P2
Corporate
Reporting (INT)
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library Published by InterActive World Wide Limited
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ISBN 978 978-907217-10-4 First Edition 2009
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We are grateful to the Chartered Institute of Management Accountants and the Institute of Chartered Accountants in England and Wales for permission to reproduce past exam questions. The answers have been prepared by InterActive World Wide.
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Foreword
FOREWORD
Foreword
3
Contents
5
About ACCA Paper P2 – Corporate Reporting
7
Syllabus and Study Guide
15
Examinable Documents
31
Pilot Paper
35
Chapter 1: Basic Group Accounting
59
Chapter 2: Complex Group Accounting
113
Chapter 3: Foreign Currency Translation
139
Chapter 4: Statements of Cash Flows
163
Chapter 5: Current Issues and Non-financial Reporting
197
Chapter 6: Reporting Financial Performance
213
Chapter 7: Provisions, Events After the Reporting Period and Related Parties
237
Chapter 8: Non-current Assets
259
Chapter 9: Leases and Substance Over Form
297
Chapter 10: Employee Benefits
317
Chapter 11: Share-based Payments
335
Chapter 12: Financial Instruments
347
Chapter 13:Tax
383
Chapter 14: Other Accounting Standards
411
Chapter 15: International Issues
419
Feedback and Review Form
431
Contents
5
P2
About ACCA
INTRODUCTION
Aim of the Paper
The aim of the paper is to apply knowledge, skills and exercise professional judgement in the application and evaluation of financial reporting principles and practices in a range of business contexts and situations.
Introduction to the Paper
This exam paper existed previously as Paper 3.6 Advanced Corporate Reporting and there have been relatively few changes to the previous syllabus and the examiner remains the same.
Format of the Exam Paper
The syllabus is assessed by a three hour paper-based examination with 15 minutes reading time. The examination consists of:
• one 50 mark compulsory case study; • two from three 25 mark questions.
Typically the questions have the following structure:
• Section A (Compulsory Case Study)
(Q1 ) The case will be based around a group scenario.There will be 35 marks of numbers and 15 marks of
narrative. (50 marks)
• Section B (Choice of two from three questions)
(Q2) Focused question. Typically the second question in the exam focuses on a single technical subject, for example, pensions, financial instruments or deferred tax. Often these questions require thorough
technical knowledge. (25 marks)
(Q3) Mixed question. Usually there are roughly five mini scenarios, each valued at five marks and covering a wide range of financial reporting issues.These questions require problem solving and usually far less technical knowledge than question two. (25 marks) (Q4) Current Issues and Corporate Social Responsibility. This question tends to have a low technical content
and is discursive in nature. (25 marks)
The Examiner
The examiner for P2 is Graham Holt, the principal lecturer of accounting and finance at Manchester
Metropolitan University. He has been an ACCA Examiner for several years and sets challenging exam papers.
Outline of the Syllabus
The detailed syllabus is provided on pages 22-23.There are eight broad areas of the syllabus: 1 Discuss the professional and ethical duties of the accountant.
2 Evaluate the financial reporting framework.
3 Advise on and report the financial performance of entities.
4 Prepare the financial statements of groups of entities in accordance with relevant accounting standards. 5 Explain reporting issues relating to specialised entities.
6 Discuss the implications of changes in accounting regulation on financial reporting. 7 Appraise the financial performance and position of entities.
8 Evaluate current developments.
Examinable Documents
The ACCA has recently changed the rules on examinable documents. Previously, documents were updated every six months but from the June 2009 sitting onwards the new rule is as follows:
Note that it is the issue date that is key, not the effective date. So an accounting standard may be examined before its effective date for application.
For December 2009, the examinable documents are as follows:
International Accounting Standards (IASs)/International Financial Reporting Standards (IFRSs)
• IAS 1 Presentation of Financial Statements • IAS 2 Inventories
• IAS 7 Statement of Cash Flows
• IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors • IAS 10 Events after the Reporting Period
• IAS 11 Construction Contracts • IAS 12 Income Taxes
• IAS 16 Property, Plant and Equipment • IAS 17 Leases
• IAS 18 Revenue
• IAS 19 Employee Benefits
• IAS 20 Accounting for Government Grants and Disclosure of Government Assistance • IAS 21 The Effects of Changes in Foreign Exchange Rates
• IAS 23 Borrowing Costs
• IAS 24 Related Party Disclosures
• IAS 27 Consolidated and Separate Financial Statements • IAS 28 Investments in Associates
• IAS 29 Financial Reporting in Hyperinflationary Economies • IAS 31 Interests in Joint Ventures
• IAS 32 Financial Instruments: Presentation • IAS 33 Earnings per Share
• IAS 34 Interim Financial Reporting • IAS 36 Impairment of Assets
11
• IAS 37 Provisions, Contingent Liabilities and Contingent Assets • IAS 38 Intangible Assets
• IAS 39 Financial Instruments: Recognition and Measurement • IAS 40 Investment Property
• IAS 41 Agriculture
• IFRS 1 First-time Adoption of International Financial Reporting Standards • IFRS 2 Share-based Payment
• IFRS 3 (revised) Business Combinations
• IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations • IFRS 7 Financial Instruments: Disclosures
• IFRS 8 Operating Segments
Other Statements
• Framework for the Preparation and Presentation of Financial Statements
Interpretations of the International Financial Reporting Interpretations Committee (IFRIC)
• SIC-12 Consolidation – Special Purpose Entities
• SIC-13 Jointly Controlled Entities – Non monetary Contributions by Venturers • SIC-15 Operating Leases – Incentives
• SIC-21 Income Taxes – Recovery of Revalued Non-depreciable Assets • SIC-27 Evaluating the Substance of Transactions in the Legal Form of a Lease • SIC-32 Intangible Assets – Website Costs
• IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities • IFRIC 4 Determining Whether an Arrangement Contains a Lease
• IFRIC 5 Rights to Interests from Decommissioning Restoration and Environmental Rehabilitation Funds • IFRIC 7 Applying the Restatement Approach under IAS 29, Financial Reporting in Hyperinflationary Economies • IFRIC 8 Scope of IFRS 2
• IFRIC 9 Reassessment of Embedded Derivatives • IFRIC 10 Interim Financial Reporting and Impairment • IFRIC 11 IFRS 2: Group and Treasury Share Transactions • IFRIC 12 Service Concession Arrangements
• IFRIC 13 Customer Loyalty Programmes
• IFRIC 16 Hedges of a Net Investment in a Foreign Operation
EDs, Discussion Papers and Other Documents
• ED IFRS for Small and Medium-sized Entities
• ED Simplifying Earnings per Share: Proposed amendments to IAS 33 • ED Improvements to IFRSs
• DP Management Commentary • DP Fair Value Measurements
• ED An Improved Conceptual Framework for Financial Reporting – Chapter 1 and 2 • DP Preliminary views on amendments to IAS 19 Employee Benefits
Past Exam Questions
Further Resources:
Examiner’s Approach to P2
On the ACCA website (www.accaglobal.com/students) in the P2 section, there is an article “Examiner’s approach to P2.” This gives useful background information to the exam and the context within which it is set.
Examiner’s reports
After each exam sitting, the examiner reports on candidates’ performance. These reports provide useful feedback as to the positive and negative aspects of performance and can give useful hints on how to avoid falling into the same traps as previous candidates. They can also be found on the ACCA website in the P2 section.
Question Pilot Dec 2007 June 2008 Dec 2008 June 2009
1 (groups) Zambeze Beth Ribby Warrburt Bravado
Classic CFS Classic B/S Classic B/S Challenging Relatively narrative on with share with foreign CFS, with CFS simple B/S but quasi sub and based payment, sub, share interpretation with two subs creative derivatives and based payment and ethics. and associate, accounting. off B/S finance. and pensions. plus lots of
Narrative on Narrative on emphasis on corporate currencies and new IFRS3. social . creative
responsibility accounting.
2 (focus) Kesare Macaljoy Norman Marrgret Aron
Deferred tax. Pensions and Operating Discussion on Solid question provisions. segments and business on Financial
revenue. combinations. Instruments.
3 (mix) Electron Ghorse Sirus Johan Carpart
Mix of revenue, Mix of Mix of financial Dense mix of Mix question provisions, impairment, instruments, intangibles, with a heavy leases, PBSE, discontinued, goodwill, revenue and leaning share based deferred tax, employee other issues. towards payment and revaluation, payments and leases. more. leases and more.
more.
4 (Current IFRS IASB Transition High Quality Smith
Issues) Convergence. Conceptual Transition to General Very specific
framework and IFRS. discussion of current issue convergence. the importance of the
Useful sources of further reading
It is very useful to undertake further reading on this subject and get an understanding of accounting issues in the real world. There are a number of good news pages and websites that may assist you with this. These include but are not limited to:
• BBC news website (http://news.bbc.co.uk/);
• Times newspaper online (www.business.timesonline.co.uk/tol/business/); • Financial Times (www.ft.com);
• Accountancy Age (www.accountancyage.com).
INTRODUCTION
17
SYLLABUS AND STUDY GUIDE
Corporate Reporting (INT) (P2)
This syllabus and study guide is designed to help with planning study and to provide detailed information on what could be assessed in any examination session.
The Structure of the Syllabus and Study Guide
RELATIONAL DIAGRAM OF PAPER WITH OTHER PAPERS
This diagram shows direct and indirect links between this paper and other papers preceding or following it. Some papers are directly underpinned by other papers such as Advanced Performance Management by Performance Management. These links are shown as solid line arrows. Other papers only have indirect relationships with each other such as links existing between the accounting and auditing papers. The links between these are shown as dotted line arrows. This diagram indicates where you are expected to have underpinning knowledge and where it would be useful to review previous learning before undertaking study. OVERALL AIM OF THE SYLLABUS
This explains briefly the overall objective of the paper and indicates in the broadest sense the capabilities to be developed within the paper.
MAIN CAPABILITIES
This paper’s aim is broken down into several main capabilities which divide the syllabus and study guide into discrete sections.
RELATIONAL DIAGRAM OF THE MAIN CAPABILITIES
This diagram illustrates the flows and links between the main capabilities (sections) of the syllabus and should be used as an aid to planning teaching and learning in a structured way.
SYLLABUS RATIONALE
This is a narrative explaining how the syllabus is structured and how the main capabilities are linked. The rationale also explains in further detail what the examination intends to assess and why.
DETAILED SYLLABUS
This shows the breakdown of the main capabilities (sections) of the syllabus into subject areas. This is the blueprint for the detailed study guide.
APPROACH TO EXAMINING THE SYLLABUS
This section briefly explains the structure of the examination and how it is assessed. STUDY GUIDE
Intellectual Levels
The syllabus is designed to progressively broaden and deepen the knowledge, skills and professional values demonstrated by the student on their way through the qualification.
The specific capabilities within the detailed syllabuses and study guides are assessed at one of three intellectual or cognitive levels:
Level 1: Knowledge and comprehension Level 2: Application and analysis | Level 3: Synthesis and evaluation
Very broadly, these intellectual levels relate to the three cognitive levels at which the Knowledge module, the Skills module and the Professional level are assessed.
Each subject area in the detailed study guide included in this document is given a 1, 2, or 3 superscript, denoting intellectual level, marked at the end of each relevant line. This gives an indication of the intellectual depth at which an area could be assessed within the examination. However, while level 1 broadly equates with the Knowledge module, level 2 equates to the Skills module and level 3 to the Professional level, some lower level skills can continue to be assessed as the student progresses through each module and level. This reflects that at each stage of study there will be a requirement to broaden, as well as deepen capabilities. It is also possible that occasionally some higher level capabilities may be assessed at lower levels.
Learning Hours
The ACCA qualification does not prescribe or recommend any particular number of learning hours for examinations because study and learning patterns and styles vary greatly between people and organisations. This also recognises the wide diversity of personal, professional and educational circumstances in which ACCA students find themselves.
Each syllabus contains between 23 and 35 main subject area headings depending on the nature of the subject and how these areas have been broken down.
Guide to Exam Structure
The structure of examinations varies within and between modules and levels.
The Fundamentals level examinations contain 100% compulsory questions to encourage candidates to study across the breadth of each syllabus.
The Knowledge module is assessed by equivalent two-hour paper based and computer based examinations. The Skills module examinations are all paper based three-hour papers. The structure of papers varies from ten questions in theCorporate and Business Law(F4) paper to four 25 mark questions inPerformance Management
(F5) andFinancial Management(F9). Individual questions within all Skills module papers will attract between 10
and 30 marks.
The Professional level papers are all three-hour paper based examinations, all containing two sections. Section A is compulsory , but there will be some choice offered in Section B.
For all three hour examination papers,ACCA has introduced 15 minutes reading and planning time.
19
SYLLABUS AND STUDY GUIDE During reading and planning time candidates may only annotate their question paper. They may not write anything in their answer booklets until told to do so by the invigilator.
The Essentials module papers all have a Section A containing a major case study question with all requirements totalling 50 marks relating to this case. Section B gives students a choice of two from three 25 mark questions. Section A of each of the Options papers contains 50-70 compulsory marks from two questions, each attracting between 25 and 40 marks. Section B will offer a choice of two from three questions totalling 30-50 marks, with each question attracting between 15 and 25 marks.
The pass mark for all ACCA Qualification examination papers is 50%.
Guide to Examination Assessment
ACCA reserves the right to examine anything contained within the study guide at any examination session. This includes knowledge, techniques, principles, theories, and concepts as specified.
For the financial accounting, audit and assurance, law and tax papers except where indicated otherwise,ACCA will publishexaminable documentsonce a year to indicate exactly what regulations and legislation could potentially be assessed within identified examination sessions.
For paper based examinations regulationissuedor legislationpassedon or before 30th September annually, will be assessed from June 1st of the following year to May 31st of the year after. Therefore, paper based examinations in June 2009, December 2009 (and March 2010 where applicable) will be assessed on regulations issued and legislation passed on or before 30 September 2008.
Regulation issued or legislation passed in accordance with the above dates may be examinable even if the
effectivedate is in the future.
The term issued or passed relates to when regulation or legislation has been formally approved.
The term effective relates to when regulation or legislation must be applied to an entity’s transactions and business practices.
CR (P2)
FR (F7)
FA (F3)
AAA (P7)
Relational Diagram of Paper with other Papers
Overall Aim of the Syllabus
To apply knowledge, skills and exercise professional judgement in the application and evaluation of financial reporting principles and practices in a range of business contexts and situations.
Main Capabilities
On successful completion of this paper, candidates should be able to: A Discuss the professional and ethical duties of the accountant. B Evaluate the financial reporting framework.
C Advise on and report the financial performance of entities.
D Prepare the financial statements of groups of entities in accordance with relevant accounting standards. E Explain reporting issues relating to specialised entities.
F Discuss the implications of changes in accounting regulation on financial reporting. G Appraise the financial performance and position of entities.
The professional and ethical duty of the
accountant(A)
The financial reporting framework(B)
Reporting the financial performance of entities
(C)
Financial statements of group of entities(D)
Specialised entities(E)
Implications of changes in accounting regulation on
financial reporting(F)
The appraisal of financial performance and position
of entities(G)
Current developments(H)
21
SYLLABUS AND STUDY GUIDE
Relational Diagram of the Main Capabilities
Syllabus Rationale
The syllabus for Paper P2, Corporate Reporting, assumes knowledge acquired at the Fundamentals level including the core technical capabilities to prepare and analyse financial reports for single and combined entities.
The syllabus examines the financial reporting framework within which the accountant operates and examines detailed financial reporting requirements for entities leading to the preparation of group financial reports in accordance with generally accepted accounting practice and relevant standards.
The syllabus then deals with the nature of reporting for specialised entities including not-for-profit and small and medium-sized enterprises.
The final sections of the syllabus explore – in more depth – the role of the accountant as financial analyst and adviser through the assessment of financial performance and position of entities, and the accountant’s role in assessing and advising on the implications of accounting regulation on corporate reporting.
Finally, the syllabus covers the evaluation of current developments and their implications for financial reporting.
Detailed Syllabus
A THE PROFESSIONAL AND ETHICAL DUTY OF THE ACCOUNTANT 1. Professional behaviour and compliance with accounting standards
2. Ethical requirements of corporate reporting and the consequences of unethical behaviour 3. Social responsibility
B THE FINANCIAL REPORTING FRAMEWORK
1. The contribution and limitations of financial statements in meeting the needs of users and capital markets 2. The applications, strengths and weaknesses of an accounting framework
3. Critical evaluation of principles and practices
C REPORTING THE FINANCIAL PERFORMANCE OF ENTITIES 1. Performance reporting
8. Provisions, contingencies and events after the reporting date 9. Related parties
10. Share-based payment
D FINANCIAL STATEMENTS OF GROUPS OF ENTITIES 1. Group accounting including statements of cash flows 2. Continuing and discontinued interests
3. Changes in group structures 4. Foreign transactions and entities E SPECIALISED ENTITIES
1. Financial reporting in specialised, not-for-profit and public sector entities 2. Reporting requirements of small and medium-sized entities (SMEs)
F IMPLICATIONS OF CHANGES IN ACCOUNTING REGULATION ON FINANCIAL REPORTING 1. The effect of changes in accounting standard s on accounting systems
23
SYLLABUS AND STUDY GUIDE G THE APPRAISAL OF FINANCIAL PERFORMA NCE AND POSITION OF ENTITIES
1. The creation of suitable accounting policies
2. Analysis and interpretation of financial information and measurement of performance H CURRENT DEVELOPMENTS
1. Environmental and social reporting
2. Convergence between national and international reporting standards 3. Comparison of national reporting requirements
4. Current reporting issues
Approach to Examining the Syllabus
The syllabus is assessed by a three-hour paper-based examination. It examines professional competences within the corporate reporting environment.
Students will be examined on concepts, the ories, and principles, and on their ability to question and comment on proposed accounting treatments.
Students should be capable of relating professional issues to relevant concepts and practical situations. The evaluation of alternative accounting practices and the identification and prioritisation of issues will be a key element of the paper. Professional and ethical judgement will need to be exercised, together with the integration of technical knowledge when addressing corporate reporting issues in a business context. Global issues will be addressed via the current issues questions on the paper. Students will be required to adopt either a stakeholder or an external focus in answering questions and to demonstrate personal skills such as problem solving, dealing with information and decision making. The paper also deals with specific
professional knowledge appropriate to the preparation and presentation of consolidated and other financial statements from accounting data, to conform with accounting standards .
The paper will comprise two sections.
Section A Compulsory question 50 marks Section B Two from three questions of 25 marks each 50 marks
1111
100 marks
1111
Study Guide
A
The Professional and Ethical Duties of the Accountant
1. PROFESSIONAL BEHAVIOUR AND COMPLIANCE WITH ACCOUNTING STANDARDS a) Appraise and discuss the ethical and professional issues in advising on corporate reporting. [3] b) Assess the relevance and importance of ethical and professional issues in complying with accounting
standards. [3]
2. ETHICAL REQUIREMENTS OF CORPORATE REPORTING AND THE CONSEQUENCES OF UNETHICAL BEHAVIOUR
a) Appraise the potential ethical implications of professional and managerial decisions in the preparation of corporate reports. [3]
b) Assess the consequences of not upholding ethical principles in the preparation of corporate reports. [3] 3. SOCIAL RESPONSIBILITY
a) Discuss the increased demand for transparency in corporate reports, and the emergence of non-financial reporting standards. [3]
b) Discuss the progress towards a framework for environmental and sustainability reporting. [3]
B
The Financial Reporting Framework
1. THE CONTRIBUTION AND LIMITATIONS OF FINANCIAL STATEMENTS IN MEETING USERS’ AND CAPITAL MARKETS’ NEEDS
a) Evaluate the consistency and clarity of corporate reports. [3]
b) Assess the insight into financial and operational risks provided by corporate reports. [3] c) Discuss the usefulness of corporate reports in making investment decisions. [3]
2. THE APPLICATIONS, STRENGTHS AND WEAKNESSES OF AN ACCOUNTING FRAMEWORK a) Evaluate the valuation models adopted by standard setters. [3]
b) Discuss the use of an accounting framework in underpinning the production of accounting standards. [3] c) Assess the success of such a framework in introducing rigorous and consistent accounting standards. [3] 3. CRITICAL EVALUATION OF PRINCIPLES AND PRACTICES
a) Identify the relationship between accounting theory and practice. [2]
b) Critically evaluate accounting principles and practices used in corporate reporting. [3]
C
Reporting the Financial Performance of Entities
1. PERFORMANCE REPORTING
a) Prepare reports relating to corporate performance for external stakeholders. [3] b) Discuss the issues relating to the recognition of revenue. [3]
25
SYLLABUS AND STUDY GUIDE 2. NON-CURRENT ASSETS
a) Apply and discuss the timing of the recognition of non-current assets and the determination of their carrying amounts including impairments and revaluations. [3]
b) Apply and discuss the treatment of non-current assets held for sale. [3]
c) Apply and discuss the accounting treatment of investment properties including classification, recognition and measurement issues. [3]
d) Apply and discuss the accounting treatment of intangible assets including the criteria for recognition and measurement subsequent to acquisition and classification. [3]
3. FINANCIAL INSTRUMENTS
a) Apply and discuss the recognition and de-recognition of financial assets and financial liabilities. [2] b) Apply and discuss the classification of financial assets and financial liabilities and their measurement. [2] c) Apply and discuss the treatment of gains and losses arising on financial assets and financial liabilities. [2] d) Apply and discuss the treatment of impairments of financial assets. [2]
e) Account for derivative financial instruments, and simple embedded derivatives. [2]
f) Outline the principles of hedge accounting and account for fair value hedges and cash flow hedges including hedge effectiveness. [2]
4. LEASES
a) Apply and discuss the classification of leases and accounting for leases by lessors and lessees. [3] b) Account for and discuss sale and leaseback transactions. [3]
5. SEGMENT REPORTING
a) Determine the nature and extent of reportable segments. [3]
b) Specify and discuss the nature of segment information to be disclosed. [3] 6. EMPLOYEE BENEFITS
a) Apply and discuss the accounting treatment of defined contribution and defined benefit plans. [3] b) Account for gains and losses on settlements and curtailments. [2]
c) Account for the “Asset Ceiling” test and the reporting of actuarial gains and losses. [2] 7. INCOME TAXES
a) Apply and discuss the recognition and measurement of deferred tax liabilities and deferred tax assets including the exceptions to recognition. [3]
b) Determine the recognition of tax expense or income and its inclusion in the financial statements. [3] 8. PROVISIONS, CONTINGENCIES AND EVENTS AFTER THE REPORTING DATE
a) Apply and discuss the recognition, derecognition and measurement of provisions, contingent liabilities and contingent assets including environmental provisions. [3]
b) Calculate and discuss restructuring provisions. [3]
d) Determine and report going concern issues arising after the reporting date. [3] 9. RELATED PARTIES
a) Determine the parties considered to be related to an entity. [3]
b) Identify the implications of related party relationships and the need for disclosure. [3] 10. SHARE-BASED PAYMENT
a) Apply and discuss the recognition and measurement criteria for share-based payment transactions. [3] b) Account for modifications, cancellations and settlements of share based payment transactions. [2]
D
Financial Statements of Groups of Entities
1. GROUP ACCOUNTING INCLUDING STATEMENTS OF CASH FLOWS
a) Apply the method of accounting for business combinations including complex group structures. [3] b) Apply the principles in determining the cost of a business combination. [3]
c) Apply the recognition and measurement criteria for identifiable acquired assets and liabilities and goodwill including step acquisitions. [3]
d) Apply and discuss the criteria used to identify a subsidiary and an associate. [3]
e) Determine and apply appropriate procedures to be used in preparing group financial statements. [3] f) Apply the equity method of accounting for associates. [3]
g) Outline and apply the key definitions and accounting methods which relate to interests in joint ventures. [3] h) Prepare and discuss group statements of cash flows. [3]
2. CONTINUING AND DISCONTINUED INTERESTS
a) Prepare group financial statements where activities have been discontinued, or have been acquired or disposed of in the period. [3]
b) Apply and discuss the treatment of a subsidiary which has been acquired exclusively with a view to subsequent disposal. [3]
3. CHANGES IN GROUP STRUCTURES
a) Discuss the reasons behind a group reorganisation. [3]
b) Evaluate and assess the principal terms of a proposed group reorganisation. [3] 4. FOREIGN TRANSACTIONS AND ENTITIES
a) Outline and apply the translation of foreign currency amounts and transactions into the functional currency and the presentational currency. [3]
b) Account for the consolidation of foreign operations and their disposal. [2]
27
SYLLABUS AND STUDY GUIDE
E
Specialised Entities
1. FINANCIAL REPORTING IN SPECIALISED, NOT-FOR-PROFIT AND PUBLIC SECTOR ENTITIES
a) Apply knowledge from the syllabus to straightforward transactions and events arising in specialised, not-for-profit, and public sector entities. [3]
2. REPORTING REQUIREMENTS OF SMALL AND MEDIUM ENTITIES (SMES)
a) Outline the principal considerations in developing a set of accounting standards for SMEs. [3] b) Discuss solutions to the problem of differential financial reporting. [3]
F
Implications of Changes in Accounting Regulation on Financial
Reporting
1. THE EFFECT OF CHANGES IN ACCOUNTING STANDARDS ON ACCOUNTING SYSTEMS a) Apply and discuss the accounting implications of the first time adoption of a body of new accounting
standards. [3]
b) Outline the issues in implementing a change to new accounting standards including organisational, behavioural, and procedural changes within the entity. [3]
2. PROPOSED CHANGES TO ACCOUNTING STANDARDS
a) Identify issues and deficiencies which have led to a proposed change to an accounting standard. [2]
b) Apply and discuss the implications of a proposed change to an accounting standard on the performance and statement of financial position of an entity. [2]
G
The Appraisal of Financial Performance and Position of
Entities
1. THE CREATION OF SUITABLE ACCOUNTING POLICIES
a) Develop accounting policies for an entity which meet the entity’s reporting requirements. [3]
b) Identify accounting treatments adopted in financial statements and assess their suitability and acceptability. [3] 2. ANALYSIS AND INTERPRETATION OF FINANCIAL INFORMATION AND MEASUREMENT OF
PERFORMANCE
a) Select and calculate relevant indicators of financial and non-financial performance. [3] b) Identify and evaluate significant features and issues in financial statements. [3]
c) Highlight inconsistencies in financial information through analysis and application of knowledge. [3] d) Make inferences from the analysis of information taking into account the limitation of the information, the
H
Current Developments
1. ENVIRONMENTAL AND SOCIAL REPORTING
a) Appraise the impact of environmental, social, and ethical factors on performance measurement. [3] b) Evaluate current reporting requirements in the area. [3]
c) Discuss why entities might include disclosures relating to the environment and society. [3]
2. CONVERGENCE BETWEEN NATIONAL AND INTERNATIONAL FINANCIAL REPORTING STANDARDS a) Evaluate the implications of worldwide convergence with International Financial Reporting Standards. [3] b) Discuss the implementation issues arising from the convergence process. [3]
3. COMPARISON OF NATIONAL REPORTING REQUIREMENTS
a) Identify the reasons for major differences in accounting practices, including culture. [2] b) Discuss the influence of national regulators on international financial reporting. [2] 4. CURRENT REPORTING ISSUESS
29
SYLLABUS AND STUDY GUIDE
Reading List
Additional reading:
‘International GAAP 2009’ -Ernst and Young LexisNexis
TITLE F3 F7 P2
International Accounting Standards (IASs)/International Financial Reporting Standards (IFRSs)
IAS 1 Presentation of Financial Statements ✔ ✔ ✔
IAS 2 Inventories ✔ ✔ ✔
IAS 7 Statement of Cash Flows ✔ ✔ ✔
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors ✔ ✔ ✔
IAS 10 Events after the Reporting Period ✔ ✔ ✔
IAS 11 Construction Contracts ✔ ✔
IAS 12 Income Taxes ✔ ✔
IAS 16 Property, Plant and Equipment ✔ ✔ ✔
IAS 17 Leases ✔ ✔
IAS 18 Revenue ✔ ✔ ✔
IAS 19 Employee Benefits ✔
IAS 20 Accounting for Government Grants and Disclosure of ✔ ✔
Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates ✔
IAS 23 Borrowing Costs ✔ ✔
IAS 24 Related Party Disclosures ✔
IAS 27 Consolidated and Separate Financial Statements ✔ ✔
IAS 28 Investments in Associates ✔ ✔
IAS 29 Financial Reporting in Hyperinflationary Economies ✔
IAS 31 Interest in Joint Ventures ✔
IAS 32 Financial Instruments: Presentation ✔ ✔
IAS 33 Earnings per Share ✔ ✔
IAS 34 Interim Financial Reporting ✔
IAS 36 Impairment of Assets ✔ ✔
IAS 37 Provisions, Contingent Liabilities and Contingent Assets ✔ ✔ ✔
IAS 38 Intangible Assets ✔ ✔ ✔
IAS 39 Financial Instruments: Recognition and Measurement ✔ ✔
International Examinable Documents 2009
FINANCIAL REPORTING
Knowledge of new examinable regulations issued by 30th September will be required in examination sessions being held in the following calendar year. Documents may be examinable even if theeffectivedate is in the future.
The documents listed as being examinable are the latest that wereissuedprior to 30th September 2008 and will be examinable in June and December 2009 examination sessions.
The Study Guide offers more detailed guidance on the depth and level at which the examinable documents will be examined. The study guide should be read in conjunction with the examinable documents list.
33
TITLE F3 F7 P2
IAS 40 Investment Property ✔ ✔
IAS 41 Agriculture ✔
IFRS 1 First-time Adoption of International Financial Reporting Standards ✔
IFRS 2 Share-based Payment ✔
IFRS 3 (revised) Business Combinations ✔ ✔
IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations ✔ ✔
IFRS 7 Financial Instruments: Disclosures ✔ ✔
IFRS 8 Operating Segments ✔
Other Statements
Framework for the Preparation and Presentation of Financial Statements ✔ ✔ ✔ Interpretations of the International Financial Reporting
Interpretations Committee (IFRIC)
SIC-12 Consolidation – Special Purpose Entities ✔
SIC-13 Jointly Controlled Entities – Non-monetary Contributions by Venturers ✔
SIC-15 Operating Leases – Incentives ✔
SIC-21 Income Taxes – Recovery of Revalued Non-depreciable Assets ✔
SIC-27 Evaluating the Substance of Transactions in the Legal Form of a Lease ✔
SIC-32 Intangible Assets – Website Costs ✔
IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities ✔
IFRIC 4 Determining Whether an Arrangement Contains a Lease ✔
IFRIC 5 Rights to Interests from Decommissioning Restoration and ✔
Environmental Rehabilitation Funds
IFRIC 7 Applying the Restatement Approach under IAS 29, Financial Reporting in ✔
Hyperinflationary Economies
IFRIC 8 Scope of IFRS 2 ✔
IFRIC 9 Reassessment of Embedded Derivatives ✔
IFRIC 10 Interim Financial Reporting and Impairment ✔
IFRIC 11 IFRS 2: Group and Treasury Share Transactions ✔
IFRIC 12 Service Concession Arrangements ✔
IFRIC 13 Customer Loyalty Programmes ✔
IFRIC 16 Hedges of a Net Investment in a Foreign Operation ✔
EDs, Discussion Papers and Other Documents ✔
ED IFRS for Small and Medium-sized Entities ✔
ED Simplifying Earnings per Share: Proposed Amendments to IAS33 ✔
ED Improvements to IFRSs ✔
DP Management Commentary ✔
DP Fair Value Measurements ✔
ED An improved Conceptual Framework for Financial Reporting- ✔
Chapter 1 and 2
Pa
pe
r
P2
(IN
T)
ACCA
Professional Pilot Paper – Essentials module
Corporate Reporting
(International)
Time allowed
Reading and planning: 15 minutes Writing: 3 hours This paper is dividen into two sections:
Section A – This ONE question is compulsory and MUST be attempted
Section B – TWO questions ONLY to be attempted
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.
Section A – This question is compulsory and MUST be attempted
1. The following draft financial statements relate to Zambeze, a public limited company: Draft Group Balance Sheets at 30 June
2006 2005
$m $m
Assets:
Non-current assets:
Property, plant and equipment 1,315 1,005
Goodwill 30 25
Investment in associate 270 290
111 111
1,615 1,320
Current assets:
Inventories 650 580
Trade receivables 610 530
Cash at bank and cash equivalents 50 140
111 111
Share premium account 30 15
Revaluation reserve 50 145
Total equity and liabilities 2,925 2,570
111 111
39
Draft Group Income Statement for the year ended 30 June 2006
$m
Revenue 4,700
Cost of sales (3,400)
111
Gross profit 1,300
Distribution and administrative expenses (600)
Finance costs (interest payable) (40)
Share of profit in associate 30
111
Profit before tax 690
Income tax expense (including tax on income from associate $10m) (210)
111
Profit for the period 480
111
Attributable to:
Equity holders of the parent 455
Minority interest 25
111
480
111
Draft Group Statement of Recognised Income and Expense for the year ended 30 June 2006
$m Foreign exchange difference of associate (5) Impairment losses on property, plant and equipment offset against
revaluation surplus (95)
111
Net expense recognised in equity (100)
Profit for period 455
111
Total recognised income and expense 355
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PILOT PAPER
Draft Statement of changes in equity for the year ended 30 June 2006
$m Total recognised income and expense for the period 355
Dividends paid (446)
New shares issued 30
111
Total movement during the year (61)
Shareholders’ funds at 1 July 2005 495
111
Shareholders’ funds at 30 June 2006 434
111
The following relates to Zambeze:
(i) Zambeze acquired a seventy per cent holding in Damp, a public limited company, on 1 July 2005. The fair values of the net assets acquired were as follows:
$m
Property, plant and equipment 70
Inventories and work in progress 90
111
160
111
The purchase consideration was $100m in cash and $25m (discounted value) deferred consideration which is payable on 1 July 2006. The difference between the discounted value of the deferred
consideration ($25m) and the amount payable ($29m) is included in “interest payable”. Zambeze wants to set up a provision for reconstruction costs of $10m retrospectively on the acquisition of Damp. This provision has not yet been set up.
(ii) There had been no disposals of property, plant and equipment during the year. Depreciation for the period charged in cost of sales was $60m.
(iii) Current liabilities comprised the following items:
2006 2005
(iv) Non-current liabilities comprised the following:
2006 2005
$m $m
Deferred consideration – purchase of Damp 29 – Liability for the purchase of Property, plant
and equipment 144 –
Loans repayable 621 555
Provision for deferred tax 30 25
Retirement benefit liability 26 20
111 111
850 600
(v) The retirement benefit liability comprised the following:
$m Movement in year:
Liability at 1 July 2005 20
Current and past service costs charged to income statement 13 Contributions paid to retirement benefit scheme (7)
111
Liability 30 June 2006 26
111
There was no actuarial gain or loss in the year.
(vi) Goodwill was impairment tested on 30 June 2006 and any impairment was included in the financial statements for the year ended 30 June 2006.
(vii) The Finance Director has set up a company, River, through which Zambeze conducts its investment activities. Zambeze has paid $400m to River during the year and this has been included in dividends paid. The money was invested in a specified portfolio of investments. Ninety five per cent of the profits and one hundred per cent of the losses in the specified portfolio of investments are transferred to Zambeze. An investment manager has charge of the company’s investments and owns all of the share capital of River. An agreement between the investment manager and Zambeze sets out the operating guidelines and prohibits the investment manager from obtaining access to the investments for the manager’s benefit. An annual transfer of the profit/loss will occur on 30 June annually and the capital will be returned in four years time. The transfer of $400m cash occurred on 1 January 2006 but no transfer of profit/loss has yet occurred. The balance sheet of River at 30 June 2006 is as follows:
River – Balance sheet at 30 June 2006
$m Investment at fair value through profit or loss 390
111
(a) Prepare a group cash flow statement for the Zambeze Group for the year ended
30 June 2006 using the indirect method. (35 marks)
(b) Discuss the issues which would determine whether River should be consolidated by
Zambeze in the group financial statements. (9 marks)
(c) Discuss briefly the importance of ethical behaviour in the preparation of financial statements and whether the creation of River could constitute unethical practice by
the finance director of Zambeze. (6 marks)
Two marks are available for the quality of the discussion of the issues regarding the consolidation of River and the importance of ethical behaviour.
43
PILOT PAPER
Section B – TWO questions ONLY to be attempted
2. Electron, a public limited company, operates in the energy sector. The company has grown significantly over the last few years and is currently preparing its financial statements for the year ended 30 June 2006.
Electron buys and sells oil and currently has a number of oil trading contracts. The contracts to purchase oil are treated as non-current assets and amortised over the contracts’ durations. On acceptance of a contract to sell oil, fifty per cent of the contract price is recognised immediately with the balance being recognised over the remaining life of the contract. The contracts always result in the delivery of the commodity. (4 marks) Electron has recently constructed an ecologically efficient power station. A condition of being granted the operating licence by the government is that the power station be dismantled at the end of its life which is estimated to be 20 years. The power station cost $100m and began production on 1 July 2005. Depreciation is charged on the power station using the straight line method. Electron has estimated at 30 June 2006, it will cost $15m (net present value) to restore the site to its original condition using a discount rate of five per cent. Ninety-five per cent of these costs relate to the removal of the power station and five per cent relates to the damage caused through generating energy. (7 marks) Electron has leased another power station which was relatively inefficient, to a rival company on 30 June 2006. The beneficial and legal ownership remains with Electron and in the event of one of Electron’s power stations being unable to produce energy, Electron can terminate the agreement. The leased power station is being treated as an operating lease with the net present value of the income of $40m being recognised in profit or loss. The fair value of the power station is $70m at 30 June 2006. A deposit of $10m was received on 30 June 2006 and it is included in the net present value calculation. (5 marks) The company has a good relationship with its shareholders and employees. It has adopted a strategy of gradually increasing its dividend payments over the years. On 1 August 2006, the board proposed a dividend of 5c per share for the year ended 30 June 2006. The shareholders will approve the dividend along with the financial statements at the general meeting on 1 September 2006 and the dividend will be paid on 14 September 2006. The directors feel that the dividend should be accrued in the financial statements for the year ended 30 June 2006 as a “valid expectation” has been created. (3 marks) The company granted share options to its employees on 1 July 2005. The fair value of the options at that date was $3m. The options vest on 30 June 2008. The employees have to be employed at the end of the three year period for the options to vest and the following estimates have been made:
Estimated percentage of employees leaving during vesting period at:
Grant date 1 July 2005 5%
30 June 2006 6% (4 marks)
Effective communication to the directors (2 marks)
Required:
Draft a report suitable for presentation to the directors of Electron which discusses the accounting treatment of the above transactions in the financial statements for the year ended 30 June 2006, including relevant calculations.
3. The following balance sheet relates to Kesare Group, a public limited company at 30 June 2006:
$’000 Assets:
Non current assets:
Property, plant, and equipment 10,000
Goodwill 6,000
Cash and cash equivalents 6,700
111
Trade and other payables 5,000
111
Total current liabilities 8,070
111
Total liabilities 25,670
111
Total equity and liabilities 48,300
333
The following information is relevant to the above balance sheet:
(i) The financial assets are classified as “available for sale” but are shown in the above balance sheet at their cost on 1 July 2005. The market value of the assets is $10.5m on 30 June 2006. Taxation is payable on the sale of the assets.
(ii) The stated interest rate for the long term borrowing is 8%. The loan of $10m represents a convertible bond which has a liability component of $9.6m and an equity component of $0.4m. The bond was issued on 30 June 2006.
45
PILOT PAPER iv) The tax bases of the assets and liabilities are the same as their carrying amounts in the balance sheet at 30
June 2006 except for the following:
(a) $’000
Property, plant, and equipment 2,400
Trade receivables 7,500
Other receivables 5,000
Employee benefits 5,000
(b) Other intangible assets were development costs which were all allowed for tax purposes when the cost was incurred in 2005.
(c) Trade and other payables includes an accrual for compensation to be paid to employees. This amounts to $1m and is allowed for taxation when paid.
(v) Goodwill is not allowable for tax purposes in this jurisdiction. (vi) Assume taxation is payable at 30%.
Required:
(a) Discuss the conceptual basis for the recognition of deferred taxation using the
temporary difference approach to deferred taxation. (7 marks)
(b) Calculate the provision for deferred tax at 30 June 2006 after any necessary adjustments to the financial statements showing how the provision for deferred taxation would be dealt with in the financial statements. (Assume that any adjustments do not affect current tax. Candidates should briefly discuss the adjustments required to calculate the provision for deferred tax). (18 marks)
Two marks will be awarded for the quality of the discussion of the conceptual basis of deferred taxation in (a).
(25 marks)
4. A significant number of entities and countries around the world have adopted International Financial Reporting
Standards (IFRS) as their basis for financial reporting, often regarding these as a means to improve the quality of information on corporate performance. However, while the advantages of a common set of global reporting standards are recognised, there are a number of implementation challenges at the international and national levels if the objective of an improved and harmonised reporting system is to be achieved.
Required:
(a) Discuss the implementation challenges faced by the International Accounting
Standards Board (IASB) if there is to be a successful move to International Financial
Reporting Standards. (18 marks)
(b) The International Accounting Standards Board recently issued Exposure Drafts of Proposed Amendments to IFRS3 Business Combinationsand IAS27Consolidated and Separate Financial Statements. The proposals radically change the basis of reporting business combinations and transactions with minority interests.
Discuss how the above exposure drafts will fundamentally affect the existing
accounting practices for business combinations. (7 marks)
Two marks will be awarded for the quality of the discussion of the ideas and information.
(25 marks)
Answers
1. (a) Zambeze Group
Group Statement of Cash Flows for the year ended 30 June 2006
$m $m
Cash flows from operating activities:
Net profit before taxation 690
Adjustments for:
Share of profit in associate (30)
Depreciation 60
Impairment of goodwill (Working 2) 8
Interest expense 40
Retirement benefit expense 13
111
91
111
Operating profit before working capital changes: 781 Increase in trade receivables (80)
Decrease in inventories (650-580-90) 20 Increase in trade payables 141
111
81
111
Cash generated from operations: 862
Interest paid (Working 5) (31) Income taxes paid (Working 4) (190) Cash paid to retirement benefit scheme (7)
111
(228)
111
Net cash from operating activities: 634 Cash flows from investing activities
Acquisition of subsidiary (100) Purchase of property, plant and equipment (Working 1) (251) Dividends received from Associate (Working 3) 35
Investment in River (400)
111
Net cash used in investing activities (716) Cash flows from financing activities:
Proceeds from issue of share capital 30 Increase in long-term borrowings 66 Dividends paid (Working 6) (46) Minority interest dividends (Working 2) (58)
111
Net cash used in financing activities (8)
111
Net decrease in cash and cash equivalents (90) Cash and cash equivalents at beginning of period 140
111
Cash and cash equivalents at the end of period 50
47
PILOT PAPER
Working 1
$m Tangible non-current assets
Balance at 1 July 2005 1,005
Impairment losses (95)
Cash flow is $395m minus the liability for property, plant and equipment of $144m, ie $251m.
Working 2
$m Purchase of subsidiary:
Net assets acquired 160
111
Group’s share of net assets (70%) 112
Goodwill 13
111
Purchase consideration (100+25) 125
111
Goodwill:
Balance at 1 July 2005 25
Goodwill on subsidiary 13
Impairment (8)
111
Balance at 30 June 2006 30
111
Minority interest:
Balance at 1 July 2005 45
Acquisition of Damp (160 x 30%) 48
Profit for year 25
Dividend (58)
111
Balance at 30 June 2006 60
111
Working 3
$m Dividend from associate:
Balance at 1 July 2005 290
Income (net of tax) (30-10) 20
Foreign exchange loss (5)
Dividends received (difference) (35)
111
Balance at 30 June 2006 270
Working 4
£m £m
Taxation:
Balance at 1 July 2005 Income tax 185
Deferred tax 25
Income statements (210–10) 200
Tax paid (difference) (190)
Balance at 30 June 2006 Income tax 190 Deferred tax 30
Balance at 1 July 2005 45
Income statement 40
Unwinding of discount on purchase (4)
Cash paid (difference) (31)
111
Closing balance at 30 June 2006 50
111
Working 6
The cash payment to River should be shown as “investing activities” of $400m and the dividend paid will then be $(446400)m, ie $46m.
(b) The definition of “control” underpins the definition of the parent and subsidiary relationship. IAS27
Consolidated and Separate Financial Statementsstates that control is presumed when the parent acquires more than half of the voting rights of the enterprise. Even when more than one half of the voting rights is not acquired, control may be evidenced by power (IAS27, para 13)
(i) over more than one half of the voting rights by virtue of an agreement with other investors; or (ii) to govern the financial and operating policies of the other enterprise under a statute or an agreement;
or
(iii) to appoint or remove the majority of the members of the board of directors; or (iv) to cast the majority of votes at a meeting of the board of directors.
IAS27 emphasises that the reference to power in the definition of “control” means the ability to do or affect something. As a result an entity has control over another entity when it has the ability to exercise that power, regardless of whether control is actively demonstrated or passive in nature. Further SIC12, Consolidation – Special Purpose Entities says that special purpose entities (SPEs) should be consolidated where the substance of the relationship indicates that the SPE is controlled by the reporting enterprise. This may arise even where the activities of the SPE are predetermined or whether the majority of voting or equity are not held by the reporting enterprise.
49
PILOT PAPER formed and, therefore, the company was set up as a vehicle with the objective of keeping certain transactions off the balance sheet of Zambeze. The investment manager manages the investments of River within the guidelines and incurs no risk and receives 5% of the profits for the management services.
(c) Ethics in accounting is of utmost importance to accounting professionals and those who rely on their services. Accounting professionals know that people who use their services, especially decision makers using financial statements, expect them to be highly competent, reliable, and objective. Those who work in the field of accounting must not only be well qualified but must also possess a high degree of professional integrity. A professional’s good reputation is one of his or her most important assets.
There is a very fine line between acceptable accounting practice and management’s deliberate
misrepresentation in the financial statements. The financial statements must meet the following criteria: (i) Technical compliance: A transaction must be recorded in accordance with generally accepted
accounting principles (GAAP).
(ii) Economic substance: The resulting financial statements must represent the economic substance of the event that has occurred.
(iii) Full disclosure and transparency: Sufficient disclosure must be made so that the effects of transactions are transparent to the reader of the financial statements.
In the case of River it could be argued that the first criterion may be met because the transaction is apparently recorded in technical compliance with IFRS, but technical compliance alone is not sufficient. The second criterion is not met because the transaction as recorded does not reflect the economic substance of the event that has occurred.
Accounting plays a critical function in society. Accounting numbers affect human behaviour especially when it affects compensation, and to deliberately mask the nature of accounting transactions could be deemed to be unethical behaviour.
River was set up with the express purpose of keeping its activities off the balance sheet. The Finance Director has an ethical responsibility to the shareholders of Zambeze and society not to mask the true nature of the transactions with this entity. Further, if the transaction has been authorised by the Finance Director without the authority or knowledge of the Board of Directors, then a further ethical issue arises.Showing the transfer of funds as a dividend paid is unethical and possibly illegal in the jurisdiction. The transfer should not be hidden and River should be consolidated.
Report to Directors of Electron
Terms of reference
This report sets out the nature of the accounting treatment and concerns regarding the following matters: • Oil contracts
Oil Contracts
The accounting policy adopted for the agreements relating to the oil contracts raises a number of concerns. The revenue recognition policy currently used is inflating revenue in the first year of the contract with 50% of the revenue being recognised, but a smaller proportion of the costs are recognised in the form of depreciation. Over the life of the contract, costs and revenues are equally matched but in the short term there is a bias towards a more immediate recognition of revenue against a straight line cost deferral policy. Additionally oil sales result in revenue whilst purchases of oil result in a tangible non-current asset. IAS18 Revenue states that revenue and expenses that relate to the same transaction or event should be recognised simultaneously and the “Framework” says that the “measurement and display of the financial effect of like transactions must be carried out in a consistent way”. Accounting policies should provide a framework to ensure that this occurs. The current accounting practice seems to be out of line with IAS18 and the Framework.
However, the election of the company to use some form of deferral policy for its agreements is to be commended as it attempts to bring its revenue recognition policy in line with the length of the agreements. The main problem is the lack of a detailed accounting standard on revenue recognition. The result is the current lack of consistency in accounting for long-term agreements. However, it may be advisable to adopt a deferral policy in terms of this type of revenue. The contracts always result in the delivery of the oil in the normal course of business and are not, therefore, accounted for as financial instruments as they qualify as normal sale and purchase contracts.
Power Station
Under IAS37Provisions, Contingent Liabilities and Contingent Assets, a provision should be made at the balance sheet date for the discounted cost of the removal of the power station because of the following reasons: (i) the installation of the power station creates an obligating event;
(ii) the operating licence creates a legal obligation which is likely to occur;
(iii) the costs of removal will have to be incurred irrespective of the future operations of the company and cannot be avoided;
(iv) a transfer of economic benefits (ie the costs of removal) will be required to settle the obligation; (v) a reasonable estimate of the obligation can be made although it is difficult to estimate a cost which will
be incurred in twenty years time (IAS37 says that only in exceptional circumstances will it not be possible to make some estimate of the obligation).
The costs to be incurred will be treated as part of the cost of the facility to be depreciated over its production life. However, the costs relating to the damage caused by the generation of energy should not be included in the provision, until the power is generated which in this case would be 5% of the total discounted provision. The accounting for the provision is shown in Appendix 1.
Operating Leases
SIC27Evaluating the Substance Of Transactions Involving the Legal Form of a Leaseconsiders whether a leasing agreement meets the definition of a lease in IAS17 Leases and how a company should account for any fee that it might receive. A lease is classified as a finance lease if it transfers substantially all the risks and rewards “incident” to ownership. All other leases are classified as operating leases. In this case, the beneficial and legal ownership remains with Electron and Electron can make use of the power station if it so wishes. Also for a lease asset to be a finance lease the present value of the minimum lease payments should be substantially all of the fair value of the leased asset. In this case this amounts to 57.1% ($40m ÷ $70m) which does not constitute “substantially all”. Thus there does not seem to be any issue over the classification of the lease as an operating lease. The immediate recognition as income of the future benefit at net present value is a little more
51
PILOT PAPER
Proposed Dividend
The dividend was proposed after the balance sheet date and the company, therefore, did not have a liability at the balance sheet date. No provision for the dividend should be recognised. The approval by the directors and the shareholders are enough to create a valid expectation that the payment will be made and give rise to an obligation. However, this occurred after the current year end and, therefore, will be charged against the profits for the year ending 30 June 2007.
The existence of a good record of dividend payments and an established dividend policy does not create a valid expectation or an obligation. However, the proposed dividend will be disclosed in the notes to the financial statements as the directors approved it prior to the authorisation of the financial statements.
Share Options
Equity-settled transactions with employees would normally be expensed on the basis of their fair value at the grant date. Fair value should be based on market prices wherever possible. Many shares and share options will not be traded on an active market. In this case, valuation techniques, such as the option pricing model, would be used. IFRS2’s objective for equity-based transactions with employees is to determine and recognise compensation costs over the period in which the services are rendered. In this case, the company has granted to employees share options that vest in three years’ time on the condition that they remain in the entity’s employ for that period. These steps will be taken:
(i) the fair value of the options will be determined at the date on which they were granted;
(ii) this fair value will be charged to the income statement equally over the three year vesting period with adjustments made at each accounting date to reflect the best estimate of the number of options that eventually will vest.
Shareholders’ equity will be increased by an amount equal to the income statement charge. The charge in the income statement reflects the number of options that are likely to vest, not the number of options granted or the number of options exercised. If employees decide not to exercise their options because the share price is lower than the exercise price, then no adjustment is made to the income statement. Many employee share option schemes contain conditions that must be met before the employee becomes entitled to the shares or options. These are called vesting conditions and could require, for example, an increase in profit or growth in the entity’s share price before the shares vest. In this case the vesting condition is the employment condition. $940,000 ($3m x 94% x 1/3) will be charged in the income statement and to equity at 30 June 2006.
Recommendations and Conclusion
Appendix 1
£m £m
Present value of obligation at 1 July 2005 (15 ÷1.05) 14.3
111
Provision for decommissioning (95% x 14.3) 13.6
111 111
Provision for damage through extraction (5% x 14.3) 0.7
111
Balance Sheet at 30 June 2006
£m £m
Tangible non current assets:
Cost of power station 100
Provision for decommissioning 13.6
111
113.6 Less depreciation (113.6 ÷ 20 years) (5.7)
111
Carrying value 107.9
111
Other provisions:
Provision for decommissioning 1 July 2005 13.6 Unwinding of discount (13.6 x 5%) 0.7
111
14.3 Provision for damage (0.7 ÷ 20 years) 0.1
111
Unwinding of discount (finance cost) 0.7
111
A simple straight line basis has been used to calculate the required provision for damage. A more complex method could be used whereby the present value of the expected cost of the provision is provided for over 20 years and the discount thereon is unwound over its life.
3. (a) Under IFRS, an asset or liability is recognised if it meets the definition of such in the Framework document. The definitions refer to the right to receive or the obligation to transfer economic benefits as a result of a past event. The accounting model used to account for deferred tax is based on the premise that the tax effects of transactions should be recognised in the same period as the transactions themselves. The reality is, however, that tax is paid in accordance with tax legislation when it becomes a legal liability. There is an argument, therefore, that deferred tax is neither asset nor liability.
The temporary difference approach is based on the assumption that an asset will ultimately be recovered or realised by a cash inflow which will enter into the determination of future taxable profits. Thus the tax payable on the realisation of the asset should be provided for. It is argued that it would be inconsistent to represent that the asset can be recovered at its balance sheet value whilst ignoring the tax consequences.
Similarly for a liability carried in the balance sheet, there is an implicit assumption that the liability will
ultimately be settled by a cash outflow. The outflow will enter into the determination of tax profits and any tax deduction allowable will effectively be an asset. As above, it would be inconsistent to recognise the liability whilst ignoring the tax consequences of its recognition.
