ACCT 301: Financial Reporting 1 Lecture 1 PDF

Department Of Distance Education ACCT 301: Financial Reporting Lecture 1 Conceptual frameworks of ﬁnancial Reporting LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Learning objectives You will be introduced to the role that conceptual frameworks (CFs) can play in the practice of ﬁnancial reporting the history of the development of the various existing conceptual framework projects the various building blocks that have been developed within various conceptual framework projects 6-2 Learning objectives (cont.) perceived advantages and disadvantages that arise from the establishment and development of conceptual frameworks factors, including political factors, that might help or hinder the development of conceptual framework projects groups within society which are likely to beneﬁt from the establishment and development of conceptual framework projects 6-3 What is a conceptual framework? ‘A coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standards’ (Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises 1978) Attempts to provide a structured theory of accounting 6-4 Conceptual frameworks as normative theories Conceptual frameworks provide prescription so they are considered normative theories of accounting ‘Prescribes the nature, function and limits of ﬁnancial accounting and reporting’ (Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises, 1978) 6-5 Rationale for conceptual frameworks To develop the practice of ﬁnancial reporting logically and consistently we need to address such issues as what we mean by ﬁnancial reporting and what should be its scope which organisational characteristics indicate that an entity should produce ﬁnancial reports the objective of ﬁnancial reporting qualitative characteristics ﬁnancial information should possess what are the elements of ﬁnancial reporting what 6-6 measurement rule should be employed Rationale for conceptual frameworks (cont.) Proponents argue that without agreement on these issues accounting standards will be developed in an ad hoc manner Limited consistency between accounting standards in the absence of a conceptual framework 6-7 The ‘building blocks’ of the conceptual framework The framework must be developed in a particular order some issues need to be resolved before moving on to subsequent ‘building blocks’ Refer to Figure 6.1 (p. 213) in the text for an overview of the IASB Framework for the Preparation and Presentation of Financial Statements 6-8 History of the development of CFs CFs were developed in a number of jurisdictions including US, UK, Canada, Australia, New Zealand, International Accounting Standards Committee In recent years many countries, including Ghana, have adopted the IASB Framework given that they have decided to adopt the accounting standards released by the IASB No standard-setters had developed a complete CF; measurement issues typically unaddressed Limited or no progress in recent years, although efforts underway to update IASB Framework 6-9 Building blocks of the CF Building blocks of the various CFs have addressed deﬁnition of the reporting entity objectives of general purpose ﬁnancial reporting (GPFR) perceived users of GPFRs qualitative characteristics that GPFRs should possess elements of ﬁnancial statements possible approaches to measuring the elements 6-10 Deﬁnition of the reporting entity The Conceptual Framework provides a deﬁnition of entities required to produce GPFRs known as reporting entities 6-11 General purpose ﬁnancial reports GPFRs are deﬁned as reports ‘… intended to meet the information needs common to users who are unable to command the preparation of reports tailored so as to satisfy, speciﬁcally, all of their information needs’ (Statement of Accounting Concepts - SAC 1, para. 6) GPFRs are reports that comply with accounting standards and other generally accepted accounting practices (GAAPs) 6-12 Special purpose ﬁnancial reports Special purpose reports are provided to meet the information demands of a particular user, or group of users 6-13 Entities required to produce GPFRs Not all entities are classed as reporting entities SAC 1 states that GPFRs should be prepared when there are users ‘… whose information needs have common elements, and those users cannot command the preparation of information to satisfy their individual information needs’ (para. 8) 6-14 Factors indicative of a reporting entity (SAC 1) Separation of management from those with an economic interest in the entity The economic or political importance/inﬂuence of the entity to/ on other parties The ﬁnancial characteristics of the entity 6-15 Objectives of GPFR Traditional objective was to enable outsiders to assess the stewardship of management Recent commonly accepted goal of ﬁnancial reporting is to assist report users’ economic decision making less emphasis placed on the stewardship function 6-16 Objective embraced within CFs Objective of GPFRs in SAC 2 is deemed to be to provide information to users that is useful for making and evaluating decisions about the allocation of scarce resources Objective of decision usefulness calls into question usefulness of historical cost information 6-17 Other objectives of GPFRs Another objective is to enable reporting entities to demonstrate accountability between the entity and those parties to which the entity is deemed accountable Accountability is deﬁned as the duty to provide an account or reckoning of those actions for which one is held responsible accountability is not generally embraced by CFs 6-18 Users of ﬁnancial reports SAC 2 identiﬁes three primary user groups for GPFRs resource providers employees, lenders, creditors, suppliers, investors and contributors recipients of goods and services customers and beneﬁciaries parties performing review or oversight function parliaments, governments, regulatory agencies, analysts, labour unions, employer groups, media and special interest groups 6-19 International perspectives on users of GPFRs The IASB Framework identiﬁes GPFRs users as investors, employees, lenders, suppliers, customers, govt. agencies and the public states that information designed to meet the needs of investors will usually meet the needs of the other groups US: SFAC 1 main focus is present and potential investors and other users with either a direct ﬁnancial interest or related to those with a direct ﬁnancial interest UK: The Corporate Report all groups impacted by an organisation’s operations have rights to information about the reporting entity, not necessarily related to resource allocation decisions 6-20 Level of expertise expected of ﬁnancial report readers Generally accepted that readers are expected to have some proﬁciency in ﬁnancial accounting IASB Framework (para. 25) ‘… users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence’ 6-21 Qualitative characteristics of ﬁnancial reports To ensure ﬁnancial information is useful for economic decision making, we need to consider the attributes or qualities that ﬁnancial information should have According to IASB Framework primary qualitative characteristics are understandability, relevance, reliability and comparability related to relevance is materiality IASB Framework appears to give greater prominence to relevance and reliability there are issues associated with the ‘trade-off’ between relevance and reliability 6-22 Reliability Information is considered to be reliable if it ‘faithfully represents’ the entity’s transactions and events Should be free from bias and undue error Reliability is a function of representational faithfulness, veriﬁability and neutrality 6-23 Reliability—implications for traditional accounting Traditionally, the doctrine of conservatism and the acceptance of ‘prudence’ has been adopted bias towards understating asset values and overstating liabilities This doctrine is not consistent with notions of reliability or freedom from bias 6-24 Relevance Something is relevant if it inﬂuences decisions on the allocation of scarce resources if it is capable of making a difference in a decision For information to be relevant it should have predictive value, and feedback value 6-25 Materiality A limiting factor on the disclosure of relevant and reliable material is the notion of materiality An item is material if (IASB Framework, para. 30) ‘... its omission or misstatement could inﬂuence the economic decisions of users taken on the basis of the ﬁnancial statements …. Materiality provides a cut-off rather than being a primary qualitative characteristic which information must have if it is to be useful’ 6-26 Uniformity and consistency Uniformity and consistency imply advantages in restricting the number of accounting methods that can be used by reporting entities has been argued that ﬁrms adopt particular accounting methods because they best reﬂect their underlying performance restricting available methods imposes costs on reporting entities 6-27 Costs vs beneﬁts Need to consider whether the cost of providing certain information exceeds the beneﬁts to be derived from its provision costs include collection, storage, retrieval, presentation, analysis and interpretation beneﬁts come from sound economic decision making by users Measuring potential costs and beneﬁts involves professional judgement 6-28 Can GPFRs provide unbiased accounts of performance? The practice of accounting is heavily reliant on professional judgement Prior to accounting standards being released, standard setters attempt to determine the economic consequences of following the standards if consider economic consequences then standards cannot be considered objective or neutral 6-29 Can GPFRs provide unbiased accounts of performance? (cont.) If we accept the notion that preparers will be driven by self- interest (from Positive Accounting Theory) notions of objectivity or neutrality are unrealistic Political nature of standard setting process also affects neutrality and objectivity In communicating reality accountants construct reality (Hines 1988) 6-30 The elements of ﬁnancial reporting The next building block considers the deﬁnition and recognition criteria of the elements of ﬁnancial reporting Deﬁnition criteria—what attributes are required before an item can be considered as belonging to a particular class of element Recognition criteria—employed to determine whether the item can be included in the ﬁnancial reports 6-31 Five elements of ﬁnancial reporting in the IASB Framework Assets Liabilities Equity Expenses Income in the IASB Framework, income is further subdivided into revenues and gains ten elements identiﬁed in the US by FASB 6-32 Deﬁnition of assets ‘… a resource controlled by the entity as a result of past events and from which future economic beneﬁts are expected to ﬂow to the entity’ (IASB Framework, para. 49(a)) Three key characteristics must be an expected future economic beneﬁt the reporting entity must control the future economic beneﬁt the transaction or other past event giving rise to the reporting entity’s control must have occurred 6-33 Deﬁnition of assets (cont.) The deﬁnition refers to the beneﬁt and not its source in the absence of future economic beneﬁts, the object or right will not qualify as an asset The beneﬁts can result from ongoing use, not necessarily a value in exchange 6-34 The characteristic of control Control relates to the capacity to beneﬁt from the asset and to deny or regulate others’ access to the beneﬁt Legal enforceability is not a prerequisite for establishing the existence of control control (and not legal ownership) is required, although controlled assets are frequently owned 6-35 Recognition of assets An asset—and all the other elements of accounting—shall be recognised when it is probable that any future economic beneﬁt associated with the item will ﬂow to or from the entity, and the item has a cost or value that can be measured with reliability (IASB Framework, para. 83) Probable is generally considered to mean ‘more likely rather than less likely’ 6-36 Deﬁnition of liabilities Liabilities are deﬁned as ‘… a present obligation of the entity arising from past events, the settlement of which is expected to result in an outﬂow from the entity of resources embodying economic beneﬁts’ (IASB Framework, para. 49(b)) present obligations not only refers to legally enforceable obligations but also those imposed by notions of equity and fairness, or by custom or other business practices 6-37 Recognition of liabilities Recognition criteria consistent with those of assets and the other elements of accounting A liability shall be recognised when it is probable that the sacriﬁce of economic beneﬁts will be required, and the amount of the liability can be measured reliably Has implications for disclosure of various provisions 6-38 Approaches to determining proﬁt Two common approaches to determining proﬁts asset/liability approach links proﬁt to changes in assets and liabilities revenue/expense approach relies on concepts such as the matching principle The deﬁnition of expenses and revenues in the CF based on asset/liability perspective 6-39 Deﬁnition of expenses ‘… decreases in economic beneﬁts during the accounting period in the form of outﬂows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants’ (IASB Framework, para. 70(b)) 6-40 Recognition of expenses An expense shall be recognised when it is probable that the consumption or loss of future economic beneﬁts resulting in a reduction in assets and/or an increase in liabilities has occurred, and the consumption or loss of economic beneﬁts can be measured reliably 6-41 Deﬁnition of 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 increases in equity, other than those relating to contributions from equity participants’ (SAC 4, para. 70(a)) 6-42 Deﬁnition of income (cont.) Income can be recognised from normal trading relations, as well as from non-reciprocal transfers such as grants, donations, bequests or where liabilities are forgiven IASB Framework further subdivides income into revenues and gains revenue arises in the course of the ordinary activities of an entity gains represent other items that meet the deﬁnition of income and may, or may not, arise in the ordinary activities of an enterprise not 6-43 clear why there is a need to break income into Recognition of income As with the other elements of accounting, income is recognised when it is probable that the inﬂow or other enhancement or saving in outﬂows of future economic beneﬁts has occurred, and the inﬂow or other enhancement or saving in outﬂows of future economic beneﬁts can be measured reliably 6-44 Deﬁnition of equity Equity is deﬁned as ‘the residual interest in the assets of the entity after deducting all of its liabilities’ (IASB Framework, para. 49(c)) As a residual interest it ranks after liabilities in terms of claims against the assets Deﬁnition is a direct function of the deﬁnitions of assets and liabilities 6-45 Measurement principles To date very little prescription in relation to measurement provided by CFs FASB statement provides description of various approaches to measuring elements without providing prescription 6-46 Beneﬁts associated with conceptual frameworks Accounting standards should be more consistent and logical Increased international compatibility of accounting standards Standard-setters should be more accountable for their decisions Communication between standard-setters and their constituents should be enhanced 6-47 Beneﬁts associated with CFs (cont.) The development of accounting standards should be more economical Where conceptual frameworks cover a particular issue, there might be a reduced need for additional standards Emphasise the ‘decision usefulness’ role of ﬁnancial reports rather than restricting concern to stewardship 6-48 Disadvantages of conceptual frameworks Smaller organisations may feel overburdened by reporting requirements Typically economic in focus so ignore transactions that have not involved market transactions or exchange of property rights further reinforces the importance of economic performance relative to social performance Represent a codiﬁcation of existing practice 6-49 CFs as a means of legitimising standard- setting bodies Some (e.g. Hines and Solomons) have suggested that CFs have been used as devices to help ensure the ongoing existence of the accounting profession Increase the ability of the profession to self-regulate, thus counteracting government intervention 6-50 Department of Distance Education ACCT 301: Lecture 1 Lecture 2 LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Focus: IAS 16 Plant, Property and Equipment – Non-current asset and Accounting for Revaluation of Plant Property and Equipment (IAS 16) LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Learning Outcomes explain the meaning of PPE and determine its initial carrying value; account for subsequent expenditure on PPE that has already been recognised; explain the meaning of depreciation and compute the depreciation charge for a period; explain the impact of alternative methods of accounting for PPE on key accounting ratios. Explain borrowing cost and capitalization criteria Explain a qualifying asset Describe the accounting procedure for capitalized owing costs Explain the disclosure requirements of IAS 23 SECTION 1 IAS 16 Plant, Property and Equipment – Non-current assets LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Key focus PPE – concepts and the relevant IASs and IFRSs PPE Determination of the cost of PPE Depreciation Constituents in the depreciation formula Calculation of depreciation Measurement subsequent to initial recognition Disclosure requirements Government grants towards the cost of PPE Effect of accounting policy for PPE and interpretation of ﬁnancial statements Accounting standards that relate to PPE IAS 16 and IAS 23 cover: What is PPE (IAS 16)? How is the cost of PPE determined (IAS 16 and IAS 23)? How is depreciation of PPE computed (IAS 16)? What are the regulations regarding carrying PPE at revalued amounts (IAS 16)? How to account for government grants (IAS 20) How is impairment of PPE accounted for (IAS 36) IAS 16 Plant, Property and Equipment – Non-current assets [Tangible Assets] Asset (purchased or constructed) held for use > one year Held by an enterprise for use In production For rental For administration IAS 16 Plant, Property and Equipment – Non-current assets [Tangible Assets] - continuation What is the cost of an asset? Does cost include interest/ﬁnance charges? IAS 16 Plant, Property and Equipment – Non-current assets [Tangible Assets] - continuation Remember the recognition criteria of assets  It is probable that any future economic beneﬁt associated with the item will ﬂow to the entity and,  The item has a cost or value that can be measured with reliability. IAS 16 Plant, Property and Equipment – Non-current assets [Tangible Assets] - continuation Initial Measurement at cost/value:  This includes directly attributable cost/value What counts as cost / value? Cost/value = purchase price + costs to bring asset to working condition, Purchase price Import duties Directly attributable costs bringing to working condition Site preparation Delivery costs Installation costs Professional fees Dismantling and restoring site IAS 37 Provisions, Contingent Liabilities and Contingent Assets [examined in later lectures] IAS 16 Plant, Property and Equipment – Non-current assets [Tangible Assets] - continuation Does the cost include ﬁnance/borrowing cost/charges??? Illustration Yawcab started construction on a building for its own use of 1 April 2017 and st incurred the following costs. GHC’000 Purchase price of land 500 Stamp duty 10 Legal fees 20 Site preparation and clearance 36 Materials 200 Labor( period 1 January to march 2018) st 300 Professional fees 40 General overheads 60 CONT. The following is also relevant: Materials costs were greater than anticipated. On investigation ,it was found that materials costing GHC 20,000 had been spoiled and therefore wasted and a further GHC 30,000 was incurred as a result of faulty design work. As a result of these problems ,work on the building ceased for a fortnight during October 2017 and it is estimated that approximately GHC 18,000 of the labor costs relate to this period. The building was completed on 1 July 2018 and occupied on 1 st st September 2018. You are required to calculate the cost of the building that will be included in tangible non-current asset additions. Solution The amount included in property, plant and equipment Is computed as follows: Total GHC’000 Purchase price of land 500 Stamp duty 10 Legal fees 20 Site preparation and clearance 36 Materials 150 Labour 282 Professional fees 40 ---------- 1,038 ----------- DEPRECIATION Systematic allocation funds already expended Depreciable amount (cost – residual value) Useful Economic Life Useful economic life Period of time in use Number of production units expected from an asset – that is, a quantity rather than time base Most assets have ﬁnite lives and are depreciated Freehold land – inﬁnite life Investment properties an exception IAS 40. How is useful economic life decided Factors to consider include: Repair costs Availability of replacement parts Comparative cash ﬂows of alternative assets Companies might manipulate the useful economic life to change the depreciation charge DEPRECIATION  matching concept  The depreciation amount is charged to income statement!  In sum! It is the systematic allocation of depreciable amount of an asset over its useful life. Depreciable amount is the cost of an asset or other amount substituted for cost in the ﬁnancial statement, less its’ residual value.  In practice it is very important to review the method of depreciation and the useful life of the asset at least every year. Choice of depreciation method impacts on reported proﬁt (2,000) (38%) Difference Depreciation – Sum of the units method Depreciation Depreciation should reﬂect the actual consumption of economic beneﬁt Disclosure: measurement base of gross carrying value, depreciation method, and the useful life Reconciliation of the carrying value and depreciation at start and end of the year. Given as a note to the Balance Sheet. Check out a set of company ﬁnancial statements Subsequent expenditure Repairs/ maintenance cost must be recognised in the Income Statement as it is incurred as expense UNLESS:  It enhances the economic beneﬁts; excess future economic beneﬁts will ﬂow; Extending useful life; Upgrade to improve quality  Adopting new production processes to signiﬁcantly reduce costs and improves sales revenue  Eg. Supermarket renovates a major store. Management budgets show a 15% increase in sales as a consequence of more / better display space. Since there is some reliability about estimates both the renovation and any speciﬁcally allocated interest could be capitalised Subsequent expenditure [continuation]  It relates to a major inspection/overhaul restoring economic beneﬁts consumed and reﬂected in depreciation  A component of an asset that is treated separately for depreciation purposes has been replaced or restored SUBSEQUENT MEASUREMENT OF NON- CURRENT ASSETS  Cost Model Cost less accumulated depreciation and impairment losses (reviewed in later discussion)  Revaluation Model Carry at revalued amount less subsequent accumulated depreciation and impairment losses Accounting for Revaluation of Plant Property and Equipment (IAS 16) LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Learning Outcomes account for PPE measured under the revaluation model; explain the accounting treatment of government grants for the purchase of PPE; distinguish between government grant and government assistance describe the accounting treatment of recurrent expenditure and capital expenditure related government grant Revaluation Recording Revaluations Revaluation surpluses/gains and losses LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Impact of Inﬂation If assets are valued at cost, inﬂation means that a gap develops between the NBV and the fair value IAS 16 permits revaluation – fair value – basically market value but if not available then use depreciated replacement cost Revaluation surplus account REVALUATION  Mechanics of revaluation Restate the cost or valuation to the revalued amount and; Adjust the accumulated depreciation at the date of revaluation When an item of property, plant and equipment is revalued, any accumulated depreciation at the date of the revaluation is treated in one of the following ways:  Restate accumulated depreciation proportionately with the change in the gross carrying amount of the asset (so that the carrying amount of the asset after revaluation equals its revalued amount); or  Eliminate the accumulated depreciation against the gross carrying amount of the asset (IAS 16 par. 35). ILLUSTRATION Example, Yaw Koﬁ (YK) Inc. owns buildings with a cost of GH¢200,000 and estimated useful life of ﬁve years, with no residual value. Accordingly, depreciation of GH¢40,000 per year is anticipated. After two years, YK obtains market information suggesting that a current fair value of the buildings is GH¢300,000 and decided to write the building up to a fair value of GH¢300,000. There are two approaches to apply the revaluation model: the asset and accumulated depreciation can be “grossed up” to reﬂect the new fair value information, or the asset can be restated on a “net” basis. These two approaches are illustrated below. For both illustrations, the net carrying amount (book value or depreciated cost) immediately prior to the revaluation is GH¢120, 000 (GH¢ 200,000 - (2XGH¢40,000). Therefore, for any of the approaches, calculate the net carrying value ﬁrstly. The net upward revaluation is given by the difference between the fair value and net carrying value, or GH¢300,000 – GH¢120,000 = GH¢180,000. Option 1: Gross up approach The asset and accumulated depreciation can be “grossed up” to reﬂect the new fair value information. We need an index to gross up [restate the asset value and depreciation and this could be ascertained by: 300/200 = 1.5 Cost Valuation Cost/Valuation GH¢200 GH¢300 Depreciation 80 120 Carrying Value – Net Book Value 120 180 Revaluation gain/surplus = GH¢300 – 120 = 180 Subsequent depreciation is based on the revalued amount of GH¢300. This method is often used when an asset is revalued by means of applying an index to determine its depreciated replacement cost. However, many users of ﬁnancial statements, including credit grantors and prospective investors, pay heed to the ratio of net property and equipment as a fraction of the related gross amounts. This is done to assess the relative age of the entity’s productive assets and, indirectly, to estimate the timing and amounts of cash needed for asset replacements. There is a signiﬁcant diminution of information under the second method. Accordingly, the ﬁrst approach described above, preserving the relationship between gross and net asset amounts after the revaluation, is recommended as the preferable alternative is the goal is meaningful ﬁnancial reporting. Revaluation There could also be a net decrease (when the revalued amount less cost value less accumulated depreciation is negative). This is a loss on revaluation. The loss on revaluation is credited to the asset account and charged to income statement. Subsequent depreciation is based on the revalued amount. Revaluation Decreases A decrease is normally an expense – in the IS However special case if the decrease reverses a previous revaluation increase Case of freehold land – no depreciation Year 1 buy land GH¢100,000, revalue year 3 to GH¢150,000 and in year 5 to GH¢90000 NB at end of 5 years the asset is worth GH¢90,000 less than the original cost (HC) of GH¢100,000 2 Steps- Years 3 and 5 Year 3 – no gain in income statement Dr FA a/c GH¢50,000 – now at GH¢150000 Cr Revaluation Reserve GH¢50000 Year 5 a reverse in value Reduce (cr) FA by GH¢60000 – to GH¢90,000 May reduce (dr) Revaluation Reserve by GH¢50000 only The remaining GH¢10,000 is an expense (dr) in income statement because value is below cost REVALUATION Any extra depreciation due upward revaluation is transferred from the revaluation surplus! Now according to IAS 16 Property, Plant and Equipment you can transfer the excess depreciation from the revaluation reserve to retained earnings (and not to income statement). In this case the excess depreciation is the difference between depreciation based on revalued amount and the depreciation on original cost. The treatment of the excess depreciation is in line with IAS 8 Accounting policies, changes in accounting estimates and errors. Under IAS 8 corrections are made via retained earnings. Eg, previous depreciation was GH¢900, new depreciation due to upward revaluation is GH¢1500; after charging GH¢1500 to Income Statement, the difference between GH¢1500 and GH¢900 ie. GH¢600 is transferred from revaluation surplus to Retained Earnings. This treatment is done in the Statement of Changes in Equity. Again, remember IAS 8 Accounting policies and changes in estimates and errors! ILLUSTRATION An item of PPE was purchased for GH¢900,000 on 1 January 2007. It is estimated to have a useful life of 10 years and is depreciated on a straight line basis. On 1 January 2009, the asset is revalued to GH¢960,000. The useful life remains unchanged at ten years. GH¢ Actual depreciation for 2009 based on revalued amount (960,000/8) 120,000 Depreciation for 2009 based on historical cost (900,000/10) (90,000) Difference 30,000 In the Statement of Comprehensive Income for 2009, a depreciation expense of GH¢120, 000 will be charged. REVALUATION A reserve transfer, which will be shown in the statement of changes in equity, may be undertaken as follows: GH¢ Debit revaluation surplus 30,000 Credit retained earnings 30,000 The closing balance on the revaluation surplus on 31 December 2009 will therefore be as follows: Balance arising on revaluation GH¢ (GH¢960,000 - GH¢720,000) 240,000 Transfer to retained earnings (30,000) 210,000 Where revaluation gain reverses a previous revaluation loss relating to the same asset  Part of this gain up to the previous loss, should be credited to the income statement and the remainder if any, should be credited to revaluation reserve Where revaluation loss reverses previous gain relating to the same asset  Part of the loss up to the previous gain can be deducted and the remaining loss if any, should be charged to the income statement.  Revaluation is optional but where an entity adopts a policy of revaluation, it must be applied to a whole class of assets.  This is to avoid cherry picking for revaluation.  The revaluation must be kept up to date, annually for signiﬁcant movement and volatile assets and 3 to 5 years for others. Department of Distance Education ACCT 302: Lecture 3 M IAS 23 BORROWING COST & IAS 20 GOVERNMENT GRANTS LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) SECTION 1 BORROWING COST (IAS 23) LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Borrowing Costs Remember Cost = purchase price + costs to bring asset to working condition! So if a loan is essential to obtain an asset and get it to a working condition, for example while it is being constructed, is this part of cost? The problems: (i) When the company credits cash because it pays interest charges what should be debited? The choices are expense it in Income Statement [IS] or capitalise it as part of the asset’s value in the Statement of Financial Position. (ii) The company may have loans that are for general purposes, not just to cover the cost of a speciﬁc asset. The cost of borrowing associated with a speciﬁc asset may be unclear. IAS 23 Borrowing Cost – continuation Borrowing/Finance costs (IAS 23) are also capitalised if they are directly attributable to the acquisition, construction or production of a qualifying asset as part of its cost. Borrowing costs – The Nature of Assets under Review The IAS 23 talks about qualifying assets, which take a substantial time to prepare for their intended use or for sale. They include: Construction work-in- process Manufacturing plants Intangible assets Investment Properties They do not include: Financial assets Inventories produced over short time scales Borrowing Costs – Changes of Treatment Textbook explains how International Accounting Standard Board [IASB] thinking has changed over time. 1980s free choice to expense, or if certain conditions were met capitalise 1990s - benchmark treatment - Interest is recognised as an expense in the period in which cost is incurred. Capitalisation was the alternative treatment. capitalisation required if certain conditions met, expensing required otherwise IAS 23 issued 1994 – restored the choice [ie can make a choice] but expensing was the benchmark treatment. 2000s - Convergence programme with the US – IASB revised IAS 23. US and IASB – capitalisation is required if certain conditions are met and otherwise expensing is required. Borrowing Costs – IAS 23 Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are to be capitalised. The relevant costs are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not occurred. Directly Attributable Borrowing Cost Borrowing may be speciﬁcally for one individual qualifying asset – cost is clear. Borrowing for general purposes across the company – then the cost must be estimated for the qualifying asset. Take a weighted average of the company’s borrowing costs for the time that the asset counts as a qualifying asset. Capitalisation of borrowing costs for self-constructed assets IAS 23 treatment Qualifying asset – time criterion Funds borrowed speciﬁcally – use actual rate Funds borrowed generally – use weighted average Capitalisation ceases when asset substantially prepared for its intended use or sale. Where funds are borrowed speciﬁcally, costs eligible for capitalisation are the actual costs incurred less any income earned on the temporary investment of such borrowings. [IAS 23.12] Where funds are part of a general pool, the eligible amount is determined by applying a capitalisation rate to the expenditure on that asset. The capitalisation rate will be the weighted average of the borrowing costs applicable to the general pool. [IAS 23.14] Capitalisation should commence when expenditures are being incurred, borrowing costs are being incurred and activities that are necessary to prepare the asset for its intended use or sale are in progress (may include some activities prior to commencement of physical production). [IAS 23.17-18] Capitalisation should be suspended during periods in which active development is interrupted. [IAS 23.20] Capitalisation should cease when substantially all of the activities necessary to prepare the asset for its intended use or sale are complete. [IAS 23.22] If only minor modiﬁcations are outstanding, this indicates that substantially all of the activities are complete. [IAS 23.23] Where construction is completed in stages, which can be used while construction of the other parts continues, capitalisation of attributable borrowing costs should cease when substantially all of the activities necessary to prepare that part for its intended use or sale are complete. [IAS 23.24] Disclosure [IAS 23.26] amount of borrowing cost capitalised during the period capitalisation rate used ILLUSTRATION Koﬁ took out a GHC10 million 6% loan on 1 January 2011 to build a new football stadium. Not all of the funds were immediately required so GHC2 million was invested in 3% bonds until 30 June 2011. Construction of the stadium began on 1 February 2011 and was completed on 31 December 2011. Calculate the amount of interest to be capitalised in respect of the football stadium as at 31 December 2011. SOLUTION Interest should only be capitalized from 1 February 2011, when the construction begins. The total interest cost for the year is GHC600,000 (GHC10 million × 6%). Of this, January's interest should be expensed as it was incurred before the building was underway. Therefore GHC550,000 (11/12) relates to the asset, with GHC50,000 (1/12) being shown as a ﬁnance cost in the statement of proﬁt or loss. In relation to the income earned, a similar situation applies. January's interest is earned before construction begins. Therefore this is taken as ﬁnance income to the statement of proﬁt or loss, with the other 5 months relating to the asset. Interest earned = GHC30,000 (GHC2 million × 3% × 6/12) Of this, GHC5,000 (1 month) is taken to the statement of proﬁt or loss, with the other GHC25, 000 (5 months) relating to the asset. The total that can be capitalized is the net interest incurred during the construction period, which will be: GHC550,000 – GHC25,000 = GHC525,000 SECTION 2 IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS Grants are not recognised until reasonably certain conditions of receipt complied with PERMITS 2 OPTIONS 1. Revenue grants - Deduct grant from asset, Reduces carrying amount 2. Capital grants - Deferred income, Income spread on systematic basis over useful life of relevant asset. REVENUE GRANTS Be presented as a credit in the income statement; Dr Cash Cr I/S or Be deducted from the related expenses in the expenditure period CAPITAL GRANT Be written off against the cost of the associated non-current asset, with depreciation then based on the resulting reduced cost or Be treated as a deferred credit in the liabilities section of the Statement of Financial Position and a portion transferred to revenue each year, so offsetting the depreciation that will have been calculated based on the original cost. Dr Cash Cr Deferred Income Release to I/S over the useful life of the asset Grants relating to assets Deferred income method Under this method grants received are credited to a deferred-income account on receipt. This deferred income is then released to income on a systematic basis over the useful life of the asset for which it was given. An entity buys an asset at a cost of 100,000. It received a grant of 30,000. Depreciation is provided at 10% straight line. DR Bank 30,000 CR Deferred grant income 30,000 Being receipt of grant At period end DR Depreciation expense 10,000 CR Asset a/c 10,000 Being depreciation charge for period DR Deferred grant income 3,000 CR Other income –grant 3,000 Being grant released in period Grants relating to assets Net-of-cost method Under this method the grant is credited to the asset account upon receipt. The grant is then recognised as income over the life of a depreciable asset by an automatically reduced depreciation charge. Facts are the same. DR Bank 30,000 CR Asset a/c 30,000 Being receipt of grant At period end DR Depreciation expense 7,000 CR Asset a/c 7,000 Being depreciation charge for period 10%(100,000-30,000) Department of Distance Education ACCT 301: Financial Reporting 1 Lecture 4 LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Lecture 4 IAS 38: Intangible Assets LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Learning Outcomes At the end of the lecture, the student will be able to deﬁne and explain how to account for: legally enforceable intangibles and internally generated intangibles; research and development (R&D); goodwill; brands; and emission trading certiﬁcates; account for development costs; comment critically on the IASB requirements in IAS 38 and IFRS 3. explain the meaning of impairment; Understand the reasons for subjecting assets to impairment test compute and account for an impairment loss; Main purpose The main purpose of this session is to consider the accounting treatments of research and development; goodwill and intangible assets; brands; emissions trading certiﬁcates. Key focus Accounting for intangible assets Accounting treatment for research and development Research and development [R & D]– why not capitalised Capitalising development costs Disclosure of R&D IFRS for SMEs – treatment of intangible assets Goodwill The accounting treatment of goodwill Critical comment on the methods used for goodwill accounting Key focus (Continued) Negative goodwill Brand accounting Justiﬁcations for reporting all brands as assets Accounting for acquired brands Emissions trading Intellectual property Review of implementation of IFRS 3 IAS 38 Intangible assets Deals with research and development costs, as well as intangible assets Intangible asset is an identiﬁable non-monetary asset without physical substance held for use in the production or supply of goods or services, for rental or others or for administrative purposes. The IAS 38 uses the same recognition criteria as those under IAS16 for tangible non current assets. 1. It is probable that any future economic beneﬁt associated with the item will ﬂow to the entity and, 2. The item has a cost or value that can be measured with Intangible assets – purchased Separately purchased, included in goodwill and with a ﬁnite life Capitalise as part of goodwill. Separately purchased and capable of reliable measurement Capitalise separately from goodwill and amortise. Intangible assets – internally developed Capitalise IF Readily ascertainable market value Intangible assets – indeﬁnite useful economic life No amortisation but should be tested for IMPAIRMENT annually. Impairment will be discussed later. Annual impairment review Improve transparency Improve comparability We now consider the accounting treatments of Research and development Goodwill Brands R&D scorecard The 2008 R&D scoreboard published by the Department of Innovation, Universities and Skills showed the scale of R&D expenditure in the UK and globally: GH¢274 billion was invested globally in 2007–2008 by most active 1,400 companies most active in R&D which was an increase of 9.5% on the previous year. Almost 80% of global R&D occurred in ﬁve countries: USA, Japan, Germany, France and the UK. Global R&D intensity, measured as R&D expenditure as a proportion of sales, had remained broadly similar to the previous year at 3.3%. The 88 UK companies in this group increased their R&D spend at a faster rate (10.3%) with 20% of the total taking place in the pharmaceuticals and aerospace sectors. Research deﬁned Obtaining new knowledge Search for alternatives materials products processes Evaluation of alternatives Original and planned investigation undertaken with the prospect of gaining new scientiﬁc or technical knowledge and understanding Research costs are written off as incurred IAS 38 – accounting treatment for Research & Development Expense in the year in which it is incurred Not to be carried forward in statement of ﬁnancial position. IAS 38 intangible assets Development deﬁned Application of research ﬁndings to a plan for production of new or substantially improved products processes systems Prior to commencement of commercial production. Development costs comprise Directly attributable costs Materials; labour fees such as patents. Allocatable on a reasonable and consistent basis Necessary and identiﬁable overheads depreciation insurance premiums, rent. Use of scientiﬁc/technical knowledge in order to produce new/ substantially improved materials devices, processes etc Write off in year of expenditure. However, where all the following circumstances [next slides] are satisﬁed, development cost can be CAPITALISED and AMORTISED. IAS 38 – development recognition criteria Technical feasibility Intention to complete and use or sell Generate future economic beneﬁts Existence of market for asset or output Availability of adequate resources to complete Technical Financial Reliable measurement of costs possible Where all the above are not satisﬁed, expense the development costs! Introduction to goodwill and intangible assets. The main requirements of IFRS 3 Business Combinations and IAS 38 Intangible Assets are Purchased goodwill and intangible assets should be capitalised as assets. Internally generated goodwill should not be capitalised. Internally developed intangible assets should be capitalised only where it is probable that future economic beneﬁts attributable to the asset will ﬂow to the enterprise and the cost of the asset can be measured reliably. Capitalised assets are subject to amortisation and/impairment review IFRS 3 Business Combinations Purchased goodwill is based on Transaction with third party at arm’s length Internally generated goodwill is based on Directors’ valuation of internal goodwill by valuing business as a whole separable assets. The cost of purchased goodwill IFRS 3 Business Combinations states: Goodwill is the difference between the cost of acquisition and the acquirer’s interest in the fair value of the identiﬁable assets, liabilities and contingent liabilities acquired at the date of the exchange transaction. Accounting treatment of goodwill Purchased goodwill is recognised in the statement of ﬁnancial position as an asset Amortisation prohibited Annual impairment reviews Inherent goodwill not normally recognised in the accounts. Economic consequence of write-off/ amortisation ROCE Write-off reduces shareholders’ reserves and capital employed. Gearing Write-off reduces shareholders’ reserves and so capital employed How this affects investor decisions How this affects creditor decisions. Negative goodwill – related to expectation of losses and expenses Note however, that where the purchase consideration is less than the net asset acquired (ie bargain purchase), there is said to be GAIN on bargain purchase. Before recognising the gain on bargain purchase, the acquirer must reassess whether it has correctly identiﬁed all the assets acquired and liabilities assumed. The acquirer must review the procedures used to measure the amounts recognised for: Identiﬁable net assets; Non-controlling interest (if any); Interest previously held (if any); Consideration transferred When it is satisﬁed that the gain on the bargain purchase is correct, it must be immediately recognised in the income statement – ie. Credit income statement immediately Brand accounting Include in statement of ﬁnancial position to pre-empt equity depletion caused by goodwill write-offs Typically not amortised but subject to impairment review. Intellectual property – two categories Industrial property Inventions Trademarks Designs. Copyright Literary and artistic works. OECD deﬁnition of intellectual capital The economic value of two categories of intangible assets: Organisational (structural) capital – Software systems – Supply chains. Human capital – Internally – staff – Externally – customers. Discussion Explain how primary ratios were distorted by immediate write-off of goodwill against reserves. Explain the criteria for recognising internally generated intangible assets. Discussion (Continued) Explain why companies began to recognise brands in their statement of ﬁnancial position. Explain the requirement at the year end with respect to intangible assets with an indeﬁnite useful economic life. Why do you think companies were motivated to measure intellectual capital? Discussion (Continued) What indications may there be that an impairment review of an intangible asset is necessary? Explain the criteria to be satisﬁed for development costs to be capitalised. Discuss why intellectual property has become increasingly important. Review questions 6. IFRS 3 has introduced a new concept into accounting for purchased goodwill – annual impairment testing, rather than amortisation. Consider the effect of a change from amortisation of goodwill (in IAS 22) to impairment testing and no amortisation in IFRS 3, and in particular: the effect on the ﬁnancial statements; the effect on ﬁnancial performance ratios; Review questions (Continued) 6. Continued the effect on the annual impairment or amortisation charge and its timing; which method gives the fairest charge over time for the value of the goodwill when a business is acquired; whether impairment testing with no amortisation complies with the IASC’s Framework for the Preparation and Presentation of Financial Statements; why there has been a change from amortisation to impairment testing – is this pandering to pressure from the US FASB and/or listed companies? ACTIVITY An entity has incurred the following expenditure during the current year: a. GHC100,000 spent on the initial design work of a new product – it is anticipated that this design will be taken forward over the next two years period to be developed and tested with a view to production in three years time b.GHC500, 000 spent on the testing of a new production system which has been designed internally and which will be in operation during the following accounting year. This new system should reduce the costs of production by 20% How should each of these costs be treated in the ﬁnancial statements of the entity? SOLUTION a. These are research costs as they are only in the early design stag e and therefore should be written off as part of proﬁt and loss for the period Further Illustrations: Boat Engines Ltd Further Illustrations: Boat Engines Ltd b. These would appear to be development stage costs as the new production system is due to be in place fairly soon and will produ ce economic beneﬁts in the shape of reduced costs. Therefore these should be capitalized as development costs End of lecture Thank you! Any comments/questions? Remember my contacts email: [email protected] mobile: 0266225129 Oﬃce: GBS13 Executive Block LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Lecture 5 IAS 36 impairment of assets LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) IAS 36 impairment of assets Report at no more than recoverable amount Higher of net selling price and value in use. Net selling price Disposal value less direct selling costs. Value in use PV of future cash ﬂows Discounted at rate for equally risky investment. IAS 36 approach Single asset or cash generating unit Judgmental Beware concealing poor performance by grouping Carrying amount = depreciated Historical Cost or depreciated revalued amount Impaired if carrying value > recoverable amount Calculate a revised carrying amount. Revised carrying amount The Indications of impairment External indicators – a fall in the market value of the asset – material adverse changes in regulatory environment – material adverse changes in markets – material long-term increases in market rates of return used for discounting. Internal indicators – material changes in operations – major reorganisation – loss of key personnel – loss or net cash outﬂow from operating activities if this is expected to continue or is a continuation of a loss-making Accounting treatment of impairment losses Asset not previously revalued – income statement Asset previously revalued – revaluation surplus Allocation of impairment losses: First, reduce any goodwill in Cash Generating Unit(CGU) Then, CGU’s other assets on a pro rata basis No asset reduced below net selling price, value in use or zero. Example of the allocation of an impairment loss Recoverable amount is GH¢150,000 of a cash generating unit with the following assets: GH¢ Goodwill 70,000 Intangible assets 10,000 PPE 100,000 Inventory 40,000 Receivables 30,000 250,000 The review estimates for the example that The PPE includes a property with a carrying amount of GH¢60,000 and a market value of GH¢75,000. The net realisable value of the inventory is greater than its carrying values. None of the receivables are considered doubtful. Table to show the allocation of the impairment loss Pre- impairment Impairment Post-impairment GH¢ GH¢ GH¢ Goodwill 70,000 (70,000) Nil Intangible assets 10,000 (6,000) 4,000 PPE 100,000 (24,000) 76,000 Inventory 40,000 Nil 40,000 Receivables 30,000 Nil 30,000 250,000 (100,000) 150,000 Notes to table The impairment loss is ﬁrst allocated against goodwill. After this has been done GH¢30,000 (GH¢100,000 − GH¢70,000) remains to be allocated. No impairment loss can be allocated to the property, inventory or receivables because these assets have a recoverable amount that is higher than their carrying value. The remaining impairment loss is allocated pro- rata to the intangible assets (carrying amount GH¢10,000) and the plant (carrying amount GH¢40,000 [GH¢100,000 − GH¢60,000]). Illustration: value in use calculation £ £ £ (£) £ Illustration – revised carrying amount GH¢ Carrying amount as at 31 December 20X3 114,500 Net realisable value 70,000 Value in use 100,565 Revised carrying amount 100,565 Published accounts – British Sky example Tangible ﬁxed assets – British Sky Broadcasting Group plc Published accounts – British Sky example (Continued) Tangible ﬁxed assets – British Sky Broadcasting Group plc Discussion Explain the effect of revaluation on ratios. Explain three factors that could lead to revision of estimate of useful economic life. Explain why depreciation policies may make intercompany comparison of ROCE and EPS misleading. Discussion (Continued) What are the arguments in favour of the diminishing balance method? Why is it thought that the annuity method is theoretically more attractive? Explain why IAS 23 benchmark treatment is the preferred treatment. Review questions 1.Deﬁne PPE and explain how materiality affects the concept of PPE. 2.Deﬁne depreciation. Explain what assets need not be depreciated and list the main methods of calculating depreciation. 3.What is meant by the phrases ‘useful life’ and ‘residual value’? 4.Deﬁne ‘cost’ in connection with PPE. 5.What effect does revaluing assets have on gearing (or leverage) ? Review questions (Continued) 6.How should grants received towards expenditure on PPE be treated? 7.Deﬁne an investment property and explain its treatment in ﬁnancial statements. 8.‘Depreciation should mean that a company has suﬃcient resources to replace assets at the end of their economic lives’. Discuss. End of lecture Thank you! Any comments/questions? Remember my contacts email: [email protected] mobile: 0266225129 Oﬃce: G13 LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Department of Distance Education Session 7 LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) IFRS 5 Non-current assets held for sale and Discontinued Operations Objective: To explain the meaning of the term and account for ‘discontinued operations’ in accordance with in IFRS 5 Non- current assets held for sale and Discontinued Operations prepare ﬁnancial statements applying IFRS 5; discuss the impact of such operations on the statement of comprehensive income; explain the criteria laid out in IFRS 5 that need to be satisﬁed before an asset (or disposal group) is classiﬁed as ‘held for sale’; Discontinued operations Discontinued deﬁned A discontinued operation is one that either has been disposed of; or is classiﬁed as held for sale and also Represents a separate major line of business or geographical area of operations as reported in accordance with IFRS 5. Is part of a single coordinated plan to dispose of a separate major line of business, or geographical area of operations, or is a subsidiary acquired exclusively with a view to resale. Discontinued operations (Continued Deﬁnition of held for sale IFRS 5 deﬁnes as held for sale If the carrying amount will be recovered principally through a sale transaction rather than through continuing use. It must be available for immediate sale in its present condition and its sale must be highly probable. Discontinued operations (Continued) Highly probable – criteria Management must be committed to a plan to sell. An active programme started to locate a buyer. Actively marketed for sale at a price that is reasonable in relation to current fair value. Sale should be expected to be completed within a year. It is unlikely that signiﬁcant changes to the plan will be made or that the plan will be withdrawn. Disclosure for discontinued operations Disclosure in the year of disposal Total on the face of the income statement of the post-tax proﬁt or loss; and the post-tax gain or loss recognised on the measurement to fair value less cost to sell. An analysis of the total proﬁt/loss into the revenue, expenses, pre-tax proﬁt/loss and tax. The net cash ﬂows attributable to the operating, investing and ﬁnancing activities. Discontinued operations presentation Discontinued operations A layered treatment is required by IFRS 5 which requires the results of continuing and discontinued operations to be disclosed separately. It is necessary to identify the revenue, cost of sales and expenses that relate to the bottling operation in arriving at the operating proﬁt. SESSION 2 IAS 2: INVENTORY LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) Department of Distance Education ACCT 301: Financial Reporting 1 Lecture 8 Lectu LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) IAS 40: Investment Properties LECTURER: C. AGYENIM-BOATENG (PhD, MSc, BSc, FCCA) IAS 40 – Objective and Scope IAS 40 identiﬁes what an investment property is, how it differs from property, plant and equipment (owner-occupied property); and what recognition, measurement and disclosure standards apply to investment properties 3 IAS 40 – Objective and Scope Investment property is deﬁned as: property held to earn rentals or for capital appreciation or both, rather than for (a) use in the production or supply of goods or services or for administrative purposes; or (b) sale in the ordinary course of business Examples of investment property: [IAS 40.8] land held for long-term capital appreciation land held for undetermined future use building leased out under an operating lease vacant building held to be leased out under an operating lease 4 property that is being constructed or developed for future use as investment IAS 40 – Objective and Scope The following are not investment property and, therefore, are outside the scope of IAS 40: [IAS 40.5 and 40.9] property held for use in the production or supply of goods or services or for administrative purposes property held for sale in the ordinary course of business or in the process of construction of development for such sale (IAS 2 Inventories) property being constructed or developed on behalf of third parties (IAS 11 Construction Contracts) owner-occupied property (IAS 16 Property, Plant and Equipment), including property held for future use as owner-occupied property, property held for future development and subsequent use as owner-occupied property, property occupied by employees and owner-occupied property awaiting disposal property leased to another 5 entity under a ﬁnance lease IAS 40 - Recognition Investment property is recognized as an asset when: - it is probable that its future economic beneﬁts will ﬂow to the entity, and - its cost can be measured reliably 6 IAS 40 – Measurement at Recognition Investment property is recognized initially at cost – applying the cost model of IAS 16 Property, Plant and Equipment – including what is capitalized in cost and the principles for non-monetary transactions Leased investment property is measured according to IAS 17 Leases 7 IAS 40 – Measurement after Recognition After initial recognition, an entity has a choice of methods to account for investment property: - Fair value model (FVM), or - Cost model (CM) Must apply one model to all of its investment property 8 IAS 40 – Measurement after Recognition Fair value model (FVM): - Assets are measured at fair value - Changes in fair value are recognized in proﬁt or loss in the period of change - No depreciation is recorded - Fair values continue to be used even if diﬃcult to measure reliably 9 IAS 40 – Measurement after Recognition Fair value: Price at which property could be exchanged between knowledgeable, willing parties in an arm’s length transaction, without any special concessions or deductions for transaction costs Best evidence is current prices in an active market for similar property in the same location and condition If not available, other methods can be used to determine 10 IAS 40 – Measurement after Recognition FVM example: Investment property is acquired August 11, 2013, at a cost of GhC200, 000. Fair values: December 31, 2013 - GhC190,000 December 31, 2014 - GhC198,000 December 31, 2015 - GhC205,000 11 IAS 40 – Measurement after Recognition FVM example: DR CR Dec.31/13 Loss in value GhC10,000 Investment property GhC10,000 Dec.31/14 Investment property GhC 8,000 Gain in value GhC 8,000 Dec.31/15 Investment property GhC 7,000 Gain in value GhC 7,000 12 IAS 40 – Measurement after Recognition Cost model (CM) - Applies cost model described in IAS 16 - Assets reported at cost less accumulated depreciation and accumulated impairment losses - Depreciation expense recognized each period 13 IAS 40 – Transfers Change in Use Circumstances Accounting From Investment Owner occupies or Deemed cost in IAS 16 or Property to owner- begins to develop the IAS 2 is Fair Value at the occupied or to inventory property for sale date of change in use From owner-occupied End of owner- Depreciate to the date of property – IAS 16 to occupation change in use. The investment property Fair difference between Value Model in IAS 40 carrying amount (Net Book Value) and Fair Value is accounted for 14 according to the IAS 40 – Transfers Change in Use Circumstances Accounting From Inventory in IAS 2 Owner enters into Difference between IAS to Investment Property operating lease with a 2 carrying amount and Fair Value Model in IAS third party IAS 40 Fair Value is 40 recognised in Income Statement In progress Investment Owner ﬁnishes Difference between Property Cost Model in construction or carrying amount and IAS 40 to Investment development Fair Value is recognised Property Fair Value in Income Statement Model in IAS 40 15 IAS 40 - Disclosures General disclosures: whether the FVM or the CM is applied if FVM, whether and when any operating leases are classiﬁed as investment property criteria used to distinguish between owner-occupied investment property and property held for sale where judgment is needed methods and assumptions underlying fair value measurements, including extent to which market-related evidence is used extent to which the fair values were determined by an experienced, professional, and independent appraiser existence of restrictions and contractual obligations related to the properties 16 Illustration 1  On 30th June, 2013, QRS Ltd acquired a site to construct a complex oﬃce building at a cost GH¢ 600,000. The complex structure is to be rented out to companies to be used as oﬃces. Construction started on 1st September, 2013 and was substantially completed on 30th June, 2014 at a cost of GH¢ 1, 000,000, at which stage, tenants could move in. The ﬁrst lease arrangement with tenants were signed on 1st October, 2014, but the building was not fully let until July, 2015.  Required: Describe the recognition and measurement of this property Suggested solution  The property was developed for future use as an investment property and should be recognized as such from 30th June , 2013 when the land was acquired. The ﬁnal cost of the asset should be measured at GH¢ 1,600,000 incurred up to 30th June, 2014 when the oﬃces were ready to be occupied. Costs incurred after this date should be recognized as an expense in income statement, even though the entity did not start to receive rentals until 1st October, 2014. Any losses incurred during this ‘idle’ period and up to the point the building is fully let are part of the entity’s normal business operations and do not form part of the cost of the investment property. Illustration 2 Scotty Ltd prepares accounts to 31st December. It acquired an administration block with an estimated useful life of 50 years at a cost of GH¢ 22 million on 1st January, 2010. The entity used the building for ﬁve years until 31st December, 2014, when it moved its oﬃce to a new building at the factory site. The building was reclassiﬁed as an investment property and leased out under a 40 year lease. The fair value of the building at 31st December, 2014 was GH¢ 24 million. As at 31st December, 2015, the fair value was GH¢ 24.4 million. Required: Explain the treatment of the building in 2015 ﬁnancial statements on the assumption that: (a) The entity uses the cost model for investment properties (b) The entity uses the fair value model for investment properties. Suggested solution (a) Cost model Until 31st December, 2014, the building should be recognized as property, plant and equipment under IAS 16. As it has 50 years useful life, it would have depreciated to 19.8million [ie. at 31st December, 2014, the building has a carrying amount of GH¢ 22million * 45/ 50 years = GH¢ 19.80 million] On 31st December, 2014, the property should be recognized as an investment property at its IAS 16 carrying amount of GH¢ 19.80 million and should continue to be depreciated over its remaining 45 year life. (b) Fair value model  Depreciate to the date of change in use. Therefore, at 31st December, 2014, the building has a carrying amount of GH¢ 19.80 million in accordance with IAS 16.  On 31st December, 2014, the building should be recognized as an investment property. The building should be revalued to fair value at 31st December, 2014. The difference between carrying amount (Net Book Value) and Fair Value is accounted for according to the revaluation model in IAS 16. Therefore, the building should be recognized at a carrying amount of GH¢ 24 million and the difference of GH¢ 4.20 million [GH¢ 24 million - GH¢ 19.8 million] should be recognized in other comprehensive income as a revaluation surplus. (b) Fair value model In subsequent periods (unless there is a further change in use, the building should be measured at fair value with any gain or loss recognized directly in income statement in accordance with IAS 40.  As at 31st December, 2015, the fair value was GH¢ 24.4 million. Therefore, a gain in value of GhC400,000 [GhC24.4million – GhC24million] should be recognised directly in income statement in accordance with IAS40 Disposals  An investment property should be derecognized: on disposal either through sale or creation of a ﬁnance lease. when the property is permanently withdrawn from use and no future economic beneﬁts are expected from its disposal.  Gains or losses, arising from retirement or disposal, represent the difference between the net disposal proceeds; and the carrying amount of the asset [in the case of cost model] and Fair Value [in the case of Fair Value Model  Gains or Losses should be recognized as proﬁts or losses respectively in the income statement in the period of that retirement or disposal. Illustration 3  ABC Ltd purchased an investment property on 1st January, 2012 at a cost of GH¢7 million, The property was estimated to have a useful life of 50 years with nil residual value. The company adopted fair value model for subsequent measurement. As at 31st December, 2014, it was fair valued at GH¢ 8.4 million. On Ist January, 2015, the property was disposed of for net proceeds of GH¢ 8million.  Required:  Calculate the proﬁt or loss on disposal under both the cost and fair value model. Suggested solution (a) Cost model GH ¢’m Net proceeds 8.00 Carrying amount (GH¢ 7m * 47/50) (6.58) Proﬁt on disposal 1.42 (b) Fair value model GH¢’ m Net proceeds 8.00 Carrying amount (8.40) Loss on disposal (0.40) END Thank you very much Oﬃce: G13 email: [email protected] mobile: 0266225129 WhatsApp: +447745808142

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