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Notes of Financial Reporting (PIPFA) Written by: Muhammad Naseem

Financial Reporting (PIPFA)

Description

Page No.
03 05 09 13 14 16 18 24 27 33 35 37 39 40 43 45 47 51 60

IAS 1 Presentation of Financial Statements IAS 2 Inventory . IAS 7 Cash Flow Statements IAS 8 Accounting polices, change in accounting estimates & errors IAS 10 Post Balance Sheet Events . IAS 11 Construction contracts . IAS 12 Deferred Taxation IAS 16 PPE IAS 17 Leases . IAS 18 Revenue Recognition . IAS 23 Borrowing Cost IAS 24 Related Parties IAS 36 Impairment IAS 37 Provision, Contingent Liabilities, Contingent Assets . IAS 38 Intangible Assets... IAS 40 Investments Partnership accounts Consolidated accounts Pass Paper solutions

Muhammad Naseem

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Financial Reporting (PIPFA)

IAS-1: Presentation of Financial Statements

Objective and Scope To prescribe the basis for presentation of general purpose financial statements, in order to ensure comparability both with the entitys own financial statements of previous periods and with the financial statements of other entities. In order to fulfill this objective, financial statements must provide information about the following aspects of an entitys results. a) b) c) d) e) f) Assets Liabilities Equity Income and expenses (including gains and losses) Contributions by and distribution to owner Cash flows

Along with other information in the notes and related documents, this information will assist users in predicting the entitys future cash flows Components of financial statements: 1. 2. 3. 4. 5. A statement of financial position at the end of period A statement of comprehensive income for the period Statement changes in equity, for the period A statement of cash flows Notes comprising summary of accounting policies and explanatory notes

Following concepts are paper related Going Concern The entity is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the entity has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations.

Muhammad Naseem

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Financial Reporting (PIPFA)


Accrual basis of accounting Items are recognized as assets, liabilities, equity, income and expenses when they satisfy the definitions and recognition criteria for those elements in the Framework. Materiality Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Prudence The inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Substance over form The principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. Impracticable Applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so.

Muhammad Naseem

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Financial Reporting (PIPFA)


IAS 2: Inventory

IAS 2 was revised in December 2003. It lays out the required accounting treatment for inventories (stock) under the historical cost system. The major area of contention is the cost value of inventory to be recorded. This is recognised as an asset of the entity until the related revenues are recognised at which point the inventory is recognised as an expense. Part or all of the cost of inventories may also be expensed if a write- down to net realizable value is necessary. In other words, the fundamental accounting assumption of accruals requires costs to be matched with associated revenues. In order to achieve this, costs incurred for goods which remain unsold at the year end must be carried forward in the statement of financial position and matched against future revenues. 1) Inventories are assets: . Held for sale in the ordinary course of business . In the process of production for such sale . In the form of materials or supplies to be consumed in the production process or in the rendering of services. 2) Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. 3) Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arms length transaction.

1 - Cost - NRV

2 Inventory System - Periodic ( FIFO & ARG) - Perpetual ( FIFO & ARG)

3 Calculation of closing stock through trading account App. By Mark up & Margin

4 - Correction of stock sheet - Stock taking before B/S date - Stock taking after B/S date

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Financial Reporting (PIPFA)


Part 1: a) Cost of purchase (purchase price + import duties + non refundable taxes + Transportation, handling Less Trade discount) b) Cost of conversion (Labor + FOH) c) Other cost directly attributable to bring the inventory to the present condition & location Overhead type FOH (Factory overhead) SOH (Selling overhead) AOH ( Admin overhead)

xxx xxx xxx ---------------------Total FC xxx Add: W.I.P opening xxx Less: W.I.P closing xxx --------------------Cost of good production xxx Add: Finish good opening xxx Less: Finish good closing xxx ----------------------Cost of good sold xxxx Inventory shall be measure at lower of cost & NRV These below costs will not be included in inventory cost a) AOH (Admin overhead) b) SOH (Selling overhead) c) Storage cost d) Abnormal loss Part 2: If stock is given in the trail balance then it assumed that company is using Perpetual inventory system If stock is given out side the trail balance then it assumed that company is using Periodic inventory system

Direct Material Direct Labor FOH

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Financial Reporting (PIPFA)


Part 3: Markup always on cost & Margin on sale, to calculate need to use following formula S = C + G.P (S is sale, C is cost & G.P is gross profit) For example: sale = Rs 100,000/- & G.P 20% Margin then find cost? S= C + G.P 100,000 = X + 20% X= 100,000 * 20% = Rs 80,000/If Sale = Rs 100,000/- & G.P 20% Markup then find cost? S=C+G.P 100,000= X + 20% of X 100,000= 1.20 X X = 100,000/1.20 X= Rs 83,333/Opening stock Purchases Sale return Carriage in Gross profit Trading Account xxx xxx xxx xxx xxx xxx Sale Purchase return Closing Stock (Bal. figure) xxx xxx xxx

xxx

Example Question: Opening stock Rs 100,000/- , purchases Rs 300,000/-, Purchase return Rs 20,000/-, Sales Rs 500,000/-, Sale Return Rs 50,000/- and GP 30% markup. Find Closing stock? Trading Account Opening stock Purchases Sale return Gross profit 100,000 300,000 50,000 103,846 553,846 S = C + GP 500,000 50,000 = X + 30% of X 450,000 = 1.30X X = 450,000/1.30 X = 346,154 * 30% GP = 103,846/Muhammad Naseem Page 7 553,846 Sale Purchase return Closing Stock 500,000 20,000 33,846

Financial Reporting (PIPFA)


Part 4: 1 - Correction of stock: Stock + under stock - over stock Adjusted stock Xxx Xxx (xxx) Xxx

2 Stock taking before balance sheet date: Stock + net purchases - net sale (cost of good sold) Adjusted stock xxx xxx (xxx) Xxx

3 Stock taking after balance sheet date: Stock - net purchases + net sale (cost of good sold) Adjusted stock Xxx (xxx) Xxx Xxx

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Financial Reporting (PIPFA)


IAS 7: Cash Flow Statements

Information relating to cash flows helps users of financial statements to assess: A. The ability of the entity to generate cash and cash equivalents B. The need of entity for cash A statement of cash flow allows users of the financial statements to evaluate the ability of the entity to generate cash flows and the timing and certainty of those cash flows. This may influence the economic decisions taken by users. A statement of cash flow is therefore required because it provides useful information that other financial statements do not provide. The statement of cash flow provides information on the liquidity, viability and adaptability of the entity, which is not provided by the other financial statements. A company may have high net assets and large profits, but these are not a guarantee of financial viability. If the entity makes sales on credit, but later cannot collect the debts it is owed by customers, it may not have cash to spend on replacing the inventory it has sold, in order to make further sales. Cash is the lifeblood of a business; the statement of cash flow therefore plays an important role in understanding the financial position of an entity. IAS 7 states that cash flow should be presented under three headings: A. Cash flow from operating activities B. Cash flow from investing activities C. Cash flow form financing activities Cash flows are itemized under each of these three headings, and the total cash flow is also shown for each heading. Together, they explain the total increase or decrease in cash equivalents during the financial period. Statements of cash flows, as their name indicates and show cash flows that have occurred during the period. Non cash transactions are excluded. For example, if a company re-values and item of property or makes a bonus issue of shares, these transactions would not feature in the statement of cash flow because they do not involve a flow of cash. The only non cash items included in a statement of cash flow are adjustments to the profit before tax, when the indirect method is used to present cash flows from operating activities. Cash flow from operating activities can be presented by using two methods; Direct & indirect method Muhammad Naseem Page 9

Financial Reporting (PIPFA)


Cash flow statement

Cash flow from Operating activities

cash flow from investing activities

cash flow from financing activities

Inflow outflow

inflow

outflow

inflow

outflow

Sale of FA Sale of LTL Int. received Inflow Less Add Out flow Add Less

purchase of FA purchase of LTL interest paid

issued Capital issued LTL

paid divid. paid LTL

CA CL

Formats of cash flow statement as follow for Direct & Indirect method Cash flow statement Indirect method RS CF from operating activities Net profit Adjustments: Add: Depreciation Exp Amortization Exp Provision for debts Provision for tax Interest Exp Loss on disposal Less: Interest income Gain on disposal Net CF from operating Act. Muhammad Naseem xxxx xxx xxx xxx xxx xxx xxx xxx xxx xxxx Cash flow statement direct method RS CF from operating activities Net CF from operating Act. Before WC item changes: Add: Decrease in CA Increase in CL Less: Increase in CA Decrease in CL Tax paid interest paid CF from investing activities Add: Sale of FA xxxx xxx xxx xxx xxx xxx xxx xxxxx xxx Page 10

RS

RS

xxxxx

Financial Reporting (PIPFA)


Before WC item changes: Add: Decrease in CA Increase in CL Less: Increase in CA Decrease in CL Tax paid interest paid Sale of LTL Interest received Purchase of FA Purchase of LTL xxx xxx xxx xxx Xxxx Xxx Xxx Xxx

xxx xxx xxx xxx xxx xxx xxxxx

Less:

xxxx

xxxxx

CF from financing activities Add: Issued s. capital Received LT Loan Less: Paid dividend Paid LT Loan

CF from investing activities Add: Sale of FA Sale of LTL Interest received Purchase of FA Purchase of LTL xxx xxx xxx xxx xxx xxxx CF from financing activities Add: Less: Issued s. capital Received LT Loan Paid dividend Paid LT Loan xxx xxx xxx xxx xxxx xxxx

Less:

Xxx Xxxx Net increase in cash & cash equivalent Add: Opening balance of Cash Closing balance of cash & cash equivalent

xxxx xxxxx xxx xxxxx

Xxxx Xxxxx Xxx Xxxxx

Net increase in cash & cash equivalent Add: Opening balance of Cash Closing balance of cash & cash equivalent

Cash and Cash equivalent Opening Cash Bank Market Securities Bank overdraft Xxx Xxx Xxx Xxxx (xxx) Xxxx Closing Xxx Xxx Xxx Xxxx (xxx) Xxxx

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Financial Reporting (PIPFA)


Note: we will make T accounts for following Fixed Asset Long term liabilities Equity Current asset (only interest received) Current liabilities (only for interest paid, taxation, dividend payable)

There are two steps for solving cash flow statement question Step 1 find cash & cash equivalent Step 2 Critical accounts for missing information

Muhammad Naseem

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Financial Reporting (PIPFA)


IAS 8: Accounting polices, change in accounting estimates & errors
There are three stages in this IAS, which are as follows: 1. Accounting polices 2. Change in accounting estimates 3. Errors (financial & non financial) Stage 1: if you change accounting polices then its effect retrospective statements (past, current, future) Stage 2: if you change accounting estimates then its effect prospective statements (current & future) Stage 3: if you change errors then its effect retrospective statements (past, current & future) Accounting Polices Accounting policies are the specific principles, bases, conventions, rules and practices adopted by an entity in preparing and presenting financial statements. Change in accounting estimate A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities, changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors Errors Prior period errors may result on the basis of mathematical calculation, over sight or omissions. Correct these retrospectively. There is no longer any allowed alternative treatment. This involves: Either restating the comparative amounts for the prior periods in which the error occurred, or when the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for that period so that the financial statements are presented as if the error had never occurred. Only where it is impracticable to determine the cumulative effects of an error on prior periods can an entity correct and error prospectively. Following disclosures are required: a) Nature of error b) Amount involved c) Circumstance leading that correction

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Financial Reporting (PIPFA)


IAS 10: Post Balance Sheet Events

1st Jan

Balance sheet date 31st December

Balance sheet publish date 15th March

Condition exists or not

Definition: Events occurring after the reporting period are those events, both favorable and unfavorable, that occur between the end of the reporting period and the date on which the financial statements are authorized for issue. Two types of events can be identified: a) Those that provide further evidence of conditions that existed at the end of the reporting period. b) Those are indicative of conditions that arose subsequent to the end of the reporting period. Accounting treatment: a) Adjust assets and liabilities where events after the reporting date provide further evidence of conditions existing at the reporting date. b) Do not adjust, but instead disclose, important events after reporting date that do not affect condition of assets and liabilities at the reporting date. c) Dividends for period proposed/declared after the reporting date but before FS are approved should not be recognised as a liability at the reporting date. Disclosure: a) Nature of events b) Estimate of financial effect Purpose of IAS 10: The financial statements are prepared as at the end of the reporting period, but often the accounts are not authorized by the directors until some months later. During this time events may take place within the entity that should be communicated to the shareholders.

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Financial Reporting (PIPFA)


Events after the reporting period have two main objectives: a) To specify when an entity should adjust its financial statements for events that occur after the reporting period, but before the financial statements are authorized for issue. b) To specify the disclosures that should be given about events that have occurred after the reporting period but before the financial statements were authorized for issue IAS 10 also includes a requirement that the financial statements should disclose when the statements were authorized for issue, and who gave the authorization. As we discuss above adjusting and non adjusting events after balance sheet date, which are as follows;

Adjusting events 1. 2. 3. 4. 5. 6. Settlement of court cases Bad debts after BS date. Inventory at lower of cost & NRV Declaration of bonus Fraud & errors Determine the cost of PPE

Non adjusting events 1. Loss due to theft or fire after BS date 2. Decline in the value of investment. 3. Dividends 4.Major business combination sale of subsidiary 5. Plan to discontinuous the major operations 6. Disposal of assets 7.Change in asset price or foreign exchange rate 8. Change in tax rate and law 9. Contingent liabilities 10. Litigation arising solely at of events 11. Implementation of major restructuring

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Financial Reporting (PIPFA)


IAS 11: Construction Contracts
Construction contract: A contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of design, technology and function or their ultimate purpose or use. Standard differentiates between fixed price contracts and cost plus contracts. Fixed price contract: A contract in which the contractor agrees to a fixed contract price or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses Cost plus contract: A construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee. Combining and segmenting construction contracts: The standard lays out the factors which determine whether the construction of a series of assets under one contract should be treated as several contracts. a) Separate proposals are submitted for each asset. b) Separate negotiations are undertaken for each asset; the customer can accept or reject each individually. c) Identifiable costs and revenues can be separated for each asset. There are also circumstances where a group of contracts should be treated as one single construction contract. a) The groups of contracts are negotiated as a single package. b) Contracts are closely interrelated, with an overall profit margin. c) The contracts are performed concurrently or in a single sequence. Rule for recognition Outcome can not be measured reliably No profit taken on contract, only Revenue recognize which can be Recoverable Outcome can be measured reliably

Expected profit

Expected loss

Revenue, cost & profit taken according to stage of completion % of completion with reference to cost =Cost to date/ total cost x 100

Full loss recognized

% of completion with reference to contract =work certified/ contract price x 100

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Financial Reporting (PIPFA)


For Cost formula Income statement A ? xx xxx B ? Xx Xxx C ? Xx Xxx For work certified formula Income statement A xx ? xxx B Xx ? Xxx C xx ? xxx

Revenue(bal.figure) Cost GP Balance Sheet

Revenue Cost(bal. figure) GP

Amount due from /due to customer Add: Cost to date Profit / loss to date Progress billing to date A xx xx (xx) xxx B xx xx (xx) xxx C Xx Xx (xx) Xxx

Less:

Estimated profit Contract price Cost to date Estimated further cost to complete Total cost Total estimated profit Xx Xx (xxx) xxxx (xxx) xxxx (xxx) Xxxx A xxx B xxx C Xxx

if percentage is not given for attributed profit then you have to find this % If you are using cost formula then: if you are using work certified then: Cost to date / total cost x 100 work certified/ contract price x 100

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Financial Reporting (PIPFA)


IAS 12: Deferred Taxation
What is deferred tax? When a company recognizes an asset or liability, it expects to recover or settle the carrying amount of that asset or liability. In other word, it expects to sell or use up assets, and to pay off liabilities. What happens if that recovery or settlement is likely to make future tax payments larger or smaller then they would otherwise have been if the recovery or settlement had no tax consequences? Deferred tax

Balance sheet (Assets)

Balance sheet (liability)

TTD (taxable temporary difference)

DTD (deductable temporary difference)

Deferred tax Expense & liability

Deferred tax asset & liability

1. Current tax estimation for current tax: Tax expense To Tax provision 1. Over provide: Tax provision To Income tax expense prior 5 Deferred tax income: Deferred tax asset To Deferred tax income

2. under provide: Tax expense prior To Income tax provision 4. Deferred tax expense: Deferred tax expense To Deferred tax liability

Definitions: 1) Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. 2) Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: a) Deductible temporary differences; b) The carry forward of unused tax losses; c) The carry forward of unused tax credits. Muhammad Naseem Page 18

Financial Reporting (PIPFA)


3) Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either: a) Taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit /loss of future periods when the carrying amount of the asset or liability is recovered or settled; b) Deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit/loss or future periods when the carrying amount or the asset or liability is recovered or settled. 4) The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes or tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to the entity when it recovers the carrying value of the asset. Where those economic benefits are not taxable, the tax base of the asset is the same as its carrying amount. Accounting profit form the basis for computing taxable profits, on which the tax liability for the year is calculated; however, accounting profits and taxable profits are different. There are two reasons for the differences. Permanent difference: These occur when certain items of revenue or expense are excluded from the computation of taxable profits (for example, entertainment expenses may not be allowable for tax purposes). Temporary differences: These occur when items of revenue or expense are included in both accounting profits and taxable profits, but not for the same accounting period. For example, an expense which is allowable as a deduction in arriving at taxable profits for 2011 might not be included in the financial accounts until 2012 or later. In the long run, the total taxable profits and total accounting profits will be the same (except for permanent differences) so that timing differences originate in one period and are capable of reversal in one or more subsequent periods. Deferred tax is the tax attributable to temporary differences. Taxable temporary differences All taxable temporary differences give rise to a deferred tax liability Transaction that affect the statement of comprehensive income under TTD a) b) c) d) e) Interest revenue received in arrears Sale of good revenue Depreciation of an asset Development cost Prepaid expenses

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Financial Reporting (PIPFA)


Transaction that affect the statement of financial position under TTD a) Depreciation of an asset is not deductible for tax purposes. No deduction will be available for tax purposes when the asset is sold/scrapped. b) A borrower records a loan at proceeds received (amount due at maturity) less transaction costs. The carrying amount of the loan is subsequently increased by amortization of the transaction costs against accounting profit. The transaction costs were, however, deducted for tax purposes in the period when the loan was first recognized.

Fair value adjustments and revaluations a) Financial assets or investment property are carried at fair value. This exceeds cost, but no equivalent adjustment is made for tax purposes. b) Property, plant and equipment is revalued by an entity under IAS 16, but no equivalent adjustment is made for tax purposes. Remember the rule I gave you above, that all taxable temporary differences give rise to a deferred liability? There are two circumstances given in the standards where this does not apply. a) The deferred tax liability arises form goodwill for which amortization is not deductible for tax purposes. b) The deferred tax liability arises from the initial recognition of an asset or liability in a transaction which: i) Is not a business combination ii) At the time of the transaction affects neither accounting profit nor taxable profit. Timing differences: Some TD are often called timing differences, when income or expense is included in accounting profit in one period, but is included in taxable profit in a different period. The main types of TTD which are timing differences and which result in deferred tax liabilities. a) Interest received which is accounted for on an accruals basis, but which for tax purposes is included on a cash basis. b) Accelerated depreciation for tax purposes c) Capitalized and amortized development costs

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Financial Reporting (PIPFA)

Deductible temporary differences All deductible temporary difference gives rise to a deferred tax asset. Transaction that affect the statement of comprehensive income under DTD a) Retirement benefit cost (pension costs) b) Accumulated depreciation of an asset c) The cost of inventories sold before the end of the reporting period d) The NRV of inventory, or the recoverable amount of an item of PPE e) Research costs or organization/ other start-up costs f) Income is deferred in the statement of financial position g) A government grant Fair value adjustments and revaluations Current investments or financial instruments may be carried at fair value which is less than cost, but no equivalent adjustment is made for tax purposes. Reasoning behind the recognition of deferred tax assets arising from DTD: a) When a liability is recognized, it is assumed that its carrying amount will be settled in the form of out flows of economic benefits form the entity in future period. b) When these resources flow from the entity, part or all may be deductible in determining taxable profit of a period later than that in which the liability is recognized. c) A temporary tax difference then exists between the carrying amount of the liability and its tax base. d) A deferred tax asset therefore arises, representing the income taxes that will be recoverable in future periods when that part of the liability is allowed as deduction form taxable profit. e) Similarly, when the carrying amount of an asset is less than its tax base, the difference gives rise to a deferred tax asset in respect of the income taxes that will be recoverable in future periods. Taxable profit in future period When can we be sure that sufficient taxable profit will be available against which a DTD can be utilized? IAS 12 states that this will be assumed when sufficient TTD exist which relate to the same taxation authority and the same taxable entity. These should be expected to reverse: a) In the same period as the expected reversal of the DTD b) In periods into which a tax loss arising from the deferred tax asset can be carried back or forward. Only in these circumstances is the deferred tax asset recognized, in the period in which the DTD arise. When there are insufficient TTD? It may still be possible to recognize the deferred tax asset, but only to the extent that:

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Financial Reporting (PIPFA)


a) Taxable profits are sufficient in the same period as the reversal of the DTD or in the periods into which a tax loss arising form the deferred tax asset can be carried forward or backward, ignoring taxable amount arising form DTD arises in future periods. b) Tax planning opportunities exist that will allow the entity to create taxable profit in the appropriate period. Unused tax losses and unused tax credits An entity may have unused tax losses or credits, which it can offset against taxable profit at the end of a period. Should a deferred tax asset be recognized in relation to such amounts? IAS 12 states that a deferred tax asset may be recognised in such circumstances to the extent that its probable future taxable profit will available against which the unused tax losses/credits can be utilized. The criteria for recognition of deferred tax assets here is the same as for recognizing deferred tax assets arising form DTD. The existence of unused tax losses is strong evidence, however, that future taxable profit may not be available. So where an entity has a history of recent tax losses, a deferred tax asset arising from unused tax losses or credits should be recognised only the extent that the entity has sufficient TTD or there is other convincing evidence that sufficient taxable profit will be available against which the unused losses/credits can be utilized by the entity. Summary a) Deferred tax is an accounting device. It does not represent tax payable to the tax authorities. b) The tax base of an asset or liability is the value of that asset or liability for tax purposes. c) You should understand the difference between permanent and temporary differences. d) Deferred tax is the tax attributable to temporary differences. e) With one or two exceptions, all TTD give rise to a deferred tax liability. f) Many TTD are timing differences. g) Timing differences arise when income or an expense is included in accounting profit in one period, but in taxable profit in a different period. h) DTD give rise to a deferred tax asset. i) Prudence dictates that deferred tax assets can only be recognised when sufficient future taxable profits exist against which they can be utilized. Calculation of TTD & DTD CV Assets Furniture Plant R&D prepaid exp Liabilities Accrued salary provision for debt Muhammad Naseem 90,000 70,000 20,000 10,000 2,000 TB 80,000 60,000 100,000 2,000 TD 10,000 10,000 (100,000) 20,000 (10,000) TTD 10,000 10,000 20,000 DTD (100,000)

(10,000) Page 22

Financial Reporting (PIPFA)


Accrued Interest 5,000 (5,000) 40,000 if tax rate is 35% then calculate deferred tax Deferred tax liability 40000 * 35% Deferred tax assets 115000 * 35% CFUTL net deferred tax Exp/income Less: opening deferred tax Tax adjustment Revaluation adjustment deferred tax Exp/income Calculate taxable profit and current tax. If accounting profit is Rs. 50,000/Accounting profit 50,000 Add: PD DTD 115,000 Less: TTD (40,000) taxable profit 125,000 tax rate 35% current tax 43,750 Taxation Disclosure Current Tax Prior tax Deferred tax 14,000 (40,250) (26,250) (26,250) (5,000) (115,000)

43,750 (26,250) 17,500

There two methods for calculating taxable profit Direct method (above use) and indirect method indirect method you can find in text book

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Financial Reporting (PIPFA)

IAS 16: Property, Plant & Equipment


Nature of non current assets Non- current assets are those which are not held for conversion into cash within a short period, such as goods and services as are currently useful. These are the assets held by an entity have a limited useful life to that entity. With the exception of land held on freehold or very long leasehold, every non-current asset eventually wears out over time. Machines, cars and other vehicles, fixtures and fittings, and even buildings do not last for ever. When a business acquires a non-current asset, it will have some idea about how long its useful life will be, and it might decide what to do with it. a) Keep on using the non-current asset until it becomes completely worn out, useless, and worthless. b) Sell off the non-current asset at the end of its useful life, either by selling it as a second-hand item or as scrap. Since a non-current asset has a cost, and a limited useful life, and its value eventually declines, it follows that a charge should be made in the statement of comprehensive income to reflect the use that is made of the asset by the business. In such a case it is necessary to apportion the value of an asset used in a period against the revenue it has helped to create. Allocation of costs for the use of an asset to an accounting period is termed as depreciation. 1) Depreciation is the result of systematic allocation of the depreciable amount of an asset over its estimated useful life. Depreciation for the accounting period is charged to net profit or loss for the period either directly or indirectly. 2) Depreciable assets are assets which: a) Are expected to be used during more than one accounting period? b) Have a limited useful life. c) Are held by an entity for use in the production or supply of goods and service, for rental to others, or for administrative purposes? 3) Useful life is one of two things: a) The period over which a depreciable asset is expected to be used by the entity. b) The number of production or similar units expected to be obtained from the asset by the entity. 4) Depreciable amount of a depreciable asset is the historical cost or other amount substituted for cost in the financial statements, less the estimated residual value. Definitions of PPE PPE are equipment are tangible assets that:

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Financial Reporting (PIPFA)


Are held by an entity for use in the production or supply of goods or services for rental to others, or for administrative purposes; ii) Are expected to be used during more than on period Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction. Residual value is the net amount which the entity expects to obtain for an asset at the end of its useful life after deducting the expected costs of disposal. Entity specific value is the present value of the cash flows an entity expects to arise from the continuing use of an asset and from its disposal at the end of its useful life, or expects to incur when settling a liability. Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms length transaction. Carrying amount is the amount at which an asset is recognised in the statement of financial position after deducting any accumulated depreciation and accumulated impairment losses. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. i)

Disclosure The standard has a long list of disclosure requirements, for each class of PPE: 1) Measurement bases for determining the gross carrying amount 2) Depreciation methods used 3) Useful life or depreciation rates used 4) Gross carrying amount and accumulated depreciation at the beginning and end of the period 5) Reconciliation of the carrying amount at the beginning and end of the period showing: i) Additions ii) Disposals iii) Acquisitions through business combinations iv) Increases/decreases during the period from revaluations and from impairment losses v) Impairment losses reversed in the statement of comprehensive income vi) Depreciation vii) Net exchange differences viii) Any other movements The financial statements should also disclose the following a) Any recoverable amounts of PPE b) Existence and amounts of restriction on title, and items pledged as security for liabilities c) Accounting policy for the estimated costs of restoring the site d) Amount of expenditures on account of items in the course of construction e) Amount of commitments to acquisitions Revalued assets require further disclosures: Muhammad Naseem Page 25

Financial Reporting (PIPFA)


a) b) c) d) e) f) Basis used to revalue the assets Effective date of the revaluation Whether an independent value was involved Nature of any indices used to determine replacement cost Carrying amount of each class of PPE that would have been included in the financial statements has the assets been carried at cost less accumulated deprecation and accumulated impairment losses Revaluation surplus, indicating the movement for the period and any restrictions on the distribution of the balance to shareholders

The standard also encourages disclosure of additional information, which the users of financial statements may find useful. a) The carrying amount of temporarily idle PPE b) The gross carrying amount of any fully depreciated PPE that is still in use c) The carry amount of PPE retired from active use and held for disposal d) The fair value of PPE when this is materially different from the carrying amount

Property, Plant & Equipment

Element of cost

Revaluation

1. Cost of purchase: (list price + import duty + non refundable tax + handling charges + transportation charges Less trade discount) 2. Directly attributable cost (Wages & salaries, professional fee, assembly cost, installation cost, cost of testing net of sale proceeds) 3. Initial estimated cost of dismantling, removing & restoration

Following costs will not be added in an asset value: 1. 2. 3. 4. 5. 6. Admin cost Cost of opening new facility Cost of conducting business with new customer Redeploying cost Abnormal loss of material, labor & overhead Internal profit Page 26

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Financial Reporting (PIPFA)


7. Incidental income

IAS 17: Leases


Lease: An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. Finance lease: A lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. Operating lease: A lease other than a finance lease

Other definitions Minimum lease payments: The payments over the lease term that the lessee is or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and be reimbursable to the lessor, together with: b) In the case of the lessee, any amounts guaranteed by the lessee or by a party related to the lessee; c) In the case of the lessor, any residual value guaranteed to the lessor by either: i) The lessee; ii) A party related to the lessee; iii) An independent third party financially capable of meeting this guarantee However, if the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised, the minimum lease payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and payment required to exercise it. Interest rate implicit in the lease: The discount rate that, at the inception of the lease, causes the aggregate present value of: a) The minimum lease payments; b) The unguaranteed residual value. To be equal to the sum of: i) The fair value of the leased asset; ii) Any initial direct cost

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Financial Reporting (PIPFA)


Initial direct costs are incremental costs that are directly attributable to negotiating and arranging a lease, expect for such costs incurred by manufacturer or dealer lessors. Examples of initial direct costs include amounts such as commissions, legal fees and relevant internal costs. Lease term: The non-cancellable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payments, which option at the inception of the lease it is reasonably certain that the lessee will exercise. A non- cancellable lease is a lease that is cancellable only in one of the following situation. a) Upon the occurrence of some remote contingency; b) With the permission of the lessor; c) If the lessee enters into a new lease for the same or an equivalent asset with the same lessor; d) Upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably certain. The inception of the lease is the earlier of the date of the lease agreement or of a commitment by the parties to the principal provisions of the lease. As at this date: a) A lease is classified as either an operating lease or a finance lease; b) In the case of finance lease, the amounts to be recognised at the lease term are determined. Economic life is either: a) The period over which an asset is expected to be economically usable by one or more users; b) The number of production or similar units expected to be obtained from the asset by one or more users. Useful life is the estimated remaining period, from the beginning of the lease term, over which the economic benefits embodied in the asset are expected to be consumed by the entity. Guaranteed residual value is: a) In the case of the lessee, that part of the residual value which is guaranteed by the lessee or by a party related to the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable); b) In the case of the lessor, that part of the residual value which is guaranteed by the lessee or by a third party unrelated to the lessor who is financially capable of discharging the obligations under the guarantee. Unguaranteed residual value is that portion of the residual value of the leased asset, the realization of which by the lessor is not assured or is guaranteed solely by a party related to the lessor. Gross investment in the lease is the aggregate of: a) The minimum lease payments receivable by the lessor under a finance lease; b) Any unguaranteed residual value accruing to the lessor Unearned finance income is the difference between: a) The aggregate of the minimum lease payments under a finance lease from the standpoint of the lessor and any unguaranteed residual value accruing to the lessor; b) The present value of (a) above, at the interest rate implicit in the lease.

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Financial Reporting (PIPFA)


Net investment in the lease is the gross investment in the lease discounted at the interest rate implicit in the lease. The lessees incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset. Contingent rent is that portion of the lease payments that is not fixed in amount but is based on a factor other than just the passage of time (for example percentage of sales, amount of usage, price indices, market rates of interest) There are three types of leases 1. Direct finance lease 2. Sale type lease / Manufacture lease / Dealer lease 3. Sale & lease back

Direct finance lease

Finance lease

Operating lease

Yes

No

Is ownership transferred by the end of the lease term? Does the lease contain a bargain purchase option? Is the lease term for a major part of the asset useful life? Is the present value of minimum lease payments greater than or substantially equal to the asset fair value?

There are two methods, which are as follows: 1. At the start of lease= amount to be recovered / 1 + PVIFAr,(n-1)

2. At the end of Lease= amount to be recovered / PVIFAr,(n) Muhammad Naseem Page 29

Financial Reporting (PIPFA)


Amount to be recovered = FV + IDC D/P PV of RV MLP = D/P + total lease rent + GRV Lease rental: MLP (Lessee) = D/P + total lease rental + GRV MLP (Lessor) = MLP (Lessee) + GRV GRV = MLP (Lessor) + UGRV UFI (unearned finance income) = GI NI (gross investment net investment) Lease amortization table; C.P Purchase D/P Balance Year - 1 Interest 10% Balance 200,000 (20,000) -----------180,000 (12,000) ------------168,000 Interest P.A Lease rental

20,000

20,000

18,000

12,000

30,000

Accounting general entries Lessor lease receivable To Asset UFI D/P Dr Cr Cr Dr Cr Dr Cr Dr Cr Asset subject to FL To Obligation in FL D/P Obligation to FL to Cash interest interest expense to Accrued interest 1st installment Asset subject to FL Dr Accrued interest Dr to Cash Cr Depreciation Dr Cr Dr Cr Lessee Dr Cr

Cash to Lease receivable Interest UFI to FI 1st installment Cash to Lease receivable Depreciation Muhammad Naseem

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Financial Reporting (PIPFA)


Dep. Expense NIL to Acc. Depreciation Dr Cr

non- CA lease receivable C.A C/M of lease receivable non- C.L UFI C.L C/M UFI

Balance Sheet Entries non- CA Xxx Asset subject to FL Less: Acc. Dep Xxx non - C.L obligation under FL C/M of obligation

xxx (xxx) xxx

Xxx

xxx xxx xxx

Xxx

2.

Manufacture or Dealer Lease

To find this type of lease just check that sale price & cost given or not in the question. If given then it is MDL. Initial direct cost (IDC) will be charge to P & L account. 3. Sale & Lease Back

Finance lease

Operating lease

FV > CV

FV < CV

SP = FV

SP > FV

SP < FV

Profit deferred & amortize over Lease terms

Loss immediately recognize

When implicit rate is given then fair value will be equal to PVMLP Muhammad Naseem Page 31

Financial Reporting (PIPFA)

Example for journal entries of Sale & Lease back as follow: Lessee Book of accounts SP 1 2 3 4 5 1 10,000 10,000 15,000 Cash to Asset Deferred profit Asset sub. To FL OUFL 2000/5 = 400 Deferred profit P&L a/c 2 Cash P&L a/c Assets Asset sub. To FL UFI 3 Cash Asset P&L a/c 4 Cash Deferred loss Asset P&L a/c Def. loss 5 Cash Asset Def. profit Muhammad Naseem FV 10,000 8,000 10,000 15,000 10,000 CV 8,000 10,000 8,000 12,000 8,000 10,000 8,000 2,000 10,000 10,000 400 400 8,000 2,000 10,000 8,000 8,000 10,000 8,000 2,000 10,000 2,000 12,000 2,000 2,000 15,000 8,000 5,000 Dr Cr Cr Dr Cr Dr Cr Dr Dr Cr Dr Cr Dr Cr Cr Dr Dr Cr Dr Cr Dr Cr Cr Page 32 Operating lease Finance Lease

Financial Reporting (PIPFA)


P&L a/c 2,000 Cr

IAS 18: Revenue Recognition


Definition of Recognition: Recognition is the process of incorporation in the statement of financial position or statement of comprehensive income an item that meets the definition of an element and satisfies the criteria for recognition. To understand the meaning of recognition, if is necessary to understand; a) The definition of an element; b) The criteria for recognition Definition of an element 1. Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics. These broad classes are termed the elements of financial statements. 2. The elements which directly measure and reflect the financial position of the entity are included in the balance sheet. These elements are called assets, liabilities & equity.

Revenue recognition

1. Sale of goods

2. Rendering of services

3. Interest, dividend & Royalties

Sale of goods: (Paragraph 14 of IFRS) 1. 2. 3. 4. 5. Transfer of risk & rewards No managerial involvement Revenue can be measure reliably Cost can be measure reliably Economic benefit flow to entity

Rendering of services: (Paragraph 20 of IFRS)

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1. 2. 3. 4. Revenue can be measure reliably Cost can be measure reliably Economic benefit flow to entity Stage of completion

Interest, Dividend & Royalties: (Paragraph 29 of IFRS) 1. Revenue can be measure reliably 2. Economic benefit flow to entity General recognition: 1. Dispatching goods 2. Services have been rendered 3. Accrued basis (when right to receive is established) If entity retain significant risk of ownership, then transaction is not sale & revenue will not be recognize. Risk & Rewards: 1. Transfer of legal title 2. Possession of goods Risk retain by entity: 1. When entity retain an obligation or ownership then unsatisfactory performance not cover by normal warranty provision. 2. When receipt of sale is particular contingent 3. When the good are shift subject to installation and installation is major part of contract 4. When the buyer have right to return the goods

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Financial Reporting (PIPFA)

IAS 23: Borrowing Cost


Borrowing cost: Interest finance charges in respect of finance leases and exchange difference arising from foreign currency borrowings and other costs incurred by an entity in connection with the borrowing of funds. Qualifying asset: An asset that necessarily takes a substantial period of time to get ready for its intended use or sale The standard lists what may be included in borrowing costs. 1. Interest on bank overdrafts and short-term and long-term borrowings 2. Interest on debentures 3. Amortization of discounts or premiums relating to borrowings 4. Amortization of ancillary costs incurred in connection with the arrangement of borrowings 5. Finance charges in respect of finance leases recognised in accordance with IAS 17 6. Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs The standard also gives examples of qualifying assets 1. Inventories that require a substantial period of time to bring them to a saleable condition 2. Manufacturing plants 3. Power generation facilities 4. Investment properties 5. Intangible assets For capitalization a) Borrowing costs are part of the total cost of bringing an asset into use b) Capitalization gives greater comparability between companies: a purchase price includes interest incurred by the seller, so a construction cost should also include interest. Against capitalization a) Finance costs are not the most direct of costs and may relate to the business as a whole b) There will still be a lack of comparability due to different financing policies: businesses with loan financing will have higher values for assets than equity backed businesses Disclosure The following should be disclosed in the financial statements in relation to borrowing costs Muhammad Naseem Page 35

Financial Reporting (PIPFA)


a) Accounting policy adopted b) Amount of borrowing costs capitalized during the period c) Capitalization rate use to determine the amount of borrowing costs eligible for capitalization

Two type of borrowing costs

General funds

Specific funds

Calculate capitalization rate: Borrowing cost / borrowing outstanding x 100% Calculate weighted average expenditure (WAE) Apply capitalization rate on WAE Comments

Actual cost of borrowing Less: investment income (If any) Borrowing cost to be capitalize

xxx (xxx) ---------xxxx ----------

When borrowing cost will be capitalize: a) Expenditures have been incurred b) Borrowing cost have been incurred c) Activity is in progress

Stop (when activity have been complete)

Suspend

Suspend (controllable)

unsuspended (not controllable)

Loan interest will be charge to asset (capitalize) and remaining will be charge to P&L account

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Financial Reporting (PIPFA)

IAS 24: Related Parties


Related party: A person or a close member of that persons family is related to a reporting entity if that person: i) Has control or joint control over the reporting entity ii) Has significant influence over the reporting entity iii) Is a member of the key management personnel of the reporting entity or of a parent of the reporting entity? An entity is related to a reporting entity if any of the following conditions applies: i) The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others). ii) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member). iii) Both entities are joint ventures of the same third party. iv) One entity is a joint venture of a third entity and the other entity is an associate of the third entity v) The entity is a post-employment defined benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is its self such a plan, the sponsoring employers are also related to the reporting entity. vi) The entity is controlled or jointly controlled by a person identified in (a) vii) A person identified in (a) (i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity). Related party transaction: A transfer of resources, services or obligations between related parties, regardless of whether a price is charged. Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Significant influence is the power to participate in the financial and operating policy decisions of an entity, but is not control over these policies. Significant ownership may be gained by share ownership, statue or agreement. Joint control is the contractually agreed sharing of control over an economic activity. Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including and director (whether executive or otherwise) of that entity. Close members of the family of an individual are those family members who may be expected to influence, or be influenced by, that individual in their dealings with the entity. They may include: a) The individuals domestic partner and children b) Children of the domestic partner Muhammad Naseem Page 37

Financial Reporting (PIPFA)


c) Dependants of the individual or the domestic partner The most important point to remember here is that, when considering each possible related party relationship, attention must be paid to the substance of the relationship, not merely the legal form.

Related parties are as follows: 1. Parent > 50% 2. Subsidiary 3. Associate >20% & <50% 4. Joint venture 5. Close family members 6. Key management personnel 7. Other related parties Transaction with related parties: (Paragraph 21 of IAS 24) 1. Sale & purchase of goods / services 2. Sale / purchase of property & other assets 3. Rendering / receiving services 4. Leasing 5. R & D 6. Provision of guarantees and collateral security 7. Transfer under licence agreements 8. Settlement of liabilities on behalf of the entity or by the entity on behalf of another party Transactions, which are not related parties: (paragraph 11 of IAS 24) 1. Common director ship 2. Provider of finance 3. Trade unions 4. Public utilities 5. Customer, supplier, distributor etc. Disclosure: Relation Subsidiary Transactions sale of good Lease R&D rendering of service Purchase of good Amount xxxx xxxx xxxx xxxx xxxx

Joint venture

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Financial Reporting (PIPFA)

IAS 36: Impairment of Losses


Impairment: A fall in the value of an asset, so that its recoverable amount is now less than its carrying value in the statement of financial position. Carrying amount: Is the net value at which the asset is included in the statement of financial position. Recoverable amount of an asset should be measured as the higher value of: i. The assets fair value less costs to sell ii. Its value in use The value in use of an asset is measured as the present value of estimated future cash flows (inflows minus outflows) generated by the asset, including its estimated net disposal value (if any) at the end of its expected useful life. Indication of impairment Internal sources of information: i. Evidence of obsolescence or physical damage ii. Adverse changes in the use to which the asset is put iii. Reducing the asset economic performance External sources of information: i. Decrease in asset market value ii. A significant change in the technological, market, legal or economic environment of the business in which the assets are employed iii. Changes in interest rate iv. The carrying amount of the entitys net assets being more than its market capitalization Even if there are no indications of impairment, the following assets must always be tested for impairment annually. i. An intangible asset with an indefinite useful life ii. Goodwill acquired in a business combination iii. Intangible asset not ready for used Recognition and measurement of an impairment loss If the recoverable amount of an asset is lower than the carrying amount, the carrying amount should be reduced by the difference as impairment loss, which should be charged as an expense in the statement of comprehensive income. The impairment loss is to be treaded as a revaluation decrease under the relevant IAS Muhammad Naseem Page 39

Financial Reporting (PIPFA)


A cash generating unit is the smallest identifiable group of assets for which independent cash flows can be identified and measured. No asset will be impair more than its fair value or recoverable amount

IAS 37: Provision, Contingent Liabilities, Contingent Assets


IAS 37 Provision, contingent liabilities, contingent assets aims to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statement to enable users to understand their nature, timing and amount. Provisions A provision is a liability of uncertain timing or amount A liability is an obligation of an entity to transfer economic benefits as a result of past transactions or events. Meaning of obligation: It is fairly clear what a legal obligation is. However, you may not know what a constructive obligation is. IAS 37 defines a constructive obligation as An obligation that derives from an entitys actions where; I. By an established pattern of past practice, published policies or a sufficiently specific current statement the entity has indicated to other parties that it will accept certain responsibilities; II. As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. Measurement of provisions: The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. Transactions, for which provision can be book, are as follows: I. Warranties II. Guarantee III. Major repairs IV. Self insurance V. Environmental contamination VI. Restructuring VII. Onerous contract (loss making contract)

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Transactions, for which provision cannot be book, are as follows: I. Taxation II. Debenture & redemption funds III. Future operating losses IV. Litigation V. Smoke filers VI. Pension & gratuity IAS 37 defines a contingent liability as: A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the entitys control; A present obligation that arises from past events but is not recognised because: It is not probable that a transfer of economic benefits will be required to settle the obligation The amount of the obligation cannot be measured with sufficient reliability IAS 37 defines a contingent asset as: A possible asset that arise from past events and whose existence will be confirmed by the occurrence of one or more uncertain future events not wholly within the entitys control Start

Present obligation Yes Probable outflow Yes Reliable estimate

No

Possible obligation

No

Yes No Remote No No (rare) Yes

Yes Provide Muhammad Naseem


Disclose contingent liability

Do nothing Page 41

Financial Reporting (PIPFA)

IAS 37

Provisions

Contingencies

Recognition criteria Present obligation Probable outflow Reliable estimate Obligation Legal Constructive Measurement Expected values Best estimate Specific scenarios Guarantee, warranty, onerous contract, Restructuring, environments etc

Contingent liability

Contingent asset

Flow Virtually certain Probable Possible Remote

Contingent liability provide provide disclosed ignore

Contingent assets Recognised Disclosed Ignore Ignore

Remote: Less then 5% chance Possible: 50 /50 % chance Probable: more then 50% chance Virtually certain: more then 95% chance

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Financial Reporting (PIPFA)

IAS 38: Intangible Assets


Definition: An intangible asset is an identifiable non monetary asset without physical substance: the asset must be: a) Controlled by the entity as a result of events in the past b) Something from which the entity expects future economic benefits to flow The critical attributes of an intangible asset are the: I. Identifiably II. Exercising control III. To obtain future economic benefits Must be identifiable An intangible asset must be identifiable in order to distinguish it from goodwill. With non physical items, there may be a problem with identifiability a) If an intangible asset is acquired separately through purchase, there may be a transfer of a legal right that would help to make an asset identifiable b) An intangible asset may be identifiable if it is separable, ie if it could be rented or sold separately. However, separability is not an essential feature of an intangible asset. Control by entity Another element of the definition of an intangible asset is that it must be under the control of the entity as a result of a past event. The entity must therefore be able to enjoy the future economic benefits from the asset, and prevent the access of others to those benefits. A legally enforceable right is evidence of such control, but is not always a necessary condition. a) Control over technical knowledge or know how only exists if it is protected by a legal right. b) The skill of employees, arising out of the benefits of training costs, are most unlikely to be recognizable as an intangible asset, because an entity does not control the future actions of its staff. c) Similarly, market share and customer loyalty cannot normally be intangible assets, since an entity cannot control the actions of its customers. Expected future economic benefits The third element of definition is that the benefits are expected to flow in the future from ownership of the asset. Economic benefits may come from the sale of products or services, or from a reduction in expenditures

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Financial Reporting (PIPFA)


Recognition criteria The standard requires recognizing an intangible asset whether acquired externally or generated internally. It should be recognised if, and only if both the following occur; a) It is probable that the future economic benefits that are attributable to the asset will flow to the entity b) The cost can be measured reliable If the above conditions are not met the expenditure incurred on an intangible asset will be recognised as an expense. Such expenditure cannot be re-instated as intangible asset at a later stage Exchanges of assets If one intangible asset is exchanged for other, the cost of the intangible asset is measured at fair value unless: a) The exchange transaction lacks commercial substance b) The fair value of neither the asset received nor the asset given up can be measured reliably. Otherwise, its cost is measured at the carrying amount of the asset given up. Internally generated goodwill may not be recognised as an asset. Research and development costs Research activities by definition do not meet the criteria for recognition under IAS 38. This is because, at the research stage of a project, is cannot be certain that future economic benefits will probably flow to the entity from the project. There is too much uncertainty about the likely success or otherwise of the project. Research costs should therefore be written off as an expense as they are incurred. Development costs may qualify for recognition as intangible assets provided that the following strict criteria are met. SECTOR: separate project, economically, commercially, technically & feasible risk, overall profitable, resources are available Amortization: a) An intangible asset with a finite useful life should be amortized over its expected useful life b) An intangible asset with an indefinite useful life should not be amortized, that such an asset is tested for impairment at least annually. Goodwill a) Good will is created by good relationships between a business and its customers. b) By building up a reputation for high quality products or high standards of services c) By responding promptly and helpfully to queries and complaints from customers d) Through the personality of the staff and their attitudes to customers Two part of good will purchase and inherent good will Recognition of good will Two type of good will be create by purchase positive & negative Muhammad Naseem Page 44

Financial Reporting (PIPFA)


Positive goodwill will be capitalized, do not amortize and test for impairment but negative goodwill will be shown in financial comprehensive statement as other income.

IAS 40: Investments


Definitions: Investment property is property (land or building or part of building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: Use in production or supply of goods or services or for administrative purposes Sale in the ordinary course of business Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms length transaction. Cost is the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction. Carrying amount is the amount at which an asset is recognised in the statement of financial position. A property interest that is held by a lessee under an operating lease may be classified and accounted for at an investment property, if and only if, the property would otherwise meet the definition of an investment property and lessee uses the IAS 40 fair value model. This classification is available on a property by property basis. Recognition Investment property should be recognised as an asset when two conditions are met. 1. It is probable that the future economic benefits that are associated with the investment property will flow to the entity 2. The cost of the investment property can be measured reliably Initial measurement I. II. An investment property should be measured initially at its cost, including transaction costs A property interest held under a lease and classified as an investment property shall be accounted for as if it were a finance lease. The asset is recognised at the lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount is recognised as a liability.

Measurement subsequent to initial recognition Muhammad Naseem Page 45

Financial Reporting (PIPFA)


IAS 40 requires an entity to choose between two models. I. The fair value model II. The cost model Fair value model a) After initial recognition, an entity that chooses the fair value model should measure all of its investment property at fair value, except in the extremely rare cases where this cannot be measured reliably. b) A gain or loss arising from a change in the fair value of an investment property should be recognised profit or loss for the period in which it arises. c) The fair value of investment property should reflect that actual market conditions at the end of the reporting period. Cost model The cost model is the cost model is IAS 16. Investment property should be measured at depreciated cost less any accumulated impairment losses. An entity that chooses the cost model should disclose the fair value of its investment property. Disclosure requirements I. II. III. IV. V. VI. VII. Choice of fair value or cost model Whether property interests held as operating leases are included in investment property Criteria for classification as investment property Assumptions in determining fair value Use of independent professional valuer (encouraged but not required) Rental income and expenses Any restrictions or obligations

Fair value model additional disclosure An entity that adopts this must also disclose a reconciliation of the carrying amount of the investment property at the beginning and end of the period. Cost model additional disclosure These relate mainly to the depreciation method. In addition, an entity which adopts the cost model must disclose the fair value of the investment property.

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Financial Reporting (PIPFA)

Partnership
Definition Partnership can be defined as the relationship which exists between persons carrying on a business in common with a view of profit. In other words, a partnership is an arrangement between two or more individuals in which they undertake to share the risks and rewards of a joint business operation The partnership agreement is a written agreement in which the terms of the partnership are set out and in particular the financial arrangements as between partners such as: I. Capital II. Profit sharing ratios III. Interest on capital IV. Partners salaries V. Withdrawals against profit In addition to a capital account, each partner normally has: I. A current account II. A withdrawals account III. A current account is used to record the profits retained in the business by the partner A partnership statement of financial position consists of: I. II. The capital accounts of each partner The current account of each partner, net of withdrawals on account

The net profit of a partnership is shared out between partners according to the terms of their agreement. This sharing out is shown in an appropriation account, which follows on from the statement of comprehensive income. Various methods are used to calculate the goodwill of a firm at a particular date. Some of the commonly used methods are: I. Average profits basis II. Super profit basis III. Capitalization methods The formation of partnership by amalgamation

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Financial Reporting (PIPFA)


When two or more businesses decide to combine their operations (to expand their range of operations, achieve some economies of scale etc) the problems of accounting for the amalgamation will arise. In respect of partnership accounts typical problems are concerned with any of the following a) Two or more sole traders amalgamating to form a partnership b) A sole trader amalgamating with an existing partnership c) Two partnerships amalgamating to form a new partnership What ever the type of amalgamation, the accounting problems are very much the same, where a partner retires from, or a new partner is admitted to, a partnership, problems arise in respect of revaluing assets, valuing goodwill, establishing new profit shares, ascertaining new capital introduced, and so on. All these problems of establishing and evaluating assets which are to be brought in, and liabilities which are to be taken over by the new partnership, are relevant to amalgamations. Step 1: The old firms assets and liabilities are realised by sale to the new firm, not for cash, but for a share in the capital of the new business, the amount of capital being determined by the value of net assets contributed. Step 2: A revaluation account is used in each of the old firms existing set of books to account for and apportion to the sole traders their share of the profit or loss on revaluation of assets and liabilities. A goodwill account is used to introduce or increase the good will, and to credit the sole traders with their share. Step 3: Once both firms have adjusted their asset, liability and capital accounts to take into account the agreed values, the separate books may be merged. The traders agreed capital balances are transferred to the new firm capital accounts and goodwill written off in new profit sharing ratio (if necessary) Further problems in amalgamations a) Certain old firm assets may be sold fro cash, while other assets and liabilities may be taken over by the individual partners at agree valuations. Care must be taken to ensure that the profits or losses on the realizations are apportioned to the relevant partners. b) An alternative to transferring the profit on transfers directly to partners accounts is to transfer it to the revaluation account. c) Where current accounts are given in a question they should be closed off to the partners capital accounts. As a new firm is being constituted there is little point in transferring current accounts to the new firm. d) Sometimes, the capitals in the new firm are fixed in profit sharing ratio. This generally requires cash adjustment in the old partnership capital accounts. e) All the assets and liabilities other than cash must be brought into the realization account at book values thereby closing the ledger accounts. The realization account is then credited with the

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Financial Reporting (PIPFA)


transfer of assets to the new firm (at agreed valuations), any transfers to partners (taking over certain assets or liabilities) and any proceeds of sale for cash.

Conversion of a partnership to a limited liability company When a partnership is completely dissolved, its assets are dispersed and it ceases to exist both as a trading and a legal entity. A partnership may, however, be sold to another firm which continues the partnership trading activities but under a different legal umbrella. The new firm may be another partnership, or a sole trader, or as often happens a limited liability company. The acquisition of the partnership business may be achieved in one of two ways. a) A completely independent limited liability company taking over the firm for cash consideration b) A limited liability company formed especially for the purpose of acquiring the business of the partnership. This may occur when a successful partnership or sole trader has reached the stage where incorporation is desirable because of: i) The benefits of limited liability ii) The need to obtain capital through issues of ordinary shares to outsiders iii) Possible taxation advantages The accounting entries for the sale of the partnership to the limited liability company record: a) The cessation of the partnership and the realization of its net assets b) The purchase by the newly created company of the business and net assets of the partnership The sale price, normally referred to as the purchase consideration, is usually paid to the partners in the form of: a) Shares in the limited liability company or b) Debentures in the limited liability company If the company has already been in existence or has incurred outside borrowings, cash may form part of the purchase consideration, if only to settle any balances due to the partners. Closing the partnership books The accounting procedures usually adopted to close off the partnership books are similar to those on the complete dissolution of a partnership. Step 1: All assets (expect cash) and liabilities are transferred to a realization account at their book value Step 2: Each partners current account is cleared to his capital account, as the distinction between the two is irrelevant at this stage. Step 3: if any liabilities are not being taken over by the company, but are settled directly, the entries needed are to credit bank and debit realization account. Step 4: If any assets are being taken over by the partners, the agreed values should be credited to the realization account and debited to the partners account. Muhammad Naseem Page 49

Financial Reporting (PIPFA)


Step 5: The purchase consideration to be paid by the company should be credited to the realization account and debited to a personal account specially opened up for the purchasing company Step 6: Close the realization account by transferring any balance to the partners accounts in their profit sharing ratios. Step 7: Close the purchasing companys personal account by crediting it with shares, debentures or cash as appropriate. Step 8: Close the partners accounts by debiting them with shares, debentures or cash in the agreed proportions. The purchasing company books The following entries are made in the purchase of business account. It is credited with assets to be taken over, individual ledger accounts being debited. Although the values at which assets are introduced into the new books may often be the same as those found in the old books, there is no general rule that this should be the case. It is important to read the question carefully to ascertain which values are to be used in the companys books. It is debited with the liabilities in amount and form assumed by the company, individual ledger accounts being credited. It is debited with the purchase consideration appropriate accounts being credited. If shares are valued at greater than nominal value a share premium account must be credited. If thee purchase consideration exceeds the tangible net assets acquired it will be necessary to balance the purchase of business account by a transfer crediting that account and debiting goodwill. Conversely, a credit balance may be regarded as a capital reserve. Allocation of profits A problem arises when a partnership converts to a limited liability company, not on a end of the reporting period, but part way through an accounting period. The partners make no closing entries at all and you are confronted with a list of account balances at the end of the year and asked to produce: a) The statement of comprehensive income for the year b) Closing entries for the partnership c) The statement of financial position of the company at the end of the year A single column trading account and a two column statement of comprehensive income must be prepared, both gross profit and expenses being apportioned by item or by any other method indicated. The profit for the first period is debited to the partners accounts, whilst that for the remaining period is dealt with by the company To close off the partnership records all that are necessary is to make appropriate entries in the partners capital accounts: a) Credit the partners with their shares of profit b) Debit the partners with shares and other consideration received

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To complicate matters further and interval sometimes emerges between the date of the companys acquisition of the business and its incorporation. In this case a three column statement of comprehensive income should be prepared and any profit allocated to the company in its preincorporation period must be regarded as a capital reserve, or be deducted from goodwill, if this arises.

IAS - 27: Consolidated Accounts


Many large companies actually consist of several companies controlled by one central or administrative company. Together these companies are called a group. The controlling company, called the parent or holding company, will own some or all of the shares in the other companies, called subsidiary and associated companies. There are many reasons for businesses to operate as groups: a) For the goodwill associated with the names of the subsidiaries b) For tax or legal purposes A group consists of a parent entity and one or more subsidiary entities. There may also be associates or joint ventures in a group. Control of parent company in the following:

Parent

More then 50% >20% & <50%

5% or less then 5% Joint Ventures

Subsidiary

Associates

Key definitions IAS 27 Consolidated financial statements: the financial statements of a group presented as those of a single economic entity. a) Parent: An entity that has one or more subsidiaries b) Subsidiary: An entity, including an unincorporated entity such as a partnership, that is controlled by another entity (know as the parent) c) Control: The power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

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Preparing a consolidated statement of financial position, you have to follow the below five steps: Step 1: Group structure % of investment & date of acquisition Step 2: Cost of investment Cash (if paid) Share capital Deferred liability Cost of invest. xxx xxx xxx -------------Xxx journal entry will be as follow share capital CR deferred liability CR cost of investment DR cash transaction will not be consider under entry

Step 2: Net asset of subsidiary Share capital Share premium Retain earning Fair value adjustment: (Assets & liabilities both) Depreciation on fair value Provision for unrealized profit (S P) -----------Total net assets xxxx At acquisition xxx xxx xxx xxx At end / reporting xxx xxx xxx xxx (xxx) (xxx) ----------xxxx

Difference between total net assets is post acquisition profit Step 3: Good will (two methods to calculate goodwill) Proportion method Cost of investment Less: % of P in net asset at Acq. Good will Impairment loss Muhammad Naseem xxx (xxx) ------------xxx (xxx) Fair value method Cost of investment Fair value of NCI xxx xxx --------------xxx (xxx) Page 52

less: net assets at Acq.

Financial Reporting (PIPFA)


Net good will -------------xxxx Good will Impairment loss ---------------xxx (xxx) ---------------xxx

Net good will Step 4: Non controlling interest (two methods to calculate NCI) Proportion method % of NCI in net asset at acq. xxx Add: % of NCI at post acq. Profit xxx Less: % of NCI in impairment loss (xxx) -------------Net NCI xxxx Step 5: Group reserve/ Retain earning Closing balance of retain earning of P % of P in post acquisition profit % of P in impairment loss Provision of unrealized profit (P S) (PURP) Net group reserve xxx xxx (xxx) (xxx) -------------------xxxx

Fair value method Fair value of NCI % of NCI at post acq. Profit % of NCI in impairment loss net NCI xxx xxx (xxx) -----------xxxx

Some time a subsidiary has reserves other than retained earnings. The same basic rules apply. If a reserve existed at the acquisition date, it is included in the goodwill calculation and treated in the same way as pre-acquisition profits. If a reserve arose after the acquisition date, it is treated in the same way as post-acquisition profits. Preparing a consolidated statement of comprehensive income A consolidated statement of comprehensive income brings together the sales revenue, income and expenses of the parent and the sales revenue, income and expenses of its subsidiaries. Pre- and post-acquisition profits When a parent acquires a subsidiary during a financial year, the profits of the subsidiary have to be divided into pre-acquisition and post-acquisition profits.

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Financial Reporting (PIPFA)


For the purpose of the consolidated statement of comprehensive income, we need to calculate the preand post-acquisition profit in the current year. a) The pre-acquisition profit is used to calculate the goodwill b) The post-acquisition profit (or loss) is included in the consolidated profit or loss for the year, in the consolidated statement of comprehensive income. Unless you are given information that suggests a alternative, assume that in the year of acquisition, the profits of the subsidiary occur at an even rate throughout the course of the year. The division of the annual profit of the subsidiary into pre-acquisition and post-acquisition elements can be done on a time basis. Non controlling interest in the consolidated statement of comprehensive income When there is a non-controlling interest in a subsidiary, the consolidated statement of comprehensive income should show: a) The post-acquisition profit or loss for the year for the group as a whole, including all the postacquisition profit of the subsidiary; b) The amount of this total profit that is attributable to the parents equity shareholders and the amount that is attributable to the non-controlling interest in the subsidiary For the purpose of preparing the consolidated statement of comprehensive income, all the preacquisition profits of the subsidiary are excluded. The final lines of a consolidated statement of comprehensive income should therefore be as follows: Attributable to: Owner of the parent Non-controlling interest Profit for the period

xxx xxx --------------------xxxx

Other adjustments to the consolidated statement of comprehensive income: impairment of good will One such adjustment is impairment of goodwill. When purchased goodwill is impaired, the impairment does not affect the individual financial statement of the parent company or the subsidiary. The effect of the impairment applies exclusively to the consolidated statement of financial position and the consolidated statement of comprehensive income. If good will is impaired: a) It is written down in value in the consolidated SFP b) The amount of the write-down is charged as an expense in the consolidated statement of comprehensive income, usually as an administration expense. A write-down in goodwill affects the parent entity only not the non-controlling interest. It should therefore be deducted from the profit attributable to the owners in the parent. Muhammad Naseem Page 54

Financial Reporting (PIPFA)


Intra group transactions and their adjustments In many groups, business and financial transactions take place between entities within the group. These intra group transactions might be: a) The sale of goods or services between the parent and a subsidiary, or between two subsidiaries in the group b) Loans by one entity in the group to another and the payment of interest on intra group loans Intra-group transactions should be eliminated on consolidation. The purpose of consolidated accounts is to show the financial position and the financial performance of the group as a whole, as if it is a single operating unit. If intra-group transactions are included in the consolidated financial statement, the statements will show too many assets, liabilities, income and expenses for the group as a single operating unit. Intra group sales The consolidated statement of comprehensive income shows the total sales and the total cost of sales for the group as a whole during a financial period. If entities within the same group sell goods or services to each other, these intra group transactions will be included: a) In the revenue of the entity making the sale b) As a cost of sale of the entity making the purchase Looking at the group as a single operating unit, however, there has been no sale and no purchase. The intra-group sale, for the group as a unit, is simply a transfer of goods or services within the group. The revenue from intra-group sales and the cost of intra-group purchases must therefore be eliminated from the consolidated statement of comprehensive income. No inventories of intra group sales items Provided that the items sold and bought internally have been used to make a sale outside the group, so that there are no inventories of intra-group sales items, the adjustment is made in the consolidated statement of comprehensive income by: a) Deducting the revenue from intra-group sales from the total revenue for the group b) Deducting the same amount from the cost of sales When there are inventories of intra-group sales items A slightly different situation arises when, at the end of the financial year, some intra-group sales items are still held as inventory by the group entity that bought them. This is because the inventory includes some unrealized profit. Intra group balances

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Financial Reporting (PIPFA)


When entities within a group sell goods to other entities in the same group, the terms of trading are normally similar to those for sales to external customers. The selling group company will expect payment in cash for the goods sold, but will give credit terms to the buying group company. When this happens, group entities will include other group entities within their trade receivable (sale) and trade payables (purchase) The trade receivables of the selling group entity should equal the trade payables of the buying group entity. These intra-group balances must be eliminated on consolidation and excluded from the consolidated balance sheet. Items in transit (cash or goods) At the year end, there might be a difference in the intra-group balances, due to goods in transit or cash in transit. When cash or goods are in transit, they are in the process of being transferred from one group entity to another. The entity sending the cash or goods will have recorded the transaction in its ledger accounts. However, the entity receiving the cash or goods has not yet received anything, and so has not yet recorded the transaction in its accounts. If the goods are in transit, the entity making the purchase will not yet have recorded the purchase, the inventory received or the trade payable in its ledger accounts. If the cash in transit, the entity might not yet have received the payment and so will not have recorded the cash received or the reduction in its total trade receivables. Difference in the intra-group balances caused by items in transit must be removed for the purpose of consolidation. If cash in transit from the parent to a subsidiary, the following adjustment should be made to the statement of financial position of the parent: Cash Dr Amount payable to the subsidiary

CR

The parent therefore reverses the transaction for the cash in transit, as though the payment has not yet been made. If cash is in transit from a subsidiary to the parent, in the statement of financial position of the parent: Cash DR Amount receivable from the subsidiary

CR

The parent therefore records the receipt of the cash payment from the subsidiary, even though the cash has not yet been received. Unrealized profit in inventory

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When intra-group sales are still held as inventory: a) The entity that made the sale has recorded a profit on the sale, but b) This profit is included within the inventory valuation of the entity that made the purchase, because inventory is valued at the purchase cost to the buying entity. The inventory is still held within the group, so the group as a unit has not made an external sale. The profit made by the selling entity is included in the cost of the closing inventory of the buying entity. The profit on the sale of this inventory must be eliminated on consolidation. It is unrealized profit. Unrealized profit is eliminated from the consolidated statement of financial position by: a) Reducing the consolidated accumulated profit by the amount of the unrealized profit b) Reducing the valuation of the inventory by the amount of the unrealized profit In the consolidated statement of comprehensive income: a) Reduce consolidated revenue by the amount of the intra-group sales (R) b) Reduce the consolidated cost of goods sold by the intra-group sales (R) minus the amount of unrealized profit in the closing inventory (P) Revenue from intra-group sales R Unrealized profit in closing inventory of intra-group sales P -------------------Reduction in consolidated cost of goods sold (R P) This has the effect of reducing the consolidated profit or loss for the year by the unrealized profit in the closing inventory. When unrealized profit is stated as percentage mark up on cost, it is calculated as: Unrealized profit = sales value X mark up% / mark-up% + 100% Intra group loans and interest It is quite common for group entities to lend money to other group entities, and to charge interest on the loan. If one group entity makes a loan to another group entity, the asset of the lender is matched by the liability of the borrowers, and the asset and liability should both be eliminated on consolidation. Any non-controlling interest in the subsidiary will be calculated taking the loan into account in calculating the net assets of the subsidiary. When one group entity makes a loan to another group entity, there may be accrued interest payable in the statement of financial position of the borrower at the year end. This should be matched by interest receivable by the lender. The current liability (interest payable) and the current asset (interest Muhammad Naseem Page 57

Financial Reporting (PIPFA)


receivable) should therefore be self cancelling on consolidation, and both the asset and the liability should be excluded from the consolidated balance sheet. Note: if one of the entities has failed to record the accrued interest in its accounts, you should correct this omission and record the transaction in the accounts of the entity where it is missing. Having recorded the missing transaction, you can then cancel the matching asset and liability. Non controlling interest and loans The non-controlling interest in the equity of a subsidiary and the subsidiarys profit or loss for the year is calculated on the assumption that the non-controlling interest is the relevant proportions of: a) The subsidiarys net assets including the intra-group loan as an asset or liability b) The subsidiarys profit or loss for the year including the interest as an expense or as income, depending on whether the subsidiary is the borrower or the lender. Consolidation for associates An associate is defined by IAS 28 as: an entity over which the investor has significant influence that is neither a subsidiary nor an interest in a joint venture. Significant influence is defined as the power to participate in the financial and operating policy decisions of the entity, but is not control or joint control. a) IAS 28 state that if an entity hold 20% or more of the voting power of another entity, is presumed that significant influence exists, and the investment should be treated as an associate. b) If an entity owns less than 20% of the equity of other entity, the normal presumption is that significant influence does not exist. Accounting for associates and joint ventures IAS 28 states that associates must be accounted for in consolidated financial statements using the equity method of accounting. This rule applies whether or not the entity also has subsidiaries and prepares consolidated financial statements. The only exceptions to the requirement to use the equity method to account for investments in associates are: a) When the reposting entity presents separate financial statements in accordance with IAS 27 b) When the associate is acquired and held with a view to disposal within 12 months of acquisition Statement of financial position: investment in the associate In the statement of financial position of the reporting entity, an investment in an associate is valued at: a) Cost b) Plus the investors share of the retained post-acquisition profits of the associate or minus the investors share of any post-acquisition losses c) Minus any impairment in the value of the investment since acquisition Muhammad Naseem Page 58

Financial Reporting (PIPFA)


There is no separately recognised goodwill on acquisition of an investment in an associate. However, the investment in the associate should be subject to an annual impairment review in accordance with IAS 36. Any impairment in the investment is deducted from the carrying value of the investment in the statement of financial position and deducted from the reporting entitys retained earnings. Statement of financial position: retained earnings The retained earnings of the reporting entity, or the consolidated accumulated reserves when consolidated accounts are prepared, should include; a) The investors share of the post-acquisition retained profits of the associate b) Minus any impairment in the value of the investment since acquisition Statement of comprehensive income In the statement of comprehensive income, there should be a separate line for: Share of profits of associates This is the share of the associates profits attributable to the owners of the associate. It is therefore a share of the associates profits after tax and after any non-controlling interests in the equity of the associate, where the associate has partly owned subsidiaries. Unrealized profit in closing inventory When the investor entity trades with an associate a) The investor entity might owe money to the associate at the end of the reporting period, or be owed money by the associate b) Closing inventory might be held by the investor entity or by the associate that includes some unrealized profit on sales between the investor entity and the associate Inter entity balances should be included in the current liabilities or current assets in the consolidated statement of financial position. In other words, inter-entity balances are not self canceling Unrealized inter-group profit, however, any unrealized profit in closing inventory must be removed. There should also be a reduction in the post-acquisition profits of the associate, and the investor entitys share of those profits. This will reduce the retained earnings in the balance sheet.

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Pass Papers
Summer paper 2011
Question # 07 Step 1: Group structure J : Parent date of acquisition: 1st July 2009 F : subsidiary shares are in million 8000/10000 * 100 80% Step: 2 Net Assets at acquisition 10,000 4,000 7,800 4,000 4,000 (3,000) 200 27,000 8000/4*3*5 30,000 6,500 36,500 36,500 4,500 41,000 (27,000) 14,000 4,500 180 4,680 at end 10,000 4,000 9,300 4,000 4,000 (400) (3,000) nil 27,900

S. Capital S. premium R/E Fair value adj: Land 8000 *50% Build. 8000 * 50% Dep. on build.4000/10 Deferred tax Inventory Cost of investment S. Capital Deferred liability Step: 3 Goodwill cost of investment Fair value of NCI Net asset at acquisition date NCI Fair value of NCI % of post acq. Profit (900 * 20%) Group reserve

Less: Step: 4

Step: 5

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Financial Reporting (PIPFA)


closing balance of R/E of J % of post acq. Profit (900 * 80%) 24,000 720 24,720

Consolidated Balance Sheet Non CA PPE (45000+18000+8000-400) Franchise right Financial assets Good will C.A Inventory (18000+10000) Trade receivable (15000+9000) Net assets Equity and liabilities S. Capital (25000+6000) S. Premium (10000+24000) R/E & other reserves NCI 28,000 24,000 52,000 159,600 W. 2 70,600 2,000 21,000 14,000 107,600

W. 3

W. 5 W. 4

31,000 34,000 24,720 4,680 94,400

Non C.L Interest bearing borrowings Deferred tax (2000+1500+3000) W. 2 C.L Trade payable Tax payable Bank overdraft provision Deferred liability W. 2

24,000 6,500 30,500 16,000 3,000 8,000 1,200 6,500 34,700 159,600

Question # 02 IAS 36 impairment Good will Cost of investment F.V NCI Net asset F.V at Acq Good will Impairment: carrying value less recoverable amount 270 75 345 (300) 45 CV: 420 + 45 = 465 impair loss 35 Dr then impair will be good will 35 Cr 465 - 430 = 35 remaining good will Rs. 10 m will be shown in B/S

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Financial Reporting (PIPFA)


Question # 3 For answer see IAS 1 of notes Question # 4 For answer see IAS 10 of notes Question # 06 IAS 02 inventory Direct material Direct labor FOH Total factory cost Op. WIP C/S WIP Cost of goods production Rs.000 785.00 735.00 404.60 1,924.60 (250.00) 1,674.60

Cost of production per unit = 1,674,600/ 8000 = 209.33 Closing stock value 5000 * 209 = 1,046,650/-

Winter paper 2011


Question # 2 Working 1. Cost of investment 5000 shares * 80% = 4000 shares 4000/2 * 1 * 100 = Rs. 200,000 2. Net assets S. capital R/E F.V adjustment: Plant Dep. On plant at acq. 50,000 250,000 10,000 310,000 at end 50,000 275,000 10,000 (2,500) 332,500 3. Good will cost of investment Fair value of NCI net asset at acq good will

200,000 70,000 270,000 (310,000) (40,000)

Negative goodwill will not be impair & charge to P/L account (only parent %) 4. Fair value of NCI 1000 share * 70 = 70,000/5. Interim dividend 25000 * 2% = 500/-

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Financial Reporting (PIPFA)


6. Interest 20000 * 30% * 10% = 600/7. Profit of SL 30000 *100/120 = 25000 30000 - 25000 = 5,000/-

Consolidated income statement of PL group Rs. 270,000 (138,000) 132,000 (35,000) (21,000) (2,400) 600 74,200 (16,700) 32,000 89,500

Revenue Cost of sale Gross profit Distribution exp Admin exp Finance cost Other income Profit before tax Tax exp Negative good will Profit for the year

W. 7 W. 2 & 7

W. 5 & 6 W. 5 & 6

W. 3

Question # 4 Partnership All figures are in Rs. 000 Freehold premises Plant & machinery Inventory T. Receivable Cash received Profit: 3/5 of K 2/5 of J 1. Realization A/C 16,000 note payable 5,000 T. Payable 16,000 Bank O/D 26,000 P. C 19,800 10,320 6,880 100,000 2. Capital A/C J 19,200 B/D Profit Cash 19,200 10,000 20,000 10,000 60,000

100,000

share in styles cash

K 28,800 1,520 30,320

K 20,000 10,320 30,320

J 10,000 6,880 2,320 19,200

Freehold premises Plant & machinery Muhammad Naseem

3. Balance Sheet 25,000 S. capital 5,000 cash

48,000 12,000 Page 63

Financial Reporting (PIPFA)


Inventory T. Receivable good will 16,000 26,000 8,000 80,000 T. Payable 20,000

80,000

Question # 5 For answer see IAS 1 of notes Question # 6 It is finance lease under sale and lease back Under IAS 17 rule is that if fair value is grater than the carrying value Then deferred profit will be there and it will amortize over lease terms Sold Cost Profit 215 200 15

FV > CV

This will be amortized over lease terms mean over 5 years Cash 215 Dr Asset 200 Cr Deferred profit 15 Cr asset sub to FL OUFL 215 215 Dr Cr

1 year will be charge 15/5 = 3 Deferred profit P&L a/c 3 Dr 3 Cr

Summer paper 2010


Question # 01
Step 1- Group structure 80% Acquisition date 1st Jan 2007 Step 2- Net Asset At acq. S. capital 100,000 R/E 20,000 Fair value adjustment: Muhammad Naseem At end 100,000 40,000 Step 4 - NCI Fair value of NCI 30,000 % of NCI post acq. Profit 13,000 * 20% 2,600 % of NCI impairment 20,000 * 20% (4,000) 28,600 Step 5 - Group Reserve O/B 100,000 % of P in Post Acq. Profit 13000 * 80% 10,400 % of P in impairment 20000 * 80% (16,000) Page 64

Financial Reporting (PIPFA)


Intangible asset PPE Depreciation (15,000) 5,000 110,000 (30,000) 15,000 (2,000) 123,000 PURP 12,000 * 1/3 * 25% (1,000) 93,400

Note: the intangible assets of S are all of a type where recognition would not be permitted under IAS 38 that's why all intangible assets will be zero. Step 3 - Goodwill Consolidated Balance Sheet Total asset Cost of investment 100,000 PPE 150,000 Fair value of NCI 30,000 adj. of fair value (w-2) 13,000 130,000 net current assets (w-5) 79,000 Net asset at acquisition date (110,000) 242,000 20,000 Equity & liability Impairment loss (20,000) share capital 120,000 Nil R/E w-5 93,400 NCI w-4 28,600 242,000

Question # 2
Part 1 under IAS 37 provision should be provided Because Present obligation court fee 100,000 Probable out flow replaced cost 400,000 * 70% 280,000 Measurement reliable repair cost 15000 * 30% 4,500 Provision should be 384,500 Part 2 Under IAS 37 provision should be provided Because Present obligation repair cost 12000 * 5% *1/3 * 1000 200,000 Probable out flow replaced cost 12000*5%*2/3*10000 4,000,000 Measurement reliable Provision should be 4,200,000 Part 3 Option # 1 Option # 2 Cost 3,000 +1,000 = 4,000 If 3,500 4,000 = 500 15,000 + 150,000 = 300,000/Cost will be 500 * 1,000 = 500,000/Provision should be option # 2 Rs. 300,000/-

Question # 3
Goodwill Cost of investment 2,200,000 Fair values 1.85 * 90% (1,665,000) 535,000 Carrying value 1,300 +200+250+535 Muhammad Naseem 2,285,000 Page 65 Allocation of impairment loss G.W C.D.E CV 535 200 Allocation (347) (200) 188 PPE 1,300 (178) 1,122 NCA 250 250

Financial Reporting (PIPFA)


Recoverable amount Impairment loss (1,550,000) 735,000

Question # 4
Statement of comprehensive income 2009 2008 Sale 104,000 73,500 Cost of good sold (80,000) (60,000) Gross profit 24,000 13,500 Tax 30% (7,200) (4,050) PAT 16,800 9,450 Statement of financial position 2009 NCA 40,000 CA 22,000 62,000 S.Capital R/E CL 5,000 36,250 20,750 62,000 Statement of changes in equity Opening R/E 20,000 adj of fraud in 2008 (10,000) Restated R/E 10,000 profit of 2008 9,450 19,450 profit of 2009 16,800 36,250 2008 30,000 7,500 37,500 5,000 19,450 13,050 37,500

(15,000 + 4,050 6,000)

For 2009 CL will be (20750 + 7200 5250 (6500 * 30%))

Question # 7
Contract price Cost to date Further cost Less: rectification cost Total cost Estimated G.P/loss Attributable profit/loss Income statement Revenue (%) cost G.P/Loss A 1,154 (900) 254 B 1,067 (800) 267 G 2,250 (3,000) (750) C 10,000 (4,500) 5,500 A 5,000 1,000 3,000 4,000 (100) 3,900 1,100 800 2,200 3,000 3,000 1,000 B 4,000 3,000 3,000 6,000 6,000 (1,500) 3,000/6,000*100 50% G 4,500 4,500 4,500 4,500 5,500 C 10,000

900/3,900*100 800/3,000*100 23.08% 26.67%

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Financial Reporting (PIPFA)


Balance Sheet cost to date Prog. Billing profit/loss A 900 (2,500) 254 (1,346) (All figures are Rs 000) B 800 (1,500) 267 (433) G 3,000 (2,000) (750) 250 C 4,500 (2,000) 5,500 8,000

Question # 8

1-Jan-08 Land 60 DR Revaluation 60 CR Building Revaluation 31-Dec-08 Land Revaluation 33 DR 33 CR 20 DR 20 CR 120/40 = 3 99 -132 = 33 3 x 7 = 21 - 120 = 99

80 -60 = 20 132 - 4 = 128 130 - 128 = 2 132 / 33 = 4 extra dep 4 - 3 = 1 will charge to I/S

Building 2 DR Revaluation 2 CR Build. Dep Acc. Dep revaluation R/E 4 DR 4 CR 1 DR 1 CR

Extract income statement dep R.S

4 (1) 3

Extract Balance sheet NCA land building

160 130 290

equity & liability revaluation surplus R/E

114 3 117

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Winter paper 2010


Question # 5
Cash flow statement CF Operating activities Net profit w-1 Adjustments: Add: Dep. Exp w-2 Amortization exp of GW Provision of tax Gain on disposal Net CF from Operating. Act BWC item change Increase in debtors Increase in stock Increase in creditors Tax paid w-3 Interest paid CF from investing Act. Sale of Fixed asset w-4 Purchase of FA w-5 CF from financing Act. Issue of S. capital Increase in S.P Increase in LTL Dividend paid w-6 Cash & Cash equitant Opening balance Closing balance of cash Rs. 000 115 275 150 50 (55) 535 (200) (100) 30 (45) (33) 187 140 (1,030) (890) 500 250 100 (90) 760 57 57 Rs. 000

Working 1Retained earning 4Disposal of Plant Page 68

Muhammad Naseem

Financial Reporting (PIPFA)


Dividend 170 c/b 405 575 2Disposal c/b Depreciation a/c 45 700 745 3P&L a/c c/b def c/b C.T 50 100 245 395 Tax a/c o/b def o/b C.T cash 150 200 45 395 O/B b/d 470 275 745 6cash c/b 90 200 290 O/B b/d 460 115 510 5o/b cash 2,000 1,030 3,030 Dividend o/b for year 120 170 290 o/b profit 130 55 185 Fixed assets plant c/b 130 2,900 3,030 Acc. Dep sale 45 140 185

Check cash flow question with your teacher


Question # 6 Year 2009 Asset PPE Prepaid Exp R&D Liability Adv. Income Loan Accrued Exp Rs. (000) CV 150,000 3,500 5,000 (2,000) TB 109,000 TD 41,000 3,500 5,000 (2,000) TTD 41,000 3,500 5,000 49,500 DTD (2,000) (2,000)

Deferred tax liability TTD (49500 x 35%) Deferred tax asset DTD (2000 x 35%) C/F unused loss (250000 x 35%) Net deferred tax O/B deferred tax Deferred tax income Muhammad Naseem

17,325 (700) (87,500) (70,875) (70,875) Page 69

Financial Reporting (PIPFA)


Deferred tax asset To deferred tax income 70,875 70,875 Dr Cr

Year 2010 Asset PPE Prepaid Exp R&D Liability Adv. Income Loan Accrued Exp

Rs. (000) CV 135,000 4,000 (9,100) (1,500) TB 92,650 (10,000) -

109000 x 15% = 92650/TD 42,350 4,000 900 (1,500) TTD 42,350 4,000 900 47,250 DTD (1,500) (1,500)

Def. tax liability TTD (47250 x 35%) Deferred tax asset DTD (1500 x 35%) Net deferred tax Less: O/B 2009 Def. tax exp

16,538 (525) 16,013 (70,875) 86,888

it add as it is income

Deferred tax ---------------------------------------------------------------------------------------------O/B 70,875 Exp 86,888 C/B 16,013 86,888 86,888

Accounting profit Add: DTD (2000 - 1500) Less: TTD (49500 - 47250) CFUTL Taxable profit Current tax (201750 x 35%)

450,000 (500) 2,250 451,750 (250,000) 201,750 70,613

Current tax exp. To C.T provision Muhammad Naseem

70,613 70,613

Dr Cr Page 70

Financial Reporting (PIPFA)

Question # 7 Loan 500 x 15% x 5/12 = 31.25 500 x 17.5% x 3/12 = 21.88 Actual cost of borrowing 53.13 Less: investment income (12 -5) (7.00) Net borrowing cost to Capitalized 46.13 Add: cost incurred 350.00 Cost of W.I.P 396.13

Best of luck for your studies and exam

Muhammad Naseem

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