Advanced Reporting and Performance Study Guide PDF - ICAS 2024

Skills Advanced Reporting and Performance Study Guide (Modules 1-3) 2024 Contents How to use ARP Study Guides............................................................................................................ 2 Module 1 – Presentation and Disclosure............................................................................................ 3 Module 2 – Assets............................................................................................................................... 20 Module 3 – Liabilities.......................................................................................................................... 37 1 How to use ARP Study Guide Welcome to Part 1 of the Advanced Reporting and Performance Study Guide! As you will have discovered working through the Advanced Reporting and Performance Course, the course materials in the majority of topic areas, builds on the technical content introduced to you in Reporting and Performance 2. These ARP study guides have been designed to be used alongside the existing RP2 study guides. The study guides should be used as an aid to your studying of ARP, whilst working through the course and as a revision resource. They are not a substitute for working through the Advantage course. The ARP study guide has two parts. The first part covers the material in the first three modules. The second part covers the remaining modules and will be released at the same time as the remainder of the course content. 2 Module 1 – Presentation and Disclosure Introduction Welcome to the study guide for Module 1 of the Advanced Reporting and Performance course. This study guide will help you prepare for the assessment. Syllabus Learning Outcomes SLO1 Advise on the requirements for financial reporting and performance in accordance with relevant standards. Module Learning Outcomes By completing this module, you will have worked towards the following module learning outcomes: 1.1.1 Construct, with appropriate workings, the financial statements for an individual company. 1.3 Advise on the effect of transactions and adjustments on the financial statements of an individual company and of a group. This will be achieved by working towards the following performance indicators: 1.1.1 Construct a statement of financial position of a company in accordance with the formats contained in IAS 1 Presentation of Financial Statements and the requirements of IFRS 5 Non- current Assets Held for Sale and Discontinued Operations. 1.1.2 Construct a statement of profit or loss and other comprehensive income in accordance with the formats contained in IAS 1 Presentation of Financial Statements. 1.1.3 Construct a statement of changes in equity of a company in accordance with the formats contained in IAS 1 Presentation of Financial Statements. 1.1.5 Calculate basic earnings per share, including situations where share capital has changed during the period, calculate diluted earnings per share and construct the disclosure note for earnings per share. 1.1.7 Advise on disclosure notes in accordance with IFRS Accounting Standards for: Events after the reporting period. 1.1.8 Identify the related parties for a company. 1.1.9 Advise on appropriate related party transaction disclosure notes in accordance with IAS 24 Related Party Disclosures. 1.1.10 Construct the disclosure notes relating to directors' remuneration in accordance with the statutory requirements. 1.1.12 Advise on the main requirements for interim reports. 1.1.13 Advise on the accounting treatment for discontinued operations in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. 1.3.1 Advise on the effect of the following transactions and adjustments on the financial statements of an individual company: 1.3.1 Events after the reporting period. 1.3.5 Consider the different types of events after the reporting period and advise of the impact on the financial statements. You will be ‘assessment ready’ for questions in Module 1 when you can confidently complete each set of the learning outcomes above. 3 Using Permitted Materials For ARP assessment you are allowed the following permitted materials: IFRS Accounting Standards and Extract from Companies Act 2006. You are allowed to highlight, tab, sideline and underline these materials, but you are NOT allowed to write on the materials. You should ensure that you practice using these materials throughout the ARP course. IFRS A book includes the accounting standards and in Advantage the RP2 course will provide references to the specific paragraphs in standards. IFRS B Book includes Illustrative Examples (IE) and Illustrative Guidance (IG) in relation to the accounting standards. It is not expected that you will need to heavily rely on the permitted materials in the ARP assessment and doing so might create additional time pressure. It’s important to go into the assessment understanding what is in the permitted materials and when it be useful. What are the main requirements of the Conceptual Framework for Financial Reporting? What are the main requirements of IFRS 13 Fair Value Measurement? You learnt all about the Conceptual Framework for Financial Reporting and IFRS 13 Fair Value Measurement at Reporting and Performance 2 and should utilise the RP2 Study guide for this content. How would you construct a statement of financial position, a statement of profit or loss and other comprehensive income as well as a statement of changes in equity in accordance with IAS 1 Presentation of Financial Statements? In Reporting and Performance 2, you learnt about the list of financial statements required by IAS 1. You are already familiar with the layout for SPLCOI and SOFP as per IAS 1, however at ARP you will note additional line item for Non-Current assets classified as Held for Sale, as requirement of IFRS 5 Non-current Assets Held for Sale and Discontinued Operation. We will come back to Discontinued operations later in this study guide. Remember, Items that are classified as OCI are transferred to components of equity in the same way that profit or loss is transferred to retained earnings in equity IAS 1 requires the items of OCI to be presented separately from profit or loss and to be classified based on whether: They will be subsequently reclassified (‘recycled’) to profit or loss if certain conditions are met. − For instance, gains and losses on foreign currency translation adjustments may be reclassified to profit or loss on the sale or liquidation of a foreign operation, or gains and losses on certain classifications of financial assets are reclassified to profit or loss when the asset is disposed of (covered in Module 5). They will not be reclassified (‘recycled’) subsequently to profit or loss. − For instance, gains or losses on property revaluation (this will be explored in Module 2). 4 The main purpose of reclassification is to ensure that items affecting the entity's financial performance are ultimately recognised in the profit or loss in the period in which they are realised, avoiding the double counting of gains and losses when they are recognised in OCI and subsequently realised. Be careful when reading the requirements in the ARP assessment to identify whether other comprehensive income is required. Some questions will ask for the statement of profit or loss only, in which case OCI is not needed. Don’t waste your time by including OCI if it is not asked for. When items of income or expense are material, an entity shall disclose their nature and amount separately, either on the face of the statement or in the notes. Circumstances that would give rise to the separate disclosure of items of income and expense include: The SOCIE is essentially a table of the movements during the year for each item in equity showing: Total comprehensive income for the period, separately the total amounts attributable to owners of the parent and to non-controlling interests For each component of equity, the effects of retrospective application or retrospective restatement recognised in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors For each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately (as a minimum) disclosing changes resulting from: − Profit or loss − OCI − Transactions with owners in their capacity as owners An entity shall present, either in the statement of changes in equity or in the notes, the amount of dividends recognised as distributions to owners during the period and the related amount of dividends per share. [Refer to your IFRS Standards, B Book, IAS 1 IG for examples] 5 What are the main requirements for interim reports? The Listing Rules applicable to the London Stock Exchange mandate specific requirements for interim reports. Although IAS 34 does not mandate which entities should prepare interim reports, in practice, only listed companies are required to prepare these statements in the UK. Efficient markets require regular and relevant information. Publicly traded entities are encouraged to: [IAS 34, 1] Provide interim reports at least at the end of the first half of the financial year. Make interim reports available no later than 60 days after the end of the interim period. The Listing Rules require publication within 3 months of the end of the reporting period. Basis for preparation The interim period should be treated as a separate accounting period and not just half of the full year. This means that financial figures, such as revenue, are reported based on actual figures for the 6-month period, not estimated from annual projections. The same principle applies to expenses. However, for items that are typically calculated on an annual basis, such as taxation or volume-based supplier discounts, these should be included in the interim report proportionally, based on anticipated annual totals. Throughout this process, the company’s standard accounting policies should be consistently applied. Content: At a minimum, the interim report should contain: Comparative figures should also be given. What are the criteria applied in the selection and change of accounting policies? You should consult the RP2 Module 1 Study Guide for selection and change of accounting policies. 6 What are the different types of events after the reporting period? You should refer to RP2 Module 1 Study guide for Events After the Reporting Period. The Advanced Reporting and Performance assessment might require you to analyse a scenario and ascertain whether events occurred after the end of the reporting period. You will not always be told in the scenario or requirement that an event is after the end of the reporting period and instead must pay attention to dates. If an event is after the end of the reporting period, you’ll need to determine how it should be accounted for or disclosed. How would you disclose events that took place after the reporting period in the financial statements? The following should be disclosed: How do we define a discontinued operation? The Conceptual Framework prioritises relevance in financial statements, which should predict or confirm future performance. Users should distinguish ongoing and discontinued operations. Companies must meet strict criteria to classify operations as discontinued, preventing manipulation for better profit presentation. Several criteria must be met before an operation can be classified as discontinued. 7 Discontinued operations can include assets to be abandoned, but only if these meet the criteria. The results and cash flows of the asset are treated as discontinued in the year the operations cease but not before, even though closure may be announced well in advance. [Held for sale assets also covered by IFRS 5 were covered in RP2 Module 2 and covered further in in Module 2 of ARP]. In the ARP assessment, don’t expect to be directly told that a component meets the definition of a diued operation. You may be expected to arrive at that conclusion based on the information provided in the scenario.How do we present and disclose a discontinued operation? The presentation and disclosure requirements for discontinued operations are as follows: The net cash flows relating to discontinued operations also must be disclosed. Comparative figures should be restated so that operations that are classified as discontinued in the current year are also classified as discontinued in the comparative figures. 8 Similarly, if an operation that was previously classified as discontinued will no longer be discontinued (e.g. because a buyer has not been found), the comparatives should be re-presented. [Refer to IFRS B Book, IAS 1 IG illustrating financial statements with discontinued operations included.] How do we calculate earnings per share? Earnings per share (EPS) fundamentally represents the annual profit divided by the total number of issued shares. It is prominently disclosed on the statement of profit or loss and other comprehensive income and demonstrates the year's profit attributable to equity shareholders, expressed as pence per share. Basic EPS: When calculating the number of shares you should do the following: 9 Issue of bonus shares In the case of a bonus share issue (also known as a ‘capitalisation’ issue), shareholders receive additional shares at no cost. Since these shares do not correspond to an inflow of new resources for generating ‘earnings’, time weighting is not applicable. Accordingly, bonus shares are considered as if they had been issued at the beginning of the earliest period that is being reported. Rights issue and adjustment factor In a rights issue, shares are offered to current shareholders at a price lower than the prevailing market value. Consequently, the issuing company receives consideration, though not equal to the full market value. Being a ‘hybrid’ between a full market issue and a bonus share issue, the calculations required for a rights issue are designed to mirror this unique characteristic. Adjustment factor The bonus adjustment factor is calculated as: 10 To deal with a rights issue, you should use the following approach: Diluted earnings per share Certain financial instruments may lead to the issuance of ordinary shares at a future date, commonly referred to as potential ordinary shares. These include instruments such as: Convertible debt or preference shares Share options or warrants Diluted EPS is calculated as: It is important to emphasise that when calculating diluted EPS, we must take into account both the earnings figure (nominator) and the number of shares (the denominator) as both are affected by the potential dilution. This contrasts with the basic EPS calculation, where we only need to adjust the denominator. You should note that diluted EPS is a ‘worst case scenario’ calculation of basic EPS on the assumption that all dilutive potential ordinary shares have been issued in the period. You must always choose the most dilutive option. 11 Share options Share options and similar instruments result in the issue of shares at a given exercise price 12 What are the disclosure requirements for companies under IAS 33? How do we identify a related party? A related party is a person (individual) or entity that is related to the entity that is preparing its financial statements (‘the reporting entity’). Person related to the reporting entity A person or a close member of that person’s family is related to the reporting entity if that person: Has control or joint control of the reporting entity Has significant influence over the reporting entity Is a member of the key management personnel of the reporting entity or of a parent of the reporting entity Please note that a close family member of a person who may be expected to influence, or be influenced by, that person in their dealings with the entity could be: That person’s children and spouse or domestic partner Children of that person’s spouse or domestic partner Dependants of that person or that person's spouse or domestic partner You should also note that key management personnel are those persons who have authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (executive or non-executive). Effectively, key management personnel can be individuals or an entity. 13 The individual and close family member are related to the reporting entity (and also the parent company). Entity related to the reporting entity An entity is related to a reporting entity if any of the following conditions apply: Members of the same group are related The associate or joint venture is related to the investor and any other group member 14 The joint ventures are related to each other The joint venture and associate are related to each other A reporting entity is related to its pension plan The reporting entity and the second entity are related (I) 15 The reporting entity and the second entity are related (II) The reporting entity and the second entity are related (III) If a related party is defined in terms of an associate or a joint venture, this definition also applies to the subsidiaries of an associate or joint venture. This approach emphasises the importance of considering the substance of a relationship over their legal form. Parties that are not related IAS 24 specifies that the following are not related: Two entities − Simply because they have key management personnel in common, or − Simply because a member of key management personnel of one has significant influence over the other Two joint venturers − Simply because they share joint control over a joint venture An entity and providers of finance, trade unions, public utilities or government departments − In the course of normal dealings An entity and a customer, supplier, franchisor, distributor or agent − Simply by virtue of economic dependence due to the volume of trade carried out 16 What are the disclosure requirements for companies under IAS 24? There are three categories of disclosure: Group relationships − Disclosure is mandatory for relationships between parent companies and their subsidiaries, regardless of the presence or absence of actual transactions between them. − It is essential to disclose not only the name of the parent entity but also, if it differs, the name of the ultimate controlling party. Related party transactions − Information about transactions and balances − Nature of related party relationship Management compensation − Key Management personnel (KMP) compensation disclosed by type: short term benefits (Salary), pension contributions, other long-term benefits, termination benefits, share- based payments What are the disclosure requirements of the Companies Act 2006 relating to directors’ remuneration? The companies Act 2006 determines company sizes when the company meets the qualifying conditions in a year when it fulfils at least two of the following conditions: Condition Micro Small Medium Large Not more than Not more than Not more than Turnover (revenue) £632,000 £10.2m £36m Thresholds not Balance sheet total (the Not more than Not more than Not more than provided but aggregate of amounts £316,000 £5.1m £18m anything above shown as assets) medium Average number of Not more than Not more than Not more than employees 10 50 250 You do not need to memorise these thresholds as an extract of the Companies Act 2006 will be provided in the ARP assessment if it is relevant. We will address the disclosure applicable to unquoted companies only. 17 The following diagram summarises the information required about directors’ remuneration. Details of highest paid director This specific disclosure requirement is NOT REQUIRED for small or micro entities. Compensation for loss of office and from subsidiaries should be disclosed. Note that amounts paid through joint ventures and associates are not included. 18 Study guide checklist Have you completed reading module 1? Have you completed the skills checkers and skills builders? Can you confidently complete the module learning outcomes listed on this module? Can you confidently answer the guiding questions? Have you completed the assessment practice questions? Have you used the discussion board to ask questions on areas you are unsure about? 19 Module 2 – Assets Introduction Welcome to the study guide for Module 2 of the Advanced Reporting and Performance course. This study guide will help you prepare for the assessment. Syllabus Learning Outcomes SLO1 Advise on the requirements for financial reporting and performance in accordance with relevant standards Module Learning Outcomes By completing this module, you will have worked towards the following module learning outcomes: 1.1 Construct, with appropriate workings, the financial statements for an individual company 1.3 Advise on the effect of transactions and adjustments on the financial statements of an individual company and of a group This will be achieved by working towards the following performance indicators: 1.1.6 Construct disclosure notes in accordance with IFRS Standards for: Property, plant and equipment Investment property Non-current assets held for sale Intangible assets Impairment of non-current assets Advise on disclosure notes in accordance with IFRS Accounting Standards for: Inventories 1.3.1 Advise on the effect of the following transactions and adjustments on the financial statements of an individual company Property, plant and equipment Investment property Non-current assets held for sale Intangible assets Impairment of non-current assets Inventories You will be ‘assessment ready’ for questions in Module 2 when you can confidently complete each set of the learning outcomes above. 20 How are inventories measured and what is included in the cost of inventories? Inventories should be measured on a line-by-line basis i.e. each product line should be measured rather than inventories as a whole. The cost to purchase inventories includes: Purchase price less any discounts Import duties and other non-recoverable taxes Transport, handling and other costs. Costs of conversion include: Direct costs (for example, labour and materials) An allocation of fixed production overheads, based on normal production capacity (for example, depreciation of production machinery, the cost of factory management and administration) An allocation of variable production overheads, based on actual production levels, for example, supervisors’ salaries). Other costs are other costs incurred in bringing inventories to their present location and condition, for example: The costs of designing products specific to a customer Borrowing costs in some situations (IAS 23, see Lesson 5). Selling price should be based on sale in the ordinary course of business. The following costs are not part of the cost of inventories and should be recognised as an expense in profit or loss as incurred: Wasted materials and labour and other abnormal production costs Storage costs, unless storage is a necessary stage in the production process Administrative overheads that are not relevant to bringing inventories to their present location and condition Selling costs. 21 How is a write-down or reversal of inventories recognised? In Advanced Reporting and Performance scenarios, you should look out for indicators that the NRV of inventories may have fallen below cost so that you can provide relevant accounting advice. Indicators may include: A fall in selling price due to adverse market conditions Physical deterioration of inventories Product obsolescence A marketing strategy decision to sell some products at a loss Errors in production or purchasing An increase in costs to complete and sell goods. The journal entry for a write down is: Account name £ £ Dr SPL - inventory write-down (COS) X Cr Inventories (SOFP) X Being the write-down of inventory to NRV Any subsequent reversal of a write-down, before the inventories are sold, is recognised in profit or loss as a reduction to cost of sales. What approximations and assumptions are used when measuring closing inventories? Refer to RP2 study guide for determining the cost of inventories including standard cost, retail cost. You are also aware from RP2 That inventories are measured at the lower of Cost and NRV. How are inventories presented and disclosed? Refer to RP2 Module 2 Study guide for how inventories are presented and disclosed in SOFP, SPLOCI, SOCF and the notes to the financial statements. In Advanced Reporting and Performance, you may be required to advise on the disclosure requirements for inventories; however, you will not be required to prepare a detailed disclosure note. How does IAS 2 interact with other IFRS Accounting Standards? Inventories is a non-complex area of accounting, and in Advanced Reporting and Performance if an assessment question involves inventories, it is also likely to test other IFRS Accounting Standards. IAS 16 Property, Plant and Equipment (IAS 2.12, IAS 16.48) IAS 2 requires that an allocation of fixed production overheads are included in the cost of inventories and IAS 16 states that depreciation may be included in the carrying amount of another asset. You may be required to apply IAS 16 in order to calculate the depreciation charge relating to production machinery for inclusion in the cost of inventories. 22 IAS 40 Investment Property (IAS 40.9) Depending on the circumstances, property may be classified as investment property, owner-occupied property or inventories. In an Advanced Reporting and Performance scenario, you may be required to analyse the facts and apply the definitions provided in IAS 40 Investment Property, IAS 16 Property, Plant and Equipment and IAS 2 Inventories in order to determine how a property is classified and apply relevant accounting treatment. IAS 23 Borrowing costs (IAS 2.17, IAS 23.7) If inventories take a substantial period of time to manufacture or produce, they are a qualifying asset for the purposes of applying IAS 23 and eligible borrowing costs should be recognised as part of the cost of the inventories. Inventories that are produced over a short period of time are not a qualifying asset and borrowing costs must be recognised as an expense. ‘Substantial period of time’ and ‘short period of time’ are not defined, and judgement is required when deciding whether inventories are qualifying assets. In an Advanced Reporting and Performance scenario you may be required to advise on the recognition of borrowing costs as part of the cost of inventories or calculate relevant amounts. IAS 10 Events After the Reporting Period (IAS 10.9) IAS 2 requires that inventories are measured at the lower of cost and NRV. IAS 10 states that the sale of inventories after the reporting date provides evidence of their selling price, and so NRV at the reporting date. If a sale after the reporting period indicates that NRV is less than cost, inventories should be written down to NRV in the SOFP at the reporting date. Damage to inventories after the reporting date is a non-adjusting event; however it requires disclosure if the financial effect is material. In the ARP assessment, you won’t necessarily be told that an event is after the end of the reporting period. Instead, you need to read the scenario carefully, paying attention to the dates, to determine the appropriate accounting treatment. IAS 19 Employee Benefits and IFRS 2 Share-based Payment (IAS 2.12, IAS 19.11,51, IFRS 2.8-9) IAS 2 requires that costs of conversion, which may include direct labour costs, indirect labour costs and management and administrative labour costs, are included in the cost of inventories. Labour costs include costs associated with all employee benefits, including wages, salaries, pensions and share-based payments. IAS 19 and IFRS 2 require that these costs are recognised in profit or loss unless they are included in the cost of an asset. In an Advanced Reporting and Performance question you may be required to advise on the measurement of inventories or calculate amounts to be included as part of the cost of inventories by applying IAS 19 or IFRS 2. 23 IFRS 15 Revenue from Contracts with Customers (IFRS 15.95) As well as providing guidance on the recognition and measurement of revenue, IFRS 15 considers the accounting treatment applicable to costs to fulfil contracts with customers. It states that any costs to fulfil a contract that are within the scope of another IFRS Accounting Standard should be dealt with by applying that Standard. In a revenue scenario in an Advanced Reporting and Performance assessment question you may therefore be required to apply IAS 2 to account for the costs of inventories purchased to fulfil a customer contract. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors A change from the FIFO to the AVCO inventories assumption (or vice versa) is a change in accounting policy. In an Advanced Reporting and Performance question you may be required to advise on the accounting required for such a change, or to prepare extracts from the financial statements. When should an item of PPE be recognised and how should PPE be measured at initial recognition? Refer to RP2 Module 2 Study guide about initial recognition of PPE. How should PPE be measured subsequent to initial recognition? Refer to RP2 Module 2 Study guide about subsequent measurement of PPE including cost model and revaluation model and impairment of PPE. How is PPE depreciated and derecognised? You are already familiar from both RP1 and RP2 how to depreciate PPE and the recognition journal. However, some further scenarios to be familiar with at ARP are listed below: Complex asset depreciation (IAS 16.43) Each component of a complex asset should be depreciated separately over their own useful lives; at the end of this period, when the component is replaced, it should be derecognised, and the cost of the new component recognised. Depreciation and derecognition of revalued assets (IAS 16.41) When an asset is revalued, future depreciation charges are calculated by spreading the revalued amount (less any residual value) over the remaining useful life of the asset. In the case of an upwards revaluation this will result in an increase to the depreciation charge to profit or loss. The excess of this amount over the historical cost depreciation charge is viewed as a realisation of the revaluation surplus and can be transferred from the revaluation surplus to retailed earnings. Advanced Reporting and Performance assessment questions will indicate whether you are expected to make this transfer. When the revalued asset is ultimately disposed of any remaining revaluation surplus is realised and can be transferred to retained earnings. These transfers do not affect OCI and are presented as a direct reserves transfer in the SOCIE. 24 Recognition of depreciation as an asset (IAS 16.48-49) Although depreciation is usually recognised in profit or loss, remember that it may be included in the cost of another asset, for example: If a machine is used to produce inventories, the machine’s depreciation is a fixed production overhead and is allocated to inventories as a cost of conversion (IAS 2). If laboratory equipment is used to develop a new medicine, the equipment’s depreciation is included in the cost of the development asset when IAS 38 recognition criteria are met. Review of depreciation estimates (IAS 16.51,61) Depreciation estimates include residual value, useful life and depreciation method. These should be reviewed at least at each reporting date, and any changes should be applied prospectively, as a change in accounting estimate, in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Where an impairment test has taken place, even if there is no impairment loss, it is appropriate to review depreciation estimates. Depreciation method (IAS 16.60, 62A) IAS 16 requires the use of a depreciation method that reflects the consumption of an asset’s future economic benefits. Although it is usual to use the straight-line or diminishing balance method, other methods are also permitted. IAS 16 does, however, prohibit the use of a depreciation method that reflects revenue patterns, because revenue reflects factors other than the consumption of an asset’s future economic benefits (for example, it reflects general economic recession and changes in customer demand). Sale and leaseback In an Advanced Reporting and Performance scenario question, a disposal of PPE may take the form of a sale and leaseback transaction. In this case, the PPE is not always derecognised. IFRS 16 provides guidance on the accounting treatment to be applied here and this is covered in the module on liabilities. How is PPE disclosed in the financial statements? In Advanced Reporting and Performance, you may be required to prepare disclosure notes related to PPE. This is something that you were also required to be able to do in Reporting and Performance 2. SOFP The carrying amount of PPE is presented as a single line item (as a minimum). Some companies disclose separate categories of PPE in the SOFP. This is acceptable as there is no ‘maximum disclosure’. The revaluation surplus is presented in equity SPLOCI The depreciation expense for the year and any impairment losses (downwards revaluation) recognised in the year are presented in the SPL. They may be included in any operating expense category. If material, an impairment loss may be disclosed separately in the SPL. Any revaluation surplus in the year is presented in OCI as an amount that will not be reclassified to profit or loss. 25 Notes to the financial statements The following disclosures should be made for each class of PPE: The selected measurement basis (cost model or revaluation model) Accounting estimates including depreciation model, residual value and useful life Gross carrying amount and depreciation at the start and end of the period A reconciliation of carrying amount at the beginning and end of the period (usually shown in the form of a ‘PPE table’, which also includes the gross carrying amount and depreciation at the start and end of the period) In addition disclosure should be made of: PPE pledged as security for liabilities The cost of assets in the course of construction included in PPE Contractual commitments to buy PPE For revalued assets the following should be disclosed: The date of the revaluation Whether an independent valuer was involved The historical cost carrying amount at the reporting date (this allows for comparison with companies that do not adopt a revaluation policy). What is investment property? Refer back to RP2 Module 2 Study guide about Investment Property definition. In Advanced Reporting and Performance, you may be required to analyse information provided in order to conclude whether a property meets the definition of investment property. This is a judgemental area, and it is important that you understand the requirements of IAS 40 Investment Property and can apply them to the scenario. You may then be required to advise on relevant accounting treatment, including the initial and subsequent measurement of investment property, accounting for transfers into and out of the investment property category and the presentation and disclosure of investment property. Application of the definition of investment property requires judgement, and IAS 40 provides additional guidelines that are relevant to some common scenarios. Property rented to employees Property rented to employees is not investment property. Even if employees are charged market rentals, any property that they occupy is owner-occupied and IAS 16 applies. Property owned by a group company and rented to another company in the same group The property is investment property in the separate financial statements of the company that owns it and IAS 40 applies. From a group perspective, the property is owner-occupied and IAS 16 applies in the consolidated financial statements. 26 Property that is part investment property and part owner-occupied If the separate parts could be sold separately, each part is accounted for separately by applying IAS 40 and IAS 16 respectively. Otherwise, the property is accounted for by applying a single IFRS Accounting Standard. IAS 40 is only applied if the portion that is owner-occupied is ‘insignificant’ which is not defined. IAS 40 also discusses scenarios in which property is rented to other parties and ancillary services are provided to those parties. Ancillary services are additional services that are provided over and above the basic service of providing rental space, for example maintenance or reception services. IAS 40 concludes that: If ancillary services are significant to the arrangement as a whole, the property is owner-occupied and IAS 16 applies. For example: an owner-managed hotel in which reception, cleaning, concierge etc services are provided. If ancillary services are insignificant to the arrangement as a whole, the property is investment property and IAS 40 applies. For example: an office building in which security and maintenance services are provided by the building owner. 27 How is owned or leased investment property initially and subsequently measured? If the investment property is owned, apply principles of IAS 16. If the investment property is held as a right – of use asset, recognise at commencement of lease, applying IFRS 16. In Reporting and Performance 2, you learnt that there is a choice of accounting policy for investment property after recognition. The chosen accounting policy must be applied to all investment property. Fair value is measured in accordance with IFRS 13 Fair Value Measurement. Companies are encouraged to use an independent, professionally qualified valuer. A change in policy is only permitted if it results in reliable and more relevant information. A change from the fair value model to the cost model is effectively prohibited because it is unlikely to result in more relevant information. IAS 8 must be applied where there is a change in policy. (See the module on presentation and disclosure for more on IAS 8.) If a company adopts the fair value model, IAS 40 provides additional guidance. Investment property held as a right-of-use asset (IAS 40.40A) When investment property is held as a right-of-use asset and is measured using the fair value model, the relevant fair value is that of the right to use the property, not the fair value of the underlying property itself. 28 Reliable measurement of fair value (IAS 40.53) IAS 40 includes a rebuttable presumption that the fair value of an investment property can be measured reliably on a continuing basis. If this is not the case the cost model of IAS 16 (for owned assets) or IFRS 16 (for right-of-use assets) should be applied instead. Double counting assets (IAS 40.50) When determining fair value a company must not double-count assets ie they are either included in the fair value of investment property or recognised as separate assets, but not both. For example, the following assets are usually included in the fair value of an investment property and so should not be recognised separately: Integral equipment such as an air conditioning or heating system Furniture, if the property is rented on a furnished basis. When is a change in accounting policy for investment property acceptable? IAS 40 does not promote the use of one measurement model over the other. It does, however, require that companies that apply the cost model disclose the fair value of their investment properties, and therefore avoidance of a fair value measurement exercise is not a valid reason to apply the cost rather than fair value model. When do transfers to and from investment property occur, and how are they accounted for? Refer to RP2 Module 2 study guide for transfers between Investment Property and Property, plant and equipment and how to account for these transfers. Investment property (IAS 40) to Owner-occupied property (IAS 16) Evidenced by the commencement of owner-occupation or commencement of the development of the property with a view to owner-occupation. Owner-occupied property (IAS 16) to Investment property (IAS 40) Evidenced by the end of owner-occupation. IAS 40 also addresses transfers between the investment property (IAS 40) and inventories (IAS 2) classifications, Evidenced by the commencement of development with a view to sale. − If investment property is measured using the cost model, the property’s previous carrying amount is its deemed cost for initial recognition under IAS 2. − If investment property is measured using the fair value model: o IAS 40 should be applied up to the date of change (with fair value remeasured at the transfer date). o The property’s initial measurement under IAS 2 is its fair value at the transfer date. o Subsequently IAS 2 measurement requirements apply and the property should be measured at the lower of cost and NRV. Inventories (IAS 2) to Investment property (IAS 40) Evidenced by entering into an agreement with another party to lease the property to them under an operating lease. − If investment property is measured using the cost model the property’s previous carrying amount is its deemed cost for initial recognition under IAS 40. − If investment property is measured using the fair value model: o At the date of transfer the property should be remeasured to fair value and any difference between carrying amount and fair value recognised in profit or loss. o The property’s initial measurement under IAS 40 is its fair value at the transfer date. 29 How is investment property presented and disclosed in the financial statements? SOFP: As a line item within non-current assets SPL: Include remeasurement gain or losses for properties measured using the fair value model and depreciation and impairment losses for properties measured using the cost model. In Advanced Reporting and Performance, you may be required to prepare disclosures related to investment property. Disclosures relevant to both measurement models Which measurement model is applied (the accounting policy) The extent to which the fair value of investment property is determined by an independent qualified valuer Amounts recognised in profit or loss in respect of: − Rental income − Direct operating expenses relating to property that is rented out (eg repairs and maintenance costs) − Direct operating expenses relating to property that is not rented out Disclosures relevant to the fair value model A reconciliation between the carrying amount of investment property at the start and end of the period, including: − Additions − Disposals and assets classified as held for sale − Gains or losses from remeasurement to fair value − Transfers to and from inventories and owner-occupied properties − Other changes Additional disclosures are also required about any investment that is measured using the cost model rather than the fair value model because its fair value cannot be measured reliably, including why this is the case. Disclosures relevant to the cost model The depreciation methods used Useful lives / depreciation rates The gross carrying amount and accumulated depreciation at the start and end of the period A reconciliation between the carrying amount of investment property at the start and end of the period, including: − Additions − Disposals and assets classified as held for sale − Depreciation − Impairment losses − Transfers to and from inventories and owner-occupied properties − Other changes The fair value of investment property. 30 What is the definition of an intangible asset and what criteria must be met in order to recognise a separately acquired and internally generated intangible asset? Refer to RP2 module 2 study guide for definition and recognition. In Advanced Reporting and Performance, you may be required to analyse a scenario and provide advice as to whether certain items of expenditure should be recognised as intangible assets. How is an intangible asset initially and subsequently measured? Refer to RP2 module 2 study guide for initial and subsequent measurement of intangible assets. In an Advanced Reporting and Performance scenario question you may be presented with a list of costs and required to determine which should be recognised as part of the cost of an intangible asset. If in doubt, think about the definition of an intangible asset and recognition criteria for an individual cost. What are the IAS 38 requirements for amortisation of an intangible asset? The mechanics of amortisation are similar to the mechanics of depreciation for PPE. In addition the following points may be relevant to Advanced Reporting and Performance questions, particularly if you are required to provide accounting advice: Indefinite life An intangible asset may have an indefinite life, in which case it is not amortised but It should be tested for impairment annually (IAS 36). Residual value The residual value of an intangible asset is generally zero unless: Another party is committed to buy the asset at the end of its useful life, or There is an active market for the asset and its residual value can be established by reference to this market. Contractual rights If an intangible asset arises from a contractual right (for example, a licence to operate in an area for a specific period of time), it is usually amortised over the period of the right, however: It may be amortised over a shorter period if that reflects expected use of the asset by the company It may be amortised over a longer period if there is evidence that the contractual right will be renewed without significant cost. Review As is the case for PPE, amortisation estimates (amortisation method, useful life and residual value) should be reviewed each year. This includes intangible assets that have an indefinite life, as this assessment might change. 31 How is an intangible asset presented and disclosed in the financial statements? Refer to RP2 Module 2 Study guide for disclosure in SOFP and SPL and notes to Financial statements. In Advanced Reporting and Performance, you may be required to prepare a disclosure note for intangible assets. This will usually take the form of a table that reconciles cost and accumulated amortisation at the start and end of the year. What borrowing costs are eligible to be capitalised as part of the cost of a qualifying asset and what assets are qualifying assets? During what period should borrowing costs be capitalised? How are eligible borrowing costs calculated and disclosed? Refer to RP2 Module 2 Study guide for Borrowing Costs. Remember: Qualifying assets are assets that necessarily take a substantial period of time to get ready for intended use or sale. In Advanced Reporting and Performance you are likely to have to deal with a number of IFRS Accounting Standards in one question. IAS 23 may be assessed alongside standards relating to both assets and liabilities. To what assets does IAS 36 apply? In Advanced Reporting and Performance you are likely to have to identify that an asset may be impaired, without expressly being told this in the question. It is therefore important that you know which assets fall within the scope of IAS 36 and what circumstances indicate that they may be impaired. IAS 36 applies to all assets other that those to which a more specific IFRS Accounting Standard applies. When should an asset be tested for impairment? Impairment reviews should be carried out when indicators of impairments exist or at least annually for Goodwill and assets with an indefinite useful life and intangible assets not yet ready for use. Indicators may exist from external information or internal information. 32 How is an impairment loss calculated and recognised? In Reporting and Performance 2, you learnt that an asset is impaired if its carrying amount exceeds its recoverable amount. You learnt how to calculate recoverable amount and how to recognise an impairment loss in relation to an individual asset measured using a cost model. Refer to RP2 Module 2 Study Guide. Impairment losses on PPE that is revalued (IAS 38.60) If property, plant and equipment is measured using the IAS 16 revaluation model, an impairment loss is not necessarily recognised in profit or loss. Instead it is recognised as a downwards revaluation. Therefore: Any amount of the loss that reverses a revaluation surplus on the same asset is recognised as a debit entry to OCI (and then reduces the revaluation reserve in equity). Any excess loss is recognised in profit or loss. How is an impaired asset subsequently measured (including reversals of impairment losses)? After an impairment is recognised, the new carrying amount of the asset should be depreciated over its remaining useful life. You should also consider whether the useful life and other depreciation estimates have changed. Even if no impairment loss is recognised, the fact that indicators of impairment were present for an asset may indicate that it is appropriate to revise depreciation estimates, such as useful life or residual value. Reversal of an impairment loss (IAS 36.110, 114) After an impairment loss has been recognised, it may be reversed at later reporting dates. A reversal of an impairment loss can only be recognised if there has been a change in estimates used to calculate recoverable amount. Recognise in profit or loss for an asset measured using the cost model. Recognise as a revaluation surplus for an asset measured using the revaluation model. After the reversal the carrying amount cannot exceed the carrying amount of the asset (after depreciation / amortisation) if it had not been impaired previously. What is a CGU and what assets and liabilities are included in a CGU? A CGU is: The smallest identifiable group of assets that generates cash flows that are largely independent of the cash flows generated by other assets. 33 How is a CGU tested for impairment? The CGU is impaired if carrying amount exceeds recoverable amount Recoverable amount is the higher of VU and FVLCOD Recognise an impairment loss in profit or loss (unless it represents a downwards revaluation) Additional considerations: What assets should be included in carrying amount of a CGU? − The carrying amount of assets that can be attributed to the CGU and that generate the future cashflows used to calculate VU should be included. − Assets such as receivables and financial assets are usually excluded because they generate independent cash flows. − Most liabilities (for example, loans) are settled independently of other cash flows and are excluded from a CGU. o The carrying amount of liabilities is only included in a CGU if the CGU’s recoverable amount cannot be determined without including them What if a particular asset is used by more than one CGU? − Assets that cannot generate their own cash flows but that contribute to the cash flows of more than one CGU are referred to in IAS 36 as ‘corporate assets’ − For the purposes of testing CGUs for impairment, the carrying amount of a corporate asset is allocated to the CGUs that it serves on a ‘reasonable and consistent’ basis How is the impairment loss allocated across the assets of the CGU? Goodwill (IAS 36. Appendix C1-C4) Sometimes a CGU is a subsidiary company and goodwill arose on the acquisition of that company. In this case: goodwill contributes to future cash flows and the overall value of the CGU and so is included in recoverable amount. goodwill should therefore be included in the carrying amount of that CGU. Remember that where a CGU includes goodwill it must be tested for impairment annually. How is an impairment loss or reversal of an impairment loss allocated to the assets of a CGU? IAS 36 requires that an impairment loss is allocated to the assets of a CGU in a specific order: Firstly, to goodwill. If the impairment loss is less than the carrying amount of goodwill, it will be fully absorbed by goodwill. If it is more than goodwill, some loss will remain to be allocated. Secondly, to the other assets of the CGU on a pro-rata basis in relation to their carrying amounts. An impairment loss should only be allocated to those assets of the CGU that are within the scope of IAS 36. Therefore no loss should be allocated to, for example, investment properties measured at fair value. In practice IAS 36 should be applied to individual assets of a CGU first where this is possible, before testing the CGU as a whole for impairment. In an Advanced Reporting and Performance question this is relevant if you are told about a CGU that includes an asset that is obviously impaired on an individual basis. For example, a machine that is used by a particular CGU may be broken down beyond repair. In this case you should allocate the impairment loss of the CGU to that asset in the first place. 34 Restrictions on the allocation of an impairment loss (IAS 36.105) When an impairment loss is allocated to the assets of a CGU, the carrying amount of an individual asset must not be reduced below: Its FVLCOD It’s value in use, if determinable Zero. Reversing an impairment loss in a CGU (IAS 36.122 -124) An impairment reversal can never be recognised in respect of goodwill. A reversal is allocated to the other assets of the CGU that are within the scope of IAS 36 on a pro-rata basis How are impairment losses disclosed in the financial statements? SPL and OCI disclosures (IAS 36.126,128) The following must be disclosed: Impairment losses / reversals recognised in profit or loss in the period and the SPL line item they are included in Impairment losses / reversals recognised in OCI in the period. These disclosures must be made by class of asset and may be presented in a PPE reconciliation note (or other similar notes for different types of asset). Additional information about an impairment loss / reversal (IAS 36.130) For an individual asset or CGU for which an impairment loss has been recognised or reversed in the period disclose: The events and circumstances leading to the impairment or reversal The amount of loss or reversal and how it is allocated to classes of assets in the case of a CGU A description of the nature of the asset or CGU (for example whether it is a product line or geographical area) The recoverable amount of the asset / CGU and whether this is VU or FVLCOD If recoverable amount is FVLCOD, a description of the technique used to measure FVLCOD If recoverable amount is VU, the discount rates applied in the calculation of VU Where a CGU includes an asset that must be tested annually (IAS 36.134) If a CGU includes goodwill or an intangible asset that has an indefinite useful life, and these are significant in relation to the company’s total recognised goodwill or intangible assets with an indefinite useful life, additional disclosures are required. This is the case even if no impairment loss or reversal is recognised. These are: The carrying amount of goodwill and intangible assets with indefinite useful lives that are allocated to the CGU Whether recoverable amount is VU or FVLCOD Assumptions and estimates used to calculate VU Assumptions and estimates used to calculate FVLCOD 35 To what assets does IFRS 5 apply? The classification and presentation requirements of IFRS 5 apply to all non-current assets. The measurement requirements apply to all non-current assets other than: Investment property measured using the fair value model (IAS 40) Deferred tax assets (IAS 12) Defined benefit pension assets (IAS 19) Financial assets (IFRS 9) When is a non-current asset classified as held for sale? Refer to RP2 Module 2 Study guide for when an NCA is classified as HFS. How is a non-current asset measured immediately before classification as held for sale, on classification and after classification and how are impairment losses recognised? Refer to RP2 Module 2 Study guide for when an NCA HFS measurement. How are non-current assets classified as held for sale presented and disclosed? Refer to RP2 Module 2 Study guide for when an NCA HFS disclosure. Study guide checklist Have you completed reading module 2? Have you completed the skills checkers and skills builders? Can you confidently complete the module learning outcomes listed on this module? Can you confidently answer the guiding questions? Have you completed the assessment practice questions? Have you used the discussion board to ask questions on areas you are unsure about? 36 Module 3 – Liabilities Introduction Welcome to the study guide for Module 3 of the Advanced Reporting and Performance course. This study guide will help you prepare for the assessment. Syllabus Learning Outcomes SLO1 Advise on the requirements for financial reporting and performance in accordance with relevant standards Module Learning Outcomes By completing this module, you will have worked towards the following module learning outcomes: 1.1 Construct, with appropriate workings, the financial statements for an individual company 1.3 Advise on the effect of transactions and adjustments on the financial statements of an individual company and of a group This will be achieved by working towards the following performance indicators: 1.1.6 Construct disclosure notes in accordance with IFRS Accounting Standards for: Leases Provisions Advise on disclosure notes in accordance with IFRS Accounting Standards for: Current Tax Deferred Tax Contingent Liabilities Contingent Assets 1.3.1 Advise on the effect of the following transactions and adjustments on the financial statements of an individual company: Leases Current Tax Deferred Tax Provisions Contingent Liabilities Contingent Assets You will be ‘assessment ready’ for questions in Module 3 when you can confidently complete each set of the learning outcomes above. 37 What is a lease contract? Refer to RP2 Study guide for what is a lease. In an Advanced Reporting and Performance assessment question, you may be presented with a scenario and asked to identify and apply relevant IFRS Accounting Standards. It is therefore important that you can identify those leases to which IFRS 16 does not apply. The following diagram summarises the approach to lessee accounting for leases that you learned in Reporting and Performance 2. In your ARP assessment you may be given details of a transaction in which one party obtains the use of an asset in exchange for consideration and may be required to determine whether it is a lease. In this case, you should state the definition of a lease and explain how it is applied to the identified transaction. What indicates that a company has the right to control the use of an asset? In order for a company to have the right to control the use of an asset it must have: 38 What is an identified asset? Factors relevant to determining whether there is an identified asset Supplier does not have a Explicitly or implicitly May be a portion of an asset substantive right to substitute identified in the contract if physically distinct the asset throughout the period of use Substance over form applies when identifying a lease: some arrangements do not take the legal form of a lease, but do meet the definition of a lease contract given in IFRS 16. Other contracts are a lease in legal terms, yet do not meet the IFRS 16 definition. The judgement involved in determining whether an arrangement is or is not a lease can lead to ethical issues as, for example, a financial controller might conclude that an agreement is not a lease as they do not want to recognise a liability in the financial statements. In the ARP assessment, you could be asked to identify such errors made, apply the correct accounting treatment and explain any ethical issues that arise. When advising on ethical issues, always make reference to the relevant fundamental principles. What is the definition of lease term? You learned the definition of a lease term (IFRS 16. Appendix A) in Reporting and Performance 2.Refer to RP2 Module 3 Study Guide. To which assets can the recognition exemption be applied? 39 What accounting treatment is applied where the recognition exemption is applied? In Advanced Reporting and Performance, where a lease qualifies for the recognition exemption, lease payments are always recognised on a straight-line basis over the lease term. How are right-of-use-assets (RoU) and lease liabilities initially measured and recognised? Refer to RP2 Module 3 study guide for how to initially calculate and recognise lease liability and RoU Asset. What discount rate is used to measure a lease liability at initial recognition? In practice, the interest rate implicit in the lease isn’t always available, often because this information is viewed as commercially sensitive. In this case, the lessee’s incremental borrowing rate is used as a substitute. This is the interest rate that would be charged on new borrowings, taking into account existing borrowings. Which future lease payments are included in the initial measurement of a lease liability? In Advanced Reporting and Performance, an assessment question may refer to different types of future payments associated with the lease and you must know which forms part of the measurement of the liability. Fixed lease payments Variable lease payments Purchase option Fixed lease payments are contractual payments for a In practice, some specific If a lease contains a purchase set amount. types of variable lease option that can be exercised payment are included in the by the lessee at the end of measurement of a lease the lease term, and the They include ‘in-substance’ liability. However, in lessee is reasonably certain fixed payments. These are Advanced Reporting and to exercise the option, the payments that may be Performance, you can exercise price is included in identified as variable assume that no variable lease the measurement of the lease payments, but practically a payments are included in the liability. fixed minimum amount must lease liability. be paid. Lease incentives receivable Lease incentives are payments made by a lessor to a lessee, including the reimbursement of costs Termination penalty incurred by the lessee. If a lease contains an option to terminate the agreement early and the lease term reflects early termination, the termination If lease incentives have already been received penalty is included in the measurement of they reduce the initial measurement of the RoU the lease liability. asset. If lease incentives will be received in the future, the receipt reduces future lease payments when measuring the lease liability. 40 How are RoU assets and lease liabilities measured subsequent to initial recognition? Refer to RP2 Module 3 study guide for how to measure lease liabilities with payments in advance and arrears and depreciating the RoU asset. How does a change to the lease term affect the measurement of an RoU asset and lease liability? The lease term may change mid-lease if: the lessee does not behave as they were originally expected to ie they do or do not exercise an option, or there is a significant event or change in circumstances within the lessee’s control that changes their assessment of whether they are reasonably certain to exercise an option. In subsequent years: The remeasured lease liability increases by interest calculated using the revised implicit rate and decreases by payments The remeasured RoU asset is depreciated over the lower of the remaining useful life or remaining lease term In the ARP assessment, you could be faced with a scenario in which a change in lease term has not been accounted for correctly and you have to advise on the correct accounting treatment, and provide supporting calculations and correcting journal entries. This type of question, involving a correction, is common in the ARP assessment. 41 What are the indicators that a transfer of an asset in a sale and leaseback transaction is a sale? Refer to RP2 Module 3 study guide for how to account for sale and leaseback transaction where the transaction is a sale. Additional indicators that the transfer qualifies as a sale at ARP. The transfer qualifies as a sale if control of the asset passes to the buyer/lessor. Indicators that control has passed include. The buyer/lessor has physical The seller/lessee has a possession. This is The buyer/lessor has legal present right to payment. This considered to be the case if title. As a result, it could sell indicator is typically satisfied the buyer/lessor obtains the the asset or use it to secure because payment is made rights of ownership and then its own debt. upfront. grants the seller/ lessee a right to use the asset. The buyer/lessor has the significant risks and rewards of ownership, and they can The buyer/lessor has obtain substantially all of the accepted the asset. remaining economic benefits from the asset during its useful life. How is a sale and leaseback recognised if the transfer is/ is not a sale? Refer to RP2 Module 3 study guide for how to account for sale and leaseback transaction where the transaction is and is not a sale. How is a sale and leaseback recognised if the transfer is a sale and the proceeds are equal to fair value? Refer to RP2 Module 3 study guide for how to account for sale and leaseback transaction where the proceeds are equal to fair value. How is a sale and leaseback recognised if the transfer is a sale and the proceeds are greater than fair value? When the proceeds of a sale are greater than fair value, although the leaseback transaction takes the legal form of a lease, any proceeds in excess of fair value are, in substance, a financing arrangement i.e. a loan to the seller/lessee from the buyer/lessor. The way to approach this type of transaction is to: 1. Record the loan at the excess of proceeds over fair value 2. Record the sale and leaseback as normal Remember that: Proceeds is fair value (since the excess has already been recorded) The lease liability is the present value of future lease payments less the loan, to avoid double- counting the liability. 42 Worked Example: Harvey Ltd (Harvey) sold a property to a bank on 1 January 20X1 for £3 million when the property had a carrying amount of £2.6 million and a fair value of £2.9 million. Harvey immediately leased the property back for a five-year term, agreeing to make payments of £150,000 on 31 December 20X1 to 20X5. The transfer is a sale and the interest rate implicit in the lease is 6%. The five-year 6% annuity factor is 4.212. How is the sale and leaseback accounted for on 1 January 20X1? Solution Sale proceeds are £100,000 in excess of the property’s fair value and therefore £100,000 is recognised as a loan by: Account name £ £ Dr Bank 100,000 Cr Loan 100,000 Being the recognition of proceeds in excess of fair value as a loan. When accounting for the sale and leaseback transaction: Proceeds are deemed to be £2.9million (£3m - £100,000) The lease liability is deemed to be £531,800. This is the present value of future lease payments (£150,000 x 4.212), less the amount of those payments that represents the amount recognised as a loan, i.e. £100,000. The standard sale and leaseback accounting is then applied: The carrying amount of the property is de-recognised. The proportion of the property that is retained is £531,800/£2,900,000. Therefore the RoU asset is £476,786 (£2.6m x £531,800/£2,900,000). The proportion of the property that is transferred is (£2,900,000 - £531,800)/£2,900,000. The total gain is £300,000 (£2.9m - £2.6m) and the proportion that relates to the transferred asset is therefore £244,986 (£300,000 x (£2,900,000 - £531,800)/£2,900,000). Therefore, the journal entry to recognise the sale and leaseback transaction is: Account name £ £ Dr Bank £2,900,000 Dr RoU asset (531.8/2,900 x £2.6m) £476,786 Cr Lease liability £531,800 Cr PPE £2,600,000 Cr Gain on disposal £244,986 Being the recognition of proceeds in excess of fair value as a loan. How is IFRS 16 lessee accounting reflected in financial statements? Refer to RP2 Module 3 study guide for disclosure of leases in financial statements. 43 What additional disclosures should lessees make in the notes to the financial statements? Information is presented in a single leases note, although if the information is also presented elsewhere in the financial statements, it need not be duplicated, providing that it is cross-referenced. Amounts recognised in operating expenses Amounts relating to RoU assets in the SOFP (IFRS 16.53) (IFRS 16.53) A company that is a lessee should disclose: A company that is a lessee should disclose: Depreciation charge for RoU assets by Additions to RoU assets class of underlying asset The carrying amount of RoU assets at the The lease expense relating to short-term reporting date, by class of underlying asset. leases to which the recognition exemption is If relevant, it should also disclose the fact that applied the recognition exemption has been applied. The lease expense relating to leases for This information may be disclosed in a PPE low-value assets to which the recognition reconciliation note in which there is a exemption is applied separate column for RoU assets, or within a The expense relating to variable lease sentence under that note. payments is not included in the lease liability Gains or losses arising on sale and leaseback transactions RoU assets that are measured using the Maturity analysis of lease liabilities (IFRS revaluation model (IFRS 16.57, IAS 16.77) 16.58) IAS 16 disclosure requirements apply and the This analysis indicates when liabilities fall due, lessee should provide: and helps users to understand the lessee’s The date of the latest revaluation shorter-term liquidity and longer-term solvency. Whether an independent valuer was If you are required to construct a lease involved in the valuation maturity table in your Advanced Reporting and Performance assessment you should The carrying amount had the asset been present the total liability as amounts due measured using the cost model within 12 months and over 12 months. The revaluation surplus and any change in the year. Additional information about leasing activities (IFRS 16.59) Additional information may include: The nature of the lessee’s leasing activities. Potential future cash flows not included in the measurement of the lease liability (for example, relating to variable lease payments, extension options and termination options). Reasons for sale and leaseback transactions and their key terms and conditions. 44 What is a provision and when should a provision be recognised? In an Advanced Reporting and Performance question in which you are presented with a scenario, you will be required to analyse the scenario and select relevant IFRS Accounting Standards before applying their requirements. It is therefore important that you know which standards do not apply, as well as which ones do. Assessment approach to scenarios: Refer to RP2 Module 3 study guide for recognition criteria for a provision. In Advanced Reporting and Performance questions in which you are discussing whether a provision should be recognised it is good practice to state these criteria and then apply them, one by one, to the scenario before concluding. What is a contingent liability and how is it reflected in the financial statements? Refer to RP2 Module 3 Study guide and IFRS B Book, IAS 37, Decision Tree. What is a contingent asset and how is it reflected in the financial statements? A contingent asset is: A possible asset arising from past events whose existence will be confirmed only by future events outside the company’s control. If probable Disclose the nature of the asset, and, Where practicable an estimate of their financial effect. If not probable Do not reflect in the financial statements. 45 How is a provision measured at initial recognition? Refer to RP2 Module 3 study guide for determining value of a provision. IAS 37 makes additional points about the measurement of provisions. These more complex issues may come up in Advanced Reporting and Performance assessment questions. Future events (IAS 37.48-49) Future events that may affect the amount transferred to settle an obligation are included in the measurement of a provision if there is sufficient evidence that they will occur. Expected disposal of assets (IAS 37.51-52) There may be an expected disposal of assets associated with an event that results in the recognition of a provision. For example, a corporate restructuring. Expected gains on the disposal of assets in these circumstances are not reflected in the measurement of a restructuring provision as to do so would not be prudent. There is no accounting need to recognise expected losses on the disposal of assets in these circumstances, because the restructuring (or other event) is a trigger for impairment testing (see the module on Assets) and any expected loss is recognised immediately as an impairment loss. How are provisions recognised in the financial statements? Refer to RP2 Module 3 study guide for recognising a provision including unwinding discount. 46 How are provisions that are recognised as part of the cost of assets accounted for? Initial recognition of Recognised in the cost of the asset. the provision Dr Asset X Cr Provision X Unwinding of the Recognised as a finance cost and increase to the carrying amount of the discount at each year- provision. end Dr Finance cost X Cr Provision X Any further If the asset is measured using the cost model, the remeasurement is remeasurement of the measured in the cost of the asset. provision at each year- Dr/Cr Asset X end Dr/Cr Provision X If the asset is measured using the revaluation model, the remeasurement is recognised in the same way as a revaluation surplus or deficit. You will not be examined on this in Advanced Reporting and Performance. The cost of the provision is recognised in profit or loss as the related asset is depreciated. When is a restructuring provision recognised and how is it measured? Refer to RP2 Module 3 study guide in relation to restructuring provisions. In an Advanced Reporting and Performance question in which there is a restructuring, and you are required to provide accounting advice, other IFRS Accounting Standards may also be relevant. IFRS 5 Discontinued Operations and Assets Held-for-Sale: relevant if involves sale of line of business IAS 19 Employee Benefits: Employees may be made redundant and termination payments. IAS 36 Impairment of Assets: non-current assets may be sold at a loss as part of restructure, providing possible evidence of impairment IAS 10 Events After the Reporting Period: if plan is announced after year end, before financial statements authorised for issue What is an onerous contract and how is a provision for an onerous contract measured? Refer to RP2 Module 3 Study guide for onerous contracts. 47 When and how is a provision for decommissioning recognised? Decommissioning and interaction with IAS 16, IFRS 16 (IAS 16.16, IFRS 16.24) You have already learned that a decommissioning or restoration provision may be recognised in the cost of an asset When the asset is initially recognised and the obligation to decommission or restore it arises, and Whilst the asset is used, and further damage is caused that must be restored at the end of the asset’s life. When is a provision for warranties recognised? Standard warranty This is a promise from the manufacturer that an asset will perform to a specified standard for a specified duration, often 12 months, and the manufacturer will correct any problems during that time. It may be known as an ‘assurance’ warranty. This type of warranty is provided free of charge. IAS 37 applies to standard warranties and a provision is recognised for future expected warranty costs. Extended warranty This is a promise over and above the promise made under the standard warranty, for example, to correct problems for an additional 2 years after the standard warranty expires, or to correct problems not covered by the standard warranty. This type of warranty may be sold to the customer or provided free of charge. IAS 37 does not apply to extended warranties and no provision is recognised. Instead IFRS 15 Revenue from Contracts with Customers applies. See module 4 on Income and Expenses for additional details and examples of extended warranties. Should a provision be made for costs associated with sustainability issues? Sustainability-related costs might include: Government levies, for example, the Climate Change Levy (CCL) is an environmental tax charged on energy used by businesses Penalties for failing to meet environmental targets Costs to put right environmental damage caused by business operations A provision can only be made for these costs if the IAS 37 recognition criteria are met. 48 How are provisions presented in the financial statements and the notes to the financial statements? Refer to RP2 Module 3 study guide for disclosure of provisions in the financial statements. In the Advanced Reporting and Performance assessment you may be asked to analyse a scenario and apply relevant IFRS Accounting Standards in order to prepare extracts from the financial statements. You may also be required to prepare the provisions note, including a reconciliation of each type of provision at the start of the year to the end of the year. Remember that the requirements of other IFRS Accounting Standards may also be relevant in scenario questions, for example. When advising on disclosures you should always consider all IFRS Accounting Standards that you have applied when accounting for an issue. In what circumstances is there an exemption from the disclosure requirements of IAS 37? IAS 37 provides an exemption from its full disclosure requirements in rare circumstances. This applies if the required disclosures for provisions, contingent liabilities and contingent assets could be expected to ‘prejudice seriously the position of the entity in a dispute with other parties’. In this case, a company should disclose: The general nature of the dispute The fact that full disclosures are not provided, and The reason why full disclosures are not provided. How is current tax recognised in the financial statements? Refer to RP2 Module 3 study guide on current tax and how it is calculated and recognised in the financial statements. How is current tax disclosed in the financial statements? Refer to RP2 Module 3 study guide on current tax and how it is disclosed the financial statements. What is the purpose of deferred tax? Deferred tax brings forward future tax amounts to match them to the related income or expense. Current tax is still calculated according to tax rules, and adjusted for any under- or overprovision in the previous year, however the tax charge in the SPL now includes an additional deferred tax element: £ Current tax on profits X Under- / overprovision for previous year X/(X) Deferred tax X/(X) Total tax charge in SPL X When a deferred tax charge (as a debit entry) increases the total tax charge, a deferred tax liability (a credit entry) is also recognised in the SOFP. This represents the fact that tax will be payable in the future. It is, however, important to realise that this is not a present obligation to pay tax to HMRC. 49 What are the limitations of deferred tax? Temporary differences For example, the expense related to writing off PPE (depreciation for accounting purposes and capital allowances for tax). Deferred tax does compensate for these differences. Permanent differences For example, client entertaining expenses never benefit from tax relief. Deferred tax does not compensate for these differences. Since deferred tax does not compensate for all differences, a discrepancy between the tax charge and profit before tax will always remain in the SPL. What is the IAS 12 approach to deferred tax? IAS 12’s approach is to instead consider the difference between the carrying amount of assets and liabilities from an accounting and a tax perspective. What steps should be followed to calculate and recognise deferred tax? 50 What is the tax base of an asset or liability? The tax base of an asset is the amount attributed to the asset or liability for tax purposes. Tax base of an asset Tax base of a liability The amount that will be deductible for tax The carrying amount of the liability less amounts purposes against economic benefits when the that will be deductible for tax purposes in the company recovers the carrying amount of the future. asset. For revenue received in advance, the tax base is If those economic benefits are not taxable tax the carrying amount of the liability less revenue base is equal to the carrying amount of the that will not be taxable in the future. asset. Assets A receivable of £100,000 that will not be taxed When the carrying amount of the receivable is until it is received (from the Zagreb Ltd example). recovered (i.e. the £100,000 cash is received), £nil will be deducted from the £100,000 economic benefits. Therefore, the tax base is £nil. Trade receivables are £230,000 and the related When the carrying amount of the receivable is revenue has already been included in taxable recovered the £230,000 economic benefits profit. received will not be taxable (because they have already been taxed as revenue in current SPL). Therefore, the tax base is equal to carrying amount at £230,000. A machine cost £20,000 and has a carrying When the carrying amount of the machine is amount of £15,000. Its tax written down value recovered (i.e. it generates an income of at least (after capital allowances) is £12,000. £15,000), the amount that will be deductible for tax purposes against this income is £12,000 (the cost of the machine that has not yet benefited from capital allowances). Therefore, the tax base is £12,000. Liabilities A loan liability has a carrying amount of The tax base is equal to the carrying amount of £250,000. The repayment of the loan has no tax the loan (£250,000) less amounts that will be consequences deducted for tax in the future (£nil). Therefore, the tax base is £250,000. An accrual has a carrying amount of £5,000 and The tax base is equal to the carrying amount of the related expense will benefit from tax relief the loan (£5,000) less amounts that will be when paid. deducted for tax in the future (£5,000). Therefore, the tax base is £nil. Deferred income has a carrying amount of The tax base is equal to the carrying amount of £120,000 and will be taxed when the revenue is the liability (£120,000) less revenue that will not recognised in the future. be taxable in the future (£nil). Therefore, the tax base is £120,000. A defined benefit pension is in deficit and has a The tax base is equal to the carrying amount of carrying amount of £700,000. This shortfall must the deficit (£700,000) less amounts that will be be made up by the payment of extra contributions deducted for tax in the future (£700,000). and these will benefit from tax relief when paid. Therefore, the tax base is £nil. 51 What is a temporary difference and how is it calculated? When deciding whether a temporary difference is taxable or deductible, a rule of thumb that can be applied is as follows: Asset in SOFP Liability in SOFP Carrying amount > tax base Taxable temporary difference Deductible temporary difference Tax base > carrying amount Deductible temporary difference Taxable temporary difference Reversal of temporary differences The nature of a temporary difference is that it is temporary and so it will reverse in the future. When does a deferred tax asset or liability arise? How is a deferred tax asset or liability measured? In your Advanced Reporting and Performance assessment you may be required to provide advice on the calculation of deferred tax, in which case you should explain the IAS 12 requirements for the tax rate to apply to temporary differences. If you are required to calculate deferred tax, you will be given a tax rate to apply. You should only consider deferred tax in your answers if you are expressly asked to do so in a requirement. 52 How is deferred tax recognised? Profit or loss (within the tax Other comprehensive Equity charge) income (OCI) Deferred tax expenses or All deferred tax expenses or Deferred tax expenses or credits relating to items credits other than those credits relating to items recognised directly in equity. recognised in other recognised in OCI. For For example, deferred tax comprehensive income (OCI) example, the revaluation of relating to a prior period or equity. PPE. adjustment to correct an error When journalling to OCI, you should be specific. For deferred tax on Revaluation Surplus Dr/Cr OCI - Revaluation Surplus, for Deferred tax on Remeasurements on Pensions, Dr/Cr OCI - Retained Earnings. What restrictions apply to the recognition of a deferred tax asset? Deferred tax assets and prudence (IAS 12.24,27-29) A deferred tax asset is only recognised if it is probable that there will be future taxable profits. In the case of tax losses, however, IAS 12 makes it clear that the existence of recent tax losses is a strong indicator that future taxable profits will not be available to absorb a loss carried forward, and therefore recognition of a deferred tax asset may not be appropriate. If a deferred tax asset is not recognised because future taxable profits are not probable, a company should reassess its position at each year end. How is deferred tax relating to depreciation calculated and recognised? Carrying amount: Calculated in accordance with IAS 16 Tax base: Tax written down value (cost less capital allowances given) Carrying amount exceeds tax base = taxable temporary difference = deferred tax liability Tax base exceeds carrying amount = deductible temporary difference How is deferred tax arising on a revaluation calculated and recognised? Where an asset is revalued upwards, a revaluation surplus is recognised for accounting purposes. This is not recognised from a current tax perspective. Therefore, additional deferred tax arises on top of that relating to accelerated capital allowances. In Advanced Reporting and Performance, you should always assume that the temporary difference arising in relation to a revalued asset is equal to the revaluation surplus. How is deferred tax relating to rollover relief calculated and recognised? A taxable temporary difference arises when the gain is rolled over and it is equal to the amount of the gain. This gives rise to a deferred tax liability. The temporary difference exists, and so a deferred tax liability is recognised, until the new asset is sold. The same approach is adopted for holdover relief. 53 How is deferred tax relating to pension plans calculated and recognised? How are deferred tax amounts presented in the financial statements? In Advanced Reporting and Performance deferred tax is presented as a single amount in the SOPF. Within this amount deferred tax assets and liabilities are offset. Deferred tax that is recognised in profit or loss is included in the tax charge which must be presented in the SPL. This total is broken down into its major components in the tax disclosure note. Deferred tax that is recognised in OCI may be presented within the SPLOCI: as a single line item in the OCI section of the SPLOCI (to include deferred tax relating to all OCI), or as separate line items relating to each individual element of OCI, or offset against the relevant item of OCI. If not disclosed in the SPLOCI, the amount of tax relating to each item of OCI must be included in a disclosure note. Deferred tax

Advanced Reporting and Performance Study Guide PDF - ICAS 2024

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