in an exam. Careful attention
must also be paid to the calculations involved in the recording of a provision, particularly those
around long-term provisions and including them at present value. If candidates are able to do this,
x
then provisions can be an area where they can score highly in the FR exam.
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Tell me a story | ACCA Global
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Tell me a story
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Analysing fnancial statements is a key area for the Financial Reporting (FR) exam, and is the area
of the syllabus that is used to help prepare FR candidates for the Strategic Business Reporting
(SBR) exam. It is also the area of the syllabus where performance varies most between students; a
well prepared candidate can often score extremely high, in contrast to those candidates who have
not prepared properly and so score very low, or even zero marks.
A well-rounded accountant must always be so much more than a number-crunching machine. The
ability to step back, to discuss and to analyse has always been important to the profession. This is
the purpose of the inclusion of this type of question in the FR exam, and it is vital that candidates
master this skill in order to perform well.
This article will look at what the FR exam is looking for in the answer to an interpretation question,
along with the key weaknesses that are consistently noted in candidate answers. It will then
examine some of the different types of scenario that candidates might face in the FR exam, and
some key recommendations of items to consider for each. Finally, these recommendations are
applied to an example to show the difference between a good and a bad answer.
What the examiner is looking for

o x
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b a
Candidates are required to combine the information in the scenario with the numbers that they have
lo
been given to produce a coherent understanding of the business and why items have moved. This
is the specifc skill that prepares candidates for SBR. Their answer needs to give succinct, key
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reasons for the movements rather than stating that performance has improved because sales or
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profts have moved.
CC
Think of how a business would be analysed in the real world. If you were looking at the fnancial
A
statements of a large company (for example Netfix) and noted that revenue had increased year on
year, you wouldn’t simply state that this was good and leave your answer at that. You would talk
about the subscriber numbers or developments into new territories. You could talk about successful
programmes, any recent flm developments or any signifcant promotional offers. All of these would
contribute to the underlying increase in revenue and should be discussed.
Similarly, in the FR exam, candidates must use the scenario. The exam will give you information in
the question, which is there to support you. Just as an analyst commenting on the increased Netfix
revenue would be expected to mention the factors outlined earlier, a candidate is expected to use
the information in the question to explain the changes in performance or position. Any candidate
who does not use this information is likely to score poorly.
A candidate’s answer must be balanced. Often, the requirement may have separate elements to it,
such as commenting on performance and position, or asking for further information. It is vital that
candidates attempt all of the requirements. If 15 marks are available for analysing performance and
position, a good answer should attempt to make 7 or 8 points on both the statement of proft or loss
and statement of fnancial position. An answer that focuses solely on proftability is not suffciently
dealing with the requirement and will not score highly.
Key weaknesses
The examiner’s reports often detail the same weaknesses over and over, and these are essential
reading to ensure that candidates do not make any of these common mistakes:
Lack of depth – Candidates often identify movements in accounting numbers without ever
attempting to discuss the reasons why there has been a movement. Candidates sometimes
comment that proftability has increased because the proft margins have improved. This is too brief
and does not give any meaningful analysis, which should always seek to explain the underlying
x
reason for the movement.
B o
Lack of use of the scenario – Too many candidates are attempting to rote learn what ratios could
a l
mean and apply them to the numbers without any consideration for the information provided. A
b
recent example is where an exam question dealt with a company that had acquired a new
lo
subsidiary and formed a group during the year. This meant that candidates were presented with
consolidated fnancial statements for the current year and fnancial statements for a single entity for
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the previous year. A signifcant number of candidates attempted to answer the question without
A
even mentioning the acquisition or that they were comparing fnancial statements that were not
C
comparable (ie group versus single entity).
A C
Calculations without workings – Candidates are often producing ratio calculations without providing
workings behind them. This means that candidates are potentially missing out on numerous marks
through the application of the ‘own fgure’ rule. The June 2018 examiner’s report contains a large
amount of detail on this and should be carefully reviewed by candidates.
Types of scenario
1. Comparison of one entity over two periods
This could examine extracts from the fnancial statements for the same entity over two time periods.
The key things to consider here are any developments or changes in the business between the two
years, and whether the performance and position of the entity has improved or deteriorated. As
stated above, this always needs to be supported with the reason (or potential reasons) for the
improvement or deterioration.
Candidates should also consider one-off events that could skew comparison. If these exist, the
question will normally ask you to strip these out of the accounting numbers and recalculate ratios to
show the underlying position for comparison. Candidates should also be considering the impact of
any new products, or changes in customers or entries into new markets.
2. Comparison of two entities in the same period
These types of question might be based on two competitor frms and ask candidates to compare
their performance or decide which is more suitable to target for acquisition. Candidates should
consider if there any differences in accounting policies which might skew the comparison. There
may also be useful information about which areas of the market the company targets or information
about signifcant customers.
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If the question includes an acquisition, candidates should look at the liquidity of the companies and
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any possible synergies that could be made through purchasing either of the entities
b a
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3. Comparison of an entity with the sector averages
G
A
In a scenario such as this, candidates should give consideration to the fact that different entities in
the sector will have different margins as they target different ends of the market. Also frms may
CC
have different year ends, which could skew the comparison. Finally, consider if the entity in
A
question has different accounting policies to the rest of the sector.
4. Analysis of consolidated fnancial statements – acquisition of

a subsidiary
If a candidate is asked to analyse consolidated fnancial statements, they must consider group-
related issues, rather than treating it the same as the analysis of a single entity. Consideration of
the fact that there may be different entities with different margins is necessary, as well as the fact
that some transactions such as intra-group sales or unrealised profts will need to be eliminated.
There may also be issues to deal with such as goodwill impairment which would not incur in
individual fnancial statements. Finally, analysis of consolidated fnancial statements could involve
either an acquisition of a subsidiary or a disposal of a subsidiary.
In a situation with the acquisition of a subsidiary, it is important to note that the results will not be
comparable year-on-year. The current year will have consolidated the results of the subsidiary ,
whereas, the previous year would not. The subsidiary may be in a different market, with different
margins and payment terms, so this could have a signifcant impact across all of the ratios.
Consideration should also be given as to when the subsidiary was acquired during the year; there
may be a mid-year acquisition in which case there will be an impact on both the consolidated
Statement of Financial Position (SOFP) and the Statement of Proft or Loss (SOPL). The results in
the SOPL will include the profts of the subsidiary since acquisition. The statement of fnancial
position will include the full assets and liabilities of the subsidiary. This means that ratios using
elements of both performance and position will present a complex picture for candidates to analyse.
For example, if a subsidiary is acquired six months into the year, then only six months revenue will
be included, but the entire receivables balance will be included within the statement of fnancial
position. This would give a false impression of the receivables collection period if this was used to
calculate this ratio.
o x
If the subsidiary was purchased at the year-end there will only be an impact on the SOFP (but not
B
the SOPL). There may also be elements of one-off costs incurred associated with the acquisition of
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the subsidiary. These are unlikely to be repeated, so candidates should consider these and
a
consider calculating ratios excluding these fgures.
lo b
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5. Analysis of consolidated fnancial statements – disposal of a
subsidiary
C A
A C
If a subsidiary has been disposed during the year, then the consolidated SOPL will only contain the
results of the subsidiary up until the date of disposal, rather than for the full period. The SOFP will
not contain any assets or liabilities of the subsidiary since it has been disposed. Therefore, similar
to as noted above, any ratios combining information from the SOPL and the SOFP may not show
an accurate picture due to this mismatch. Candidates would be expected to spot this and talk about
the limitations of this comparison.
There are also likely to be one-off items relating to the disposal. These might include gains or
losses on disposal, any potential closure or redundancy costs, and any professional fees
associated with the disposal.
6. Analysis of cash fow information
In questions that require the analysis of cash fow statements, tThe frst key fgure to discuss is the
cash generated from operations. This shows how much cash the business can generate from its
core activities, before looking at one-off items such as asset purchases/sales and raising money
through debt or equity. The cash generated from operations fgure is effectively the cash proft from
operations.
Candidates should then consider other cash infows and outfows from the remainder of the cash
fow statement. Consider these in/outfows are one-off items (such as purchases or sales of non-
current assets), or regular in/outfows such as interest paid or tax paid.
Candidates should not simply comment on the overall movement in the total cash and cash
equivalents fgure in the year. An increase in this fgure will not simply mean that the entity has
performed well in the year. A situation could easily arise where an entity is struggling to generate
cash in a period and is forced to sell its owned premises and rent them back in order to continue to
trade. This may mean that the entity’s overall cash position increases in the period, but is clearly not
a sign that the entity has performed well. This should cause signifcant concern, as the entity cannot
x
sell the premises to raise cash again in the future.
Example
B o
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b
The following fnancial statement extracts are for Janssen Co for the years ending 31 December
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20X7 and 20X8.
G

C A 20X8 20X7

A C $000 $000
Revenue 35,100 42,300
Cost of sales (24,200) (27,400)
Gross proft 10,900 14,900

Trade receivables 2,400 1,500
The following information is also relevant.
Janssen Co is a manufacturer of confectionary, selling through supermarkets and small

convenience stores. In recent years there has been a decline in demand following concerns over
the level of sugar in confectionary products. To combat this, in July 20X8 Janssen Co rebranded
some of its chocolate bars as health food supplements and began to sell them to chains of gyms
and hotels, in addition to the existing confectionary lines.
Janssen Co reduced the selling price on other items by 10% to combat the falling demand. Janssen
Co also outsourced its packaging to a third party, whereas previously Janssen Co had packaged its
x
own goods.
Answer tips
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b
In the exam, most candidates would calculate ratios correctly, as these are pretty straightforward.
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This would give the following:
G

C A 20X8 20X7
Gross proft margin
A C 31.0% 35.2%
(10,900/35,100) (14,900/42,300)

Receivables collection period 25 days 13 days
(2,400/35,100 x 365) (1,500/42,300 x 365)
Remember to provide workings for your ratios as demonstrated above (unless the spreadsheet
answer space is used where cell formula might be used to calculate ratios).
The most common errors in the analysis would be to comment on the numbers above without a
single consideration of the scenario. Based on these fgures, there would be many comments such
as:
• Gross proft margin is down, meaning Janssen Co is generating less profts from the core
product
• Janssen Co may be managing costs poorly
• Janssen Co may have changed supplier
• Janssen Co may have a risk of irrecoverable debts
x
These answers do not have suffcient depth to score signifcant marks. Candidates cannot simply
o
learn what a decrease in the ratios could mean, and apply these generic reasons across each exam
B
diet. None of these bullet points really consider what we know about the entity, and will score poorly
a l
because of that. Typically many candidates fail to even comment on the movement in revenue
b
because there is no ratio to calculate. Therefore they would omit it from their analysis, despite it
lo
being a key accounting number.
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A much better answer would consider what we know about the business, and what we would
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expect to see happen to the fgures. The answer below shows how candidates should be combining
C
the information in the narrative with the fgures calculated to come up with the key reasons why
C
accounting numbers have moved.
A
Revenue – decrease of $7.2m, which is a fall of 17%.
The fall in revenue is likely to be driven by the decreased consumer demand following the concerns over
sugar.
We would potentially have expected an underlying decrease in the confectionary revenue as Janssen Co cut
the price by 10%. This suggests that the reduction in sale price has not resulted in the increase in volume that
Janssen Co may have hoped for.
It may also mean that the move into the new market has been unsuccessful, as the demand for the sports food
supplement may not be there.
It is also important to note that the product was only launched in July 20X8 so may not have had time to
generate signifcant sales yet.
A candidate who has commented on the items above is likely to score 4 marks. All of those points
are using the scenario, telling the reader a story which is derived directly from the question. This will
signifcantly outscore the student who states that the decline in revenue is a poor sign for the
business and not much else.
Gross proft margin – fall of 4%
Whilst the fall in gross margin is a poor sign, this is surprising as Janssen Co has cut the price by 10%, so a
fall in gross proft margin of greater than 4% may have been expected.
We are told that Janssen Co has outsourced its wrapping department. This move may have led to a reduction
in cost of sales, enabling Janssen Co to offset some of this price reduction.
The new products launched may have a higher gross proft margin than the remaining confectionary products,
x
as they are aimed at a different market.
B o
a l
Candidates who produce comments like those noted above will score signifcantly higher than those
lo b
making generic comments regarding cost management. These comments are based around the
scenario and are bringing in sensible commentary based on what would be expected to be seen.
G
This is what the exam is looking for, rather than simply stating that a decrease in the margin is a
A
negative thing.
CC
Receivables collection period – increase of 12 days
A
Previously Janssen Co made the majority of its sales via retail outlets, meaning that there would have been
almost no credit terms on the majority of its sales.
The increase in receivables is likely to be due to the new contracts with gyms and hotels, as these are likely to
have negotiated credit terms with Janssen Co.
A high proportion of Janssen Co’s sales are likely to remain as retail sales, which would aid Janssen Co’s cash
fows even with this introduction of new credit terms.
These are the kind of comment that will score marks. Comments referring to ‘ideal’ receivables
collection periods of 30 days are likely to not score anything. These are rote learned and not what
the examiner is looking for.
Summary
The analysis question is likely to be one that continues to divide candidates. By taking a step back,
making sensible points and basing these points on the scenario, candidates will ensure that they
are performing towards towards the top end of the range of marks. So, don’t simply comment on the
movements in numbers without explaining ‘why’, move away from the ‘textbook’ answers, don’t
suggest answers with are not based on the scenario, and make sure you tell the examiner a story!
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How to improve your answer to FR interpretation exam questions | ACCA Global
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How to improve your answer
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to FR interpretation exam
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How to improve your answer to FR interpretation exam questions
For some time now, the Financial Reporting (FR) examining team has observed that candidates
perform really well in the preparation of fnancial statements, whether that is in the context of a
group or a single entity. Unfortunately, their performance is less strong when they are asked to
analyse these fnancial statements, which unfortunately tends to suggest that they don’t fully
understand their composition.
The main reasons that analysis questions do not score high marks is because:
• candidates do not provide workings for their ratio calculations and so markers cannot apply the
'own fgure rule' when marking. Therefore, if an answer is wrong and there are no workings,
candidates get no marks. If the answer is wrong but workings are provided, it is possible that
markers can award marks for the parts of the calculation that are correct
• candidates often say that a ratio has increased or decreased but don’t provide an explanation
of why that might be the case – this may indicate that a candidate does not understand how
different parts of the fnancial statements (and so the ratios) are connected to each other
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• candidates do not make use of the information provided in the question scenario and so the
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answer lacks depth.
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Unfortunately, there is little that the examining team can do to help with the last two observations –
candidates need to understand what is expected of them and the only way to do this is to practise
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past exams/revision questions and compare their response to the suggested solution. However, in
A
an effort to encourage candidates to produce workings in their ratio calculations, the examining
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team have decided to use pre-formatted responses in some of the analysis questions, but not all.
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So, for example, where candidates are asked to calculate: (i) gross proft margin; (ii) operating proft
margin and; (iii) interest cover for Loop Co and then to compare these ratios to a sector average,
the pre-formatted response area may look like this:

Ratio Working Loop Co Sector Average
Gross proft margin To be calculated 30%
Operating proft margin To be calculated 10%
Interest cover To be calculated 4 times
This means that candidates do not have to 'build' a table in the response area and that the Sector
Average information is pre-populated. When candidates see such a pre-formatted response area,
they would be expected to provide their workings in the appropriate column and put their answer in
the cell where it currently states 'to be calculated'. It would be better to delete the 'to be calculated'
text but you won’t lose marks if you don’t. However, you should be aware that it is possible to delete
any text that currently exists in this table (including the sector average information).
Obviously, you will need this information to complete your analysis so, in case you do delete this by
mistake, the table has been replicated in the question scenario for your information and the
requirement will remind you of this. So, to reiterate, if you delete something by mistake in the
response area, don’t panic – you will be able to fnd it again in the scenario on the left-hand-side of
the screen. Hopefully, this strategy will help candidates to pick up vital marks in the ratio
calculations.
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Once you have calculated these ratios, you should look at the requirement to establish what you
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have been asked to comment on and set up the required headings in the response area; for
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example, performance and/or liquidity. It’s usually best to start at the top of the statement of proft or
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loss (if provided) and work down because changes/differences in revenue often drive similar
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changes/differences in other ratios. You should then ask yourself the following questions:
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• Is there a difference between the ratio that I have been asked to compare?
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• Does the change/difference in this ratio impact other ratios?
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• Is there an obvious reason for this? To fnd the answer, you will need to examine the
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relationships between different ratios and/or look at the question scenario for a potential
explanation.
• Is there anything that the directors of the company can do to resolve this issue?
In following this strategy, candidates can provide answers to analysis questions that have depth
and are supported by the evidence provided in the question scenario.
We hope that you fnd this information useful and that you can use it to improve your answers to
analysis questions whether in the context of a group or a single entity.
Written by the Financial Reporting examining team

July 2020
IFRS 16, Leases | F7 Financial Reporting | ACCA Qualification | Students | ACCA Global
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IFRS 16, Leases
1. Introduction and context setting

International Financial Reporting Standard (IFRS®) 16 – Leases - was issued in January 2016 and,
in comparison to its predecessor International Accounting Standard (IAS ®) 17 makes signifcant

changes to the way in which leasing transactions are reported in the fnancial statements of lessees
(although not in the fnancial statements of lessors). The purpose of this article is to summarise the
key changes introduced by IFRS 16 from the perspective of the lessee and how these impact on
their fnancial reporting.
A lease is an agreement whereby the lessor (the legal owner of an asset) conveys to the lessee
(the user of the asset) the right to use an asset for an agreed period of time in return for a payment
or series of payments.
The approach of IAS 17 was to distinguish between two types of lease. Leases that transfer
substantially all the risks and rewards of ownership of an asset were classifed as fnance leases.
All other leases were classifed as operating leases. The lease classifcation set out in IAS 17 was
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subjective and there was a clear incentive for the preparers of lessee’s fnancial statements to
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‘argue’ that leases should be classifed as operating rather than fnance leases in order to enable
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leased assets and liabilities to be left out of the fnancial statements.
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It was for this reason that IFRS 16 was introduced.
2. IFRS 16 – assets
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IFRS 16 defnes a lease as “A contract, or part of a contract, that conveys the right to use an asset
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for a period of time in exchange for consideration”. In order for such a contract to exist the user of
the asset needs to have the right to:
• Obtain substantially all of the economic benefts from the use of the asset.
• The right to direct the use of the asset.
2.1 An ‘identifed asset’
One essential feature of a lease is that there is an ‘identifed asset’. This normally takes place
through the asset being specifed in a contract, or part of a contract. For the asset to be ‘identifed’
the supplier of the asset must not have the right to substitute the asset for an alternative asset
throughout its period of use. The fact that the supplier of the asset has the right or the obligation to
substitute the asset when a repair is necessary does not preclude the asset from being an
‘identifed asset’.
Example – identifed assets

Under a contract between a local government authority (L) and a private sector provider (P), P
provides L with 20 trucks to be used for refuse collection on behalf of L for a 6-year period. The
trucks, which are owned by P, are specifed in the contract. L determines how they are used in the
refuse collection process. When the trucks are not in use, they are kept at L’s premises. L can use
the trucks for another purposes if it so chooses. If a particular truck needs to be serviced or
repaired, P is required to substitute a truck of the same type. Otherwise, and other than on default
by L, P cannot retrieve the trucks during the six-year period.
Conclusion: The contract is a lease. L has the right to use the 20 trucks for six years which are
identifed and explicitly specifed in the contract. Once delivered to L, the trucks can be substituted
only when they need to be serviced or repaired.
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2.2 The right to direct the use of the asset
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IFRS 16 states that a customer has the right to direct the use of an identifed asset if either:
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• The customer has the right to direct how and for what purpose the asset is used throughout its
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period of use; or
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• The relevant decisions about use are pre-determined and the customer has the right to operate
the asset throughout the period of use without the supplier having the right to change these
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operating instructions.
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Example – the right to direct the use of an asset
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A customer (C) enters into a contract with a road haulier (H) for the transportation of goods from
London to Edinburgh on a specifed truck. The truck is explicitly specifed in the contract and H does
not have substitution rights. The goods will occupy substantially all of the capacity of the truck. The
contract specifes the goods to be transported on the truck and the dates of pickup and delivery.
H operates and maintains the truck and is responsible for the safe delivery of the goods. C is
prohibited from hiring another haulier to transport the goods or operating the truck itself.
Conclusion: This contract does not contain a lease.
There is an identifed asset. The truck is explicitly specifed in the contract and H does not have the
right to substitute that specifed truck.
C does have the right to obtain substantially all of the economic benefts from use of the truck over
the contract period. Its goods will occupy substantially all of the capacity of the truck, thereby
preventing other parties from obtaining economic benefts from use of the truck.
However, C does not have the right to control the use of the truck because C does not have the
right to direct its use. C does not have the right to direct how and for what purpose the truck is
used. How and for what purpose the truck will be used (i.e. the transportation of specifed goods
from London to Edinburgh within a specifed timeframe) is predetermined in the contract. C has the
same rights regarding the use of the truck as if it were one of many customers transporting goods
using the truck.
3. Accounting for leases
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With a very few exceptions (see section 3.4 for further details) IFRS 16 abolishes the distinction
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between an operating lease and a fnance lease in the fnancial statements of lessees. Lessees will
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recognise a right of use asset and an associated liability at the inception of the lease.
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IFRS 16 requires that the ‘right of use asset’ and the lease liability should initially be measured at
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the present value of the minimum lease payments. The discount rate used to determine present
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value should be the rate of interest implicit in the lease.
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3.1 Recording the asset
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The ‘right of use asset’ would include the following amounts, where relevant:
• Any payments made to the lessor at, or before, the commencement date of the lease, less any
lease incentives received.
• Any initial direct costs incurred by the lessee.
• An estimate of any costs to be incurred by the lessee in dismantling and removing the
underlying asset, or restoring the site on which it is located (unless the costs are incurred to
produce inventories, in which case they would be accounted for in accordance with IAS 2 –
Inventories). Costs of this nature are recognised only when an entity incurs an obligation for them. IAS 37 – Provisions,
Contingent Liabilities and Contingent Assets would be applied to ascertain if an obligation existed.
3.2 Depreciation
The right of use asset is subsequently depreciated. Depreciation is over the shorter of the useful life
of the asset and the lease term, unless the title to the asset transfers at the end of the lease term, in
which case depreciation is over the useful life.
3.3 Lease liability
The lease liability is effectively treated as a fnancial liability which is measured at amortised cost,
using the rate of interest implicit in the lease as the effective interest rate.
Example – accounting for leases
A lessee enters into a 20-year lease of one foor of a building, with an option to extend for a further
fve years. Lease payments are $80,000 per year during the initial term and $100,000 per year
during the optional period, all payable at the end of each year. To obtain the lease, the lessee
incurred initial direct costs of $25,000
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At the commencement date, the lessee concluded that it is not reasonably certain to exercise the
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option to extend the lease and, therefore, determined that the lease term is 20 years. The interest
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rate implicit in the lease is 6% per annum. The present value of the lease payments is $917,600.
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At the commencement date, the lessee incurs the initial direct costs and measures the lease liability
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$917,600.
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The carrying amount of the right of use asset after these entries is $942,600 ($917,600 + $25,000)
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and consequently the annual depreciation charge will be $47,130 ($942,600 x 1/20).
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The lease liability will be measured using amortised cost principles. In order to help us with the
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example in the following section, we will measure the lease liability up to and including the end of
year ten. This is done in the following table:
Balance
Finance cost (6%) Balance c/fwd
b/fwd Rental
$ $
Year $ $
1 917,600 55,056 (80,000) 892,656
2 892,656 53,559 (80,000) 866,215
At the end of year one, the carrying amount of the right of use asset will be $895,470 ($942,600
less $47,130 depreciation).
The interest cost of $55,056 will be taken to the statement of proft or loss as a fnance cost.
The total lease liability at the end of year one will be $892,656. As the lease is being paid off over
20 years, some of this liability will be paid off within a year and should therefore be classed as a
current liability.
To fnd this fgure, we look at the remaining balance following the payment in year two. Here, we
can see that the remaining balance is $866,215. This will represent the non-current liability, being
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the amount of the $892,656 which will still be outstanding in over a year. The current liability
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element is therefore $26,441. This represents the $80,000 paid in year two less year two’s fnance
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costs of $53,559 (or $892,656-$866,215).
3.4 A simplifed approach for short-term or low-value leases
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A short-term lease is a lease that, at the date of commencement, has a term of 12 months or less. A
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lease that contains a purchase option cannot be a short-term lease. Lessees can elect to treat
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short-term leases by recognising the lease rentals as an expense over the lease term rather than
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recognising a ‘right of use asset’ and a lease liability. The election needs to be made for relevant
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leased assets on a ‘class-by-class’ basis. A similar election – on a lease-by-lease basis – can be
made in respect of ‘low value assets’.
The assessment of whether an underlying asset is of low value is performed on an absolute basis.
Leases of low-value assets qualify for the simplifed accounting treatment explained above
regardless of whether those leases are material to the lessee. The assessment is not affected by
the size, nature or circumstances of the lessee. Accordingly, different lessees are expected to reach
the same conclusions about whether a particular underlying asset is of low value.
An underlying asset can be of low value only if:
(a) The lessee can beneft from use of the underlying asset on its own or together with other
resources that are readily available to the lessee; and
(b) The underlying asset is not highly dependent on, or highly interrelated with, other assets.
A lease of an underlying asset does not qualify as a lease of a low-value asset if the nature of the
asset is such that, when new, the asset is typically not of low value. For example, leases of cars
would not qualify as leases of low-value assets because a new car would typically not be of low
value.
Examples of low-value underlying assets can include tablet and personal computers, small items of
offce furniture and telephones.
4. Sale and leaseback transactions

4.1 Introduction
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The treatment of sale and leaseback transactions depends on whether or not the ‘sale’ constitutes
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the satisfaction of a relevant performance obligation under IFRS 15 – Revenue from Contracts with
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Customers. The relevant performance obligation would be the effective ‘transfer’ of the asset to the
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lessor by the previous owner (now the lessee).
4.2 Transaction constituting a sale
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If the transaction does constitute a ‘sale’ under IFRS 15 then the treatment is as follows:
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the seller-lessee shall recognise only the amount of any gain or loss that relates to the rights
transferred to the buyer-lessor.
•
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The buyer-lessor shall account for the purchase of the asset applying applicable Standards,
and for the lease applying the lessor accounting requirements in IFRS 16 (these being
essentially unchanged from the predecessor standard).
If the fair value of the consideration for the sale of an asset does not equal the fair value of the
asset, or if the payments for the lease are not at market rates, an entity shall make the following
adjustments to measure the sale proceeds at fair value:
• Any below-market terms shall be accounted for as a prepayment of lease payments; and
• Any above-market terms shall be accounted for as additional fnancing provided by the buyer-
lessor to the seller-lessee.
Example – sale and leaseback
Entity X sells a building to entity Y for cash of $5 million. Immediately before the transaction, the
carrying amount of the building in the fnancial statements of entity X was $3.5 million. At the same
time, X enters into a contract with Y for the right to use the building for 20 years, with annual
payments of $200,000 payable at the end of each year. The terms and conditions of the transaction
are such that the transfer of the building by X satisfes the requirements for determining when a
performance obligation is satisfed in IFRS 15 - Revenue from Contracts with Customers.
Accordingly, X and Y account for the transaction as a sale and leaseback.
The fair value of the building at the date of sale is $4.5 million. Because the consideration for the
sale of the building is not at fair value, X and Y make adjustments to measure the sale proceeds at
fair value. The amount of the excess sale price of $500,000 ($5 million - $4.5 million) is recognised
as additional fnancing provided by Y to X.
The annual interest rate implicit in the lease is 5%. The present value of the annual payments (20
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payments of $200,000, discounted at 5%) amounts to $2,492,400, of which $500,000 relates to the
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additional fnancing and $1,992,400 ($2,492,200 - $500,000) relates to the lease (as adjusted for
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the fair value difference already identifed). The annual payment that would be required to be made
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20 times in arrears to repay additional fnancing of $500,000 when the rate of interest is 5% per
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annum would be $40,122 ($500,000/12.462 (the cumulative discount factor for 5% for 20 years)).
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Therefore the residual would be regarded as a ‘lease rental’ at an amount of $159,878 ($200,000 –
$40,122).
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Given the IFRS 15 treatment as a ‘sale’ B would almost certainly regard the lease of the building as
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an operating lease. This means that B would recognise the ‘lease rentals’ of $159,878 as income.
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4.3 – Transaction not constituting a ‘sale’
In these circumstances the seller does not ‘transfer’ the asset and continues to reconise it, without
adjustment. The ‘sales proceeds’ are recognised as a fnancial liability and accounted for by
applying IFRS 9 – Financial Instruments. In the same circumstances, the buyer recognizes a
fnancial asset equal to the ‘sales proceeds’.
5. Summary
The requirements of IFRS 16 will have signifcant impacts on key accounting ratios of lessees. The
greater recognition of leased assets and lease liabilities on the statement of fnancial position will
reduce return on capital employed and increase gearing. Initial measures of proft are likely to be
reduced, as in the early years of a lease the combination of depreciation of the right of use asset
and the fnance charge associated with the lease liability will exceed the lease rentals (normally
charged on a straight-line basis).
Revenue revisited | ACCA Qualification | Students | ACCA Global
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Revenue revisited
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Revenue revisited
On 28 May 2014, the International Accounting Standards Board (the Board), as a result of the joint
project with the US Financial Accounting Standards Board (FASB), issued IFRS ® 15, Revenue from
Contracts with Customers. Application of the standard is mandatory for annual reporting periods
starting from 1 January 2017 onward (though there is currently a proposal to defer this date to 1
January 2018) and earlier application is permitted.
This article considers the application of IFRS 15, Revenue from Contracts with Customers using the
fve-step model. The new standard introduces some signifcant changes so you should ensure that
you have the latest editions of all study materials.
Historically, there has been a signifcant divergence in practice over the recognition of revenue,
mainly because IFRS standards have contained limited guidance in certain areas. The original
standard, IAS® 18, Revenue, was issued in 1982 with a signifcant revision in 1993, however, IAS
18 was not ft for purpose in today’s corporate world as the guidance available was diffcult to apply
to many transactions. The result was that some companies applied US GAAP when it suited their
needs.
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Users often found it diffcult to understand the judgments and estimates made by an entity in
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recognising revenue, partly because of the ‘boilerplate’ nature of the disclosures. As a result of the
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varying recognition practices, the nature and extent of the impact of the new standard will vary
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between entities and industries. For many transactions, such as those in retail, the new standard
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will have little effect but there could be signifcant change to current practice in accounting for long-
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term and multiple-element contracts.
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IFRS 15 replaces the following standards and interpretations:
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IAS 11, Construction Contracts
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• IAS 18, Revenue
• IFRIC 13, Customer Loyalty Programmes
• IFRIC 15, Agreements for the Construction of Real Estate
• IFRIC 18, Transfer of Assets from Customers
• SIC-31, Revenue – Barter Transactions Involving Advertising Services
One effect of this for the ACCA exams is that construction contracts (previously excluded from P2)
are examinable in Strategic Business Reporting.
The core principle of IFRS 15 is that an entity shall recognise revenue from the transfer of promised
good or services to customers at an amount that refects the consideration to which the entity
expects to be entitled in exchange for those goods and services. The standard introduces a fve-
step model for the recognition of revenue.
The fve-step model applies to revenue earned from a contract with a customer with limited
exceptions, regardless of the type of revenue transaction or the industry.
Step one in the fve-step model requires the identifcation of the contract with the customer.
Contracts may be in different forms (written, verbal or implied), but must be enforceable, have
commercial substance and be approved by the parties to the contract. The model applies once the
payment terms for the goods or services are identifed and it is probable that the entity will collect
the consideration. Each party’s rights in relation to the goods or services have to be capable of
identifcation. If a contract with a customer does not meet these criteria, the entity can continually
reassess the contract to determine whether it subsequently meets the criteria.
Two or more contracts that are entered into around the same time with the same customer may be
combined and accounted for as a single contract, if they meet the specifed criteria. The standard
provides detailed requirements for contract modifcations. A modifcation may be accounted for as a
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separate contract or as a modifcation of the original contract, depending upon the circumstances of
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the case.
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Step two requires the identifcation of the separate performance obligations in the contract.
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This is often referred to as ‘unbundling’, and is done at the beginning of a contract. The key factor in
identifying a separate performance obligation is the distinctiveness of the good or service, or a
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bundle of goods or services. A good or service is distinct if the customer can beneft from the good
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or service on its own or together with other readily available resources and it is separately
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identifable from other elements of the contract.
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IFRS 15 requires that a series of distinct goods or services that are substantially the same with the
same pattern of transfer, to be regarded as a single performance obligation. A good or service
which has been delivered may not be distinct if it cannot be used without another good or service
that has not yet been delivered. Similarly, goods or services that are not distinct should be
combined with other goods or services until the entity identifes a bundle of goods or services that is
distinct. IFRS 15 provides indicators rather than criteria to determine when a good or service is
distinct within the context of the contract. This allows management to apply judgment to determine
the separate performance obligations that best refect the economic substance of a transaction.
Step three requires the entity to determine the transaction price, which is the amount of
consideration that an entity expects to be entitled to in exchange for the promised goods or
services. This amount excludes amounts collected on behalf of a third party – for example,
government taxes. An entity must determine the amount of consideration to which it expects to be
entitled in order to recognise revenue.
The transaction price might include variable or contingent consideration. Variable consideration
should be estimated as either the expected value or the most likely amount. The expected value
approach represents the sum of probability-weighted amounts for various possible outcomes. The
most likely amount represents the most likely amount in a range of possible amounts.
Management should use the approach that it expects will best predict the amount of consideration
and it should be applied consistently throughout the contract. An entity can only include variable
consideration in the transaction price to the extent that it is highly probable that a subsequent
change in the estimated variable consideration will not result in a signifcant revenue reversal. If it is
not appropriate to include all of the variable consideration in the transaction price, the entity should
assess whether it should include part of the variable consideration. However, this latter amount still
has to pass the ‘revenue reversal’ test.
Variable consideration is wider than simply contingent consideration as it includes any amount that
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is variable under a contract, such as performance bonuses or penalties.
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Additionally, an entity should estimate the transaction price, taking into account non-cash
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consideration, consideration payable to the customer and the time value of money if a signifcant
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fnancing component is present. The latter is not required if the time period between the transfer of
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goods or services and payment is less than one year. In some cases, it will be clear that a
signifcant fnancing component exists due to the terms of the arrangement.
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In other cases, it could be diffcult to determine whether a signifcant fnancing component exists.
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This is likely to be the case where there are long-term arrangements with multiple performance
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obligations such that goods or services are delivered and cash payments received throughout the
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arrangement. For example, if an advance payment is required for business purposes to obtain a
longer-term contract, then the entity may conclude that a signifcant fnancing obligation does not
exist.
If an entity anticipates that it may ultimately accept an amount lower than that initially promised in
the contract due to, for example, past experience of discounts given, then revenue would be
estimated at the lower amount with the collectability of that lower amount being assessed.
Subsequently, if revenue already recognised is not collectable, impairment losses should be taken
to proft or loss.
Step four requires the allocation of the transaction price to the separate performance

obligations. The allocation is based on the relative standalone selling prices of the goods or
services promised and is made at the inception of the contract. It is not adjusted to refect
subsequent changes in the standalone selling prices of those goods or services.
The best evidence of standalone selling price is the observable price of a good or service when the
entity sells that good or service separately. If that is not available, an estimate is made by using an
approach that maximises the use of observable inputs – for example, expected cost plus an
appropriate margin or the assessment of market prices for similar goods or services adjusted for
entity-specifc costs and margins or in limited circumstances a residual approach. The residual
approach is different from the residual method that is used currently by some entities, such as
software companies.
When a contract contains more than one distinct performance obligation, an entity should allocate
the transaction price to each distinct performance obligation on the basis of the standalone selling
price.
Where the transaction price includes a variable amount and discounts, it is necessary to establish
whether these amounts relate to all or only some of the performance obligations in the contract.
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Discounts and variable consideration will typically be allocated proportionately to all of the
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performance obligations in the contract. However, if certain conditions are met, they can be
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allocated to one or more separate performance obligations.
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This will be a major practical issue as it may require a separate calculation and allocation exercise
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to be performed for each contract. For example, a mobile telephone contract typically bundles
together the handset and network connection and IFRS 15 will require their separation.
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Step fve requires revenue to be recognised as each performance obligation is satisfed. This
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differs from IAS 18 where, for example, revenue in respect of goods is recognised when the
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signifcant risks and rewards of ownership of the goods are transferred to the customer. An entity
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satisfes a performance obligation by transferring control of a promised good or service to the
customer, which could occur over time or at a point in time. The defnition of control includes the
ability to prevent others from directing the use of and obtaining the benefts from the asset. A
performance obligation is satisfed at a point in time unless it meets one of the following criteria, in
which case, it is deemed to be satisfed over time:
• The customer simultaneously receives and consumes the benefts provided by the entity’s
performance as the entity performs.
• The entity’s performance creates or enhances an asset that the customer controls as the asset
is created or enhanced.
• The entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.
Revenue is recognised in line with the pattern of transfer. Whether an entity recognises revenue
over the period during which it manufactures a product or on delivery to the customer will depend
on the specifc terms of the contract.
If an entity does not satisfy its performance obligation over time, it satisfes it at a point in time and
revenue will be recognised when control is passed at that point in time. Factors that may indicate
the passing of control include the present right to payment for the asset or the customer has legal
title to the asset or the entity has transferred physical possession of the asset.
As a consequence of the above, the timing of revenue recognition may change for some point-in-
time transactions when the new standard is adopted.
In addition to the fve-step model, IFRS 15 sets out how to account for the incremental costs of
obtaining a contract and the costs directly related to fulflling a contract and provides guidance to
assist entities in applying the model to licences, warranties, rights of return, principal-versus-agent
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considerations, options for additional goods or services and breakage.
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IFRS 15 is a signifcant change from IAS 18 and even though it provides more detailed application
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guidance, judgment will be required in applying it because the use of estimates is more prevalent.
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For exam purposes, you should focus on understanding the principles of the fve-step model so that
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you can apply them to practical questions.
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Written by a member of the Strategic Business Reporting examining team
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Accounting for property, plant and equipment | ACCA Global
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Accounting for property,
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and equipment
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Accounting for property, plant and equipment
The accounting for International Accounting Standard (IAS ®) 16, Property, Plant and Equipment is a
particularly important area of the Financial Reporting syllabus. You can almost guarantee that in
every exam you will be required to account for property, plant and equipment at least once.
This article is designed to outline the key areas of IAS 16, Property, Plant and Equipment that you
may be required to attempt in the Financial Reporting exam.
IAS 16, Property, Plant and Equipment overview

There are essentially four key areas when accounting for property, plant and equipment that you
must ensure that you are familiar with:
• initial recognition
• depreciation
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• revaluation
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• derecognition (disposals).
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Initial recognition
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The basic principle of IAS 16 is that items of property, plant and equipment that qualify for
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recognition should initially be measured at cost.
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One of the easiest ways to remember this is that you should capitalise all costs to bring an asset to
its present location and condition for its intended use.
Commonly used examples of cost include:
• purchase price of an asset (less any trade discount)

• directly attributable costs such as:
• cost of site preparation
• initial delivery and handling costs
• installation and testing costs
• professional fees
• the initial estimate of dismantling and removing the asset and restoring the site on which it is
located, to its original condition (ie to the extent that it is recognised as a provision per IAS 37,
Provisions, Contingent Assets and Liabilities)
• borrowing costs in accordance with IAS 23, Borrowing Costs.
EXAMPLE 1
On 1 March 20X0 Yucca Co acquired a machine from Plant Co under the following terms:
$
List price of machine 82,000
x
Import duty 1,500
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Delivery fees 2,050
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Electrical installation costs 9,500
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Pre-production testing 4,900
CC
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Purchase of a fve-year maintenance contract with Plant 7,000
In addition to the above information Yucca Co was granted a trade discount of 10% on the initial list
price of the asset and a settlement discount of 5% if payment for the machine was received within
one month of purchase. Yucca Co paid for the plant on 25 March 20X0.
How should the above information be accounted for in the fnancial statements? (See 'Related links'
for the solution to Example 1.)
EXAMPLE 2
Construction of Ham Co’s new store began on 1 April 20X1. The following costs were incurred on
the construction:
$000
Freehold land 4,500
Architect fees 620
Site preparation 1,650
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Materials 7,800
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Direct labour costs 11,200
Legal fees
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C A
C
General overheads 940
A
The store was completed on 1 January 20X2 and brought into use following its grand opening on
the 1 April 20X2. Ham Co issued a $25m unsecured loan on 1 April 20X1 to aid construction of the
new store (which meets the defnition of a qualifying asset per IAS 23). The loan carried an interest
rate of 8% per annum and is repayable on 1 April 20X4.
Required
Calculate the amount to be included as property, plant and equipment in respect of the new store
and state what impact the above information would have on the statement of proft or loss (if any)
for the year ended 31 March X2.
(See 'Related links' for the solution to Example 2.)

Subsequent costs
Once an item of PPE has been recognised and capitalised in the fnancial statements, a company
may incur further costs on that asset in the future. IAS 16 requires that subsequent costs should be
capitalised if:
• it is probable that future economic benefts associated with the extra costs will fow to the entity
• the cost of the item can be reliably measured.
All other subsequent costs should be recognised as an expense in the income statement in the
period that they are incurred.
x
EXAMPLE 3
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On 1 March 202 Yucca Co purchased an upgrade package from Plant Co at a cost of $18,000 for
a
the machine it originally purchased in 20X0 (Example 1). The upgrade took a total of two days
b
where new components were added to the machine. Yucca agreed to purchase the package as the
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new components would lead to a reduction in production time per unit of 15%. This will enable
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Yucca to increase production without the need to purchase a new machine.
C A
Should the additional expenditure be capitalised or expensed? (See 'Related links' for the solution
C
to Example 3.)
Depreciation
A
Depreciation is defned in IAS 16 as being the systematic allocation of the depreciable amount of an
asset over its useful life. In other words, depreciation applies the accruals concept to the capitalised
cost of a non-current asset and matches this cost to the period that it relates to.
Depreciation methods
There are many methods of depreciating a non-current asset with the most common being:
• Straight line
• % on cost, or
• Cost – residual value divided by useful life
• Reducing balance
• % on carrying amount
EXAMPLE 4
An item of plant was purchased on 1 April 20X0 for $200,000 and is being depreciated at 25% on a
reducing balance basis.
Prepare the extracts of the fnancial statements for the year ended 31 March 20X2. (See 'Related
links' for the solution to Example 4.)
Useful life and residual value
IAS 16 requires that these estimates be reviewed at the end of each reporting period. If either
changes signifcantly, the change should be accounted for over the useful life remaining.
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EXAMPLE 5
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A machine was purchased on 1 April 20X0 for $120,000. It was estimated that the asset had a
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residual value of $20,000 and a useful life of 10 years at this date. On 1 April 20X2 (two years later)
the residual value was reassessed as being only $15,000 and the useful life remaining was
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considered to be only fve years.
C A
How should the asset be accounted for in the years ending 31 March 20X1/20X2/20X3? (See
C
'Related links' for the solution to Example 5.)
Component depreciation
A
If an asset comprises two or more major components with different useful lives, then each
component should be accounted for separately for depreciation purposes and depreciated over its
own useful life.
EXAMPLE 6
A company purchased a property with an overall cost of $100m on 1 April 20X1. The property
elements are made up as follows:
$000 Estimated life

Land and buildings

(Land element $20,000) 65,000 50 years
Fixtures and fttings 24,000 10 years
Lifts 11,000 20 years
100,000
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Calculate the annual depreciation charge for the property for the year ended 31 March 20X2. (See
a
'Related links' for the solution to Example 6.)
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Revaluations
C A
This is an important topic in the exam and features regularly in Question 2, so you should ensure
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that you are familiar with all aspects of revaluations.
IAS 16 rules
A
IAS 16 permits the choice of two possible treatments in respect of property, plant and equipment:
• The cost model (carry an asset at cost less accumulated depreciation/impairments).

• The revaluation model (carry an asset at its fair value at the revaluation date less subsequent
accumulated depreciation impairment).
If the revaluation policy is adopted this should be applied to all assets in the entire category, ie if
you revalue a building, you must revalue all land and buildings in that class of asset. Revaluations
must also be carried out with suffcient regularity so that the carrying amount does not differ
materially from that which would be determined using fair value at the reporting date.
Accounting for a revaluation

There are a series of accounting adjustments that must be undertaken when revaluing a non-
current asset. These adjustments are indicated below.
The initial revaluation
You may fnd it useful in the exam to frst determine if there is a gain or loss on the revaluation with
a simple calculation to compare:
Carrying amount of non-current asset at revaluation date X
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Valuation of non-current asset X
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Difference = gain or loss revaluation X
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Revaluation gains
CC
A gain on revaluation is always recognised in equity, under a revaluation reserve (unless the gain
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reverse’s revaluation losses on the same asset that were previously recognised in the income
statement – in this instance the gain is to be shown in the income statement).
The revaluation gain is known as an unrealised gain which later becomes realised when the asset
is disposed of (derecognised).
Double entry:
• Dr Non-current asset cost (difference between valuation and original cost/valuation)

• Dr Accumulated depreciation (with any historical cost accumulated depreciation)
• Cr Revaluation reserve (gain on revaluation)
EXAMPLE 7
A company purchased a building on 1 April 20X1 for $100,000. The asset had a useful life at that
date of 40 years. On 1 April 20X3 the company revalued the building to its current fair value of
$120,000.
What is the double entry to record the revaluation? (See 'Related links' for the solution to Example
7.)
Revaluation losses
A revaluation loss should be charged against any related revaluation surplus to the extent that the
decrease does not exceed the amount held in the revaluation surplus in respect of the same asset.
Any additional loss must be charged as an expense in the statement of proft or loss.
x
Double entry:
• Dr Revaluation reserve (to maximum of original gain)
B o
• Dr Income statement (any residual loss)
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• Cr Non-current asset (loss on revaluation)
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A
EXAMPLE 8
CC
The carrying amount of Zen Co’s property at the end of the year amounted to $108,000. On this
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date the property was revalued and was deemed to have a fair value of $95,000. The balance on
the revaluation surplus relating to the original gain of the property was $10,000.
What is the double entry to record the revaluation? (See 'Related links' for the solution to Example
8.)
Depreciation
The asset must continue to be depreciated following the revaluation. However, now that the asset
has been revalued the depreciable amount has changed. In simple terms the revalued amount
should be depreciated over the assets remaining useful life.
Reserves transfer
The depreciation charge on the revalued asset will be different to the depreciation that would have
been charged based on the historical cost of the asset. As a result of this, IAS 16 permits a transfer
to be made of an amount equal to the excess depreciation from the revaluation reserve to retained
earnings.
Double entry:
• Dr Revaluation reserve
• Cr Retained earnings
Be careful, in the exam a reserves transfer is only required if the examiner indicates that it is
company policy to make a transfer to realised profts in respect of excess depreciation on revalued
assets. If this is not the case then a reserves transfer is not necessary.
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This movement in reserves should also be disclosed in the statement of changes in equity.
EXAMPLE 9
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A company revalued its property on 1 April 20X1 to $20m ($8m for the land). The property originally
cost $10m ($2m for the land) 10 years ago. The original useful life of 40 years is unchanged. The
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company’s policy is to make a transfer to realised profts in respect of excess depreciation.
C A
How will the property be accounted for in the year ended 31 March 20X2? (See 'Related links' for
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the solution to Example 9.)
Exam focus A
In the exam make sure you pay attention to the date that the revaluation takes place. If the
revaluation takes place at the start of the year then the revaluation should be accounted for
immediately and depreciation should be charged in accordance with the rule above.
If however the revaluation takes place at the year-end then the asset would be depreciated for a full
12 months frst based on the original depreciation of that asset. This will enable the carrying amount
of the asset to be known at the revaluation date, at which point the revaluation can be accounted
for.
A further situation may arise if the examiner states that the revaluation takes place mid-way through
the year. If this were to happen the carrying amount would need to be found at the date of
revaluation, and therefore the asset would be depreciated based on the original depreciation for the
period up until revaluation, then the revaluation will take place and be accounted for. Once the
asset has been revalued you will need to consider the last period of depreciation. This will be found
based upon the revaluation rules (depreciate the revalued amount over remaining useful life). This
will be the most complicated situation and you must ensure that your working is clearly structured
for this; ie depreciate for frst period based on old depreciation, revalue, then depreciate last period
based on new depreciation rule for revalued assets.
EXAMPLE 10
A company purchased a building on 1 April 20X1 for $100,000 at which point it was considered to
have a useful life of 40 years. At the year end 31 March 20X6 the company decided to revalue the
building to its current value of $98,000.
x
How will the building be accounted for in the year ended 31 March 20X6? (See 'Related links' for
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EXAMPLE 11
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At 1 April 20X1 HD Co carried its offce block in its fnancial statements at its original cost of $2
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million less depreciation of $400,000 (based on its original life of 50 years). HD Co decided to
revalue the offce block on 1 October 20X1 to its current value of $2.2m. The useful life remaining
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was reassessed at the time of valuation and is considered to be 40 years at this date. It is the
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company’s policy to charge depreciation proportionally.
A C
How will the offce block be accounted for in the year ended 31 March 20X2? (See 'Related links' for
Derecognition
Property, plant and equipment should be derecognised when it is no longer expected to generate
future economic beneft or when it is disposed of.
When property, plant and equipment is to be derecognised, a gain or loss on disposal is to be

calculated. This can be found by comparing the difference between:
Carrying amount X
Disposal proceeds X
Proft or loss on disposal X
Tip: When the disposal proceeds are greater than the carrying amount there is a proft on disposal
and when the disposal proceeds are less than the carrying amount there is a loss on disposal.
EXAMPLE 12
An asset that originally cost $16,000 and had accumulated depreciation on it of $8,000 was
disposed of during the year for $5,000 cash.
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How should the disposal be accounted for in the fnancial statements? (See 'Related links' for the
B
solution to Example 12.)
a l
b
Disposal of previously revalued assets
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When an asset is disposed of that has previously been revalued, a proft or loss on disposal is to be
calculated (as above). Any remaining surplus on the revaluation reserve is now considered to be a
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‘realised’ gain and therefore should be transferred to retained earnings as:
CC
A
Dr Revaluation reserve
• Cr Retained earnings
In summary, it can be seen that accounting for property, plant and equipment is an important topic
that features regularly in the Financial Reporting exam. With most of what is examinable feeding
though from the Financial Accounting exam, this should be a comfortable topic that you can tackle
well in the exam.
Bobbie-Anne Retallack is a content specialist at Kaplan Publishing
Performance appraisal | Paper F7 Financial Reporting | ACCA Qualification | Students | ACCA Global
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Performance appraisal requires good interpretation and a good understanding of what the
information means in the context of the question
Performance appraisal is an important aspect of Paper F7, Financial Reporting and of interest to
Paper P3 students. At this level you are not only required to prepare fnancial statements but
understand the information underpinning the results.
You will often be required to make use of ratios to aid interpretation of the fnancial statements for
the current year and to compare them to the results of a prior period, another entity, or against
industry averages.
Increasingly, candidate exam performance is demonstrating a lack of commercial awareness and

knowledge that barely stretches past the 'rote learned' phase. Candidates regularly state facts such
as 'gross proft margin has increased' or, 'payables days have gone down' but this offers no
interpretation of the reason behind the change in ratio. As a result markers fnd it diffcult to award
suffcient marks to candidates to achieve a pass.
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This article is designed to aid candidates in understanding what is expected to create a solid
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answer to a performance appraisal question.
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Specifc problems
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When marking this style of question there are some common weaknesses that are identifed, some
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of which are highlighted below:
• A C
limited knowledge of ratio calculations
appraisal not linked to scenario

• poor understanding of the topic
• limited understanding of what accounting information represents
• lack of commercial awareness
• discursive elements often not attempted
• inability to come to a conclusion
• poor handwriting (often illegible in some instances)
• poor English.
Use the scenario
The majority of questions that feature performance appraisal have an accompanying scenario to the
question requirement. A weak answer will make no attempt to refer to this information in the
appraisal and, therefore, will often score few marks. It is important that you carefully consider this
information and incorporate it into your appraisal because it has been provided for a reason. Do not
simply list all the possibilities of why a ratio may have changed; link the reason to the scenario that
you have been provided with.
Example
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The question scenario may provide you with a set of fnancial statements and some further
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information such as details of non-current assets (potentially including a revaluation, a major
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acquisition or disposal) or measures undertaken during the year in an attempt to improve
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performance. When constructing your answer you must consider the effect that information such as
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this would have on the company results.
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A major asset disposal would most likely have a signifcant impact on a company's fnancial
statements in that it would result in a proft or loss on disposal being taken to the statement of proft
C A
or loss and a cash injection being received. It is worth noting that while the current year results will
C
be affected by this, it is a one-off adjustment and bears little resemblance to future periods. When
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calculating ratios the disposal will improve asset turnover as the asset base becomes smaller over
which revenue is spread and will, therefore, also improve return on capital employed. The operating
margin is likely to be affected also as the proft or loss on disposal will be included when calculating
this.
It is often worth calculating some of the results again (eg ROCE or operating proft margin) as part
of your interpretation without the one?off disposal information, as arguably this will help make the
information more comparable to the results that do not include such disposals (if time is limited a
comment about the disposal's effect will be suffcient).
From a liquidity point of view the cash received on disposal of the asset will have aided cash fow
during the year - ask yourself what would have happened if the company had not received this cash
- ie are they already operating on an overdraft? If so, the cash fow position would be far worse
without the disposal cash.
If a revaluation of non-current assets has taken place during the year the capital employed base will
grow - this will have the impact of reducing both the asset turnover and return on capital employed
ratios without any real change in operating capacity or proftability.
A major asset purchase again would cause both asset turnover and return on capital employed to
deteriorate as the capital employed base would grow. It may appear that as a result of the
acquisition the company has become less effcient at generating revenue and proft but this may not
always be the case.
If, for example, the purchase took place during the latter half of the year, the new asset will not have
contributed to a full year's proft and it may be that in future periods the business will begin to see a
better return as a result of the investment. When analysing the performance and position of the
company, if management have implemented measures during the year to improve performance it is
worth considering whether or not these measures have actually been effective. If, for example, a
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company chose to give rebates to customers for orders above a set quantity level - this would have
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the impact of improving revenue at the sacrifce of gross proft margin.
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Know the basics
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Ratios can generally be broken down into several key areas: proftability, liquidity, gearing and
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investment. As a student taking the Paper F7 exam you need to know the formulae for the relevant
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ratios and also what movements in these ratios could possibly mean. Provided below is a brief
overview of the key ratios and what movements could indicate - further clarifcation and
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understanding can be found through your study text and then by practising past questions (due to
the limited space of this article, investment ratios will not be discussed but this does not make them
any less important).
Proftability
Return on capital employed (ROCE)
Proft before interest and tax

Shareholders' equity + debt
This ratio is generally considered to be the primary proftability ratio as it shows how well a business
has generated proft from its long?term fnancing. An increase in ROCE is generally considered to
be an improvement.
Movements in return on capital employed are best interpreted by examining proft margins and
asset turnover in more detail (often referred to as the secondary ratios) as ROCE is made up of
these component parts. For example, an improvement in ROCE could be due to an improvement in
margins or more effcient use of assets.
Asset turnover
Revenue
Total assets - current liabilities
Asset turnover shows how effciently management have utilised assets to generate revenue. When
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looking at the components of the ratio a change will be linked to either a movement in revenue, a
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movement in net assets, or both.
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a
There are many factors that could both improve and deteriorate asset turnover. For example, a
b
signifcant increase in sales revenue would contribute to an increase in asset turnover or, if the
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business enters into a sale and operating lease agreement, then the asset base would become
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smaller, thus improving the result.
A
Proft margins
Gross or Operating proft
CC
Revenue
A
The gross proft margin looks at the performance of the business at the direct trading level.
Typically variations in this ratio are as a result of changes in the selling price/sales volume or
changes in cost of sales. For example, cost of sales may include inventory write downs that may
have occurred during the period due to damage or obsolescence, exchange rate fuctuations or
import duties.
The operating proft margin (or net proft margin) is generally calculated by comparing the proft
before interest and tax of a business to revenue, but, beware in the exam as sometimes the
examiner specifcally requests the calculation to include proft before tax.
Analysing the operating proft margin enables you to determine how well the business has managed
to control its indirect costs during the period. In the exam when interpreting operating proft margin it
is advisable to link the result back to the gross proft margin. For example, if gross proft margin
deteriorated in the year then it would be expected that operating margin would also fall.
However, if this is not the case, or the fall is not so severe, it may be due to good indirect cost
control or perhaps there could be a one-off proft on disposal distorting the operating proft fgure.
Liquidity
Current ratio
Current assets

Current liabilities
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The current ratio considers how well a business can cover the current liabilities with its current
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assets. It is a common belief that the ideal for this ratio is between 1.5 and 2 to 1 so that a business
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may comfortably cover its current liabilities should they fall due.
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However this ideal will vary from industry to industry. For example, a business in the service
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industry would have little or no inventory and therefore could have a current ratio of less than 1.
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This does not necessarily mean that it has liquidity problems so it is better to compare the result to
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previous years or industry averages.
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Quick ratio (sometimes referred to as acid test ratio)
Current assets - inventory

Current liabilities
The quick ratio excludes inventory as it takes longer to turn into cash and therefore places
emphasis on the business's 'quick assets' and whether or not these are suffcient to cover the
current liabilities. Here the ideal ratio is thought to be 1:1 but as with the current ratio, this will vary
depending on the industry in which the business operates.
When assessing both the current and the quick ratios, look at the information provided within the
question to consider whether or not the company is overdrawn at the year-end. The overdraft is an
additional factor indicating potential liquidity problems and this form of fnance is both expensive
(higher rates of interest) and risky (repayable on demand).
Receivables collection period (in days)

Receivables x 365
Credit sales
It is preferable to have a short credit period for receivables as this will aid a business's cash fow.
However, some businesses base their strategy on long credit periods. For example, a business that
sells sofas might offer a long credit period to achieve higher sales and be more competitive than
similar entities offering shorter credit periods.
If the receivables days are shorter compared to the prior period it could indicate better credit control
or potential settlement discounts being offered to collect cash more quickly whereas an increase in
credit periods could indicate a deterioration in credit control or potential bad debts.
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Payables collection period (in days)
Payables x 365
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Credit purchases*
*(or cost of sales if not available)
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An increase in payables days could indicate that a business is having cash fow diffculties and is
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therefore delaying payments using suppliers as a free source of fnance. It is important that a
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business pays within the agreed credit period to avoid confict with suppliers. If the payables days
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are reducing this indicates suppliers are being paid more quickly. This could be due to credit terms
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being tightened or taking advantage of early settlement discounts being offered.
Inventory days
Closing (or average) inventory x 365

Cost of sales
Generally the lower the number of days that inventory is held the better as holding inventory for
long periods of time constrains cash fow and increases the risk associated with holding the
inventory. The longer inventory is held the greater the risk that it could be subject to theft, damage
or obsolescence. However, a business should always ensure that there is suffcient inventory to
meet the demand of its customers.
Gearing
Debt or Debt

Equity Debt + equity
The gearing ratio is of particular importance to a business as it indicates how risky a business is
perceived to be based on its level of borrowing. As borrowing increases so does the risk as the
business is now liable to not only repay the debt but meet any interest commitments under it. In
addition, to raise further debt fnance could potentially be more diffcult and more expensive.
If a company has a high level of gearing it does not necessarily mean that it will face diffculties as a
result of this. For example, if the business has a high level of security in the form of tangible non-
current assets and can comfortably cover its interest payments (interest cover = proft before
interest and tax compared to interest) a high level of gearing should not give an investor cause for
concern.
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Conclusion
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In the exam make sure all calculations required are attempted so that you can offer possible
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reasons for any change in the discussion part of the question.
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There is no absolute correct answer to a performance appraisal question. What sets a good answer
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apart from a poor one is the discussion of possible reasons for why (specifcally in the given
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scenario) changes in the ratios may have occurred.
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Bobbie Retallack is Kaplan Publishing's content specialist for Paper F7
Impairment of goodwill | F7 Financial Reporting | ACCA Qualification | Students | ACCA Global
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Following the revisions to IFRS 3, Business Combinations, in January 2008, there are now
two ways of measuring the goodwill that arises on the acquisition of a subsidiary and each
has a slightly different impairment process.
This article discusses and shows both ways of measuring goodwill following the acquisition of a
subsidiary, and how each measurement of goodwill is subject to an annual impairment review.
How to calculate goodwill
The established measurement of goodwill on the acquisition of a subsidiary is the excess of the fair
value of the consideration given by the parent over the parent’s share of the fair value of the net
assets acquired. This method can be referred to as the proportionate method. It determines only the
goodwill that is attributable to the parent company.
The more recent method, following the revision to IFRS 3, of measuring goodwill on the acquisition
of the subsidiary is to compare the fair value of the whole of the subsidiary (as represented by the
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fair value of the consideration given by the parent and the fair value of the non controlling interest)
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with all of the fair value of the net assets of the subsidiary acquired. This method can be referred to
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as the gross or full goodwill method. It determines the goodwill that relates to the whole of the
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subsidiary, ie goodwill that is both attributable to the parent’s interest and the non-controlling
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interest (NCI).
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You should note that either method is acceptable and therefore for the FR exam you need to be
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able to apply both approaches. You will be given a clear indication of which method the examiner
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wishes you to use.
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Consider calculating goodwill
Borough acquires an 80% interest in the equity shares of High for consideration of $500. The fair
value of the net assets of High at that date is $400. The fair value of the NCI at that date (ie the fair
value of High’s shares not acquired by Borough) is $100.
Required
1. Calculate the goodwill arising on the acquisition of High on a proportionate basis.
2. Calculate the gross goodwill arising on the acquisition of High, ie using the fair value of the NCI.
Solution
1. The proportionate goodwill arising is calculated by matching the consideration that the parent has
given, with the interest that the parent acquires in the net assets of the subsidiary, to give the
goodwill of the subsidiary that is attributable to the parent.
Parent’s cost of investment at the

$500
fair value of consideration given
Less the parent’s share of the fair

value of the net assets of the
subsidiary acquired (80% x $400) ($320)
Goodwill attributable to the parent $180
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2. The gross goodwill arising is calculated by matching the fair value of the whole business with the
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whole fair value of the net assets of the subsidiary to give the whole goodwill of the subsidiary,
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attributable to both the parent and to the NCI.
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Parent’s cost of investment at the
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$500
fair value of consideration given
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Fair value of the NCI $100
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Less the fair value of the net
assets of the subsidiary acquired (100% x $400) ($400)

Gross goodwill $200
Given a gross goodwill of $200 and a goodwill attributable to the parent of $180, the goodwill
attributable to the NCI is the difference of $20.
In these examples, goodwill is said to be a premium arising on acquisition. Such goodwill is

accounted for as an intangible asset in the group accounts, and as we shall see later, be subject to
an annual impairment review.
In the event that there is a bargain purchase, ie negative goodwill arises, then this is regarded as a
gain and immediately recognised in the group statement of proft or loss on the acquisition date. In
subsequent years this will be an adjustment to the group retained earnings.
Basic principles of impairment
An asset is impaired when its carrying value exceeds the recoverable amount. The recoverable
amount is, in turn, defned as the higher of the fair value less cost to sell and the value in use;
where the value in use is the present value of the future cash fows.
An impairment review calculation looks like this.
This is the net book value, ie the fgure that the asset is currently recorded at in the accounts.
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Consider an impairment review
A company has an asset that has a carrying value of $800. The asset has not been revalued. The
asset is subject to an impairment review. If the asset was sold then it would sell for $610 and there
would be associated selling costs of $10. (The fair value less costs to sell of the asset is therefore
$600.) The estimate of the present value of the future cash fows to be generated by the asset if it
were kept is $750. (This is the value in use of the asset.)
Required
Determine the outcome of the impairment review.
Solution
An asset is impaired when its carrying value exceeds the recoverable amount, where the
recoverable amount is the higher of the fair value less costs to sell and the value in use. In this
case, with a fair value less cost to sell of only $600 and a value in use of $750 it both follows the
rules, and makes common sense to minimise losses, that the recoverable amount will be the higher
of the two, ie $750.
Impairment review
Carrying value of the asset $800
x
Recoverable amount ($750)
Bo
l
Impairment loss $50
b a
G lo
The impairment loss must be recorded so that the asset is written down. There is no accounting
policy or choice about this. In the event that the recoverable amount had exceeded the carrying
A
amount then there would be no impairment loss to recognise and as there is no such thing as an
C
impairment gain, no accounting entry would arise.
A C
As the asset has never been revalued, the loss has to be charged to proft or loss. Impairment
losses are non-cash expenses, like depreciation, so in the statement of cash fows they will be
added back when reconciling proft before tax to cash generated from operating activities (indirect
method) or removed as a non-cash expense to arrive at the cash outfows under the direct method.
This is the same treatment as other non-cash expenses like depreciation and amortisation.
Assets are generally subject to an impairment review only if there are indicators of impairment. IAS
36, Impairment of Assets lists examples of circumstances that would trigger an impairment review.
External sources
• market value declines

• negative changes in technology, markets, economy, or laws
• increases in market interest rates
• company share price is below book value
Internal sources
• obsolescence or physical damage

• asset is part of a restructuring or held for disposal
• worse economic performance than expected
However certain intangible assets must be assessed for impairment annually, irrespective of
whether there are indications of impairment. These are:
assets with an indefnite useful life
x
•
o
• assets not yet available for use
• goodwill acquired in a business combination
l B
b a
lo
Goodwill and impairment
G
A
The asset of goodwill does not exist in a vacuum; rather, it arises in the group accounts because it
C
is not separable from the net assets of the subsidiary that have just been acquired.
A C
The impairment review of goodwill therefore takes place at the level of a cash-generating unit, that
is to say a collection of assets that together create an stream of cash independent from the cash
fows from other assets. The cash-generating unit will normally be assumed to be the subsidiary. In
this way, when conducting the impairment review, the carrying value will be that of the net assets
and the goodwill of the subsidiary compared with the recoverable amount of the subsidiary.
When looking to assign the impairment loss to particular assets within the cash generating unit,
unless there is an asset that is specifcally impaired, it is goodwill that is written off frst, with any
further balance being assigned on a pro rata basis.
The goodwill arising on the acquisition of a subsidiary is subject to an annual impairment review.
This requirement ensures that the asset of goodwill is not being overstated in the group accounts.
Goodwill is an asset that cannot be revalued so any impairment loss will automatically be charged
against proft or loss. Goodwill is not deemed to be systematically consumed or worn out thus there
is no requirement for a systematic amortisation unlike most intangible assets.
Proportionate goodwill and the impairment review
When goodwill has been calculated on a proportionate basis then for the purposes of conducting
the impairment review it is necessary to gross up goodwill so that in the impairment review goodwill
will include an unrecognised 'notional goodwill' attributable to the NCI.
Any impairment loss that arises is frst allocated against the total of recognised and unrecognised
goodwill in the normal proportions that the parent and NCI share profts and losses.
Any amounts written off against the notional goodwill will not affect the consolidated fnancial
statements and NCI. Any amounts written off against the recognised goodwill will be attributable to
the parent only, without affecting the NCI.
x
If the total amount of impairment loss exceeds the amount allocated against recognised and
o
notional goodwill, the excess will be allocated against the other assets on a pro rata basis. This
B
further loss will be shared between the parent and the NCI in the normal proportion that they share
a l
profts and losses.
An example should make this rule clearer.
lo b
G
A
Consider an impairment review of proportionate goodwill
CC
A
At the year-end, an impairment review is being conducted on a 60%-owned subsidiary. At the date
of the impairment review the carrying value of the subsidiary’s net assets were $250 and the
goodwill attributable to the parent $300 and the recoverable amount of the subsidiary $700.
Required
Solution
In conducting the impairment review of proportionate goodwill, it is frst necessary to gross it up.
Goodwill including the
Proportionate goodwill Grossed up
notional unrecognised NCI
$300 x 100/60 = $500
Now, for the purposes of the impairment review, the goodwill of $500 together with the net assets of
$250 form the carrying value of the cash-generating unit.
Impairment review
Carrying value
x
Net assets $250
Bo
a l
Goodwill $500
lo b $750
G
C A
Recoverable amount ($700)
Impairment loss
A C $50
The impairment loss does not exceed the total of the recognised and unrecognised goodwill so
therefore it is only goodwill that has been impaired. The other assets are not impaired. As
proportionate goodwill is only attributable to the parent, the impairment loss will not impact NCI.
Only the parent’s share of the goodwill impairment loss will actually be recorded, ie 60% x $50 =
$30.
The impairment loss will be applied to write down the goodwill, so that the intangible asset of
goodwill that will appear on the group statement of fnancial position will be $270 ($300 – $30).
In the group statement of fnancial position, the accumulated profts will be reduced $30. There is no
impact on the NCI.
In the group statement of proft or loss, the impairment loss of $30 will be charged as an extra
operating expense. There is no impact on the NCI.
Gross goodwill and the impairment review
Where goodwill has been calculated gross, then all the ingredients in the impairment review
process are already consistently recorded in full. Any impairment loss (whether it relates to the
gross goodwill or the other assets) will be allocated between the parent and the NCI in the normal
proportion that they share profts and losses.
x
Consider an impairment review of gross goodwill
Bo
l
At the year-end, an impairment review is being conducted on an 80%-owned subsidiary. At the date
a
of the impairment review the carrying value of the net assets were $400 and the gross goodwill
lo b
$300 (of which $40 is attributable to the NCI) and the recoverable amount of the subsidiary $500.
G
Required
A
Solution
CC
A
The impairment review of goodwill is really the impairment review of the net asset’s subsidiary and
its goodwill, as together they form a cash generating unit for which it is possible to ascertain a
recoverable amount.
Impairment review
Carrying value
Net assets $400
Goodwill $300
$700
Recoverable amount $500
Impairment loss $200
The impairment loss will be applied to write down the goodwill, so that the intangible asset of
goodwill that will appear on the group statement of fnancial position, will be $100 ($300 – $200).
In the equity of the group statement of fnancial position, the accumulated profts will be reduced by
the parent’s share of the impairment loss on the gross goodwill, ie $160 (80% x $200) and the NCI
x
reduced by the NCI’s share, ie $40 (20% x $200).
Bo
In the statement of proft or loss, the impairment loss of $200 will be charged as an extra operating
a l
expense. As the impairment loss relates to the gross goodwill of the subsidiary, so it will reduce the
b
NCI in the subsidiary’s proft for the year by $40 (20% x $200).
Observation
G lo
C A
C
In passing, you may wish to note an apparent anomaly with regards to the accounting treatment of
A
gross goodwill and the impairment losses attributable to the NCI. The goodwill attributable to the
NCI in this example is stated as $40. This means that goodwill is $40 greater than it would have
been if it had been measured on a proportionate basis; likewise, the NCI is also $40 greater for
having been measured at fair value at acquisition.
The split of the gross goodwill between what is attributable to the parent and what is attributable to
the NCI is determined by the relative values of the NCI at acquisition to the parent’s cost of
investment. However, when it comes to the allocation of impairment losses attributable to the write
off of goodwill then these losses are shared in the normal proportions that the parent and the NCI
share profts and losses, ie in this case 80%/20%.
This explains the strange phenomena that while the NCI are attributed with only $40 out of the $300
of the gross goodwill, when the gross goodwill was impaired by $200 (ie two thirds of its value), the
NCI are charged $40 of that loss, representing all of the goodwill attributable to the NCI.
Tom Clendon and Sally Baker are tutors at Kaplan Financial

Deferred tax | ACCA Global
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o x
Deferred tax
l B
b a
Deferred tax is a topic that is consistently
G lo
A
tested in Financial Reporting (FR) and is
C
often tested in further detail in Strategic
A C
Business Reporting (SBR). This article
will start by considering aspects of
deferred tax that are relevant to FR before
moving on to the more complicated
situations that may be tested in SBR.
The basics
The FR exam
The SBR exam
The basics
Deferred tax is accounted for in accordance with

IAS® 12, Income Taxes. In FR, deferred tax
normally results in a liability being recognised within
the Statement of Financial Position. IAS 12 defnes
a deferred tax liability as being the amount of
income tax payable in future periods in respect of
taxable temporary differences. So, in simple terms,
deferred tax is tax that is payable in the future.
However, to understand this defnition more fully, it
is necessary to explain the term ‘taxable temporary
differences’.
Temporary differences are defned as being
o x
differences between the carrying amount of an
l B
a
asset (or liability) within the Statement of Financial
b
Position and its tax base ie the amount at which the
lo
asset (or liability) is valued for tax purposes by the
G
relevant tax authority.
C A
Taxable temporary differences are those on which
C
tax will be charged in the future when the asset (or
A
liability) is recovered (or settled).
IAS 12 requires that a deferred tax liability is

recorded in respect of all taxable temporary
differences that exist at the year-end – this is
sometimes known as the full provision method.
All of this terminology can be rather overwhelming

and diffcult to understand, so consider it alongside
an example. Depreciable non-current assets are the
typical deferred tax example used in FR.
Within fnancial statements, non-current assets with

a limited useful life are subject to depreciation.
However, within tax computations, non-current
assets are subject to capital allowances (also
known as tax depreciation) at rates set within the

relevant tax legislation. Where at the year-end the
cumulative depreciation charged and the cumulative
capital allowances claimed are different, the
carrying amount of the asset (cost less accumulated
depreciation) will then be different to its tax base
(cost less accumulated capital allowances) and
hence a taxable temporary difference arises.
EXAMPLE 1
A non-current asset costing $2,000 was acquired at
the start of year 1. It is being depreciated straight
line over four years, resulting in annual depreciation
charges of $500. Thus a total of $2,000 of
o x
depreciation is being charged. The capital
B
allowances granted on this asset are:
a l
lo b
G

C A $
Year 1
A C 800
Year 2 600
Year 3 360
Year 4 240
Total capital allowances 2,000
Table 1 shows the carrying amount of the asset, the

tax base of the asset and therefore the temporary
difference at the end of each year.
As stated above, deferred tax liabilities arise on

taxable temporary differences, ie those temporary
differences that result in tax being payable in the
future as the temporary difference reverses. So,
how does the above example result in tax being
payable in the future?
Entities pay income tax on their taxable profts.

When determining taxable profts, the tax authorities
start by taking the proft before tax (accounting
profts) of an entity from their fnancial statements
o x
and then make various adjustments. For example,
B
depreciation is considered a disallowable expense
l
for taxation purposes but instead tax relief on capital
a
expenditure is granted in the form of capital
b
allowances. Therefore, taxable profts are arrived at
lo
by adding back depreciation and deducting capital
G
allowances from the accounting profts. Entities are
A
then charged tax at the appropriate tax rate on
C
these taxable profts.
A C
In the above example, when the capital allowances

are greater than the depreciation expense in years
1 and 2, the entity has received tax relief early. This
is good for cash fow in that it delays (ie defers) the
payment of tax. However, the difference is only a
temporary difference and so the tax will have to be
paid in the future. In years 3 and 4, when the capital
allowances for the year are less than the
depreciation charged, the entity is being charged
additional tax and the temporary difference is
reversing. Hence the temporary differences can be

said to be taxable temporary differences.
Notice that overall, the accumulated depreciation

and accumulated capital allowances both equal
$2,000 – the cost of the asset – so over the four-
year period, there is no difference between the
taxable profts and the profts per the fnancial
statements.
At the end of year 1, the entity has a temporary

difference of $300, which will result in tax being
payable in the future (in years 3 and 4). In
accordance with the concept of prudence, a liability
o x
is therefore recorded equal to the expected tax
B
payable.
Assuming that the tax rate applicable to the
a l
lo b
company is 25%, the deferred tax liability that will
be recognised at the end of year 1 is 25% x $300 =
G
$75. This will be recorded by crediting (increasing) a
A
deferred tax liability in the Statement of Financial
C
Position and debiting (increasing) the tax expense
C
in the Statement of Proft or Loss.
A
By the end of year 2, the entity has a taxable
temporary difference of $400, ie the $300 bought
forward from year 1, plus the additional difference of
$100 arising in year 2. A liability is therefore now
recorded equal to 25% x $400 = $100. Since there
was a liability of $75 recorded at the end of year 1,
the double entry that is recorded in year 2 is to
credit (increase) the liability and debit (increase) the
tax expense by $25.
At the end of year 3, the entity’s taxable temporary

differences have decreased to $260 (since the
company has now been charged tax on the
difference of $140). Therefore in the future, the tax
payable will be 25% x $260 = $65. The deferred tax
liability now needs reducing from $100 to $65 and
so is debited (a decrease) by $35. Consequently,
there is now a credit (a decrease) to the tax
expense of $35.
At the end of year 4, there are no taxable temporary

differences since now the carrying amount of the
asset is equal to its tax base. Therefore the opening
liability of $65 needs to be removed by a debit entry
(a decrease) and hence there is a credit entry (a
decrease) of $65 to the tax expense. This can all be
summarised in the following working.
The movements in the liability are recorded in the
x
Statement of Proft or Loss as part of the taxation
charge
B o
a l
lo b
G
Year 1
C A2 3 4
C
$ $ $ $
Opening deferred
tax liability
A0 75 100 65
Increase/(decrease) 75 25 (35) (65)

in the year
Closing deferred tax 75 100 65 0

liability
The closing fgures are reported in the Statement

of Financial Position as part of the deferred tax
liability.
Proforma
Example 1 provides a proforma, which may be a
useful format to deal with deferred tax within a
published fnancial statements question. The
movement in the deferred tax liability in the year is
recorded in the Statement of Proft or Loss where:
an increase in the liability, increases the tax

expense
a decrease in the liability, decreases the tax
expense.
The closing fgures are reported in the Statement of
o x
B
Financial Position as the deferred tax liability.
a l
b
The Statement of Proft or Loss
lo
As IAS 12 considers deferred tax from the
G
perspective of temporary differences between the
carrying amount and tax base of assets and
A
liabilities, the standard can be said to take a
C
‘balance sheet approach’. However, it will be helpful
C
to consider the effect on the Statement of Proft or
A
Loss.
Continuing with the previous example, suppose that

the proft before tax of the entity for each of years 1
to 4 is $10,000 (after charging depreciation). Since
the tax rate is 25%, it would then be logical to
expect the tax expense for each year to be $2,500.
However, income tax is based on taxable profts not
on the accounting profts.
The taxable profts and so the actual tax liability for

each year could be calculated as in Table 2.
The income tax liability is then recorded as a tax

expense. As we have seen in the example,
accounting for deferred tax then results in a further
increase or decrease in the tax expense. Therefore,
the fnal tax expense for each year reported in the
Statement of Proft or Loss would be as in Table 3.
It can therefore be said that accounting for deferred

tax is ensuring that the matching principle is
applied. The tax expense reported in each period is
the tax consequences (ie tax charges less tax relief)
of the items reported within proft in that period.
o x
l B
ba
G lo
C A
A C
The FR exam
Deferred tax is consistently tested in the published

fnancial statementsfnancial statements question in
the FR exam. Here are some hints on how to deal
with the information in the question.
The deferred tax liability given within the trial

balance or draft fnancial statements will be
the opening liability balance.
In the notes to the question there will be
information to enable you to calculate the
closing liability for the SFP or the

increase/decrease in the liability.
It is important that you read the information

carefully. You will need to ascertain exactly what
you are being told within the notes to the question
and therefore how this relates to the working that
you can use to calculate the fgures for the answer.
Consider the following sets of information – all of

which will achieve the same ultimate answer in the
published fnancial statements.
x
EXAMPLE 2
o
The trial balance shows a credit balance of $1,500
B
in respect of a deferred tax liability.
a l
b
The notes to the question could contain one of the
lo
following sets of information:
G
1. At the year-end, the required deferred tax
A
liability is $2,500.
C
2. At the year-end, it was determined that an
C
increase in the deferred tax liability of $1,000
A
was required.
3. At the year-end, there are taxable temporary
differences of $10,000. Tax is charged at a
rate of 25%.
4. During the year, taxable temporary
differences increased by $4,000. Tax is
charged at a rate of 25%.
Situations 1 and 2 are both giving a fgure that can
x
be slotted straight into the deferred tax working. In
o
situations 3 and 4 however, the temporary
l B
differences are being given. These are then used to
a
calculate a fgure which can be slotted into the
b
working. In all situations, the missing fgure is
lo
calculated as a balancing fgure. Table 4 shows the
G
completed workings.
C A
Revaluations of non-current assets
C
Revaluations of non-current assets (NCA) are a
A
further example of a taxable temporary difference.
When an NCA is revalued to its current value within
the fnancial statements, the revaluation surplus is
recorded in equity (in a revaluation reserve) and
reported as other comprehensive income. While the
carrying amount of the asset has increased, the tax
base of the asset remains the same and so a
temporary difference arises.
Tax will become payable on the surplus when the

asset is sold and so the temporary difference is
taxable. Since the revaluation surplus has been
recognised within equity, to comply with matching,
the tax charge on the surplus is also charged to
equity. Suppose that in Example 1, the asset is
revalued to $2,500 at the end of year 2, as shown in
Table 5.
The carrying amount will now be $2,500 while the

tax base remains at $600. There is, therefore, a
temporary difference of $1,900, of which $1,500
relates to the revaluation surplus. This gives rise to
a deferred tax liability of 25% x $1,900 = $475 at the
x
year-end to report in the Statement of Financial
o
Position. The liability was $75 at the start of the year
B
( Example 1) and thus there is an increase of $400
l
to record.
b a
lo
However, the increase in relation to the revaluation
surplus of 25% x $1,500 = $375 will be charged to
G
the revaluation reserve and reported within other
A
comprehensive income. The remaining increase of
C
$25 will be charged to the Statement of Proft or
C
Loss as before.
A
The overall double entry is:
Dr Tax expense in Statement of Proft or $25

Loss
Dr Revaluation reserve in equity $375
Cr Deferred tax liability in SFP $400
The SBR exam
It is important to appreciate that deferred tax can

arise in respect of many different types of asset or
liability and not just non-current assets as discussed
above. Therefore, for SBR it is more important that
candidates understand the principles behind
deferred tax so that they can be applied to any
given situation. Some of the situations that may be
seen are discussed below. In all of the following
x
situations, assume that the applicable tax rate is
o
25%.
l B
a
Deferred tax assets
b
It is important to be aware that temporary
lo
differences can result in needing to record a
G
deferred tax asset instead of a liability. Temporary
A
differences affect the timing of when tax is paid or
C
when tax relief is received. While normally they
C
result in the payment being deferred until the future
A
or relief being received in advance (and hence a
deferred tax liability) they can result in the payment
being accelerated or relief being due in the future.
In these latter situations the temporary differences

result in a deferred tax asset arising (or where the
entity has other larger temporary differences that
create deferred tax liabilities, a reduced deferred tax
liability).
Whether an individual temporary difference gives

rise to a deferred tax asset or liability can be
ascertained by applying the following rule:
Carrying Tax base Temporary

amount of asset of asset / = difference
/ (Liability)
(Liability)
If the temporary difference is positive, a deferred tax

liability will arise. If the temporary difference is
negative, a deferred tax asset will arise.
o x
l B
b a
G lo
C A
EXAMPLE 3
A C
Suppose that at the reporting date the carrying
amount of a non-current asset is $2,800 while its tax
base is $3,500, as shown in Table 6 above.
In this scenario, the carrying amount of the asset

has been written down to below the tax base. This
might be because an impairment loss has been
recorded on the asset which is not allowable for tax
purposes until the asset is sold. The entity will
therefore receive tax relief on the impairment loss in
the future when the asset is sold.
The deferred tax asset at the reporting date will be

25% x $700 = $175.
It is worth noting here that revaluation gains, which
increase the carrying amount of the asset and leave
the tax base unchanged, result in a deferred tax
liability. Conversely, impairment losses, which
decrease the carrying amount of the asset and
leave the tax base unchanged, result in a deferred
tax asset.
EXAMPLE 4
At the reporting date, inventory which cost $10,000
has been written down to its net realisable value of
$9,000. The write down is ignored for tax purposes
until the goods are sold.
o x
The write off of inventory will generate tax relief, but
B
only in the future when the goods are sold. Hence
l
the tax base of the inventory is not reduced by the
a
write off. Consequently, a deferred tax asset of 25%
lo b
x $1,000 = $250 as shown in Table 8 should be
recorded at the reporting date.
G
A
EXAMPLE 5
C
At the reporting date, an entity has recorded a
C
liability of $25,000 in respect of pension
A
contributions due. Tax relief is available on pension
contributions only when they are paid.
The contributions will only be recognised for tax

purposes when they are paid in the future. Hence
the pension expense is currently ignored within the
tax computations and so the liability has a nil tax
base, as shown in Table 8. The entity will receive
tax relief in the future and so a deferred tax asset of
25% x $25,000 = $6,250 should be recorded at the
reporting date.
Group fnancial statements

When dealing with deferred tax in group fnancial
statements, it is important to remember that a group
does not legally exist and so is not subject to tax.
Instead, tax is levied on the individual legal entities

within the group and their individual tax assets and
liabilities are cross-cast in the consolidation
process. To calculate the deferred tax implications
on consolidation adjustments when preparing the
group fnancial statements, the carrying amount
refers to the carrying amount within the group
fnancial statements while the tax base will be the
tax base in the entities’ individual fnancial
statements.
Fair value adjustments

At the date of acquisition, a subsidiary’s net assets
are measured at fair value. The fair value
o x
adjustments may not alter the tax base of the net
B
assets and hence a temporary difference may arise.
l
Any deferred tax asset/liability arising as a result is
a
included within the fair value of the subsidiary’s net
lo b
assets at acquisition for the purposes of calculating
goodwill.
G
A
Goodwill
C
Goodwill only arises on consolidation – it is not
C
recognised as an asset within the individual
A
fnancial statements. Theoretically, goodwill gives
rise to a temporary difference that would result in a
deferred tax liability as it is an asset with a carrying
amount within the group fnancial statements but will
have a nil tax base. However, IAS 12 specifcally
excludes a deferred tax liability being recognised in
respect of goodwill.
Provisions for unrealised profts (PUPs)

When goods are sold between group companies
and remain in the inventory of the buying company
at the year-end, an adjustment is made to remove
the unrealised proft from the consolidated fnancial
statements. This adjustment also reduces the
inventory to the original cost when a group company
frst purchased it. However, the tax base of the
inventory will be based on individual fnancial
statements and so will be at the higher transfer
price. Consequently, a deferred tax asset will arise.
Recognition of the asset and the consequent
decrease in the tax expense will ensure that the tax
already charged to the individual selling company is
not refected in the current year’s consolidated
Statement of Proft or Loss but will be matched
against the future period when the proft is
recognised by the group.
EXAMPLE 6
P owns 100% of the equity share capital of S. P
sold goods to S for $1,000 recording a proft of
o x
$200. All of the goods remain in the inventory of S
B
at the year-end. Table 9 shows that a deferred tax
l
asset of 25% x $200 = $50 should be recorded
a
within the group fnancial statements.
Measurement of deferred tax
lo b
G
IAS 12 states that deferred tax assets and liabilities
A
should be measured based on the tax rates that are
C
expected to apply when the asset/liability will be
C
realised/settled. Normally, current tax rates are
A
used to calculate deferred tax on the basis that they
are a reasonable approximation of future tax rates
and that it would be too unreliable to estimate future
tax rates.
Deferred tax assets and liabilities represent future

taxes that will be recovered or that will be payable.
It may therefore be expected that they should be
discounted to refect the time value of money, which
would be consistent with the way in which other
liabilities are measured. IAS 12, however, does not
permit or allow the discounting of deferred tax
assets or liabilities on practical grounds.
The primary reason behind this is that it would be

necessary for entities to determine when the future
tax would be recovered or paid. In practice this is
highly complex and subjective. Therefore, to require
discounting of deferred tax liabilities would result in
a high degree of unreliability. Furthermore, to allow
but not require discounting would result in
inconsistency and so a lack of comparability
o x
between entities.
Deferred tax and the framework
l B
a
As we have seen, IAS 12 considers deferred tax by
lo b
taking a “balance sheet” approach to the accounting
problem by considering temporary differences in
G
terms of the difference between the carrying
A
amounts and the tax values of assets and liabilities
C
– also known as the valuation approach. This can
C
be said to be consistent with the approach taken to
A
recognition in the International Accounting
Standards Board’s Conceptual Framework for
Financial Reporting® (the Conceptual Framework).
However, the valuation approach is applied
regardless of whether the resulting deferred tax will
meet the defnition of an asset or liability in its own
right.
Thus, IAS 12 considers the overriding accounting

issue behind deferred tax to be the application of
matching – ensuring that the tax consequences of
an item reported within the fnancial statements are
reported in the same accounting period as the item
itself.
For example, in the case of a revaluation surplus,
since the gain has been recognised in the fnancial
statements, the tax consequences of this gain
should also be recognised – that is to say, a tax
charge. In order to recognise a tax charge, it is
necessary to complete the double entry by also
recording a corresponding deferred tax liability.
However, part of the Conceptual Framework’s

defnition of a liability is that there is a ‘present
obligation’. Therefore, the deferred tax liability
arising on the revaluation gain should represent the
current obligation to pay tax in the future when the
asset is sold. However, since there is no present
obligation to sell the asset, there is no present
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obligation to pay the tax.
Therefore, it is also acknowledged that IAS 12 is
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inconsistent with the Conceptual Framework to the
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extent that a deferred tax asset or liability does not
necessarily meet the defnition of an asset or
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liability.
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Sally Baker and Tom Clendon are tutors at
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Kaplan Financial
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Measurement and depreciation
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Measurement and depreciation
Part 1
This is the frst of two articles which consider the main features of International Accounting
Standard (IAS®) 16, Property, Plant and Equipment (PPE). This standard deals with the four main
aspects of fnancial reporting of PPE that are likely to be of major relevance in the FR exam,
namely:
• initial measurement and depreciation – covered in this article

• revaluation and derecognition – covered in the second article.
IAS 16 defnes PPE as tangible items that are:
• held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes and
• expected to be used during more than one accounting period.
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The initial measurement of PPE
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IAS 16 requires that PPE should initially be measured at ‘cost’. The cost of an item of PPE
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comprises:
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• the cost of purchase, net of any trade discounts plus any import duties and non-refundable
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sales taxes
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• any costs directly attributable to bringing the asset to the location and condition necessary for it
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to be capable of operating in the manner intended by management.
These are costs that would have been avoided if the asset had not been purchased or constructed.
General overhead costs cannot be allocated to the cost of PPE. Directly attributable costs include:
• employee benefts payable to staff installing, constructing, or initially testing the asset
• site preparation
• professional fees directly associated with the installation, construction, or initial testing of the
asset
• any other overhead costs directly associated with the installation, construction, or initial testing
of the asset.
Where these costs are incurred over a period of time (such as employee benefts), the period for
which the costs can be included in the cost of PPE ends when the asset is ready for use, even if the
asset is not brought into use until a later date. As soon as an asset is capable of operating it is
ready for use. The fact that it may not operate at normal levels immediately, because demand has
not yet built up, does not justify further capitalisation of costs in this period. Any abnormal costs (for
example, wasted material) cannot be included in the cost of PPE.
IAS 16 does not specifcally address the issue of whether borrowing costs associated with the
fnancing of a constructed asset can be regarded as a directly attributable cost of construction. This
issue is addressed in IAS 23, Borrowing Costs. IAS 23 requires the inclusion of borrowing costs as
part of the cost of constructing the asset. In order to be consistent with the treatment of ‘other
costs’, only those fnance costs that would have been avoided if the asset had not been constructed
are eligible for inclusion. If the entity has borrowed funds specifcally to fnance the construction of
an asset, then the amount to be capitalised is the actual fnance costs incurred. Where the
borrowings form part of the general borrowing of the entity, then a capitalisation rate that represents
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the weighted average borrowing rate of the entity should be used.
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The cost of the asset will include the best available estimate of the costs of dismantling and
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removing the item and restoring the site on which it is located, where the entity has incurred an
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obligation to incur such costs by the date on which the cost is initially established. This is a
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component of cost to the extent that it is recognised as a provision under IAS 37, Provisions,
Contingent Liabilities and Contingent Assets. In accordance with the principles of IAS 37, the
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amount to be capitalised in such circumstances would be the amount of foreseeable expenditure
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appropriately discounted where the effect is material.
EXAMPLE 1
CC
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On 1 October 20X6, Omega began the construction of a new factory. Costs relating to the factory,
incurred in the year ended 30 September 20X7, are as follows:
$000
Purchase of the land 10,000
Costs of dismantling existing structures on the site 500
Purchase of materials to construct the factory 6,000

Employment costs (Note 1) 1,800
Production overheads directly related to the construction

1,200
(Note 2)
Allocated general administrative overheads 600
Architects’ and consultants’ fees directly related to the construction 400
x
Costs of relocating staff who are to work at the new factory 300
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Costs relating to the formal opening of the factory 200
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Interest on loan to partly fnance the construction of the factory (Note 3) 1,200
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Note 1: The factory was constructed in the eight months ended 31 May 20X7. It was brought into
use on 30 June 20X7. The employment costs are for the nine months to 30 June 20X7.
Note 2: The production overheads were incurred in the eight months ended 31 May 20X7. They
included an abnormal cost of $200,000, caused by the need to rectify damage resulting from a gas
leak.
Note 3: Omega received the loan of $12m on 1 October 20X6. The loan carries a rate of interest of
10% per annum.
Note 4: The factory has an expected useful economic life of 20 years. At that time the factory will be
demolished and the site returned to its original condition. This is a legal obligation that arose on
signing the contract to purchase the land. The expected costs of fulflling this obligation are $2m. An
appropriate annual discount rate is 8%.
Requirement
Compute the initial carrying value of the factory (see solution).
Depreciation of PPE
IAS 16 defnes depreciation as ‘the systematic allocation of the depreciable amount of an asset
over its useful life’. The ‘depreciable amount’ is the cost of an asset, cost less residual value, or
other amount (for example the revaluation of the asset). Depreciation does not provide for loss of
value of an asset, but is an accruals accounting technique that allocates the depreciable amount of
the asset to the periods expected to beneft from the use of the asset. Therefore assets that are
increasing in value still need to be depreciated.
IAS 16 requires that depreciation should be recognised as an expense in the statement of proft or
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loss, unless it is permitted to be included in the carrying amount of another asset. An example of
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this practice would be the possible inclusion of depreciation in the costs incurred on a construction
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contract that are carried forward and matched against future income from the contract, under the
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provisions of International Financial Reporting Standard (IFRS®) 15, Revenue from Contracts with
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Customers.
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A number of methods can be used to allocate depreciation to specifc accounting periods. Two of
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the more common methods, specifcally mentioned in IAS 16, are the straight line method, and the
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reducing (or diminishing) balance method.
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The assessments of the useful life (UL) and residual value (RV) of an asset are extremely
subjective. They will only be known for certain after the asset is sold or scrapped, and this is too
late for the purpose of computing annual depreciation. Therefore, IAS 16 requires that the estimates
should be reviewed at the end of each reporting period. If either changes signifcantly, then that
change should be accounted for over the remaining estimated useful life.
EXAMPLE 2
An item of plant was acquired for $220,000 on 1 January 20X6. The estimated UL of the plant was
fve years and the estimated RV was $20,000. The asset is depreciated on a straight line basis. On
31 December 20X6 the future estimate of the UL of the plant was changed to three years, with an
estimated RV of $12,000.
At the date of purchase, the plant’s depreciable amount would have been $200,000 ($220,000 –
$20,000). Therefore, depreciation of $40,000 would have been charged in 20X6, and the carrying
amount would have been $180,000 at the end of 20X6. Given the reassessment of the UL and RV,
the depreciable amount at the end of 20X6 is $168,000 ($180,000 – $12,000) over three years.
Therefore, the depreciation charges in 20X7, 20X8 and 20X9 will be $56,000 ($168,000/3) unless
there are future changes in estimates. Where an asset comprises two or more major components
with substantially different useful lives, each component should be accounted for separately for
depreciation purposes, and each depreciated over its UL.
EXAMPLE 3
On 1 January 20X2, an entity purchased a furnace for $200,000. The estimated UL of the furnace
was 10 years, but its lining needed replacing after fve years. On 1 January 20X2 the entity
estimated that the cost of relining the furnace (at 1 January 20X2 prices) was $50,000. The lining
was replaced on 1 January 20X7 at a cost of $70,000.
Requirement
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Compute the annual depreciation charges on the furnace for each year of its life.
Solution
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20X2–20X6 inclusive: Compute the annual depreciation charges on the furnace for each year of its
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useful life.
CC
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Solution 20X2–20X6 inclusive: The asset has two depreciable components: (i) the lining element
(allocated cost $50,000 – UL fve years); and (ii) the balance of the cost (allocated cost $150,000 –
UL 10 years). Therefore, the annual depreciation is $25,000 ($50,000 x 1/5 + $150,000 x 1/10). At
31 December 20X6, the ‘lining component’ has a carrying amount of zero.
From 20X7: The $70,000 spent on the new lining is treated as the replacement of a separate
component of an asset and added to PPE. The annual depreciation is now $29,000 ($70,000 x 1/5
+ $150,000 x 1/10).
Paul Robins is a lecturer at Kaplan
Revaluation and derecognition | ACCA Global
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Revaluation and derecognition
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Revaluation and derecognition
Part 2
This is the second of two articles, and considers revaluation of property, plant and equipment (PPE)
and its derecognition in accordance with International Accounting Standard (IAS ®) 16, Property,
Plant and Equipment (PPE). It also summarises the provisions of International Financial Reporting
Standard (IFRS®) 5, Non-current assets held for sale and discontinued operations. The frst part of
this article (see 'Related links') considered the initial measurement and depreciation of PPE.
Revaluation of PPE – IAS 16 position

General principles
IAS 16 allows entities the choice of two valuation models for PPE – the cost model or the
revaluation model. Each model needs to be applied consistently to all PPE of the same ‘class’. A
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class of assets is a grouping of assets that have a similar nature or function within the business. For
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example, properties would typically be one class of assets, and plant and equipment another.
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Additionally, if the revaluation model is chosen, the revaluations need to be kept up to date,
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although IAS 16 is not specifc as to how often assets need to be revalued.
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When the revaluation model is used, assets are carried at their fair value, defned as ‘the amount
for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length
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transaction’.
Revaluation gains
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Revaluation gains are recognised in equity unless they reverse revaluation losses on the same
asset that were previously recognised in the statement of proft or loss. In these circumstances, the
revaluation gain is recognised in the statement of proft or loss. Revaluation changes the
depreciable amount of an asset so subsequent depreciation charges are also affected.
EXAMPLE 1
A property was purchased on 1 January 20X0 for $2m (estimated depreciable amount was $1m
and it had a useful life 50 years). Annual depreciation of $20,000 was charged from 20X0 to 20X4
inclusive and on 1 January 20X5 the carrying amount of the property was $1.9m. The property was
revalued to $2.8m on 1 January 20X5 (estimated depreciable amount was $1.35m and the
estimated useful life was unchanged). Show the treatment of the revaluation surplus and compute
the revised annual depreciation charge.
Solution
The revaluation surplus of $900,000 ($2.8m – $1.9m) is recognised in the statement of changes in
equity by crediting a revaluation reserve. The depreciable amount of the property is now $1.35m
and the remaining estimated useful life 45 years (50 years from 1 January 20X0). Therefore, the
depreciation charge from 20X5 onwards would be $30,000 ($1.35m x 1/45).
A revaluation usually increases the annual depreciation charge in the statement of proft or loss. In
the above example, the annual increase is $10,000 ($30,000 – $20,000). IAS 16 allows (but does
not require) entities to make a transfer of this ‘excess depreciation’ from the revaluation reserve
directly to retained earnings.
Revaluation losses
Revaluation losses are recognised in the statement of proft or loss. The only exception to this rule
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is where a revaluation surplus exists relating to a previous revaluation of that asset. To that extent,
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a revaluation loss can be recognised in equity.
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a
EXAMPLE 2
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The property referred to in Example 1 was revalued on 31 December 20X6. Its fair value had fallen
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to $1.5m. Compute the revaluation loss and state how it should be treated in the fnancial
statements.
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Solution
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The carrying amount of the property at 31 December 20X6 would have been $2.74m ($2.8m – 2 x
$30,000). This means that the revaluation defcit is $1.24m ($2.74m – $1.5m).
If the transfer of excess depreciation (see above) is not made, then the balance in the revaluation
reserve relating to this asset is $900,000 (see Example 1). Therefore $900,000 is deducted from
equity and $340,000 ($1.24m – $900,000) is charged to the statement of proft or loss.
If the transfer of excess depreciation is made, then the balance on the revaluation reserve at 31
December 20X6 is $880,000 ($900,000 – 2 x $10,000). Therefore $880,000 is deducted from equity
and $360,000 ($1.24m – $880,000) charged to the statement of proft or loss.
Derecognition of PPE – the IAS 16 position

PPE should be derecognised (removed from PPE) either on disposal or when no future economic
benefts are expected from the asset (in other words, it is effectively scrapped). A gain or loss on
disposal is recognised as the difference between the disposal proceeds and the carrying amount of
the asset (using the cost or revaluation model) at the date of disposal. This net gain is included in
the statement of proft or loss – the sales proceeds should not be recognised as revenue.
Where assets are measured using the revaluation model, any remaining balance in the revaluation
reserve relating to the asset disposed of is transferred directly to retained earnings. No recycling of
this balance into the statement of proft or loss is permitted.
Disposal of assets – IFRS 5 position

IFRS 5 is another standard that deals with the disposal of non-current assets and discontinued
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operations. An item of PPE becomes subject to the provisions of IFRS 5 (rather than IAS 16) if it is
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classifed as held for sale. This classifcation can either be made for a single asset (where the
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planned disposal of an individual and fairly substantial asset takes place) or for a group of assets
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(where the disposal of a business component takes place). This article considers the implications of
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disposing of a single asset.
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IFRS 5 is only applied if the held for sale criteria are satisfed, and an asset is classifed as held for
sale if its carrying amount will be recovered principally through a sale transaction rather than
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through continued use. For this to be the case, the asset must be available for immediate sale in its
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present condition and its sale must be highly probable. Therefore, an appropriate level of
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management must be committed to a plan to sell the asset, and an active programme to locate a
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buyer and complete the plan must have been initiated. The asset needs to be actively marketed at
a reasonable price, and a successful sale should normally be expected within one year of the date
of classifcation.
The types of asset that would typically satisfy the above criteria would be property, and very
substantial items of plant and equipment. The normal disposal or scrapping of plant and equipment
towards the end of its useful life would be subject to the provisions of IAS 16. When an asset is
classifed as held for sale, IFRS 5 requires that it be classifed separately from all other non-current
assets on the statement of fnancial position under the heading – ‘non-current assets held for sale’.
No further depreciation is charged as its carrying amount will be recovered principally through sale
rather than continuing use.
The existing carrying amount of the asset is compared with its ‘fair value less costs to sell’
(effectively the selling price less selling costs). If fair value less costs to sell is below the current
carrying amount, then the asset is written down to fair value less costs to sell and an impairment
loss recognised. When the asset is sold, any difference between the new carrying amount and the
net selling price is shown as a proft or loss on sale.
EXAMPLE 4
An asset has a carrying amount of $600,000. It is classifed as held for sale on 30 September 20X6.
At that date its fair value less costs to sell is estimated at $550,000. The asset was sold for
$555,000 on 30 November 20X6. The year end of the entity is 31 December 20X6.
1. How would the classifcation as held for sale, and subsequent disposal, be treated in the 20X6
fnancial statements?
2. How would the answer differ if the carrying amount of the asset at 30 September 20X6 was
$500,000, with all other fgures remaining the same?
x
Solution 1
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1. On 30 September 20X6, the asset would be written down to its fair value less costs to sell of
a
$550,000 and an impairment loss of $50,000 recognised. It would be removed from non-current
b
assets and presented in ‘non-current assets held for sale’. On 30 November 20X6 a proft on
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sale of $5,000 would be recognised.
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2. On 30 September 20X6 the asset would be transferred to non-current assets held for sale at its
existing carrying amount of $500,000. When the asset is sold on 30 November 20X6, a proft on
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sale of $55,000 would be recognised.
CC
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Where an asset is measured under the revaluation model then IFRS 5 requires that its revaluation
must be updated immediately prior to being classifed as held for sale. The effect of this treatment is
that the selling costs will always be charged to the statement of proft or loss at the date the asset is
classifed as held for sale.
EXAMPLE 5
An asset being classifed as held for sale is currently carried under the revaluation model at
$600,000. Its latest fair value is $700,000 and the estimated costs of selling the asset are $10,000.
Show how this transaction would be recorded in the fnancial statements.
Solution
Immediately prior to being classifed as held for sale, the asset would be revalued to its latest fair
value of $700,000, with a credit of $100,000 to equity. The fair value less costs to sell of the asset is
$690,000 ($700,000 – $10,000). On reclassifcation, the asset would be written down to this value
(being lower than the updated revalued amount) and $10,000 charged to the statement of proft or
loss.
Paul Robins is a lecturer at Kaplan
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Suspense accounts and error correction
Suspense accounts and error correction are popular topics for examiners because they test
understanding of bookkeeping principles so well. A suspense account is a temporary resting place
for an entry that will end up somewhere else once its fnal destination is determined. There are two
reasons why a suspense account could be opened:
1. A bookkeeper is unsure where to post an item and enters it to a suspense account pending
instructions
2. There is a difference in a trial balance and a suspense account is opened with the amount of the
difference so that the trial balance agrees (pending the discovery and correction of the errors
causing the difference). This is the only time an entry is made in the records without a
corresponding entry elsewhere (apart from the correction of a trial balance error – see error type
8 in Table 1). Financial Accounting (previously F3) tested a candidate’s working knowledge of
these types of error. Financial Reporting (FR - previously F7) tests how these errors are
corrected and the suspense account is eliminated before fnancial statements are prepared.
Types of error
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Before we look at the operation of suspense accounts in error correction, we need to think about
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types of error because not all types of error affect the balancing of the accounting records and
a
hence the suspense account. Refer to Table 1.
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Table 1: Types of error
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Error type A C
Suspense
account
involved?
1 Omission – a transaction is not recorded at all No
2 Error of commission – an item is entered to the correct side of the wrong account
No
(there is a debit and a credit here, so the records balance)
3 Error of principle – an item is posted to the correct side of the wrong type of
account, as when cash paid for plant repairs (expense) is debited to plant account
(asset) No
(errors of principle are really a special case of errors of commission, and once again
there is a debit and a credit)
4 Error of original entry – an incorrect fgure is entered in the records and then
posted to the correct account
No
Example: Cash $1,000 for plant repairs is entered as $100; plant repairs account is
debited with $100
5 Reversal of entries – the amount is correct, the accounts used are correct, but the
account that should have been debited is credited and vice versa
Example: Factory employees are used for plant maintenance:
Correct entry: No
Debit: Plant maintenance
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Credit: Factory wages
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Easily done the wrong way round
6 Addition errors – fgures are incorrectly added in a ledger account
a lB Yes
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7 Posting error
a. an entry made in one record is not posted at all
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b. an entry in one record is incorrectly posted to another
Yes
C
Examples: cash $10,000 entered in the cash book for the purchase of a car is:
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a. not posted at all
b. posted to Motor cars account as $1,000
8 Trial balance errors – a balance is omitted, or incorrectly extracted, in preparing

Yes
the trial balance
Yes, to correct
9 Compensating errors – two equal and opposite errors leave the trial balance
each of the
balancing (this type of error is rare, and can be because a deliberate second error has
errors as
been made to force the balancing of the records or to conceal a fraud). Yes, to correct
discovered
each of the errors as discovered
Correcting errors
Errors 1 to 5, when discovered, will be corrected by means of a journal entry between the ledger
accounts affected. Errors 6 to 9 also require journal entries to correct them, but one side of the
journal entry will be to the suspense account opened for the difference in the records. Type 8, trial
balance errors, are different. As the suspense account records the difference, an entry to it is
needed, because the error affects the difference. However, there is no ledger entry for the other
side of the correction – the trial balance is simply amended.
An illustrative question
The bookkeeping system of Turner is not computerised, and at 30 September 20X8 the bookkeeper
was unable to balance the the trial balance. The trial balance totals were: Debit $1,796,100 Credit
x
$1,852,817
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Nevertheless, he proceeded to prepare draft fnancial statements, inserting the difference as a
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balancing fgure in the statement of fnancial position. The draft statement of proft or loss showed a
proft of $141,280 for the year ended 30 September 20X8.
b a
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He then opened a suspense account for the difference and began to check through the accounting
records to fnd the difference. He found the following errors and omissions:
C A
1. $8,980 – the total of the sales returns book for September 20X8, had been credited to the
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purchases returns account.
A
2. $9,600 paid for an item of plant purchased on 1 April 20X8 had been debited to plant repairs
account. The company depreciates its plant at 20% per annum on a straight line basis, with
proportional depreciation in the year of purchase.
3. The cash discount totals for the month of September 20X8 had not been posted to the general
ledger accounts. The fgures were: Discount allowed $836 Discount received $919. For
discounts allowed, it was not anticipated that these customers would take advantage of these
cash discounts when the invoices were frst issued.
4. $580 insurance prepaid at 30 September 20X7 had not been brought down as an opening
balance.
5. The balance of $38,260 on the telephone expense account had been omitted from the trial
balance.
6. A car held as a non-current asset had been sold during the year for $4,800. The proceeds of sale
were entered in the cash book but had been credited to the sales account in the general ledger.
The original cost of the car $12,000, and the accumulated depreciation to date $8,000, were
included in the motor vehicles account and the accumulated depreciation account. The company
depreciates motor vehicles at 25% per annum on a straight line basis with proportionate
depreciation in the year of purchase but none in the year of sale.
Required:
(a) Open a suspense account for the difference between the trial balance totals. Prepare the journal
entries necessary to correct the errors and eliminate the balance on the suspense account.
Narratives are not required. (10 marks)
(b) Draw up a statement showing the revised proft after correcting the above errors. (6 marks)
Total (16 marks)
x
Note: it is unlikely that this format of question will be used in either the FA or FR exam. Both of
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these exams can test any of the errors included in the above question but an FA or FR exam
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question is unlikely to test this learning outcome using such a high concentration of marks. Despite
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this, the above question is still considered useful for teaching purposes.
The approach to the question should be:
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1. Read the requirement paragraph at the end of the question.
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2. Begin by opening the suspense account. Which side? More debit is needed to balance the trial
C
balance, so debit the suspense account with $56,717.
A
Then deal with the errors in order:
1. Sales returns should have been debited to the sales returns account and they have been
credited to the purchases returns account. There are two errors here – the wrong account has
been used and an entry which should have been a debit has been entered as a credit. The
suspense account entry must therefore be for 2 x $8,980 or $17,960.
2. An error of principle – no suspense account entry. Depreciation must be adjusted.
3. Items have not been posted, therefore the suspense account is involved.
4. Effectively a posting error – the suspense account is again involved.
5. A trial balance error must affect the suspense account – but no ledger entry.
6. This one needs thought. Take it one sentence at a time. Is the suspense account involved? No,
because we have an error of commission followed by some unrecorded transactions.
Attempt Part (a) of the question before studying the answer as detailed in Table 2. Let's now turn to
Part (b). The most convenient format for the answer is two columns for – and +. Set them up and
enter the adjustments appropriately. Which of the errors affect the proft? In fact they all do. Attempt
Part (b) now before looking at the answer detailed in Table 3.

Table 2: Answer – Part (a)
Suspense Account
$ $
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Difference 56,717 Sales returns 8,980
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Discount received 919 Purchases returns 8,980
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A
Revenue (customer cash
836
C
discounts)
A C --- Insurance 580
Telephone (trial balance) 38,260
57,636 57,636
Journal Entries
$ $
1 Sales returns account 8,980
Suspense account 8,980
Purchases
8,980
returns account
2 Plant account 9,600
Plant repairs
9,600
account
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Depreciation
a
(statement of proft or 960
b
loss)
Plant depreciation
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A
account
CC
A
3 Revenue (customer cash discounts) 836
Suspense account 836
Discount received
919
account
4 Insurance account 580
5 Trial balance
38,260
(no ledger entry)
6 Sales account 4,800
Motor vehicles
4,800
disposal account
Motor vehicles
x
12,000
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disposal account
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a
Motor vehicles
12,000
b
asset account
Motor vehicles
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A
8,000
depreciation account
CC
A
Motor vehicles
8,000
disposal account
Motor vehicles
800
disposal account
Statement of proft or loss 800
Table 3: Answer – Part (b)
Adjustment to proft - +
$ $
Proft as in draft statement of proft or loss 141,280
1 Sales returns adjustment

17,960
(2 x $8,980)
o x
B
2 Plant: reduction in repairs 9,600
a l
b
depreciation – 6/12 x 20% x
lo
960
$9,600 960
G
A
3 Revenue (customer cash discounts) 836
CC
A
Discount received 919
4 Insurance – opening balance

580
omitted
5 Telephone expense omitted 38,260
6 Proft on sale of car 800
Proceeds taken out of sales 4,800 -----
63,396 152,599
(63,396)
Revised net proft 89,203
Some hints on preparing suspense accounts
• Does a correction involve the suspense account? The type of error determines this. Practice,
and study of Table 1 should ensure that you see immediately which errors affect the balancing
of the records and hence the suspense account.
•
o x
Which side of the suspense account must an entry go? This is one of the most awkward
B
problems in preparing suspense accounts. The best way of solving it is to ask yourself which
l
side the entry needs to be on in the other account concerned. The suspense account entry is
b a
then obviously to the opposite side.
lo
• Look out for errors with two aspects. In the illustrative question earlier, error 1 is a case in point.
G
An entry has been made to the wrong account, but also to the wrong side of the wrong account.
Both errors must be corrected. It is very easy to fall into the trap of correcting only one of the
A
errors, especially when working quickly under examination conditions.
CC
A

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ALL F7 (FR) TECHNICAL ARTICLES

Financial Reporting (FR) was previously known as F7 Financial

Financial Reporting (FR)

Study support videos

Financial Reporting (FR)

Watch your step

Extreme makeover – IASB edition

The use of fair values in the goodwill calculation

Analysing a statement of cash fows

IAS 37 – Provisions, contingent liabilities and contingent assets

IFRS 16, Leases

Accounting for property, plant and equipment

subsidiary, and how each measurement of goodwill is subject to an impairment review.

Property, plant and equipment – part 1: Measurement and depreciation

Property, plant and equipment – part 2: Revaluation and derecognition

Suspense accounts and error correction

The calculation of goodwill is as follows:

Add: Non-controlling interest at acquisition X

Less: Net assets at acquisition (X)

Goodwill at reporting date

3. Net assets at acquisition

At 31 December 20X4, Fifer Co has determined that goodwill is impaired by 10%.

1. Non-controlling interest is valued at its fair value of $1,000,000; and

2. Non-controlling interest is valued as a proportionate share of net assets.

1. Fair value method

Consideration paid 5,000

Add: Non-controlling interest at acquisition 1,000

Less: impairment to date (10% x 2,000)

2. Proportionate share of net assets method

Consideration paid 5,000

Add: Non-controlling interest at acquisition 800

Less: Net assets at acquisition (4,000)

Goodwill at acquisition 1,800

Less: impairment to date (10% x 1,800) (180)

On 1 October 20X6, Plateau Co acquired the following non-current investments:

The following information is relevant:

(w1) Group structure:

(w2) Net assets of Savannah Co:

SFP Post acq’n

Share capital 4,000 4,000 -

Excess depreciation (w7)

A 11,000 13,700 2,700

- Shares issued (3,000/2 x $6) 9,000

Non-controlling interest at acquisition (1m x $3.25) 3,250

Less: Net assets at acquisition (w2) (11,000)

Goodwill at acquisition 5,000

Fair value at acquisition (see (w3) 3,250

NCI % x S post acq’n (25% x 2,700 (w2)) 675

(w5) Retained earnings:

Plateau Co’s retained earnings 25,250

Professional fees (500)

P% x S post acq’n 75% x 2,700 (w2) 2,025

P% x A post acq’n 30% x (5,000 (16,000 – 11,000)) 1,500

Non-current asset PURP (w7)

Investment gain (9,000 – 6,500)

Cost (4,000 x 30% x $7.50) 9,000

Share post-acquisition proft (see w5) 1,500

(w7) Property, plant and equipment

Written by a member of the FR examining team