CONCEPTUAL AND REGULATORY FRAMEWORK

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ADVANTAGES OF IFRS:

 It would be easier for investors to compare the financial statements of companies with
those of foreign competitors
 Cross-border listing would be facilitated
 Multinational companies could more easily transfer accounting staff across national
borders
FRAMEWORK:
The Framework's/basic structure purpose is to assist the IASB in developing and revising IFRSs
that are based on consistent concepts, to help preparers to develop consistent accounting
policies for areas that are not covered by a standard or where there is choice of accounting
policy, and to assist all parties to understand and interpret IFRS.
WHY CONCEPTUAL FRAMEWORK?
 Before conceptual framework, accounting standards were set as a result of political
process
 Different accounting standards proposed different treatments
 To support the board in developing future standards
 To assist in determining the treatment of items not covered by an existing IFRS
 To support practitioners and auditors in reaching a conclusion

Note: If there is any conflict between IFRS and conceptual framework then specific IFRS always
over rule Conceptual framework.

ADVANTAGES OF GLOBAL HARMONIZATION OF ACCOUNTING STANDARDS

 Greater comparability between different firms

 Easier for large international accounting firms
 Consolidation of financial statement is easier
 Preparation of financial statement is easier if business is operated in different countries

PRINCIPLES-BASED AND RULES-BASED FRAMEWORK

Principles-based framework:

 Based upon a conceptual framework such as the International Accounting Standards

Board's (the Board's) Framework
 Accounting standards are created using the conceptual framework as a basis. (use of
judgement)
 Principles‐based standards are thought to be harder to circumvent (overruled)
 It avoids ‘fire‐fighting’, where standards are developed in responses to specific problems
as they arise

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 Rules-based framework:

 ‘Cookbook’ approach (step by step procedure without any explanation)

 Accounting standards are a set of rules which companies must follow. Generally, give
rise to larger number of accounting rules

THE ELEMENTS OF FINANCIAL STATEMENTS

The objective of financial statement as set out by IASB is to provide information about financial
position and performance and changes in financial position of an enterprise that is useful to a
wide range of users. The elements of financial statements.

The elements directly related to financial position (balance sheet) are:

 Assets, Liabilities & Equity

The elements directly related to performance (income statement) are:

 Income & Expenses

The cash flow statement reflects both income statement elements and some changes in
balance sheet elements.
Definitions of the elements relating to financial position
Asset. A present economic resource controlled by the entity as a result of past events. An
economic resource is a right that has potential to produce economic benefits.
Liability. A present obligation of the entity to transfer an economic resource as a result of past
events. An obligation is a duty or responsibility that the entity has no practical ability to avoid.
Equity. Equity is the residual interest in the assets of the entity after deducting all its liabilities.

EQUITY DEBT
ORDINARY
IRREDEEMABLE REDEEMABLE PREF.
PARTICULARS SHARE LOAN NOTES
PREF. SHARE SHARES
CAPITAL
VOTING RIGHTS YES NO NO NO
NATURE OWNERSHIP CREDITORS CREDITORS CREDITORS
PROFIT DIVIDEND DIVIDEND INTEREST INTEREST
VARIABLE/
AMOUNT FIXED/MANDATORY FIXED/MANDATORY FIXED/MANDATORY
OPTIONAL
NON CUMULATIVE/NON
PROFIT CUMULATIVE CUMULATIVE CUMULATIVE
CUMULATIVE CUMULATIVE
PRIORITY AT
LAST/LOW HIGH MODERATE MODERATE
BACKCRUPTCY/LIQUIDATION

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Recognition of the elements
Recognition of assets
An asset will only be recognized if:
• it gives rights or other access to future economic benefits controlled by an entity as a result of
past transactions or events
• it can be measured with sufficient reliability
• there is sufficient evidence of its existence.
Recognition of liabilities
A liability will only be recognized if:
• there is an obligation to transfer economic benefits as a result of past transactions or events
• it can be measured with sufficient reliability
• there is sufficient evidence of its existence.
Recognition of income
Income is recognized in profit or loss when:
• an increase in future economic benefits arises from an increase in an asset (or a reduction in a
liability), and
• the increase can be measured reliably.
Recognition of expenses
Expenses are recognized in profit or loss when:
• a decrease in future economic benefits arises from a decrease in an asset or an increase in a
liability, and
• it can be measured reliably.
Financial position approach to recognition
It can be seen therefore that:
• income is an increase in an asset/decrease in a liability – unearned into income
• expenses are an increase in a liability/decrease in an asset.
As income and expenses are therefore recognized on the basis of changes in assets and
liabilities this is known as a financial position (or balance sheet) approach to recognition.

QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION

Qualitative characteristics are the attributes that make information provided in financial
statements useful to others.
The Framework splits qualitative characteristics into two categories:
i. Fundamental qualitative characteristics
a. Relevance
b. Faithful representation
ii. Enhancing qualitative characteristics
a. Comparability

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 b. Verifiability
c. Timeliness
d. Understandability

A. RELEVANCE:
Information is relevant if:
 it has the ability to influence the economic decisions of users, and
 is provided in time to influence those decisions.
 Has predictive / confirmatory value i.e. user must be able to predict future values and
user could check or confirm the earlier predictions
Materiality (threshold) has a direct impact on the relevance of information.

Information is material if its omission or misstatement could influence the economic decisions of
users taken on the basis of the financial statements.

Example: If the going concern of the entity is valid then net book value of machinery is most
relevant than the fair value of machine.
B. FAITHFUL REPRESENTATION:

To be a perfectly faithful representation, financial information would possess the following

characteristics:

 Completeness – To be understandable information must contain all the necessary

descriptions and explanations.
 Neutrality – Information must be neutral, i.e. free from bias. Financial statements are
not neutral if, policies and estimates are used to achieve a predetermined result or
outcome.
 Free from error – Information must be free from error within the bounds of materiality.
A material error or omission can cause the financial statements to be false or
misleading, and thus unreliable and deficient in terms of their relevance.
 Substance over form

Enhancing Qualitative characteristics of financial information

'Comparability, verifiability, timeliness and understandability are qualitative characteristics that
enhance the usefulness of information that is relevant and faithfully represented'
A. COMPARABILITY:
 User must be able to compare financial statement from one year to another year
 User must be able to compare financial statements of different entities to evaluate the
financial performance

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 Comparability is not uniformity.
To achieve the quality of comparability financial statement must follow consistency and
disclosure requirements – informed about the policies applied and changes made
B. VERIFIABILITY:
Verifiability means that different knowledgeable and independent observers could reach
consensus. Information can be verified by undertaking stock count, independent verification by
a third party like bank’s confirmation and lawyer’s confirmation
For e.g: Confirming the cash balance by conducting a physical count of cash

C. TIMLINESS:
Timeliness means having information available to decision makers in time to be capable of
influencing their decisions. Generally, the older the information is the less useful it becomes
D. UNDERSTANDIBILITY:
Classifying, characterizing and presenting information clearly and concisely makes it
understandable
It is assumed that users:
o Have a reasonable knowledge of business and economic activities
o Are willing to study the information provided with reasonable diligence.
GOING CONCERN (underlying assumption)
The Framework identifies that the underlying assumption governing financial statements is the
going concern concept. The going concern basis assumes that the entity has neither the need
nor the intention to liquidate or materially curtail the scale of its operations. If this is not the
case then the financial statements would be prepared on a different basis, which must be
disclosed.

PRACTISE QUESTIONS:
1) Under the Conceptual Framework for Financial Reporting, which of the following is the
‘threshold quality’ of useful information?
a. Relevance
b. Reliability
c. Materiality
d. Understandability
2) According to The Conceptual Framework for Financial Reporting, which of the following
is the underlying assumption of a set of financial statements?
a. Going Concern
b. Prudence

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 c. Accruals
d. Comparability
3) Link the terms below to whether they relate to the principle of relevance or faithful
representation.

Relevance Faithful representation

Free from bias

Materiality
Confirmatory value
Complete

4) Which TWO of the following criteria need to be satisfied in order for an item to be
recognized in the financial statements?
a. It meets the definition of an element of the financial statements
b. It is probable that future economic benefits will flow to or from the enterprise
c. It is certain that future economic benefits will flow to or from the enterprise
d. The entity has paid for the item
5) The Board's Framework identifies qualitative characteristics.
i. Relevance
ii. Comparability
iii. Verifiability
iv. Understandability
v. Faithful representation.
Which of the above are not listed as an enhancing characteristic?

a) (i), (iv) and (v)

b) (ii), (iii) and (iv)
c) (ii) and (iii)
d) (i) and (v)

6) The Conceptual Framework for Financial Reporting provides definitions of the elements
of financial statements. One of the elements defined by the framework is ‘expenses’. In
no more than 35 words, give the Framework’s definition of expenses.

7) The International Accounting Standards Board’s Conceptual Framework for Financial

Reporting sets out two fundamental qualitative characteristics of financial information,
relevance and faithful representation. Which characteristics would you expect
information to possess if it is to have faithful representation?

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 8) According to the International Accounting Standards Board’s Framework for Financial
Reporting, what is the objective of financial statements?

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 IAS 16 – PROPERTY, PLANT AND EQUIPMENT
DEFINITION OF PROPERTY, PLANT AND EQUIPMENT:
As per IAS 16 property, plant and equipment are tangible assets that:
o Are held by entity for use in the production or supply of goods or services, for rental to
others, or for administrative purposes; and
o Are expected to be used during more than one period.
INITIAL MEASUREMENT:
Once an item of property, plant and equipment qualifies for recognition as an asset, it will
initially be measured at cost. include all costs involved in bringing the asset into working
condition
A. Include in this initial cost capital costs such as;
i. Purchase price, less any trade discount or rebate
ii. Import duties and non-refundable purchase taxes
iii. Site preparation,
iv. Delivery costs,
v. Professional surveyor fees and staff cost directly arising for construction or
purchase of non-current asset
vi. Installation costs,
vii. Borrowing costs (in accordance with IAS 23 – see later in this course).
viii. Dismantling costs – the present value of these costs should be capitalized, with
an equivalent liability set up. The discount on this liability would then be
unwound over the period until the dismantling costs are paid. This means that
the liability increases by the interest rate each year, with the increase taken to
finance costs in the statement of profit or loss.
– You may need to use the interest rate given and apply the discount fraction
where r is the interest rate and “n” the number of years to settlement.

EXAMPLE 1:
If an oil rig was built in the sea, the cost to be capitalised is likely to include the cost of
constructing the asset and the present value of the cost of dismantling it. If the asset cost $10
million to construct, and would cost $4 million to remove in 20 years, then the present value of
this dismantling cost must be calculated. If interest rates were 5%, the present value of the
dismantling costs are calculated as follows:
$4 million × 1/1.0520 = $1,507,558
The total to be capitalised would be $10 million + $1,507,558 = $11,507,558.
This would be depreciated over 20 years, so 11,507,558 × 1/20 = $575,378 per year.

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EXAMPLE 2:
On 1st January 2020 purchase asset for $10million. Expected cost of dismantling asset at the
end of useful life i.e.3 years is $5million. Cost of capital is 10%.
Required: Calculate the cost of machine and prepare entry for first year
Note:
The following cost should not be included in the cost of an asset, unless these costs are directly
attributed to the asset’s acquisition.
 Expenses of operations that are incidental to the construction or development of the item
 Administration and general overhead costs
 Start-up and similar pre-production costs
 Initial operating losses before the asset reaches planned performances
 Staff training costs (it is uncertain that the particular staff training will provide benefit in
future)
 Maintenance contracts purchased with the asset
 Insurance of the asset

QUESTION 1:
An entity started construction on a building for its own use on 1 April 20X7 and incurred the
following costs:
$000
Purchase price of land 250,000
Stamp duty 5,000
Legal fees 10,000
Site preparation and clearance 18,000
Materials 100,000
Labour (period 1 April 20X7 to 1 July 20X8) 150,000
Architect’s fees 20,000
General overheads 30,000
–––––––
583,000
–––––––
The following information is also relevant:
o Material costs were greater than anticipated. On investigation, it was found that
materials costing $10 million had been spoiled and therefore wasted and a further $15
million was incurred on materials as a result of faulty design work.
o As a result of these problems, work on the building ceased for a fortnight during
October 20X7 and it is estimated that approximately $9 million of the Labour costs
relate to this period.
o The building was completed on 1 July 20X8 and occupied on 1 September 20X8.

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 Required: You are required to calculate the cost of the building that will be included in
tangible non-current asset additions. (ANS. 519,000)
DEPRECIATION:
'Depreciation is the systematic allocation of the depreciable amount of an asset over its useful
life' (IAS 16, para 6).
DEPRECIABLE AMOUNT: Historical cost less estimated residual value is called depreciable amount
RAAZ KI BATEIN:
i. Depreciation charge from the date when asset is available for use and not when asset is
brought into use.
ii. Depreciation is continued even if the asset is idle
iii. Depreciation is charged in order to match revenues and expenses with one another in
the same accounting period so that profits are fairly calculated. Known as matching
(accrual system)
DEPRECIABLE ASSETS (NON-CURRENT ASSETS):
Depreciable asset are assets which;
 Are expected to be used during more than one accounting period
 Are held by an enterprise for use in the production or supply of goods and service, for
rental to others, or for administrative purposes; and
 Have a limited useful life
RESIDUAL VALUE:
The residual value is the net amount which the entity expects to obtain for an asset at the end
of its useful life after deducting the expected cost of disposal.
USEFUL LIFE:
Depreciable amount of an asset is allocated over its useful life is either;
 The period over which a depreciable asset is expected to be used by the enterprise; or
 The number of production or similar units expected to be obtained from the asset by
the enterprise
Before estimating the useful life of assets company must consider the following:
 Expected physical wear and tear
 Obsolescence
 Legal or other limits on the use of the assets
DEPRECIATION CEASE:
Company should stop depreciating the assets whichever is earlier:
o When asset is derecognized; or
o When asset is classified as held for sale (IFRS 5); or
o When asset is fully depreciated

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METHODS OF DEPRECIATION:
While deciding the method of depreciation the benefit pattern of the asset must be considered.
Following methods are recommended by IAS 16:
 Straight line method
 Reducing balance method
 Activity based method (Machine hours/units/days method)

QUESTION 2: A lorry bought for Titan Co. Cost $17,000. It is expected to last for five years. Life
in days is estimated to be 590 days and then be sold for scrap for $2,000. Usage over the five
years is expected to be:
Year 1 200 days
Year 2 100 days
Year 3 100 days
Year 4 150 days
Year 5 40 days
Required: Work out the depreciation to be charged for five years under:
A. Straight line method
B. Reducing balance method @ 35%
C. Machine hours/days method

SUBSEQUENT EXPENDITURE:
Subsequent expenditure on property, plant and equipment should only be
capitalised if:
 It enhances the economic benefits provided by the asset (this could be extending the
asset's life, an expansion or increasing the productivity of the asset)
 It relates to an overhaul or required major inspection of the asset – the costs associated
with this should be capitalised and depreciated over the time until the next overhaul or
safety inspection. (recorded as separate asset). They are then depreciated over their
useful life until the next inspection or overhaul is due.
Note: All other expenditure that do not improve the asset and mere maintain the asset should
be written off in P&L as repair expense.

Overhaul cost is associated with scheduled reconstruction and/or replacement of major

components such as engines and transmissions.

ILLUSTRATION:
A piece of machinery has an annual service costing $10,000. During the most recent service it was
decided to replace part of the engineering meaning that it will work faster and produce more units of
product per hour. The cost of the replacement part is $20,000. Would this expenditure be treated as
capital or revenue expenditure?

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 QUESTION 3:
An entity purchases an aircraft that has an expected useful life of 20 years with no residual
value. The aircraft requires substantial overhaul at the end of years 5, 10 and 15. The aircraft
cost $25 million and $5 million of this figure is estimated to be attributable to the economic
benefits that are restored by the overhauls. In year 6, the cost of the overhaul is estimated to
be $6 million.
Required: Calculate the annual depreciation charge for the years 1–5 and years 6–10.

Subsequent expenditure:
FARIDA APA COMPANY purchased machine on 1st January 2005. Cost of machine $1000,000.
Scarp value is $200,000. Company uses SLM with a useful life of 5 years. On 1st January 2008
major expenditure was incurred for $300,000 which improved the efficiency of Machine.
It is estimated useful life of assets from 1st January 2008 is 10 years.
Required:
Calculate depreciation for the year 2005, 2006, 2007, 2008 & 2009
COMPLEX ASSETS
These are the assets which are made up of separate components. Each component is separately
depreciated over its useful life. If it is replacing a component of a complex asset. The replaced
component will be derecognized. A complex asset is an asset made up of a number of
components, which each depreciate at different rates, e.g. an aircraft would comprise body,
engines and interior.

ILLUSTRATION:
An Aircraft could be considered as having the following components:

Required: Calculate the depreciation at the end of year, where 150 flights totaling, 400 hours were made.

CHANGE IN ESTIMATES (METHOD/SCRAP VALUE/USEFUL LIFE)

As per IAS 16 Depreciation estimates should be reviewed at least at the end of each accounting
year. As per the IAS 8 the company should adopt the prospective impact for the change in
estimate. Therefore, any change in the method or useful life of an asset will be treated as
prospective change.
When life or method is changed the company needs to subsequently depreciate the asset at
the carrying amount, and depreciate the asset at the remaining or new life.

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 UPDATED COST (CARRYING AMOUNT) -- RESIDUAL VALUE
ANNUAL DEPRECIATION =
REVISED/REMAINING USEFUL LIFE
QUESTION 4:
Imran Khan and Company purchased an asset for $100,000 on 1 January 2001. It had an
estimated useful life of 5 years and it was depreciated using the reducing balance method at a
rate of 40%. On 1 January 2003 it was decided to change the method to straight line.
Required: Calculate the depreciation for the entire life of an asset

QUESTION 5:
A business purchased a non-current asset costing $12,000 with an estimated life of four years
and no residual value. The company uses the straight line method of depreciation. The business
has decided after two years that the useful life of the asset has been underestimated, and still
had five more years in use to come i.e. total seven years.
Required: Calculate the depreciation for first three years of an asset

DISPOSAL ACCOUNTING
QUESTION 6:
RAKSHANDA Company purchased a machine on 1st January 2013 at a cost of $25,000 with a
useful life of 6 years having a residual value of $7,000, sold after 3 years on 1 st January 2016 for
$17,500. Company uses straight line method for depreciation.
Required:
a) Calculate gain/loss on disposal
b) Prepare disposal entries

QUESTION 7:
FAZOOL INSAN purchased a machine on 1st January 2010 for $50,000. Life of the asset was 5
years. On 1st January 2013 Company exchanged a new machine with an old one with a trade in
value of $17,000. Cost of new machine is $80,000. Company uses straight line method.
Required:
a) Calculate gain/loss on disposal
b) Prepare disposal entries

QUESTION 8:
On 1st April 2014 company purchased furniture for $450,000 with a useful life of 5 years.
Company uses straight line method.
On 1st August 2014 equipment was purchased for $650,000 with useful life of 8 years. Company
uses WDV method @20%.

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On 30th October 2016 Company disposed of furniture and suffered a loss of $2500
On 2nd February 2017 equipment was exchanged with a new equipment costing $600,000 and
paid excess cash $215,021.
Company’s accounting year ends on 31st December every year.

Required: Prepare entries to record disposal of equipment and furniture separately.

REVALUATION MODEL:
IAS 16 allows entity to revalue their assets at their fair value amount. It depends on the entity if
they wish to record their fixed assets at revaluation model rather than cost model.
Revalued amount is the fair market value of the fixed asset. After the revaluation the asset
should be depreciated at the revalued amount for the remaining life.
RAAZ KI BATEIN:
a) Revaluation test should be carried out at each reporting period
b) Whole class of assets should be revalued
c) As per IAS 16, revaluation should be done by the independent person.
d) Offset of gains and losses between different properties is not permitted.
Revaluation surplus can be calculated as follows:

FAIR MARKET VALUE 56,000

CARRYING AMOUNT (35,000)
REVALUATION SURPLUS 21,000
Gain on revaluation is not recognized as an income in profit or loss account. Instead it should be
recorded in other comprehensive income. From there the gain is transferred to the revaluation
account. It is done because as per prudence concept such gain is not yet realized.
At the time of revaluation, the accumulated depreciation of the asset is debited.

FROM THE DESK OF M. JUNAID KHALID 15

QUESTION 9:

EXCESS DEPRECIATION:
Any excess depreciation due to the revaluation may be transferred to the retained earning
account.
QUESTION 10:
An asset was purchased three years ago, at the beginning of Year 1, for Rs. 100,000. Its
expected useful life was six years and its expected residual value was Rs. 10,000. It has now
been re-valued to Rs. 120,000. Its remaining useful life is now estimated to be three years and
its estimated residual value is now Rs. 15,000. The straight-line method of depreciation is used.
Required
(a) What is the transfer to the revaluation surplus at the end of Year 3?
(b) What is the annual depreciation charge in Year 4?
(c) What is the carrying amount of the asset at the end of Year 4?

DOWNWARD REVALUATION
When the fair market value is decreased as compare to the carrying amount then it is called the
downward revaluation which means the market value of the asset is decreased. As per IAS 16
the revalued asset must be evaluated at least once in every year.

FROM THE DESK OF M. JUNAID KHALID 16

QUESTION 11:
ABC Company started a business on 1st January 2001. Following are the information given
related to the assets;
a) Land part of the business premises was worth $20,000; this would not be depreciated.
b) The building part of the business premises was worth $30,000. This would be
depreciated by the straight line method to a nil residual value over 30 years.
c) After five years of trading on 1st January 2006 ABC Company decides that his business
premises are now Worth $150,000 divided into:
Land $75000
Building $75000
st
d) On 31 December 2010 fair market value of building was $40,000.
Required:
a) Calculate the annual charge for depreciation for the first 10 years of the building’s life.
b) Prepare necessary entries.
c) What possible treatment is suggested by IAS 16 for excess depreciation?

QUESTION 12:
Company purchased a building on 1st January 2013 for $600,000, estimated a useful life of 10
years. Company uses a straight line method for depreciation. On 1st January 2015 Company
decided to adopt revaluation model and the market value of building was assessed as $850,000.
Company decided to transfer the revaluation surplus into retained earning when the asset is
derecognized. On 31st December 2017 the building was disposed of at a gain of $18750.
Accounting period ends on 31st December each year
Required:
a) Record the necessary transaction
b) Prepare necessary ledgers.
QUESTION 13:
On 1 April 20X8 the fair value of Xu's property was $100,000 with a remaining life of 20 years.
Xu’s policy is to revalue its property at each year end. At 31 March 20X9 the property was
valued at $86,000. The balance on the revaluation surplus at 1 April 20X8 was $20,000 which
relates entirely to the property. Xu does not make a transfer to realized profit in respect of
excess depreciation.
Required:
a) Prepare extracts of Xu's financial statements for the year ended 31 March 20X9
reflecting the above information.
b) State how the accounting would be different if the opening revaluation surplus did not
exist.

FROM THE DESK OF M. JUNAID KHALID 17

Note: If the asset has previous revaluation surplus, then any decrease in subsequent period
should initially reverse the previous upward then balance to be transferred in P & L. (R/S will
never be negative)
QUESTION 14:
PINKIE CO. has an item of land carried in its book on 1st January 2016 at $15,000. At 31st
December 2016 the value of land was valued at $20,000. At 31st December 2017 the value of
land was valued at $13,000.
Required: Record the revaluation at 31 st December 2017

Note: If the asset has previously suffered a decrease in value that was charged to profit or loss,
any increase in the value of subsequent revaluation should be recognized in profit or loss to the
extent that it reverses the previous decrease.

QUESTION 15:
BINKIE CO. has an item of land carried in its book on 1st January 2016 at $15,000. At 31st
December 2016 the value of land was valued at $13,000 (had no previous revaluation). At 31 st
December 2017 the value of land was valued at $20,000.
Required: Record the revaluation at 31 st December 2017

QUESTION 16:
Derek purchased a property costing $750,000 on 1 January 20X4 with a useful economic life of
10 years. It has no residual value. At 31 December 20X4 the property was valued at $810,000
resulting in a gain on revaluation being recorded in other comprehensive income of $135,000.
There was no change to its useful life. Derek does not make a transfer to realised profits in
respect of excess depreciation on revalued assets.
On 31 December 20X6 the property was sold for $900,000.
Required:
Prepare entries for the disposal of property at 31 December 20X6?

SUMMARY OF REVALUATION CASES:

CASE 1:
COST = $8000 M.V =$12000 PREVIOUS P/L = NIL

CASE 2:
NBV = $12000 M.V =$16000 PREVIOUS P/L = NIL

CASE 3:
COST = $20000 M.V =$18000 PREVIOUS R/S = NIL

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CASE 4:
NBV = $25000 M.V =$20000 PREVIOUS R/S = 10000

CASE 5:
NBV = $30000 M.V =$25000 PREVIOUS R/S = 3000

CASE 6:
NBV = $35000 M.V =$40000 PREVIOUS P/L CHARGE = 2000

QUESTION 17:
The following trial balance extract relates to a property which is owned by Veeton as at 1st April
2014:
DR CR

$000 $000
Property at cost (20-year original life) 12,000
Accumulated depreciation as at 1st April 2014 3,600
On 1st October 2014, following a sustained increase in property prices, Veeton revalued its
property to $10.8 million.
Required: What will be the deprecation charge veeton’s statement of profit or loss for the
year ended 31st March 2015?
QUESTION 18:
Smith Co. purchased a machine for $90,000 on 1st January 20x7 and assigned it a useful life of
15 years. On 31ST May 20x9 it was revalued to $150,000 with no change in useful life.
What will be the depreciation charge in relation to this machine in statement of profit and loss
account for the year ending 31st December 20x9?
QUESTION 19:
An entity purchased property for $6million on 1st July 2013. The Land element of the purchase
was $1 million. The expected life of the building was 50 years and expected residual value is nil.
On the 30th June 2015 the property was revalued to $7 million of which the Land element was
$1.24 million and the building $5.76 million. On 30th June 2017 the property was sold for $6.8
million.
What is the gain on disposal of the property that would be reported in the statement of profit
or loss for the year ended 30th June 2017?
A. Gain $40,000
B. Loss $200,000
C. Gain $1000,000
D. Gain $1240,000

FROM THE DESK OF M. JUNAID KHALID 19

QUESTION 20:

Which two of the following items should be capitalized within the initial carrying amount of an
item of plant?
A. Cost of transporting the plant to the factory
B. Cost of installing a new power supply required to operate the plant
C. A deduction to reflect the estimated realizable value
D. Cost of a three-year maintenance agreement
E. Cost of three-week training course for staff to operate the plant

QUESTION 21: Which of the following statement is correct?

Statement 1: if the revaluation model is used for property, plant and equipment, revaluation
must subsequently be made with sufficient regularity to ensure that the carrying amount does
not differ materially from the fair value at each reporting date.

Statement 2: When an item of property, plant and equipment is revalued, there is no

requirement that the entire class of assets to which the items belongs must be revalued.
A. 1 only
B. 1 and 2
C. 2 only
D. None of them

QUESTION 22: IAS 16 property, plant and equipment requires an asset to be measured at cost
on its original recognition in the financial statements. EW used its own staff, assisted by
contactors when required, to construct a new warehouse for its own use.
Identify whether the costs listed below should be capitalized or expensed?
1) Clearance of the site prior to commencement of construction
2) Professional surveyor fees for managing the construction work
3) EW’s own staff wages for time spent working on construction
4) A proportion of EW’s administration costs, based on staff time spent

FROM THE DESK OF M. JUNAID KHALID 20

 PRACTISE QUESTIONS:
QUESTION 1:
An entity purchased a property 15 years ago at a cost of $100,000 and have been depreciating
it at a rate of 2% per annum, on the straight line basis. The entity has had the property
professionally revalued at $500,000. What is the revaluation surplus that will be recorded in the
financial statements in respect of this property?

A $400,000
B $500,000
C $530,000
D $430,000
QUESTION 2:

An entity owns two buildings, A and B, which are currently recorded in the books at carrying
amounts of $170,000 and $330,000 respectively. Both buildings have recently been valued as
follows:

Building A $400,000
Building B $250,000
The entity currently has a balance on the revaluation surplus of $50,000 which arose when
building A was revalued several years ago. Building B has not previously been revalued.
What double entry will need to be made to record the revaluations of buildings A and B?

FROM THE DESK OF M. JUNAID KHALID 21

 QUESTION 3:

QUESTION 4:

PRACTISE QUESTIONS ANSWERS:

1) D
2) A
3) 93920
4) A

FROM THE DESK OF M. JUNAID KHALID 22

DISCLOSURES:
IAS 16 requires the following disclosures related to property, plant and equipment;
a) Measurement basis
b) Depreciation method
c) Useful life and depreciation rates
d) Gross carrying amount and accumulated depreciation
e) Reconciliation
 Addition
 Disposals
 Reduction in carrying amount
 Depreciation
 Any other movement
 Impairment losses
 Increase/ decrease in revaluation surplus

TOTAL EQUIPMENT BUILDINGS

COST
AT 1 JANUARY 2004 40,000 30,000 10,000
ADDITIONS IN YEAR 19,000 15,000 4,000
DISPOSALS IN YEAR (1,000) - (1,000)
AT 31 DECEMBER 2004 58,000 45,000 13,000
DEPRECIATION
AT 1 JANUARY 2004 11,000 5,000 6,000
CHARGE FOR YEAR 4,000 1,000 3,000
AT 31 DECEMBER 2004 15,000 6,000 9,000
CARRYING AMOUNT
AT 31 DECEMBER 2004 43,000 39,000 4,000
AT 1 JANUARY 2004 29,000 25,000 4,000

As well as the reconciliation above, the financial statements should also disclose the following:
a) Accounting policies for tangible assets should be disclosed
b) Revalued asset requires the following disclosures
i. Effective date of revaluation
ii. Carrying amount of the asset if no revaluation had taken place
iii. Whether an independent valuer was involved
c) The carrying amount of temporarily idle property, plant and equipment
d) Gross carrying amount of any fully depreciated P, P & E that is still in use
BPP KIT: 24, 30, 31, 57 – 61, 67 – 69 KAPLAN KIT: 1 -- 3, 8 – 11, 221 –224

FROM THE DESK OF M. JUNAID KHALID 23

 EVENTS AFTER THE REPORTING PERIOD – IAS 10
DEFINITION:
As per international accounting standard;
“Events after the reporting period are those events, both favorable and unfavorable, that
occur between the reporting date and the date on which the financial statements are
authorized for issue. Two types of events can be identified:
 Those that provide further evidence of conditions that existed at the reporting
date (Adjusting events); and
 Those are indicative of conditions that arose subsequent to the reporting date
(Non Adjusting events)

EXPLAINATION:
Events after reporting period which provide additional evidence of conditions existing
at the reporting date will cause adjustments to be made to the assets and liabilities in
the financial statements or that disclosure of such events should be given.
Events that provide further evidence of conditions that existed at the reporting date
should be adjusted for in the financial statements. Events for which evidence was not
available at the reporting date should be disclosed in the financial statements.

 EXAMPLES OF ADJUSTING EVENTS

a) The settlement of a court case after the reporting period that confirms that the
entity had a present obligation at the end of the reporting period.
b) The bankruptcy of a customer that occurs after the reporting period usually
confirms that a loss existed at the end of the reporting period on a trade
receivable.
c) Sale of inventory after the end of the reporting period for less than its
carrying value at the year end.
d) The determination of the cost of assets purchased or the proceeds from the
sale of assets, after the reporting date, which was purchased before the end
of the reporting period.
e) The determination of the amount of profit - sharing or bonus payments
after the reporting date. If the entity had a present legal or constructive
obligations at the end of reporting date.
f) The discovery of fraud or errors that show that the financial statements are
incorrect.
g) Evidence of a decrease in the value of a long-term investment prior to the
year end.
h) Amount received or receivable is respect of insurance claims which were
being negotiated at the reporting date

FROM THE DESK OF M. JUNAID KHALID 24

 EXAMPLES OF NON-ADJUSTING EVENTS
a) Acquisition of, or disposal of, a subsidiary after the year end.
b) Announcement of a plan to discontinue an operation after the year end.
c) Major purchase or disposal of assets after year end.
d) Destruction of a production plant by fire after the end of the reporting
period.
e) Announcement or commencing implementation of a major restructuring after
the year end.
f) Share transactions after the end of the reporting period.
g) Litigation commenced after the end of the reporting period.
h) Abnormal changes in the foreign exchange rates after the year end.

Note: Non adjusting events that are material should be disclosed in the notes to the
financial statements.

 REQUIREMENTS OF DISCLOSURE
The following disclosure requirements are given for material events which occur
after the reporting period which do not require adjustment.
a) The nature of the event.
b) An estimate of the financial effect or a statement that such an estimate cannot
be made.
 DIVIDENDS
Dividend proposed or declared after the end of the reporting period are not
recognized as a liability in the accounts at the reporting date, but are disclosed in the
notes to the accounts.
 GOING CONCERN
Deterioration in operating results and financial position after the reporting period may
indicate a need to consider whether the going concern assumption is no longer
appropriate. If an event after the reporting date indicates that the going concern
assumption is inappropriate for the entity, then the statement of financial position
should be prepared on a break-up basis.

FROM THE DESK OF M. JUNAID KHALID 25

 ILLUSTRATIONS
 ILLUSTRATION 1:
The company has been sued for illegal behavior. This has been denied by the
company, and no provision was made in your financial statements at 31 st December
2004. On January 14th 2005, the court awards Rs.5 million damages against your
firm.
What would be the accounting treatment as per IAS 10?

 ILLUSTRATION 2:
One of the printing firms at 31st December 2004 repaired a largest printing press. It
has a carrying value of Rs.2 million in your financial statements. On January 16 th
2005 you are informed that the press is irreparable, and the scrap value is only
Rs.0.4 million.
What would be the accounting treatment as per IAS 10?
 ILLUSTRATION 3:
One of the clients owes you Rs.8 million on 31st December 2004. On January 9th
2005 client goes into liquidation. You are informed that you will receive nothing from
the liquidation.
What would be the accounting treatment as per IAS 10?

 ILLUSTRATION 4:
Company has a profit-sharing system, based on the audited profit in the financial
statements of 31st December 2004.
On February 26th 2005 auditors confirm the firm’s profit. The resulting profit-share,
that will be paid in March 2005 amounts to Rs.2.4 Million.
What would be the accounting treatment as per IAS 10?

 ILLUSTRATION 5:
Company has invested heavily in Far-eastern stocks that have performed well in the
period to 31st December 2004. On January 14th 2005 a series of earthquake hit the
region, causing major industrial devastation. Stock markets plummet, and remain
very depressed until the date of approval of your financial statements.
What would be the accounting treatment as per IAS 10?

 ILLUSTRATION 6:
On January 5th 2005 the government announced that a new road would be built.
This road will result in the destruction of the firm’s head office. Negotiations have
started with the government for compensation. The carrying value of the head office
building and the land on which it stands was Rs.6.3 million as at 31 st December
2004.What would be the accounting treatment as per IAS 10?

FROM THE DESK OF M. JUNAID KHALID 26

 ILLUSTRATION 7:

 ILLUSTRATION 8:
Shortly after the reporting date a major credit customer of an entity went into
liquidation because of heavy trading losses and it is expected that little or none of
the $12,500 debt will be recoverable. $10,000 of the debt relates to sales made
prior to the year-end and $2,500 relates to sales made in the first two days of the
new financial year.
In the 20X1 financial statements the whole debt has been written off, but one of
the directors has pointed out that, as the liquidation is an event after the reporting
date, the debt should not in fact be written off but disclosure should be made by
note to this year’s financial statements, and the debt written off in the 20X2
financial statements.
Advise whether the director is correct.

FROM THE DESK OF M. JUNAID KHALID 27

 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS (IAS 37)
 PROVISIONS
A provision is a liability of uncertain timing or amount.
A liability is an obligation of an entity to transfer economic benefits as a result of past
transaction or events.

DEFINITION: As per IAS 37 a provision should be recognized (adjusted in the financial

statement) as a liability when all three of the following conditions are met:
a) An entity has a present obligation (legal or constructive) as a result of a past event.
b) It is probable (i.e. more than 50% likely) that a transfer of economic benefits will be
required to settle the obligation.
c) A reliable estimate can be made of the obligation.

POINTS TO BE REMEMBERED:
 Obligating event is an event that creates a legal or constructive obligation.
 Legal obligation may be deriving from;
 A contract through its explicit or implicit terms; or
 Legislation (requirement of law)
 Court
 Constructive obligation is an obligation where;
 By practice, policies or a statement, the undertaking has indicated that it will accept
certain responsibilities; and
 The undertaking has created an expectation that it will discharge those responsibilities.
 Example: Constructive obligation would arise if a business which doesn’t offer
warranties on its product has a history of usually carrying out free small repairs on its
product, so that customers have come to expect this benefit when they make a
purchase.
 Reliable estimate is also required for the provision. Reliable estimate can be made through
past experience, through the expert’s opinion, lawyer’s suggestions, and through the
calculations of expected value for warranty calculation.
 Example: Parker co. sells goods with a warranty under which customers are covered for
the cost of repairs of any manufacturing defect that becomes apparent within the first six
months of purchase. The company’s past experience and future expectations indicate the
following pattern of likely repairs.

What should be the warranty provision in parker co.’s financial statements?

FROM THE DESK OF M. JUNAID KHALID 28

 % of goods sold Defects cost of repairs

75 none -
20 Minor 1 Million
5 Major 4 million

 ACCOUNTING ENTRIES FOR PROVISIONS:

For the recording of provision, the following entry is passed.
DEBIT: Expenses
CREDIT: provisions
For the increase in previous provision;
DEBIT: Expenses
CREDIT: provisions
For the decrease in previous provisions;
DEBIT: provisions
CREDIT: expenses

 ILLUSTRATON 1:
An undertaking sells goods, with a warranty under which clients are covered for the cost of
repairs of any manufacturing defects that become apparent within the first six months after
purchase.
If minor defects are detected in all products sold, repair costs of Rs.5 million would result.
If major defects are detected in all products sold, repair costs of Rs.9 million would result.
The undertaking’s past and future expectations indicate that, for the coming year, 60% of
the goods sold will have no defects, 30% of the goods sold will have minor defects and 10%
of the goods sold will have major defects.
What would be the accounting treatment for this scenario?
ILLUSTRATON 2:
A retail store has a policy of refunding purchases by dissatisfied customers, even though it is
under no legal obligation to do so. Its policy of making refunds is generally known. Should a
provision be made at the year end?
 CONTINGENT LIABILITIES
As per IAS 37 contingent liability is:
I. A possible obligation that arises from past events, and whose existence will be
confirmed by the occurrence or non-occurrence, of uncertain future events not
wholly within the control of the entity or
II. A present obligation that arises from past events, but is not recorded because:
a. It is not probable that payment will be required to settle the obligation; or

FROM THE DESK OF M. JUNAID KHALID 29

 b. The amount of the obligation cannot be measured reliably.

A contingent liability must not be recognized as a liability in the financial statement. Instead it
should be disclosed in the notes to the accounts. If the outflow of economic benefit is remote
(rare) then disclosure is also not required.
Note: As a general rule, probable means more than 50% likely. If an obligation is probable then
it is not a contingent liability, instead a provision is required. If the obligation is remote, it
does not need to be disclosed in the accounts.
 CONTINGENT ASSETS:

As per IAS 37 contingent asset is:

Contingent asset is a possible/probable asset that arises from past events, and whose existence
will be confirmed by the occurrence of one or more uncertain future events not wholly within
the enterprise’s control. It should not be recognized but should be disclosed if it is probable
that the economic benefits associated with the asset will flow to the entity.

If the flow of economic benefits associated with the contingent assets become virtually
certain, it should then be recognized as an asset in the statement of financial position as it is no
longer a contingent asset.
SUMMARY:
The accounting treatment can be summarized in a table:

Degree of probability Outflow Inflow

Virtually certain Recognize liability Recognize asset
Probable Recognize provision Disclose contingent asset
Possible Disclose contingent liability Ignore
Remote Ignore Ignore
REMOTE < 5% NAI HOSKTA
POSSIBLE >5% < 50% HOSKTA HA
PROBABLE >50% < 90% HOJAYEGA

VIRTUALLY CERTAIN >90% SMJHO HOGAYA

FROM THE DESK OF M. JUNAID KHALID 30

SPECIAL CASES:
GURANTEES: In some instances, (particularly in groups) one entity will make a guarantee on
behalf of another to pay off a loan, etc. if the other entity is unable to do so.
A provision should be made for this guarantee if it is probable that the payment will have to be
made. It may otherwise require disclosure as a contingent liability.
FUTURE OPERATING LOSSES/ FUTURE REPAIRS: No provision may be made for future operating
losses or repairs (exception: Onerous contract) because they arise in the future and can be
avoided (close the division that is making losses or sell the asset that may need repair) and
therefore no obligation exists.
ONEROUS CONTRACTS: 'An onerous contract is a contract in which the unavoidable costs of
meeting the obligations under the contract exceed the economic benefits expected to be
received under it' (IAS 37, para 10).
The signing of the contract is the past event giving rise to the obligation to make the payments
and those payments, discounted if the effect is material, will be the measure of the excess of
cost over the benefits.
A provision for this net cost should be recognized as an expense in the statement of profit or loss
in the period when the contract becomes onerous. In subsequent periods, this provision will be
increased by the unwinding of the discount (recognized as a finance charge) and reduced by any
payments made.
ILLUSTRATION 3:
K limited entered into a contract with A limited following are details:
Supply of goods from September 2019 to march 2020:
Cost of goods per month (expected) $40million
Selling price per month $50million
st
On 1 December raw material price rises and cost of goods is now $55million per month.
However, sales price cannot be increased.
Required: Prepare entries if year-end is 31st December
ENVIRONMENTAL PROVISIONS: A provision will be made for future environmental costs if there is
either a legal or constructive obligation to carry out the work, this will be discounted to present
value at a pre-tax market rate.

FROM THE DESK OF M. JUNAID KHALID 31

PROVISION OF DISMANTLING COST: Provision for dismantling cost/cost of removing the asset
should be recognized at its present value.
RESTRUCTURING PROVISIONS: A restructuring is a programme that is planned and controlled by
management, and materially changes either:
o the scope of a business undertaken by an entity, or
o the manner in which that business is conducted’ (IAS 37, para 10).
 Examples of restructuring:
 Discontinue of operation/unit
 Closure of business location or relocation
 Changes in directors, termination of maximum employees
 Change in the nature and focus of entity’s operation

A
provision may only be made if:
o a detailed, formal and approved plan exists, and
o the plan has been announced to those affected.

The provision should:

o include direct expenditure arising from restructuring
o exclude costs associated with ongoing activities. (relocation cost, training cost,
marketing cost)

REIMBURSEMENTS:

 Reimbursements will only be recorded when it is virtually certain and it should be

separately recorded as an asset and not adjusted with the amount of provision,
 However, amount recognized in profit or loss may be netted off
 Reimbursement amount should not exceed the amount of provision

EXAMPLE: One of the customer has claimed $10m from their supplier NAWAZ BHAI ltd on account
of supply of inferior quality of raw material NAWAZ BHAI ltd believes they receive defective raw
material from their supplier ZARDARI LTD and hence they raised counter claim to ZARDARI LTD
for $12m. At year end lawyer of NAWAZ BHAI ltd is certain that they have to pay $10m to their
customer and will definitely receive $12m from ZARDARI LTD.
Required: Prepare entries in the books of NAWAZ BHAI ltd

FROM THE DESK OF M. JUNAID KHALID 32

RAAZ KI BAATEIN:
1) Where the effect of time value of money is material, the amount of a provision should be
the present value of the expenditure required to settle the obligation. An appropriate
pre-tax discount rate should be used.
2) Future event should also be considered while making a provision (like change in
technology or legislation)
3) Gains from expected disposal of assets are not taken into account in measuring provision
4) Amount of provision should be reviewed at the end of reporting date

DISCLOSURES:

PROVISION CONTINGENT LIABILITY CONTINGENT ASSET

OPENING BALANCES DESCRIPTION DESCRIPTION
FOR THE YEAR FINANCIAL IMPACT FINANCIAL IMPACT
WHY PROVISION NOT MADE/ WHY ASSET NOT RECORDED/
WRITE OFF/REVERSAL
DETAILS OF UNCERTAINTIES DETAILS OF UNCERTAINTIES
PAYMENTS
UNWINDING OF DISCOUNTS
CLOSING BALANCES

PRACTISE QUESTIONS:
Illustration 1:
Which one of the following is a disclosure about non-adjusting events required by IAS 10?
a) Dividends declared before the end of the reporting period and paid after the end of the
reporting period.
b) The nature of both material and non-material non-adjusting events
c) The date that the non-adjusting events occurred
d) An estimate of the financial effect of the event, unless a reasonable estimate cannot be
made

Illustration 2:
If an entity has a warranty obligation and expects, with more than 50% probability, it will result
in some payments from the entity, a provision should be made for:
 50% of the expected amount of the payments
 The expected amount of the payments/best estimates
 An amount agreed upon by management
 The entire amount of the sales in the period

FROM THE DESK OF M. JUNAID KHALID 33

Illustration 3:
Where is a contingent liability contained in the financial statements?
 As a non-current liability
 A current liability
 In equity
 A note to the financial statements

Illustration 4:
Which of the following is not a disclosure requirement for a contingent liability?
 Exact timing of outflow
 Indication of uncertainties relating to the amount
 Estimated financial effect
 Possibility of any reimbursement

Illustration 5:
Which of the following does not create a constructive obligation under IAS 37?
 Established pattern of past practice
 Legislation
 Published policies
 A current statement

Illustration 6:
After a wedding in the year 2010 ten people became seriously ill, possibly as a result of food
poisoning from products sold by CALLOW COMPANY”. Legal proceedings are started seeking
damages from CALLOW COMPANY but it disputes liability. Up to the date of approval of the
financial statements for the year to 31st December 2010, CALLOW’S lawyer’s advice that it is
probable that it will not be found liable. However, when CALLOW prepares the financial
statements for the year to 31st December 2011 its lawyers advise that owing to developments
in the case, it is probable that it will be found liable. What is the required accounting
treatment? At 31st December 2010 and at 31st December 2011
Illustration 7:
During the year to 31 March 20X9, a customer commenced legal proceedings against a
company, claiming that one of the food products that it manufactures had caused several
members of his family to become seriously ill. The company’s lawyers have advised that this
action will probably not succeed. Should the company disclose this in its financial statements?

FROM THE DESK OF M. JUNAID KHALID 34

Illustration 8:
On 14 June 20X5 a decision was made by the board of an entity to close down a division. The
decision was not communicated at that time to any of those affected and no other steps were
taken to implement the decision by the year end of 30 June 20X5. The division was closed in
September 20X5. Should a provision be made at 30 June 20X5 for the cost of closing down the
division?
Illustration 9:

FROM THE DESK OF M. JUNAID KHALID 35

Illustration 10:

KAPLAN KIT 129 – 140, 306 -- 312

FROM THE DESK OF M. JUNAID KHALID 36

 IAS 21 – FOREIGN CURRENCY TRANSACTIONS
Exchange rate: The rate of exchange between two currencies
Spot rate: The exchange rate at the date of the transaction
Closing rate: The spot exchange rate at the end of the reporting period
Presentation currency: The currency in which the financial statements of an entity are
presented
Functional currency: 'the currency of the primary economic environment in which an entity
operates' (IAS 21, para 8). This will usually be the currency in which the majority of an entity's
transactions take place.
IAS 21 says that an entity should consider the following primary factors when determining its
functional currency:
o the currency that mainly influences sales prices for goods and services
o the currency of the country whose competitive forces and regulations mainly determine
the sales price of goods and services
o the currency that mainly influences labor, materials and other costs of providing goods
and services.

If the primary factors are inconclusive then the following secondary factors should also be
considered:
o the currency in which funds from financing activities are generated
o the currency in which receipts from operating activities are retained.

Foreign currency: A currency other than the functional currency of the entity
Monetary items: Units if currency held and assets and liabilities to be received or paid in a fixed
or determinable number of units of currency. items that can be easily converted into cash, e.g.
receivables, payables, loans.
Non- Monetary items: Non-monetary items: items that give no right to receive or deliver cash,
e.g. inventory, plant and machinery.
QUESTION 1:
A Pakistani company with the rupee as its functional currency has a financial year ending on
31st December. It buys goods from an Australian supplier (with the Australian dollar as its
functional currency on 1st December 20x6 invoiced in A$10,000.
The Australian supplier is eventually paid in march 20x7.
Exchange rates over the period were as follows:

FROM THE DESK OF M. JUNAID KHALID 37

1st December 20x6 Rs.75/A$1
31st December 20x6 Rs.80/A$1
31st March 20x7 Rs.81/A$1
Required: Prepare entries on transaction, reporting and settlement date.

QUESTION 2:
On 1 April 20X8 Collins Co, a company that uses the dollar ($) as its functional currency, buys
goods from an overseas supplier, who uses Kromits (Kr) as its functional currency. The goods
are priced at Kr54,000. Payment is made 2 months later on 31 May 20X8.
The prevailing exchange rates are:
1 April 20X8 Kr1.80: $1
31 May 20X8 Kr1.75: $1
Required: Record the journal entries for these transactions.

QUESTION 3:
On 1 April 20X8 Collins Co, a company that uses the dollar ($) as its functional currency, buys
goods from an overseas supplier, who uses Kromits (Kr) as its functional currency. The goods
are priced at Kr54,000. Payment is still outstanding at the reporting date of 30 June 20X8.
The prevailing exchange rates are:
1 April 20X8 Kr1.80: $1
30 June 20X8 Kr1.70: $1
Required:
a) Record the journal entries for these transactions.
b) Prepare extract of financial statements on 30 th June 20x8

Note: Unsettled transactions

• If a transaction is still unsettled at the reporting date, there will be an outstanding asset or
liability on the statement of financial position.
• If the asset/liability is a monetary item it should be retranslated at the closing rate.
• If the asset/liability is a non-monetary item it should remain at the historic rate.
• Exchange differences will arise on the retranslation of the monetary items, and these are
also posted to the statement of profit or loss.

QUESTION 4:
ABC Co has a year end of 31 December 20X1 and uses the dollar ($) as its functional currency.
On 25 October 20X1 ABC Co buys machine from a Swedish supplier for Swedish Krona (SWK)
286,000.
Rates of exchange:
25 October 20X1 $1 = SWK 11.16

FROM THE DESK OF M. JUNAID KHALID 38

16 November 20X1 $1 = SWK 10.87
31 December 20X1 $1 = SWK 12.02
Required:
Show the accounting treatment for the above transactions if:
(a) A payment of SWK286,000 is made on 16 November 20X1.
(b) The amount owed remains outstanding at the year-end date.

QUESTION 5:
US company buys a consignment of goods from a supplier in Germany. The order is placed on
1st May and the agreed price is €124,250. At the time of delivery, the rate of foreign exchange
was €2 to $1. When the US company comes to pay the supplier, it needs to obtain some foreign
currency. By this time, however, if the rate of exchange has altered to €2.05 to $1
Required: Record the above transactions

QUESTION 6:
US company sells goods to a Mexican company, and it is agreed that payment should be made
in Mexican pesos at a price of MXN116,000. We will further assume that the exchange rate at
the time of sale is MXN 17.2 to $1, but when the debt is eventually paid, the rate has altered to
MXN 18.1 to $1.
Required: Record the above transactions

Treatment of exchange differences

 If the exchange difference relates to trading transactions it is disclosed within other
operating income/operating expenses.
 If the exchange difference relates to non-trading transactions it is disclosed within
interest receivable and similar income/finance costs.
 If exchange differences arise due to revaluation surplus, then such gain or loss should be
adjusted in OCI.

QUESTION 7:
Seattle Co, whose year-end is 31 December, buys some goods from Telomere SA of France on
30 September. The invoice value is €60,000 and is due for settlement in equal instalments on 30
November and 31 January. The exchange rate moved as follows.
€= $1
30 September 1.60
30 November 1.80
31 December 1.90
31 January 1.85
Required: State the accounting entries in the books of Seattle Co.

FROM THE DESK OF M. JUNAID KHALID 39

QUESTION 8:
An entity, waiter, has a reporting date of 31st December and the dollar as its functional
currency. Waiter borrows in the foreign currency of the Kram (K). the loan of K120,000 was
taken out on 1st January 20x7. A repayment of K40,000 was made on 1st March 20x7.
Exchange rates were as follows:
1st January 20x7 K1: $2
st
1 March 20x7 K1: $3
st
31 December 20x7 K1: $3.5
Required: State the accounting entries in the books of Waiter Co. and financial extracts on 31st
December 20x7

PRACTISE QUESTIONS:
QUESTION 1:
On 19 December 2019 Star Limited bought goods from Morgan plc for 80,000 British Pounds. At
the date of the transactions, the exchange rates were: £1 = PKR 186
On 31 December 2019, Star Limited’s financial year end, the equivalent rates were: £1 = PKR
182
The average rate for the year ended 31 December 2019 was £1 = PKR 185
Star Limited paid this creditor on 3 February 2020 when the exchange rates were: £1 = PKR 188
Star Limited should recognize purchases on 19 December 2019 at:
(a) Rs. 14,880,000
(b) Rs. 14,560,000
(c) Rs. 14,800,000
(d) Rs. 15,040,000

QUESTION 2:
On 19 December 2019 Star Limited bought goods from Morgan plc for 80,000 British Pounds. At
the date of the transactions, the exchange rates were: £1 = PKR 186
On 31 December 2019, Star Limited’s financial year end, the equivalent rates were: £1 = PKR
182. The average rate for the year ended 31 December 2019 was £1 = PKR 185
Star Limited paid this creditor on 3 February 2020 when the exchange rates were: £1 = PKR 188
The carrying amount of trade payables in respect of above on 31 December 2019 shall be:
(a) Rs. 14,880,000
(b) Rs. 14,560,000
(c) Rs. 14,800,000
(d) Rs. 15,040,000

FROM THE DESK OF M. JUNAID KHALID 40

QUESTION 3:
On 19 December 2019 Star Limited bought goods from Morgan plc for 80,000 British Pounds. At
the date of the transactions, the exchange rates were: £1 = PKR 186
On 31 December 2019, Star Limited’s financial year end, the equivalent rates were: £1 = PKR
182. The average rate for the year ended 31 December 2019 was £1 = PKR 185
Star Limited paid this creditor on 3 February 2020 when the exchange rates were: £1 = PKR 188
The amount of exchange gains or loss for the year ended 31 December 2019 shall be:
(a) Rs. 320,000 gain
(b) Rs. 320,000 loss
(c) Rs. 480,000 gain
(d) Rs. 480,000 loss

ANS Q1: A
ANS Q2: B
ANS Q3: A

FROM THE DESK OF M. JUNAID KHALID 41

FROM THE DESK OF M. JUNAID KHALID 42
FROM THE DESK OF M. JUNAID KHALID 43
ANSWERS:

KAPLAN KIT : 97 – 101, 286 – 288

BPP KIT: 181 – 183

FROM THE DESK OF M. JUNAID KHALID 44

 IAS 20 -- ACCOUNTING FOR GOVERNMENT GRANT AND DISCLOSURE OF
GOVERNMENT ASSISTANCE
Governments often provide money or incentives to companies to export their goods or to
promote local employment.
IAS 20 does not cover the following situation;
1) Tax related relief (covered in IAS 12)
2) Agriculture grant (covered in IAS 41)
3) Government partnership/joint venture (covered in IFRS 11)
4) Normal trading with government

GOVERNMENT GRANT:
Government grants are assistance by government in the form of transfers of resources to an
entity in return for past or future compliance with certain conditions relating to the operating
activities of the entity.' If either of the condition is not satisfied, then this will be considered as
assistance.
GOVERNMENT ASSISTANCE:
Government assistance is action by government designed to provide an economic benefit
specific to an entity or range of entities qualifying under certain criteria'. E.g. export advice,
business feasibilities, guarantees, interest free loan etc.
FORGIVABLE LOANS:
Forgivable loans which the lender undertakes to waive repayment under certain prescribed
conditions. It should be treated in a same way as government grant when it is reasonably
assured that entity will meet relevant terms for forgiveness.

ACCOUNTING TREATMENT OF GOVERNMENT GRANT AND ASSISATANCE:

o Government assistance are disclosed in notes to the accounts
o Government grant may be divided in two categories;
 Revenue grant; and
 Asset grant
REVENUE GRANT:
Revenue grant is other than asset grant. IAS 20 allows such grants to either be:
1) Recognize grant as deferred income and then presented as a credit in the statement of
profit or loss, or
2) Deducted from the related expense.

FROM THE DESK OF M. JUNAID KHALID 45

 NOTE:

And if no cost to be incurred by the company then such grant is prorated on yearly basis
PRACTISE QUESTION 1:
A company receives a cash grant of $30,000 on 31 December 2010. The grant is towards the
cost of training young apprentices, and the training program is expected to last for 18 months
from 1 January 2011. Actual costs of the training were $50,000 in 2011 and $25,000 in Year
2012.
Required: Prepare entries for 31st December 2010, 2011 and 2012
PRACTISE QUESTION 2:

A company receives a cash grant of $40,000 on 31 December 2015. The grant is towards the
cost of training young apprentices, and the training program is expected to last for 24 months
from 1 January 2016. Actual costs of the training were $40,000 in 2016 and $20,000 in Year
2017.
Required: Prepare entries for 31st December 2015, 2016 and 2017

PRACTISE QUESTION 3:
An entity is given $300,000 on 1 January 20X1 to keep staff employed within a deprived area.
The entity must not make redundancies for the next three years, or the grant will need to be
repaid. By 31 December, 20X1, no redundancies have taken place and none are planned. Co
policy to recognize grant as other income.

Required: Prepare entries for the year 20x1

ASSETS GRANT/CAPITAL GRANT:

Grants for purchases of non-current assets should be recognised over the expected useful lives
of the related assets. IAS 20 permits two treatments. Both treatments are equally acceptable
and capable of giving a fair presentation.
Method 1
On initial recognition, deduct the grant from the cost of the non-current asset and depreciate
the reduced cost.
Method 2
Recognize the grant initially as deferred income and transfer a portion to revenue each year on
the basis of depreciation method, so offsetting the higher depreciation charge based on the
original cost.

FROM THE DESK OF M. JUNAID KHALID 46

PRACTISE QUESTION 4:
An entity opens a new factory and receives a government grant of $15,000 in respect of capital
equipment costing $100,000. It depreciates all plant and machinery at 20% pa straight-line.
Required: Show the statement of profit or loss and statement of financial position extracts in
respect of the grant in the first year under both methods.
PRACTISE QUESTION 5:

A company receives a government grant of $400,000 towards the cost of an asset with a cost of
$1,000,000. The asset has an estimated useful life of 10 years and no residual value.

Required: Show the statement of profit or loss and statement of financial position extracts in
respect of the grant in the first year under both methods.

PRACTISE QUESTION 6:
A company receives a government grant of $1500,000 on 1st July 20x5 towards the cost of an
asset with a cost of $5,000,000. The asset has an estimated useful life of 10 years and use 20%
reducing balance method for depreciation. Company policy to account for all grants received as
deferred income.

Required: Show the statement of profit or loss and statement of financial position extracts in
respect of the grant for the year ended 31st December 20x5 and 31st December 20x6
REPAYMENT OF GOVERNMENT GRANT (REVENUE GRANT):
A government grant might become repayable by the entity (e.g. when the entity fails to meet
the underlying conditions for the grant).
When a government grant becomes repayable it is accounted for as a change in accounting
estimate (IAS 8: Accounting policies, changes in accounting estimates and errors).

Repayment of a grant related to income is applied in the first instance against any
unamortized deferred credit recognized in respect of the grant. If the repayment exceeds
any such deferred credit any excess is recognized immediately in profit or loss.

PRACTISE QUESTION 7:
On 1 January 20X1 Sty received $1m from the local government on the condition that they
employ at least 100 staff each year for the next 4 years. Due to an economic downturn and
reduced consumer demand on 1 January 20X2, sty no longer needed to employ any more staff
and the conditions of the grant required full repayment. Co policy to recognize grant as other
income.
Required: What should be recorded in the financial statements on 1 January 20X2?

FROM THE DESK OF M. JUNAID KHALID 47

PRACTISE QUESTION 8:
On 1 January Year 1 X Limited received a cash grant of $500,000 towards the cost of employing
an environmental impact analyst on a new project for a 5 Year period. The grant is repayable in
full if the project is not completed.
The analyst was employed and the project commenced from the 1 January Year 1. On 1 January
Year 3 the project was abandoned and the grant became repayable in full.
Required: Prepare entries
REPAYMENT OF GOVERNMENT GRANT (ASSET GRANT):
Accounting for a repayment of a grant related to an asset depends on how the grant was
accounted for originally.
If the grant was accounted for as reduction of the carrying amount of the related asset, its
repayment is recognized by increasing the carrying amount of the asset.
If the grant was accounted for as deferred income, its repayment is recognized by reducing the
deferred income balance by the amount repayable. (no impact on assets carrying value)
The cumulative additional depreciation that would have been recognized in profit or loss to
date in the absence of the grant must be recognized immediately in profit or loss.

PRACTISE QUESTION 9:
USA ltd received a grant of $1M against purchase of assets costing $5M. On 1st January 2019
Asset life was 5 years on that date. On 1st January 2020 grant become repayable in full.
Required: Prepare entries under;
a) Gross method
b) Net method

PRACTISE QUESTION 10:

INDIA ltd received a grant of $3M against purchase of assets costing $5M. On 1st January 2019
Asset life was 5 years on that date. On 1st January 2021 grant become repayable in full.
Required: Prepare entries under;

a) Gross method
b) Net method

FROM THE DESK OF M. JUNAID KHALID 48

PRACTISE QUESTION 11:
Arturo Company receives a government grant representing 50% of the cost of a depreciating
asset which costs $40,000. How will the grant be recognized of Arturo Company depreciates the
asset; the residual value is nil and useful life is four years
a) Over four years’ straight line
b) At 40% reducing balance

Required: Calculate the amount of depreciation and grant income for first three years. Under
straight line method and reducing balance method separately.
PRACTISE QUESTION 12:
On 1st January 2016 Gardenbugs Company received a $30,000 government grant relating to
equipment which cost $90,000 and had a useful life of six years. The grant was netted of against
the cost of asset.
On 1st January 2017, when equipment had a carrying amount of $50,000, its use was changed
so that it was no longer being used in accordance with the grant. This meant that the grant
needed to be repaid in full but by 31st December 2017, this has not yet been done.
Which journal entry is required to reflect the correct accounting treatment of the government
grant and the equipment for the year ended 31st December 2017?
a) Dr. Property, plant and equipment $10,000
Dr. Depreciation expense $20,000
Cr. Liability $30,000

b) Dr. Property, plant and equipment $15,000

Dr. Depreciation expense $15,000
Cr. Liability $30,000

c) Dr. Property, plant and equipment $10,000

Dr. Depreciation expense $15,000
Dr. Retained earnings $5,000
Cr. Liability $30,000

d) Dr. Property, plant and equipment $20,000

Dr. Depreciation expense $10,000
Cr. Liability $30,000

FROM THE DESK OF M. JUNAID KHALID 49

GRANT FOR PAST EXPENSES:
As company has already met the conditions now there is no need to recognize deferred income,
hence it should directly be recognizing as other income.
PRACTISE QUESTION 13:
On 1st September, a grant of $40,000 from local government. The grant was in respect of
training costs of $70,000 which Company had already incurred.

Required: Prepare entry on 1st September

NON MONETARY GOVERNMENT GRANT:
A Non-monetary asset may be transferred by government to an entity as a grant, for example a
piece of land, or other resources. The fair value of such asset is usually assessed and this is used
to account for both the asset and the grant. Alternatively, both may be valued at a nominal
amount.
PRACTISE QUESTION 14:
A government grant a company a license. The fair value of license is $50,000. The company was
required to pay a small sum of $ 1,000 for the license.
Required: Show the entries assuming;
a) The company chooses to measure license at fair value
b) The company chooses to measure license at nominal value

PRACTISE QUESTION 15:

FROM THE DESK OF M. JUNAID KHALID 50

DISCLOSURE REQUIREMENTS:
IAS 20 requires the following disclosures in the notes to the financial statements:
o The accounting policy adopted for government grants, including the method of
presentation in the financial statements
o The nature and extent of government grants recognized in the financial statements and
an indication of other forms of government assistance from which the entity has directly
benefitted.
o Unfulfilled conditions and other contingencies attaching to government assistance (if
this assistance has been recognized in the financial statements).
o Government assistance may be significant so that disclosure of the nature, extent and
duration of the assistance is necessary in order that the financial statements may not be
misleading.

BPP KIT QUESTIONS 78, 81, 87, 140, 141

KAPLAN KIT QUESTIONS 4, 5, 12, 237, 240

FROM THE DESK OF M. JUNAID KHALID 51

 IAS 40 – INVESTMENT PROPERTY
Investment property is land or a building ‘held to earn rentals or for capital appreciation or
both’ (IAS 40, para 5), rather than for use by the entity or for sale in the ordinary course of
business.
PROPERTIES INCLUDES:
1) Land held for long term capital appreciation
2) Land held for indeterminate future use
3) Building leased out under an operating lease
4) Vacant building held to be leased out under an operating lease
5) Property being constructed (developed for future use as investment property)

PROPERTIES DOES NOT INCLUDES:

1) Property held for use in supply of goods or services or production purpose or for admin
purposes
2) Property intended for sale in ordinary course of business
3) Property being constructed on behalf of third party (construction company)
4) Owner occupied property
5) Property leased to another entity under finance lease

RECOGNITION CRITERIA:
The recognition criteria for investment property are the same as for property, plant and
equipment under IAS 16. An owned investment property should be recognized as an asset only
when:
 It is probable that future economic benefits associated with the property will flow to the
entity; and
 The cost of the property can be measured reliably.
INITIAL MEASUREMENT:
Owned investment property should be measured initially at cost plus any directly attributable
expenditure (e.g. legal fees, property transfer taxes and other transaction costs) incurred to
acquire the property.
The cost of an investment property is not increased by:
o Start-up costs (unless necessary to bring the property to the condition necessary for it to
be capable of operating in the manner intended by management);
o Operating losses incurred before the investment property achieves the planned level of
occupancy; or
o Abnormal waste incurred in constructing or developing the property.

FROM THE DESK OF M. JUNAID KHALID 52

QUESTION 1:
A limited purchased a land for $60 Million further following expenses on this property;
$
Cement used for making building on land 10million
Iron used 10million
Labour 1/3 of iron cost
Over heads 5million
Additional information:
 10% of cement is wasted due to negligence
 15% overheads are allocated to admin overheads
 Company paid 5% brokerage fee to agent involved in dealing of land
 Building has a life of 30 years
 Land purchased on 18 November 2018 but building was completed on 31st March 2019
 Company intend to earn rental for 10 years from building and then to sell it
Required: Prepare entries in the books of A limited for the year ended 30 June 2019

QUESTION 2:
A limited a land for $90 Million further following expenses on this property;
$
Cement used for making building on land 11million
Iron used 16million
Labour 3/11 of iron cost
Overheads 2.5million
Additional information:
 17% of cement is wasted due to negligence
 2% overheads are allocated to admin overheads
 Company paid 15% brokerage fee to agent involved in dealing of land
 Building has a life of 20 years
 Land purchased on 18 November 2018 but building was completed on 1st March 2019
 Company intend to earn rental for 15 years from building and then to sell it
Required: Prepare entries in the books of A limited for the year ended 30 June 2019

MEASUREMENT AFTER RECOGNITION

After initial recognition an entity may choose as its accounting policy:
o The fair value model; or
o The cost model.

FROM THE DESK OF M. JUNAID KHALID 53

RECLASSIFICATION OF COST MODEL AND FAIR VALUE MODEL:
 Fair value to cost model is not allowed
 Cost model to fair value is allowed
QUESTION 3:
On 1st January 2012 Smart Company purchased a building for its investment potential. The
building cost $1 million with transaction cost of $10,000.
The residual value of the building at this date was $700,000. The property has a useful life of 50
years.
Required: Treatment under
a) cost model; and
b) fair value model (At the end of 2012 the building’s fair value had risen to $1.3million)

QUESTION 4:
On 1st January 2014 Over Smart Company purchased a property for its investment potential.
The property cost 40million which includes building cost $10million. Total transaction cost of
$200,000. Allocated to building 30%.
The residual value of the building at this date was $500,000. The property has a useful life of 50
years. (At the end of 2014 the land components fair value had risen to $35million. While no
change in the building component)
Required: Treatment under
a) cost model; and
b) fair value model

QUESTION 5:
An entity purchased an investment property on 1 January 2013 for a cost of $35m. The
property had an estimated useful life of 50 years, with no residual value, and at 31 December
2015 had a fair value of $42m.
On 1 January 2016 the property was sold for net proceeds of $40m.
Calculate the profit or (loss) on disposal under both the cost and fair value (FV) model.
(a) Cost model: $7.1 m and FV model: ($2.0 m)
(b) Cost model: $2.0 m and FV model: $2.0 m
(c) Cost model: $5.0 m and FV model: ($ 2.0 m)
(d) Cost model: $7.1 m and FV model: $5.0 m

FROM THE DESK OF M. JUNAID KHALID 54

QUESTION 6:
An investment property with a useful life of 10 years was purchased by Akram Limited on 1
January 2019 for $200 million. By 31 December 2019 the fair value of the property had risen to
$300 million. Akram Limited measures its investment properties under the fair value model.
What values would go through the statement of profit or loss in the year?

(a) Gain: $100 million and Depreciation $30 million

(b) Gain: $0 and Depreciation of $30 million
(c) Gain: $100 million and Depreciation of $0
(d) Gain: $120 million and Depreciation of $20 million

QUESTION 7:
Celine, a manufacturing entity, purchases a property for $1 million on 1 January 20X1 for its
investment potential. The land element of the cost is believed to be $400,000, and the buildings
element is expected to have a useful life of 50 years. At 31 December 20X1, local property
indices suggest that the fair value of the property has risen to $1.1 million.
Required: What amount should be included in Profit & Loss and balance sheet at 31 December
20X1 if Celine adopts:
(a) the cost model
(b) the fair value model.

NOTE:
o If fair value cannot be determined then even in fair value, investment property will be
measured at cost.
o Different models cannot be used for investment properties. Same model should be used
for all investment properties.
o If a building is rented by a subsidiary of the entity, then the building will be classed as an
investment property in the individual accounts, but will be classed as property, plant
and equipment per IAS 16 in the consolidated financial statements. This is because the
asset will be used by the group, so must be accounted for in accordance with IAS 16.

PROVISION OF ANCILLARY SERVICES TO OCCUPANTS

If those services (e.g. security or maintenance services) are a relatively insignificant component
of the arrangement as a whole, then the entity may treat the property as investment property.
Where the services provided are more significant (such as in the case of an owner managed
hotel), the property should be classified as owner-occupied property, plant and equipment.

FROM THE DESK OF M. JUNAID KHALID 55

QUESTION 8:
a) An entity has a factory that has been shut down due to chemical contamination, worker
unrest and strike. Now the entity plans to sells this factory.
b) An entity has purchased a building that it intends to lease out under an operating lease.
c) An entity has acquired has acquired a large- scale office building, with the intention of
enjoying its capital appreciation. Rather than holding it empty, the entity has decided to
try to recover its running costs by renting the space out for periods which run from one
week to one year. To make the building attractive to potential customers, the entity has
fitted the space out as small office units, complete with full-scale tele communication
facilities, and offers reception, cleaning, a loud speaker system and secretarial services.
The expenditure incurred in fitting out the offices has been a substantial proportion of
the value of the building.
d) An entity acquired a site on 30th April 20x4 with the intention of building office blocks to
let. After receiving planning permission, construction started on 1st September 20x4 and
was completed at a cost of $10 million on 30th March 20x5 at which point the building
was ready for occupation.
The building remains vacant for several months and the entity incurred significant
operating losses during the period.
The first leases were signed in July 20x5 and the building was not fully let until 1 st
September 20x6.

Required: Do the buildings referred to (a) – (d) above meet the definition criteria of investment
property?

PARTIAL OWN USE

 If the owner uses part of the property for its own use, and part to earn rentals or for
capital appreciation, and the portions can be sold or leased out separately under a
finance lease, they are accounted for separately. The part that is rented out is
investment property
 If the owner-occupied (property, plant and equipment) portion is insignificant, the
property is investment property.

FROM THE DESK OF M. JUNAID KHALID 56

QUESTION 9:
A limited was in the process of constructing a building to be used to earn rental income when,
due to financial difficulties, it could not complete the construction thereof.
Explain how A limited should account for the building if its intention is now to;
a) Sell the building ‘as is’ (A limited sometimes sells buildings as part of its business
activities);
b) Hold the building ‘as is’ for capital appreciation;
c) Borrow form the bank and complete the building, then use it as the entity’s head office.

QUESTION 10:
Cool Limited acquired a building with a 40-year life for its investment potential for Rs. 8 million
on 1 January 2013. At 31 December 2013, the fair value of the property was estimated at Rs. 9
million with costs to sell estimated at Rs. 200,000.
If Cool Limited uses the fair value model for investment properties, what gain should be
recorded in the statement of profit or loss for the year ended 31 December 2013?
Rs. _______________

Note: If payment is made in future for the purchase of investment property, then such
investment property shall be recorded at its present value.
QUESTION 11:
X company purchased a land for investment potential. Payment of $5m against land should be
made after 2 years i.e. 31st December 2020. Fair value of land on 31st December 2019 is $4.5m
and on 31st December 2020 is $4.7m. market rate is 10%. Company uses fair value model.
Required: Prepare entries for 2019 and 2020.

RECLASSIFICATION OF INVESTMENT PROPERTY

Possible reclassification may be as follows;
FROM IAS 40 TO IAS 16
FROM IAS 16 TO IAS 40
FROM IAS 2 TO IAS 40
FROM IAS 40 TO IAS 2

FROM THE DESK OF M. JUNAID KHALID 57

CHANGE FROM OWNER OCCUPIED PROPERTY TO INVESTMENT PROPERTY (USING COST
MODEL)

QUESTION 12:
Osama ltd follows cost model for both investment property and property, plant and equipment.
Followings are details of one of his properties;
Date of purchase 1 January 2020 (FOR HEAD OFFICE)
Cost 100m
Useful life 50 years
On 1 January 2026 Osama Ltd shifted his head office in another location from this property.
On 1 January 2030 Osama Ltd again shifted his office on this property. Property was on rent
from 2026 till 31st December 2029

REQUIRED: Prepare entries for the year 2020, 2026 and 2030
QUESTION 13:
Mastana ltd follows cost model for both investment property and property, plant and
equipment. Followings are details of one of his properties;
Date of purchase 1 January 2016 (FOR HEAD OFFICE)
Cost 200m
Useful life 50 years
On 1 January 2019 Mastana Ltd shifted his head office in another location from this property.
On 1 January 2023 Mastana Ltd again shifted his office on this property. Property was on rent
from 2019 till 31st December 2022

REQUIRED: Prepare entries for the year ended 31st December 2016, 2019 and 2023

CHANGE FROM OWNER OCCUPIED PROPERTY TO INVESTMENT PROPERTY (USING FAIR

VALUE MODEL)
When owner occupied property is to be reclassified to investment property that will then be
accounted for in terms of the fair value model, the entity must revalue the property to its fair
value immediately before making the transfer for investment property

 Any change from the carrying amount to fair value is accounted for in the same way that
a revaluation would be accounted for under the revaluation model IAS 16; and
 This revaluation is done even if the property had been measured using the cost model
 Once the property becomes investment property measure using the fair value model, it
is no longer depreciated

FROM THE DESK OF M. JUNAID KHALID 58

QUESTION 14:
Land purchased on 1st January 2008 for own use for $100m. subsequently value started
declining till 2013. Land was on cost model, as per IAS 16. Value started rising from 2014 and on
31st December 2015 value was $110m. At that date company decided to classify property as
investment property and give it on rentals. Company uses fair value model for investment
property.
Required: Prepare entries for transfer

QUESTION 15:
BILAWAL Company had its head office at LAYARI. Due to earth quake the building which
company owned and was rented to one of the tenant was destroyed on 30th June 20x5.
BILAWAL COMPANY decided to move its own head office to another building nearby and rent
out that property to that value tenant as ‘replacement’. This move was effective on 30th June
20x5.
Other information
o The head office was purchased on 1st January 20x5 for $500,000 (useful life 5 years)
o The fair value of the building was:
o $520,000 on 30th June 20x5; and
o $490,000 on 31st December 20x5
o BILAWAL COMPANY uses the;
o Cost model for IAS 16; and
o Fair value model to measure investment properties

Required: Prepare Entries for the year 20x5 in the books of BILAWAL COMAPNY

QUESTION 16:
Afternoon Limited (AL) uses cost model for its property, plant and equipment and fair value
model for its investment property. AL has an office building which was being used for
administrative purposes. At 1 July 2018, the building had a carrying amount of Rs. 20 million.
On that date, the building was let out to a third party and therefore reclassified as an
investment property. The building had a fair value of Rs. 23 million on 1 July 2018 and Rs. 23.4
million on 30 June 2019.
What would be the increase in the profit or loss and other comprehensive income for the year
ended 30 June 2019?
Profit or loss Other comprehensive income
(a) Nil Rs. 3.4 million
(b) Rs. 0.4 million Rs. 3 million
(c) Rs. 3.4 million Nil
(d) Rs. 3 million Rs. 0.4 million

FROM THE DESK OF M. JUNAID KHALID 59

QUESTION 17:
Which TWO of the following fall under the definition of investment property?
(a) Property occupied by an employee
(b) A building owned by an entity and leased out under an operating lease
(c) Property being constructed on behalf of third party
(d) Land held for long term appreciation

QUESTION 18:
Sarfraz Limited (SL) uses fair value accounting where possible and has an office building used by
SL for administrative purposes. At 1 April 2012 it had a carrying amount of Rs. 20 million and a
remaining life of 20 years. On 1 October 2012, the property was let to a third party and
reclassified as an investment property. The property had a fair value of Rs. 23 million at 1
October 2012, and Rs. 23.4 million at 31 March 2013.
What is the correct treatment when the above property is reclassified as an investment
property?
(a) Take Rs. 3,500,000 gain to other comprehensive income
(b) Take Rs. 3,500,000 gain to the statement of profit or loss
(c) Take Rs. 4,000,000 gain to other comprehensive income
(d) Take Rs. 4,000,000 gain to the statement of profit or loss

CHANGE FROM INVESTMENT PROPERTY (FAIR VALUE MODEL) TO PROPERTY, PLANT AND
EQUIPMENT
The entity must first adjust the investment property’s carrying amount to the fair value on the
date of change. The resultant change must be recognized in profit or loss. The fair value date of
transfer, measured with IAS 40, will then be deemed to be the initial cost of the owner
occupied property or inventory.
QUESTION 19:
BILAWAL Company owned a building at LAYARI and was rented out (recorded as investment
property) at 31st December 20x4. Due to earth quake the head office building was destroyed on
30th June 20x5 and company decided to relocate the head office to rented building, which
forced the tenant to move out. BILAWAL COMPANY shifted the office on 1st July 20x5.
On 31st December 20x4 the fair value of the building was $200,000
On 30th June 20x5 the building;
 Had a fair value of $260,000; and
 Had a remaining useful life of 10 years and a nil residual value
BILAWAL COMPANY uses the;
o Cost model for property, plant and equipment; and
o Fair value model to measure investment properties

Required: Prepare Entries for the year 20x5 in the books of BILAWAL COMAPNY

FROM THE DESK OF M. JUNAID KHALID 60

QUESTION 20:
BILAWAL Company owned a building at LAYARI and was rented out (recorded as investment
property) at 31st December 20x4. Due to earth quake the head office building was destroyed on
30th June 20x5 and company decided to relocate the head office to rented building, which
forced the tenant to move out. BILAWAL COMPANY shifted the office on 1st July 20x5.
On 31st December 20x4 the fair value of the building was $300,000
On 30th June 20x5 the building;
 Had a fair value of $460,000; and
 Had a remaining useful life of 10 years and a nil residual value
BILAWAL COMPANY uses the;
o Cost model for property, plant and equipment; and
o Fair value model to measure investment properties

Required: Prepare Entries for the year 20x5 in the books of BILAWAL COMAPNY

QUESTION 21:
Capital company owns a building which it has been using as a head office. In order to reduce
costs, on 30th June 2019 it moved its head office functions to one of its production centers and
is now letting out its head office. Company policy is to use the fair value model for investment
property.
The building had an original cost on 1st January 2010 of $250,000 and was being depreciated
over 50 years. At 30th June 2019 its fair value was judged to be $350,000 and 380,000 at 31st
December 2020.
Required: How will this appear in the financial statements of Capital Co at 31st December 2019
and 2020?
TRANSFER FROM INVESTMENT PROPERTY (USING COST MODEL) TO INVENTORY
STEP 1: Compute the depreciation of investment property on date of transfer
STEP 2: Transfer to Inventory @ carrying amount

QUESTION 22:
ABC LIMITED purchased investment property having cost $10million and useful life was 10
years on 1st January 2020. On 30th June 2020, company decided to sell it immediately, hence
they classified it as inventory.
Required: Prepare entries in the books of ABC Limited.
TRANSFER FROM INVENTORY TO INVESTMENT PROPERTY (USING COST MODEL)
STEP 1: Value inventory at lower of cost or NRV
STEP 2: Transfer to investment property @ value calculated above

FROM THE DESK OF M. JUNAID KHALID 61

QUESTION 23:
Sameer limited purchased a building to sell it in ordinary course of business for $20million on
1st January 2020. Sameer was unable to sell it till 31st March 2020 and on that date it was
decided to give on operating lease. Life on 31st March was 20 years. NRV on 31st March was
21million. Accounting year ends on31st December. Co uses cost model for IAS 40
Required: Prepare entries in the books of Sameer Limited.

TRANSFER FROM INVESTMENT PROPERTY (USING FAIR VALUE MODEL) TO INVENTORY

STEP 1: Compute the FAIR VALUE GAIN of investment property on date of transfer
STEP 2: Transfer to Inventory @ fair value
QUESTION 24:
ABC LIMITED purchased investment property having cost $10million and useful life was 10
years on 1st January 2020. On 30th June 2020, company decided to sell it immediately, hence
they classified it as inventory. Fair value at 30th June 2020 was $10.5 million. Company uses fair
value model for investment property
Required: Prepare entries in the books of ABC Limited.

BPP REVISION KIT: 27, 28, 32,47, 48, 261

KAPLAN REVISION KIT: 6, 13, 15, 226 -- 230

FROM THE DESK OF M. JUNAID KHALID 62

 IAS 23 -- BORROWING COST
IAS 23 Borrowing Costs regulates the extent to which entities are allowed to capitalize
borrowing costs incurred on money borrowed to finance the acquisition of certain assets.

Borrowing costs must be capitalised as part of the cost of an asset if that asset is a qualifying
asset (one which 'necessarily takes a substantial period of time to get ready for its intended
use or sale' (IAS 23, para 5)).

QUALIFYING ASSET:
As noted above qualifying is the one which necessarily;
i. Takes substantial time period (Audit firm practice is minimum 6 months) and;
ii. Intended for use or sell

EXAMPLES OF QUALIFYING ASSET:

 Inventories
 Manufacturing plant
 Power generation facilities
 Intangible assets
 Investment properties
 Bearer plants

Note: Two types of assets are not recognized as qualifying assets.

1) Inventories that are produced in bulk quantity over a short period of time
2) Assets that are ready for their intended use or sale when it was purchased.

QUESTION 1:
Usama Limited to construct a building work started on 1st January 2020 and ends on 15th July
2020. Following cost are incurred;
$
Cement 100M
Iron 20M
Labour 30M
Interest on loan 5M
Required: Calculate the Cost of Building.

FROM THE DESK OF M. JUNAID KHALID 63

TYPES OF BORROWINGS:
There are two types of borrowings;
1) Specific borrowings
2) General borrowings

QUESTION 2:
A limited constructed a qualifying asset, cost of construction is $100million. To finance
construction following loan was under taken;
 Loan amount $100million
 Date of loan 1st January 2020
 Date of commencement qualifying asset 1st January 2020
 Loan contains interest @ 10%
 Asset was completed on 31st December 2020. $50million was spent on 1st January 2020
and remaining on 1st July 2020.
 Unused amount was invested @ 8%.
 Loan will be repaid after 2 years.
Required: Calculate the total cost of asset at 31st December 2020

QUESTION 3:
A limited constructed a qualifying asset, cost of construction is $50million. To finance
construction following loan was under taken;
 Loan amount $50million
 Date of loan 1st January 2020
 Date of commencement qualifying asset 1st January 2020
 Loan contains interest @ 10%
 Asset was completed on 31st December 2020. $20million was spent on 1st January 2020
and remaining on 1st July 2020.
 Unused amount was invested @ 8%.
 Loan will be repaid after 2 years.
Required: Calculate the total cost of asset at 31st December 2020

BORROWING COST CAPITALIZATION CRITERIA:

IAS 23 states that capitalization of borrowing costs should commence when all
of the following conditions are met:
• Expenditure for the asset is being incurred (CASH OUTFLOW)
• Borrowing costs are being incurred (LOAN BORROWED)
• Activities that are necessary to prepare the asset for its intended use or sale are in progress.

FROM THE DESK OF M. JUNAID KHALID 64

QUESTION 4:
Jazz Limited (JL) has borrowed $24 million to finance the building of a factory. Construction is
expected to take two years.
The loan was drawn down and incurred on 1 January 2019 and work began on 1 March 2019.
$10 million of the loan was not utilized until 1 July 2019 so JL was able to invest it until needed.
JL is paying 8% on the loan and can invest surplus funds at 6%.
Required: Calculate the borrowing costs to be capitalised for the year ended 31 December 2019
in respect of this project.

QUESTION 5:
Ufone Limited (UL) has borrowed $54 million to finance the building of a factory. Construction
is expected to take two years.
The loan was drawn down and incurred on 1 January 2019 and work began on 1 May 2019. $10
million of the loan was not utilized until 1 July 2019 so UL was able to invest it until needed. UL
is paying 6% on the loan and can invest surplus funds at 4%.
Required: Calculate the borrowing costs to be capitalised for the year ended 31 December 2019
in respect of this project.

SUSPENSION IN WORK:
Capitalization of borrowing costs should be suspended if development of the asset is suspended
for an extended period of time. Suspension may be of two types;
a) Normal suspension
b) Abnormal suspension (default)

CESSATION OF CAPITALIZATION
Capitalization of borrowing costs should cease earlier of;
 When the asset is substantially complete; or
 Full repayment of loan
Note: The costs that have already been capitalised remain as a part of the asset’s cost, but no
additional borrowing costs may be capitalised. If one part of the asset is completed and is ready
for use while other is in construction, then borrowing cost ceases to be capitalized on the part
which is substantially completed.

QUESTION 6:
Company A borrowed $9,000 @ 15% per annum to fund a project on 1st Jan 2016.
The following expenditures were made on the project during the year ending 31 December
2016
Date: 1st March 2016: $2,500
Date: 1st Oct 2016: $4,200

FROM THE DESK OF M. JUNAID KHALID 65

Unused amount invested @ 9%
Work on the project was suspended during the month of August and resumed in September
and completed on 31st December 2016.
Required:
a) Calculate the amount of borrowing cost to be capitalized for the year ended 31st
December 2016
b) Calculate the amount of borrowing cost and investment income to be included in Profit
and loss for the year ended 31st December 2016

QUESTION 7:
Company B borrowed $10,000 @ 14% per annum to fund a project on 1st Feb 2018.
The following expenditures were made on the project during the year ending 31 December
2018
Date: 1ST March 2018: $6,500
Date: 1ST Nov 2018: $3,500
Unused amount invested @ 9%
Work on the project was suspended during the month of August and resumed in September
and completed on 31st December 2018.
Required:
a) Calculate the amount of borrowing cost to be capitalized for the year ended 31st
December 2018
b) Calculate the amount of borrowing cost and investment income to be included in Profit
and loss for the year ended 31st December 2018

QUESTION 8:
Fine Limited (FL) received a Rs.10 million loan at 7.5% on 1 April 2017. The loan was specifically
issued to finance the building of a new store.
Construction of the store commenced on 1 May 2017 and it was completed and ready for use
on 28 February 2018 but did not open for trading until 1 April 2018.
Required: How much should be recorded as finance costs in the statement of profit or loss for
the year ended 31 March 2018?
QUESTION 9:
Fine Limited (FL) received a Rs.10 million loan at 7.5% on 1 April 2017. The loan was specifically
issued to finance the building of a new store.
Construction of the store commenced on 1 May 2017 and it was completed and ready for use
on 28 February 2018 but did not open for trading until 1 April 2018.
Required: What amount of borrowing cost should be capitalized at 31 March 2018?

FROM THE DESK OF M. JUNAID KHALID 66

GENERAL BORROWINGS
When there is a shortage of funds company might use general borrowings to construct a
qualifying asset.

QUESTION 10
A ltd. Decided to construct a factory through general borrowings details of running finance
facilities are as follows;

BANK AMOUNT OF FACILITY AVG AMOUNT OUTSTANDING RATE

HBL 200MILLION 50 MILLION 10%
UBL 300MILLION 100 MILLION 9%

Construction on factory started on 1st January 2020 & completed on 31st December 2020. Both
loans were outstanding throughout the year & $10million withdrawn for asset on 1 st January
2020 & $15 Million on 1st July 2020.
Required: Calculate the amount of Borrowing cost to be capitalized during the year 2020.

QUESTION 11
On January 1, 2018 Sara Limited (SL) started the construction of an asset. To meet the financing
requirements, general borrowings was made from three different banks at the start of the year
as follows:
Banks Amount $ Interest Rate p.a
A 70,000 10%
B 60,000 8%
C 50,000 12%
The funds were used on the assets as follows:
Date of Payment $
Jan 1, 2018 30,000
May 1, 2018 20,000
Oct 1, 2018 15,000
The construction of asset was completed on 31 December 2018.
Required: Calculate the amount of Borrowing cost to be capitalized

FROM THE DESK OF M. JUNAID KHALID 67

QUESTION 12
Acruni Co had the following running finance in place at the beginning and end of 20x6.
1st January 20x6 31st December 20x6
$ Million $Million
10% bank loan repayable 20x9 120 120
9.5% debenture repayable 20x7 80 80

On 1st January 20x6. Acruni Co. began construction of qualyfing asset, a piece of machinery for
a electric plant, using existing borrowings. Expenditure drawn down for the constructiuon was
$30m on 1st January 20x6, $20m on 1st October 20x6.

Required: Compute the amount of borrowing cost to be capitalized

QUESTION 13
Shayan Limited (SL) started the construction of its new factory on 1 January 2018 with a loan of
$50,000,000 borrowed at an interest rate of 8% per annum. The loan was used on the factory
as follows:
Date of Payment $ in million
Jan 1, 2018 15
May 1, 2018 20
Oct 1, 2018 10
The construction of the asset was completed on 31 December 2018. However, during the
accounting period SL invested the surplus funds at an interest rate of 3%.
Required: Calculate the amount of Borrowing cost to be capitalized

QUESTION 14

Work on asset started on 1th January 2020 and ended on 31st December 2020. Following
expenditures were incurred. Assume no investment income.
Date incurred Amount
st
31 March 6M

FROM THE DESK OF M. JUNAID KHALID 68

 31st July 2M
th
30 October 0.5M
Required: Calculate the amount of Borrowing cost to be capitalized
DISCLOSURES

IAS 23 requires disclosure of the following:

 The amount of borrowing costs capitalised during the period; and

 The capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.

KAPLAN KIT 7, 14, 232, 233, 234, 235

BPP KIT 25, 26, 29, 150, 151, 152, 153, 154

FROM THE DESK OF M. JUNAID KHALID 69

 IAS 36 - IMPAIRMENT OF ASSETS
IAS 36 does not deal with the following assets;
o Inventories (IAS 2)
o Construction contract (IFRS 15)
o Deferred tax assets (IAS 12)
o Employees benefits (IAS 19)
o Investment property – fair value model (IAS 40)
o Financial asset (IFRS 9)
o Biological asset (IAS 41)
o Insurance contract assets (IFRS 4)
o Assets held for sale (IFRS 5)

IMPAIRMENT
 Impairment is the sudden fall in the value of an asset
 Impairment is said to arrive when carrying value exceeds the recoverable amount
 When the asset value in the accounts is higher than the realistic value (recoverable
amount) then is said to have impairment loss

Carrying value xxx

Recoverable amount xxx
Impairment loss XXX

Carrying value: Carrying value is the difference of cost and accumulated depreciation
Recoverable amount: Recoverable amount is also termed as realistic value of an asset. It is
calculated as higher of;
o Fair value less cost to sell; and
o Value in use

Important Note:
It is not always necessary to determine both fair values less cost to sell
and value in use to determine asset recoverable amount. If any of these
value exceeds carrying value that means, there is no impairment and in
that case there is no need to calculate other value

FROM THE DESK OF M. JUNAID KHALID 70

FAIR VALUE LESS COST TO SELL
“Amount obtainable in an arm’s length transaction less costs of disposal”
Fair value
o Binding sale agreement
o Market price in an active market.
Costs of disposal
Incremental costs attributable to the disposal of an asset. Example: advertisement cost, legal
charges, tender cost, sale agreement.
Note: Dismantling cost is not an incremental cost. However, with respect to paper it is considered in
cost to sell.

ILLUSTRATION:
Online limited purchased a machine for $100,000. Machine is required to dismantle after 2
years for $10,000. Discount rate 10%. Calculate the Cost of machine.

QUESTION 1:
As part of annual routine, PQR & COMPANY is testing the value of its assets to ascertain the
impairment (if any). Following information is available in respect of the assets:
ASSETS WDV VALUE IN USE FORCED SALE FAIR VALUE
VALUE
RS {000} RS{000} RS{000} RS{000}
A 3200 3100 2400 2500
B 1500 1200 1225 1400
C 1700 1500 1900 2000
Every asset is sold through public tender, which costs around Rs50,000. Assets A and C are
required to be dismantled at the time of sales and the cost of dismantling is Rs.100 thousand
and Rs.200 thousand respectively. Sale agreement of the assets are prepared by the company’s
legal advisor whose annual fee is Rs.365 thousand. It takes about 4 days to draft a sale’s
agreement.
REQUIRED: Compute Impairment if any
Question 2:
Meez operates in leased premises. It owns a glass plant which is situated in a single factory unit.
Glass plants are sold periodically as complete assets.
Professional valuer has estimated that the plant might be sold for $100,000 they have charged
fee of $1000 to providing these services.
Meez would need to dismantle the asset and ship it to any buyer. Dismantling would cost
$5000. Specialist packaging would cost $4000 and legal fees of $1500
Required: Calculate the Fair value less cost to sell.

FROM THE DESK OF M. JUNAID KHALID 71

 The price which would be
received to sell an asset or
to transfer a liability in an
orderly transaction
between market
participants at the
measurement date.

Fair value less cost

to sell If there is no active
market then it must be
estimated that what the
buyers would have paid
in an orderly transaction.

Recoverable Cost to sell means any

Amount Higher of
associated disposal costs, such
as legal cost, stamp duty,
advertisement, tender cost etc.

Value in use is calculated as

the present value of future
cash flows expected to be
derived from the use of an
Value in use
asset or cash generating
unit, and applying suitable
discount rate to these cash
flows

Question 3:
ASSETS FAIR VALUE LESS VALUE IN USE CARRYING
COST TO SELL AMOUNT
$ $ $
MACHINE 1050 900 1000
VEHICLE 980 900 1000
EQUIPMENT 925 960 1000

REQUIRED: Calculate the amount of impairment loss of each asset.

FROM THE DESK OF M. JUNAID KHALID 72

Question 4:
Machine A Machine B Machine C
$ $ $
Carrying amount 100 150 120
Net realizable Value/fair 110 125 100
value
Value in Use 120 130 90

REQUIRED: Calculate the amount of impairment loss of each asset.

QUESTION 5:
On 1st January year 1 entity Q Purchased for $240,000 a machine with an estimated useful life
of 20 years and an estimated zero residual value. Depreciation is charged on straight line
method.
On 1st January year 4 an impairment review showed the machine’s recoverable amount to be
$100,000 and its remaining useful life to be 10 years.
Required:
a) Calculate the impairment loss
b) Recognize impairment loss
c) Depreciation charge in the year to 31st December year 4

QUESTION 6:
A fire at the factory on 1 October 2016 damaged the machine, leaving it with a lower operating
capacity. The accountant considers that entity will need to recognised an impairment loss in
relation to this damage. The accountant has ascertained the following information at 1 October
2016:

o The carrying amount of the machine is Rs.60,750.

o An equivalent new machine would cost Rs.90,000.
o The machine could be sold in its current condition for a gross amount of Rs.45,000.
Dismantling costs would amount to Rs.2,000.
o In its current condition, the machine could operate for three more years which gives it a
value in use figure of Rs.38,685.

What is the total impairment loss associated with the above machine at 1 October 2016?
(a) Rs.nil
(b) Rs.17,750
(c) Rs.22,065
(d) Rs.15,750

FROM THE DESK OF M. JUNAID KHALID 73

QUESTION 7:
An asset is impaired if:
(a) Its carrying amount equals the amount to be recovered through use (or sale) of the asset
(b) Its carrying amount exceeds the amount to be recovered through use (or sale) of the asset
(c) The amount to be recovered through use (or sale) of the asset exceeds its carrying amount
(d) If it has been damaged

QUESTION 8:
IAS 36 applied to which of the following assets:
(a) Inventories.
(b) Financial assets including property plant and equipment and intangible assets
(c) Assets held for sale.
(d) Property, plant, and equipment and intangible assets

QUESTION 9:
What is the recoverable amount of an asset?
(a) Its current market value less costs of disposal
(b) The lower of carrying amount and value in use
(c) The higher of fair value less costs of disposal and value in use
(d) The higher of carrying amount and market value

QUESTION 10:
The following information relates to an item of plant.
o Its carrying amount in the statement of the financial position is Rs. 3 million.
o The company has received an offer of Rs. 2.7 million from a company in Karachi
interested in buying the plant.
o The present value of the estimated cash flows from continued use of the plant is Rs. 2.6
million.
o The estimated cost of transport the plant to Karachi is Rs. 50,000.
What is the amount of the impairment loss that should be recognised on the plant?
(a) Rs. 300,000
(b) Rs. 400,000
(c) Rs. 350,000
(d) Rs. 250,000

FROM THE DESK OF M. JUNAID KHALID 74

QUESTION 11:
A vehicle was involved in an accident exactly halfway through the year. The vehicle cost Rs. 10
million and had a remaining life of 10 years at the start of the year. Following the accident, the
expected present value of cash flows associated with the vehicle was Rs. 3.4 million and the fair
value less costs to sell was Rs. 6.5 million.

What is the recoverable amount of the vehicle following the accident?

Rs. ___________
QUESTION 12:
Which of the following is covered by IAS 36 – Impairment?
(a) Non-current assets held for sale
(b) Investment property carried at cost
(c) Investment property carried at fair value
(d) Inventories
ANSWERS:
QUESTION 5 104000
QUESTION 6 B
QUESTION 7 B
QUESTION 8 D
QUESTION 9 C
QUESTION 10 C
QUESTION 11 6.5 M
QUESTION 12 B

When to perform impairment test?

As per IAS 36 an entity shall perform impairment test (carrying value v/s recoverable amount)
whenever there is any “indicator or hint” that asset is impaired. Indicator may be internal or
external.
If there are no indicators for impairment there is no need for organization to estimate a
recoverable amount of asset.

Note: In case of intangible assets, whether there is indication for impairment or not following
intangible assets must be reviewed for impairment annually:

 Goodwill acquired in business combination (Purchased goodwill)

 Those with an indefinite useful life.

FROM THE DESK OF M. JUNAID KHALID 75

Indicators of impairment loss:
There are two types if indicators of impairment loss:
o External indicators
o Internal indicators
External source of information/indicators:
1) Increase in interest rates
2) Increase in industry tax rates
3) Recession
4) Sudden fall in value of asset/ decline in market value
5) Technological change/ economic environment
6) Change in fashion
7) Low market capitalization (MV less than BV)
8) Adverse change in legal environment.

Internal source of information/indicators:

1) Physical damage/obsolescence to the asset
2) There are plans to discontinue or restructure the operation for which the asset is
currently used.
3) Change in use of asset
4) Cash flows for maintaining the asset is more than the budgeted

Value in use
Represents the discounted future net pre-tax cash flows from the continuing use and ultimate
disposal of the asset.
Cash flow from continuing use and disposal
 Based on asset in its current form (subsequent expenditure will not become part of
value in use)
 Exclude financing activities (lease cash flows)
 Does not include tax payments

QUESTION 13:
A machine has a carrying amount of Rs. 850,000 at the year end of 31 March 2019. Its market
value is Rs. 780,000 and costs of disposal are estimated at Rs. 25,000. A new machine would
cost Rs. 1,500,000. The company which owns the machine expects it to produce net cash flows
of Rs. 300,000 per annum for the next three years. The company has a cost of capital of 8%.

Required: What is the impairment loss on the machine to be recognised in the financial
statements at 31 March 2019?

FROM THE DESK OF M. JUNAID KHALID 76

QUESTION 14:
Radium Limited (RL) acquired a non-current asset on 1 October 2019 at a cost of Rs. 100 million
which had a useful life of ten years and a nil residual value. The asset had been correctly
depreciated up to 30 September 2024.
At that date the asset was damaged and an impairment review was performed. On 30
September 2024, the fair value of the asset less costs to sell was Rs. 30 million and the expected
future cash flows were Rs. 8.5 million per annum for the next five years. The current cost of
capital is 10% and a five-year annuity of Rs. 1 per annum at 10% would have a present value of
Rs. 3.79.
Required: What amount would be charged to profit or loss for the impairment of this asset for
the year ended 30 September 2024?
Accounting for Impairment Loss:
If the recoverable amount is less than the carrying value of asset, then impairment loss need to
be recognized in statement of profit and loss
Dr. Cr.
Impairment loss XX
Acc. Impairment loss/asset XX
After the impairment the carrying amount of the asset less any residual value is depreciated
over its remaining expected useful life.
However, for previously revalued assets under IAS 16, impairment loss should decrease
revaluation reserve to the extent previously created and any further charge shall charge to P&L.
Dr. Cr.
P&L (impairment loss) XX
Revaluation reserve XX
Asset/acc. I. Loss XX

QUESTION 15:
A company has a machine in its statement of financial position at a carrying amount of Rs.300,
000 including a previously recognized surplus of Rs.20,000. The machine has been tested for
impairment and found to have recoverable amount of Rs.275,358
Required: Record the impairment loss

QUESTION 16:
An entity owns a car that was involved in an accident at the year end. It is barely useable, so the
value in use as estimated at $1000. However, the car is a classic and there is a demand for the
parts. This results in a fair value less costs to sell of $3000. The opening carrying amount was
$8000 and the car was estimate to have a life of 8 years from the start of the year.
Required: Identify the recoverable amount of the car and any impairment required?

FROM THE DESK OF M. JUNAID KHALID 77

QUESTION 17:
An entity owns a property which was revalued to $500,000 on 31st March 20x3 with a
revaluation gain of $200,000 being recognized as other comprehensive income and recorded in
the revaluation surplus. At 31st march 20x5 the property had a carrying value of $460,000 but
the recoverable amount of the property was estimated at only $200,000
Required: What is the amount of impairment and how should this be treated in the financial
statements?

QUESTION 18:
Which of the following is NOT an indicator of impairment?
a) Advances in the technological environment in which an asset is employed have an
adverse impact on its future use
b) An increase in interest rates which increases the discount rate an entity uses
c) The carrying amount of an entity’s net assets is higher than the entity’s number of
shares in issue multiplied by its share price
d) The estimated net realizable value of inventory has been reduced due to fire damage
although this value is greater than its carrying value

Question 19:
Metric owns an item of plant which has a carrying amount of $248,000 as at 1 April 2014. It is
being depreciated at 12½% per annum on a reducing balance basis. The plant is used to
manufacture a specific product which has been suffering a slow decline in sales. Metric has
estimated that the plant will be retired from use on 31 March 2018. The estimated net cash
flows from the use of the plant and their present values are:

Net cash flows$ Present values$

Year to 31 March 2016 120,000 109,200
Year to 31 March 2017 80,000 66,400
Year to 31 March 2018 52,000 39,000
252,000 214,600
st
On 31 March 2015, Metric had an alternative offer from a rival to purchase the plant for
$200,000.
Required: At what value should the plant appear in Metric’s statement of financial position as
at 31 March 2015?
a) $248,000.
b) $217,000.
c) $214,600.
d) $200,000

FROM THE DESK OF M. JUNAID KHALID 78

Question 20:
On 1 January Year 1 Entity Q purchased for Rs.240, 000 a machine with an estimated useful life
of 20 years and an estimated zero residual value.
Depreciation is on a straight-line basis.
The asset had been re-valued on 1 January Year 3 to Rs.250, 000, but with no change in useful
life at that date.
On 1 January Year 4 an impairment review showed the machine’s recoverable amount to be
Rs.100, 000 and its remaining useful life to be 10 years.
Required: Financial position at 31st December year 4.

Cash generating unit (CGU):

A CGU is defined as “the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets”
If there is any indication that an asset may be impaired, recoverable amount should be
estimated for the individual asset. If it is not possible to estimate the recoverable amount of the
individual asset, an enterprise should determine the recoverable amount of the cash-generating
unit to which the asset belongs (the asset’s cash-generating unit).
An impairment loss should be recognized for a cash-generating unit if, and only if, its
recoverable amount is less than its carrying amount. The impairment loss should be allocated
to reduce the carrying amount of the assets of the unit in the following order:
 First to any asset that is impaired (e.g. if an asset was specifically damaged)
 Second, to goodwill in the cash generating unit
 Third, to all other assets in the CGU on a pro rata basis based on carrying value These
reductions in carrying amounts should be treated as impairment losses on individual
assets.
Note: While allocating the impairment loss the carrying value of the individual asset should
not be reduced below the higher of Fair value less cost to sell or Value in Use (recoverable
amount). In this scenario remaining impairment loss should be allocated to remaining assets of
the unit on pro rata basis. Current assets are unlikely to be impaired as part of a CGU, as they
are already likely to be carried at their recoverable amounts.

FROM THE DESK OF M. JUNAID KHALID 79

Question 21:
The net assets of Fyngle, a cash generating unit (CGU), are:
$
Property, plant and equipment 200,000
Allocated goodwill 50,000
Product patent 20,000
Net current assets (at Net Realizable value) 30,000
300,000
As a result of adverse publicity, Fyngle has a recoverable amount of only $200,000.
What would be the value of Fyngle’s property, plant and equipment after the allocation of the
impairment loss?
A $154,545
B $170,000
C $160,000
D $133,333
Question 22:
A cash generating unit comprises of the following:
Building $30m
Plant and equipment $6m
Goodwill $10m
Current assets $20m
Total $66m
Following a recession an impairment review has estimated the recoverable amount of the CGU
to be $50m
Required: How to allocate impairment loss?
Question 23:
A company has acquired another business for $4.5 million comprising of tangible assets of $4
million and the rest is paid for goodwill.
A building with a carrying amount of $1m is destroyed in a terrorist attack. The building was not
insured. The loss of the asset, without insurance, has prompted the company to assess whether
there has been an impairment of assets in the acquired business as a whole and what amount
of any such loss is?
What are the impairment loss and its allocation if recoverable amount is measured at $3.1
million for the whole business?

FROM THE DESK OF M. JUNAID KHALID 80

 Note: In allocating an impairment loss, the carrying amount of an asset should not be reduced
below the highest of:
 Its fair value less cost to sell
 Its value in use
 Zero

Any remaining amount of the impairment loss should be recognized as a liability if

required by other standards.

Question 24:
A division of a company has the following balances in its financial statements:
$
Goodwill 700,000
Plant 950,000
Property 2300,000
Intangibles 800,000
Other net assets 430,000
Following a period of losses, the recoverable amount of the division is deemed to be $4million.
A recent valuation of the building showed that the building has a market value of $2.5 million.
The other net assets are at their recoverable amount. The company uses the cost model for
valuing property, plant and equipment.
i. What is the balance on property following the impairment review?
A. $2300,000
B. $2500,000
C. $2027,000
D. $1776,000
ii. What is the balance on plant following the impairment review?
A. $862,000
B. $837,000
C. $689,000
D. $261,000
iii. What is the impairment loss on property following the impairment review if recoverable
amount or market value is $2 million for property?
A. $300,000
B. $2000,000
C. $2500,000
D. $2300,000

FROM THE DESK OF M. JUNAID KHALID 81

Question 25:
Sebb Co. runs a unit that suffers a massive drop in income due to the failure of its technology
on 1st January 20x8. The following carrying amounts were recorded in the books immediately
prior to impairment:
$million
Goodwill 20
Technology 5
Brands 10
Land 50
Building 30
Other net assets 40
The recoverable amount of the unit is estimated at $85 Million. The technology is worthless,
following its complete failure.
The other net assets include inventory and receivables. It is considered that the carrying
amount of other net assets is a reasonable representation of their net realizable value.
Required: Show the impact of the impairment on 1st January 20x8.

REVERSAL OF IMPAIRMENT LOSS:

An enterprise should assess at each reporting date whether there is any indication that an
impairment loss recognized for an asset in prior years may no longer exist or may have
decreased. If any such indication exists, the enterprise should estimate the recoverable amount
of that asset.
Indicators of impairment reversal:
 External indicators of an impairment reversal are:
o Increase in the asset market value
o Favorable changes in the technological, market, economic or legal environment
o Decrease in the interest rates
 Internal indicators of an impairment reversal are:
o Favorable changes in the use of the asset
o Improvement in the asset’s economic performance
Considerations on reversal of an impairment loss for an individual asset:
 A reversal of an impairment loss been recognized as income immediately in the statement
of profit or loss, unless the asset is carried at revalued amount (for example, under the
allowed alternative treatment in IAS 16, Property, Plant and Equipment). Any reversal of an
impairment loss on a revalued asset should be treated as a revaluation increase as per the
respective standard.
 A reversal of an impairment loss on a revalued asset is credited directly to equity under the
heading revaluation surplus. However, to the extent that an impairment loss on the same

FROM THE DESK OF M. JUNAID KHALID 82

 revalued asset was previously recognized as an expense in the statement of profit or loss, a
reversal of that impairment loss is recognized, as income in the statement of profit or loss.
 Cost model - The increase in carrying value of the asset due to a reversal on impairment loss
can only be up to should not exceed the carrying amount that would have been determined
(net of amortization or depreciation) had no impairment loss been recognized for the asset
in prior years.
Explanation: Carrying amount shall be increased to the lower of;
o Recoverable amount; and
o Carrying amount had there been no impairment
 Under no circumstances, the reversal of impairment can be higher than previous
impairment
Note: An impairment loss recognized for goodwill shall not be reversed in a subsequent
period.

Question 26:
Boxer purchased a non-current asset on 1st January 20x1 at a cost of $30,000. At that date, the
asset had an estimated useful life of ten years. Boxer does not revalue this type of asset, but
accounts for it on the basis of depreciated historical cost. At 31st December 20x2, the asset was
subject to an impairment review and had a recoverable amount of $16,000.
At 31st December 20x5, the circumstances which caused the original impairment to be
recognized have reversed and are no longer applicable, with the result that the recoverable
amount is now $40,000.
Required:
Explain, with supporting computations, the impact on the financial statements of the two
impairment reviews.

Question 27:
Xerox Co. purchased a Machine at a cost of $1500,000 on 1st January 2015. Life of the asset was
estimated 15 years with nil scrap value. Company uses straight line method for depreciation.
On 30th June 2018 due to some indicators company had an impairment review and following
information was available;
 Fair value less cost to sell of particular was $1200,000
 Expected future cash flow and discounted present value for next five years are;
o 2019 $60,000 @ 0.75
o 2020 $80,000 @ 0.73
o 2021 $75,000 @ 0.72
o 2022 $80,000 @ 0.71
o 2023 $90,000 @ 0.69

FROM THE DESK OF M. JUNAID KHALID 83

On 31st December 2019 due to decrease in the prices of assets company decided to had an
impairment review and recoverable amount on that date was $750,000.
Later in 2021 market prices of machine started to rise and on 31st December 2021 company
reviewed the impairment and recoverable amount on that date was $1000,000.
Company uses cost model, and company accounting year ends on 31st December each year.

Required:
a) What will the value of Machine on 31st December 2021 to be reported in balance sheet?
b) Record all the necessary impairment loss and impairment reversal (if any)
c) Record reversal of impairment assuming recoverable amount on 31st December 2021
was $700,000
d) Record reversal of impairment assuming recoverable amount on 31st December 2021
was $800,000

Question 28:
Bond Co. purchased a Machine at a cost of $2000,000 on 1st January 2018. Life of the asset was
estimated 16 years with nil scrap value. Company uses straight line method for depreciation.
On 30th June 2022 Company decided to opt revaluation model and market value of machine on
that date was $1500,000. Subsequently on 31st December 2024 increase in interest rates
indicated that asset might be impaired and recoverable amount on that date was $1000,000.
Later in 2025 market prices of machine started to rise and on 31st December 2025 company
reviewed the impairment and recoverable amount on that date $1300,000.
Company accounting year ends on 31st December each year.

Required: What amount should appear in financial statement for revaluation surplus on 31 st
December 2025?
Question 29:
Bond Co. purchased a Machine at a cost of $2000,000 on 1st January 2018. Life of the asset was
estimated 16 years with nil scrap value. Company uses straight line method for depreciation.
On 30th June 2022 Company decided to opt revaluation model and market value of machine on
that date was $2500,000. Subsequently on 31st December 2024 market value was assessed as
$600,000. Later in 2025 market prices of machine started to rise and on 31st December 2025
the recoverable amount on that date $3000,000.
Company accounting year ends on 31st December each year.
Required: What amount should appear in financial statement for revaluation surplus on 31 st
December 2025? And what amount should be reported in profit and loss account for the year
ended 31st December 2025.

FROM THE DESK OF M. JUNAID KHALID 84

QUESTION 30
In accordance with IAS 36 Impairment of Assets which of the following statements are true?

1. An impairment review must be carried out annually on all intangible assets.

2. If the fair value less costs to sell of an asset exceed the carrying amount there is no need to
calculate a value in use.
3. Impairment is charged to the statement of profit or loss unless it reverses a gain that has been
recognised in equity in which case it is offset against the revaluation surplus.
a. All three.
b. 1 and 2 only.
c. 1 and 3 only.
d. 2 & 3 only.

DISCLOSURES: [IAS 36.126]

o Impairment losses recognised in profit or loss
o Impairment losses reversed in profit or loss which line item(s) of the statement of
comprehensive income impairment losses on revalued assets recognised in other
comprehensive income
o Impairment losses on revalued assets reversed in other comprehensive income
Other disclosures:
o If an individual impairment loss (reversal) is material disclose: [IAS 36.130]
o Events and circumstances resulting in the impairment loss amount of the loss or reversal
individual asset: nature and segment to which it relates cash generating unit:
description, amount of impairment loss (reversal) by class of assets and segment

FROM THE DESK OF M. JUNAID KHALID 85

QUESTION 31:

FROM THE DESK OF M. JUNAID KHALID 86

KAPLAN KIT: 23 –29, 246 – 250

BPP KIT: 38 – 46, 49 – 51, 55, 56, 71 -- 76

FROM THE DESK OF M. JUNAID KHALID 87

 IAS 12 – INCOME TAX
Accounting profit is profit or loss for a period before deducting tax expense.
Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules
established by the taxation authorities, upon which income taxes are payable (recoverable).
Tax base:
Tax payable by an entity is calculated by the tax authorities using a tax computation. A tax
computation is similar to a statement of profit or loss, except that it is constructed using tax
rules instead of IFRS.
Tax expense (tax income) is the aggregate amount included in the determination of profit or
loss for the period in respect of current tax, deferred tax and prior period tax.
Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit
(tax loss) for a period.
Deferred tax is an accounting measure, used to match the tax effects of transactions with their
accounting impact and thereby produce less distorted results.
Carrying amount is the value at which an item is appearing in the statement of financial
position. The tax base of an asset or liability is the amount attributed to that asset or liability for
tax purposes.
Temporary differences are differences between the carrying amount of an asset or liability in
the statement of financial position and its tax base.
Temporary differences may be either:
(a) taxable temporary differences, which are temporary differences that will result in taxable
amounts in determining taxable profit (tax loss) of future periods when the carrying amount of
the asset or liability is recovered or settled; or
(b) deductible temporary differences, which are temporary differences that will result in
amounts that are deductible in determining taxable profit (tax loss) of future periods when the
carrying amount of the asset or liability is recovered or settled.
Permanent differences. These occur when certain items of revenue or expense are excluded
from the computation of taxable profits (for example, certain expenses may not be allowable
for tax purposes). E.g. entertaining expense and fines

FROM THE DESK OF M. JUNAID KHALID 88

Question 1:
$
Accounting profit 5000,000
Fixed assets 2500,000
Depreciation rate (accounting) 5%
Depreciation rate (tax) 10%
Bad debt provision 10%
Accounts receivables 1000,000
Donations 500,000
Fine and penalties (deduction not allowed in income tax) 30,000
Tax rates is 30% and donation to servant is 20% of total donation.
Required:
 Calculate the taxable profit
 Current tax payable

Note: Income tax includes;

o Current tax
o Prior period tax
o Deferred tax

Question 2
Kashif traders had an accounting profit before of tax of Rs. 1,000,000. Below is a list of
admissible and inadmissible deductions under tax regime:
Inadmissible Deductions:
- Accounting Depreciation Rs. 100,000
- Provision for Doubtful Debt Rs. 15,000
Admissible Deductions:
- Tax Depreciation Rs. 150,000
- Write off of Trade Receivables (not yet adjusted) Rs. 5,000
Corporate tax rate on Kashif traders is 30%.
Required: Calculate the taxable profit and current tax

FROM THE DESK OF M. JUNAID KHALID 89

Question 3
Simple has estimated its income tax liability for the year ended 31 December 20X8 at $180,000.
In the previous year the income tax liability had been estimated as $150,000.
Required:
Calculate the tax expense that will be shown in the statement of profit and loss for the year
ended 31 December 20X8 if the amount that was actually agreed and settled with the tax
authorities in respect of 20X7 was:
a) $165,000
b) $140,000.

Question 4
In 20x8 Darton Co. had taxable profits of $120,000. In the previous year 20x7 income tax on
20x7 profits had been estimated as $30,000. The income tax rate is 30%.
Required: Calculate tax payable and the charge for 20x8 if the tax due on 20x7 profits was
subsequently agreed with the tax authorities as:
a) $35,000; or
b) $25,000

Question 5
Fresh Company has a financial year ending on 31 December. At 31 December 2016 it had a
liability for income tax of Rs. 77,000. The tax on profits for the year to 31 December 2017 was
Rs. 114,000. The tax charge for the year to 31 December 2016 was over-estimated by Rs. 6,000.
During the year to 31 December 2017, the company made payments of Rs. 123,000 in income
tax.
Required: Calculate tax liability at 31st December 2017

Question 6
Bond co. Profit before tax and depreciation is $100 million each year from year 1 till year 4.
Asset cost is $60 million
Asset life (tax) is 3 years
Asset life (Accounting) is 4 years
Tax rate 30%
Required: Compute current and deferred tax for year 1 till year 4

FROM THE DESK OF M. JUNAID KHALID 90

Question 7
James co. Profit before tax and depreciation is $200 million each year from year 1 till year 4.
Asset cost is $120 million
Asset life (tax) is 3 years
Asset life (Accounting) is 4 years
Tax rate 30%
Required: Compute current and deferred tax for year 1 till year 4

Question 8
Sky co. Profit before tax and depreciation is $200 million each year from year 1 till year 4.
Asset cost is $120 million
Asset life (tax) is 4 years
Asset life (Accounting) is 3 years
Tax rate 30%
Required:
a) Compute current and deferred tax for year 1 till year 4
b) Compute deferred tax for year 1 till year 4 using balance sheet approach

Question 9
Custard Co. purchased an asset costing $1500. At the end of 20x8 the carrying amount is $1000.
The cumulative depreciation for tax purposes is $900 and the current tax rate is 25%.
Required: Calculate the deferred tax liability for the asset.

Question 10
A company’s financial statements show profit before tax of $1,000 in each of years 1, 2 and 3.
This profit is stated after charging depreciation of $200 per annum, due to the purchase of an
asset costing $600 in year 1 which is being depreciated over its 3-year useful life on a straight
line basis.
The tax allowances granted for the asset are:
Year 1 $240
Year 2 $210
Year 3 $150
Income tax is calculated as 30% of taxable profits.
Apart from the above depreciation and tax allowances there are no other differences between
the accounting and taxable profits.
Required:
Accounting for deferred tax, prepare statement of profit or loss and statement of financial
position extracts for each of years 1, 2 and 3.

FROM THE DESK OF M. JUNAID KHALID 91

Question 11
Gripper Rod Co. buys an item of equipment on 1st January 20x1 for $1000,000. It has a useful
life of 10 years and an estimated residual value of $100,000. The equipment is depreciated on a
straight line basis. For tax purposes, a tax expense can be claimed on a 20% reducing balance
basis. Tax rate is 30%.
Required: Calculate the deferred tax charge/credit in the company’s profit or loss for the year
to 31st December 20x2 and the deferred tax balance in the statement of financial position at
that date.

QUESTION 12:
State the tax base of each of the following assets and any temporary difference arising.
a) A machine cost $10,000 and has a carrying amount of $8,000. For tax purposes,
depreciation of $3,000 has already been deducted in the current and prior periods and
the remaining cost will be deductible in future periods.
b) Interest receivables has a carrying amount of $1,000. The related interest revenue will
be taxed on a cash basis.
c) Trade receivables have a carrying amount of $10,000. The related revenue has already
been included in taxable profit.
d) A loan receivable has a carrying amount of $1m. the repayment of the loan will have no
tax consequences. (Which means tax department has considered this as inflow)

REVALUATION OF NON-CURRENT ASSETS

As seen in IAS 16, it is permissible to revalue non-current assets to represent their fair value.
When a revaluation takes place the carrying amount of the asset will change but the tax base
will remain unaffected.
The difference between the carrying amount of a revalued asset and its tax base is an example
of a temporary difference and will give rise to a deferred tax liability or asset, which will be
taken to the revaluation surplus (via other comprehensive income), rather than the statement
of profit or loss.

FROM THE DESK OF M. JUNAID KHALID 92

QUESTION 13:
Cyclon Co. purchased some land on 1st January 20x7 for $400,000. On 31st December 20x8 the
land revalued to $500,000. In the tax regime in which the company operates revaluations do
not affect either tax base of the asset or taxable profits. The income tax rate is 30%
Required: Prepare the accounting entry to record the deferred tax in relation to this revaluation
for the year ended 31st December 20x8
QUESTION 14:
Hall Limited has the following balances included on its trial balance at 30 June 2013:
Rs. 000
Taxation 7,000 Credit
Deferred taxation 16,000 Credit
The taxation balance relates to an overprovision from 30 June 2013.
At 30 June 2014, the directors estimate that the provision necessary for taxation on current
year profits is Rs. 12 million. The balance on the deferred tax account needs to be increased to
Rs. 23 million, which includes the impact of the increase in property valuation below. During
the year Hall Limited revalued its property for the first time, resulting in a gain of Rs. 10 million.
The rate of tax is 30%.
What is the charge for taxation that will appear in the statement of profit or loss for the year to
30 June 2014?
(a) Rs. 9 million
(b) Rs. 12 million
(c) Rs. 23 million
(d) Rs. 1 million

DEVELOPMENT COST:
Normally development expenditure is allowed by the tax authorities on payment basis,
therefore tax base is considered as zero. And in future amortization expenditure will not be
allowed.

FROM THE DESK OF M. JUNAID KHALID 93

QUESTION 15:

QUESTION 16:
The carrying amount of Jewel Limited (JL)'s property, plant and equipment at 31 December
2013 was Rs. 310,000 and the tax written down value was Rs. 230,000.
The following data relates to the year ended 31 December 2014:
i. At the end of the year the carrying amount of property, plant and equipment was Rs.
460,000 and the tax written down value was Rs. 270,000. During the year some items
were revalued by Rs. 90,000. No items had previously required revaluation. In the tax
jurisdiction in which JL operates revaluations of assets do not affect the tax base of an
asset or taxable profit. Gains due to revaluations are taxable on sale.
ii. JL began development of a new product during the year and capitalised Rs. 60,000 in
accordance with IAS 38. The expenditure was deducted for tax purposes as it was
incurred. None of the expenditure had been amortized by the year end.

What is the taxable temporary difference to be accounted for at 31 December 2014 in relation
to property, plant and equipment and development expenditure?
Property, plant and equipment Development expenditure
a) Rs. 270,000 Rs. 60,000
b) Rs. 270,000 Nil
c) Rs. 190,000 Rs. 60,000
d) Rs. 190,000 Nil

FROM THE DESK OF M. JUNAID KHALID 94

QUESTION 17:
The carrying amount of Jewel Limited (JL)'s property, plant and equipment at 31 December
2013 was Rs. 310,000 and the tax written down value was Rs. 230,000.
At the end of the year, 31 December 2014, the carrying amount of property, plant and
equipment was Rs. 460,000 and the tax written down value was Rs. 270,000. During the year
some items were revalued by Rs. 90,000. No items had previously required revaluation. In the
tax jurisdiction in which JL operates revaluations of assets do not affect the tax base of an asset
or taxable profit. Gains due to revaluations are taxable on sale.
The corporate income tax rate is 30%. The current tax charge was calculated for the year as Rs.
45,000. What amount should be charged to the revaluation surplus at 31 December 2014 in
respect of deferred tax?
a) Rs. 60,000
b) Rs. 90,000
c) Rs. 18,000
d) Rs. 27,000

QUESTION 18:
The following information relates to a building of Jet limited.
i. At 1st January 2018, the carrying amount of the building exceeded its tax base by
Rs.1275,000
ii. In 2018, JL claimed tax depreciation of Rs. 750,000 and charged accounting depreciation
of Rs. 675,000
iii. As at 31st December 2018, JL increased the carrying amount of the building by Rs.
375,000 on account of revaluation. Revaluation is not allowed in tax.
iv. Applicable tax rate is 32%.

Required: The deferred tax liability as at 31st December 2018 in respect of building?

QUESTION 19:
The following information relates to an entity.
i. At 1 January 2018 the carrying amount of non-current assets exceeded their tax written
down value by Rs. 850,000.
ii. For the year to 31 December 2018 the entity claimed depreciation for tax purposes of
Rs. 500,000 and charged depreciation of Rs. 450,000 in the financial statements.
iii. During the year ended 31 December 2018 the entity revalued a property. The
revaluation surplus was Rs. 250,000. There are no current plans to sell the property.
iv. The tax rate was 30%.
What is the deferred tax liability required by IAS 12 Income Taxes at 31 December 2018?

FROM THE DESK OF M. JUNAID KHALID 95

(a) Rs. 240,000
(b) Rs. 270,000
(c) Rs. 315,000
(d) Rs. 345,000
Tax losses
Where unused tax losses are carried forward, a deferred tax asset can be recognised
to the extent that taxable profits will be available in the future to offset the losses. The
asset is equal to the tax losses expected to be utilized multiplied by the tax rate.

QUESTION 20:
The following information relates to Galaxy International (GI), a listed company, which was
incorporated on January 1, 2014.
i. The (loss) / profit before taxation for the years ended December 31, 2014 and 2015
amounted to (Rs.1.75 million) and Rs.23.5 million respectively.
ii. Cost of asset is Rs.100 million. The details of accounting and tax depreciation on fixed
assets is as follows:

2015 2014
Rs. million Rs. million
Accounting depreciation 15 15
Tax depreciation 6 45
iii. In 2014, GI accrued certain expenses amounting to Rs. 2 million which were disallowed
by the tax authorities. However, these expenses are to be allowed on the basis of
payment in 2015.
iv. GI earned interest on Special Investment Bonds amounting to Rs. 1.0 million and Rs.
1.25 million in the years 2014 and 2015 respectively. This income is exempt from tax.
v. GI operates an unfunded gratuity scheme. The provision during the years 2014 and 2015
amounted to Rs. 1.7 million and Rs. 2.2 million respectively. No payment has so far been
made on account of gratuity.
vi. The applicable tax rate is 35%.
Required: Calculate the amount of tax to be included in profit and loss account for the year
ended 31st December 2014 and 2015

FROM THE DESK OF M. JUNAID KHALID 96

QUESTION 21:
A piece of machinery cost Rs. 500,000. Tax depreciation to date has amounted to Rs. 220,000
and depreciation charged in the financial statements to date is Rs. 100,000. The rate of income
tax is 30%. Which of the following statements is incorrect according to IAS 12 Income Taxes?
(a) The deferred tax liability in relation to the asset is Rs. 36,000
(b) The tax base of the asset is Rs. 280,000
(c) There is a deductible difference of Rs. 120,000
(d) There is a taxable temporary difference of Rs. 120,000

QUESTION 22:
The accountant of an entity is confused by the term 'tax base'. What is meant by 'tax base'?
(a) The amount of tax payable in a future period
(b) The tax regime under which an entity is assessed for tax
(c) The amount attributed to an asset or liability for tax purposes
(d) The amount of tax deductible in a future period

QUESTION 23:
Tall Limited (TL)’s accounting records shown the following:
Rs. 000
Income tax payable for the year 60,000
Over provision in relation to the previous year 4,500
Opening deferred tax liability 2,600
Closing for deferred tax liability 3,200
What is the income tax expense that will be shown in the statement of profit or loss for the
year?
a) Rs. 54,900,000
b) Rs. 67,700,000
c) Rs. 65,100,000
d) Rs. 56,100,000

FROM THE DESK OF M. JUNAID KHALID 97

QUESTION 24:
The following information has been extracted from the accounting records of Candle Limited:
Rs. 000
Estimated income tax at year ended 30 September 2020 Rs. 75,000
Income tax paid for the year ended 30 September 2021 Rs. 80,000
Estimated income tax at the year ended 30 September 2021 Rs. 83,000
What figures will be shown in the statement of comprehensive income for the year ended 30th
September 2021 in respect of income tax?
a) Rs. 75,000,000
b) Rs. 80,000,000
c) Rs. 88,000,000
d) Rs. 83,000,000
QUESTION 25:
Home Limited (HL) has the following balances included on its trial balance at 30 June 2013.
Rs. 000
Taxation 4,000 Credit
Deferred taxation 12,000 Credit
The taxation balance relates to an over-provision from 30 June 2013.
At 30 June 2014, the directors estimate that the provision necessary for taxation on current
year profits is Rs. 15,000,000.
The carrying amount of HL’s non-current assets exceeds the tax written-down value by Rs.
30,000,000.
The rate of tax is 30%.
What is the charge for taxation that will appear in the statement of profit or loss for the year to
30 June 2014?
(a) Rs. 23,000,000
(b) Rs. 28,000,000
(c) Rs. 8,000,000
(d) Rs. 12,000,000
QUESTION 26:
Girdo Co. begins trading on 1st January 2017. In its first year it makes profit of $5 million, the
depreciation charge is $1million and the tax allowances on those assets amount to $1.5million.
The rate of income tax is 30%.
Required: Calculate the amount of current and deferred tax.
QUESTION 27:
On 1 January 20X8 Simone Co decided to revalue its land for the first time. A qualified property
valuer reported that the market value of the land on that date was $80,000. The land was
originally purchased 6 years ago for $65,000.

FROM THE DESK OF M. JUNAID KHALID 98

The required provision for income tax for the year ended 31 December 20X8 is $19,400. The
difference between the carrying amounts of the net assets of Simone (including the revaluation
of the land above) and their (lower) tax base at 31 December 20X8 is $27,000. The opening
balance on the deferred tax account was $2,600. Simone’s rate of income tax is 25%.
Required:
Prepare extracts of the financial statements to show the effect of the above transactions.
Disclosure
This section does not include the IAS 12 disclosure requirements in respect of those aspects of
deferred taxation which are not examinable at this level. Components of tax expense (income)
The major components of tax expense (income) must be disclosed separately. Components of
tax expense (income) may include:
 current tax expense (income);
 any adjustments recognised in the period for current tax of prior periods;
 the amount of deferred tax expense (income) relating to the origination and reversal of
temporary differences;
 the amount of deferred tax expense (income) relating to changes in tax rates or the
imposition of new taxes;
 the amount of the benefit arising from a previously unrecognized tax loss, tax credit or
temporary difference of a prior period that is used to reduce current tax expense;
 deferred tax expense arising from the write-down, or reversal of a previous write-down,
of a deferred tax asset;
 the amount of tax expense (income) relating to those changes in accounting policies and
errors that are included in profit or loss in accordance with IAS 8, because they cannot
be accounted for retrospectively.

Answers:
Q 14 = A
Q 15 = 0.38m
Q 16 = C
Q 17 = D
Q 18 = 552000
Q 19 = D
Q 21 = C
Q 22 = C
Q 23 = D
Q 24 = C
Q 25 = C
Q 26 = 1.5 MILLION
Q27 = 19800

FROM THE DESK OF M. JUNAID KHALID 99

BPP KIT QUESTIONS: 133 – 139, 170 – 174
KAPLAN KIT QUESTIONS: 115 – 118, 213, 289 – 290

QUESTION 28:

FROM THE DESK OF M. JUNAID KHALID 100

QUESTION 29:

FROM THE DESK OF M. JUNAID KHALID 101

FROM THE DESK OF M. JUNAID KHALID 102
 IFRS 16 -- LEASES
LEASE:
A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for
a period of time in exchange for consideration.
The lessor is the 'entity that provides the right to use an underlying asset in exchange for
consideration.'
The lessee is the 'entity that obtains the right to use an underlying asset in exchange for
consideration.'
A right-of-use asset 'represents the lessee's rights to use an underlying asset for the lease
term.'
SCOPE:

All arrangements that meet the definition of a lease except for:

(a) Leases to explore for minerals, oil, natural gas and similar non-regenerative resources
(b) Leases of biological assets within the scope of IAS 41 Agriculture held by a lessee
(c) Service concession arrangements within the scope of IFRIC 12
(d) Licenses of intellectual property granted by a lessor within the scope of IFRS 15 Revenue
from Contracts with Customers
(e) Rights held by a lessee under a licensing agreement within the scope of IAS 38 Intangible
Assets (e.g. Rights to motion pictures, video recordings, plays, patents and copyrights, etc.)

NOTE: A lessee is also permitted, but not required, to apply IFRS 16 to leases of intangible
assets other than those described in (e) above. E.g. Software.

FROM THE DESK OF M. JUNAID KHALID 103

IDENTIFICATION OF LEASE:

EXAMPLES: Identify in each situation whether it is a lease or not.

Situation 1:
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 specified 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.
Situation 2:
A customer (C) enters into a contract with a road haulier (H) for the transportation of goods
from London to Edinburgh on a specified truck. The truck is explicitly specified in the contract
and H does not have substitution rights. The goods will occupy substantially all of the capacity
of the truck. The contract specifies the goods to be transported on the truck and the dates of
pickup and delivery.
Situation 3:

FROM THE DESK OF M. JUNAID KHALID 104

Situation 4:

INITIAL RECOGNITION AND MEASUREMENT

As per IFRS 16 lessee shall recognize lease as finance lease. However, a lessee makes use of
optional exemptions for operating lease;

 short-term leases (those having a term of 12 months or less, including the effect of
extension options) or;
 leases for which the underlying asset is of low value (e.g. telephones, laptop computers,
and office furniture).
 The election for short term leases is by class of asset, and for low value leases can be
made on a lease-by-lease basis

QUESTION 1:
IFRS 16 Leases permits certain assets to be exempt from the recognition treatment for right-of-
use assets. Which of the following assets leased to an entity would be permitted to be exempt?
a) A used motor vehicle with an original cost of $1,500,000 and a current fair value of
$70,000, leased for 24 months
b) A new motor vehicle with a cost of $1,500,000, leased for 24 months
c) A new motor vehicle with a cost of $1,500,000, leased for 24 months, to be rented to
customers on a daily rental basis
d) A new motor vehicle with a cost of $1,500,000, leased for 12 months

LESSEE ACCOUNTING UNDER FINANCE LEASE:

Basic principle: At the commencement of the lease, the lessee should recognize a lease liability
and a right-of use asset.

LEASE LIABILITY:
The lease liability is initially measured at the present value of the lease payments that have not
yet been paid.
Lease payments should include the following (IFRS 16, para 27):
 Fixed payments (Rentals)
 Amounts expected to be payable under residual value guarantees
 Options to purchase the asset that are reasonably certain to be exercised (BPO)

FROM THE DESK OF M. JUNAID KHALID 105

  Termination penalties, if the lease term reflects the expectation that these will be
incurred.
THE RIGHT-OF-USE ASSET
The right-of-use asset is initially recognised at cost. The initial cost of the right-of-use asset
comprises (IFRS 16, para 24):
 The amount of the initial measurement of the present value of lease liability (see above)
 lease payments made at or before the commencement of the lease (less any lease
incentives received)
 Any initial direct costs
 The present value of estimated costs of removing or dismantling the underlying asset as
per the conditions of the lease.

Examples of initial direct costs of a lessee include:

- Commissions
- Legal fees
- Costs of negotiating lease terms and conditions
- Costs of arranging collateral
- Payments made to existing tenants to obtain the lease
Note: The right-of-use asset is measured using the cost model (unless another measurement
model is chosen). This means that the asset is measured at its initial cost less accumulated
depreciation and impairment losses. Depreciation is calculated as follows:
 If ownership of the asset transfers to the lessee at the end of the lease term then
depreciation should be charged over the asset's useful life,
 Otherwise, depreciation is charged over the shorter of the useful life and the lease term
 Periods covered by an option to extend the lease if reasonably certain to be exercised
should be considered in lease term.
QUESTION 2: (lease payment in arrears)
Riyad enters into an agreement to lease an asset. The terms of the lease are as follows.
i. Primary period is for four years from 1 January 20X2 with a rental of $2,000 pa payable
on 31 December each year.
ii. The present value of the lease payments is $5,710
iii. The interest rate implicit in the lease is 15%.
Required: What figures will be shown in the financial statements for the year ended 31
December 20X2 and 31st December 20x3?

FROM THE DESK OF M. JUNAID KHALID 106

QUESTION 3:
An entity leases an asset with three annual payments in arrears of $200 each. The present value
of the asset at inception is $450. The useful life of asset is 5 years.
Note: allocate the finance cost on straight line basis.
Required: Prepare lease amortization schedule.

QUESTION 4:
A company acquired a plant under a term of lease on 1st April 20x7. The present value of
minimum lease was $15.6 million and the rentals are $6 million per annum payable in arrears
on 31st March for three years lease period.
The interest rate implicit in the lease is 8% per annum.
Required: What amount will appear under current liabilities in respect of the lease in SOFP at
31st March 20x8?

QUESTION 5:
On 1 January 20X1, Dynamic entered into a two-year lease for a lorry. The contract contains an
option to extend the lease term for a further year (one year). Dynamic believes that it is
reasonably certain to exercise this option. Lorries have a useful economic life of ten years.
Lease payments are $10,000 per year for the initial term and $15,000 per year for the option
period. All payments are due at the end of the year. To obtain the lease, Dynamic incurs initial
direct costs of $3,000. The interest rate within the lease is not readily determinable. Dynamic’s
incremental rate of borrowing is 5%.
Required: Calculate the initial carrying amount of the lease liability and the right-of-use asset
and provide the double entries needed to record these amounts in Dynamic's financial records.

QUESTION 6:
A lion enters into a five-year lease of a building which has a remaining useful life of ten years.
Lease payments are $50,000 per annum, payable in arrears.
Lion Co. incurs initial direct costs of $20,000 and receives lease incentives of $5,000. There is no
transfer of the asset at the end of the lease and no purchase option.
The interest rate implicit in the lease is not immediately determinable but the lessee’s
incremental borrowing rate is 5%.
Required: Prepare Lease schedule.

FROM THE DESK OF M. JUNAID KHALID 107

QUESTION 7: (Payment in advance)
A lion enters into a five-year lease of a building which has a remaining useful life of ten years.
Lease payments are $50,000 per annum, payable in advance.
Lion Co. incurs initial direct costs of $20,000 and receives lease incentives of $5,000. There is no
transfer of the asset at the end of the lease and no purchase option.
The interest rate implicit in the lease is not immediately determinable but the lessee’s
incremental borrowing rate is 5%. At the commencement date Lion Co. pays initial $50,000.
Required: Prepare Lease schedule.

QUESTION 8:
On 1 January 20X3 Rabbit acquires a new machine with an estimated useful life of 6 years
under the following agreement:
Initial payment of $13,760 will be payable immediately.
5 further annual payments of $20,000 will be due, commencing 1 January 20X3
The interest rate implicit in the lease is 8%
The present value of the lease payments, excluding the initial payment, is $86,240
Required: What will be recorded in Rabbit’s financial statements at 31 December 20X4 in
respect of the lease liability?

QUESTION 9:
Aqua company makes up its accounts to 31st December each year. It enters into a lease (as
lessee) to lease an item of equipment with the following terms;
 Inception of lease: 1st January 20x1
 Term: Five years: $2,000 paid at commencement of lease, followed by four payments
of $2,000 payable at the start of each subsequent year
 Fair value: $8,000
 Present value of future lease payment: $6075
 Useful life: 8 years
 Implicit rate: 12%
Required: Prepare the extract of financial position as at 31st December 20x1

NOTE:
Recognition of the lease liability would cause debt liabilities and finance costs to increase.
This means that the capital employed would be higher, therefore decreasing return on
capital employed. Gearing would increase due to the increased debt. Interest cover would
decrease due to the higher level of finance costs.

FROM THE DESK OF M. JUNAID KHALID 108

MID-YEAR ENTRY INTO A LEASE
If a company enters into a lease part-way through the year, the depreciation
and interest will need to be time-apportioned.

QUESTION 10:
Shaeen Ltd entered into an agreement to lease an item of plant on 1 October 20X8. The lease
required four annual payments of $200,000 each, commencing on 1 October 20X8. Last lease
payment will be made for $203500. The plant has a useful life of four years and is to be
scrapped at the end of this period. The present value of the lease payments is $700,000. The
implicit interest rate within the lease is 10%.
Required: Prepare extracts of the financial statements in respect of the leased asset for the
year ended 31 March 20X9.
QUESTION 11:
On 1st January 20x6 Fellini Co. hired a machine under a four-year lease. A deposit of $700,000
was payable on the commencement of the lease on 1st January 20x6. The present value of the
future lease payments was 1871,100. A further 3 installments of $700,000 are payable annually
in advance. The interest rate implicit in the lease is 6%.
Required: What amount will appear under non-current liabilities is respect of this lease in the
financial position of Fellini Co. at 31st December 20x6?

LESSEE ACCOUNTING UNDER OPERATING LEASE:

IFRS 16 Leases permits a simplified treatment for assets with a lease period of 12 months or
less, or of low value. Although the standard does not give a numerical definition of ‘low value’ it
does give examples of the types of assets that may be included, and this includes telephones.
The simplified treatment allows the lease payments to be charged as an expense over the lease
period, applying the accruals concept.
IFRS 16 Leases does not specify a particular monetary amount below which an asset would be
considered ‘low value’, although the basis for conclusion indicates a value of $5,000 as a guide
The standard also gives the following examples of low value assets:
 Tablets
 Small personal computers
 Telephones
 Small items of furniture.
The assessment of whether an asset qualifies as having a ‘low value’ must be made based on its
value when new. Therefore, a car would not qualify as a low value asset, even if it was very old
at the commencement of the lease.

FROM THE DESK OF M. JUNAID KHALID 109

QUESTION 12:
On 1 April 20X6 Taggart acquires telephones for its sales force under a two-year lease
agreement. The terms of the lease require an initial payment of $2,000, followed by two
payments of $8,000 each on 31 March 20X7 and 31 March 20X8.
Required: Show the impact of this lease arrangement on the financial statements of Taggart for
the year ended 31 December 20X6.

QUESTION 13:
On 1 October 20X6 Fino entered into an agreement to lease twenty telephones for its team of
sales staff. The telephones are to be leased for a period of 24 months at a cost of $240 per
telephone per annum, payable annually in advance. The present value of the lease payments at
1 October 20X6 is $9,164.
How much would be charged to Fino’s statement of profit or loss for the year ended
30 September 20X7 in respect of the telephones?
a) $4,800
b) $4,582
c) $4,364
d) $5,498

QUESTION 14:
On 1st April 20x7 Fino Co also took out a lease on another piece of equipment. The lease runs
for ten months and payments of $1000 per month are payable in arrears. As an incentive to
enter into the lease, Fino received the first month rent free.
What amount should be recognized as payments under short-term lease for the period up to
30th September 20x7?
a) $5,000
b) $6,000
c) $4,500
d) $5,400

SALE AND LEASEBACK:

If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and then leases it
back from the buyer, the seller-lessee must assess whether the transfer should be accounted for as a
sale.

For this purpose, the seller must apply IFRS 15 Revenue from Contracts with Customers to decide
whether a performance obligation has been satisfied. This normally occurs when the buyer obtains
control of the asset. Control of an asset refers to the ability to obtain substantially all of the remaining
benefits.

FROM THE DESK OF M. JUNAID KHALID 110

Transfer is not a sale:

If the transfer is not a sale, then the seller-lessee continues to recognised the transferred asset and will
recognize a financial liability equal to the transfer proceeds. In simple terms, the transfer proceeds are
treated as a secured loan.

QUESTION 15:
Apple required funds to finance a new ambitious rebranding exercise. It’s only possible way of raising
finance is through the sale and leaseback of its head office building for a period of 10 years. The lease
payments of $0.8 million are to be made at the end of the lease period.

The current fair value of the building is $10 million and the carrying value is $8.4 million. The interest
rate implicit in the lease is 5%.

Required: Prepare financial statement extract of Apple on how to account for the sale and leaseback in
its financial statements if the office building were to be sold at the fair value of $10 million. Assuming
performance obligations are not satisfied.

Transfer is a sale
If the transfer does qualify as a sale, then the seller-lessee must measure the right-of-use asset as the
proportion of the previous carrying amount that relates to the rights retained.
• This means that the seller-lessee will recognize a profit or loss based only on the rights transferred to
the buyer-lessor.
Following steps to be considered:
o Step1: Calculate the present value of lease liability
o Step2: Calculate the ROU retained %
o Step3: Calculate ROU = Carrying amount x %
o Step4: Prepare entry and Balancing figure would be gain on transferred

QUESTION 16:
Apple required funds to finance a new ambitious rebranding exercise. It’s only possible way of raising
finance is through the sale and leaseback of its head office building for a period of 10 years. The lease
payments of $1 million are to be made at the end of each year.

The current fair value of the building is $10 million and the carrying value is $8.4 million. The interest
rate implicit in the lease is 5%.

Required: Prepare financial statement extract of Apple on how to account for the sale and leaseback in
its financial statements if the office building were to be sold at the fair value of $10 million. Assuming
performance obligations are satisfied.

QUESTION 17:

On 1st April 20x2, Wigton Co. bought an injection molding machine for $600,000. The carrying amount of
the machine as at 31st March 20x3 was $500,000. On 1st April 20x3, Wigton Co. sold it to Whitehaven Co.
for $740,000 its fair value. Wigton Co. immediately leased the machine back for 5 years, the remainder

FROM THE DESK OF M. JUNAID KHALID 111

of its useful life, at $160,000 per annum payable in arrears. The present value of the annual lease
payments is $700,000 and the transaction satisfies the IFRS 15 criteria to be recognized as a sale.

Required: What gain should Wigton Co. recognize for the year ended 31st March 20x4 as a result of the
sale and leaseback?

QUESTION 18:
On 1 January 20X1, Painting sells an item of machinery to Collage for its fair value of $3 million.
The asset had a carrying amount of $1.2 million prior to the sale. This sale represents the
satisfaction of a performance obligation, in accordance with IFRS 15 Revenue from Contracts
with Customers. Painting enters into a contract with Collage for the right to use the asset for
the next five years. Annual payments of $500,000 are due at the end of each year. The interest
rate implicit in the lease is 10%.
The present value of the annual lease payments is $1.9 million. The remaining useful life of the
machine is much greater than the lease term.
Required: Explain how Painting will account for the transaction on 1 January 20X1.

FROM THE DESK OF M. JUNAID KHALID 112

QUESTION 18:

FROM THE DESK OF M. JUNAID KHALID 113

KAPLAN KIT: 76 – 86, 266 – 275
BPP KIT 103 – 114, 160 – 164

FROM THE DESK OF M. JUNAID KHALID 114

 IAS 2 -- INVENTORY
Inventories are assets:
– Held for sale in the ordinary course of business;
– In the process of production for such sale; or
– In the form of materials or supplies to be consumed in the production process or in the
rendering of services.

Inventories can include any of the following.

 Goods purchased and held for resale, e.g. goods held for sale by a retailer, or land and
buildings held for resale
 Finished goods produced
 Work in progress being produced
 Materials and supplies awaiting use in the production process (raw materials)

Net realizable value: is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale. (IAS 2)

Fair value: is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
The standard states that 'Inventories should be measured at the lower of cost and net
realizable value.'
COST OF INVENTORIES:
The cost of inventories will consist of all costs of:
 Purchase
 Costs of conversion
 Other costs incurred in bringing the inventories to their present location and condition

Costs of purchase
The standard lists the following as comprising the costs of purchase of inventories.
o Purchase price PLUS
o Import duties and other taxes PLUS
o Transport, handling and any other cost directly attributable to the acquisition of finished
goods, services and materials LESS
o Trade discounts, rebates and other similar amounts

FROM THE DESK OF M. JUNAID KHALID 115

Costs of conversion
Costs of conversion of inventories consist of two main parts.
a) Costs directly related to the units of production, e.g. direct materials, direct labour
b) Fixed and variable production overheads that are incurred in converting materials into
finished goods, allocated on a systematic basis.

Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, e.g. the cost of factory management and
administration.
Variable production overheads are those indirect costs of production that vary directly, or
nearly directly, with the volume of production, e.g. indirect materials and labour.

The standard emphasizes that fixed production overheads must be allocated to items of
inventory on the basis of the normal capacity of the production facilities. This is an important
point.

Illustration: The following costs relate to a unit of goods:

Cost of raw materials $1, Direct labour $0.50
During the year $60,000 of production overheads were incurred. 8,000 units were
produced during the year which is lower than the normal level of 10,000 units. This was as
a result of a fault with some machinery which resulted in 2,000 units having to be
scrapped. At the year-end, 700 units are in closing inventory. What is the value of closing
inventory?
$ _________
Other costs
Any other costs should only be recognised if they are incurred in bringing the inventories to
their present location and condition.
The standard lists types of cost which would not be included in cost of inventories. Instead, they
should be recognised as an expense in the period they are incurred.
a) Abnormal amounts of wasted materials, labour or other production costs
b) Storage costs (except costs which are necessary in the production process before a
further production stage)
c) Administrative overheads not incurred to bring inventories to their present location and
conditions Selling costs

FROM THE DESK OF M. JUNAID KHALID 116

NET REALIZABLE VALUE (NRV)
As a general rule asset should not be carried at amounts greater than those expected to be
realised from their sale or use. In the case of inventories this amount could fall below cost when
items are damaged or become obsolete, or where the costs to completion have increased in
order to make the sale.

In fact, we can identify the principal situations in which NRV is likely to be less than cost, i.e.
where there has been:
a) An increase in costs or a fall in selling price
b) A physical deterioration in the condition of inventory
c) Obsolescence of products
d) A decision as part of the company's marketing strategy to manufacture and sell products
at a loss
e) Errors in production or purchasing

INVENTORY VALUATION METHODS

IAS 2 deals with three methods of arriving at cost:
 Actual unit cost
 First in, first out (FIFO)
 Weighted average cost (AVCO).

DISCLOSURE REQUIREMENTS
The main disclosure requirements of IAS 2 are:
 accounting policy adopted, including the cost formula used
 total carrying amount, classified appropriately
 amount of inventories carried at NRV
 amount of inventories recognised as an expense during the period
 details of any circumstances that have led to the write-down of inventories to their NRV.

QUESTION 1:

FROM THE DESK OF M. JUNAID KHALID 117

QUESTION 2:
Value the following items of inventory.
(a) Materials costing $12,000 bought for processing and assembly for a profitable special order.
Since buying these items, the cost price has fallen to $10,000.
(b) Equipment constructed for a customer for an agreed price of $18,000. This has recently
been completed at a cost of $16,800. It has now been discovered that, in order to meet certain
regulations, conversion with an extra cost of $4,200 will be required. The customer has
accepted partial responsibility and agreed to meet half the extra cost.

QUESTION 3:
Neville has only two items of inventory on hand at its reporting date.

Item 1 – Materials costing $24,000 bought for processing and assembly for a customer under a
‘one off’ order which is expected to produce a high profit margin. Since buying this material,
the cost price has fallen to $20,000.

Item 2 – A machine constructed for another customer for a contracted price of $36,000. This
has recently been completed at a cost of $33,600. It has now been discovered that in order to
meet certain health and safety regulations modifications at an extra cost of $8,400 will be
required. The customer has agreed to meet half of the extra cost.
What should be the total value of these two items of inventory in the statement of financial
position?
QUESTION 4:
During the year company sold goods amounting to Rs. 600,000. On January 1st 2012 company
had goods in inventory Rs.6000. on 31st December2013 Company had goods in inventory
Rs.7500 including the goods costing Rs.3500 which had an estimated selling price of Rs.3800.
Estimated selling expense of Rs.300 and an estimated agent commission was required at Rs.500
to sell such product. During the year inventory was purchased for Rs. 100,000. Calculate the
gross profit?
QUESTION 5:
Inventory measured at 7th July 2020 was $650,000. However, company’s accounting year ends
on 30th June 2020. Following transactions were taken place from 1st July till 7th July.
 Sales for $40,000 profit margin is 20%
 Purchases $10,000
Required: Calculate the value of inventory at 30th June 2020

BPP KIT QUESTIONS: 124, 125, 129, 131, 132

KAPLAN KIT QUESTIONS: 70 – 73

FROM THE DESK OF M. JUNAID KHALID 118

 IFRS 9 -- FINANCIAL INSTRUMENTS
There are three reporting standards that deal with financial instruments:
• IAS 32 Financial Instruments: Presentation
• IFRS 7 Financial Instruments: Disclosures
• IFRS 9 Financial Instruments

IAS 32 deals with the classification of financial instruments and their presentation in financial
statements.
IFRS 9 deals with how financial instruments are measured and when they should be recognised
in financial statements.
IFRS 7 deals with the disclosure of financial instruments in financial statements.

A financial instrument is any contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity.

A financial asset is any asset that is:

a) 'cash'
b) 'a contractual right to receive cash or another financial asset from another entity'
c) 'a contractual right to exchange financial assets or liabilities with another entity under
conditions that are potentially favorable'
d) 'an equity instrument of another entity' (IAS 32, para 11)

Examples of financial assets include:

o trade receivables
o options
o investments in equity shares.
A financial liability is any liability that is a contractual obligation:
o 'to deliver cash or another financial asset to another entity', or
o 'to exchange financial assets or liabilities with another entity under conditions that are
potentially unfavorable', or
o 'that will or may be settled in the entity’s own equity instruments.' (IAS 32, para 11)
Examples of financial liabilities include:
o trade payables
o debenture loans
o redeemable preference shares.

FROM THE DESK OF M. JUNAID KHALID 119

FINANCIAL ASSETS – EQUITY INSTRUMENTS
Initial recognition of financial assets
IFRS 9 deals with recognition and measurement of financial assets. 'An entity shall recognize a
financial asset on its statement of financial position when, and only when, the entity becomes
party to the contractual provisions of the instrument' (IFRS 9, para 3.1.1)
Initial measurement of financial assets
At initial recognition, all financial assets are measured at fair value. This is likely to be the
purchase consideration paid to acquire the financial asset. Transaction costs are included unless
the asset is fair value through profit or loss.
Equity instruments
Equity instruments (purchases of shares in other entities) are measured at either:
• fair value through profit or loss, or
• fair value through other comprehensive income
Fair value through profit or loss
This is the default category for equity investments. Any transaction costs associated with the
purchase of these investments are expensed to profit or loss, and are not included within the
initial value of the asset.
The investments are then revalued to fair value at each year-end, with any gain or loss being
shown in the statement of profit or loss.
Fair value through other comprehensive income
Instead of classifying equity investments as fair value through profit or loss (FVPL), an entity
may designate the investment as 'fair value through other comprehensive income' (FVOCI)
(alternate treatment). This designation must be made on acquisition and can only be done if
the investment is intended as a long- term investment.
Once designated this category cannot later be changed to FVPL.

FROM THE DESK OF M. JUNAID KHALID 120

Under FVOCI:
• Transaction costs are capitalised
• The investments are revalued to fair value each year-end, with any gain or loss being shown in
other comprehensive income and taken to an investment reserve in equity.
This is similar to a revaluation of property, plant and equipment under IAS 16. The main
difference is that the investment reserve can be negative.
If a FVOCI investment is sold, the investment reserve can be transferred into retained earnings
or left in equity.

FINANCIAL ASSET (EQUITY)

FV THROUGH OCI FV THROUGH P/L
FV GAIN/LOSS OCI P/L
TRANSACTION COST CAPITALIZE EXPENSE OUT
DISPOSAL GAIN/LOSS P/L P/L
DIVIDEND P/L P/L

QUESTION 1:
What is the default classification for an equity investment?
a) Fair value through profit or loss
b) Fair value through other comprehensive income
c) Amortized cost
d) Net proceeds

QUESTION 2:
Copper Limited has purchased an investment of 15,000 shares on 1 August 2016 at a cost of Rs.
65 each. Copper Limited intend to sell these shares in the short term and are holding them for
trading purposes. Transaction costs on the purchase amounted to Rs. 15,000. As at the year-
end 30 September 2016, these shares are now worth Rs. 77.5 each. What is the gain on this
investment during the year ended 30 September 2016, and where in the Financial Statements
will it be recognized?
a) Rs. 187,500 in Other Comprehensive Income
b) Rs. 187,500 in Profit or Loss
c) Rs. 172,500 in Other Comprehensive Income
d) Rs. 172,500 in Profit or Loss

FROM THE DESK OF M. JUNAID KHALID 121

QUESTION 3:
Gold Limited’s draft statement of financial position as at 31 March 2018 shows financial assets
at fair value through profit or loss with a carrying amount of Rs. 12.5 million as at 1 April
2017.These financial assets are held in a fund whose value changes directly in proportion to a
specified market index. At 1 April 2017 the relevant index was 1,200 and at 31 March 2018 it
was 1,296. What amount of gain or loss should be recognized at 31 March 2018 in respect of
these assets?
Rs. ___________
QUESTION 4:
Mercury Limited purchased 1 million shares in Jupiter Limited, a listed company, for Rs. 40
million on 1 January 2017. By the year end, 31 December 2017, the fair value of a Jupiter
Limited’s share had moved to Rs. 48million. If Mercury Limited were to dispose of the shares,
broker fees of Rs. 500,000 would be incurred. What is the correct treatment for shares at year
end?
a) Hold shares in investments at Rs.47.5 million, with Rs. 7.5 million gain being taken to the
statement of profit or loss
b) Hold shares in investments at Rs. 48 million, with Rs. 8 million gain being taken to the
statement of profit or loss
c) Hold shares in investments at Rs. 48 million, with Rs. 8 million gain shown in the
statement of changes in equity
d) Hold shares in investments at Rs. 48 million, with Rs. 7.5 million gain shown in the
statement of changes in equity

QUESTION 5:
Diamond Limited purchased 10,000 shares on 1 September 2014, making the election to use
the alternative treatment under IFRS 9. The shares cost Rs. 35 each. Transaction costs
associated with the purchase were Rs. 5,000.
At 31 December 2014, the shares are trading at Rs. 45 each.
What is the gain to be recognized on these shares for the year ended 31 December 2014?
a) Rs. 100,000
b) Rs. 450,000
c) Rs. 95,000
d) Rs. 350,000

FROM THE DESK OF M. JUNAID KHALID 122

QUESTION 6:
In February 20x8 a company purchased 20,000 $1 ordinary shares at a price of $4 per share.
Transaction costs were $2,000. At the year-end of 31st December 20x8, these shares were
trading at $5.50. A dividend of 20c per share was received on 30th September 20x8.

Show the financial statement extract at 31st December 20x8 relating to this investment on the
basis that:

a) The shares were bought for trading (conditions for FVTOCI have not been met)
b) Conditions for FVTOCI have been met

QUESTION 7:
An equity investment is purchased for Rs30,000 plus 1% transaction costs on 1st January 20x6. It
is classified as at fair value through OCI.

At the end of the financial year (31st December 20X6) the investment is revalued to its fair value
of Rs. 40,000. On 11 December 20x7 it is sold for Rs. 50,000

Required: Explain the accounting treatment for this investment. (prepare entries)
QUESTION 8:
Mohsin ltd purchased listed company shares on 1st July 2017, following are details:
o Number of shares = 5000
o Price on 1st July $32 per share
o Commission paid per share is $1.250
o Classification is FVTOCI
On 31st December 2018 disposed 2000 shares for $38 each
Fair values on different dates are:
 30th June 2018 is $35 per share
 30th June 2019 $40 per share
Required: Entries for 2018 and 2019
QUESTION 1 B
QUESTION 2 B
QUESTION 3 1MILLION
QUESTION 4 B
QUESTION 5 C
QUESTION 6A INVESTMENT 110000, TRANASCTION COST 2000, DIVIDEND INCOME 4000, FV GAIN 30000
QUESTION 6B INVESTMENT 110000, DIVIDEND INCOME 4000, FV GAIN(OCI) 28000
QUESTION 7 BANK 50000 DR, INVESTMENT 40000 CR, P/L 10000 CR
QUESTION 8 GAIN DISPOSAL 6000, FVOCI GAIN 8750, FV GAIN OCI 15000

FROM THE DESK OF M. JUNAID KHALID 123

FINANCIAL ASSETS – DEBT INSTRUMENTS
Debt instruments (such as bonds or redeemable preference shares) are categorized in one of three
ways:
o Amortized cost
o Fair value through profit or loss
o Fair value through other comprehensive income

The default category is again fair value through profit or loss (FVPL). The other two categories depend
on the instrument passing two tests:

o Business model test. This considers the entity's purpose in holding the investment.
o Contractual cash flow characteristics test. This looks at the cash that will be received as a result
of holding the investment, and considers what it comprises.

The contractual cash flow characteristics test determines whether the contractual terms of the
financial asset give rise to cash flows on specified dates that are solely of principal and interest
based upon the principal amount outstanding. If this is not the case, the test is failed and the
financial asset must be measured at FVPL. For example, convertible bonds contain rights in
addition to the repayment of interest and principal (the right to convert the bond to equity) and
therefore would fail the test and must be accounted for at FVPL.

AMORTIZED COST
For an instrument to be carried at amortized cost, the two tests to be passed are:
o Business model test. The entity must intend to hold the investment to maturity.
o Contractual cash flow characteristics test. The contractual terms of the financial asset must give
rise to cash flows that are solely of principal and interest.
If a debt instrument is held at amortized cost, the interest income (calculated using the effective
interest as for liabilities) will be taken to the statement of profit or loss.

FAIR VALUE THOUGH OTHER COMPREHENSIVE INCOME (FVOCI)

For an instrument to be carried at FVOCI, the two tests to be passed are:
o Business model test. The entity must intend to hold the investment to maturity but may sell the
asset if the possibility of buying another asset with a higher return arises.
o Contractual cash flow characteristics test. The contractual terms of the financial asset must give
rise to cash flows that are solely of principal and interest, as for amortized cost.

FROM THE DESK OF M. JUNAID KHALID 124

TREATMENT:

AMORTIZED COST FV THROUGH OCI FV THROUGH P/L

INTEREST INCOME RECOGNIZED @ EFFECTIVE RECOGNIZED @ RECOGNIZED @
RATE IN P/L EFFECTIVE RATE IN COUPON RATE IN P/L
P/L
FV GAIN/LOSS N/A IN OCI AS PER TABLE IN P/L AS PER TABLE
TRANSACTION COST CAPITALIZE CAPITALIZE EXPENSE OUT
DISPOSAL GAIN/LOSS P/L P/L P/L
RECLASSIFICATION ON N/A YES TO P/L PREVIOUS N/A
DISPOSAL OCI
IN BALANCE SHEET AS PER TABLE @FV @FV
TABLE START WITH PURCHASE PRICE/ISSUE PURCHASE PRICE + PURCHASE PRICE
PRICE/FV + TRANSACTION COST TRANSACTION COST

AMORTIZED COST:
Note:
 Coupon rate is applied on par value
 Coupon rate interest is the amount/interest that is actually received
 Effective rate is applied on invested amount
 Effective rate is the interest that is actually earned
QUESTION 9:
Norman bought 10,000 debentures at a 2% discount on the par value of $100. The debentures
are redeemable in four years’ time at a premium of 5%. The coupon rate attached to the
debentures is 4%. The effective rate of interest on the debenture is 5.73%.

Required: Prepare financial statement extract for four years.

FROM THE DESK OF M. JUNAID KHALID 125

QUESTION 10:
On 1st January 20x1 Abacus co. purchases a debt instrument for its fair value of $1,000. The
debt instrument is due to mature on 31st December 20x5. The instrument has a principal
amount of $1250 and the instrument carries fixed interest @ 4.72% that is paid annually. The
effective rate of interest is 10%.

Required: Prepare financial statement extract for five years.

QUESTION 11:
On 1 January 20X1, Tokyo bought a $100,000 5% bond for $95,000, incurring acquisition costs
of $2,000. Interest is received annually in arrears. The bond will be redeemed at a premium of
$5,960 over nominal value on 31 December 20X3. The effective rate of interest is 8%. The fair
value of the bond was as follows:

o 31 December 20X1 $110,000

o 31 December 20X2 $104,000

Required: Explain, with calculations, how the bond will have been accounted for over all
relevant years if:

a) Tokyo planned to hold the bond until the redemption date.

b) Tokyo may sell the bond if the possibility of an investment with a higher return arises.
c) Tokyo planned to trade the bond in the short-term, selling it for its fair value on 1
January 20X2.

QUESTION 12:
A company invests $5,000 in 10% loan notes. The loan notes are repayable at a premium after 3
years. The effective rate of interest is 12%. The company intends to collect the contractual cash
flows which consist solely of repayments of interest and capital and have therefore chosen to
record the financial asset at amortized cost.
Required: What amounts will be shown in the statement of profit or loss and statement of
financial position for the financial asset for years 1–3?
QUESTION 13:
A company invested in 10,000 shares of a listed company in November 20X7 at a cost of $4.20
per share. At 31 December 20X7 the shares have a market value of $4.90.
Required: Prepare extracts from the statement of profit or loss for the year ended 31
December 20X7 and a statement of financial position as at that date.

FROM THE DESK OF M. JUNAID KHALID 126

QUESTION 14:
A company invested in 20,000 shares of a listed company in October 20X7 at a cost of $3.80 per
share. At 31 December 20X7 the shares have a market value of $3.40. The company is not
planning on selling these shares in the short term and elects to hold them as fair value through
other comprehensive income.

Required: Prepare extracts from the statement of profit or loss and other comprehensive
income for the year ended 31 December 20X7 and a statement of financial position as at that
date.

QUESTION 15:

QUESTION 16:
On 1 July 2018, Gypsum Limited purchased 5,000 debentures issued by Iron Limited at par
value of Rs. 100 each. The transaction cost associated with the acquisition of the debentures
was Rs. 24,000. The coupon interest rate is 11% per annum payable annually on 30 June. On 1
July 2018, the effective interest rate was worked out at 9.5% per annum whereas the market
interest rate on similar debentures was 12% per annum.

As on 30 June 2019, the debentures were quoted on Pakistan Stock Exchange at Rs. 96 each.
Required:
Prepare journal entries for the year ended 30 June 2019 if the investment in debentures is
subsequently measured at:
(a) amortized cost (03)
(b) fair value through OCI (03)

FROM THE DESK OF M. JUNAID KHALID 127

QUESTION 17:
Kalam limited has invested in a debt instrument, details of which are as follows:

 Face value of the instrument $10,000

 Premium paid on the investment of the instrument $1,245
 Transaction cost paid on the investment of the instrument $325
 Coupon rate of the instrument 16%
 Term of instrument 4 years
 Kalam limited has a policy to classify investment in debt instrument through OCI
 Effective rate /IRR is 10.95%
 Fair value of instrument year wise is as follows:
o Yr 1 $11,500
o Yr 2 $11,200
o Yr 3 $10,700
 On 1st January yr 4 instrument was disposed of $10,500.

Required: Explain, with calculations, how the bond will have been accounted for over all
relevant years

FINANCIAL LIABILITIES:
A financial liability is initially recognised at its fair value. This is usually the net proceeds of the cash
received less any costs of issuing the liability (transaction cost).
Financial liabilities will be carried at amortized cost, other than liabilities held for trading will be
recognized at fair value through profit or loss account.

QUESTION 18:
Norma issues 20,000 redeemable debentures at their $100 par value, incurring issue costs of $100,000.
The debentures are redeemable at a 5% premium in 4 years’ time and carry a coupon rate of 2%. The
effective rate on the debenture is 4.58%.

Required: Calculate the amounts to be shown in the statement of financial position and statement of
profit or loss for each of the four years of the debenture.

QUESTION 19:
loan note is issued for $1,000. The loan note is redeemable at $1,250. The term of the loan is five years
and interest is paid at 5.9% pa. The effective rate of interest is 10%.

Required: Show how the value of the loan note changes over its life.

FROM THE DESK OF M. JUNAID KHALID 128

QUESTION 20:
A company issues 6% loan notes with a nominal value of $200,000. They are issued at a 5% discount and
$1,700 of issue cost are incurred. The loan notes will be repayable at a premium of 10% after four years.
The effective interest rate is 10%.

Required: What amount will be shown in the statement of profit or loss and statement of financial
position at the end of years 1 – 4?

QUESTION 21:
A company issues 4% loan notes with a nominal value of $20,000. The loan notes are issued at a
discount of 2.5% and $534 of issue costs are incurred. The loan notes will be repayable at a premium of
10% after 5 years. The effective rate of interest is 7%.

Required: What amount will be recorded as a financial liability when the loan notes are issued? What
amounts will be shown in the statement of profit or loss and statement of financial position for year 1?

COMPOUND INSTRUMENTS:
A compound instrument is a financial instrument that has characteristics of both equity and
liabilities, such as a convertible loan.
A convertible loan has the following characteristics:
o It is repayable, at the lender's option, in shares of the issuing company instead of cash
o The number of shares to be issued is fixed at the inception of the loan
o The lender will accept a rate of interest below the market rate for nonconvertible
instruments
As the lender is allowing the company a discounted rate in return for the potential issue of
equity, these convertible instruments are accounted for using split accounting, recognizing both
their equity and liability components.
o There is a liability or debt element, as the issuer has the potential obligation to deliver
cash
o There is also an equity element, as the investors may choose to convert the loan into
shares instead.
The accounting for a convertible loan falls into two stages, initial and subsequent measurement.

INITIAL RECOGNITION:
The liability is measured at its fair value. The fair value is the present value of the future cash
flows (interest and capital) discounted using the market rate of interest for non-convertible
debt instruments.
The equity element is equal to the loan proceeds less the calculated liability element.

FROM THE DESK OF M. JUNAID KHALID 129

SUBSEQUENT MEASUREMENT
The liability is measured at amortized cost:
Initial value + market-rate interest – interest paid
The equity is not re-measured and remains at the same value on the statement of financial
position until the debt is redeemed.
CONVERTIBLE DEBENTURES/BONDS:
If a convertible instrument is issued, the economic substance is a combination of equity and
liability and is accounted for using split equity accounting.
The liability element is calculated by discounting back the maximum possible amount of cash
that will be repaid assuming that the conversion doesn’t take place. The discount rate to be
used is that of the interest rate on similar debt without and conversion option.
The equity element is the difference between the proceeds on issue and the initial liability
element.
The liability element is subsequently measured at amortized cost, using the interest rate on
similar debt without the conversion option as the effective rate. The equity element is not
subsequently changed.
Note: The carrying amount of the liability at the end of the 3 years will equal the amount to be
repaid.
Steps to calculate the equity portion:
Step 1: Calculate the future cash flows by using coupon rate
Step 2: Calculate the present value of future cash flows by using market rate
Step 3: deduct the present value of future cash flows with net proceeds

QUESTION 22:
Alice issued one million 4% convertible debentures at the start of the accounting year at par
value of $100 million.

The rate of interest on similar debt without the conversion option is 6%.
Required: Explain how Alice should account for the convertible debenture in its financial
statements for each of the three years.
QUESTION 23:
Rathbone Co issues 2,000 convertible bonds at the start of 20X2. The bonds have a three-year
term, and are issued at par with a face value of $1,000 per bond, giving total proceeds of

FROM THE DESK OF M. JUNAID KHALID 130

$2,000,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%. Each
bond is convertible at any time up to maturity into 250 ordinary shares.
When the bonds are issued, the prevailing market interest rate for similar debt without
conversion options is 9%.
Required: What is the value of the equity component in the bond?
QUESTION 24:
Convert Co issues a convertible loan that pays interest of 2% per annum in arrears. The market
rate is 8%, being the interest rate for an equivalent debt without the conversion option. The
loan of $5 million is repayable in full after three years or convertible to equity. Discount factors
are as follows:
Year Discount factor at 8%
1 0.926
2 0.857
3 0.794
Required: Split the loan between debt and equity at inception and calculate the finance charge
for each year until conversion/redemption.
QUESTION 25:
An entity issues 2% convertible bonds at their nominal value of $36,000. Interest is payable
annually in arrears. The bonds are convertible at any time up to maturity into 40 ordinary
shares for each $100 of bond. Alternatively, the bonds will be redeemed at par after 3 years.
Similar non-convertible bonds would carry an interest rate of 9.1%. The present value of $1
payable at the end of year, based on rates of 2% and 9.1% are as follows:
End of year 2% 9.1%
1 0.98 0.92
2 0.96 0.84
3 0.94 0.77
Required: What amounts will be shown as a financial liability and as equity when the
convertible bonds are issued? What amounts will be shown in the statement of profit or loss
and statement of financial position for years 1–3?
Work to the nearest $000.

FROM THE DESK OF M. JUNAID KHALID 131

Objection: would an investment (FINANCIAL ASSETS) in the convertible bond qualify to be measured at
amortized cost under IFRS 9?
No because of the inclusion of the conversion option which is not deemed to represent receipts of principal
and interest. However, with respect to issuing company (financial liability) covetable bonds are measured at
amortized cost.

OFFSETTING FINANCIAL ASSETS/FINANCIAL LIABILITIES:

In common with all IFRS Standards rules on offsetting, a financial asset and a financial liability
may only be offset in very limited circumstances. The net amount may only be presented in the
statement of financial position when the entity:
o Has a legally enforceable right to set off the amounts, and
o Intends either to settle on a net basis or to realize the asset and settle the liability
simultaneously.

INTEREST AND DIVIDENDS

The accounting treatment of interest and dividends depends upon the accounting treatment of
the underlying instrument itself:

 Equity dividends declared are reported directly in equity

 Dividends on instruments classified as a liability are treated as a finance cost in the
statement of profit or loss.
 Transaction costs of an equity transaction should be accounted for as a deduction from
equity usually debited to share premium.

QUESTION 26:
On 1 April 20X7, a company issued 40,000 $1 redeemable preference shares with a coupon rate
of 8% at par. They are redeemable at a large premium which gives them an effective finance
cost of 12% per annum.
Required: How would these redeemable preference shares appear in the financial statements
for the years ending 31 March 20X8 and 20X9?
FACTORING OF RECEIVABLES:
Factoring of receivables is where a company transfers its receivables balances to another
organization (a factor) for management and collection, and receives an advance on the value of
those receivables in return.

FROM THE DESK OF M. JUNAID KHALID 132

POINTS TO BE CONSIDERED:
Who bears the risk (of slow payment and irrecoverable debts)?
A sale of receivables with recourse means that the factor can return any unpaid debts to the
business, meaning the business retains the risk of irrecoverable debts. In this situation the
transaction is treated as a secure loan against the receivables, rather than a sale.
A sale of receivables without recourse means the factor bears the risk of irrecoverable debts. In
this case, this is usually treated as a sale and the receivables are removed from the entity’s
financial statements.

EXAMPLE:
Receivables can be factored with recourse (significant benefits and risks retained) or without
recourse (benefits and risks not retained).

A company has a cash shortage and $50,000 of receivables collectible within the next three
months. It sells the receivables to a factoring company for $40,000. The factoring company will
collect and retain the full $50,000 as it falls due. The factoring company bears the liability for
any bad debts. This is factoring without recourse.
A company has a cash shortage and $50,000 of receivables collectible within the next three
months. It assigns the receivables to a factoring company in exchange for an advance totaling
$42,000. If any of the debts are not paid within the three months, the advance paid for those
debts must be repaid to the factor. The company therefore bears the liability for bad debts. This
is factoring with recourse.

FROM THE DESK OF M. JUNAID KHALID 133

QUESTION 27:
An entity has an outstanding receivables balance with a major customer amounting to $12
million, and this was factored to Finance Co on 1 September 20X7. The terms of the factoring
were:
Finance Co will pay 80% of the gross receivable outstanding account to the entity immediately.

 The balance will be paid (less the charges below) when the debt is collected in full. Any
amount of the debt outstanding after four months will be transferred back to the entity
at its full book value.
 Finance Co will charge 1% per month of the net amount owing from the entity at the
beginning of each month. Finance Co had not collected any of the factored receivable
amount by the year-end.
 The entity debited the cash from Finance Co to its bank account and removed the
receivable from its accounts. It has prudently charged the difference as an
administration cost.

Required: How should this arrangement be accounted for in the financial statements for the
year ended 30 September 20X7?
DISCLOSURE OF FINANCIAL INSTRUMENTS
IFRS 7 provides the disclosure requirements for financial instruments. The major elements of
disclosures required are:
i. The carrying amount of each class of financial instrument should be recorded either on
the face of the statement of financial position or within the notes.
ii. An entity must also disclose items of income, expense, gains and losses for each class of
financial instrument either in the statement of profit or loss and other comprehensive
income or within the notes.
iii. An entity must also make disclosures regarding the nature and extent of risks faced by
the entity. This must cover the entity's exposure to risk, management's objectives and
policies for managing those risks and any changes in the year.

The objective of IFRS 7 is to allow users of the accounts to evaluate:

a) The significance of the financial instruments for the entity’s financial position and
performance
b) The nature and extent of risks arising from financial instruments
c) The management of the risks arising from financial instruments Nature and extent of
financial risks

Financial risk arising from the use of financial instruments can be defined as:

FROM THE DESK OF M. JUNAID KHALID 134

 i. Credit risk
ii. Liquidity risk
iii. Market risk
Disclosures with regards to these risks need to be both qualitative and quantitative.

BPP KIT 96 – 102 & 155 – 159

KAPLAN KIT 87 – 96 & 276 -- 285

FROM THE DESK OF M. JUNAID KHALID 135

QUESTION 1:

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FROM THE DESK OF M. JUNAID KHALID 137
PRACTISE QUESTIONS:

FROM THE DESK OF M. JUNAID KHALID 138

FROM THE DESK OF M. JUNAID KHALID 139
SOLUTION:

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FROM THE DESK OF M. JUNAID KHALID 141
FROM THE DESK OF M. JUNAID KHALID 142
FROM THE DESK OF M. JUNAID KHALID 143
SOLUTION OF PRACTISE QUUESTIONS:

FROM THE DESK OF M. JUNAID KHALID 144

 CONSOLIDATED FINANCIAL STATEMENT BASICS (IAS 27/IAS 28/IFRS 10/IFRS 3)
DEFINITIONS:

 CONTROL
Control is identified by IFRS 10 as the sole basis for consolidation and comprises the
following three elements:
o 'Power over the investee
o Exposure, or rights, to variable returns from its involvement with the investee
o The ability to use its power over the investee to affect the amount of the
investor's returns' (IFRS 10, para 7)
NOTE: If decisions need the unanimous consent of shareholders then majority
shareholding will not lead to control
 POWER
Power is the existing rights that give the current ability to direct the relevant activities.
 PARENT
Parent company is an entity that controls one or more entities.
 SUBSIDIARY
Subsidiary is an entity that is controlled by another entity (known as the parent).
 ASSOCIATES COMPANY
An associate is an entity over which another entity exerts significant influence (power
to participate).
 INVESTMENT
Trade investment is simple investment in the shares of another company for the
accretion of wealth.
 GROUP
A Group consists of parent and all its subsidiaries.
 CONSOLIDATED FINANCIAL STATEMENTS
The financial statements of a group in which the assets, liabilities, equity, income,
expenses and cash flows of the parent and its subsidiaries are presented as those of a
single economic entity.
 NON CONTROLLING INTEREST
Non-controlling interest is the equity in a subsidiary not attributable, directly or
indirectly, to a parent

 How is a parent-subsidiary relationship identified?

IAS 27 defines consolidated financial statements as ‘the financial statements of a group
presented as those of a single economic entity.’
A group is made up of a parent and its subsidiary.

FROM THE DESK OF M. JUNAID KHALID 145

Illustration 1 shows an example of a typical group structure.

The illustration shows how a parent company has control over a subsidiary, it is assumed that
control exists if the parent company has more than 50% of the ordinary (equity) shares – i.e.
giving them more than 50% of the voting power.
However, there are examples where a holding of less than 50% of the ordinary shares can still
lead to control existing. This may be because the parent has:

 the power over more than 50% of the voting rights/potential voting rights by virtue of
agreement with other investors
 the power to govern the financial and operating policies of the entity under statute or an
agreement
 the power to appoint or remove the majority of the members of the board of directors, or
 The power to cast the majority of the votes at meetings of the board of directors.
 Convertible bonds acquired which will result in acquisition of major shares on maturity.

Significant influence can be presumed not to exist if the investor holds less than 20% of the
voting power of the investee, unless it can be demonstrated otherwise.
The existence of significant influence is evidenced in one or more of the following ways.
(a) Representation on the board of directors (or equivalent) of the investee
(b) Participation in the policy making process
(c) Material transactions between investor and investee
(d) Interchange of management personnel
(e) Provision of essential technical information
IAS 28 requires the use of the equity method of accounting for investments in associates.

CONCEPT OF SUBSTANCE OVER FORM AND GROUP ACCOUNTS:

Although from the legal point of view, every company is a separate entity, from the economic
point of view companies may not be separate. In particular, when one company owns enough
shares in another company to have a majority of votes at that company’s annual general
meeting (AGM), the first company may appoint all the directors of, and decide what dividends
should be paid by, the second company.

FROM THE DESK OF M. JUNAID KHALID 146

This degree of control enables the first company to manage the trading activities and future
plans of the second company as if it were merely a department of the first company.
International accounting standards recognize this situation, and require a parent company to
produce consolidated financial statements showing the position and results of the whole group.
ILLUSTRATION 1: Green Co owns the following investments in other companies:
Equity shares Non-equity shares held

Violet Co 80% Nil

Amber Co 25% 80%

Black Co 45% 25%

Green Co also has appointed five of the seven directors of Black Co.
Which of the following investments are accounted for as subsidiaries in the consolidated
accounts of Green Co Group?
A. Violet only
B. Amber only
C. Violet and Black
D. All of them
Answer
Let’s consider each of the investments in turn to determine if control exists and, therefore, if
they should be accounted for as a subsidiary.
 Violet Co – by looking at the equity shares, Green Co has more than 50% of the voting
shares – i.e. an 80% equity holding. This gives them control and, therefore, Violet Co is a
subsidiary.
 Amber Co – you must remember to look at the equity shares, as despite having the
majority of the non-equity shares, these do not give voting power. As Green Co only has
25% of the equity shares, they do not have control and, therefore, Amber Co is not a
subsidiary.
 Black Co – by looking at the percentage of equity shares, you may incorrectly conclude
that Black Co is not a subsidiary, as Green Co has less than half of the voting rights.
However, by looking at the fact that Green Co has appointed five of the seven directors,
effectively they have control over the decision making in the company. This control should
make you conclude that Black Co is a subsidiary.

Therefore the correct answer is C.

FROM THE DESK OF M. JUNAID KHALID 147

ILLUSTRATION 2: Pink Co acquired 80% of Scarlett’s Co ordinary share capital on 1 January
2012.
As at 31 December 2012, extracts from their individual statements of financial position showed:
Pink Co Scarlett Co
$ $

Current assets:
Receivables 50,000 30,000

Current liabilities:
Payables 70,000 42,000

As a result of trading during the year, Pink Co’s receivables balance included an amount due
from Scarlett of $4,600.
What should be shown as the consolidated figure for receivables and payables?
Receivables Payables
$ $

A 80,000 112,000

B 75,400 112,000

C 74,000s 103,600

D 75,400 107,400
Answer
From the question, we can see that Pink Co has control over Scarlett Co. This should mean that
you immediately consider adding together 100% of Pink Co’s balances and Scarlett Co’s
balances to reflect control.
However, the intra-group balances at the yearend need to be eliminated, as the consolidated
accounts need to show the group as a single economic entity – in other words, the group
position with the outside world.
As Pink Co shows a receivable of $4,600, then in Scarlett Co’s individual accounts there must be
a corresponding payable of $4,600. When these balances are eliminated, the consolidated
figures become:
Receivables ($50,000 + $30,000 – $4,600) = $75,400
Payables ($70,000 + $42,000 – $4,600) = $107,400

FROM THE DESK OF M. JUNAID KHALID 148

Therefore, the correct answer is D, not A which completely omits the elimination of the intra-
group balances, nor answer B which omits to cancel the corresponding payable within
liabilities.
You would not select answer C, which incorrectly adds 100% of Pink Co (the parent) and only
80% of Scarlett Co (the subsidiary).

ILLUSTRATION 3: Which of the following investment would be treated as subsidiary, associate or

trade investment?
A. Smith Co. owns 15% of the ordinary share of Red Co. and has significant influence over
Red Co.
B. Smith Co. owns 45% of the ordinary share of Pink Co. and can appoint 4 out of 5
directors to the BOD of Pink Co.
C. Smith Co. owns 40% of the preference shares (non-voting) and 15% of the ordinary
shares of Yellow Co.
D. Smith Co. owns 60% of the preference shares (non-voting) and 40% of the ordinary
shares of Green Co.

EXCLUDED SUBSIDIARIES:
IFRS 10 and IAS 27 (revised) do not specify any other circumstances when subsidiaries must be excluded
from consolidation. However, there may be specific circumstances that merit particular consideration as
follows:

Reason for exclusion Accounting treatment

Subsidiary held for resale Held as current asset investment at the lower of carrying amount and fair
value less costs to sell.

Materiality Accounting standards do not apply to immaterial items. Therefore, an

immaterial item need not be consolidated.

The directors of a parent company may not wish to consolidate some subsidiaries due to:
 Poor performance of the subsidiary
 Poor financial position of the subsidiary
 Differing activities of the subsidiary from the rest of the group.
These reasons are not permitted under IFRS Standards.

EXEMPTION FROM PREPARATION OF GROUP FINANCIAL STATEMENTS

A parent need not present consolidated financial statements if and only if:
 The parent itself is a wholly owned subsidiary or a partially-owned subsidiary and its
owners, including those not otherwise entitled to vote, have been informed about, and
do not object to, the parent not preparing consolidated financial statements.

FROM THE DESK OF M. JUNAID KHALID 149

  The ultimate parent company produces consolidated financial statements that comply
with IFRS Standards and are available for public use.
 The parent's debt or equity instruments are not traded in a public market
 The parent did not file its financial statements with a securities commission or other
regulatory organization for the purpose of issuing any class of instruments in a public
market

DIFFERENT REPORTING DATES:

Some companies in the group may have differing accounting dates. In practice such companies
will often prepare financial statements up to the group accounting date for consolidation
purposes.

For the purpose of consolidation, IFRS 10 states that where the reporting date for a parent is
different from that of a subsidiary, the subsidiary should prepare additional financial
information as of the same date as the financial statements of the parent unless it is
impracticable to do so.
If it is impracticable to do so, IFRS 10 allows use of subsidiary financial statements made up to a
date of not more than three months earlier or later than the parent's reporting date, with due
adjustment for significant transactions or other events between the dates.
UNIFORM ACCOUNTING POLICIES:
Consolidated financial statements should be prepared using uniform accounting policies for like
transactions and other events in similar circumstances.
Adjustments must be made where members of a group use different accounting policies, so
that their financial statements are suitable for consolidation.
DATE OF INCLUSION/EXCLUSION

IFRS 10 requires the results of subsidiary undertakings to be included in the consolidated

financial statements from:
(a) The date of 'acquisition', i.e. the date on which the investor obtains control of the investee,
to
(b) The date of 'disposal', i.e. the date the investor loses control of the investee.
Once an investment is no longer a subsidiary, it should be treated as an associate under IAS 28
(if applicable) or as an investment under IFRS 9

FROM THE DESK OF M. JUNAID KHALID 150

PRACTISE MCQS:
1) Which of the following definitions is not included within the definition of control per IFRS 10?
A. Having power over the investee
B. Having exposure, or rights, to variable returns from its investment with the investee
C. Having the majority of shares in the investee
D. Having the ability to use its power over the investee to affect the amount of the
investor’s returns

2) Which of the following situations is unlikely to represent control over an investee?

A. Owning 55% and being able to elect 4 of the 7 directors
B. Owning 51 %, but the constitution requires that decisions need the unanimous consent
of shareholders
C. Having currently exercisable options which would take the shareholding of the company
to 55%
D. Owning 40% of the shares, but having the majority of voting rights within the company

3) Which of the following is NOT a condition which must be met for the parent to be exempt
from producing consolidated financial statements?
A. The activities of the subsidiary are significantly different to the rest of the group and to
consolidate them would prejudice the overall group position
B. The ultimate parent company produces consolidated financial statements that comply
with IFRS Standards and are publicly available
C. The parent’s debt or equity instruments are not traded in a public market
D. The parent itself is a wholly-owned subsidiary or a partially owned subsidiary whose
owners do not object to the parent not producing consolidated financial statements

4) Which of the following statements regarding consolidated financial statements is correct?

A. For consolidation, it may be acceptable to use financial statements of the subsidiary if
the year-end differs from the parent by 2 months
B. For consolidation, all companies within the group must have the same year-end
C. All companies within a group must have the same accounting policy in their individual
financial statements
D. Only 100% subsidiaries need to be consolidated

FROM THE DESK OF M. JUNAID KHALID 151

FROM THE DESK OF M. JUNAID KHALID 152
 CONSOLIDATED STATEMENT OF FINANCIAL POSITION
QUESTION 1:
STATEMENT OF FINANCIAL POSTION
AS AT 31-12-2001
P COMPANY S COMPANY
ASSETS
PROPERTY PLANT AND EQUIPMENT 10,000 3,000
INVESTMENT IN 'S' CO. AT COST 5,000 -
CASH AT BANK 12,000 2,000

TOTAL ASSETS 27,000 5,000

EQUITIES AND LIABILITIES

$1 ORDINARY SHARES 15,000 3,000
RESERVES 8,000 1,500
PAYABLES 4,000 500

TOTAL EQUITY AND LIABILITIES 27,000 5,000

Required: P Company acquired 100% shares in “S” on 31-12-2001 for $5000. Prepare
consolidated statement of financial position.

CONCEPT OF PRE-ACQUISITION AND POST-ACQUISITION RESERVES/RETAINED EARNING:

Reserves of subsidiary company are included in net assets only if these reserves belong to pre-
acquisition i.e. before acquisition of parent company. Any retained earnings or reserves earned
after acquisition will be included in “consolidated statement of financial position”. In CSFP only
group profits or reserves are included. Pre reserves are the part of goodwill and post reserves
are the part of group reserves.

FROM THE DESK OF M. JUNAID KHALID 153

QUESTION 2:
P Company acquired 100% shares in “S” on 1-1-2001 for $10,000 when ‘S’ Company reserves at
the time of acquisition were $ 200.
STATEMENT OF FINANCIAL POSITION
AS AT 31-12-2001
P COMPANY S COMPANY
ASSETS
PROPERTY PLANT AND EQUIPMENT 20,000 6,000
INVESTMENT 15,000 -
CASH AT BANK 5,000 3,000

TOTAL ASSETS 40,000 9,000

EQUITIES AND LIABILITIES

$1 ORDINARY SHARES 20,000 7,000
RESERVES 5,000 1,000
PAYABLES 15,000 1,000

TOTAL EQUITY AND LIABILITIES 40,000 9,000

Required: Prepare consolidated statement of financial position as at 31-12-2001

QUESTION 3:
P Company acquired 100% shares in “S” on 1-1-2001 for $12,000 when ‘S’ Company reserves at
the time of acquisition were $ 600.
STATEMENT OF FINANCIAL POSITION
AS AT 31-12-2001
P COMPANY S COMPANY
ASSETS
PROPERTY PLANT AND EQUIPMENT 20,000 6,000
INVESTMENT 15,000 -
CASH AT BANK 5,000 3,000

TOTAL ASSETS 40,000 9,000

EQUITIES AND LIABILITIES

$1 ORDINARY SHARES 20,000 7,000
RESERVES 5,000 1,000
PAYABLES 15,000 1,000

TOTAL EQUITY AND LIABILITIES 40,000 9,000

Required: Prepare consolidated statement of financial position as at 31-12-2001.

FROM THE DESK OF M. JUNAID KHALID 154

NON-CONTROLLING INTEREST:
In some situations, a parent may not own all of the shares in the subsidiary, e.g. if P owns a
controlling 80% interest in the ordinary shares of S, there is a non-controlling interest of 20%.
Note, however, that P still controls S.
Note: There are 2 methods by which goodwill may be calculated:
i. Proportion of net assets method
ii. Fair value method.

How to calculate NCI:

If fair value method adopted:
NCI value = fair value of NCI's holding at acquisition (number of shares NCI own × subsidiary
share price).
If proportion of net assets method adopted:
NCI value = NCI % × fair value of net assets at acquisition
QUESTION 4:
P Company acquired 80% shares in “S” on 1-1-2001 for $13000. When Company “S” reserves
were $400. Prepare consolidated statement of financial position as at 31-12-01
STATEMENT OF FINANCIAL POSITION
AS AT 31-12-2001
P COMPANY S COMPANY
ASSETS
PROPERTY PLANT AND EQUIPMENT 20,000 6,000
INVESTMENT 15,000 -
CASH AT BANK 5,000 3,000

TOTAL ASSETS 40,000 9,000

EQUITIES AND LIABILITIES

$1 ORDINARY SHARES 20,000 7,000
RESERVES 5,000 1,000
PAYABLES 15,000 1,000

TOTAL EQUITY AND LIABILITIES 40,000 9,000

FROM THE DESK OF M. JUNAID KHALID 155

QUESTION 5:
P Company purchased 75% of the share capital of S Company on 1 January 2001 for $60,000
when the retained earnings of S Company were $5000. The fair value of the non-controlling
interest in S Company at that date was $15,000. The statement of financial position of P
Company and S Company as at 31 December 2001 is given below.
P COMPANY S COMPANY
ASSETS
PROPERTY PLANT AND EQUIPMENT 50,000 35,000
INVESTMENT IN 'S' CO. AT COST 60,000 -
CASH AT BANK 45,000 40,000

TOTAL ASSETS 155,000 75,000

EQUITIES AND LIABILITIES

$1 ORDINARY SHARES 80,000 40,000
RETAINED EARNING 55,000 15,000
PAYABLES 20,000 20,000

TOTAL EQUITY AND LIABILITIES 155,000 75,000

Required: Prepare the consolidated statement of financial position at 31 December 2001.

QUESTION 6:

FROM THE DESK OF M. JUNAID KHALID 156

 QUESTION 7:
Daniel acquired 80% of the ordinary share capital of Craig on 31 December 20X6 for $78,000. At
this date the net assets of Craig were $85,000.
Required: What goodwill arises on the acquisition:
i. if the NCI is valued using the proportion of net assets method?
ii. if the NCI is valued using the fair value method and the fair value of the NCI on the
acquisition date is $19,000?

QUESTION 8:
Wing Co. had 50,000 ordinary shares of $1 each. Sing Co. acquired 40,000 shares in Wing Co.
for $70,000. Net asset at the date of acquisition was $60,000. The market price of Wing Co. at
that date was $1.25 per share.
Required: What goodwill arises on the acquisition:
i. If the NCI is valued using the proportion of net assets method?
ii. If the NCI is valued using the fair value method

GOODWILL:
'Goodwill is an asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and separately
recognised' (IFRS 3, Appendix A).
Goodwill is calculated as the excess of the consideration transferred and amount of any non-
controlling interest over the net of the identifiable assets acquired and liabilities assumed at the
acquisition date.

Note:
 If goodwill is positive, treat it as a non-current asset on the statement of financial position.
 If goodwill is negative, it is regarded as a gain on a bargain purchase and is included as a gain
in profit or loss and ultimately within retained earnings

TREATMENT OF GOODWILL
Positive goodwill
o Capitalised as an intangible non-current asset.
o Tested annually for possible impairments
o Amortization of goodwill is not permitted by the IFRS Standard

Impairment of positive goodwill

If goodwill is considered to have been impaired during the post-acquisition period, this must be
reflected within the group financial statements. Accounting for the impairment differs
according to the policy followed to value the non-controlling interests, reflecting the ownership
of the goodwill.

FROM THE DESK OF M. JUNAID KHALID 157

Proportion of net assets method:
Dr Group retained earnings
Cr Goodwill
Fair value method:
Dr Group retained earnings (% of impairment attributable to the parent)
Dr NCI (% of impairment attributable to NCI)
Cr Goodwill

QUESTION 9:
P acquired 75% of the shares in S on 1 January 2007 when S had retained earnings of $15,000.
The market price of S's shares just before the date of acquisition was $1.60. P values NCI at fair
value. Goodwill was impaired by 20%

FAIR VALUE ADJUSTMENT:

To ensure that an accurate figure is calculated for goodwill:
 The consideration paid for a subsidiary must be accounted for at fair value
 The subsidiary’s identifiable assets and liabilities acquired must be accounted for at
their fair values.
The cost of acquisition/Investment includes the following elements:
 Cash paid at the date of acquisition

FROM THE DESK OF M. JUNAID KHALID 158

  Fair value of any other consideration i.e. deferred/contingent considerations and share
exchanges
 Incidental costs/other cost of acquisition such as legal, accounting, valuation and other
professional fees should be written off as expenses through profit or loss as incurred.
The issue costs of debt or equity associated with the acquisition should be recognised in
accordance with IFRS 9/IAS 32
DEFERRED/CONTINGENT CONSIDERATIONS:
In some situations, part or all of the purchase consideration is deferred until a later date –
deferred consideration.
 Deferred consideration (i.e. a promise to pay an agreed sum on a predetermined date in
the future) should be measured at fair value at the date of the acquisition, taking into
account the time value of money.
 The fair value of any deferred consideration is calculated by discounting the amounts
payable to present value at acquisition.
 IFRS 3 requires recognition of all contingent consideration, measured at fair value, at the
acquisition date. Entry for the recognition of contingent consideration is as follows;
o Investment Dr Contingent consideration(liability) Cr
o Any change in the post-acquisition contingent consideration shall be recorded as
follows;
o Increase in CC
 R/e – P (Dr) CC – P (Cr)
o Decrease in CC
 CC – P (Dr) R/e – P (Cr)
SHARE EXCHANGE:
Where contingent consideration involves the issue of shares, there is no liability (obligation to
transfer economic benefits). This potential share issue should be recognised as part of equity
under a separate caption representing shares to be issued.
Often the parent will issue shares in itself in return for the shares acquired in the subsidiary.
The share price at acquisition should be used to record the fair value of the shares.
ILLUSTRATION:
Jack acquired 24 million $1 shares (80%) of the ordinary shares of Becky on 1st January 20x7 by
offering a share-for-share exchange of two shares for every three shares acquired in Becky, and
a cash payment of $1 per share payable three years later. Jack's shares have a nominal value of
$1 and a current market value of $2. The cost of capital is 10% and the value of $1 receivable in
3 years’ time can be taken as $0.75.
Required: Calculate the cost of investment and show the journals to record it in Jack's financial
statements. Also Show how the discount would be unwound at 31st December 20x7.

FROM THE DESK OF M. JUNAID KHALID 159

QUESTION 10:

FAIR VALUE OF NET ASSETS ACQUIRED

IFRS 3 requires that the subsidiary’s assets and liabilities are recorded at their fair value for the
purposes of the calculation of goodwill and production of consolidated accounts.
Adjustments will therefore be required where the subsidiary’s financial statements do not
reflect the fair value of assets and liabilities. Following cases might be relevant for Fair value
adjustments;
o Adjustment for revaluation surplus
o Recognizing internally generated intangible of subsidiary as now parent is purchasing

FROM THE DESK OF M. JUNAID KHALID 160

 o Any contingent liabilities in the subsidiary need to be recognised as liabilities in the
consolidated financial statements
o Measure the inventory of subsidiary at replacement cost/fair value in consolidated
financial position

QUESTION 11:

FROM THE DESK OF M. JUNAID KHALID 161

POST-ACQUISITION REVALUATIONS:
If there is a post-acquisition revaluation in the subsidiary's non-current assets, the full amount
of the gain should be added to non-current assets. The parent's share/group share of the gain is
taken to the revaluation surplus, with the NCI share of the gain being taken to NCI
Illustration:
P has owned 80% of S for many years. During the current year, P and S both revalue their
properties for the first time. Both properties increase by $100,000.
The revaluations will be shown as follows:
$000 $000
Dr Property, plant & equipment 200
Cr Revaluation surplus (via OCI) 180
($100,000 + (80% × $100,000))
Cr Non-controlling interest (20% × $100,000) 20

INTRA-GROUP TRADING:
P and S may well trade with each other leading to the following potential problem areas:
 Current accounts between P and S
 Loans held by one company in the other
 Dividends and loan interest
 Unrealized profits on sales of inventory
 Unrealized profits on sales of non-current assets

FROM THE DESK OF M. JUNAID KHALID 162

CURRENT ACCOUNTS
If P and S trade with each other than this will probably be done on credit. Note that these intra-
group transactions are usually recorded within a single account in each entity, known as the
current account. This will lead to:
 A receivables (current) account in one entity’s SFP
 A payables (current) account in the other entity’s SFP.
These are amounts owing within the group rather than outside the group and therefore they
must not appear in the consolidated statement of financial position.
They are therefore cancelled against each other on consolidation, by deducting from the
relevant lines on the SFP.
CASH/GOODS IN TRANSIT:
At the year end, the current accounts may not agree, owing to the existence of in-transit items
such as goods or cash.
The usual rules are as follows:
 If there are goods or cash in transit, adjust the statement of financial position as if the
goods or cash had been received:
o cash in transit adjusting entry is: (assuming cash is received)
 Dr Cash
 Cr Receivables
o goods in transit adjusting entry is:
 Dr Inventory
 Cr Payables
Note: This adjustment is for the purpose of consolidation only.
• Once in agreement, the current accounts may be cancelled as normal.
• This means that reconciled current account balance amounts are removed from both
receivables and payables in the consolidated statement of financial position.

FROM THE DESK OF M. JUNAID KHALID 163

QUESTION 12:

FROM THE DESK OF M. JUNAID KHALID 164

QUESTION 13:

FROM THE DESK OF M. JUNAID KHALID 165

UNREALIZED PROFIT
Profits made by entities within a group on transactions with other group entities are:
 Recognised in the accounts of the individual entities concerned, but
 In terms of the group as a whole, such profits are unrealized and must be eliminated
from the consolidated financial statements.
Unrealized profit may arise within a group on:
 Inventory where entities trade with one another
 non-current assets where one group entity has transferred an asset to another.

The key is that we need to remove this profit by creating a Provision for Unrealized Profit (PUP)
INTRA-GROUP TRADING AND UNREALIZED PROFIT IN INVENTORY

When one group entity sells goods to another a number of adjustments may be needed.

 Current accounts must be cancelled (see earlier in this chapter).

 Where goods are still held by a group entity, any unrealized profit must be cancelled.
 Inventory must be included at cost to the group (i.e. original cost to the entity which
then sold it) i.e. remove the unrealized profit form inventory.

Note: An adjustment will need to be made so that the single entity concept can be upheld i.e.
the group should report external profits, external assets and external liabilities only.

FROM THE DESK OF M. JUNAID KHALID 166

QUESTION 14:

FROM THE DESK OF M. JUNAID KHALID 167

QUESTION 15:

FROM THE DESK OF M. JUNAID KHALID 168

INTRA-GROUP OF NON- CURRENT ASSETS AND UNREALIZED PROFIT
In their individual accounts the companies concerned will treat the transfer just like a sale
between unconnected parties: the selling company will record a profit or loss on sale, while the
purchasing company will record the asset at the amount paid to acquire it, and will use that
amount as the basis for calculating depreciation.
On consolidation, the usual 'group entity' principle applies. The consolidated statement of
financial position must show assets at their cost to the group, and any depreciation charged
must be based on that cost. Two consolidation adjustments will usually be needed to achieve
this.
a) An adjustment to alter retained earnings and non-current assets cost so as to remove
any element of unrealized profit or loss. This is similar to the adjustment required in
respect of unrealized profit in inventory.
b) An adjustment to alter retained earnings and accumulated depreciation is made so that
consolidated depreciation is based on the asset's cost to the group.

The retained earnings of the entity making the sale are debited with the unrealized profit and
the additional depreciation is credited back to the entity holding the asset.
The double entry is as follows.

(a) Sale by Parent

DEBIT Group retained earnings
CREDIT Non-current assets - Subsidiary
(with the profit on disposal)
DEBIT Non-current assets - Subsidiary
CREDIT Subsidiary’s retained earnings
(With the excess depreciation)
(a) Sale by Subsidiary
DEBIT Subsidiary’s retained earnings
CREDIT Non-current assets - Parent
(with the profit on disposal)

DEBIT Non-current assets -- Parent

CREDIT Group retained earnings
(With the excess depreciation)

FROM THE DESK OF M. JUNAID KHALID 169

 QUESTION 16:
P acquired 80% of S a number of years ago. P transferred an item of plant to S for $6,000 on 1
January 20X1. The plant originally cost P $10,000 and had an original useful economic life of 5
years when purchased 3 years ago. The useful economic life of the asset has not changed as a
result of the transfer.

Required: What is the unrealized profit on the transaction and how should this be treated
within the financial statements at 31 December 20X1?
QUESTION 17:
P Co owns 60% of S Co and on 1 January 20X1 S Co sells plant costing $10,000 to P Co for
$12,500. The companies make up accounts to 31 December 20X1 and the balances on their
retained earnings at that date are:

P Co after charging depreciation of 10% on plant $27,000

S Co including profit on sale of plant (post Acq.) $18,000

Required: Show the working for consolidated retained earnings.

ACQUISITION OF A SUBSIDIARY PART WAY THROUGH THE YEAR/ MID YEAR:

When a parent company acquires a subsidiary during the year, the profits for the period need
to be apportioned between pre- and post-acquisition. Only post-acquisition profits are included
in the group’s consolidated statement of financial position.
The subsidiary’s accounts to be consolidated will show the subsidiary’s profit or loss for the
whole year. For consolidation purposes, however, it will be necessary to distinguish between:
a) Profits earned before acquisition – so that we can calculate goodwill.
b) Profits earned after acquisition – so that we can calculate group retained earnings.

Calculation of reserves at date of acquisition

If a parent acquires a subsidiary mid-year, the net assets at the date of acquisition must be
calculated based on the net assets at the start of the subsidiary's financial year plus the profits
of up to the date of acquisition.

To calculate this, it is normally assumed that S’s profit after tax accrues evenly over time.
However, there may be exceptions to this. The most common one of these is an intra-group
loan from the parent to the subsidiary at the date of acquisition.

If this is the case, the subsidiary will have incurred loan interest in the post-acquisition period
that would not have been charged in the pre-acquisition period.

FROM THE DESK OF M. JUNAID KHALID 170

QUESTION 18:
P acquired 80% of S on 1 July 20X1. S's retained earnings at 31 December 20X1 are $15,000 and
S's profit for the year was $8,000.
REQUIRED: What were S's retained earnings at acquisition?
QUESTION 19:
P acquired 80% of S on 1 July 20X1. S's retained earnings at 31 December 20X1 are $15,000 and
S's profit for the year was $8,000. Immediately after acquisition, P made a loan to S of $40,000
which carried interest at 10%.
REQUIRED: What were S's retained earnings at acquisition?

FROM THE DESK OF M. JUNAID KHALID 171

QUESTION 20:

FROM THE DESK OF M. JUNAID KHALID 172

QUESTION 21:
Hinge Co. acquired 80% of the ordinary shares of Singe Co. on 1 April 2005. On 31 December
2004 S Co. accounts showed a share premium of $ 4000 and retained earnings of $ 15000. The
NCI is valued at fair value share price of subsidiary at acquisition was $2.50 per share. The
statement of financial position of the two companies at 31 December 2005 is set below.
H COMPANY S COMPANY
ASSETS
PROPERTY PLANT AND EQUIPMENT 32,000 30,000
16000 ord. shares of 50c each in S Co. 50,000 -
CURRENT ASSETS 85,000 43,000

TOTAL ASSETS 167,000 73,000

EQUITIES AND LIABILITIES

$1 ORDINARY SHARES 100,000 -
20000 ORD. SHARES OF 50 C EACH - 10,000
SHARE PREMIUM 7,000 4,000
RETAINED EARNING 40,000 39,000
PAYABLES 20,000 20,000

TOTAL EQUITY AND LIABILITIES 167,000 73,000

REQUIRED: Prepare the consolidated statement of financial position of H Co. at 31 December
2005. You should assume that profits have accrued evenly over the year to 31 December 2005.

FROM THE DESK OF M. JUNAID KHALID 173

QUESTION 22:
P Co acquired all 50,000 $1 ordinary shares in S Co for $20,000 on 1 January 20X1 when there
was a debit balance of $35,000 on S Co's retained earnings. In the years 20X1 to 20X4 S Co
makes profits of $40,000 in total, leaving a credit balance of $5,000 on retained earnings at 31
December 20X4. P Co's retained earnings at the same date are $70,000.

Required: Calculate the amount of goodwill and group retained earnings.

PRACTISE QUESTIONS:

FROM THE DESK OF M. JUNAID KHALID 174

FROM THE DESK OF M. JUNAID KHALID 175
ANSWERS:

FROM THE DESK OF M. JUNAID KHALID 176

 CONSOLIDATED STATEMENT OF PROFIT OR LOSS
The consolidated statement of profit or loss shows the profit generated by all resources disclosed in the
related consolidated statement of financial position, i.e. the net assets of the parent entity (P) and its
subsidiary (S). The consolidated statement of profit or loss follows these basic principles:

 From revenue down to profit for the year include all of P’s income and expenses plus all of S’s
income and expenses (reflecting P’s control of S).
 After profit for the year show split of profit between amounts attributable to the parent's
shareholders and those attributable to the non-controlling interest (to reflect ownership).

QUESTION 1:

DIVIDENDS
A payment of a dividend by S to P will need to be removed from investment income in the
statement of profit or loss. The effect of this on the consolidated statement of profit or loss is
that any dividend income shown in the consolidated statement of profit or loss must arise from
investments other than those in subsidiaries or associates

FROM THE DESK OF M. JUNAID KHALID 177

QUESTION 2:

PROVISION FOR UNREALISED PROFIT --INVENTORY

If any goods sold intra-group are included in closing inventory, their value must be adjusted to
the cost to the group (as in the CSFP). The adjustment for unrealized profit should be shown as
an increase to cost of sales, returning closing inventory back to true cost to group and
eliminating the unrealized profit.

FROM THE DESK OF M. JUNAID KHALID 178

QUESTION 3:

FROM THE DESK OF M. JUNAID KHALID 179

QUESTION 4:
P Co. acquired 75% of the ordinary shares of S Co. on that company’s incorporation in 2001. S
Company had recorded sales of $ 5000 at a gross margin of 40% to P Company during 2001.
50% of the goods remained in P Company’s inventories at 31 December 2001. The summarized
statements of profit and loss of the two companies for the year ending 31 December 2001 are
set below.
P COMPANY S COMPANY
REVENUE 75,000 38,000
COST OF SALES (30,000) (20,000)
GROSS PROFIT 45,000 18,000
ADMINISTRATIVE EXPENSS (14,000) (8,000)
PROFIT BEFORE TAX 31,000 10,000
INCOME TAX EXPENSE (10,000) (2,000)
PROFIT AFTER TAX 21,000 8,000

MOVEMENT ON RETAINED EARNING

RETAINED EARNINGS BROUGHT FORWARD 87,000 17,000
PROFIT FOR THE YEAR 21,000 8,000
RETAINED EARNINGSCARRIED FORWARD 108,000 25,000

TRANSFERS OF NON-CURRENT ASSETS

If one group company sells a non-current asset to another group company, the following
adjustments are needed in the statement of profit or loss to account for the unrealized profit
and the additional depreciation.

 Any profit or loss arising on the transfer must be removed from the consolidated
statement of profit or loss included in the seller's profit
 The depreciation charge for the buyer must be adjusted so that it is based on the cost of
the asset to the group.

IMPAIRMENT OF GOODWILL
Once any impairment has been identified during the year, the charge for the year will be passed
through the consolidated statement of profit or loss. This will usually be through operating
expenses, but always follow any instructions from the examiner.
If non-controlling interests have been valued at fair value, a portion of the impairment expense
must be removed from the non-controlling interest's share of profit.

FROM THE DESK OF M. JUNAID KHALID 180

FAIR VALUES
If a depreciating non-current asset of the subsidiary has been revalued as part of a fair value
exercise when calculating goodwill, this will result in an adjustment to the consolidated
statement of profit or loss.
The subsidiary's own statement of profit or loss will include depreciation based on the carrying
amount of the asset in the subsidiary's individual statement of financial position.
The consolidated statement of profit or loss must include a depreciation charge based on the
fair value of the asset, as included in the consolidated SFP.
Extra depreciation must therefore be calculated and charged to an appropriate cost category
(usually cost of sales, but in line with examiner requirements).

FROM THE DESK OF M. JUNAID KHALID 181

QUESTION 5:

FROM THE DESK OF M. JUNAID KHALID 182

QUESTION 6:

From London

FROM THE DESK OF M. JUNAID KHALID 183

MID-YEAR ACQUISITION PROCEDURE
If a subsidiary is acquired part way through the year, then the subsidiary’s results should only
be consolidated from the date of acquisition, i.e. the date on which control is obtained.
In practice this will require:
o Identification of the net assets of S at the date of acquisition in order to calculate
goodwill.
o Time apportionment of the results of S in the year of acquisition. For this purpose,
unless indicated otherwise, assume that revenue and expenses accrue evenly.
o After time-apportioning S’s results, deduction of post-acquisition intragroup items as
normal.

QUESTION 7:

FROM THE DESK OF M. JUNAID KHALID 184

QUESTION 8:

FROM THE DESK OF M. JUNAID KHALID 185

THE CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
QUESTION 9:
P acquired 80% shares in “S” Company on 1-1-2001. Prepare consolidated statement of
comprehensive income for the year ended 31-12-2001. Following individual income statement
for the two companies is as follows for the year 31-12-2001.
P COMPANY S COMPANY

REVENUE 12,000 8,000

COST OF SALES (5,000) (2,500)
GROSS PROFIT 7,000 5,500
INCOME TAX EXPENSE (2,000) (1,500)
PROFIT AFTER TAX 5,000 4,000
OTHER COMPREHENSIVE INCOME 1,500 1,000
TOTAL COMPREHENSIVE INCOME 6,500 5,000

Prepare Consolidated statement of comprehensive income for the year ended 31 st December
2001.
QUESTION 10:

FROM THE DESK OF M. JUNAID KHALID 186

 after

FROM THE DESK OF M. JUNAID KHALID 187

QUESTION 11:

FROM THE DESK OF M. JUNAID KHALID 188

FROM THE DESK OF M. JUNAID KHALID 189
QUESTION 12:

FROM THE DESK OF M. JUNAID KHALID 190

 DISPOSAL OF SUBSIDIARY:
When a shareholding in a subsidiary is disposed of it must be reflected in:
 The parent company’s individual financial statements and
 The group financial statements.

PARENT COMPANY FINANCIAL STATEMENTS

Gain to parent company
The gain/loss on disposal in the parent company’s accounts is calculated as follows:
$
Sale proceeds X
Carrying amount of investment (X)
––––
Parent gain/loss on disposal X(X)
The gain is reported as an exceptional item –

 Must be disclosed separately on the face of the parent’s SPL

 After profit from operations.
Any tax on the gain is calculated by reference to the gain in the parent's individual financial
statements.
CONSOLIDATED FINANCIAL STATEMENTS – FULL DISPOSAL
Disposal of whole subsidiary
The impact of the disposal on the financial statements can be seen below.

 Statement of profit or loss

o 100% of the subsidiary’s results consolidated up to date of disposal
o Gain/(loss) on disposal.
 Statement of financial position
o At the year-end no shares are held by the parent and therefore the disposed
subsidiary is not included in the group statement of financial position.
o Gain/loss on disposal to be included within retained earnings

FROM THE DESK OF M. JUNAID KHALID 191

GAIN ON DISPOSAL
$ $
Sales proceeds X
Net assets at date of disposal X
Net goodwill at date of disposal X
NCI at date of disposal (X)
––––
(X)
––––
Group gain/loss on disposal X(X)
––––
 This gain will be included in the consolidated statement of profit or loss.
 Carrying amount of goodwill at the date of disposal will be calculated in the same way as
we have done previously
 Carrying amount of net assets at date of disposal will be calculated as opening net
assets add any profits till date of disposal and less any dividend paid
 Non-controlling interest (NCI) at disposal: NCI at acquisition add post net assets/ r/e @
NCI PERCENTAGE and less any impairment related to NCI

QUESTION 1:
Rock acquired a 70% investment in Dog for $2,000 two years ago. It is group policy to
measure non-controlling interests at fair value at the date of acquisition. The fair value of
the non-controlling interest in Dog at the date of acquisition was $800 and the fair value of
Dog's net assets was $1,900. The goodwill has not been impaired. Rock disposed of all of its
shares in Dog for sale proceeds of $3,000. The fair value of Dog’s net assets at the date of
disposal was $2,400.
Required:
Calculate the profit/loss on disposal that would be recorded in:
a) Rock's individual statement of profit or loss.
b) Rock's consolidated statement of profit or loss.

FROM THE DESK OF M. JUNAID KHALID 192

QUESTION 2:

FROM THE DESK OF M. JUNAID KHALID 193

QUESTION 3:

PRACTISE QUESTIONS:

FROM THE DESK OF M. JUNAID KHALID 194

FROM THE DESK OF M. JUNAID KHALID 195
ANSWERS:

FROM THE DESK OF M. JUNAID KHALID 196

FROM THE DESK OF M. JUNAID KHALID 197
 IAS 28 INVESTMENTS IN ASSOCIATES AND JOINT VENTURES
IAS 28 defines an associate as:
'An entity over which the investor has significant influence' (IAS 28, para 3).
'Significant influence is the power to participate in the financial and operating policy decisions
of the investee but is not control or joint control over those policies' (IAS 28, para 3).
Significant influence is assumed with a shareholding of 20% to 50%
PRINCIPLES OF EQUITY ACCOUNTING

Equity accounting is a method of accounting whereby the investment is initially recorded at

cost and adjusted thereafter for the post-acquisition change in the investor’s share of the net
assets of the associate.
The effect of this is that the consolidated statement of financial position includes:

 100% of the assets and liabilities of the parent and subsidiary company on a line by line
basis
 An ‘investment in associate’ line within non-current assets which includes the cost of
the investment plus the group share of post-acquisition reserves.

The consolidated statement of profit or loss includes:

 100% of the income and expenses of the parent and subsidiary company on a line by
line basis
 Single line ‘share of profit of associates’ which includes the group share of any
associate’s profit after tax.

Note: The equity method should not be used if:

 The investment is classified as held for sale in accordance with IFRS 5 or
 The parent is exempted from having to prepare consolidated accounts on the
grounds that it is itself a wholly, or partially, owned subsidiary of another company
(IFRS 10).

FROM THE DESK OF M. JUNAID KHALID 198

INVESTMENT IN ASSOCIATE
The CSFP is prepared on a normal line-by-line basis following the acquisition method for the
parent and subsidiary. The associate is included as a non-current asset investment calculated
as:
$000
Cost of investment X
Share of post-acquisition profits X
Less: Impairment losses (X)
Less: PUP (If P to A) (X)
Less: Dividend share from associate (X)
–––––
X
–––––
The group share of the associate’s post-acquisition profits or losses, the impairment of
associate investment and the PUP will also be included in the group retained earnings
calculation

STANDARD WORKINGS
The calculations for an associate (A) can be incorporated into standard CSFP workings as
follows.

FROM THE DESK OF M. JUNAID KHALID 199

FROM THE DESK OF M. JUNAID KHALID 200
 (P to A)

QUESTION 1:
Penny had different subsidiaries and bought 30% of the equity share capital of Alex on 1
January 20X5 for $250,000. Alex’s profits for the year were $170,000.
An impairment review was carried out at the end of the year and the investment in Alex was
found to be impaired by $20,000.
REQUIRED: Calculate the investment in associate to appear in Penny’s financial statements at
31 December 20X5.

FROM THE DESK OF M. JUNAID KHALID 201

QUESTION 2:

FROM THE DESK OF M. JUNAID KHALID 202

BALANCES WITH THE ASSOCIATE
Generally, the associate is considered to be outside the group. Therefore, balances between
group companies and the associate will remain in the consolidated statement of financial
position.
So if a group company trades with the associate, the resulting payables and receivables will
remain in the consolidated statement of financial position.
UNREALIZED PROFIT IN INVENTORY
Unrealized profits on trading between group and associate must be eliminated to the extent of
the investor's interest (i.e. % owned by parent).
Adjustment must be made for unrealized profit in inventory as follows.
1) Determine the value of closing inventory which is the result of a sale to or from the
associate.
2) Use mark-up/margin to calculate the profit earned by the selling company.
3) Make the required adjustments as below:
a. If Parent sells goods to Associate
i. COST OF SALES – PARENT /GROUP R/E DR
INVESTMENT IN ASSOCIATE CR
b. If Associate sells goods to Parent
i. SHARE OF PROFIT IN ASSOCIATE/ GROUP R/E DR
INVENTORY -- PARENT CR

FROM THE DESK OF M. JUNAID KHALID 203

QUESTION 3:

FROM THE DESK OF M. JUNAID KHALID 204

QUESTION 4:

1,300

FROM THE DESK OF M. JUNAID KHALID 205

FROM THE DESK OF M. JUNAID KHALID 206
FROM THE DESK OF M. JUNAID KHALID 207
ASSOCIATES IN THE CONSOLIDATED STATEMENT OF PROFIT OR LOSS
Equity accounting
The equity method of accounting requires that the consolidated statement of profit or loss:

 Does not include dividends from the associate

 Instead includes the parent’s share of the associate’s profit after tax less any
impairment of the associate in the year, presented below group profit from operations.

TRADING WITH THE ASSOCIATE

Generally, the associate is considered to be outside the group. Therefore, any sales or
purchases between group companies and the associate are not normally eliminated and will
remain part of the consolidated figures in the statement of profit or loss.
It is normal practice to adjust for the unrealized profit in inventory. Only P's share of the
unrealized profit must be adjusted.
QUESTION 5:

FROM THE DESK OF M. JUNAID KHALID 208

TREATMENT OF DIVIDEND IN CONSOLIDATED FINANCIAL STATEMENTS:
Illustration:
Peanut Co, a company with subsidiaries, acquires 25,000 of the 100,000 $1 ordinary shares in
Almond Co for $60,000 on 1 January 20X8. In the year to 31 December 20X8, A Co earns profits
after tax of $24,000, from which it pays a dividend of $6,000.
Required: How will A Co's results be accounted for in the individual and consolidated accounts
of P Co for the year ended 31 December 20X8?
Illustration:
Alfred Co bought a 25% shareholding on 31 December 20X8 in Grimbald Co at a cost of
$38,000. During the year to 31 December 20X9 Grimbald Co made a profit before tax of
$82,000 and the taxation charge on the year's profits was $32,000. A dividend of $20,000 was
paid on 31 December out of these profits.
Required: Calculate the entries for the associate which would appear in the consolidated
accounts of the Alfred group, in accordance with the requirements of IAS 28.

FROM THE DESK OF M. JUNAID KHALID 209

QUESTION 6:

88,000

FROM THE DESK OF M. JUNAID KHALID 210

QUESTION 7:

FROM THE DESK OF M. JUNAID KHALID 211

KAPLAN KIT: 141 -- 185, 316 –330, 369 -- 400
BPP KIT: 231 – 259, 270 – 289, 295 – 306

FROM THE DESK OF M. JUNAID KHALID 212

 CONSOLIDATION MCQS PRACTISE

FROM THE DESK OF M. JUNAID KHALID 213

FROM THE DESK OF M. JUNAID KHALID 214
FROM THE DESK OF M. JUNAID KHALID 215
ANSWERS

FROM THE DESK OF M. JUNAID KHALID 216

FROM THE DESK OF M. JUNAID KHALID 217
FROM THE DESK OF M. JUNAID KHALID 218
ANSWERS:

FROM THE DESK OF M. JUNAID KHALID 219

 IFRS 15 – REVENUES FROM CONTRACTS WITH CUSTOMERS
Income. Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in an increase in equity, other than
those relating to contributions from equity participants.

Revenue. Income arising in the course of an entity's ordinary activities.

Contract. An agreement between two or more parties that creates enforceable rights and
obligations.
Customer. A party that has contracted with an entity to obtain goods or services that are an
output of the entity's ordinary activities in exchange for consideration.
Performance obligation. A promise in a contract with a customer to transfer to the customer
either:
a) a good or service (or a bundle of goods or services) that is distinct; or
b) a series of distinct goods or services that are substantially the same and that have the
same pattern of transfer to the customer.

Transaction price. The amount of consideration to which an entity expects to be entitled in

exchange for transferring promised goods or services to a customer, excluding amounts
collected on behalf of third parties (e.g. sales tax).
5-STEP APPROACH
IFRS 15 – REVENUE RECOGNITION: A FIVE STEP PROCESS
An entity recognizes revenue by applying the following five steps:
1) Identify the contract
2) Identify the separate performance obligations within a contract
3) Determine the transaction price
4) Allocate the transaction price to the performance obligations in the contract
5) Recognize revenue when (or as) a performance obligation is satisfied

FROM THE DESK OF M. JUNAID KHALID 220

STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER
A contract with a customer is within the scope of IFRS 15 only when:
a) The parties have approved the contract and are committed to carrying it out.
b) Each party's rights regarding the goods and services to be transferred can be identified.
c) The payment terms for the goods and services can be identified.
d) The contract has commercial substance.
e) It is probable that the entity will collect the consideration to which it will be entitled.
f) The contract can be written, verbal or implied.

Illustration:
Aluna Co has a year end of 31 December 20X1. On 30 September 20X1, Aluna Co signed a
contract with a customer to provide them with an asset on 31 December 20X1. Control over the
asset passed to the customer on 31 December 20X1. The customer will pay $1m on 30 June
20X2. By 31 December 20X1, Aluna Co did not believe that it was probable that it would collect
the consideration that it was entitled to.
Therefore, the contract cannot be accounted for and no revenue should be recognised.
STEP 2: SEPARATE PERFORMANCE OBLIGATIONS:
The key point is distinct goods or services. A contract includes promises to provide goods or
services to a customer. Those promises are called performance obligations. A company would
account for a performance obligation separately only if the promised good or service is distinct.
A good or service is distinct if it is sold separately or if it could be sold separately because it has
a distinct function and a distinct profit margin.
IFRS 15 states that a goods or services that is promised to a customer is distinct if both of the
following criteria are met:
a) The customer can benefit from the goods or services either on its own or tighter with
other resources that are readily available to the customer (i.e. the goods or services is
capable of being distinct): and
b) The entity’s promise to transfer the goods or services to the customer is separately
identifiable from other promises in the contract (i.e. the goods or services is distinct
within the context of the contract)

Some contracts contain more than one performance obligation. For example:
o An entity may enter into a contract with a customer to sell a car, which includes one
year’s free servicing and maintenance
o An entity might enter into a contract with a customer to provide 5 lectures, as well as to
provide a textbook on the first day of the course.

FROM THE DESK OF M. JUNAID KHALID 221

ILLUSTRATION:
Office Solutions, a limited company, has developed a communications software package called
CommSoft. Office Solutions has entered into a contract with Logisticity to supply the following:
a) License to use Commsoft
b) Installation service. This may require an upgrade to the computer operating system, but
the software package does not need to be customized.
c) Technical support for three years
d) Three years of updates for Commsoft

Office Solutions is not the only company able to install CommSoft, and the technical support
can also be provided by other companies. The software can function without the updates and
technical support.
Required: Identify performance obligation

An entity must decide if the nature of a performance obligation is:

• to provide the specified goods or services itself (i.e. the entity is the principal), or
• to arrange for another party to provide the goods or service (i.e. the entity is an agent)
If an entity is an agent, then revenue is recognised based on the fee or commission to which it
is entitled.
ILLSUTRATION: Rosemary Co's revenue includes $2 million for goods it sold acting as an agent
for Elaine. Rosemary Co earned a commission of 20% on these sales.
Required: How should the agency sale be treated in Rosemary's statement of profit or loss?

STEP 3: DETERMINING THE TRANSACTION PRICE

The transaction price is the 'amount of consideration to which an entity expects to be entitled
in exchange for transferring promised goods or services to a customer' (IFRS 15, Appendix A).
Amounts collected on behalf of third parties (such as sales tax) are excluded. The consideration
promised in a contract with a customer may include fixed amounts, variable amounts, or both.
'When determining the transaction price, an entity shall consider the effects of all of the
following:
a) variable consideration (discounts, penalties)
b) the existence of a significant financing component in the contract
c) non-cash consideration (transaction price will be fair value at the time of completion of
contract)
d) consideration payable to a customer' (entity should account for it as a reduction of the
transaction price. (refund, rebates) (IFRS 15, para 48).

FROM THE DESK OF M. JUNAID KHALID 222

Financing
In determining the transaction price, an entity must consider if the timing of payments provide
the customer or the entity with a significant financing benefit. If there is a significant financing
component, then the consideration receivable needs to be discounted to present value using
the rate at which the customer would be able to borrow.

QUESTION 1:
Rudd Co enters into a contract with a customer to sell equipment on 1 January 20X1. Control of
the equipment transfers to the customer on that date. The price stated in the contract is $1m
and is due on 31 December 20X3.
Market rates of interest available to this particular customer are 10%.

Required: Explain how this transaction should be accounted for in the financial statements of
Rudd Co for the year ended 31 December 20X1.
QUESTION 2:
Taplop supplies laptop computers to large businesses. On 1 July 20X5, Taplop entered into a
contract with TrillCo, under which TrillCo was to purchase laptops at $500 per unit. The
contract states that if TrillCo purchases more than 500 laptops in a year, the price per unit is
reduced retrospectively to $450 per unit. Taplop's year end is 30 June.
(a) As at 30 September 20X5, TrillCo had bought 70 laptops from Taplop. Taplop therefore
estimated that TrillCo's purchases would not exceed 500 in the year to 30 June 20X6, and
TrillCo would therefore not be entitled to the volume discount.
(b) During the quarter ended 31 December 20X5, TrillCo expanded rapidly as a result of a
substantial acquisition, and purchased an additional 250 laptops from Taplop. Taplop then
estimated that TrillCo's purchases would exceed the threshold for the volume discount in the
year to 30 June 20X6.
Required: Calculate the revenue Taplop would recognise in:
(a) Quarter ended 30 September 20X5
(b) Quarter ended 31 December 20X5
STEP 4: ALLOCATE THE TRANSACTION PRICE TO PERFORMANCE OBLIGATION

The total transaction price should be allocated to each performance obligation in proportion to
stand-alone selling prices.

The best evidence of a stand-alone selling price is the observable price of a good or service
when the entity sells that good or service separately in similar circumstances and to similar
customers.

FROM THE DESK OF M. JUNAID KHALID 223

If a stand-alone selling price is not directly observable, then the entity estimates the stand-
alone selling price.
Discounts
In relation to a bundled sale, any discount should generally be allocated across each component
in the transaction. A discount should only be allocated to a specific component of the
transaction if that component is regularly sold separately at a discount.
QUESTION 3:
Manish receives an order from customer for a computer as well as 12 months’ technical
support on 1st March 2017, he deliver computer same day & customer paid total of Rs. 42,000.
Computer sells for Rs. 30,000 and technical support of Rs. 12,000.
Required: Prepare entries for the year ending 31st December 2017
QUESTION 4:
Shred Co sells a machine and one year’s free technical support for $100,000. It usually sells the
machine for $95,000 but does not sell technical support for this machine as a stand-alone
product. Other support services offered by Shred Co attract a mark-up of 50%. It is expected
that the technical support will cost Shred Co $20,000.
Required:
How should the transaction price be allocated between the machine and the technical support?
QUESTION 5:
A mobile phone company gives customers a free handset when they sign a two-year contract
for provision of network services. The handset has a stand-alone price of $100 and the contract
is for $20 per month.
Required: Calculate the amount of handset and contract
STEP 5: RECOGNISE REVENUE
Revenue is recognised 'when (or as) the entity satisfies a performance obligation by transferring
a promised good or service to a customer' (IFRS 15, para 31).

For each performance obligation identified, an entity must determine at contract inception
whether it satisfies the performance obligation over time, or satisfies the performance
obligation at a point in time. Satisfying a performance obligation at a point in time
If a performance obligation is satisfied at a point in time, then the entity must determine the
point in time at which a customer obtains control of a promised asset.

FROM THE DESK OF M. JUNAID KHALID 224

Control of an asset refers to the ability to direct the use of, and obtain substantially all of the
remaining benefits (inflows or savings in outflows) from, the asset. Control includes the ability
to prevent other entities from obtaining benefits from an asset.
The following are indicators of the transfer of control:
• The entity has a present right to payment for the asset
• The customer has legal title to the asset
• The entity has transferred physical possession of the asset
• The customer has the significant risks and rewards of ownership of the asset
• The customer has accepted the asset.

Illustration:
On 1 December 20X1, Wade receives an order from a customer for a computer as well as 12
months of technical support. Wade delivers the computer (and transfers its legal title) to the
customer on the same day.
The customer paid $420 on 1 December 20X1. The computer normally sells for $300 and the
technical support for $120.
Required: Identify whether 5 steps model criteria are met?

CONSIGNMENT INVENTORY
This can raise the issue of consignment inventory, where one party legally owns the inventory
but another party keeps the inventory on its premises. The key issue relates to which party has
the majority of indicators of control.
ILLUSTRATION Consignment inventory
On 1 January 20X6 Gillingham, a manufacturer, entered into an agreement to provide
Canterbury, a retailer, with machines for resale. The terms of the agreement were as follows.
 Canterbury pays a fixed rental per month for each machine that it holds.
 Canterbury pays the cost of insuring and maintaining the machines.
 Canterbury can display the machines in its showrooms and use them as demonstration
models.
 When a machine is sold to a customer, Canterbury pays Gillingham the factory price at
the time the machine was originally delivered.
 All machines remaining unsold six months after their original delivery must be
purchased by Canterbury at the factory price at the time of delivery.
 Gillingham can require Canterbury to return the machines at any time within the six-
month period. In practice, this right has never been exercised.
 Canterbury can return unsold machines to Gillingham at any time during the six-month
period, without penalty. In practice, this has never happened.

FROM THE DESK OF M. JUNAID KHALID 225

At 31 December 20X6 the agreement is still in force and Canterbury holds several machines
which were delivered less than six months earlier.
Required: How should these machines be treated in the accounts of Canterbury for the year
ended 31 December 20X6?

REPURCHASE AGREEMENTS
i. A repurchase agreement is not a sale transaction.
ii. It will either be a lease transaction or financing transaction (secured loan)
iii. If the repurchase price is lower than the original selling price, then it is a lease
transaction
iv. If the repurchase price is equal or more than the original selling price, then it is a
financing (secured loan) transaction

BILL-AND-HOLD ARRANGEMENTS
Under a bill-and-hold arrangement goods are sold but remain in the possession of the seller for
a specified period, perhaps because the customer lacks storage facilities.
An entity will need to determine at what point the customer obtains control of the product. For
some contracts, control will not be transferred until the goods are delivered to the customer.
For others, a customer may obtain control even though the goods remain in the entity's
physical possession. In this case the entity would be providing custodial services (which may
constitute a separate performance obligation) to the customer over the customer's asset.
For a customer to have obtained control of a product in a bill and hold arrangement, the
following criteria must all be met:
a) The reason for the bill-and-hold must be substantive (for example, requested by the
customer).
b) The product must be separately identified as belonging to the customer.
c) The product must be ready for physical transfer to the customer.
d) The entity cannot have the ability to use the product or to transfer it to another
customer.
This example is taken from the standard.
An entity enters into a contract with a customer on 1 January 20X8 for sale of a machine and
spare parts. It takes two years to manufacture these and on 31 December 20X9 the customer
pays for both the machine and the spare parts but only takes physical possession of the
machine. The customer inspects and accepts the spare parts but requests that they continue to
be stored at the entity's warehouse.
There are now three performance obligations – transfer of the machine, transfer of the spare
parts and the custodial services. The transaction price is allocated to the three performance
obligations and revenue is recognised when (or as) control passes to the customer.

FROM THE DESK OF M. JUNAID KHALID 226

The machine and the spare parts are both performance obligations satisfied at a point in time,
and for both of them that point in time is 31 December 20X9. In the case of the spare parts, the
customer has paid for them, the customer has legal title to them and the customer as control of
them as they can remove them from storage at any time.
The custodial services are a performance obligation satisfied over time, so revenue will be
recognised over the period during which the spare parts are stored.

CONSTRUCTION CONTRACTS
IFRS 15 says that the following costs must be capitalised:
 The incremental costs of obtaining a contract (Referral fee).
 The costs of fulfilling a contract if they do not fall within the scope of another standard
(such as IAS 2 Inventories) and the entity expects them to be recovered. The capitalised
costs will be amortized as revenue is recognised.
CONTRACT COSTS
Contract costs comprise:
 costs that relate directly to the specific contract
 costs that are attributable to contract activity in general and can be allocated to the
contract
 such other costs as are specifically chargeable to the customer under the terms of the
contract.
Costs that relate directly to a specific contract include:
o site labor costs, including site supervision
o costs of materials used in construction
o depreciation of plant and equipment used on the contract
o costs of moving plant, equipment and materials to and from the contract site
o costs of hiring plant and equipment
o costs of design and technical assistance that is directly related to the contract
o the estimated costs of rectification and guarantee work, including expected warranty
costs
o claims from third parties.
Costs that may be attributable to contract activity in general and can be allocated to specific
contracts include:
o insurance
o costs of design and technical assistance that are not directly related to a specific
contract
o construction overheads.

FROM THE DESK OF M. JUNAID KHALID 227

CONTRACT PROFIT:
For a contract with a customer where revenue is recognised over time, there are three
important rules to be aware of:
1) If the expected outcome is a profit:
a. revenue should be recognised according to the progress of the contract and cost
should be recorded as “cost incurred to date”
2) If the expected outcome is a loss:
a. the whole loss should be recognised immediately,
b. Revenue is recorded on the basis of progress and;
c. Cost would be the balancing figure,
d. Recording a provision as an onerous contract.
3) If the expected outcome or progress is unknown (often due to it being in the very early
stages of the contract):
a. Revenue should be recognised to the level of recoverable costs (usually costs
spent to date).
b. Contract costs should be recognised as an expense in the period in which they
are incurred.
In the majority of cases, this will mean that revenue and cost of sales will both be stated at
costs incurred to date, with no profit or loss recorded.

Contract revenue will include the followings:

a) Revenue agreed
b) Variation in work & claim to the extend reliably measured (customer fault)
c) Incentive payment (additional payment received for meeting standards)
d) Less any penalties paid

QUESTION 1:
X limited wins a 5-year contract to provide a service to a customer. The contract contains a
single performance obligation satisfied over time. X limited recognizes revenue on a time basis.
Costs incurred by the end of year 1 and forecast future costs are as follows:
Rs
Costs to date 10,000
Estimate of future costs 18,000
Total expected costs 28,000
Contract revenue 35,000

Required: Calculate profit to be recognized in profit or loss

FROM THE DESK OF M. JUNAID KHALID 228

QUESTION 2:
Bashir limited has a contract & following are details.
Rs
Costs to date 10,000
Estimate of future costs 18,000
Total expected costs 28,000
Contract revenue 35,000
As per expert by end of year 1, 25% contract has been completed.
Required: Calculate profit to be recognized in profit or loss as per;
a) Output method
b) Input method

QUESTION 3:
The following information relates to a construction contract:
Contract price $800,000
Costs to date $320,000
Estimated costs to complete $280,000
Estimated stage of completion 60%
Required:
(a) What amounts of revenue, costs and profit should be recognised in the statement of profit
or loss from both methods?
(b) Take the same contract, but now assume that the business is not able to reliably estimate
the outcome of the contract although it is believed that all costs incurred will be recoverable
from the customer. What amounts should be recognised for revenue, costs and profit in the
statement of profit or loss?

QUESTION 4:
Suppose that a contract is started on 1 January 20X5, with an estimated completion date of 31
December
20X6. The final contract price is $1,500,000. In the first year, to 31 December 20X5:
a) Costs incurred amounted to $600,000.
b) Half the work on the contract was completed.
c) Certificates of work completed have been issued, to the value of $750,000.
d) It is estimated with reasonable certainty that further costs to completion in 20X6 will be
$600,000.
What is the contract profit in 20X5, from output methods?

FROM THE DESK OF M. JUNAID KHALID 229

CONTRACT ASSET/ CONTRACT LIABILITY:
At the year end, there will be a contract asset or liability, recorded in current asset or current
liability. This will be calculated as shown below:

Revenue recognized to date xxx

Less: Amount invoiced to date (xxx)
Contract asset/ (contract liability) xxx/(xxx)
Note: If a contract is loss making, there will be a provision recorded to recognize the full loss
under the onerous contract. This can be either termed as contract liability or a provision.
QUESTION 5:
On 1 January 20X1, Baker entered into a contract with a customer to construct a specialized
building for consideration of $2m plus a bonus of $0.4m if the building is completed within 18
months. Estimated costs to construct the building were $1.5m. If the contract is terminated by
the customer, Baker can demand payment for the costs incurred to date plus a mark-up of 30%.
On 1 January 20X1, as a result of factors outside of its control, Baker was not sure whether the
bonus would be achieved. At 31 December 20X1 Baker had incurred costs of $1m. They were
still unsure as to whether the bonus target would be met. Baker measures progress towards
completion based on costs incurred. At 31 December 20X1 Baker had received $1 million from
the customer.
Required: How should this transaction be accounted for in the year ended 31 December 20X1?

QUESTION 6:
Pappa Co has the following contract in progress:
$m
Total contract price 750
Costs incurred to date 225
Estimated costs to completion 340
Payments invoiced and received 290
Required: Calculate the amounts to be recognised for the contract in the statement of profit or
loss and statement of financial position assuming the amount of performance obligation
satisfied is calculated using the proportion of costs incurred method.

Note: IFRS 15 states that an entity's right to payment for performance completed to date should
approximate the selling price of the service completed to date. Selling price would be recovery of
costs incurred plus a reasonable profit margin. Where no profit can be estimated, revenue is
limited to recoverable costs.
Where a loss is anticipated, this means that a proportion of the entity's costs will not be
recovered, and this needs to be recognised. Whole loss should be recognized than cost would be
the balancing figure.

FROM THE DESK OF M. JUNAID KHALID 230

QUESTION 7:
Pappa Co has the following contract in progress:
$m
Total contract price 550
Costs incurred to date 225
Estimated costs to completion 340
Payments invoiced and received 290
Required: Calculate the amounts to be recognised for the contract in the statement of profit or
loss and statement of financial position assuming the amount of performance obligation
satisfied is calculated using the proportion of costs incurred method.

QUESTION 8:
The main business of Santolina Co is building work. At the end of September 20X3 there is an
uncompleted contract on the books, details of which are as follows.
Date commenced 1.4.X1
Expected completion date 23.12.X3
$
Total contract revenue 290,000
Costs to 30.9.X3 210,450
Value of performance obligations satisfied to 30.9.X3 230,000
Amounts invoiced for work certified to 30.9.X3 210,000
Cash received to 30.9.X3 194,000
Estimated costs to completion at 30.9.X3 20,600
Santolina calculates satisfaction of performance obligations based on work certified as a
percentage of contract price.
Required
Prepare calculations showing the amount to be included in the statement of profit or loss and
statement of financial position at 30 September 20X3 in respect of the above contract.

QUESTION 9:
Haggrun Co has two contracts in progress, the details of which are as follows.
Happy (profitable) Grumpy (loss-making)
$'000 $'000
Total contract revenue 300 300
Costs incurred to date 90 150
Estimated costs to completion 135 225
Payments invoiced and received 116 116
Haggrun measures satisfaction of performance obligations based on percentage of work
certified as complete.

FROM THE DESK OF M. JUNAID KHALID 231

Required: Show extracts from the statement of profit or loss and other comprehensive income
and the statement of financial position for each contract, assuming they are both certified as
40% complete

QUESTION 10:
Malik is a construction business, recognizing progress based on work certified as a proportion
of total contract value. Malik will satisfy the performance obligation over time.
The following information relates to one of its long-term contracts as at 31 May 20X4, Malik’s
year-end.
$
Contract price 200,000
Costs incurred to date 130,000
Estimated cost to complete 20,000
Invoiced to customer 120,000
Work certified to date 180,000
In the year to 31 May 20X3 Malik had recognised revenue of $60,000 and profit of $15,000
in respect of this contract.
Required: What profit should appear in Malik’s statement of profit or loss as at 31 May 20X4 in
respect of this contract?
$___________

SELF-PRACTICE QUESTIONS
Question 1:
On 1 January 20X1, Castle entered into a contract with a customer to construct a specialised
building for consideration of $10m. Castle is not able to use the building themselves at any
point during the construction.
At 31 December 20X1, Castle had incurred costs of $6m. Costs to complete are estimated at
$6m. Castle measures progress towards completion based on costs incurred. At 31 December
20X1 Castle had received $3 million from the customer.
Required: Calculate the amount of profit recognized and contract asset/liability?

Question 2:
On 1 January 20X1 Amir entered into a contra ct with a customer to construct a stadium for
consideration of $100m. The contract was expected to take 2 years to complete.
At 31 December 20X1 Amir had incurred costs of $24m. Costs to complete are estimated at
$20m. In addition to these costs, Amir purchased plant to be used on the contract at a cost of
$16m. This plant was purchased on 1 January 20X1 and will have no residual value at the end of
the 2-year contract. Depreciation on the plant is to be allocated on a straight line basis across
the contract. Amir measures progress on contracts using an output method, based

FROM THE DESK OF M. JUNAID KHALID 232

on the value of work certified to date. At 31 December 20X1, the value of the work certified
was $45 million, and the customer had paid $11.4m.
Required: What amount of profit to be recognized in profit & loss and the value of contract
asset and liability?

Question 3:

Question 4:
Merryview specializes in long-term contracts. In each contract Merryview is entitled to receive
payments reflecting the progress of the work, so revenue should be recognised over time.
One of its contracts, with Better Homes, is to build a complex of luxury flats. The price agreed
for the contract is $40 million and its scheduled date of completion is 31 December 20X2.
Details of the contract to 31 March 20X1 are:
Commencement date 1st July 20X0
Contract costs: $000
Architects’ and surveyors’ fees 500
Materials delivered to site 2,800
Direct Labour costs 3,500
Overheads are apportioned at 40% of direct Labour costs
Estimated cost to complete (excluding depreciation – see below) 14,800
Plant and machinery used exclusively on the contract cost $3,600,000 on 1 July 20X0. At the
end of the contract it is expected to be transferred to a different contract at a value of
$600,000. Depreciation is to be based on a time-apportioned basis. Better Homes made a
progress payment of $12,800,000 to Merry view on 31 March 20X1.
At 31 March 20X2 the details for the construction contract have been summarized as:
$000

FROM THE DESK OF M. JUNAID KHALID 233

Contract costs to date (i.e. since the start of the contract) excluding all depreciation 20,400
Estimated cost to complete (excluding depreciation) 6,600
A further progress payment of $16,200,000 was received from Better Homes on 31 March
20X2. Merry view accounts for profit on its construction contracts using the input method,
measured using the percentage of the cost to date compared to the total estimated contract
cost.
Required: Prepare extracts from the financial statements of Merry view reflecting the impact of
the contract with Better Homes for:
(i) the year to 31 March 20X1
(ii) the year to 31 March 20X2.

Question 5:

Question 6:

FROM THE DESK OF M. JUNAID KHALID 234

Question 7:

Question 8:

Question 9:

FROM THE DESK OF M. JUNAID KHALID 235

Question 10:

ANSWERS OF SELF-PRACTICE QUESTIONS:

QUESTIONS ANSWERS
P/L = 2000 O.LOSS, CONTRACT ASSET =
QUESTION 1 2000
P/L = 13000 PROFIT, PPE 8000, CONTRACT
QUESTION 2 ASSET = 33600
QUESTION 3 PROFIT CONTRACT ASSET
J 42000 62
K 16000 76
L 0 20
QUESTION 4 31ST MARCH 20X1 31ST MARCH 20X2
PROFIT 4900 2600
CONTRACT ASSET 1200 1000
PPE 2700 1500
QUESTION 5 P/L = 0.2 PROFIT
QUESTION 6 P/L = 40 LOSS
QUESTION 7 D
QUESTION 8 $3,375,000
QUESTION 9 A
QUESTION 10 B

FROM THE DESK OF M. JUNAID KHALID 236

 IAS 33 – EARNINGS PER SHARE
BASIC EPS
Basic EPS should be calculated by dividing the net profit or loss for the period attributable to
ordinary shareholders by the weighted average number of ordinary shares outstanding during
the period.
Basic EPS = Net profit /(loss) attributable to ordinary shareholders
Weighted average number of ordinary shares outstanding during the period

This should be expressed as cents per share to 1 decimal place.

• Earnings: group profit after tax, less non-controlling interests (see group chapters) and
irredeemable preference share dividends.

• Shares: weighted average number of ordinary shares in issue during the period.
Issue of shares at full market price
Earnings should be apportioned over the weighted average equity share capital (i.e. taking
account of the date any new shares are issued during the year).
QUESTION 1:
An entity, with a year-end of 31 December 20X8, issued 200,000 shares at full market price of
$3 on 1 July 20X8.
Relevant information

20X8 20X7
Profit attributable to the ordinary shareholders for the year ending
31 December $550,000 $460,000

Number of ordinary shares in issue at 31 December 1,000,000 800,000

Required: Calculate the EPS for each of the years.

There are other events, however, which change the number of shares outstanding, without a
corresponding change in resources. In these circumstances it is necessary to make adjustments
so that the current and prior period EPS figures are comparable.
Four such events are considered by IAS 33.
(a) Capitalization or bonus issue (sometimes called a stock dividend)
(b) Bonus element in any other issue, e.g. a rights issue to existing shareholders
(c) Share split
(d) Reverse share split (consolidation of shares)

FROM THE DESK OF M. JUNAID KHALID 237

BONUS ISSUE
A bonus issue (or capitalization issue or scrip issue):
• does not provide additional resources to the issuer
• means that the shareholder owns the same proportion of the business before and after the
issue.
In the calculation of EPS:
o in the current year, the bonus shares are deemed to have been issued at the start of the
year
o comparative figures are restated to allow for the proportional increase in share capital
caused by the bonus issue. Doing this treats the bonus issue as if it had always been in
existence.
Note: If you have an issue of shares at full market price and a bonus issue, you apply a bonus
fraction from the start of the year up to the date of the bonus issue. For example, if the bonus
issue was 1 share for every 5 owned, the bonus fraction would be 6/5 (as everyone who
had 5 shares now has 6).

QUESTION 2:
An entity makes a bonus issue of one new share for every five existing shares held on 1 July
20X8.
20X8 20X7
Profit attributable to the ordinary shareholders for the year ending
31 December $550,000 $460,000
Number of ordinary shares in issue at 31 December 1,200,000 1,000,000
Required: Calculate the EPS in 20X8 accounts.

QUESTION 3:
Greymatter Co had 400,000 shares in issue, until on 30 September 20X2 it made a bonus issue
of 100,000 shares. Calculate the EPS for 20X2 and the corresponding figure for 20X1 if total
earnings were $80,000 in 20X2 and EPS for 20X1 was $0.1875. The company's accounting year
runs from 1 January to 31 December.
Required: Calculate the EPS for 20x1 and 20x2

RIGHTS ISSUE
Rights issues present special problems:
 they contribute additional resources
 they are normally priced below full market price.
Therefore, they combine the characteristics of issues at full market price and bonus issues, and
the calculation of shares in issue reflects this

FROM THE DESK OF M. JUNAID KHALID 238

 1) adjust for bonus element in rights issue, by multiplying capital in issue before the rights
issue by the following fraction:
Market price before issue
Theoretical ex rights price
2) calculate the weighted average capital in the issue as above. Calculating EPS when there
has been a rights issue can be done using a four step process:

Step 1 – Calculate theoretical ex-rights price (TERP)

Step 2 – Bonus fraction
Step 3 – Weighted average number of shares (the bonus fraction would be applied from the
start of the year up to the date of the rights issue, but not afterwards.)
Step 4 – Earnings per share (EPS)

NOTE: It is important to note that if you are asked to restate the prior year EPS, then this is
simply the prior year's EPS multiplied by the inverse of the bonus fraction. This calculation
effectively increases the number of shares in the previous year's calculation.

QUESTION 4:
An entity issued one new share for every two existing shares held by way of a rights issue at
$1.50 per share on 1 July 20X8. Pre-issue market price was $3 per share.
Relevant information
20X8 20X7
Profit attributable to the ordinary shareholders for the year ending 31 December $550,000 $460,000
Number of ordinary shares in issue at 31 December 1,200,000 800,000

Required: Calculate the EPS for 20x8 and 20x7

QUESTION 5:
On 31 December 20X1, the issued share capital consisted of 4,000,000 ordinary shares of 25¢
each. On 1 July 20X2 the entity made a rights issue in the proportion of 1 for 4 at 50¢ per share
and the shares were quoted immediately before the issue at $1. Its trading results for the last
two years were as follows:
Year ended 31 December
20X2 20X1
$ $
Profit after tax 425,000 320,000

Required: Show the calculation of basic EPS to be presented in the financial statements for the
year ended 31 December 20X2 (including comparative).

FROM THE DESK OF M. JUNAID KHALID 239

DILUTED EARNINGS PER SHARE (DEPS)
Equity share capital may increase in the future due to circumstances which exist now. When it
occurs, this increase in shares will reduce, or dilute, the earnings per share. The provision of a
diluted EPS figure attempts to alert shareholders to the potential impact on EPS of these
additional shares.
Examples of dilutive factors are:
a) The conversion terms for convertible bonds/convertible loans etc.
b) the exercise price for options and the subscription price for warrants.

Basic principles of calculation

To deal with potential ordinary shares, adjust the basic earnings and number of shares
assuming convertibles, options, etc. had converted to equity shares on the first day of the
accounting period, or on the date of issue, if later.

DEPS is calculated as follows:

Earnings + notional extra earnings
Number of shares + notional extra shares

Convertible instruments
The principles of convertible bonds and convertible preference shares are similar and will be
dealt with together.
If the convertible bonds/preference shares had been converted:
 The interest/dividend would be saved therefore earnings would be higher
 The additional earnings would be subject to tax
 The number of shares would increase.
Diluted EPS is calculated as follows.
Step 1 -- Number of shares
Step 2 – Calculate total Earnings
Step 3 -- Calculation: Diluted EPS
Step 4 – Dilution= EPS – DEPS

QUESTION 6:
In 20X7 Farrah Co had a basic EPS of $1.05 based on earnings of $105,000 and 100,000 ordinary
$1 shares. It also had in issue $40,000 15% convertible loan stock which is convertible in two
years' time at the rate of 4 ordinary shares for every $5 of stock. The rate of tax is 30%.
Required: Calculate the diluted EPS.

FROM THE DESK OF M. JUNAID KHALID 240

QUESTION 7:
Ardent Co has 5,000,000 ordinary shares of 25 cents each in issue, and also had in issue in 20X4:
a) $1,000,000 of 14% convertible loan stock, convertible in three years' time at the rate of
two shares per $10 of stock
b) $2,000,000 of 10% convertible loan stock, convertible in one year's time at the rate of
three shares per $5 of stock
The total earnings in 20X4 were $1,750,000.
The rate of income tax is 35%.
Required: Calculate the basic EPS and diluted EPS.
Note. The calculation of DEPS should always be based on the maximum number of shares that can be issued. For
instance, if the 14% loan stock above had the following conversion rights.
20X5: 4 shares per $10
20X6: 3 shares per $10
20X7: 2 shares per $10
DEPS would be calculated at 4 shares per $10.

OPTION SHARES:
An option or warrant gives the holder the right to buy shares at some time in the future at a
predetermined price.

QUESTION 8:
On 1 January 20X7, a company has 4 million ordinary shares in issue and issues options for a
further million shares. The profit for the year is $500,000.
During the year to 31 December 20X7 the average fair value of one ordinary share was $3 and
the exercise price for the shares under option was $2.
Required: Calculate basic EPS and DEPS for the year ended 31 December 20X7.

QUESTION 9:
A company had 8.28 million shares in issue at the start of the year and made no issue of shares
during the year ended 31 December 20X4, but on that date there were outstanding options to
purchase 920,000 ordinary $1 shares at $1.70 per share. The average fair value of ordinary
shares was $1.80. Earnings for the year ended 31 December 20X4 were $2,208,000.
Required: Calculate the diluted earnings per share for the year ended 31 December 20X4.

QUESTION 10:
On 1 October 20X3, Hoy had $2.5 million of equity shares of 50 cents each in issue. No new
shares were issued during the year ended 30 September 20X4, but on that date there were
outstanding share options to purchase 2 million equity shares at $1.20 each. The average
market value of Hoy’s equity shares during the year was $3 per share. Hoy’s profit after tax for
the year ended 30 September 20X4 was $1,550,000.

FROM THE DESK OF M. JUNAID KHALID 241

Required: What is Hoy’s diluted earnings per share for the year ended 30 September 20X4?

The importance of EPS

The EPS figure is used to compute the major stock market indicator of performance, the price
earnings ratio (P/E ratio). The calculation is as follows:
P/E ratio = Market value of share
EPS

BPP KIT QUESTIONS: 184 – 190 KAPLAN KIT QUESTIONS: 119 – 128, 301 – 305

FROM THE DESK OF M. JUNAID KHALID 242

 INTERPRETATION OF FINANCIAL STATEMENT / RATIOS
USERS OF FINANCIAL STATEMENTS
When interpreting financial statements, it is important to identify the users of financial
statements and the information they need:
o Shareholders and potential investors – primarily concerned with receiving an adequate
return on their investment, but it must at least provide security and liquidity
o Suppliers and lenders – concerned with the security of their debt or loan
o Management – concerned with the trend and level of profits, since this is the main
measure of their success.
Other potential users include:
o bank managers
o financial institutions
o employees
o professional advisors to investors
o financial journalists and commentators.

There are three broad areas on which analysis can be done:

i. Performance of the company
ii. Position of the company
iii. Investor perspective
Tip: Increase in numerator will increase the ratio & increase in denominator will reduce the
ratio
GROSS PROFIT MARGIN (GP MARGIN -- %)
1) GP margin may increase or decrease because of change in selling price due to increased
competition
2) GP margin may change because of sales mix
3) GP margin may decrease because of new product promotion or launching of new
product
4) Possible ways to increase gross profit margin are as follows;
a. Increase sales price
b. Reduce cost of production or cost of sales
NET PROFIT MARGIN/ OPERATING PROFIT MARGIN (NP MARGIN -- %)
1) Must consider that NP margin is changing in line with GP margin and sales revenue
2) Major reduction in NP margin may because of unusual expenditures like penalties or
redundancies

FROM THE DESK OF M. JUNAID KHALID 243

 3) Must evaluate the scenario if there is any situation that future distribution and admin
cost will increase because of current strategies (e.g. higher distribution cost for online
orders)
4) Possible way to increase net profit margin is as follows;
a. Reduce admin/ distribution/ operational cost where possible

ASSET TURNOVER (ASSET TURNOVER – TIMES)

1) Increase in asset turnover might indicate that entity is focusing more on sales volume at
low profit margin
2) Low asset turnover might indicate luxury goods
3) Sales mix might affect asset turnover ratio
4) Possible ways to increase asset turnover ratio are as follows
a. Reduce selling price
b. Aggressive marketing
c. Discounts on bulk purchases
RETURN ON CAPITAL EMPLOYED (ROCE -- %)
1) Lower ROCE indicate poor performance of entity but this might not be the case all the
time as lower ROCE may because company recorded their assets at revalued amount
(R/S)
2) Higher ROCE may because of higher profit margin or high asset turnover as ROCE is the
product of profit margin and asset turnover
3) ROCE may be compared with previous year ROCE, borrowing cost and other entities in
same industry
CURRENT RATIO (CR – 1.5:1)
1) Ideal/ safe current ratio is 1.5:1
2) Too much higher CR may indicate following problems;
a. Collection problems in A/R that may lead to bad debt
b. Inventory stock is increasing this may be because of slow moving items
3) Reason / consequences of lower CR
a. Company may face issue if long term debts become due
b. Company might have availed overdraft facility
c. Higher interest rates/expenses indicate higher borrowings and hence lower CR
d. Lower CR create issues for bills payment and supplier’s payments
QUICK RATIO (CR – 0.8:1)
1) Ideal quick ratio is 0.8:1
2) Higher quick ratio might indicate the following;
a. Collection problems in A/R that may lead to bad debt

FROM THE DESK OF M. JUNAID KHALID 244

 b. Tangible asset or investment disposed of during the year
c. Share transactions
d. Borrowed long term debts
3) Lower quick ratio may indicate problems in short term liabilities. Although this will not
create problem if company have overdraft facility available

OVERTRADING
Overtrading often occurs when companies expand their own operations too quickly
(aggressively). Overtraded companies enter a negative cycle, where an increase in interest
expenses negatively impacts the net profit, which leads to lesser working capital, and that leads
to increased borrowings, which in turn leads to interest expenses and the cycle continues.
Overtraded companies eventually face liquidity problems and can run out of working capital.
Overtrading arises where a company expands its sales revenue rapidly without securing
adequate long-term capital for its needs. The symptoms of overtrading are:
i. Inventory increasing, possibly more than proportionately to revenue
ii. Receivables increasing, possibly more than proportionately to revenue
iii. Cash and liquid assets declining
iv. Trade payables increasing rapidly.
A/R TURNOVER & A/R DAYS RATIO (AT/AD – IN TIMES/ IN DAYS)
1) Higher A/R turnover and lower days indicate efficiency in collection of credit sales
2) Sometimes it is also possible that company has finance issue and therefore factored
accounts receivables which resulted lower days and high turnover
3) Lower A/R turnover and higher days may because of;
a. Policy to attract more trade and customers
b. Customers might be in financial difficulties
c. Might have some disputes over invoices
4) To improve turnover and days company might offer early payment cash discount

INVENTORY TURNOVER & INVENTORY DAYS RATIO (IN TIMES/ IN DAYS)

1) Higher inventory turnover and lower days indicate efficient working capital
management or inventory management
2) Inventory turnover can be improved by lower inventory level this will also result in
lower days
3) But care should be taken lower inventory level might cause “stock outs”
4) Higher inventory days might indicate the following;
a. Slowdown in trading
b. Buying inventories in bulk to avail discounts
c. Build up inventory level that raw material prices will rise

FROM THE DESK OF M. JUNAID KHALID 245

 d. Supplier is unreliable
e. Increase in cost of storage
ACCOUNTS PAYABLE TURNOVER & ACCOUNTS PAYABLE DAYS RATIO (IN TIMES/ IN DAYS)
1) Lower A/P turnover or higher days is favorable as company delaying payments to
creditors till the last possible days to shorten its cash conversion cycle
2) However, this may also suggest that company might face some difficulty in paying
suppliers
3) Higher days may cause following disadvantage;
a. Poor reputation as slow payer may not be able to find new suppliers (negative
credit rating)
b. Existing supplier may discontinue
c. Company might be losing early payment discounts

WORKING CAPITAL DAYS = AR DAYS + INVENTORY DAYS – AP DAYS

STEPS TO IMPROVE WORKING CAPITAL DAYS:

1) Speedup collection process, offer early payment discounts if feasible
2) Speedup production process or lower inventory level
3) Delay supplier’s payment if possible
GEARING & LEVERAGE RATIO/ DEBT TO EQUITY RATIO (%)
1) High gearing indicated company relying more on external lenders
2) This will also result in high interest expense
3) More than 50% is highly geared
4) Company can reduce gearing by issuing shares
5) High gearing will cause following problems;
a. Greater risk of insolvency
b. Low return will be given to shareholders as high interest is paid
c. Will also cause problem in future borrowings
6) High gearing is suitable for;
a. Companies having stable profits to pay high interest
b. Company having suitable assets for security/pledge. An entity with most of its
capital invested in fast-depreciating assets or inventory subject to rapid changes
in demand and price would not be suitable for high gearing.
c. Entities not suited to high gearing would include those in the extractive, and
high-tech, industries where constant changes occur. These entities could
experience erratic profits and would generally have inadequate assets to pledge
as security.

FROM THE DESK OF M. JUNAID KHALID 246

INTEREST COVER RATIO (TIMES)
1) Higher value of times interest earned ratio is favorable meaning greater ability of a
business to repay its interest and debt
2) Ideal interest cover ratio is 3 times
3) Low interest cover may cause difficulty in borrowing
4) Low interest cover may cause a difficulty to pay dividend to its shareholders as most of
the profit is eaten up by interest payment
EARNING PER SHARES (EPS -- $)
1) A higher EPS means a company is profitable enough to pay out more money to its
shareholders. For example, a company might increase its dividend as earnings increase
over time
2) A company with a steadily increasing EPS is considered to be a more reliable investment
than one whose EPS is on the decline or varies substantially

PRICE EARNING (P/E -- $)

1) Represents the market’s view of the future prospects of the share
2) High P/E suggests that high growth is expected
3) A high P/E ratio could mean that a company's stock is over-valued, or else that investors
are expecting high growth rates in the future
4) Companies that have no earnings or that are losing money do not have a P/E ratio since
there is nothing to put in the denominator
DIVIDEND YIELD (%)

1) Dividend yield is the amount of money a company pays shareholders for owning a share
of its stock divided by its current stock price.
2) Higher dividend yield is favorable
3) Higher dividend yields do not always indicate attractive investment opportunities
because the dividend yield of a stock may be elevated as the result of a declining stock
price as denominator will reduce will lead to increase in ratio

DIVIDEND COVER (TIMES)

Generally, a dividend covers of 2 or more is considered a safe coverage, as it allows the
company to safely pay out dividends and still allow for reinvestment or the possibility of a
downturn. A low dividend cover can make it impossible to pay the same level of dividends in a
bad year's trading or to invest in company growth.
LIMITATIONS OF FINANCIAL STATEMENTS
Ratios are a tool to assist analysis.

FROM THE DESK OF M. JUNAID KHALID 247

  They help to focus attention systematically on important areas and summarise
information in an understandable form.
 They assist in identifying trends and relationships.
However, ratios are not predictive if they are based on historical information.
 They ignore future action by management.
 They can be manipulated by window dressing or creative accounting.
 They may be distorted by differences in accounting policies. E.g. IAS 16 and IAS 40
Historical cost accounts
Asset values shown in the statement of financial position at historical cost may bear no
resemblance to their current value or what it may cost to replace them.
This may result in a low depreciation charge and overstatement of profit in real terms. As a
result of historical costs the financial statements do not show the real cost of using the non-
current assets.
Window dressing
Window dressing is a method of carrying out transactions in order to distort the position shown
by the financial statements and generally improve the position shown by them. Examples of
window dressing include:
o A company might chase receivables more quickly at the year end to improve their bank
balance;
o A company may change its depreciation estimate i.e. by increasing the expected useful
economic life of an asset, the depreciation charge will be smaller resulting in increased
profits; and
o An existing loan may be repaid immediately before the year end and then taken out
again in the next financial year.

Transactions with related parties

If an entity trades with related parties, such as other entities within the same group or other
entities run by the same directors,
o Then these transactions may not be at market price.
o This can involve items such as purchase or sale transactions at rates other than market
value or loans carrying interest rates not at market value.
The impact of these transactions on the entity must be assessed to give a fair comparison with
other entities, and to show the position if the entity was removed from the group and no longer
enjoyed the benefit of such transactions.
Seasonal trading
Ratio analysis can be distorted when a company has seasonal trading. For example, a company may
position their year-end to be after a particularly busy period. Suppliers are paid soon after the
season has ended and inventory levels are lower than usual. During the peak season have shown
more sales revenue. In comparison if the financial statements had been drawn up at a different
period in time then the results could appear quite different.

FROM THE DESK OF M. JUNAID KHALID 248

LIMITATIONS OF RATIO ANALYSIS
o Companies having ratios less than ideal ratios may still be acceptable
o Uniform data should be used for ratio analysis
o Companies may select the accounting year end in which they could improve their financial
position like seasonal trading. E.g. Christmas
o Impact of inflation may increase profit
o Focus on financial information rather than non-financial information like number of units
ordered

SPECIALISED, NOT-FOR-PROFIT AND PUBLIC SECTOR ORGANISATIONS

Not-for-profit and public sector organisations cover a range of entities, such as charities,
schools, healthcare providers and government departments. Their main focus will to be to
achieve certain objectives rather than make a profit. For example, a school's primary aim may
relate to exam pass rates. While their aim may not be to make a profit, there are many
accounting standards which would still be relevant, such as IAS 16 Property, Plant and
Equipment, IAS 20 Government Grants and IFRS 16 Leases.

As profit and return are not so meaningful, many ratios will have little importance in these
organisations, for example:
o ROCE
o Gearing
o Investor ratios in general.
However, such organisations must also keep control of income and costs Therefore, other ratios
will still be important, such as working capital ratios.

INTERPRETATION OF CONSOLIDATED FINANCIAL STATEMENTS

Subsidiary acquired during the year:
o This will not have a full year's results from the subsidiary, as the results will only be
consolidated from the date of acquisition
o Margins will be affected as the newly acquired subsidiary is likely to have different
margins to the rest of the group
o Working capital ratios may also be affected adversely as the ratio uses the year-end
assets or liabilities, but the income/expenses included may be time-apportioned in the
statement of profit or loss. For example, a subsidiary with revenue for the year of
$1,000,000 and closing receivables of $90,000 would have a receivables collection
period of 33 days in its individual financial statements (90,000/1,000,000 × 365). If this
had been acquired exactly halfway through the year, only $500,000 revenue would be
included within the consolidated statement of profit or loss, with the full $90,000 of
receivables included in the consolidated statement of financial position. This would

FROM THE DESK OF M. JUNAID KHALID 249

 effectively give a receivables collection period of 66 days (90,000/500,000 × 365), giving
a distorted picture.
o Return on capital employed and net asset turnover may decrease as the subsidiary's
profit will be time apportioned, but any debt held by the subsidiary will be included in
full at the reporting date (see the statement of financial position below).

FORMULA SHEET

GROSS PROFIT MARGIN

Gross Profit
Revenue/Net sales

NET PROFIT MARGIN

Net Income
Revenue/Net Sales

ASSET TURNOVER
SALES
CAPITAL EMPLOYED

RETURN ON CAPITAL EMPLOYED

PBIT
CAPITAL EMPLOYED

CURRENT RATIO

QUICK RATIO

FROM THE DESK OF M. JUNAID KHALID 250

ACCOUNTS RECEIVABLE TURNOVER RATIO

Revenues /Credit Sales

Accounts Receivable

INVENTORY TURNOVER RATIO

Cost of goods sold

Inventory

ACCOUNTS PAYABLE TURNOVER

Purchases/cogs
Trade payables

GEARING RATIO/ DEBT TO EQUITY RATIO

Total Long term debt

Shareholders' Equity + Total long term debt

LEVERAGE RATIO

SHAREHOLDER'S EQUITY
SHAREHOLDER'S EQUITY + TOTAL LONG TERM DEBT

INTEREST COVER RATIO

Earnings before Interest and Tax

Interest Expense

EARNING PER SHARE

Net Profit -- Preference Dividend
No of Equity Shares

FROM THE DESK OF M. JUNAID KHALID 251

PRICE EARNING PER SHARE
Current share price
Latest EPS
DIVIDEND YIELD RATIO
Dividend per share
Current share price
DIVIDEND COVER RATIO
Profit after tax
Dividends

FROM THE DESK OF M. JUNAID KHALID 252

ILLUSTRATION 1:

FROM THE DESK OF M. JUNAID KHALID 253

FROM THE DESK OF M. JUNAID KHALID 254
Required: Calculate gross profit margin, net profit margin, asset turnover and ROCE and also
comment on these ratios

FROM THE DESK OF M. JUNAID KHALID 255

ILLUSTRATION 2:
ILLUSTRATION:

380

FROM THE DESK OF M. JUNAID KHALID 256

FROM THE DESK OF M. JUNAID KHALID 257
FROM THE DESK OF M. JUNAID KHALID 258
FROM THE DESK OF M. JUNAID KHALID 259
ILLUSTRATION 3:

FROM THE DESK OF M. JUNAID KHALID 260

FROM THE DESK OF M. JUNAID KHALID 261
 INTANGIBLE NON-CURRENT ASSETS (IAS 38)
 DEFINITION OF INTANGIBLE ASSETS:
An intangible asset is an identifiable (separable/must arise from legal or contractual right)
non-monetary asset without physical substance. The asset must be;
 Controlled by the entity as a result of past event; and
 It is expected that future benefit will flow to the entity
 EXAMPLES OF INTANGIBLE ASSETS:
Following are the examples intangible assets;
 Licenses
 Intellectual property
 Trade marks
 Software
 Patents
 Copyright
 Motion picture films
 Customer lists
 Franchise
Purchased intangible assets
If an intangible asset is purchased separately (such as a license, patent, brand name), it should
be recognised initially at cost.

Measurement after initial recognition

There is a choice between:
 The cost model
 The revaluation model.
The cost model
o The intangible asset should be carried at cost less amortization and any impairment
losses.
o This model is more commonly used in practice.
Amortization works the same as depreciation. The intangible asset is amortized over the useful
life, with the annual expense being shown in the statement of profit or loss each year.
 An intangible asset with a finite useful life must be amortized over that life, normally
using the straight-line method with a zero residual value.
 An intangible asset with an indefinite useful life:
o Should not be amortized
o Should be tested for impairment annually, and more often if there is an actual
indication of possible impairment.

FROM THE DESK OF M. JUNAID KHALID 262

The revaluation model
o The intangible asset may be revalued to a carrying amount of fair value less subsequent
amortization and impairment losses.
o Whole class of intangible shall be revalued
o Fair value should be determined by reference to an active market.
Internally-generated intangible assets
Generally, internally-generated intangible assets cannot be capitalised, as the costs associated
with these cannot be identified separately from the costs associated with running the business.
The following internally-generated items may never be recognised:
o goodwill ('inherent goodwill')
o brands
o mastheads
o publishing titles
o customer lists
Note: Staff training or staff shall not be recognized as an asset because they are not controlled
by an entity and their cost cannot be measured reliably.
Goodwill
Goodwill is defined as 'an asset representing the future economic benefits arising from assets
acquired in a business combination that are not individually identified and separately
recognised' (IFRS 3, Appendix A).
Negative goodwill (gain on a bargain purchase) is treated as income, as the purchaser has paid
less than the fair value of the identifiable net assets.
Accounting for non-purchased goodwill
Non-purchased goodwill should not be recognised in the financial statements. It certainly exists,
but fails to satisfy the recognition criteria in the Framework, since it is not capable of being
measured reliably.

RESEARCH AND DEVELOPMENT:

The relationship between the research and development costs and the economic benefit
expected to derive from them will determine the allocation of those to different periods.
Recognition of the cost as an asset will only occur where it is probable that the cost will
produce future benefits for the entity and cost can be measured reliably.
o In the case of research cost, this will not be the case due to uncertainty about the
resulting benefits from them. So they should be expensed in the period in which
they arose.
o Development activities tend to be much further advanced than the research stage
and so it may be possible to determine the likelihood of future economic benefit,
where this can be determined, and the development costs should be carried forward
as an asset.

FROM THE DESK OF M. JUNAID KHALID 263

 RESEARCH COSTS:
“Research is original and planned investigation undertaken with the prospect of gaining
new scientific or technical knowledge and understanding.”
Research costs should be recognized as an expense in the period in which they are
incurred. They should not be recognized as an asset.

 EXAMPLES OF RESEARCH COSTS:

Following are the examples of research cost given by the IAS 38;
o Activities aimed at obtaining new knowledge
o The search for application of research findings or their knowledge
o The search for product or process alternatives
o The formulation and design of possible new or improved product or process
alternatives

 DEVELOPMENT COSTS:
“Development is the application of research findings or other knowledge to a plan or design
for the production of new or substantially improved materials, devices, products,
processes, systems or services prior to the commencement of commercial production or
use.”
Development expenditure must be recognized as an intangible asset (sometimes called
“deferred development expenditure”) if, and only if, the business can demonstrate all of the
criteria mentioned in IAS 38.

 EXAMPLES OF DEVELOPMENT COSTS:

Following are the examples of development costs given by the IAS 38;
o The design, construction and testing of pre-production prototypes and models
o The design of tools, jigs, moulds and dies involving new technology
o The design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production
o The design, construction and testing of a chosen alternative for new/improved
materials

FROM THE DESK OF M. JUNAID KHALID 264

 RECOGNITION CRITERIA FOR THE DEVELOPMENT EXPENDITURE
As per IAS 38 development expenditure shall be recognized as an intangible asset if the
following criteria are met.
 P - How the intangible asset will generate probable future economic benefits. (This
is demonstrated by the existence of an external market or by how the asset will be
useful to the business if it is to be used internally.
 I - Its intention to complete the intangible asset and use or sell it
 R - The availability of adequate technical, financial and other resources to complete
the development and to use or sell the intangible asset
 A - Its ability to use or sell the intangible asset
 T - The technical feasibility of completing the intangible asset so that it will be
available for use or sell
 E - Its ability to measure reliability the expenditure attributable to the intangible
asset during its development
Note: The amount of development cost should not exceed the amount of the future economic
benefits.
 SUMMARY FOR THE RECOGNITION OF DEVELOPMENT COSTS:
As per IAS 38 the recognition of an item as an intangible asset require an entity to
demonstrate that the item meets;
 The definition of an intangible asset
 The recognition criteria

 COMPONENTS OF RESEARCH AND DEVELOPMENT COST:

Research and development cost will include all costs that are directly attributable to
research and development activities, or that can be allocated on a reasonable basis.
 Salaries and wages and other employment related cost of personnel engaged in
R&D activities. Staff training cost should not be recognized as staff is uncontrollable
and its value cannot be reliably measured
 Costs of materials and services consumed in R&D activities.
 Depreciation of property, plant and equipment to the extent that these assets are
used for R&D activities.
 Overhead costs, other than general and admin overheads
 Other cost such as amortization of patents and licenses, to the extent that these
assets are used in R&D activities.

FROM THE DESK OF M. JUNAID KHALID 265

AMORTIZATION OF DEVELOPMENT COST:
Once capitalized as an asset, development cost must be amortized and recognized as an
expense. The amortization will begin when asset is available for use and it has a finite useful
life.
DISCLOSURE OF INTANGIBLE ASSETS IN FINANCIAL STATEMENT:

The financial statement should show a reconciliation of the carrying amount of intangible assets
at the beginning and at the end of the period. The reconciliation should show the movement on
intangible assets including:

 Addition
 Disposals
 Reduction in carrying amount
 Amortization
 Any other movement

DEVELOPMENT
TOTAL PATENTS
COST

COST
AT 1 JANUARY 2004 40,000 30,000 10,000
ADDITIONS IN YEAR 19,000 15,000 4,000
DISPOSALS IN YEAR (1,000) - (1,000)
AT 31 DECEMBER 2004 58,000 45,000 13,000
AMORTIZATION
AT 1 JANUARY 2004 11,000 5,000 6,000
CHARGE FOR YEAR 4,000 1,000 3,000
AT 31 DECEMBER 2004 15,000 6,000 9,000
CARRYING AMOUNT
AT 31 DECEMBER 2004 43,000 39,000 4,000
AT 1 JANUARY 2004 29,000 25,000 4,000

As well as the reconciliation above, the financial statements should also disclose the following:

e) Accounting policies for intangible assets should be disclosed

f) For each class of intangible assets (including development costs), disclosure is required
for the following:
a. The method of amortization used

FROM THE DESK OF M. JUNAID KHALID 266

 b. Useful life of the intangible assets or the amortization rate
c. The gross carrying amount, the accumulated amortization and the accumulated
impairment losses as at the beginning and the end of the period

QUESTION 1:
Project A -- ($ 280,000)
New flame-proof padding: Expected total cost $400,000 to complete development. Expected
total revenue $2000,000 once work completed – probably late 2006. Customers already placed
orders for the material after seeing demonstrations of its capabilities earlier in the year.

Project B – ($150,000)
New colour – fast dye: Expected to cost a total of $3000,000 to complete. The dye is being
developed as a cheaper replacement for a dye already used in Y Co’s most successful product,
cost saving of over $10,000,000 are expected from its use. Although Y has demonstrated that
the dye is a viable product, and has the intention to finish developing it, the completion date is
currently uncertain because external funding will have to be obtained before the development
work can be completed.
Project C – ($110,000)
Investigation of new adhesive recently developed in aerospace industry. If this proves effective
then Y Co. may well generate significant income because it will be used in place of existing
adhesives.
REQUIRED:
Explain how the three researches project A, B and C will be dealt with in Y Co’s statement of
profit and loss and statement of financial position.

Question 2
When does amortisation of an intangible asset commence?
 When the asset is substantially complete
 When the asset is available for use
 When management determine
 At the start of the accounting period

Question 3
Research costs may be recorded as an intangible asset.
 True
 False

FROM THE DESK OF M. JUNAID KHALID 267

Question 4
Big Limited has spent $100,000 developing a software product, which is obsolete before
it reaches the market.
May Big Limited recognise the $100,000 expense as an intangible asset?
 Yes
 No

Question 5
An intangible asset with a finite useful life should be amortised over…
 Its expected useful life
 A period determined by management
 Five years
 No foreseeable limit

Question 6
What are intangible assets?
 Monetary assets without physical substance
 Monetary assets with physical substance
 Non-monetary assets without physical substance
 Non-monetary assets with physical substance

PRACTICE QUESTION

FROM THE DESK OF M. JUNAID KHALID 268

FROM THE DESK OF M. JUNAID KHALID 269
Answers:

BPP KIT QUESTIONS: 33 –37, 62 – 66

KAPLAN KIT QUESTIONS: 17 – 24, 241 – 245

FROM THE DESK OF M. JUNAID KHALID 270

 IAS 41 – AGRICULTURE
Scope of IAS 41
IAS 41 Agriculture relates to Biological assets, government grants and agricultural produce at
the point of harvest. Products which are the result of processing after harvest will be dealt with
under IAS 2 Inventories, or other applicable standards.
IAS 41 does not apply to:
 the harvested agricultural product (IAS 2Inventory applies);
 land relating to the agricultural activity (IAS 16 or IAS 40 applies);
 bearer plants related to agricultural activity (however, IAS 41 does apply to the produce
on those bearer plants).
 intangible assets related to agricultural activity (IAS 38 Intangible assets applies).
Agricultural activities – The management by an entity of the biological transformation and
harvest of biological assets:
a) for sale; or
b) Into agricultural produce; or
c) Into additional biological assets.

Biological asset – a living animal or plant, such as sheep, cows, plants, trees and so on.
Biological transformation means the processes of growth, production, degeneration and
procreation that cause changes in the quality or the quantity of a biological asset
Agricultural produce is the harvested product of the entity’s biological assets.

Harvest – the detachment of produce from a biological asset or the cessation of a biological
asset’s life. A bearer plant is a living plant that:

a) is used in the production or supply of agricultural produce;

b) is expected to bear produce for more than one period; and
c) has a remote likelihood of being sold as agricultural produce, except for incidental scrap
sales?
Illustration:
o A farmer has a field of lambs (‘biological assets’).
o As the lambs grow they go through biological transformation.
o As sheep they are able to procreate and lambs will be born (additional biological assets)
and the wool from the sheep provides a source of revenue for the farmer (‘agricultural
produce’).
o Once the wool has been sheared from the sheep (‘harvested’), IAS 2 requires that it be
accounted for as regular inventory.

FROM THE DESK OF M. JUNAID KHALID 271

Biological assets
A biological asset is a living animal or plant. A biological asset should be recognised if:
 It is probable that economic benefits will flow to the entity
 The cost or fair value of the asset can be reliably measured, and
 The entity controls the asset.
Recognition and measurement
Initial measurement is at:
 Fair value less any estimated 'point of sale' costs
 If there is no fair value, then the cost model should be used for both biological asset and
agriculture produce
Point of sale includes: Commission to brokers, taxes on animal etc.
Subsequent measurement:
Revalue to fair value less point of sale costs at year-end, taking any gain or loss to the
statement of profit or loss agriculture produce after produce has been harvested, IAS 41 ceases
to apply.

FROM THE DESK OF M. JUNAID KHALID 272

Bearer plants
Bearer plants are accounted for under IAS 16 Property, Plant and Equipment, rather than IAS 41
Agriculture. A bearer plant is a living plant that
 is used in the production or supply of agricultural produce;
 is expected to bear fruit for more than one period; and
 It has a remote likelihood of being sold as agricultural produce, except for incidental
scrap sales.
 Therefore, items such as vines, tea bushes and fruit trees may be classed as bearer
plants and treated as property, plant and equipment rather than being accounted for
under the provisions of IAS 41 Agriculture.

QUESTION 1:
Jacs owned a one-year-old herd of cattle on 1 January 20X6, recognised in the financial
statements at $140,000. At 31 December 20X6, the fair value of a two-year-old herd of cattle is
$170,000. Costs to sell are estimated to be $5,000.
What is the correct accounting treatment for the cattle at 31 December 20X6 according to IAS
41 Agriculture?
a) Revalue to $165,000, taking gain of $25,000 to other comprehensive income
b) Revalue to $165,000, taking gain of $25,000 to the statement of profit or loss
c) Revalue to $170,000, taking gain of $30,000 to other comprehensive income
d) Revalue to $170,000, taking gain of $30,000 to the statement of profit or loss
QUESTION 2:
A herd of five 4 year-old pigs was held on 1 January 20X3. On 1 July 20X3 a 4.5-year-old pig was
purchased for $212. The fair values less estimated point of sale costs was:
 4-year-old pig at 1 January 20X3 $200
 4.5-year-old pig at 1 July 20X3 $212
 5-year-old pig at 31 December 20X3 $230
Required:
Calculate the amount that will be taken to the statement of profit or loss for the year ended 31
December 20X3.
QUESTION 3:

FROM THE DESK OF M. JUNAID KHALID 273

QUESTION 4:
McDonald operates a dairy farm. At 1 January 20X1, he owns 100 cows worth $1,000 each on
the local market. At 31 December 20X1, he owns 105 cows worth $1,100 each. During 20X1 he
sold 40,000 gallons of milk at an average price of $5 a gallon. When cows are sold at the local
market, the auctioneer charges a commission of 4%.
Required: Show extracts from the financial statements for 20X1 for these activities, assuming
that no cows were purchased or sold during the year.

QUESTION 5:

Government grants and biological assets

Government grants
IAS 41 applies to government grants related to a biological asset.
 Unconditional government grants received in respect of biological assets measured at
fair value are reported as income when the grant becomes receivable.
 If such a grant is conditional (including where the grant requires an entity not to engage
in certain agricultural activity), the entity recognizes it as income only when the
conditions have been met.

BPP KIT 126 –128

KAPLAN KIT 69,74,75

FROM THE DESK OF M. JUNAID KHALID 274

 IAS 8 -- Accounting Policies, Changes in Accounting Estimates
And Prior Period Errors
ACCOUNTING POLICIES:
Accounting policies are the specific principles, bases, conventions, rules and practices applied
by an entity in preparing and presenting financial statements' (IAS 8, para 5)

Examples of policies:
IAS 7 DIRECT OR INDIRECT
IAS 16 COST AND REVALUATION MODEL
IAS 40 FAIR VALUE AND COST MODEL
IAS 2 FIFO AND AVCO MEASUREMENT

CHANGES IN ACCOUNTING POLICIES:

IAS 8 requires accounting policies to be changed 'only if the change:

o is required by an IFRS Standard or

o results in the financial statements providing reliable and more relevant information' (IAS 8, para
14).

A change in accounting policy occurs if there has been a change in:

o recognition, e.g. an expense is now recognised rather than an asset –e.g. borrowing cost
o presentation, e.g. depreciation is now included in cost of sales rather than administrative
expenses, or
o measurement basis, e.g. stating assets at replacement cost rather than historical cost.

ACCOUNTING FOR A CHANGE IN ACCOUNTING POLICY

The required accounting treatment is that:

o the change should be applied retrospectively, with an adjustment to the opening balance of
retained earnings in the statement of changes in equity
o comparative information should be restated unless it is impracticable to do so
o if the adjustment to opening retained earnings cannot be reasonably determined, the change
should be adjusted prospectively, i.e. included in the current period’s statement of profit or loss.
o If new accounting policy is adopted, then such adoption of new policy is not considered in
change in policy

FROM THE DESK OF M. JUNAID KHALID 275

DISCLOSURE
Certain disclosures are required when change in accounting policy has material effect
a) Reason for change/ nature of change
b) Reason why new policy provides more relevant/reliable information
c) Amount of the adjustment for the current period and for each period presented
d) The fact that comparative information has been restated or that it is impracticable to do
ACCOUNTING ESTIMATES
An accounting estimate is a method adopted by an entity to arrive at estimated amounts for
the financial statements. Most figures in the financial statements require some estimation:
o the exercise of judgement based on the latest information available at the time
o at a later date, estimates may have to be revised as a result of the availability of new
information, more experience or subsequent developments.

EXAMPLES OF ESTIMATES

 the useful lives of non-current assets

 the residual values of non-current assets
 provision for doubtful debt
 the method of depreciating non-current assets
 warranty provisions, based upon more up-to-date information about claims frequency
and value.

CHANGES IN ACCOUNTING ESTIMATES

The requirements of IAS 8 are:

• The effects of a change in accounting estimate should be included in the statement of profit or loss in
the period of the change (bad debt provision) and, if subsequent periods are affected, in those
subsequent periods (change in life).

• The effects of the change should be included in the same income or expense classification as was used
for the original estimate.

• If the effect of the change is material, its nature and amount must be disclosed.

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ILLUSTRATION

ANSWER:

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PRIOR PERIOD ERRORS:
Errors discovered during a current period which relate to a prior period may arise through:
a) Mathematical mistakes
b) Mistakes in the application of accounting policies
c) Misinterpretation of facts
d) Oversights
e) Fraud

ACCOUNTING TREATMENT FOR PRIOR PERIOD ERROR:

According to IAS 8 retrospective treatment is recommended and there is no other alternate.
Only when it is impracticable to determine the effect of error an entity correct an error
prospectively.
i. Either restating the comparative amounts for the prior periods in which the error
occurred, or
ii. When the error occurred before the earliest prior period presented, restating the
opening balances of assets, liabilities and equity for that period

DISCLOSURE:
 Nature
 Amount of correction
 Circumstances led to impracticable for retrospective treatment

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ILLUSTRATION:

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BPP AND KAPLAN KIT QUESTIONS:

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ANSWERS:

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ANSWERS:

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 IFRS 5 – NON CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
The objectives of IFRS 5 are to set out:
 Requirements for the classification, measurement and presentation of noncurrent assets
held for sale, in particular requiring that such assets should be presented separately on
the face of the statement of financial position
 Updated rules for the presentation of discontinued operations, in particular requiring
that the results of discontinued operations should be presented separately in the
statement of profit or loss.

CLASSIFICATION OF ASSETS HELD FOR SALE

A non-current asset (or disposal group) should be classified as held for sale if its carrying
amount will be recovered principally through a sale transaction rather than through continuing
use. A number of detailed criteria must be met:
i. The asset must be available for immediate sale in its present condition.
ii. Its sale must be highly probable/expected (i.e. significantly more likely than not).

For the sale to be highly probable, the following must apply:

a) Management must be committed to a plan to sell the asset.
b) There must be an active programme/work started to locate a buyer.
c) The asset must be marketed for sale at a price that is reasonable in relation to its
current fair value.
d) The sale should be expected to take place within one year/12 months from the date of
classification.
e) It is unlikely that significant changes to the plan will be made or that the plan will be
withdrawn.

An asset (or disposal group) can still be classified as held for sale, even if the sale has not
actually taken place within one year. However, the delay must have been caused by events or
circumstances beyond the entity's control and there must be sufficient evidence that the entity
is still committed to sell the asset or disposal group. Otherwise the entity must cease to classify
the asset as held for sale.
If an entity acquires a disposal group (e.g., a subsidiary) exclusively with a view to its
subsequent disposal it can classify the asset as held for sale only if the sale is expected to take
place within one year and it is highly probable that all the other criteria will be met within a
short time (normally three months).
An asset that is to be abandoned should not be classified as held for sale. This is because its
carrying amount will be recovered principally through continuing use. However, a disposal

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group to be abandoned may meet the definition of a discontinued operation and therefore
separate disclosure may be required
QUESTION 1:
On 1 December 20X3, a company became committed to a plan to sell a manufacturing facility
and has already found a potential buyer. The company does not intend to discontinue the
operations currently carried out in the facility. At 31 December 20X3 there is a backlog of
uncompleted customer orders. The company will not be able to transfer the facility to the
buyer until after it ceases to operate the facility and has eliminated the backlog of uncompleted
customer orders. This is not expected to occur until spring 20X4.
Required: Can the manufacturing facility be classified as 'held for sale' at 31 December 20X3?

MEASUREMENT OF NON-CURRENT ASSETS HELD FOR SALE

Non-current assets that qualify as held for sale should be measured at the lower of:

 Their carrying amount and

 Fair value less costs to sell.
Note: If fair value less cost to sell is higher than carrying amount then no change is required,
and if fair value less cost to sell is lower than carrying amount than impairment loss shall be
recognized.
Held for sale non-current assets should be:
 Presented separately on the face of the statement of financial position under current
assets
 Not depreciated.

Where assets held under the revaluation model are reclassified as held for sale, these assets
should be revalued using the method in IAS 16 Property, Plant and Equipment or IAS 40
Investment Property as appropriate prior to reclassification.
o Non-current asset classified as held for sale should be re measured at each reporting
date at which it is still classified as held for sale. Any further impairment is recognized in
profit and loss
o Any increase in fair value will be recognized as income but should not increase the
amount previously charged to profit and loss account

Reclassification from held for sale to non-current asset

A non-current asset (or disposal group) that is no longer classified as held for sale (for example,
because the sale has not taken place within one year) is measured at the lower of:
a) Its carrying amount before it was classified as held for sale, adjusted for any
depreciation that would have been charged had the asset not been held for sale

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 b) Its recoverable amount at the date of the decision not to sell

QUESTION 2:
On 1 January 20X1, Michelle Co bought a stamping machine for $20,000. It has an expected
useful life of 10 years and a nil residual value. On 30 September 20X3, Michelle Co decides to
sell the machine and starts actions to locate a buyer. The machines are in short supply, so
Michelle Co is confident that the machine will be sold fairly quickly. Its market value at 30
September 20X3 is $13,500 and it will cost $500 to dismantle the machine and make it available
to the purchaser. The machine has not been sold at the year end.
Required: At what value should the machine be stated in Michelle Co’s statement of financial
position at 31 December 20X3?
QUESTION 3:
On 1st January 2012 company purchased a machine for $100,000 having a useful life of 10
years. On 31st December 2013 company classified the machine as held for sale and quoted a
reasonable price. Fair value on that date was $65,000 and estimated cost of disposal was
$2,000. Subsequent in 31st December 2015 it was abandoned and management decided not to
sell the machine, the fair value on that date was $58,000.
Required: At what value should the machine be stated in Michelle Co’s statement of financial
position at 31 December 2015?

Additional disclosures
In the period in which a non-current asset (or disposal group) has been either classified as held
for sale or sold the following should be disclosed.
a) A description of the non-current asset (or disposal group)
b) A description of the facts and circumstances of the disposal
c) Any gain or loss recognised when the item was classified as held for sale

Where an asset previously classified as held for sale is no longer held for sale, the entity should
disclose a description of the facts and circumstances leading to the decision and its effect on
results.
DISCONTINUED OPERATIONS
A discontinued operation is a 'component of an entity that has either been disposed of, or is
classified as held for sale, and:
 Represents a separate major line of business or geographical area of operations
 Is part of a single coordinated plan to dispose of a separate major line of business or
geographical area of operations, or
 Is a subsidiary acquired exclusively with a view to resale' (IFRS 5, para 32)

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By showing the performance of discontinued operations separately, users can see the
performance of the remaining operations, enabling them to predict future performance more
accurately.
An entity must disclose a single amount on the face of the statement of profit or loss,
'comprising the total of:

 The post-tax profit or loss of discontinued operations, and

 The post-tax gain or loss recognised on the measurement to fair value less costs to sell
or on the disposal of the assets constituting the discontinued operation' (IFRS 5, para
33(a))

An analysis of this single amount must be presented, either in the notes or on the face of the
statement of profit or loss.
The analysis must disclose:
 'the revenue, expenses and pre-tax profit or loss of discontinued operations
 the related income tax expense
 the gain or loss recognised on the measurement to fair value less costs to sell or on the
disposal of the assets constituting the discontinued operation' (IFRS 5, para 33(b)).

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QUESTION 3:

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PRACTISE QUESTIONS:

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FROM THE DESK OF M. JUNAID KHALID 291
FROM THE DESK OF M. JUNAID KHALID 292
ANSWERS:

Kaplan kit questions: 30 – 36 , 251 – 155

Bpp kit questions: 21 – 24, 176, 177, 180

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 CASH FLOW STATEMENT -- IAS 7
Importance of Cash
 Higher profits don’t mean that company will be able to pay more dividend
 Higher profits don’t mean that company will pay higher wages
 Survival of the business not only depends on profit only e.g. repayment of loan and
purchase of non-current assets are not paid from revenues
 Profits may be manipulated as it involves judgement like provision for doubtful debt,
depreciation and etc.

Cash flow statement shows the net inflow/outflow of cash. This statement mainly consists of
three parts. These are as follows;
a) Cash flow from operating activities
b) Cash flow from investing activities
c) Cash flow from financing activities

CASH FLOW FROM OPERATING ACTIVITIES

These activities include the following items
 (Increases)/decrease in inventory
 (Increases)/decrease in Receivables
 Increases/(decrease) in payables
 Interest paid
 Income tax paid
 Dividend paid **
IAS 7 simply summarizes that following items are considered in cash flow from operating
activities;
a) Cash receipts from the sale of goods and rendering of services
b) Cash receipts from royalties, fees, commissions and other revenue
c) Cash payments to suppliers for goods and services
d) Cash payments to and on behalf of employees

CASH FLOW FROM INVESTING ACTIVITIES

 Interest received
 Dividend received
 Payment to acquire NCA
 Proceeds from sale of NCA
 Sale/purchase of investment

IAS 7 simply summarizes that following items are considered in cash flow from investing
activities;

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 a) Cash payment to acquire NCA (tangible and Intangible)
b) Cash receipts from the sale of NCA (tangible and Intangible)
c) Cash payment to acquire share or debentures of other entities
d) Cash receipts from sales of shares or debentures of other entities
e) Cash advances and loans made to other parties
f) Cash receipts from the repayment of advances and loans made to other parties

CASH FLOW FROM FINANCING ACTIVITIES

 Proceeds from issuance of shares
 Redemptions by company
 Cash proceeds from issuance of loans, borrowings and bonds
 Repayment of loan
 Dividend paid**

ADJUSTMENT OF NON CASH ITEMS

 Depreciation/amortization – ADD
 Impairment loss --ADD
 Profit/loss on disposal – LESS/ADD
 Interest expense/finance cost – ADD
 Provision increase/decrease -- ADD/LESS
 Foreign exchange loss – ADD
 Investment income -- LESS
IAS 7 simply summarizes that following items are considered in cash flow from Financing
activities;
a) Cash proceeds from issuing shares
b) Cash payments to owners to acquire or redeem the entity’s shares
c) Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short
or long term borrowings
d) Principal repayments of amounts borrowed under leases (under lease hold asset
repayment of principal amount would become the part of financing activities and
interest payment will become the part of operating activities)

METHODS TO PREPARE CASH FLOW STATEMENT

IAS 7 offers to choose the either one;
1) Direct method
2) Indirect method
However, IAS 7 prefer direct method to prepare cash flow statement because it discloses
information, not available elsewhere in the financial statements.

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Exam note: Direct method is not examinable in F7 paper

Cash & cash equivalent: They are not held for investment or other long-term purposes, but
rather to meet short-term cash commitments. Maturity date should normally be within three
months from its acquisition date.

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ILLUSTRATION 1:

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ILLUSTRATION 2: (Self practice)

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ILLUSTRATION 3:

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ILLUSTRATION 4:
Gatis has the following Statement of Profit or Loss for the year ended 31 December 2007:
$
Sales Revenue 1,200,000
Cost of sales (Purchases) (840,000)
Gross profit 360,000
Distribution and administrative expenses (120,000)
Net profit before tax 240,000
The following are extracts from Gatis’s Statements of Financial Position:
2007 2006
$ $
Current assets
Inventory 160,000 140,000
Trade receivables 259,000 235,000
Current liabilities
Trade payables 168,000 138,000
You are given the following further information:
1) Expenses include depreciation of $36,000, bad debt write-offs of $14,000 and
employment costs of $42,000
2) During the year Gatis disposed of a non-current asset for $24,000 which had a book
value of $18,000, the profit on which had been netted off expenses.
You are required to show:
a) How the cash generated from operations would be presented on the Statement of Cash
Flows using the indirect method.

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PRACTISE QUESTIONS:

Question 3
Company has the following information about property plant and equipment
2007 2006
Cost 750,000 600,000
Acc.Dep 250,000 150,000
Carrying amount 500,000 450,000
Plant with a carrying value of $75000 (original cost of $90,000) was sold for $30,000 during the
year. What is the cash flow from investing activities for the year? (ans.210,000 outflow)

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Question 6:
A company has the following extract from a statement of financial position.
2007 2006
Share Capital 2,000,000 1,000,000
Share Premium 500,000 0
Loan Stock 750,000 1,000,000

If there had been a bonus issue of 500,000 share of $1 each during the year, what is the cash
flow from financing activities during the year?

Question 7:
The principal revenue-producing activities of an entity are called…

a) Operating activities
b) Investing activities
c) Financing activities
d) None of these

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Question 8:
Activities that result in changes in the size and composition of the equity capital and borrowings
of an entity are called:

a) Operating activities
b) Investing activities
c) Financing activities
d) None of these

Question 9:
Which of the following is not a heading for cash flows under IAS 7?

a) Cash flows from operating activities

b) Cash flows from investing activities
c) Cash flows from normal activities
d) Cash flows from financing activities

Question 10:
Cash payments to and on behalf of employees is an example of cash flows from

a) Operating activities
b) Financing activities
c) Investing activities
d) None of these

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 FINAL ACCOUNTS/ PREPARATION OF FINANCIAL STATEMENTS
SPECIMEN OF STATEMENT OF PROFIT AND LOSS ACCONT

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SPECIMEN OF STATEMENT OF FINANCIAL POSITION

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SPECIMEN OF STATEMENT OF CHANGES IN EQUITY

ILLUSTRATION:

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PRACTISE QUESTION:

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IMPORTANT QUESTIONS OF FINAL ACCOUNT, CONSOLIDATION AND RATIOS:

S.NO QUESTION NAME ATTEMPT

1 PEDANTIC DECEMBER 2008
2 DARGENT CO JUNE 2017
3 PALISTAR DECEMBER 2015
4 PREMIER DECEMBER 2010
5 PLANK JUNE 2020
6 RUNNER DECEMBER 2019
7 DUGGAN DECEMBER 2018
8 VERNON JUNE 2019
9 PLANK CO MARCH/JUNE 2020
10 DUKE CO SEP/DEC 2018 FOR RATIOS AND CONSOLIDATION
11 RUNNER CO SEP/DEC 2019
12 BUN CO SEP/DEC 19 FOR RATIOS
13 HAVERFORD MARCH/JUNE 2018
14 TRIAGE
15 PERKINS GROUP MARCH/JUNE 2018 FOR RATIOS AND CONSOLIDATION

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