Fin119 CSG PDF

Financial Accounting
& Reporting
(FIN)119
Candidate Study Guide
January 2019
Dear Candidate,
Welcome to the Financial Accounting & Reporting (FIN) module of the Chartered Accountants Program.
On completion of this module you will be one step closer to becoming a Chartered Accountant.
Inside this pack you will find your Candidate Study Guide (CSG), which includes the core content for
each unit. For those new to the Chartered Accountants Program, the Module Outline directs you to the
key resources available to you, both within this printed CSG and online through myLearning.
In choosing the Chartered Accountants Program, you are partnering with one of the world’s leading
higher education providers in accounting.
Candidate feedback is vital to our success, and each term we reflect carefully on candidate feedback.
The following pages discuss the changes we have made to the module in response to this feedback.
Above all, work hard to achieve the exam results you want and to set yourself up for a successful
career as a Chartered Accountant.
Yours faithfully,
Joanne Ross CA
Senior Module Leader, Financial Accounting & Reporting module
charteredaccountantsanz.com
Copyright © Chartered Accountants Australia and New Zealand 2019. All rights reserved.
This publication is copyright. Apart from any use as permitted under the Copyright Act 1968 (Australia) and Copyright Act 1994 (New Zealand), as applicable, it may not be copied, adapted, amended, published,
communicated or otherwise made available to third parties, in whole or in part, in any form or by any means, without the prior written consent of Chartered Accountants Australia and New Zealand.
Contents
Introduction i
Module outline v
Suggested module plan viii
Candidate support and special consideration xiv
Unit 1: Financial reporting 1–1
Unit 2: Presentation of financial statements 2–1
Unit 3: Revenue 3–1
Unit 4: Income taxes 4–1
Unit 5: Foreign exchange 5–1
Unit 6: Fair value measurement 6–1
Unit 7: Property, plant and equipment 7–1
Unit 8: Intangible assets 8–1
Unit 9: Financial instruments 9–1
Unit 10: Impairment of assets 10–1
Unit 11: Provisions (including employee benefit entitlements),

contingent liabilities and contingent assets 11–1
Unit 12: Leases 12–1
Unit 13: Earnings per share (EPS) 13–1
Unit 14: Share-based payments 14–1
Introduction to Units 15–17 15–i
Unit 15: Business combinations 15–1
Unit 16: Accounting for subsidiaries 16–1
Unit 17: Equity accounting 17–1
Present and future value tables FT–1

Chartered Accountants Program Financial Accounting & Reporting
Introduction
Welcome to the Financial Accounting & Reporting (FIN) module. This module will develop
your understanding of the conceptual framework for financial reporting, and enable you to
reference Accounting Standards and pronouncements and apply your knowledge to various
practical scenarios.
Learning model
The Chartered Accountants Program (the Program) material has been constructed applying
the learning principles of ‘tell, show, do’ to learning outcomes devised for each unit. Each unit
is made up, primarily, of core content, worked examples, activities and a unit quiz.
TELL SHOW DO
Tell me the relevant + Show me how to + Can I do the task
theory do the task unassisted?
The material is delivered in two modes:

1. The Candidate study guide – this print pack, and
2. myLearning – our online environment.
Where do I start?
•• The module outline (included in this pack).
•• The module plan (included in this pack), to help structure your studies.
•• The online orientation video, to introduce you to myLearning.
•• Past papers (available in myLearning), to understand how topics are addressed in exams.
It is best to work through the Candidate Study Guide (CSG) units in order. The CSG provides
the ‘Tell’ part of your learning, giving core principles and basic examples. The CSG also directs
you to required readings, which are an essential part of your studies in FIN.
myLearning is an important part of your studies. It contains:
•• Important announcements.
•• Overview videos in each unit.
•• Worked examples and solutions (the ‘show’ part of your learning).
•• Activities and solutions (the ‘do’ part of your learning).
•• Tables of required readings by unit.
•• Adaptive learning lesson in Unit 16 – an interactive online problem that ‘adapts’ and
‘changes’ based on your responses. This lesson was designed to support your learning
in consolidations.
•• Quiz on each unit.
•• PDFs of all activities, worked examples and their solutions.
Introduction Page i
Financial Accounting & Reporting Chartered Accountants Program
•• Details and access to virtual classrooms.

•• Past exams and solutions for the previous term.
•• Exam preparation series – essential to your study, released in week 11.
When reviewing the Module outline in the following pages, check that you understand
the following:
•• Assumed knowledge.
•• Accounting Standards.
•• Assessment requirements.
•• Prescribed textbooks.
•• The six-month rule.
•• Date formats.
Response to candidate feedback

Candidate feedback for FIN218 focused on issues with exam preparation, exam predictability
and length and the study time required for the module. While candidates found virtual
classrooms relevant and helpful, these sessions had low attendance and recorded sessions were
not an active learning experience. For some candidates the resulting learning gaps can affect
exam performance.
To respond to this feedback, as well as performance issues seen during exam marking, the
learning materials this offering have the following changes:
•• We have adjusted examples and explanations to Unit 4 Income taxes, to ensure the
examples are understandable to candidates who may not remember this content from their
undergraduate studies.
•• Unit 5 has been adjusted to make a clearer distinction between the two sets of principles
around IAS 21 The effects of changes in foreign exchange rates.
•• Virtual classrooms have been replaced with new live polling videos to allow candidates to
test their knowledge as they progress and to make the video experience more interactive.
•• A new integrated activity which globally examines how each topic slots into the financial
reports has been introduced to assist candidates in exam preparation and revision.
•• A number of simpler activities have been introduced in the units where candidates
traditionally need additional help.
•• Ethics content in Unit 1 has been expanded to address the change in the IESBA code and
wider implications of ethics on financial reporting decisions.
Some candidate concerns, particularly around the structure of learning, the number of learning
outcomes and the alignment of online assessments to final exams will be addressed via a longer
term CA Program review across all modules.
Page ii Introduction
Good luck!
The Chartered Accountants Program is challenging. It is designed to be the best educational
product it can be for you, the future practitioners in this profession. As it constantly evolves,
Chartered Accountants Australia and New Zealand will continually be actively seeking your
feedback to ensure the Program meets the learner’s needs now and for future development.
We hope you find your journey through the Program a rewarding and enjoyable experience
and encourage you to work steadily through the material. If you require further assistance,
post your questions on the discussion forum.
Finally, best of luck with your studies. I and the FIN team look forward to conversing with
you on the discussion forum online over the course of your studies.
Joanne Ross
Senior Module Leader, FIN module
Introduction Page iii

[This page has deliberately been left blank]
Page iv
Module outline
Overview
Financial accounting is a pivotal aspect of an accountant’s work and is the main reporting
mechanism for preparing financial statements for organisations across all sectors of the economy.
FIN includes practical examples and activities that will develop your understanding of
the conceptual framework for financial reporting, and enable you to reference Accounting
Standards and pronouncements and apply your knowledge to a variety of practical scenarios.
The FIN module is one of the five compulsory modules in the Chartered Accountants Program.
It requires a good understanding of financial accounting from a candidate’s previous tertiary
studies.
How is the FIN module taught?

The FIN module is 12 weeks in duration and offers flexible learning options with the delivery of
materials online through myLearning. myLearning is accessible after you enrol in the module by
logging into myAccount and selecting myLearning.
Assessment
The assessment components are outlined below:
Assessment Contribution Details

component to final marks
Online assessment 20 marks Three (3) online assessments.

Each assessment will consist of 10 single response, multiple-choice
questions.
It is important you attempt all online assessments
Exam 80 marks Format: Four (4) compulsory multi-part written questions based on
the learning outcomes.
Time: Three (3) hours, plus 15 minutes reading time.
Resources: The exam is open book – you can bring in any printed or
handwritten resources you require.
MUST PASS
100 marks You must achieve 50 marks or more overall,

AND 40 marks out of 80 in the exam to pass the module.
To pass the module, you must:

1. pass the exam (achieving 40 out of 80 marks or more) and
2. pass the module overall (achieving 50 out of 100 marks or more).
It is therefore critical to practise your exam technique and make the most of the time that you have.
Introduction Page v
Time allocation
The expected workload for this module is a minimum of 10 hours per week over 12 weeks, or
120 hours in total, excluding module orientation, online assessments, final exam and study time
for the final exam. Candidates are advised to plan their enrolment carefully around work and
other commitments, to ensure they are able to devote the time required to their studies.
Assumed knowledge
It is assumed that candidates have a good understanding of financial accounting and reporting
from their tertiary studies. Detailed below is a summary of the assumed knowledge of the
module:
•• Understanding of the relevant framework, in particular the definitions of and recognition
criteria for assets, liabilities, equity, income and expenses.
•• Basic understanding of financial accounting and reporting concepts, particularly the general
format and content of a set of financial statements.
•• Understanding of the principles of disclosure relating to the presentation of financial
statements.
•• Understanding of the principles relating to the selection and changing of accounting
policies.
•• Understanding of the accounting treatment and disclosure of changes in accounting
policies, accounting estimates and corrections of errors.
•• Basic understanding of revenue recognition requirements.
•• Understanding of the principles of accrual accounting.
•• Basic understanding of the taxation treatments for assets, liabilities, income and expenses.
•• Understanding of accounting for inventory.
•• Basic understanding of accounting for property, plant and equipment and intangible assets.
•• Basic understanding of the principles of consolidated financial statements.
•• Basic understanding of accounting for intragroup transactions.
•• Basic understanding of acquired goodwill – its nature and accounting treatment under the
relevant standard on business combinations.
•• Understanding of the concept of the time value of money and discounted cash flows and
how to calculate its impact.
•• Understanding of accounting for equity.
•• Understanding of accounting for the issue of equity and movements in retained earnings
and other reserves.
•• Basic understanding of the accounting for income tax.
•• Basic understanding of the accounting for a business combination.
•• Understanding of the translation of an amount from one currency to a foreign currency.
Candidates can check their assumed knowledge for each of the technical modules by taking the
Quiz in myLearning and if necessary, using the recommended resources to refresh their learning.
Learning resources and supports

Each technical module has a range of resources and support available for candidates, including:
•• Online learning material.
•• Announcements.
•• Core content.
•• Worked examples and solutions.
•• Activities and solutions.
Page vi Introduction
•• Adaptive learning lesson.

•• Integrated activities.
•• ‘FIN bites’ technical videos.
•• Excel worksheets, supporting selected activities.
•• Exam preparation series.
•• Unit quiz.
•• Readings.
Additional support
•• Virtual classrooms have been replaced this offering with videos that include live polling.
These are designed to prepare you for each online assessment.
•• Candidate Study Guide – after enrolment you will receive a Candidate Study Guide for all
technical modules, containing the module core content and the list of required readings for
each unit.
•• Discussion forums
–– Technical query forums – where candidates can post specific questions to a technical
specialist.
–– Peer-to-peer forums – where candidates can form study groups or discuss issues with
other candidates.
•• Past exams – to help candidates prepare for the final exam, past exams will be available to
download with suggested solutions.
Prescribed reading material

The required reference for this module is:
For Australia:
Chartered Accountants Australia New Zealand 2019, Financial Reporting Handbook Australia 2019,
John Wiley & Sons Australia Ltd, Milton, Qld.
For New Zealand:
Chartered Accountants Australia New Zealand 2019, Financial Reporting Handbook New Zealand
2019, John Wiley & Sons Australia Ltd, Milton, Qld.
Accounting Standards
All references to Accounting Standards in the learning elements are to International Standards,
except where they relate to jurisdiction-specific content.
The unit landing page on myLearning provides a summary of the readings from the
International Pronouncements together with the equivalent Australian and New Zealand
Pronouncements.
In the exam, you can refer to the International Standards or the Australian or New Zealand
Standards. This is explained in more detail in Unit 1.
Introduction Page vii

Suggested module plan

MODULE COMMENCEMENT
21 January 2019
WEEK 1 Unit 1 (8 hrs) Fin. Reporting

JANUARY
commencing Unit 2 (3 hrs) up to end of

21 January
Fin. statements
WEEK 2 Unit 2 (10 hrs)
commencing Remainder
28 January
WEEK 3 Unit 3 (8 hrs) ONLINE ASSESSMENT 1

commencing Unit 4 (9 hrs) 7 - 11 February
4 February Covering Units 1-4
Revenue/Tax effect
Results: released by 15 Feb
FEBRUARY
Unit 6 (4 hrs)
commencing
11 February Unit 7 (5 hrs) INTEGRATED
Forex/Fair value/PPE ACTIVITY 1
WEEK 5 Unit 8 (5 hrs) (1 hr)
commencing Unit 9 Part A (9 hrs) CENSUS DATE
18 February Intangibles/Fin. Instruments 22 February 2019
WEEK 6 Unit 9 Part B (6 hrs)

ONLINE ASSESSMENT 2
commencing Fin. Instruments
25 February 28 February - 4 March
Catch-up week Covering Units 5-9
WEEK 7 Unit 10 (5 hrs) Results: released by 8 Mar
commencing Unit 11 (4 hrs)
4 March
Impairment/Provisions
MARCH
11 March Leases/EPS INTEGRATED

ACTIVITY 2
18 March Share-based pay/Bus. comb. ONLINE ASSESSMENT 3
21 - 25 March
Adaptive WEEK 10 Unit 16 (14 hrs) Covering Units 10-15
learning commencing Subsidiaries Results: released by 29 Mar
lesson 25 March INTEGRATED
ACTIVITY 3
commencing Equity accounting
1 April
INTEGRATED EXAM PREPARATION SERIES
ACTIVITY 4 Available on myLearning
WEEK 12 Exam (2 hr)
commencing preparation (can be attempted
8 April
throughout the
APRIL
module)
WEEK 13 Exam
commencing preparation
15 April
EXAM
23 April 2019
Results: 17 May 2019
Page viii Introduction

Date convention
Generally, the date format is as follows:
Dates for the current decade are expressed as 20XX, the preceding decade are expressed as
20WX and future years outside of this decade dates are expressed as 20Y3. For example, if a
date given in an example is 20X6, 20W6 would be 10 years earlier and 20Y6 would be 10 years in
the future. All years are treated as having 365 days.
Dates in the exam will use actual years e.g. 2019.
Learning outcomes
Learning outcomes provide an outline of the expected knowledge and skill level achieved on
completion of the unit. Learning outcomes are shown on the unit learning page and on the
first CSG page for each unit. Each learning outcome commences with a verb, such as explain,
calculate, demonstrate etc. These terms are in the following table of task words.
Word Meaning
Account for Demonstrate the accounting treatment by using a set of accounts
Advise Communicate appropriately the recommended course of action based on an analysis

of specific circumstances
Analyse Examine closely; examine something in terms of its parts and show how they are
related to each other
Apply Use established methods/tools/procedures to resolve relatively straightforward

scenario or problem
Appraise Assess the value or quality of something; or assess its performance
Assess Decide the value of something in a particular context
Calculate Ascertain or determine by mathematical processes, usually by the ordinary rules

of arithmetic
Classify Place objects/concepts into appropriate categories using an established tool/

methodology or framework
Compare Critically consider two or more things, emphasising their similarities
Consider Think carefully about something before making a decision, to look closely or attentively
at something
Construct Build or make something, to form an idea, a process or procedure by bringing together
various theoretical and conceptual elements
Contrast Critically consider two or more things, emphasising their differences
Critique Give a judgement about the value of something and support that judgement with
evidence
Define Make clear what is meant by something; or use a definition or definitions to explore
a concept
Demonstrate A practical explanation of how something works or is performed
Describe Present a detailed account of something focusing on depth of knowledge
Design Develop a procedure/process or course of action based on a selection of the optimum

combination from a range of available options
Determine Establish the most appropriate or most correct answer or course of action from a range
of available options
Develop Bring something into existence that has not previously existed, or to reshape
something from its initial position into something more refined
Introduction Page ix
Word Meaning
Discuss Present a detailed account offering an interpretation of something or focusing

on breadth of knowledge
Distinguish Separate one from the other by distinct difference
Evaluate Determine the value of something, normally with reference to specific criteria
Examine Inspect something in detail and investigate the implications
Explain Make clear the details of something; or show the reason for or underlying cause of
something; or the means by which something occurs
Identify Point to the essential part or parts. You might also have to explain clearly what
is involved
Illustrate Offer an example or examples, to show how something happens, or that something
happens, or to make concrete a concept by giving examples
Integrate Combine one aspect of their learning with another to form a holistic understanding
of a process, procedure or course of action
Interpret Make clear the meaning of something and its implications
Justify Provide reasons why certain decisions should be made, conclusions reached and/or
courses of action taken
List Note or itemise in point form
Outline Go through and identify briefly the main features of something
Plan Prepare a detailed proposal for doing or achieving something
Prepare Follow established procedures/methods to create a report of financial information

or commentary (e.g. Using a pro forma spreadsheet)
Prioritise Designate or treat something as being very or more important; or determine the order
for dealing with (a series of items or tasks) according to their relative importance
Produce Without using a pro forma spreadsheet, or without any guidance, create a report of
financial information with commentary
Recommend Advocate a particular outcome or course of action based on an analysis of a range

of available options
Review Report the main facts about something
Select Carefully choose as being the best or most suitable
Solve Resolve; or work out to a result or conclusion
State Accurately articulate established principles, concepts, terms, etc.
Summarise Describe something concisely
Unit 1
At the end of this unit you will be able to:
1. Describe the purpose of financial reporting.
2. Analyse the reporting requirements of an entity based on the national regulatory framework
including whether an entity is a reporting entity.
3. Explain the interaction between the national and international financial reporting regulatory
frameworks including the relationship with their respective Accounting Standards.
4. Explain a Chartered Accountant’s ethical requirements relating to financial reporting.
5. Explain contemporary issues affecting financial reporting.
Page x Introduction
Unit 2
1. Advise on the requirements for financial statements
2. Prepare, analyse and explain a complete set of financial statements.
3. Explain and account for changes in accounting policies, revisions of accounting estimates
and errors.
4. Identify and analyse related parties.
5. Explain and account for discontinued operations.
6. Explain and account for events after the reporting period.
Unit 3
1. Identify, measure and recognise revenue from contracts with customers.
Unit 4
1. Explain the purpose of tax effect accounting.
2. Calculate and account for current tax.
3. Calculate and account for deferred tax.
4. Explain and account for changes in prior year taxes.
5. Explain and account for income tax expense.
Unit 5
1 Explain and account for foreign currency transactions and balances.
2. Determine the functional currency.
3. Explain and account for the translation of financial statements of an entity from its
functional currency to its presentation currency.
Unit 6
1. Explain and identify the key principles of fair value measurement, along with the related
disclosure requirements.
Unit 7
1. Describe the nature of property, plant and equipment.
2. Explain and account for property, plant and equipment during its useful life.
3. Explain and account for borrowing costs in relation to a qualifying asset.
Unit 8
1. Identify and explain the key characteristics of an intangible asset, including whether it can
be recognised for financial reporting purposes.
2. Explain and account for an intangible asset.
Introduction Page xi
Unit 9
1. Explain and identify financial instruments and the principles for classifying them as
financial assets, financial liabilities or equity instruments of the issuer.
2. Account for financial assets, financial liabilities and equity instruments of the issuer
(including derivatives).
3. Explain and account for basic cash flow and fair value hedges.
4. Explain and account for impairment of financial assets.
5. Explain and account for the derecognition of financial assets and financial liabilities.
Unit 10
1. Explain and account for an impairment loss for an individual asset.
2. Identify, explain and account for an impairment loss for a cash-generating unit (CGU)
including impairment of goodwill.
3. Explain and account for reversals of impairment losses.
Unit 11
1. Explain and account for a provision.
2. Identify and explain a contingent liability.
3. Identify and explain a contingent asset.
Unit 12
1. Discuss the characteristics of a lease.
2. Explain and account for lease transactions (for lessees).
3. Explain and account for lease transactions (for lessors).
4. Explain and account for sale and leaseback transactions.
Unit 13
1. Explain the requirements for disclosing earnings per share (EPS) information, including
which entities need to include EPS information.
2. Calculate basic and diluted EPS for continuing and discontinued operations.
Unit 14
1. Identify and account for share-based payments.
Units 15-17
At the end of this introduction you will be able to:
1. Identify the appropriate classification for investments as subsidiaries, associates or joint
arrangements.
Page xii Introduction

Unit 15
1. Identify a business combination.
2. Explain the concept of control.
3. Explain and account for a business combination in the books of the acquirer.
4. Account for subsequent adjustments to the initial accounting for a business combination.
Unit 16
1. Explain how a business combination is accounted for in the books of the acquiree.
2. Explain and account for a consolidation for a wholly-owned subsidiary.
3. Explain and account for a consolidation for a partly-owned subsidiary.
4. Account for movements in the parent’s interest in a subsidiary
Unit 17
1. Explain and account for an investment using the equity method.
2. Explain the concepts of significant influence and joint control.
Six-month rule
Legislation changes constantly. In the Program modules, you are expected to be up to date with
relevant legislation, Standards, cases, rulings, determinations and other guidance as they stand
six months before the exam date unless otherwise stated. In some instances the International
Accounting Standard may have been updated while the Australian Standard or New Zealand
Standard may not. International Standards can be accessed from the IFRS website (www.ifrs.org),
you will need to register to access the content on this website but it is free to do so
You are always encouraged to be aware of developments in financial reporting. The relevant
date for legislation is the date the legislation receives royal assent. The relevant date for
Accounting Standards and other material is the issue date. Early adoption of Standards
is generally encouraged.
Goods and service tax

You should ignore the impact of goods and service tax (GST) throughout the module unless the
learning element specifically refers to it.
CA Program policies and Candidate code of conduct

As a CA program candidate, you are bound by the CA program candidate code of
conduct. This is available in the orientation section of myLearning. The policies governing
the CA program are available on our website. The policy also applies to social media use.
Candidates need to behave professionally and ethically when posting anything about the
CA Program on social media.
Introduction Page xiii

Candidate support and Special consideration

Policies around special consideration are available on our website. You will find links to special
consideration forms on our Contacts page in myLearning.
Should you find you require additional support during your studies, please get in touch with us
via email in FINmodule@charteredaccountantsanz.com, or contact our Candidate Support team
on CandidateSupportProgram@charteredaccountantsanz.com.
Page xiv Introduction

Unit 1: Financial reporting
Contents
Introduction 1-3
Overview of international standard-setting 1-4
Convergence of national and international standards 1-5
International financial reporting regulatory framework 1-6
The Conceptual Framework and the purpose of financial reporting 1-7
Qualitative characteristics 1-7
Elements of financial statements, recognition and measurement criteria 1-8
Definition and recognition criteria 1-9
Future developments 1-10
Practical issues in using Accounting Standards 1-11
Comparing the IASB, AASB and XRB standards 1-11
Australia-specific 1-12
New Zealand-specific 1-12
National reporting requirements and the regulatory framework 1-12
Interrelationship between international and national requirements 1-28
International and national frameworks – interaction and key differences 1-28
Ethical requirements in preparing financial reports 1-38
Ethical requirements 1-38
IESBA Code 1-39
Fundamental principles 1-39
Threats and safeguards 1-39
Non-compliance with laws and regulations (NOCLAR) 1-43
Contemporary financial reporting issues 1-44
International level 1-44
fin11901_csg_13
Unit 1 – Core content Page 1-1

Page 1-2 Core content – Unit 1

Learning outcomes
2. Analyse the reporting requirements of an entity based on the national regulatory
framework including whether an entity is a reporting entity.
3. Explain the interaction between the national and international financial reporting
regulatory frameworks including the relationship with their respective Accounting
Standards.
Introduction
Financial reporting is a key tool that entities use to communicate with users of financial reports.
Information about the resources of the entity and claims against those resources is central to
users’ decision-making.
The new Conceptual Framework for Financial Reporting (the Conceptual Framework), issued in
March 2018, describes the objective of general purpose financial reporting and defines the
concepts supporting this objective.
The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in
making decisions relating to providing resources to the entity.
Those decisions involve decisions about:
(a) buying, selling or holding equity and debt instruments;
(b) providing or settling loans and other forms of credit; or
(c) exercising rights to vote on, or otherwise influence, management’s actions that affect the use of
the entity’s economic resources.
IASB 2018, The Conceptual Framework for Financial Reporting
Users of financial reports also use such information when trying to form a view about an entity
and its management. For example, what can the user expect in terms of future cash flows? How
does this entity compare to other entities? How has management discharged its responsibilities?
Has management used the entity’s resource efficiently and effectively?
Financial reporting relies on the information from financial accounting processes within the
entity, and entities use this information to prepare reports for external users. However, users
have different information needs, and they generally do not have the power to request tailored
financial information. This is where general purpose financial reports (GPFR), prepared under
International Financial Reporting Standards (IFRS), play a vital role.
The Financial Accounting & Reporting (FIN) module considers both the financial accounting
methods and the formal financial reports. Entities want to minimise the work during report
preparation, so financial accounting processes are designed with the Accounting Standards and
disclosure requirements in mind.
This unit provides an overview of the financial reporting framework and the regulatory
requirements applicable to financial reporting, both nationally and internationally. It also
explains the ethical requirements that apply to the work of a Chartered Accountant when
preparing financial reports.
Core content – Unit 1 Page 1-3

This unit addresses the learning outcomes via the following sections:
•• Overview of international standard-setting.
•• The Conceptual Framework and the purpose of financial reporting.
•• Practical issues in using Accounting Standards.
•• National reporting requirements and the regulatory frameworks.
•• Interrelationship between international and national requirements.
•• Ethical requirements in preparing financial reports.
•• Contemporary issues in financial reporting.
Later units discuss financial reporting from an International perspective, applying the IFRS
standards topic by topic in more detail.
Please note that for exam purposes only, the international standards, the Australian Accounting
Standards Board (AASB) standards, or the New Zealand IFRS (NZ IFRS) can be used
interchangeably. This unit will explain how to navigate the different standards for the purposes
of both your study and your professional practice.
Unit 1 overview video

[Available online in myLearning]
Overview of international standard-setting

Prior to the formation of the International Accounting Standards Board (IASB), Accounting
Standards were set by the International Accounting Standards Committee (IASC). These
International Accounting Standards (IAS) went through a variety of processes to be adopted in
member nations; however, reporting standards differed widely between countries.
The IASB was formed in 2001 to work towards convergence between national and international
standards. Currently, the IASB is the standard-setting body, overseen by the IFRS Foundation.
‘Our mission is to develop IFRS Standards that bring transparency, accountability and
efficiency to financial markets around the world. Our work serves the public interest by
fostering trust, growth and long-term financial stability in the global economy.’
www.IFRS.org, accessed 13 April 2018
‘If we really believe in open international markets and the benefits of global finance, then it
can’t make sense to have different accounting rules and practices for companies and investors
operating across national borders. That is why we need global standards.
Ultimately this will get done.’
Paul A Volcker
Chairman of the US Federal Reserve (1979–1987) and
Chairman of the IFRS Foundation Trustees (2000–2005).

Convergence of national and international standards
‘The IASB is committed to developing, in the public interest, a single set of high quality global
accounting standards that provide high quality, transparent and comparable information in
general-purpose financial Statements.’
Pacter, Paul 2015, IFRS as Global Standards: a Pocket Guide, IFRS Foundation.
A converged set of financial reporting standards make sense. As entities expand and operate
across many jurisdictions, converged reporting is less costly, improves an entity’s access to
capital and ensures reports to the users are comparable.
The extent of cross-border investment is growing constantly, and financial reporting must
respond to, and enhance, this growth. In line with the IASB and IFRS Foundation’s aims,
convergence should aid in bringing transparency, accountability and efficiency to financial
markets around the world.
It is important to remember that measurements in financial reporting are often not exact.
In practice, decisions around applying Accounting Standards are not always black and white.
The IASB’s Conceptual Framework for Financial Reporting (the Conceptual Framework) states that
’to a large extent, financial reports are based on estimates, judgements and models’. This use
of estimates and judgements in reporting creates even more need for converged standards and
agreed-upon principles for financial reporting.
Of course, in reality, full convergence is not always possible. The IASB does not have the power
to require adoption of IFRS in any jurisdiction, nor is it able to supervise a country’s adoption.
There are differing local requirements and local regulatory frameworks, and there are cultural
differences in implementing the same set of standards. Partial convergence is common in
many countries. This unit considers the requirements in your local jurisdiction, and how these
requirements interact with those of the IASB.
The IASB issues regular updates on the adoption of IFRS. Currently, these standards are
required or permitted to be used in 150 countries.
Some countries have taken the approach of adopting IFRS, replacing their previous generally
accepted accounting principles (GAAP) with equivalent IFRS. For example, the European
Union has adopted this approach for the preparation of consolidated financial statements of
listed companies. Australia has largely adopted this approach with some exceptions, including
tailoring the Australian Standards for use by not-for-profit (NFP) entities and by entities that
meet the criteria for reduced disclosure requirements reporting.
Other countries have chosen to eliminate differences between their existing national GAAP and
the IFRS, where possible and practicable. Countries following this strategy include Japan, China
and India.
Companies in both Australia and the European Union have been reporting under the IFRS
regime since 2005, and companies in New Zealand since 2007. In general, the move to the
standard platform of reporting under IFRS has been successful; however, not all members of the
business community agree that the adoption of IFRS has been useful.
For an overview of the aims of the IASB, the IFRS Foundation and the standard-setting process,
consider the further reading below.
Further reading
Pacter, Paul 2017, Pocket Guide to IFRS® Standards: the global financial reporting language,
www.ifrs.org → Use around the world – Pocket Guide to IFRS Standards, accessed 13 April 2018.

International financial reporting regulatory framework

The diagram below depicts how international financial reports are regulated. For the purposes
of the FIN module, we are concentrating on the private sector; that is, the roles of the IASB, the
IFRS Interpretations Committee and the IFRS Foundation, including the IASB’s Conceptual
Framework. The role of the International Public Sector Accounting Standards Board (IPASB) is
beyond the scope of the module.
International Financial Reporting Regulatory Framework
International Financial Reporting
PRIVATE SECTOR PUBLIC SECTOR

(including not-for-profit) (including not-for-profit)
IFRS Foundation International Federation of Accountants
IASB IFRS IPSASB

(International Interpretations (International Public Sector
Accounting Committee Accounting Standards Board)
Standards Board) Issues: Issues:
Issues: IFRICs IPSASs
IFRSs (Interpretations of IFRS) (International Public Sector Accounting Standards)
International Financial
Reporting Standards
IPSASB Conceptual Framework for
IASB Conceptual Framework General Purpose Financial Reporting by
for Financial Reporting Public Sector Entities
(Underpins IFRS and IFRICs) (Underpins IFRS and IFRICs)
To understand each of the relevant roles above, refer to the IFRS website (www.ifrs.org),
or download the ‘Who we are and what we do’ brochure (www.ifrs.org → About us → Who we
are → Who we are and what we do document).
This international approach (i.e. having separate standard setters for different sectors) differs
to the approach adopted by national jurisdictions. In Australia, the Australian Accounting
Standards Board (AASB) sets Accounting Standards for both the private and public sectors,
including NFP entities. Similarly, in New Zealand, Accounting Standards are set by the External
Reporting Board (XRB).
Drawing on the concepts set out in the Conceptual Framework, the IASB then sets and modifies
the IFRSs.
This unit will now go on to examine the foundation layer of international financial reporting as
shown in the diagram above. Specific IFRSs, as set by the IASB, are discussed in later units.

The Conceptual Framework and the purpose of financial

reporting
Learning outcome
A new version of the Conceptual Framework was issued by the IASB in March 2018.
The elements and concepts defined and explained within the Conceptual Framework are
the building blocks for a set of meaningful and robust financial statements. The Conceptual
Framework acts as the foundation, defining the concepts that underpin the IFRS standards.
Before we can delve into the focus areas of this unit, we need to consider the purpose of
financial reporting, so as to better understand an entity’s reporting requirements.
Paragraph 1.2 of the Conceptual Framework states:
The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in making
decisions relating to providing resources to the entity.
Financial reports tell a story about an entity. The users need these reports to assist them in
making decisions and, as per the Conceptual Framework, these decisions rely on information
such as:
(a) the economic resources of the entity, claims against the entity and changes in those
resources and claims, and
(b) how efficiently and effectively the entity’s management and governing Board have
discharged its responsibilities to use the entity’s economic resources.
As you may recall from your university studies, general purpose financial reports are designed
to meet the needs of users who do not have the power to request reports specifically designed to
meet their own needs. These reports do not ’value’ the entity, but instead provide information
to help in users own estimations of value.
As noted above, the Conceptual Framework sets out the objective of financial reporting.
It also discusses the qualitative characteristics of useful information, and the definitions and
recognition criteria for the elements within the financial statements, and concepts of capital and
capital maintenance.
Qualitative characteristics
The Conceptual Framework para. 2.4 states:
For financial information to be useful, it must be relevant and faithfully represent what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely
and understandable.
These qualitative characteristics, along with the Conceptual Framework definitions and
recognition criteria, underpin most of the more specific principles within individual Accounting
Standards. The Conceptual Framework is not mandatory in most circumstances; however, the
concepts within form the foundation of the mandatory Accounting Standards.
The exception to this statement lies in the requirements of IAS 8 Accounting Policies, Changes in
Accounting estimates and Errors (IAS 8). Paragraphs 10 and 11 state that where the standards do
not specifically cover an issue or transaction the entity is facing, the entity should first look at
guidance from Accounting Standards covering similar or related issues, and then look at the
definitions, recognition criteria and measurement concepts in the Conceptual Framework.
It is worth reading the key aspects of the Conceptual Framework, as this should further develop
your understanding of all standards.

Required reading
The Conceptual Framework for Financial Reporting 2018.
Elements of financial statements, recognition and measurement

criteria
We are currently in a unique situation where the new Conceptual Framework for Financial
Reporting (2018) has been immediately adopted by the Standard-setters and the interpretations
committee. For other users, the effective date is 1 January 2020, although earlier application
is permitted.
The Conceptual Framework defines the elements of the financial statements as assets, liabilities,
equity, income and expenses. It also specifies the recognition criteria for each of these elements.
Before an item can be recognised, it is first checked against the definition set out in the
Conceptual Framework. An item that both meets this definition and satisfies the related
recognition criteria should be recognised in the financial statements.
An asset or liability is recognised only if recognition of that asset or liability and of any resulting
income, expenses or changes in equity provides users of financial statements with information
that is useful :
(a) relevant information about the asset or liability and about any resulting income, expenses or
changes in equity (see paras 5.12–5.17); and
(b) a faithful representation of the asset or liability and of any resulting income, expenses or
changes in equity (see paras 5.18–5.25).
The definition and recognition criteria are summarised in the table below. Further discussion on
each element is contained within the Conceptual Framework.

Definition and recognition criteria
Conceptual framework (2010) Conceptual Framework (2018)
Item Definition Recognition Definition Recognition Recognised in
Asset A resource controlled by the entity It is probable that the future An asset is a present It is recognised if: Statement of
Core content – Unit 1

as a result of past events and from economic benefits will flow to the economic resource controlled 1. it meets the definition financial position
which future economic benefits entity, and that the asset has a cost by the entity as a result of past
are expected to flow to the entity or value that can be measured events. (para. 4.3) AND
(para. 4.4(a) reliably (para. 4.44) 2. the asset or liability and any resultant
Chartered Accountants Program
Liability A present obligation of the entity It is probable that an outflow of A present obligation of the income, expense or changes in equity Statement of
arising from past events, the resources embodying economic entity to transfer an economic provide users with useful information financial position
settlement of which is expected to benefits will result from the resource as the result of past (para. 5.7)
result in an outflow from the entity settlement of a present obligation, events (para. 4.26) What is useful information?
of resources embodying economic and the amount at which the (a) Relevant information about the
benefits (para. 4.4(b)) settlement will take place can be asset or liability (and related income,
measured reliably (para. 4.46) expense or change in equity)
Equity The residual interest in the assets Because equity is the arithmetic The residual interest in the (b) A faithful representation of the asset Statement of
of the entity after deducting all its difference between assets and assets of the entity after or liability (and related income, financial position
liabilities (para. 4.4(c)) liabilities, a separate recognition deducting all its liabilities expense or changes in equity) Statement of
criteria for equity is not needed (para. 4.63) changes in equity
The new 2018 Conceptual Framework
Income Increases in economic benefits during Increases in assets, or discusses cases where these criteria Statement of profit
the accounting period in the form of decreases in liabilities, that may not apply, that is: or loss and other
inflows or enhancements of assets or result in increases in equity, Information may not be relevant if: comprehensive
decreases of liabilities that result in other than those relating to income
(a) it is uncertain whether the asset or
increases in equity, other than those contributions from holders of
liability exists (para. 5.14), or
relating to contributions from equity equity claims (para. 4.68)
participants (para. 4.25(a)) (b) The asset or liability exists but
the probability of an inflow or
Expenses Decreases in economic benefits When a decrease in future Decreases in assets, or outflow of economic benefits is low Statement of profit
during the accounting period in the economic benefits related to a increases in liabilities, that (para. 5.12) or loss and other
form of outflows or depletions of decrease in an asset or an increase result in decreases in equity, comprehensive
assets or incurrences of liabilities that of a liability has arisen that can be other than those relating to Information may lack representational income
result in decreases in equity, other measured reliably (para. 4.49) distributions to holders of faithfulness if there is a high degree of
than those relating to distributions to equity claims (para. 4.69) measurement uncertainty (paras 5.19,
equity participants (para. 4.25(b)) 5.21 and 5.22)
Economic An economic resource is a

resource right that has the potential to
Page 1-9
produce economic benefits
(para. 4.4)
Financial Accounting & Reporting
Future developments
Definition of reporting entity
According to the Conceptual Framework (2018) para. 3.10,
a reporting entity is an entity that chooses, or is required, to prepare general purpose financial
statements.
A reporting entity is not necessarily a legal entity. It can comprise a portion of an entity, or two
or more entities.
At the time of writing, the IASB has not yet made the 2018 Conceptual Framework publicly
available. Check myLearning for more information. Australian candidates should note that the
IASB definition of ‘reporting entity’ differ significantly from the AASB definition. The AASB
is currently working to resolve these differences and their impact on financial reporting
in Australia.

Practical issues in using Accounting Standards

In the FIN module, candidates may refer to either the International, Australian, or New Zealand
standards. The majority of the learning material for the module contains references to IFRS and
IAS; however, paragraph references to equivalent local standards are provided in the Required
readings list which can be found in myLearning.
Comparing the IASB, AASB and XRB standards

The IASB, AASB and XRB standards are mostly the same. The international standards come in
two ’generations’:
•• IFRS (the new generation standards). These are current and latest standards, issued by the IASB.
•• IAS (the older generation standards). These are the older standards, issued by the previous
standard-setting body and were adopted by the IASB when it took over in 2001.
For the purposes of this module, when referring to the international standards as a whole, the
term IFRS is used. This is consistent with the definition of IFRS in IAS 1 para. 7.
A comparison between the IASB, AASB and XRB standards is best demonstrated through
examples. Below is an example of a comparison, using a ‘new generation’ IFRS standard:
IASB AASB XRB
IFRS 13 Fair Value Measurement, AASB 13 Fair Value Measurement, NZ IFRS 13 Fair Value
para. 9 states, ’This IFRS defines para. 9 states, ’This standard Measurement, para. 9 states,
fair value as the price that would defines fair value as the price that ’This NZ IFRS defines fair value as the
be received to sell an asset or would be received to sell an asset price that would be received to
paid to transfer a liability in an or paid to transfer a liability in sell an asset or paid to transfer a
orderly transaction between an orderly transaction between liability in an orderly transaction
market participants at the market participants at the between market participants at
measurement date measurement date’ the measurement date’
It is clear from the above example that the paragraphs are directly comparable.
Below is an example of a comparison from an ‘older generation’ of IAS standards.
Please note that in Australia, these standards are numbered as 100 series – therefore, IAS 12 is
referred to as AASB 112. However, in New Zealand, the numbering agrees to the IASB standard
and therefore IAS 12 is referred to as NZ IAS 12.
IASB AASB XRB
IAS 12 Income Taxes, para. 56 AASB 112 Income Taxes, para. NZ IAS 12 Income Taxes, para.
states, ’The carrying amount 56 states, ’The carrying amount 56 states, ’The carrying amount
of a deferred tax asset shall be of a deferred tax asset shall be of a deferred tax asset shall be
reviewed at the end of each reviewed at the end of each reviewed at the end of each
reporting period…’ reporting period…’ reporting period…’
Similarly, Interpretations, which help clarify the intended application of an Accounting

Standard, are either IFRIC (for the new generation) or SIC (for the older generation).
For local standards, there are usually some jurisdiction-specific paragraphs within the standards:
•• In Australia, jurisdiction-specific paragraphs, which often relate to how the standard applies to
NFP entities and application of the Reduced Disclosure Regime (RDR), are prefaced by ‘Au’.
•• In New Zealand, jurisdiction-specific paragraphs are prefaced by ’NZ’.
As candidates work through a given unit, we recommend referring to the related paragraphs
of the standard. While the Candidate Study Guide provides extensive guidance, a Chartered
Accountant needs to be able to access the most authoritative source of information for financial
reporting, and navigating the standards is part of your professional skill set. It is always best to
go to the source.

AU Australia-specific
The numbering system of Australian accounting pronouncements differs to the numbering
system used by the IASB, as shown below:
Correlation between Australian standard numbering and international standard numbering
systems
Australian pronouncements Corresponding IASB pronouncements
AASB Standards
AASB 1 to AASB 17 IFRS 1 to IFRS 17
AASB 101 to 141 IAS 1 to IAS 41
AASB 1004 to AASB 1059 Australia-specific standards with no international equivalent
AASB Interpretations
Interpretation 1 to 23 IFRIC 1 to 23
Interpretation 107 to 132 SIC 7 to SIC 32
Interpretation 1003 to 1055 Australia-specific interpretations with no international equivalent
NZ New Zealand-specific
The numbering system of the New Zealand pronouncements is broadly the same as that
developed by the IASB, with the exception of those relating to New Zealand-specific standards.
This is further explored below:
New Zealand pronouncements Corresponding IASB pronouncements
NZ IFRS 1 to NZ IFRS 17 IFRS 1 to IFRS 17
NZ IAS 1 to NZ IAS 41 IAS 1 to IAS 41
FRS 42 to FRS 44 New Zealand-specific
NZ Interpretations
NZ IFRIC 1 to NZ IFRIC 23 IFRIC 1 to IFRIC 23
NZ SIC 7 to NZ SIC 32 SIC 7 to SIC 32
National reporting requirements and the regulatory

framework
Learning outcome
2. Analyse the reporting requirements of an entity based on the national regulatory framework
including whether an entity is a reporting entity.
Each country has its own requirements for the preparation of financial reports. Some countries
largely draw on the international financial reporting regulatory framework, while others have
their own long-established frameworks.
In the following pages, there is a substantial amount of jurisdiction material. Candidates should
note that they are only required to study the material related to their region. Australian and
MICPA candidates should read the Australia-specific boxes. New Zealand candidates should
read the New Zealand-specific boxes.

Australia-specific AU
Australian regulatory framework
The Australian regulatory framework determines an entity’s financial reporting obligations.
This framework is overseen by statutory bodies or enshrined in legislation which establishes the
rules and regulations for financial report preparation.
The Australian financial reporting regulatory framework is depicted in the following diagram:
Financial
Financial Reporting Reporting
Regulatory Regulatory
Framework Framework (Australia)
(Australia)
ASIC ASX APESB

(Australian Securities and Investments Commission) (Australian (Accounting
Conducts: Surveillance program to improve quality of Securities Professional
financial reporting Exchange) and Ethical
Standards Board)
Corporations Act (2001) FRC Issues: Issues:

(Financial Reporting Council)
Establishes: Listing Rules • Code of ethics
Legislative and regulatory Oversees: • Professional standards
requirements which include class AASB and AUASB
orders and regulatory guides
Lobby groups:
CA ANZ/CPAA/IPA
ASX
ASIC
AASB AUASB
(Australian Accounting (Auditing and Assurance
Standards Board) Standards Board)
Issues: Issues:
• AASBs (Accounting Standards) • Auditing Standards
• Interpretations • Guidance statements
Australian Conceptual Proposed short term approach Proposed longer term

Framework (two frameworks) approach
AASB Framework for the Revised Conceptual Framework SAC 1 amended
Preparation and Presentation of (2018) applies to publicly Change to legislation
Financial Statements accountable for-profit entities to define who publicly lodges
and what they should report
SAC 1 Existing Conceptual Framework

Single Conceptual
Definition of the Reporting Entity (2010) & SAC 1 applies
Framework
to other entities
OUTPUT
Australian general purpose financial report1
Notes
1. A non-reporting entity may be required to prepare a financial report. Where a financial report is
prepared, the output may be a special purpose financial report.
Details on the roles and responsibilities of each regulatory body can be obtained from their
respective websites. A brief summary is also provided in the ‘Regulatory Bodies’ document,
available in the Unit 1 folder in myLearning.

Standards and legislation affecting Financial Reporting in Australia

AU (based on current situation at 29 November 2018 and Conceptual Framework 2010)
The following section outlines some of the key components of regulation in Australia
surrounding financial reporting.
The Corporations Act 2001
The Corporations Act 2001 (Corporations Act or the Act) plays an integral role within the
accounting framework of Australia. Key sections of the Corporations Act that you should be
familiar with from your university studies include:
•• Section 334 – grants the AASB power to make Accounting Standards.
•• Section 336 – grants the AUASB power to make Auditing Standards.
•• Chapter 2M, especially s. 286, Part 2M.3 (financial reporting), and Corporations
Regulation 2M.3.01 – for annual financial reports.
•• Part 1.2A (disclosing entities), ss 302–306 and s. 320 – for half-year reports.
Other relevant provisions of the Corporations Act include:
•• Section 601CK – financial reporting by registered foreign companies.
•• Section 989B – Financial reporting by financial services licensees.
Reporting requirements for an Australian entity
Determining the reporting requirements for Australian entities requires considering the
following three questions:
Which entities are What are the main What are the rules
required to prepare a components of a financial governing how a
financial report in Australia? report in Australia? financial report is prepared?
Entities that are required to prepare a financial report
Entities with reporting obligations

Entities operating under
under other legislation or
Corporations Act 2001
regulatory requirements
In Australia, a large number of business entities are registered under, and governed by, the
Corporations Act.
Australian entities under the Corporations Act
The following table identifies the types of entities in Australia that you need to have an
understanding of in the FIN module. It shows how they are defined under the Corporations Act
and also includes a brief summary of the additional reporting requirements for each.
Types of Australian entities
Entity Corporations Act definition Reporting requirements
Disclosing entities An entity is a disclosing entity if it There are extended reporting

has issued any enhanced disclosures obligations for an entity that is a
securities (ED securities) (s. 111AC). disclosing entity. For example, a
The most common types of disclosing disclosing entity must also prepare
entities are those listed on a stock a half-year financial report under
exchange (e.g. the ASX) and those the Corporations Act s. 302 that is
entities that have raised funds by way also prepared in accordance with
of a product disclosure statement AASB 134 Interim Financial Reporting
(e.g. managed investment schemes
with more than 100 security holders)

Types of Australian entities AU

Public companies As defined in s. 9, includes: Public companies have some specific
•• Companies other than proprietary reporting implications, in particular
companies content that must be included in
directors’ reports
•• Listed companies (which are also
disclosing entities)
•• Companies limited by guarantee
Proprietary companies A proprietary company is either a Large proprietary companies must

company limited by shares or an prepare and lodge an audited
unlimited company with share capital, financial report
which has less than 50 non-employee Small proprietary companies
shareholders. In addition, proprietary generally are not required to prepare
companies cannot offer securities for and lodge a financial report
sale, except in limited circumstances
(s. 45A(1))
Other types of entities that are defined under the Corporations Act are:
•• Registered schemes.
•• Companies limited by guarantee.
•• Australian financial services licence (AFSL).
Section 292 of the Act requires the following types of entities to prepare an annual financial
report, which must be lodged with the Australian Securities and Investments Commission (ASIC):
•• Disclosing entities.
•• Public companies.
•• Large proprietary companies.
•• Registered schemes.
•• Small proprietary companies (in limited circumstances only).
Large or small proprietary companies
A large proprietary company is required to prepare and lodge a financial report with ASIC,
while a small proprietary company generally is not. It is therefore important to understand the
distinction between a large and a small proprietary company.
Section 45(A) of the Corporations Act prescribes the criteria for small and large proprietary
companies, the tests of which are outlined in the table below. If a proprietary company falls
below the threshold in two or more of the tests, it is classified as a small proprietary company;
otherwise, it is classified as a large proprietary company.
Classification of proprietary limited companies – criteria
Test Threshold
1. Consolidated revenue for the year $25 million
2. Consolidated gross assets at the end of the financial year $12.5 million
3. Employees at the end of the financial year 50 employees (full-time equivalent)
At the time of writing, the Department of the Treasury of Australia is proposing to double the
thresholds in the table above. If approved, the new thresholds will apply for financial years
beginning on or after 1 July 2019. For the purposes of the FIN, module the existing thresholds
will be applied.
Further reading (Australia)

Reducing the financial reporting burden by increasing the thresholds for large proprietary
companies
The Department of the Treasury 2018, https://static.treasury.gov.au/uploads/sites/1/2018/11/
c2018-t342318-Explanatory-Statement.pdf, accessed 29 November 2018.

AU Reporting by small proprietary companies

As per the Corporations Act s. 292(2), small proprietary companies are required to prepare a
financial report when:
•• Shareholders with at least 5% of votes direct the company to do so in writing.
The shareholders can also specify the extent to which Accounting Standards are applied, and
whether the financial report is to be audited (s. 293).
•• ASIC directs the company to prepare a financial report (s. 294).
•• It is controlled by a foreign company and was not consolidated into financial statements
lodged with ASIC (s. 292(2)(b)).
Other entities required to prepare financial statements
In Australia, there are entities other than those identified above that are required to prepare
financial statements under other legislative or regulatory requirements. For example:
•• Entities that are registered under certain state and territory legislation (e.g. incorporated
associations).
•• Superannuation entities.
•• Registered charities.
•• Public sector entities.
The reporting requirements for these other entities are not discussed in the FIN module.
Main components of financial reports in Australia
Financial statements versus financial report

As discussed above, specific entities are required to prepare a financial report. So what is the
difference between financial statements and a financial report?
Financial statements
A complete set of financial statements is defined in Australian Accounting Standard AASB 101
Presentation of Financial Statements (AASB 101) and the equivalent International Accounting
Standard IAS 1 Presentation of Financial Statements (IAS 1). As laid out in AASB 101/IAS 1 para. 10,
this generally comprises:
•• Statement of financial position.
•• Statement of profit or loss and other comprehensive income.
•• Statement of changes in equity.
•• Statement of cash flows.
•• Comparative information (as specified in AASB 101 paras 38 and 38A).
•• Notes, which comprise a summary of significant accounting policies and other explanatory
information.
Financial report
Australian entities that are registered under the Corporations Act prepare, where required,
a financial report. In accordance with s. 295, the financial report comprises:
•• Financial statements.
•• Notes to the financial statements including disclosures required by regulations under the
Corporations Act.
•• Directors’ declaration.
A financial report is effectively the complete set of financial statements and the directors’
declaration, and is often referred to as the ‘statutory financial report’.

Directors’ declaration : AU
A requirement of Corporations Act ss 295(4) and (5), a directors’ declaration is a signed statement
on behalf of the board of directors that covers a number of assertions, including whether:
•• There are reasonable grounds to believe that the entity will be able to pay its debts as and
when they become due and payable.
•• The financial statements and notes give a true and fair view of an entity’s financial position
and performance, and comply with Accounting Standards.
The following diagram summarises the required elements for a financial report in Australia
Financial reports in Australia
Directors’ declaration
AASB 101/IAS 1 Corporations Act ss 295(4) and (5)

• Statement of financial position • Statement of solvency from
• Statement of profit or loss and the directors
other comprehensive income • Statement of compliance with
• Statement of changes in equity Accounting Standards, and
true and fair view
• Statement of cash flows
• Notes
Required reading (Australia)

Corporations Act 2001, ss 292–295.
AASB 101 paras Aus1.1 and 10.
Rules governing how financial reports are prepared
‘True and fair’ view

The fundamental requirement for a financial report to give a ‘true and fair’ view of an entity’s
financial position and performance is contained in the Corporations Act s. 297. In practice, this
means that if, in rare circumstances, the financial report does not give a true and fair view when
prepared in accordance with the applicable Accounting Standards, additional disclosures must
be made to provide this (s. 295(3)(c)).
Obligation to comply with Accounting Standards
Where the Corporations Act requires a financial report to be prepared, this must be done in
accordance with Accounting Standards (s. 296(1)).
Corporations Act 2001, ss 296(1) and 297.

AU Relief from requirements to prepare financial reports :

ASIC class orders – exemptions from specified financial reporting requirements
ASIC has the power, in certain circumstances, to provide entities with relief from certain financial
reporting requirements of the Corporations Act through class orders. ASIC’s class orders
commonly entail extensive prerequisites for any entity that wishes to apply for relief.
The following table lists some of ASIC’s commonly used class orders, with a brief description of
the relief they provide:
Commonly used ASIC class order
Class order Relief
2016/784 Provides relief from preparing and lodging an audited financial

ASIC Corporations (Audit report for large proprietary companies, and also for small proprietary
Relief ) Instrument companies that are controlled by a foreign company
Applies when an entity’s financial report has not been audited since
1993, is not a disclosing entity, and all its directors and shareholders
have resolved to dispense with an audit, in addition to a range of strict
financial conditions
2016/785 Wholly owned entities may be relieved from the requirement to prepare
ASIC Corporations (Wholly and lodge audited financial statements under Chapter 2M of the
Owned Companies) Corporations Act when they enter into deeds of cross-guarantee with
Instrument their parent entity and meet certain other conditions
CO 2017/204 Provides relief to small proprietary companies that are controlled by a

ASIC Corporations (Foreign- foreign company but not part of a large group from the requirement to
controlled companies reports) prepare and lodge an audited financial report
CO 10/654 Allows companies, registered schemes and disclosing entities that

Inclusion of parent entity present consolidated financial statements to include their own parent
financial statements in entity financial statements as part of their full-year financial report or
financial reports concise report under Chapter 2M of the Corporations Act
Entities taking advantage of the relief are not required to present
the summary parent entity information that is otherwise required by
Corporations Regulations 2001, reg. 2M.3.01. The directors’ declaration
and auditor’s report must include the relevant opinions in relation to
the parent entity financial statements and related notes
ASIC regulatory guides

ASIC also issues regulatory guides providing practical guidance and advice to regulated entities
by explaining when and how ASIC will exercise specific powers under legislation (primarily
the Corporations Act); and explaining how it interprets the law, and the principles underlying
its approach.
Some of the key regulatory guides applicable to financial reporting include:
Key ASIC regulatory guides
Regulatory guide Title Brief description
RG 43 Financial reports and Explains how ASIC may exercise its powers to grant relief
audit relief from the financial reporting and audit requirements of
Parts 2M.2, 2M.3 and 2M.4 (other than Division 4) of the
Corporations Act
RG 85 Reporting Provides guidance on the application of the reporting

requirements for non- entity test, and the reporting obligations for non-
reporting entities reporting entities
RG 115 Audit relief for Refers to the class order relief given under2016/784. It also
proprietary indicates when ASIC will give additional relief from audit
companies requirements to individual proprietary companies on a
case-by-case basis under s. 340

Key ASIC regulatory guides AU

Regulatory guide Title Brief description
RG 230 Disclosing non-IFRS Provides guidance on the use of financial information that
financial information is not presented in accordance with Accounting Standards
in financial reports and other corporate documents.
RG 247 Effective disclosure Provides guidance to listed entities and their directors on
in an operating and providing useful and meaningful information to share/unit
financial review holders when preparing an operating and financial review
in a directors’ report
The Australian Conceptual Framework (Australian Framework)

The Australian Framework largely incorporates the IASB’s Conceptual Framework, as well as some
Australia-specific guidance. Unlike the IASB’s Conceptual Framework, the Australian Framework
also contains guidance for not-for-profit entities.
As with the IASB’s Conceptual Framework, the Australian Framework is not mandatory, but the
principles underpin the AASB Standards.
The Australian Conceptual Framework forms the foundation underpinning the AASB standards.
Drawing on the concepts outlined in the Australian Conceptual Framework, the AASB then
goes on to set new accounting standards, or amend existing ones. Where there are difficulties
applying accounting standards in practice, an interpretation may be issued.
Statement of Accounting Concepts 1: Definition of the Reporting entity
The reporting entity concept established in SAC 1 is currently central to financial reporting in
Australia. Given that the SAC 1 definition of ‘reporting entity’ is in conflict with the definition
in the IASB Conceptual Framework (2018), the AASB is currently undertaking a project to
investigate potential changes both to SAC 1 and the Corporations Act 2001.
The AASB is proposing to remove the current definition of ‘reporting entity’ from Australian
Accounting requirements to resolve this conflict, among other things. Removing this definition
would also remove the option to prepare special purpose financial statements, if entities are
required to comply with Australian Accounting Standards.
SAC 1 defines and explains the concept of a reporting entity. SAC 1 para. 40 states:
Reporting entities are all entities (including economic entities) in respect of which it is reasonable to expect the
existence of users dependent on general purpose financial reports for information which will be useful to them
for making and evaluating decisions about the allocation of scarce resources.
SAC 1 requires the use of professional judgement to determine whether an entity is a reporting or
non-reporting entity. This means that the preparer of a financial report must consider the likely users
and their information needs. In deciding these issues, the following factors are considered:
•• The degree to which management and ownership interest is separated – for example, listed
companies have many investors who are not involved in the management of the business.
•• Political or economic interest – for example, financial reports of public sector bodies are of
interest to the public.
•• Financial characteristics – for example, very large organisations and those that employ many
people are often considered to be reporting entities.
Examples of reporting entities
In applying SAC 1:
•• some types of entities will always be reporting entities
•• other types of entities will require professional judgement to determine their reporting status.
At present, reporting entities in Australia must prepare a GPFR to comply with all relevant
Accounting Standards.

AU Reporting and non-reporting entities
Reporting Non-reporting
•• Disclosing entities •• Some proprietary companies (e.g. wholly owned

•• Registered schemes subsidiaries of Australian reporting entities)
•• Listed public companies •• Some unlisted public companies
•• Some proprietary companies
•• Some unlisted public companies
•• Public sector entities
GPFR versus SPFR

A GPFR is designed to meet the information needs of a wide group of users, whereas a special
purpose financial report (SPFR) is tailored to meet the needs of a specific group of users.
The reporting framework used in an SPFR is therefore particular to the report, and based on the
information needs of its users.
When preparers in Australia are choosing the type of financial report to present, the entity’s
reporting entity status is an important factor to consider. If an entity is classified as a reporting
entity, it must prepare a GPFR, whereas non-reporting entities can prepare a SPFR.
The Corporations Act requires a financial report to provide a true and fair view of the financial
position and performance of an entity and comply with Accounting Standards, but at present it
does not specify what form of financial report must be prepared.
There may be amendments proposed to the Corporations Act in response to the issues around
the reporting entity concept in Australia.
Reporting requirements resulting from the SAC 1 classification
The reporting frameworks for reporting and non-reporting entities based on a user’s information
needs, both for GPFRs and SPFRs, are summarised below:
Reporting entities General purpose Comply with all

(SAC 1) financial report Accounting Standards
Non-reporting entities Special purpose Specific financial reporting

(SAC 1) financial report is based on information
needs of specified users –
may or may not comply
with some or all
Accounting Standards
Special purpose reporting

As discussed above, the ability to produce special purpose financial reports may soon be
removed from the Australian financial reporting landscape.
Special purpose reporting involves the reporting of information that meets the needs of specific
users (e.g. a financial report prepared on a tax basis for lodgement with the taxation authority, or
a financial report prepared on a cash basis for specific users). These types of reports, however, are
outside the scope of this unit.
The discussion in this section is focused on an SPFR that is prepared by entities under the
Corporations Act. As mentioned, an SPFR is prepared based on the needs of its specified users;
however, the Corporations Act requires the financial report to still present a true and fair view of
an entity’s financial position and performance, and comply with Accounting Standards.
The application paragraphs in certain Accounting Standards (e.g. AASB 107 Statement of Cash
Flows), state that the Standards apply to all entities that prepare financial reports under Part 2M.3
of the Corporations Act (i.e. regardless of whether they are reporting entities or not).

Despite these application paragraphs, there is some debate as to whether preparing an SPFR
in compliance only with these Accounting Standards is sufficient to allow the presentation of a
financial report that gives a true and fair view under the Corporations Act.
To provide guidance on classifying a non-reporting entity and the financial reporting
requirements, ASIC issued Regulatory Guide 85 Reporting requirements for non-reporting
entities (RG 85). In this guide, ASIC states that, in its view, the recognition and measurement
requirements of all accounting standards must be applied in order to determine the
financial position and profit or loss of an entity reporting under the Corporations Act (RG 85
paras 2.1‑2.10). In practice, most preparers of SPFRs, if required to prepare and lodge a financial
report under the Corporations Act, follow the requirements of RG 85.
Further information
This podcast covers the issues around applying the IASB’s Revised Conceptual Framework and
solving the reporting entity and special purpose financial statement problems (commencing at
6 minutes, 30 seconds on the podcast)
Stevens, T 2018, The biggest changes in years are happening now are you ready?, podcasts,
1 June, www.accountantsdaily.com.au, accessed 29 November 2018

•• SAC 1 paras 6, 12, 19–22 and 40.
•• RG 85 paras 2.1–2.10.

Summary of annual reporting requirements (current situation at November 2018 prior to proposed
AU amendments)
The requirements for annual financial reporting in Australia are summarised in the following
flowchart:
Refer to any other applicable

Is the entity within the scope NO
legislation or regulation for
of the Corporations Act 2001?
reporting requirements
YES
Is the entity a small YES Has the entity been NO Not required to prepare
proprietary company or small directed to prepare
a financial report
company limited by guarantee? a financial report by
members or by ASIC?
NO
YES
Checkpoint
Entity should be one of the following:
• Disclosing entity Prepare a financial report
• Public company based on the standards and
• Large proprietary company interpretations to the extent
• Registered scheme directed by members or ASIC
YES Is the entity a

reporting entity?
NO
In preparing SPFR, comply with the accounting
standards necessary to give a true and fair view
Is the entity electing to NO (must include AASB 101, 107, 108, 1031, 1048 and
prepare a GPFR? 1054). Compliance with the recognition and
measurement rules of all accounting standards
may also be required
YES
Is the entity publicly YES

accountable?
NO
Is the entity electing to apply Prepare GPFR

Tier 1 reporting requirements YES complying with all
under the reduced disclosure accounting
regime? standards
NO
Apply Tier 2 reporting

requirements in preparing
general purpose financial
report

New Zealand-specific NZ
Financial reporting regulatory framework in New Zealand
Financial reporting in New Zealand is regulated by a combination of legal and professional

pronouncements. The combination of these Acts of Parliament, professional codes and
accounting standards is referred to as the New Zealand Financial Reporting Framework
(the Framework).
The Framework sets out the requirements for the preparation, audit, filing requirements and
presentation of financial statements.
Financial Reporting Regulatory Framework (New Zealand)
FMA Acts and XRB NZX NZICA

(Financial Markets Regulations (External Reporting (New Zealand Stock (New Zealand
Authority) Board) Exchange) Institute of
Chartered
Financial markets • Companies Act Establishes: Issues: Accountants)
regulator 1993 Standard-setting • Listing Rules
• Financial Markets Issues:
strategies
Promotes and Conduct Act 2013 • Code of ethics
facilitates: • Financial Reporting Oversees: • Professional
Development of Act 2013/1993 • NZASB Standards
fair, efficient and • NZAuASB • Engagement
transparent Standards
financial markets Establish:
Legislative and
regulatory
requirements for
financial reporting
by companies and
specific
requirements for
issuers
NZASB NZAuASB
(New Zealand Accounting (New Zealand Auditing and
Standards Board) Assurance Standards Board)
Issues: Key responsibilities:
• NZ IFRSs (Accounting • Professional and ethical
Standards) standards for auditors
• Interpretations in accordance • Auditing Standards
with XRB’s strategy
New Zealand Conceptual

Framework
Conceptual Framework for
Financial Reporting
OUTPUT
NZ GAAP compliant general purpose financial reports

NZ Legal framework of financial reporting in New Zealand

This section gives a brief overview of the legislation relating to financial reporting in New Zealand.
There is a great deal of change occurring to the financial reporting framework due to the enactment
of the Financial Markets Conduct Act 2013 (FMCA 2013), the Financial Reporting Act 2013 (FRA 2013)
and amendments to other pieces of legislation (for example the Companies Act 1993 which were
enacted through the Financial Reporting (Amendments to other Enactments) Act 2013. These Acts
commenced on 1 April 2014, with a two-year period of transition.
The implementation of these Acts changed the financial reporting requirements for a number of
entities. The changes are based on three important underlying policy development principles,
which are public accountability, economic significance and separation of ownership and
management. The changes in the legislation resulted in the following:
•• Removal of GPFR requirements for a number of small- to medium-sized entities.
•• Captured a broader range of entities that are economically significant based on the
size criteria.
•• Where an entity has subsidiaries, only group financial statements are required.
•• Audit requirements with opt-out/opt-in options.
•• Amended the time frame for the filing or distribution of the financial statements.
•• Amended the preparation, audit and filing requirements for overseas companies based on a
size criteria that is smaller than those applying to domestic companies.
The following table gives a brief overview of the key Acts of Parliament that underpin financial
reporting. (There are many other Acts that have an impact on financial reporting, this unit will
only focus on the key legislation.)
FMCA 2013 This Act governs how financial products are created, promoted and sold.
It also sets out the obligations for entities that offer, deal and trade in
financial products
The concept of ‘issuer’ from Financial Reporting Act 1993 (FRA 1993) (i.e. entity
with public accountability) was replaced with the concept of ‘FMC reporting
entity’, which has a wider scope. FMC reporting entities are required to prepare
general purpose financial statements (GPFS), have them audited and file them
with the Registrar of Companies. The applicable financial reporting obligations
reside within the FMCA 2013, rather than the FRA 2013
Under the FMCA 2013, financial statements have to be filed within four months
of balance date, compared to five months and 20 days under the FRA 1993
FRA 2013 and FRA 1993 sets out the requirements for the preparation and content of financial
FRA 1993 statements. The new FRA 2013 replaced FRA 1993, although the two ran in
conjunction for the period of transition, which ceased on 1 December 2016
The FRA 2013 is applicable for reporting periods beginning on or after 1 April 2014
Financial Reporting The purpose of this Act is to make amendments to other enactments in
(Amendments to other connection with the FRA 2013
Enactments) 2013 The Act effectively details all the changes to the enabling legislation of other
types of entities such as limited partnerships, companies, partnerships, building
societies, charities and retirement villages
Companies Act 1993 CA 1993 provides the administrative requirements (e.g. registration, formation,
(CA 1993) operation and cessation of a company) for companies and their members
It sets out the responsibilities of directors, and the requirements for keeping
accounting records, preparing an annual report, and appointing auditors
CA 1993 has been amended as a result of FMCA 2013 and FRA 2013
Required reading (New Zealand)

The Financial Markets Authority (FMA) website has a dedicated section on financial reporting
for FMC reporting entities as well as FAQs for questions about transition to the FMC Act.
www.fma.govt.nz → Compliance → Financial reporting – accessed April 2018.

Regulatory framework NZ
In addition to the legal framework, the government and other agencies are also responsible for
monitoring and (should breaches under the legal framework occur) disciplining entities and
their members.
The following parties are involved in the regulatory process:
•• Financial Markets Authority (FMA).
•• Registrar of Companies.
•• New Zealand Stock Exchange (NZX).
Financial Markets Authority
The Financial Markets Authority Act 2011 (FMAA 2011) established the FMA as an independent
Crown entity, and sets out FMA’s main objective, which is to ‘promote and facilitate the
development of fair, efficient, and transparent financial markets’.
The FMAA 2011 also sets out FMA’s functions, which are to:
•• Promote participation of businesses, investors, and consumers in the financial markets.
•• Exercise its powers and duties under various financial markets and other legislation.
•• Monitor compliance with, investigate, and enforce financial markets legislation.
•• Monitor, inquire into and investigate matters relating to financial markets, or the activities of
financial market participants or any person involved with those markets.
•• Review the regulations and practices relating to financial markets and its participants.
•• Cooperate with other law enforcement or regulatory agencies, including overseas regulators.
In addition, the FMA also:
•• Produces policies and guidance to help professionals comply with the legislation.
•• Provides useful information and resources to help investors make better financial decisions.
•• Issues warnings and alerts to the public.
Registrar of Companies
Part 21 of CA 1993 includes a list of penalties for financial reporting offences, which could lead to
fines ranging from $5,000 to $200,000 plus prison terms for more serious offences.
Financial reporting offences in relation to the preparation, audit and registration of the financial
statements are specified in s. 207G. If convicted of a reporting offence (e.g. failing to prepare,
audit or file financial statements) a company is liable to a fine not exceeding $50,000 and each
director is liable to a penalty not exceeding the same amount (s. 374(3) CA 1993).
New Zealand Stock Exchange
The New Zealand Stock Exchange (NZX) also has a role in the regulation of entities listed on its
exchange. This involves supervising listed entities’ compliance with the NZX Listing Rules and
assisting the FMA as a co-regulator under the FMCA 2013.
The New Zealand Markets Disciplinary Tribunal (NZMDT) is an independent body charged
with hearing matters referred to it in relation to the conduct of parties who are regulated by
NZX’s market rules. NZMDT is empowered to impose penalties on parties it determined to have
engaged in conduct that breached any of the NZX rules. Disciplinary tribunal announcements
are publicly available on the NZX website.
Reporting requirements for New Zealand entities
To appropriately determine the financial reporting requirements and applicable standards for
New Zealand entities, it is important to consider the following questions:
•• Is the entity required to prepare GPFS under legislation? If not, is it opting in to prepare
general purpose financial statements?
•• Is it a public benefit entity (PBE) or a for-profit entity?
•• Which tier of reporting will it fall under?

NZ We will explore each of the above questions in further detail below.

Is the entity required to prepare GPFS under legislation?
Under the new legislation, the following entities will need to prepare general purposes financial
statements (GPFS):
FMC reporting entities
An FMC reporting entity is a new term arising in the FMCA 2013. Section 451 states which
entities are FMC reporting entities:
(a) every person who is an issuer of a regulated product (except for those that have less than 50 shareholders
or 50 parcels of shares for their voting shares (s. 452))
(b) every person who holds a licence (e.g. a fund manager) under Part 6
(c) every licensed supervisor
(d) every listed issuer (e.g. companies listed on the NZX)
(e) every operator of a licensed market (e.g. the NZX)
(f ) every recipient of money from a conduit issuer (entities that raise funds and pass onto another entity)
(g) every registered bank (these are banks registered by the Reserve Bank of New Zealand (RBNZ))
(h) every licensed insurer (these are licensed by the RBNZ)
(i) every credit union (these are licensed by the RBNZ)
(j) every building society (these are licensed by the RBNZ)
(k) every person that is an FMC reporting entity under clause 27A of Schedule 1 (entities that have gained
more than 50 shareholders through small offers under the FMCA).
As you can see the list of entities that will be required to report under the FMCA is extensive.
For the purpose of your studies, the most common will be (a) and (d) – entities that have issued
shares to more than 50 shareholders and listed companies on the NZX.
The financial reporting requirements for FMC reporting entities are detailed in Part 7 of the
FMCA 2013, which covers ss 450–461M. The key points to note are; ss 460–461, which requires
financial statements (or group financial statements if relevant) to be prepared within four
months of balance date; s. 461D, which requires those financial statements be audited; and
s. 461H, which requires the financial statements be lodged with the Registrar of Companies.
Large companies
When determining the reporting requirements for a large company, the first check is to make
sure it is not an FMC reporting entity as detailed above. FRA 2013 directs any entity that is an
FMC reporting entity to FMCA 2013 where its financial reporting requirements are detailed
(s. 56 (3) FRA 2013). An entity that is not an FMC reporting entity will prepare financial statements
under FRA 2013 only if it meets the size criterion in s. 45(1) FRA 2013, which states:
…an entity (other than an overseas company or a subsidiary of an overseas company) is large in respect of an
accounting period if at least 1 of the following paragraphs applies:
(a) as at the balance date of each of the 2 preceding accounting periods, the total assets of the entity and its
subsidiaries (if any) exceed $60 million;
(b) in each of the 2 preceding accounting periods, the total revenue of the entity and its subsidiaries (if any)
exceeds $30 million.
Note that the size criterion is only that either revenue or total assets meets the criterion, not
both. Additionally, the group financial statements of a large company are not required to be
prepared if it is a subsidiary of a New Zealand incorporated entity and the group prepares GAAP
group financial statements.
A large company should have its financial statements audited although there are opt-out
arrangements. At a meeting of shareholders, 95% of those entitled to vote must pass a resolution
to opt out of the audit requirement (s. 207J CA 1993).
There is no requirement for a large company to lodge its financial statements with the Registrar
unless it has significant overseas ownership (25% or more).
Note that the size criterion also applies to partnerships and limited partnerships, industrial and
provident societies, although we do not focus on these types of entities in this unit.

Overseas companies
The size criterion for an overseas-owned company to determine whether it is required to prepare
NZ
financial statements is smaller than New Zealand resident companies. Section 45(2) of the
FRA 2013 states:
…an overseas company or a subsidiary of an overseas company is large in respect of an accounting period if at
least 1 of the following paragraphs applies:
(a) as at the balance date of each of the 2 preceding accounting periods, the total assets of the entity and its
subsidiaries (if any) exceed $20 million;
(b) in each of the 2 preceding accounting periods, the total revenue of the entity and its subsidiaries (if any)
exceeds $10 million.
If this criterion is met, s. 201 CA 1993 requires the company to prepare financial statements.
These financial statements must be filed with the Registrar of Companies within five months of
balance date (ss 201 and 207E CA 1993).
A large overseas company is not required to have an audit of its financial statements or group
financial statements if its New Zealand business is not large, and under the law in force in the
country where the overseas company is incorporated or constituted, the qualifying financial
statements are required to be prepared, but are not required to be audited (s. 206(3) CA 1993).
Other reporting entities
The following entities must also prepare financial statements:
•• Retirement villages (but only if publicly listed).
•• Registered charities.
•• Large friendly societies with $30 million or more in total expenditure.
•• Maori incorporations.
•• Public sector PBEs.
Opt-in and opt-out provisions
CA 1993 provides opt-in and opt-out provisions. These permit shareholders to determine
whether a company should opt in or out of compliance with CA 1993. The key points are:
•• Companies with 10 or more shareholders can opt out of preparing financial statements,
audit requirements and annual report by a 95% majority vote. Large companies cannot take
advantage of this provision (s. 207I CA 1993).
•• Large companies can opt out of the audit requirements only by a 95% majority vote (s. 207J
CA 1993).
•• Companies with fewer than 10 shareholders can opt in to preparing financial statements,
audit requirements and annual report by written notice from shareholders of at least 5% of
voting shares (s. 207K CA 1993).
Below is a summary of the financial reporting, audit and filing requirements for companies in
New Zealand.
Category Prepare Audit Filing requirement
GPFS requirement
FMC reporting entities
  Within four months of
balance date
Large overseas companies/overseas
  Within five months of balance
1
owned companies date

Large companies
  Only if it is more than 25%
2
overseas owned
Companies with 10 or more shareholders
  No1
2 2
Companies with fewer than 10

  No
3 3
shareholders and chose to opt in to GPFS

NZ Notes
1 Can be excused from the audit requirement if s. 206(3) CA 1993 applies.
2 Can opt out by resolution approved by not less than 95% of the votes of shareholders entitled to vote and voting on
the question.
3 Can opt in by written notice from shareholders who together hold not less than 5% of the voting shares.
The financial reporting requirements of entities other than companies are outside the scope of
the FIN module.
Interrelationship between international and national

requirements
Learning outcome
3. Explain the interaction between the national and international financial reporting regulatory
frameworks including the relationship with their respective Accounting Standards.
International and national frameworks – interaction and key

differences
As discussed earlier, some countries largely draw on the International Financial Reporting
Standard regulatory framework, while other nations have their own, long-established
frameworks for financial reporting.
The similarities between the international and national frameworks are evidenced by the
relationship between the IFRS and national standards. Differences in the frameworks, or their
application, may arise due to a national framework involving additional statutory bodies and/
or legislation establishing the rules and regulations for financial report preparation. Conversely,
aspects of a country’s regulatory framework may appear to follow the international framework,
yet differences may still arise for various reasons.
Some of the main sources of differences between the International and Australian regulatory
frameworks for financial reporting are as follows:
1. The Reporting entity concept in Australia’s SAC 1 was needed, owing to the prior lack of a
definition at international level.
2. ’Au’ requirements inserted into IFRS-equivalent standards (also known as jurisdiction-specific
requirements, usually related to Australia’s commitment to sector-neutral standards).
3. Australian standards with no international equivalent.
4. Differential reporting requirements from SAC 1 and the Corporations Act.
5. The non-adoption of IFRS for SMEs in Australia and the use of the RDR.
The Conceptual Framework and the reporting entity concept
The Australian Conceptual Framework is a slightly modified version of the IASB’s Conceptual
Framework. One of the major differences between the IASB’s Conceptual Framework and the
Australian Framework is their view on the reporting entity. Given this concept decides who
prepares GPFRs in Australia, this is a significant difference. As we can see from the table below,
the two definitions have quite a different emphasis, that is, the Australian definition is focused
on the users, while the IASB definition is focused on the actual choices of the entity in relation to
financial reporting.

Australian definition, per SAC 1 The new IASB definition, as per the IASB
Conceptual Framework 2018
AU
Reporting entities are all entities (including A reporting entity is an entity that chooses, or is
economic entities) in respect of which it is required, to prepare general purpose financial
reasonable to expect the existence of users statements
dependent on general purpose financial reports A reporting entity is not necessarily a legal entity.
for information which will be useful to them It can comprise a portion of an entity, or two or
for making and evaluating decisions about the more entities
allocation of scarce resources
As the IASB has now issued its Conceptual Framework, the Australian reporting requirements will
need to change to ensure compliance with IFRS.
Australia-specific paragraphs
For a variety of reasons there may be Australian clauses included within an AASB Standard
(indicated by the paragraph prefix ‘Aus’ within the Standard) that are not included in the
IFRS. Most of these Australian clauses are due to either specific requirements applying to NFP
entities, or Australia-specific issues. Where such clauses have been inserted, the AASB includes
an explanation of any divergences from the IFRS version of the Accounting Standard at the
beginning of each standard.
Australia aims to issue sector-neutral standards, that is, the same transaction will be treated in
the same way by different sectors. The IASB does not take this approach as IFRSs are designed
to apply to the reporting of for-profit entities. Internationally, NFP or public sector standards
are issued by different international standard-setting bodies. This is a key source of difference
between AASB standards and IFRS.
Other differences may relate to Australia-specific issues. For example, AASB 124 Related Party
Disclosures requires disclosure of the name of the ultimate controlling entity incorporated within
Australia (AASB 124 para. Aus13.1).
The AASB adopts the practice of inserting NFP-specific paragraphs within each Standard. It also
inserts Australia-specific clauses in the application paragraphs when adopting an IFRS, making
that Standard applicable to NFP entities that:
•• prepare financial reports in accordance with Part 2M.3 of the Corporations Act
•• as reporting entities, prepare a GPFR
•• prepare financial statements that are held out to be GPFRs.
Note that an NFP entity is consistently defined in several Accounting Standards, including in
AASB 102 Inventories, as one ‘whose principal objective is not the generation of profit’ (AASB 102
para. Aus6.1).
Australian standards with no international equivalent
There are also AASB standards for which there is no international equivalent. These include:
•• AASB 1004 Contributions (a NFP-specific standard).
•• AASB 1039 Concise Financial Reports.
•• AASB 1048 Interpretation of Standards.
•• AASB 1052 Disaggregated Disclosures.
•• AASB 1053 Application of Tiers of Australian Accounting Standards.
•• AASB 1054 Australian Additional Disclosures.
•• AASB 1057 Application of Australian Accounting Standards.
•• AASB 1058 Income of Not-For-Profit Entities
•• AASB 1059 Service Concession Arrangements: Grantors
Differential financial reporting
Differential reporting is the different reporting and disclosure requirements for different tiers of
entities. In Australia, these differences may arise as a result of the reporting entity concept (as per
SAC 1) and some provisions of the Corporations Act, as follows:

AU •• The reporting entity concept (application of SAC 1). As discussed earlier in this unit, SAC 1
prescribes the classification of entities as reporting entities where it is reasonable to expect
the existence of users dependent on GPFRs for information. Such entities are required to
prepare their GPFRs in accordance with full IFRS as adopted in Australia.
•• The Corporations Act prescribes differential reporting requirements on entities based on:
–– classification (as public or proprietary, disclosing or non-disclosing entities)
–– size (as a large or small proprietary company).
As a result of the current differential reporting requirements, there are a large number of entities
in Australia that are required to apply full IFRSs as adopted in Australia, but find the associated
disclosures as adopted in Australia burdensome.
Because of this differential reporting framework, the AASB decided not to adopt IFRS for SMEs.
Instead, Australia uses AASB 1053 Application of Tiers of Australian Accounting Standards to
apply two tiers of reporting, whereby Tier 2 entities may reduce their disclosures via the RDR.
These tiers of reporting are likely to change with the proposed AASB amendments.
AASB 1053 identifies two tiers of GPFR reporting requirements, as follows:
AASB 1053 tiers of reporting
Tier Includes Reporting requirements
1 •• For-profit private sector entities that have These entities are required to prepare GPFRs
public accountability using the full set of IFRSs as adopted in
•• Australian government and state, territory Australia
and local governments
2 •• For-profit private sector entities that do not Entities in Tier 2 have the option of:
have public accountability •• Preparing their GPFRs in accordance with
•• Not-for-profit private sector entities the full set of IFRSs as adopted in Australia
•• Public sector entities, whether for-profit OR
or not-for-profit, other than the Australian
•• Complying with AASB 1053, which requires
government and state, territory and local
compliance with the recognition and
governments
measurement elements of AASBs but allows
substantially reduced disclosures
Public accountability as defined in AASB 1053

It is important to understand the term ’public accountability’ when applying the tiers of financial
reporting under AASB 1053. Public accountability means accountability to those existing and
potential resource providers and others external to the entity that make economic decisions but
are not in a position to demand reports tailored to meet their particular information needs.
A for-profit private sector entity has public accountability if:
(a) its debt or equity instruments are traded in a public market or it is in the process of issuing
such instruments for trading in a public market, or
(b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary
businesses.
This is typically the case for banks, credit unions, insurance companies, securities brokers/dealers,
mutual funds and investment banks (AASB 1053 Appendix A).
Commonwealth, state and territory governments and local governments are deemed to have
public accountability, and the appropriate regulator would be able to declare any other public
sector entity to be publicly accountable.
As part of the introduction of the RDR, the AASB issued a number of Standards to make
amendments to many of the AASB Standards and Interpretations.
Consequences of adopting the RDR
•• When an entity applies Tier 2 RDR, the entity has prepared a GPFR.
•• To transition from full IFRS as adopted in Australia to adopting the RDR, an entity merely
omits the disclosures that are now optional for non-publicly accountable reporting entities.

•• Because this is an Australian-specific Standard, the entity applying the RDR to its financial
report cannot claim compliance with IFRS. This can be an issue where the report is presented
AU
to an overseas audience.
•• The entity applying the RDR will be complying with all IFRS recognition and measurement
requirements, but not with all of the disclosure requirements.
•• Where an entity using the RDR wishes to move to full IFRSs as adopted in Australia in the
future, it will need to apply AASB 1 First-time Adoption of Australian Accounting Standards on
transition because it is unable to make an ‘explicit and unreserved statement of such compliance
[with IFRS] in the notes’ (AASB 101 Presentation of Financial Statements, para. 16) as only some
disclosures were presented in financial statements in previous reporting periods.
Accessing RDR versions of AASB Standards and Interpretations
The RDR versions apply only when AASB 1053 is being applied. The disclosure requirements that
eligible entities are not required to comply with are clearly identified within each Standard as
shaded text.
Model illustrative RDR financial statements are prepared by some of the large accounting firms
and these can be found on their websites.

AASB 1053 Application of Tiers of Australian Accounting Standards.
Deloitte, Reduced Disclosure Regime (RDR) Model Financial Statements, accessed 27 April 2018,
www.deloitte.com.au → Services → Audit & Assurance → Accounting Technical → Illustrative
financial reports.
The External Reporting Board
The External Reporting Board (XRB) is the standard-setter in New Zealand. It is an independent
Crown entity established on 1 July 2011 under s. 22 FRA 1993 (now seen in s. 11 FRA 2013).
The XRB’s functions are as follows:
•• Developing and implementing an overall strategy for Financial Reporting Standards and
Auditing and Assurance Standards (including developing and implementing tiers of financial
reporting and assurance).
•• Preparing and issuing Accounting Standards.
•• Preparing and issuing Auditing and Assurance Standards, including the professional and
ethical standards that will govern the professional conduct of auditors.
•• Liaising with national and international organisations that exercise functions that correspond
with, or are similar to, those conferred on the XRB.
New Zealand generally accepted accounting practice (NZ GAAP)
There have been significant changes in the Accounting Standards framework subsequent to its
initial release in April 2012. The changes have been implemented progressively from 2012 to
2016. The new framework is based on a multi-sector, multi-tier reporting approach. Under the
new framework:
•• For-profit entities will report under Financial Reporting Standards that are different to those
for public sector and not-for-profit entities.
•• For-profit entities that are required to prepare GPFS will report using for-profit Accounting
Standards based on NZ IFRS. If there is no such statutory obligation, then it can prepare special
purpose financial statements (SPFS) for their users (e.g. Inland Revenue or its bank).
•• Public benefit entities (PBEs) will use PBE Accounting Standards based on International
Public Sector Accounting Standards (IPSAS) and are separated between public sector PBEs
and not-for-profit public benefit entities (NFP PBEs) entities.

NZ XRB A1 Accounting Standards Framework

In previous sections, we have identified who should prepare GPFS. This section deals with the
accounting standards framework under which GPFS should be prepared.
XRB A1 Accounting Standards Framework provides the criteria for determining under which tier
of reporting an entity falls. In December 2015 the XRB issued a final version of XRB A1 which
is effective from 1 January 2016 , which has had minor amendments made during 2017 which
apply to reporting periods beginning on or after 1 January 2018. At time of writing, the most
recent version on the website is signalled by the notation ‘Date compiled to: 20 December 2017’.
All previous versions of XRB A1 are also available on the XRB website.
Difference between public benefit and for-profit entities
It is important to understand the distinction between PBEs and for-profit entities, as the
accounting standards framework is different for these two types of entities. For-profit entities
report under for-profit accounting standards, whereas public benefit entities report in
accordance with PBE accounting standards.
Paragraph 6 of XRB A1 defines PBEs as ‘reporting entities whose primary objective is to provide
goods or services for community or social benefit and where any equity has been provided with
a view to supporting that primary objective rather than for a financial return to equity holders’.
It also defines for-profit entities as ‘reporting entities that are not public benefit entities’.
Therefore, the test is to determine first whether or not the reporting entity meets the criteria to
be a public benefit entity. If it doesn’t, then it is a for-profit entity.
Determining the appropriate tier for for-profit entities
The flowchart below can assist preparers to determine which tier of reporting a for-profit entity
that is preparing general purpose financial reports must report under:
For-Profit
Entity
Public Yes Use

Accountability? Tier 1 NZ IFRS
(as defined)
No
Large Public Yes

Sector
Entity?
No
Elect to be Yes
in Tier 1
anyway?
No
Tier 2
Use NZ IFRS
RDR
Source: Modified from XRB website, 1 February 2017 (no longer available).

Below is a summary of the criteria for each tier of reporting for for-profit entities:
Tier of
reporting
Criteria Accounting standards
framework
NZ
Tier 1 •• Public accountability, or NZ IFRS
•• Large for-profit public sector entity (large is defined as total
expenses > $30 million)
Tier 2 •• No public accountability, and NZ IFRS RDR

•• Not a large for-profit public sector entity
It is worth noting that an entity sits in Tier 1 unless it elects to report in accordance with Tier 2,
provided that it meets the criteria to be able to report under the lower tier.
Required reading (New Zealand)
Companies Act 1993, Sections 200-205, 207E-207L, 208, 211.
Financial Markets Conduct Act 2013, Part 7.
Financial Reporting Act 2013, Sections 45, 47, 56.
Determining the appropriate tier for not-for-profit public benefit entities

Below is the flowcharts for NFP PBEs, applicable for accounting periods beginning on or after
1 April 2015:
NFP PBE
Public
Yes Use PBE
Accountability? Tier 1
(as defined) Standard
No
Large Yes
Entity?
No
Decide to be
in Tier 1 Yes
anyway?
No
Meet criteria Yes Elect to be Yes Use PBE SFR C

Tier 4
for Tier 4? in Tier 4? (NFP)
No
No
Meet criteria Yes Elect to be Yes Use PBE SFR A

Tier 3
for Tier 3? in Tier 3? (NFP)
No No
Use
PBE
Tier 2 Standards
RDR
Source: Modified from XRB website, 1 February 2017 (no longer available).

NZ Below is a summary of the criteria for each tier of reporting for NFP entities:
Tier of Criteria Accounting Standards

reporting framework
Tier 1 •• Public accountability, or PBE Standards
•• Large entity (large is defined as total expenses > $30 million)
Tier 2 •• No public accountability, and PBE Standards – RDR
•• The entity is not large as defined above
Tier 3 •• No public accountability, and PBE SFR-A*
•• Has total expenses of less than, or equal to, $2 million
Tier 4 •• Entity is permitted by an Act to report in accordance PBE SFP-C***
with non-GAAP Standards (i.e. cash basis of accounting)
because it has no public accountability and does not meet
the size threshold to be a ‘specified not-for-profit entity’**
Notes
* Public Benefit Entity Simple Format Reporting Standard – Accrual.
** If in each of the two preceding accounting periods, total operating payments are less than $125,000 (s. 46 FRA 2013).
*** Public Benefit Entity Simple Format Reporting Standard – Cash.
The flowcharts for NFP PBEs and public sector PBEs are identical and both apply PBE accounting
standards. However, there are differences between the public sector PBE accounting standards
and NFP PBE accounting standards, denoted by ‘PS’ for public sector and ‘NFP’ for the not-for-
profit sector. In addition, the public sector PBE accounting standards are applicable for reporting
periods beginning on or after 1 July 2014, whereas the NFP PBE accounting standards are
applicable for reporting periods beginning on or after 1 April 2015.
Defining public accountability
To establish whether an entity sits in Tier 1, one key definition to satisfy is that of public
accountability. An entity has public accountability if:
(a) its debt or equity instruments are traded in a public market, or it is in the process of issuing
such instruments for trading in a public market (a domestic or foreign stock exchange or an
over-the-counter market, including local and regional markets), or
(b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary
businesses. This is typically the case for banks, credit unions, insurance providers, securities
brokers/dealers, mutual funds and investment banks.
An entity is deemed to be publicly accountable in the New Zealand context if:
(a) it is an FMC reporting entity or a class of FMC reporting entities that is considered to have a
‘higher level of public accountability’ than other FMC reporting entities under section 461K
of the Financial Markets Conduct Act 2013, or
(b) it is an FMC reporting entity or a class of FMC reporting entities that is considered to have a
‘higher level of public accountability’ by a notice issued by the FMA under section 461L(1)(a)
of the FMC 2013.
Further reading (New Zealand)

•• XRB A1 Accounting Standards Framework.
•• XRB website – for information on the tiers of reporting and the financial reporting
framework. There is a specifically useful section ‘Know your standard’ (www.xrb.govt.nz →
Know your Standard), which is helpful in ascertaining which standards to apply.
•• EY Financial Reporting Guide – An overview of the New Zealand Financial Reporting
Framework (January 2017) – www.ey.com/NZ/en/issues/ifrs → Financial Reporting
tools for For-Profit entities → EY Publications → Financial Reporting Guide an overview
of the New Zealand financial reporting framework (December 2017), accessed
27 November 2018.

Main components of financial reports in New Zealand

NZ
Under NZ IAS 1 Presentation of Financial Statements (NZ IAS 1) para. 10, a complete set of financial
statements comprises of:
•• Statement of financial position.
•• Statement of profit or loss and other comprehensive income (also known simply as
statement of comprehensive income).
•• Statement of changes in equity.
•• Statement of cash flows.
•• Notes, comprising a summary of significant accounting policies and other explanatory
information.
•• Comparative information in respect of the preceding period.
Annual reports
The contents of the annual report are detailed in s. 211 CA 1993. According to s. 211, the annual
report should:
•• Describe the company’s state of affairs and any change in the nature or class of its business.
•• Disclose any entries in the interest register for the accounting period.
•• Disclose the total remuneration and other benefits of the directors for the accounting period.
•• Disclose the number of employees who, during the period, received remuneration and other
benefits exceeding $100,000, and state the number of such employees or former employees
in brackets of $10,000.
•• Disclose the total amount of donations made by the company for the period.
•• Disclose the names of the directors of the company at the end of the period, as well as the
names of any directors who ceased to hold office during the period.
•• Disclose separately the amount payable to the auditor of the company for audit fees and
other services.
•• Be signed on behalf of the board by two directors of the company or, if the company has
only one director, by that director.
•• Include financial statements, or group financial statements, for the accounting period that
are prepared in accordance with Part 11 of the CA 1993 or Part 7 of the FMCA 2013 or any
other enactment (if any).
•• Include the auditor’s report if required.
While the requirements of CA 1993 in relation to the annual report seem large, note that
s. 211(3) states that if 95% of the shareholders agree, the first seven items on the above list
are not required to be disclosed. If this was the case, then only the financial statements, audit
report and signing of the financial statements are required. In practice, many smaller companies
take advantage of this exemption from all the disclosure requirements. However, many large
listed companies prepare annual reports that include a detailed analysis and commentary
on the performance of the business over the accounting period, as well as the annual
financial statements.
Other standards and guidance relating to financial reporting
There are other New Zealand Financial Reporting Standards (FRS) and guidance that may be
relevant to the preparation of financial information, depending on the entity or circumstances of
the report. These are:
•• FRS-42 Prospective Financial Statements (FRS-42).
•• FRS-43 Summary Financial Statements (FRS-43).
•• FRS-44 New Zealand Additional Disclosures (FRS-44).

NZ FRS-44 sets out the additional New Zealand specific disclosure requirements for for-profit entities
applying NZ IFRS. The disclosure requirements relate to compliance with NZ IFRS, the applicable
financial reporting standards, the reporting framework, disclosure around audit fees, imputation
credits, and reconciliation of net operating cash flows to profit (loss), prospective financial
statements and the statement of service performance.
Compliance with NZ GAAP
FRA 2013 s. 9 states that the financial statements of a reporting entity must comply with
NZ GAAP if any Act that applies to an entity provides that the financial statements must comply,
or be prepared, in accordance with GAAP. As per s. 8 FRA 2013, NZ GAAP means that financial
statements must comply with:
(a) applicable financial reporting standards, and
(b) in relation to matters for which no provision is made in applicable financial reporting
standards, an authoritative notice.
True and fair view
It is implicit that if financial statements are prepared under NZ GAAP, they will show a true and
fair view of the financial performance and position of an entity. The legislative requirements for
financial statements to give a true and fair view have been removed. Instead, the requirements in
applicable financial reporting standards (e.g. NZ IAS 1) apply.
In the previous FRA 1993, if compliance with NZ GAAP resulted in financial statements that did
not present a true and fair view, the directors of the reporting entity added such information
and explanations as to give a true and fair view of the matters. Under FRA 1993, entities were not
permitted to depart from accounting standards; however, under FRA 2013, entities can now do
so only if complying with the Standards would be so misleading as to conflict with the objective
of financial statements (para. 19 NZ IAS 1). Such situations are expected to be extremely rare
in practice.
Special purpose financial statements
As discussed earlier, certain entities (e.g. FMC reporting entities) are required to prepare GPFS in
accordance with legislation, and that such financial statements must comply with NZ GAAP.
Special purpose financial statements (SPFS) are those other than GPFS, and are tailored to the
needs of specific users. The reporting framework used in SPFS is therefore determined separately
for each set of SPFS based on the information needs of users.
SPFS do not have to comply with NZ GAAP; rather, they specify the accounting policies
according to which they have been prepared. Examples of SPFS would include those that have
been prepared for an entity that is not a reporting entity, but wishes to provide some financial
information to its shareholders, and those for which shareholders are able to specify what
information they would like to receive. Another example would be larger entities that prepare
specified financial information for banks and other finance providers (which is sometimes done
for certain companies within a group). For such cases, reports may be prepared on a special
purpose basis for specific users in addition to the annual financial statements that are prepared
for shareholders.
As discussed earlier, many small- to medium-sized companies in New Zealand no longer have
to prepare GPFS, provided that they meet certain criteria. However, they still need to prepare
SPFS that meet the need of other users (e.g. Inland Revenue minimum requirements), as part
of the amendments to the Tax Administration Act 1994. Chartered Accountants Australia and
New Zealand (through one of its predecessors, New Zealand Institute of Chartered Accountants)
recognised that the Inland Revenue minimum requirements may not provide all the necessary
information that other potential users may need, especially the larger medium-sized entities.
Therefore, it has developed an optional special purpose financial reporting framework, called
Special Purpose Financial Reporting Framework for For-Profit Entities, to provide guidance on the
preparation of SPFS.

Small- and medium-sized entity reporting

NZ
International
Since IFRS were adopted in New Zealand and many other countries, it has been debated whether
the requirements are too onerous for small- and medium-sized entities (SMEs) that are required
to prepare GPFS. In response to these concerns, the IASB issued a new Standard, IFRS for SMEs,
in July 2009.
IFRS for SMEs is an Accounting Standard that a country can apply to entities that do not need to
apply the full set of IFRS. It is a large Standard, covering all financial reporting topics. It contains
significantly reduced disclosure requirements (in comparison to the full IFRS), as well as some
modifications to the recognition and measurement requirements.
New Zealand
In New Zealand, IFRS for SMEs was not adopted, as there was already a differential reporting regime
for smaller entities in place. Differential reporting and Old GAAP were withdrawn from use from
the period that begins on or after 1 April 2015 (i.e. 31 March 2016 balance dates).
Under the new tier structure, entities with public accountability are required to prepare financial
statements using NZ IFRS or PBE Standards (if they are PBEs). Companies that do not have public
accountability can apply the RDR, unless they meet the ‘small’ criterion. This means that small for-
profit entities do not need to prepare GPFSs, and PBEs can use a simpler method of preparation.
Reduced disclosure regime
The RDR was implemented in New Zealand as part of the new tier structure and offers
reduced disclosure requirements that are harmonised with those in Australia. RDR applies
the same recognition and measurement requirements as previously in NZ IFRS, but allows
disclosure concessions.
Rather than issuing a new set of RDR financial reporting standards, the XRB has amended the
existing standards by including an asterisk (*) to paragraphs that RDR entities do not have
to comply with. In place of these exempted disclosures, additional New Zealand-specific
paragraphs with the prefix ‘RDR’ have been entered into the standard where necessary.
Interim financial reporting
Entities listed on the NZX are required to produce interim financial reports in accordance with
the NZSX/NZDX Listing Rules (Listing Rules). Appendix 1 of the Listing Rules specifies the
information that must be contained in the interim reports, including:
•• Details of the reporting period and the previous corresponding period.
•• Statement of financial performance.
•• Statement of financial position (may be condensed).
•• Statement of cash flows (may be condensed).
•• Other relevant information, such as dividends, purchase or sale of subsidiaries, net tangible
assets per security, details of associates, and joint ventures.
Half-year reports must be prepared in accordance with applicable financial reporting Standards,
and disclosure of critical accounting policies/changes in accounting policies. Interim reports are
prepared in accordance with NZ IAS 34 Interim Financial Reporting.

Ethical requirements in preparing financial reports
Learning outcome
The preparation of financial information often involves the exercise of professional judgement;
for example, in assessing the useful life of an asset or determining a provision. An accountant
will face choices when preparing financial statements and will need to use their professional
judgement to determine the outcome. When using their professional judgement it is important
that the accountant understands their ethical obligations and the need to comply with those
ethical obligations.
Ethical requirements
The accounting profession is self-regulated by a code of ethics that governs professional
behaviour. The ethical principles and guidelines are set out in the Code of Ethics for Professional
Accountants (the IESBA Code), issued by the International Ethics Standards Board of
Accountants (IESBA).
A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the
public interest. Therefore, a professional accountant’s responsibility is not exclusively to satisfy the
needs of an individual client or employer. In acting in the public interest, a professional accountant
shall observe and comply with this code.
IESBA Code, s. 100.1 A1
A new version of the Code was issued by the IESBA in April 2018, which applies from 1 July 2019.
IESBA Code of ethics
R110.2 Professional accountants

shall comply with each of the
fundamental principles
Professional
Professional
Integrity Objectivity Confidentiality competence
behaviour
and due care
R120.5 When applying the conceptual framework, the

professional accountant shall:
R120.3 Apply the conceptual (a) Exercise professional judgement
(b) Remain alert for new information and to
framework (ie s.120 IESBA code) changes in facts and circumstances
(c) Use the reasonable and informed third
party test described in paragraph 120.5A4.
Identify threats Evaluate threats Address threats

R120.6 R120.7 R120.10
Self-interest Eliminate
circumstances
Self-review
Apply
Advocacy safeguards
Decline/end
Familiarity
activity
Intimidation NOCLAR s.260/s.360 creates a self

interest or intimidation threat to
compliance with principles of integrity
and professional behaviour
Alert mgt/ Take further
Duty to those in action in
comply governance public interest

IESBA Code
The IESBA Code sets out the ethics requirements for professional accountants. The IESBA Code
is structured into three parts:
•• Part 1 – Complying with the Code, Fundamental Principles and Conceptual Framework.
•• Part 2 – Professional Accountants in Business.
•• Part 3 – Professional Accountants in Public Practice.
Part 1 establishes the fundamental principles and provides a conceptual framework that can be
applied to:
•• identify threats to independence
•• evaluate the significance of the threats identified
•• apply safeguards (when necessary) to eliminate or reduce the threats to an acceptable level.
Parts 2 and 3 describe how the conceptual framework applies in specific circumstances.
They provide examples of safeguards that may appropriately address threats to compliance
with the fundamental principles. Where no safeguard is available in a particular circumstance,
the threat must be avoided altogether. It is important to note that accountants are expected to be
guided by both the words and the spirit of the IESBA Code, using the conceptual framework.
While all sections of the IESBA Code are equally important, this unit focuses on Part 1,
sections 110 and 120; Part 2 sections 200 and 260; Part 3 sections 300 and 360.
Fundamental principles
The IESBA Code lists its five fundamental principles in para. 110.1 A1, as outlined below:
IESBA Code – fundamental principles
Paragraph Principle Definition
110.1 A1(a) Integrity To be straightforward and honest in all professional and business relationships
R111.1
110.1 A1(b) Objectivity Not to compromise professional or business judgments because of bias, conflict
R112.1 of interest or undue influence of others
110.1 A1(c) Professional (i) Attain and maintain professional knowledge and skill at the level required
R113.1 competence to ensure that a client or employing organization receives competent
and due care professional service, based on current technical and professional standards
and relevant legislation; and
(ii) Act diligently and in accordance with applicable technical and professional
standards
110.1 A1(d) Confidentiality To respect the confidentiality of information acquired as a result of professional
R114.1 and business relationships
110.1 A1(e) Professional To comply with relevant laws and regulations and avoid any conduct that the
R115.1 behaviour professional accountant knows or should know might discredit the profession
Each of these principles is discussed in more detail in Section 110 subsections 111-115 of the
IESBA Code.
Threats and safeguards

An accountant experience a wide range of relationships and circumstances, some of which may
create a threat to their compliance, or perceived compliance, with the fundamental principles.
Paragraph R120.6 of the IESBA Code requires the accountant to identify threats to compliance
with the fundamental principles:

IESBA Code – threats to fundamental principles

Paragraph Threat Definition Example
120.6 A3(a) Self-interest The threat that a financial or other •• A financial accountant within an
interest will inappropriately influence organisation with a bonus based on
the professional accountant’s judgment accounting profit
or behaviour •• Other ‘at risk’ compensation
affected by financial reporting
choices
120.6 A3(b) Self-review The threat that a professional accountant •• Reporting on systems where
will not appropriately evaluate the the professional accountant has
results of a previous judgment made; or been involved in their design or
an activity performed by the accountant, implementation
or by another individual within the
accountant’s firm or employing
organization, on which the accountant
will rely when forming a judgment as
part of performing a current activity
120.6 A3(c) Advocacy The threat that a professional •• Pressure from within an entity to
accountant will promote a client’s or make reporting choices to manage
employing organization’s position earnings or EPS
to the point that the accountant’s •• Acting as an advocate on behalf of
objectivity is compromised your employer in resolving disputes
with third parties
120.6 A3(d) Familiarity The threat that due to a long or close •• Accepting preferential treatment
relationship with a client, or employing with suppliers or customers unless
organization, a professional accountant the value is clearly insignificant
will be too sympathetic to their
interests or too accepting of their work
120.6 A3(e) Intimidation The threat that a professional •• Being threatened with dismissal
accountant will be deterred from unless particular financial reporting
acting objectively because of actual outcomes are achieved
or perceived pressures, including •• Being threatened with litigation
attempts to exercise undue influence
•• Being pressured to reduce the
over the accountant
extent of work required in order to
reduce fees
‘Safeguards’ are actions or other measures that may eliminate threats or reduce them to an
acceptable level. There are two broad categories of safeguards:
•• Those created by the profession, legislation or regulation – for example, professional
Standards, professional or regulatory monitoring, and disciplinary procedures.
•• Those created in the workplace – for example, documented internal policies or a firm’s
quality control policies and procedures.
Further reading
IESBA Code Section 110, ss 111-115, sections 120, 200, 260, 300 and 360.
Further reading
IESBA Code remaining sections.

Australian ethical requirements
The Accounting Professional and Ethical Standards Board (APESB) issues standards that
outline the professional conduct required by members of the professional accounting bodies.
Compliance with these standards is mandatory for all Australian Chartered Accountants.
Three key requirements of the standards are relevant to financial reporting:
1. APES 110 Code of Ethics for Professional Accountants. This replicates the fundamental ethical
principles contained within the IESBA Code.
2. APES 205 Conformity with Accounting Standards. This Australian-specific professional
standard imposes obligations on members to follow accounting standards when they
prepare, present, audit, review or compile financial statements which are either GPFR or
an SPFR.
3. APES 315 Compilation of Financial Information. This Australian-specific professional standard
is applicable to members in public practice who compile financial information. Financial
information includes financial statements. The standard sets out the format of reports that
a member must issue to accompany a GPFR or SPFR that the member has compiled at the
request of the client.
Should an Australian Chartered Accountant be disciplined for failure to comply with an ethical
principle/principles, such a breach is taken by Chartered Accountants Australia and New Zealand
(Chartered Accountants ANZ) as a breach of APES 110 rather than the IESBA Code.
APES 205 paras 5.1–5.6.

APES 110, Section 100 – Introduction and Fundamental Principles.
APES 205, remaining paragraphs.
APES 315.
The IESBA has been ’trickled down’ into New Zealand via the Professional Engagement Standards
and Code of Ethics that was issued by NZICA.
New Zealand ethical requirements
New Zealand Institute of Chartered Accountants
The New Zealand Institute of Chartered Accountants (NZICA) entity retains a duty to control and
regulate the practice of the profession of accountancy by its members in New Zealand and it
cannot delegate that duty (in whole or in part) to any person under the NZICA Act 1996.
This governing body takes the form of the New Zealand Regulatory Board under the Chartered
Accountants Australia and New Zealand governance model. The New Zealand Regulatory Board:
•• prescribes the Code of Ethics
•• appoints, authorises delegations for oversees and directs the permanent bodies specified in
the NZICA Rules, and
•• carries out any other functions or responsibilities that are conferred by the Act, any
other enactment, the NZICA Rules or the Chartered Accountants Australia and New Zealand
By-Laws.
The New Zealand Regulatory Board reports to the Chartered Accountants Australia and New
Zealand Board.

NZ The NZICA Code of Ethics is binding on all New Zealand members, and mandates the
professional and ethical expectations of members. Under the NZICA Code of Ethics, all
New Zealand members shall comply with the following fundamental principles:
•• Integrity: be straightforward and honest in all professional and business relationships.
•• Objectivity: to not allow bias, conflict of interest or undue influence of others to override
professional or business judgements.
•• Professional competence and due care: maintain professional knowledge at the level
required to ensure that a client receives competent professional services.
•• Confidentiality: to respect the confidentiality of information acquired as a result of
professional and business relationships.
•• Professional behaviour: to comply with relevant laws and regulations, and avoid any action
that discredits the member’s profession.
NZICA can investigate complaints against New Zealand members. If the complaint is found to
be valid, the member may be cautioned, suspended from membership for a period of time, or
removed from the register of members. They may also be fined.
The External Reporting Board (XRB)
The New Zealand Audit and Assurance Standards Board (NZ AuASB), a sub-board of the XRB, also
sets professional and ethical standards that apply to all assurance providers adopting the XRB
Auditing and Assurance Standards.
Further reading (New Zealand)
NZICA Code of Ethics (effective from 15 July 2017).

Non-compliance with laws and regulations (NOCLAR)

The IESBA Code has been revised recently to address accountants’ responsibility in relation
to non-compliance with laws and regulations (NOCLAR). The revised IESBA Code sets out a
framework for professional accountants to respond to identified or suspected non-compliance
with laws and regulations. The IESBA Code has always required professional accountants to act
in public interest; however, when breaches of laws and regulations have been identified there
has been a conflict with the accountant’s duty of confidentiality. The revisions to the IESBA
Code set out how accountants may, in certain cases, disclose non-compliance to appropriate
authorities without breaching client confidentiality. These revisions will allow professional
accountants to play a greater role in combating fraud, money laundering and corruption.
NOCLAR is a new ethical Standard effective from July 2017 that sets the framework for auditors
and other accountants on how to act in the public interest when they become aware of non-
compliance or suspected non-compliance with laws and regulations. The NOCLAR Standard
is incorporated in s. 360 (Professional Accountants in Public Practice) and 260 (Professional
Accountants in Business) of the new IESBA Code. NOCLAR also impacts on other sections of
the IESBA Code.
NOCLAR is defined as any act of omission or commission (intentional or unintentional)
committed by a client that is contrary to the prevailing laws or regulations. It is an act that
causes substantial harm and involves serious adverse consequences to investors, creditors,
employees or the general public in either financial or non-financial terms; for example,
committing financial fraud resulting in significant losses to investors.
Fiancial products & services

Public health & safety Proceeds of crime
Banking securities markets trading
corruption
Tax & pension fraud
protection bribery
liabilities data
Environmental protection Money laundering
Terrorist financing Data protection
NOCLAR
Required reading
‘Responding to Non-compliance with Laws and Regulations’, www.ifac.org → Publications →
responding to NOCLAR, accessed 30 April 2018.

Contemporary financial reporting issues
Learning outcome
There are a number of important developments relevant to broad financial reporting issues.
International level
Important contemporary financial reporting issues at the international level are outlined below.
Better communication in financial reporting – making disclosures more meaningful

In the face of increasing complexity in financial reports, there has been a significant movement
to improve the relevance of financial information and how it is communicated.
The IASB’s participation has been to undertake a series of implementation projects and research
projects focused on disclosures.
The current research projects and exposures are focused on the following:
•• Primary financial statements. The IASB is exploring targeted improvements to the structure
and content of financial statements with a focus on the statements of financial performance.
The focus is on reducing presentation choices for items in the statement of profit or loss and
other comprehensive income and the statement of cash flows to make it easier for investors
to compare the performance and future prospects of companies.
A number of sub-totals are required by para. 81A of IAS 1, and new totals such as profit
before financing and tax (or EBIT), are being developed by the IASB. However, an entity
may decide that a different, non-IFRS total is a more relevant measure of its financial
performance. This is referred to as a management performance measure (MPM). The IASB
is proposing to bring MPMs within the financial statements, to make these measures more
transparent and subject to audit. The MPMs will not be subject to constraints, but they must
be identified as MPMs and be reconciled to the most appropriate IFRS sub-total.
•• Principles of disclosure. The IASB’s objective is to develop new or clarify existing
disclosure principles in order to address concerns arising from the level of judgement
exercised by companies in deciding what information to disclose in financial statements and
the most effective way to organise and communicate it.
In March 2017 the IASB released a discussion paper called Disclosure Initiative – Principles
of Disclosure.
•• Standards-level review of disclosures. This project will develop guidance for the standard
setter on disclosure principles, then test the guidance out via a targeted application to
one or two standards. This is expected to result in an exposure draft by the end of 2018.
IFRS Taxonomy
•• Materiality. This aspect of disclosures has progressed to amendments to two accounting
standards and is detailed below.
Further reading
‘Better Communication: making disclosures more meaningful’ shows examples of improved
disclosures in real financial reports, accessed 4 Dec 2018, www.ifrs.org/-/media/project/disclosure-
initative/better-communication-making-disclosures-more-meaningful.pdf?la=en
Materiality
The principle of materiality is applied when determining whether an Accounting Standard
applies and in assessing how to apply Accounting Standards. In October 2018 the IASB made
amendments to IAS 1 and IAS 8 to clarify and align the definition of materiality in IAS 1, IAS 8,
and the Conceptual Framework, and provide guidance to improve consistency in their application.

These amendments are effective for annual reporting periods beginning on or after 1 January 2020,
however earlier application is permitted. The definition of ‘materiality’ is as follows:
Information is material if omitting, misstating, or obscuring it could reasonably be expected to influence
the decisions that the primary users of general-purpose financial statements make on the basis of those
financial statements, which provide financial information about a specific entity.
The IASB does not expect the amended definition to significantly affect how materiality
judgements are made in practice, or to significantly affect an entity’s’ financial statements.
In addition, in September 2017 the IASB also issued a practice statement on materiality entitled:
Practice Statement 2: Making materiality judgements. The statement provides guidance on how
to make materiality judgements when preparing their general purpose financial statements
in accordance with IFRS. The Practice Statement is not mandatory and it neither changes the
requirements nor introduces new ones. The aim is to drive behavioural change by supporting
preparers of financial statements with the tools to make their financial statements more useful
and concise, rather than view disclosure preparation as completing a checklist from each
relevant standard.
It recommends a four-step process in making materiality judgements:
Step 1 Requirements Knowledge about primary users’

Identify of IFRS Standards common information needs
Step 2 Quantitative Qualitative

Access factors factors
(entity-specific
and external)
Step 3 Organise the information within

Organise the draft financial statements
Step 4 Renew the draft

Review financial statements
The practice statement also provides illustrations and explanations to help preparers of financial
statements to better apply the concept when identifying appropriate disclosures.

Further reading
Better communication in financial reporting, www.ifrs.org → Project → Better communication in
financial reporting, accessed 23 November 2018.
Reducing disclosures
The issue of financial statement disclosures is topical, as many are finding the current level
of disclosures overwhelming. The key issue is that there is so much noise and distraction in
financial reports that it is difficult for users to ‘cut through’ and find the key messages.
Current discussions on the topic suggest that there is scope for entities to improve the clarity
in financial reports under existing disclosure requirements by highlighting key information,
reordering content into logical sections and removing unnecessary disclosures. As identified
in a paper published by the CA ANZ, Noise, Numbers and Cut-Through, some listed companies
in Australia and New Zealand are into their second year of ‘streamlining’ their financial
reports, and many more are expected to follow suit this reporting season. Standard-setters and
regulators have added their voice, publicly supporting the removal of immaterial disclosures.
The IASB is also considering this topic with their Disclosure Initiative project (discussed above),
which aims to improve how information is presented and disclosed in financial reports.
Further reading
CA ANZ 2015, ‘Noise, Numbers and Cut-Through’, www.charteredaccountantsanz.com → News
and analysis → Insights → Future[inc] → Archive → Noise, Numbers and Cut-Through, accessed
25 April 2018.
Sustainability reporting
The Global Reporting Initiative (GRI) is an international independent organisation that
promotes the use of sustainability reporting as a way for entities to become more sustainable
and contribute to sustainable development. Sustainability issues include issues such as climate
change, human rights and corruption.
The GRI Framework includes reporting guidelines, sector guidance and other resources.
It is supportive of integrated reporting as it develops as an important and necessary innovation
of corporate reporting.
During 2015 thought leaders in various fields were interviewed on a number of subjects
related to sustainability reporting. Articles, videos and papers based on these interviews were
disseminated to the GRI network. The final publication, ‘The Next Era of Corporate Disclosure:
Digital, Responsible, Interactive’ was issued in March 2016.
Further reading
GRI, ‘The Next Era of Corporate Disclosure: Digital, Responsible, Interactive’, www.globalreporting.org
→ Information → In the Spotlight → Sustainability and Reporting 2025, accessed 19 April 2018.
Integrated reporting
The International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors,
companies, standard-setters, the accounting profession and non-government organisations. It was
formed in 2010 as part of global efforts to increase integrated business reporting.
While many companies prepare traditional financial reports and separate sustainability reports,
integrated reports attempt to serve as the reporting centrepiece to integrated thinking within
an organisation. These reports widen the traditional views of capital beyond financial capital,
to incorporate manufactured capital, human capital, social and relationship capital, intellectual
capital and natural capital.

An integrated approach argues that the interrelationships between these forms of capital act
to create short-, medium- and long-term value, and that examining the integrated whole and
embedding this in decision-making processes within an entity is key to understanding an
entity’s value creation over time.
The International Integrated Reporting Framework, (the IIR Framework) was released in
December 2013 following extensive consultation and testing by businesses and investors in
all regions of the world who participated in the IIRC Pilot Programme. The purpose of the
IIR Framework is to establish guiding principles and content elements that govern the overall
content of an integrated report, and to explain the fundamental concepts that underpin them.
The IIR Framework defines reporting boundaries, users and materiality quite differently to
traditional financial reporting, and these reports are deliberately more forward-looking.
In 2014 a new group called the Corporate Reporting Dialogue (CRD) was created. The CRD
operates under the umbrella of the IIRC and its participants include the IASB, FASB, GRI and IIRC.
The CRD is an initiative designed to respond to market calls for greater coherence, consistency
and comparability between frameworks, standards and related requirements. To assist with this,
the CRD published a corporate reporting landscape map that is intended to help stakeholders
understand the similarities and differences in the corporate reporting frameworks and standards.
Further reading
•• Integrated Reporting <IR>, ‘What? The tool for better reporting’, www.integratedreporting.org
→ What? The tool for better reporting, accessed 19 April 2018.
•• Corporate Reporting Dialogue, www.corporatereportingdialogue.com, accessed 19 April 2018.
As discussed earlier, the IASB develops, amends and publishes IFRSs and IFRICs, which are used
in preparing financial reports in numerous countries. Therefore, many changes to financial
reporting are directed from the international level. However, significant changes may still occur
at the national level, driven by country-specific issues.
Important contemporary financial reporting issues at the national level are outlined below.
Australian Securities and Investments Commission (ASIC) – Areas of focus
Each year, ASIC announces the areas on which it will focus its reviews of financial reports of listed
entities and other entities of public interest. The current areas of focus are:
•• Estimates – impairment and asset values.
•• Accounting policy choice
–– Revenue recognition – ensuring that revenue is recognised based on the substance of
the underlying transactions.
–– Expense deferral – ensuring that expenses are only deferred when permitted to by
Accounting Standards.
–– Tax accounting.
–– Estimates and accounting policy judgements.
–– Impact of new revenue, financial instrument, lease and insurance standards.
These areas have been ASIC’s focus for a number of periods.
AASB
The AASB is currently conducting outreach sessions to clarify the future of special purpose
financial reports in light of the changes to the IASB conceptual framework
Exposure draft ED/2017/5 Accounting Policies and Accounting Estimates which proposes
amendments to IAS 8. The objective of the amendments is to better distinguish accounting
policies from accounting estimates. This is discussed further in Unit 2.

Activity 1.1: Applying the regulatory framework

Quiz

Unit 2: Presentation of financial statements
Contents
Introduction 2-3
Content of general purpose financial statements 2-4
Statement of financial position 2-4
Statement of profit or loss and other comprehensive income 2-8
Statement of changes in equity 2-12
Statement of cash flows 2-15
Disclosures 2-16
Steps in preparing financial statements under International Accounting Standards 2-21
Step 1 – Prepare the year-end adjusting entries 2-22
Step 2 – Prepare the year-end tax entries 2-22
Step 3 – Prepare the final trial balance 2-22
Step 4 – Prepare the statement of financial position, statement of profit or loss
and other comprehensive income, and statement of changes in equity 2-22
Step 5 – Prepare the statement of cash flows 2-22
Step 6 – Prepare the notes to the financial statements 2-23
Standards that impact disclosures and adjustments 2-24

Accounting policies, changes in accounting estimates and errors (IAS 8) 2-24
Selecting accounting policies 2-24
Importance of accounting policies 2-25
Changes in accounting policies 2-26
Accounting policies versus accounting estimates 2-27
Accounting estimates 2-27
Applying a change in an accounting estimate 2-28
Summary – changes in accounting policies, changes in accounting estimates
and prior period errors 2-31
Future developments 2-32
Related party disclosures 2-33
Related party relationships 2-33
Example – Related party relationships 2-34
Related party transactions 2-34
Disclosures 2-35
Discontinued operations 2-36
Definition of a discontinued operation 2-36
Measuring the assets and liabilities of a discontinued operation 2-36
Presentation of discontinued operations 2-36
Disclosures 2-38
Events after the reporting period 2-38
Timing of events 2-38
Accounting for events after the reporting period 2-39
Adjusting events 2-39
Non-adjusting events 2-40
Disclosures 2-41
fin11902_csg_07


Learning outcomes
1. Advise on the requirements for financial statements
3. Explain and account for changes in accounting policies, revisions of accounting estimates
and errors.
Introduction
This unit provides an overview of the requirements for preparing financial statements, and
the content of those financial statements. It is important to work through the concepts and the
issues discussed in this unit as they are consistently referred to throughout this module.
This unit assumes that the preceding unit on financial reporting has been worked through
and understood.
While financial statements are often seen as just a set of statements and supporting notes, being
able to understand and explain how and what information is disclosed in financial statements
and notes is a very important skill for a Chartered Accountant. The career of a Chartered
Accountant is likely to involve the preparation of sets of financial statements, whether for
clients or employers.
The unit is structured in the following sections:
•• Content of general purpose financial statements.
•• Steps in preparing financial statements under International Accounting Standards.
•• Standards that impact disclosures and adjustments:
(a) Accounting policies, changes in estimates and errors (IAS 8).
(b) Related parties (IAS 24).
(c) Discontinued operations (IFRS 5).
(d) Events after reporting period (IAS 10).


Content of general purpose financial statements
Learning outcomes
1. Advise on the requirements for financial statements.
IAS 1 Presentation of Financial Statements sets out the basic structure and contents for all financial
statements, including:
•• the overall requirements for the presentation of GPFSs
•• guidelines for their structure, and
•• the minimum requirements for their content.
As per IAS 1 para. 10, a ‘complete set of financial statements’ contains:

•• a statement of financial position
•• a statement of profit or loss and other comprehensive income
•• a statement of changes in equity
•• a statement of cash flows
•• notes, made up of a summary of significant accounting policies and other explanatory
information
•• comparative information for the preceding period
•• a statement of financial position ‘as at the beginning of the earliest comparative period
when an entity applies an accounting policy retrospectively’, or makes a retrospective
restatement, or reclassification, of items in its financial statements.
In preparing a complete set of financial statements, IAS 1 also states that an entity:
•• may use other titles for any one of these statements (para. 10); for example, the entity may
call the statement of financial position a balance sheet, and
•• needs to present each of the financial statements with ‘equal prominence’ (para. 11).
Each of the financial statements is discussed in turn below, as well as the basic requirements
for the face of the financial statement. Some published financial statements are also used as
examples, to illustrate the learning.
Required reading
IAS 1 (or local equivalent).
Statement of financial position

The statement of financial position is a statement, at a specified date, of an entity’s:
•• assets
•• liabilities
•• equity.
The definitions of assets, liabilities and equity were discussed in relation to the Conceptual
Framework in Unit 1.

IAS 1 and the statement of financial position paragraphs (paras 54-80A)

The following diagram illustrates some key requirements of IAS 1 for the statement of financial
position:
Line items on face of the statement

Para. 54
of financial position
Information on face of statement of

IAS 1 financial position, statement of Paras 77 and 79
changes in equity OR in notes
to financial statements
Current/non-current asset and Paras 60, 61,

liability distinction 66 and 69
The table below shows a simple balance sheet or statement of financial position, cross-
referenced to relevant paragraphs of IAS 1, and units in the CSG or other FIN learning elements.
(Other accounts are covered in different units throughout the module.) Further disaggregation
may be required by IAS 1 paras 77–80A; however, this would normally be shown in the notes to
the accounts.
Statement of financial position as at 30.06.X8
CSG unit IAS 1 paragraph
Current assets 60 and 66
Cash and cash equivalents 54(i)
Trade and other receivables Unit 9 54(h)
Inventories Assumed knowledge – See 54(g)

video on myLearning
Other financial assets including derivatives Unit 9 54(d)
Current tax assets Unit 4 54(n)
Assets held for sale Unit 2 54(p)
Total current assets
Non-current assets 60 and 66
Property plant and equipment Unit 7 54(a)
Intangible assets Unit 8 54(c)
Goodwill Unit 8 54(c)
Financial assets Unit 9 54(d)
Deferred tax assets Unit 4 54(o)
Total non-current assets
Total assets
Current liabilities 60 and 69
Bank overdraft Unit 9 54(i) and 54(m)
Trade and other payables Unit 9 54(k)
Provisions Unit 11 54(l)

Statement of financial position as at 30.06.X8
Current tax liability Unit 4 54(n)
Total current liabilities
Non-current liabilities 60 and 69
Financial liabilities Unit 9 54(m)
Deferred tax liabilities Unit 4 54(o)
Bank loan Unit 9 54(m)
Total non-current liabilities
Total liabilities
Net assets
Shareholders equity
Share capital Unit 9 54(r)
Reserves Units 5, 9 54(r)
Retained earnings 54(r)
Equity attributable to the owners of the entity Unit 16 54(r)
Equity attributable to non-controlling interest Unit 16 54(q)
Total equity
Distinction between current and non-current assets or liabilities

IAS 1 sets out the rules for distinguishing between current and non current assets, and current
and non current liabilities. Having clear requirements around this classification ensures
comparability between sets of financial statements. The format of these rules within IAS 1
allows for the differences that arise due to industry factors and operating cycles.
An entity is generally required to present its current and non-current assets and liabilities
separately on the face of the statement of financial position (IAS 1 para. 60).
Assets are current if: Liabilities are current if:
no
unconditional
cash or right to defer
cash settlement
equivalent beyond
OR 12 months
OR
held
for
trading
OR
expects to held
realise within due within
for 12 months OR
12 months OR trading
normal OR expects to settle
operating within 12 months
cycle OR within normal
operating
cycle
…all other assets are non-current (IAS 1 para. 66) …all other liabilities are non-current (IAS 1 para. 69)

The only exception to this is when a presentation based on liquidity would provide users of the
financial statements with information that is reliable and more relevant. For example, financial
institutions present their statements of financial position on a liquidity basis (rather than on
a current/non-current format) as this is more reflective of how their assets are used and their
liabilities expected to be settled.
The balance sheet
STATEMENT OFbelow is an extract
FINANCIAL fromAS
POSITION theAT
Harvey Norman
30 JUNE 2018Holdings Limited’s 2018
Annual Report:
Statement of Financial Position as at 30 June 2018

CONSOLIDATED
June June
2018 2017
Note $000 $000
Current Assets
Cash and cash equivalents 28(a) 170,544 80,224
Trade and other receivables 7 724,690 640,686
Other financial assets 8 31,463 29,191
Inventories 9 345,287 315,968
Other assets 10 45,144 45,878
Intangible assets 11 490 486
Total current assets 1,317,618 1,112,433
Non-Current Assets
Trade and other receivables 12 78,443 78,777
Investments accounted for using equity method 37 4,497 26,355
Other financial assets 13 18,283 30,076
Property, plant and equipment 14 660,337 625,112
Investment properties 15 2,429,397 2,241,754
Intangible assets 16 69,067 75,237
Total non-current assets 3,260,024 3,077,311
Total Assets 4,577,642 4,189,744
Current Liabilities
Trade and other payables 17 289,986 238,628
Interest-bearing loans and borrowings 18 422,191 386,651
Income tax payable 15,608 42,541
Other liabilities 19 66,825 41,571
Provisions 20 35,354 34,034
Total current liabilities 829,964 743,425
Non-Current Liabilities
Interest-bearing loans and borrowings 21 503,203 333,858
Provisions 20 11,645 13,052
Deferred income tax liabilities 5(d) 280,735 267,219
Other liabilities 23 14,163 19,283
Total non-current liabilities 809,746 633,412
Total Liabilities 1,639,710 1,376,837
NET ASSETS 2,937,932 2,812,907
Equity
Contributed equity 24 388,381 386,309
Reserves 25 185,384 174,950
Retained profits 26 2,337,241 2,229,200
Parent entity interests 2,911,006 2,790,459
Non-controlling interests 27 26,926 22,448
TOTAL EQUITY 2,937,932 2,812,907
The above Statement of Financial Position should be read in conjunction with the accompanying notes.
Source: Harvey Norman, 2018 Annual Report.
HARVEY NORMAN HOLDINGS LIMITED | ANNUAL REPORT 2018 67

IAS 1 para. 54 requires a number of line items to be included in a financial statement, but
additional line items are allowed. Similarly, paras 77–79 outline a number of disclosures and
disaggregations that are required, but these can be shown on the face of the balance sheet or in
the notes.
As previously discussed, the Standard sets out the rules for classifying current and non-current
assets and liabilities. It also states that deferred tax liabilities cannot be shown as current.
The split of equity attributable to the parent entity interests and non-controlling interests shown
in the balance sheet above is required by IAS 1 para. 54. This split will be discussed further in
the units on business combinations (Unit 15) and accounting for subsidiaries (Unit 16).
Much of the presentation of the balance sheet, such as some line items, sub totals, order
and format are not prescribed by the Standard, and it is up to the entity to decide the most
appropriate presentation method. In practice, most entities follow model financial statements
and present the statement of financial position in one of a few ’accepted’ formats.
Statement of profit or loss and other comprehensive income

A simple example of a statement of profit or loss and other comprehensive income (SPLOCI)
is shown below. The statement can be presented as two statements, or, in this case, as a single
statement. This entity shows expenses by function, but an entity can also classify expenses by
nature.
Please note that this is an example only and does not reflect all possible inclusions.
Some additional disclosures may also be required in the notes.
This statement is cross-referenced to relevant paragraphs of IAS 1 and also maps where you will
touch on key items within the FIN CSG.
Statement of profit or loss and other comprehensive income for the year ended 30.06.X8
Revenue Unit 3 82 – essential line item
Cost of sales 103 – classify expenses by function (or

nature: para. 102) – on face of SPLOCI or
in notes
Gross profit
Other income
Selling and distribution expenses
Administrative expenses
Research and development expenses Unit 8 97, if material, show separately (on face or
notes)
Other expenses
Share of profit from associates accounted for using Unit 17 82, essential line items
the equity method of accounting
Finance costs 82, essential line items
Finance income
Profit before tax
Income tax expense Unit 4 82, essential line items
Profit for the year from continuing operations
Profit/(loss) for the year from discontinued Unit 2 82, 97, 98

operations

Statement of profit or loss and other comprehensive income for the year ended 30.06.X8
Profit for the year
Profit for the period attributable to: Units 15–16 81B, must split totals between owners/NCI
Owners of the parent entity
Non-controlling interest
Other comprehensive income (OCI)
Items that will not be reclassified to profit and 82A, classifications within OCI
loss
Revaluation of land and buildings Unit 7
Income tax on items that will not be reclassified
Items that are or may be reclassified to profit 82A

and loss
Foreign currency translations of overseas Unit 5

subsidiaries
FVTOCI investments Unit 9

Net change in fair value
Reclassification to profit and loss 92, disclose reclassification adjustments

in OCI
Cash flow hedging Unit 9

Net change in fair value
Reclassification to profit and loss 92
Share of other comprehensive income from Unit 17

associates accounted for using the equity method
Income tax on items that are or may be reclassified 91, show OCI items either net of tax or
aggregate, split by may be reclassified/
never reclassified
Other comprehensive income for the period, net 81A, must have totals
of tax
Total comprehensive income for the period 81A
Total comprehensive income attributable to: Units 15–16 81B, must split totals between owners/NCI
Owners of the parent entity
Non-controlling interest
IAS 1 requirements for the statement of profit or loss

IAS 1 allows some flexibility for the presentation of items in the profit or loss (section or
statement). This flexibility recognises that different entities in different industries will have
different classes of expenses that provide information to the users of the financial statements.
Other comprehensive income

Accounting Standards do not permit certain items to be included in measuring an entity’s
profit or loss. Typically, the items disclosed in other comprehensive income (OCI) are current
year movements in reserves other than retained earnings (the movement in a revaluation
surplus account).

Recycling OCI
When an item is classed as ’may be reclassified’, it is often referred to as ‘recycling OCI’.
This is because the item first appears in other comprehensive income, but may later be moved
to the profit and loss and ‘recycled’.
Examples of items which are recycled include the cumulative movements in the fair value of fair
value through OCI (FVTOCI) financial assets. These gains and losses are originally recognised
in a reserve account within OCI, with the reserves reclassified to the profit or loss when they are
derecognised under IFRS 9 Financial Instruments. FVTOCI financial assets are discussed in the
unit on financial instruments (Unit 9).
Other comprehensive income video

Further reading
IFRS 9 Appendix B para. B5.7.1A.
Below is a SPLOCI for Harvey Norman Limited for the year ended 30 June 2018. Note that:
•• Harvey Norman has chosen to present the SPLOCI as two separate statements.
•• Harvey Norman has chosen to classify expenses by function.
•• The functional presentation shows a cost of goods sold and a gross profit amount, and
groups expenses in categories such as distribution, marketing and occupancy.
•• The statement of comprehensive income shows two categories of OCI: may be reclassified
and will not be reclassified to profit or loss.
You are hopefully familiar with revaluations of property, plant and equipment from your
university studies. A revaluation on property, plant and equipment is shown here under the
heading of never to be reclassified to profit and loss. Also note that any tax relating to this
revaluation is disclosed with the OCI item. Under IAS 1 para. 90, the tax related to OCI can
either be shown on the face of the SPLOCI or in the notes.
Accounts that you may be less familiar with are the foreign currency translation reserve and
cash flow hedge reserve. We will later examine these accounts in the units on foreign exchange
(Unit 5) and financial instruments (Unit 9), respectively. For now, just note that these items are
shown as other comprehensive income under the sub-heading ’Items that may be reclassified
subsequently to profit or loss’.

INCOME STATEMENT FOR THE YEAR ENDED 30 JUNE 2018
Income statement for the year ended 30 June 2018

CONSOLIDATED
June June
2018 2017
Note $000 $000
Sales revenue 3 1,993,760 1,833,123

Cost of sales (1,326,339) (1,235,602)
Gross profit 667,421 597,521
Revenues and other income items 3 1,240,703 1,305,344

Distribution expenses (41,602) (36,189)
Marketing expenses (374,322) (384,885)
Occupancy expenses 4 (241,220) (226,994)
Administrative expenses 4 (585,683) (492,453)
Other expenses 4 (114,573) (107,666)
Finance costs 4 (26,344) (20,072)
Share of net profit of joint ventures entities 37 5,792 5,200
Profit before income tax 530,172 639,806
Income tax expense 5(a) & 5(c) (150,122) (186,840)
Profit after tax 380,050 452,966
Attributable to:
Owners of the parent 375,378 448,976
Non-controlling interests 4,672 3,990
380,050 452,966
Earnings Per Share:

Basic earnings per share (cents per share) 6 33.71 cents 40.35 cents
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 2016

Diluted earnings per share (cents per share) 6 33.67 cents 40.30 cents
OF COMPREHENSIVE INCOME26FOR THE YEAR

Dividends per share (cents per share)
STATEMENT 30.0 cents 26.0 cents
ENDED 30 JUNE 2018
Statement
The aboveof Comprehensive
Income Statement should be Income for the
read in conjunction withyear ended 30
the accompanying June 2018
notes. CONSOLIDATED
June June
2016 2015
CONSOLIDATED
$000 $000
June June
2018 2017
Profit for the year $000 351,340 $000 268,914
Profit for the year 380,050 452,966

Items that may be reclassified subsequently to profit or loss:
Foreign currency translation 29,742 (3,560)
Items that may be reclassified subsequently to profit or loss:
Net fair value gains on available-for-sale investments 1,101 1,302
Foreign currency translation (221) (6,942)
Net movement on cash flow hedges 3,978 4,699
Net fair value (losses) / gains on available-for-sale investments (1,830) 4,050
Income tax effect on net movement on cash flow hedges (1,193) (1,406)
Net movement on cash flow hedges 16 18
Income tax effect on net movement on cash flow hedges (4) (6)
Items that will not be reclassified subsequently to profit or loss:
Fair value revaluation of land and buildings 12,777 13,115
Items that will not be reclassified subsequently to profit or loss:
Income tax effect on fair value revaluation of land and buildings (3,499) (2,055)
Fair value revaluation of land and buildings 15,553 25,467
Income tax effect on fair value revaluation of land and buildings (2,693) (5,362)
Other comprehensive
Other comprehensive income for
income for the
the year
year (net(net of tax)
of tax) 42,906 12,095
10,821 17,225
Total comprehensive income for the year (net of tax) 394,246 281,009
Total comprehensive income for the year (net of tax) 390,871 470,191
68comprehensive income attributable to:
Total
Total comprehensive income attributable to:
- Owners of the Parent 390,938 278,433
Owners of the parent
- Non-controlling interests 385,067 3,308 467,496 2,576
Non-controlling interests 5,804 2,695
390,871 394,246 470,191 281,009
The above Statement of Comprehensive Income should be read in conjunction with the accompanying notes.
The above Statement of Comprehensive Income should be read in conjunction with the accompanying notes.

* Note that available-for-sale investments relate to IAS 39. This would now be FVTOCI financial instruments under IFRS 9.

Statement of changes in equity

The statement of changes in equity presents a reconciliation between the carrying amount at the
beginning and end of the period for each component of equity. These components vary between
entities, but may include:
Equity account Some examples of movements to show in the statement

of changes in equity
Share capital Share issues, buybacks
Business combinations
Retained earnings or accumulated losses Profit or loss for period, dividends, transfers to/from reserves
Accumulated balances of OCI items/reserves
Foreign currency translation reserve +/– amounts on translation of a foreign subsidiary
Cash flow hedge reserve Effective portions of cash flow hedges
Reclassifications to profit and loss
FVOCI reserve +/– changes in fair value
+/– reclassifications to profit and loss
Revaluation surplus + revaluation increments
– Revaluation decrements for assets previously revalued
upwards
Share-based payments reserve Equity settled share-based payments (see the unit on
share‑based payments (Unit 14) for detailed discussion on
possible equity accounts)
The total amount of movement in equity is equal to the change in the entity’s net assets or
liabilities.
The statement of changes in equity separately discloses changes arising from (IAS 1 para. 106(d)):
(i) profit or loss
(ii) other comprehensive income
(iii) transactions with the owners.
Like equity on the balance sheet, the total comprehensive income must be split between owners
of the parent and the non-controlling interest (IAS 1 para. 106 (a)).
The components of equity and the movements that bring about changes to these movements are
illustrated in the following diagram:
Profit or loss IAS 1 para. 106d

Share capital
Components Other comprehensive income

OCI balances/reserves Movements IAS 1 para. 106a
of equity
for each
component
Retained earnings/ of equity Transactions with owners
accumulated losses (e.g. dividends) IAS 1 para. 106b
Retrospective adjustments on
changes in accounting policies
and material errors

Below is an example of the format for a statement of changes in equity for a group where all
subsidiaries are wholly owned. This is the format that should be used in FIN module exams.
(Extract from FIN216 main exam, examiner’s feedback.)
Epic Limited Group

Consolidated statement of changes in equity for the year ended 30 June 20X6
Attributable to owners of the parent
Issued Cash flow Foreign Revaluation Retained Total
capital hedge currency surplus earnings equity
reserve translation
reserve
$ $ $ $ $ $
Opening balance at 1 July 20X5 3,290,000 401,000 200,000 – 2,375,000 6,266,000
Total comprehensive income:

Profit for the year – – – – 3,700,000 3,700,000
Other comprehensive income
Revaluation of property, plant – – – 7,000,000 – 7,000,000
and equipment
Foreign currency translation – – (11,436) – – (11,436)
differences on foreign subsidiary
Effective portion of changes in – 849,632 – – – 849,632
fair value of cash flow hedge
Total OCI – 849,632 (11,436) 7,000,000 – 7,838,196
Total comprehensive income – 849,632 (11,436) 7,000,000 3,700,000 11,538,196
Transactions with owners recorded directly in equity

Contributions by and distributions to owners
Dividends – – – – (2,300,000) (2,300,000)
Total transactions with owners – – – – (2,300,000) (2,300,000)
Balance at 30 June 20X6 3,290,000 1,250,632 188,564 7,000,000 3,775,000 15,504,196
Below is an extract from the published financial statements of Harvey Norman, showing one
year’s statement of changes in equity. Comparatives were also presented on a separate page.

Statement of changes in equity for the year ended 30 June 2018
Owners v NCI split

Required by IAS 1
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 2018
para. 10a
Attributable to Equity Holders of the Parent
Contributed Retained Asset Foreign Available for Cash Flow Employee Acquisition Non- TOTAL
Equity Profits Revaluation Currency Sale Reserve Hedge Reserve Equity Reserve controlling EQUITY
Reserve Translation Benefits Interests
Reserve Reserve
$000 $000 $000 $000 $000 $000 $000 $000 $000 $000
At 1 July 2017 386,309 2,229,200 131,304 42,374 13,732 (20) 9,611 (22,051) 22,448 2,812,907
Other comprehensive income:

Revaluation of land and buildings - - 13,222 - - - - - (362) 12,860
Reverse expired or realised cash
flow hedge reserves - - - - - 20 - - - 20
Currency translation differences - - - (1,715) - - - - 1,494 (221)
Fair value of forward foreign exchange
contracts - - - - - (8) - - - (8)
Fair value of available for sale
financial assets - - - - (1,830)
Agrees
-
to- total - - (1,830)
Other comprehensive income - - 13,222 (1,715) (1,830) amounts -in SPLOCI-
12 1,132 10,821
Profit for the year - 375,378 - - - - - - 4,672 380,050
Total comprehensive income for the
year - 375,378 13,222 (1,715) (1,830) 12 - - 5,804 390,871
Cost of share based payments - - - - - - 745 - - 745

Shares issued 2,072 - - - - - - - - 2,072
Dividends paid - (267,337) - - - - - - (976) (268,313)
Distribution to members - - - - - - - - (350) (350)
At 30 June 2018 388,381 2,337,241 144,526 40,659 11,902 (8) 10,356 (22,051) 26,926 2,937,932
The above Statement of Changes in Equity should be read in conjunction with the accompanying notes.
Totals agree to line items in equity

section of the balance sheet
Statement of changes in equity for the year ended 30 June 2018 (cont.)
Under IFRS 9 this will be the

In the FIN module we use
FVTOCI reserve
the wording in the standard,
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR
Revaluation ENDED 30 JUNE 2018
surplus (CONTINUED
(Harvey )
Norman has not yet
adopted IFRS 9)
Attributable to Equity Holders of the Parent
Contributed Retained Asset

Asset Foreign Available
Availablefor Cash Flow Employee Acquisition Non-controlling TOTAL
Equity Profits Revaluation
Revaluation Currency Sale
forReserve
Sale Hedge Reserve Equity Benefits Reserve Interests EQUITY
Reserve
Reserve Translation Reserve Reserve
Reserve
$000 $000 $000 $000 $000 $000 $000 $000 $000 $000
At 1 July 2016 385,296 2,125,186 111,199 48,021 9,682 (32) 8,995 (22,051) 22,378 2,688,674
Other comprehensive income:

Revaluation of land and buildings - - 20,105 - - - - - - 20,105
Reverse expired or realised cash
flow hedge reserves - - - - - 32 - - - 32
Currency translation differences - - - (5,647) - - - - (1,295) (6,942)
Fair value of forward foreign exchange
contracts - - - - - (20) - - - (20)
Fair
Fairvalue
valueofofavailable
availablefor
forsale
sale
financial
financial assets
assets - - - - 4,050 - - - - 4,050
Other comprehensive income - - 20,105 (5,647) 4,050 12 - - (1,295) 17,225
Profit for the year - 448,976 - - - - - - 3,990 452,966
Total comprehensive income
for the year - 448,976 20,105 (5,647) 4,050 12 - - 2,695 470,191
Cost of share based payments - - - - - - 616 - - 616

Shares issued 1,013 - - - - - - - - 1,013
Dividends paid - (344,962) - - - - - - (645) (345,607)
Distribution to members - - - - - - - - (1,980) (1,980)
At 30 June 2017 386,309 2,229,200 131,304 42,374 13,732 (20) 9,611 (22,051) 22,448 2,812,907
Under IFRS 9
The above Statement of Changes in Equity should be read in conjunction with the accompanying notes. In the FIN module this section
this will be net should have a heading
movement “transactions with owners
in FVTOCI recorded directly in equity,
financial assets with a sub-total
The above Statement of changes in equity should be read in conjunction withHARVEY

the NORMAN
accompanying
HOLDINGS LIMITEDnotes.
| ANNUAL REPORT 2018 71

Statement of cash flows

The statement of cash flows provides information on how an entity generated and used cash
and cash equivalents during a financial period. This information assists users of financial
statements in understanding movements in net assets and changes in the entity’s financial
structure. It may also provide useful information in determining whether the entity can:
•• generate positive cash flows in the future
•• meet its financial commitments as and when they fall due
•• continue to provide goods and services in the future
•• obtain external finance where necessary.
The requirements relating to the presentation and disclosures included in the statement of cash
flows are contained in IAS 7. The statement of cash flows must disclose some specific categories
of cash flows, such as interest, dividends and income tax (IAS 7 paras 31 and 35). However,
most line items in the statement of cash flows are not prescribed.
Required reading
IAS 7.
Preparing the statement of cash flows and related disclosures

IAS 7 para. 6 defines cash flows as ‘inflows and outflows of cash and cash equivalents’. The key
issues to remember when preparing the statement of cash flows include:
•• Cash flows are classified into operating, investing and financing activities.
•• The cash balances of an entity, including movements between items of cash, is shown in a
separate part of the statement of cash flows.
•• Cash and cash equivalents are discussed in IAS 7 paras 6–9.
•• Operating cash flows can be presented via the direct or indirect method.
•• When the direct method is used, local reporting requirements in Australia and New Zealand
require entities to reconcile cash flow to operating profit.
•• Generally, gross inflows and outflows are shown separately under IAS 7 para. 21.
Paragraph 22 sets out when a net basis can be used.
In general, the preparation of a statement of cash flows follows the following steps:
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5

Define cash Classify the Determine the Prepare the Prepare
and cash cash flows. format of the statement of disclosures
equivalents. statement of cash flows. relating to
cash flows. the statement
of cash flows.
IAS 7 para. 10 requires an entity to present cash flows classified by operating, investing and
financing activities. Each classification is summarised in the diagram below. You should read
the required reading, IAS 7, for full details.

Summary of IAS 7 statement of cash flows
Cash and cash equivalents

defined in IAS 7 para. 6
• cash and cash equivalents
definition:
– readily convertible
– into known amounts of cash
– insignificant risk of changes
in value
e.g. deposit, < 3 months
maturity from acquisition date
• bank overdrafts repayable on
demand are part of cash
mangement (classed as cash)
• most borrowings are financing
activities
Operating Investing Financing

IAS 7 paras 6, 13–15 IAS 7 paras 6, 16 IAS 7 paras 6, 17
• payments to suppliers and • payments to acquire PPE • proceeds on share issue/other
employees • proceeds from sale of PPE equity instruments
• receipts from customers • payments to purchase • outlay for share buy-back
• receipts of other revenue investments • proceeds from short and long
• Income tax paid or refunded • proceeds from sale term borrowings
• Interest paid* (varies) investments • repayments of short and long
• cash loans and advances to term borrowings
• financial institutions: cash
advances and loans made other parties • dividends paid* (varies)
re principal revenue-producing • interest and dividends • cash payments by a lessee
activities received to reduce outstanding liability
on a lease
* The classification of interest paid and interest and dividends received may vary between enitities
The classification of cash flows, and ‘cash and cash equivalents’ often involves exercising
professional judgement. Classifications may differ between entities because of their differing
revenue-producing activities, but should be consistent from period to period.
Changing a cash flow classification would fall under a change of accounting policy in IAS 8.
This is discussed later in this unit.
Operating cash flows: methods and reconciliations

Operating cash flows are reported using either the direct method or the indirect method.
The standard encourages entities to use the direct method due to the additional information
provided.
When the direct method is used for operating cash flows, entities in Australia and New Zealand
entities need to prepare a note which reconciles the operating cash flow to their profit or loss.
These additional requirements are set out in AASB 1054 in Australia and FRS-44 New Zealand
Additional Disclosures (FRS-44) in New Zealand.
Disclosures
The disclosure requirements of IAS 1 are spread throughout the Standard. There are disclosure
requirements under the IAS 1 heading for each financial statement. It is important to read IAS 1,
to understand the disclosures required for each financial statement in turn, and remember that
other accounting standards will add further disclosure requirements which are often more
extensive. Some disclosures must be on the face of the financial statement, however most can be
shown within the notes.

Australia-specific disclosures
Many AASB Standards include Australia-specific requirements. Note particularly AASB 101
Presentation of Financial Statements para. Aus19.1, which precludes a departure from AASB
Standards by entities that report under Part 2M.3 of the Corporations Act, public and private
sector not-for-profit entities, and entities that report under reduced disclosure requirements.
AASB 1054 Australian Additional Disclosures contains additional disclosure requirements that
relate to financial statements that are prepared in accordance with Australian Accounting
Standards (e.g. a breakdown of audit fees required by paras 10 and 11; imputation credits
available for use in future reporting periods to frank dividends per para. 13).
The reduced disclosure requirements, described in Unit 1, affect the application of the AASB
equivalents of IAS 1, IAS 7 Statement of Cash Flow, IAS 8, IAS 10, IAS 24, IFRS 5 and IFRS 8.
Required reading
AASB 1054 paras 10–16.
Further reading
Refer to a set of model general purpose financial statements and review each of the financial
statements. These can be found on the websites of many of the large accounting firms.
An example is given below:
KPMG 2016, KPMG Example Public Company Limited: Guide to annual reports – Illustrative
disclosures 2016–17.
Additional disclosures required under AASB 1054
In addition to the IAS 7 disclosure requirements, additional consideration that is relevant to
Australian entities is contained in AASB 1054.
AASB 1054 para. 16 requires Australian entities that use the direct method to present its
statement of cash flows (see Step 3 above) in accordance with IAS 7 para. 18(a) to provide a
reconciliation of the net cash flow from operating activities to profit/(loss) in the notes to the
Required reading
AASB 1054 para. 16.
Additional disclosures required under FRS-44
FRS-44 para. 10 requires New Zealand entities that use the direct method to present their
statement of cash flows in accordance with IAS 7 para. 18(a), to provide a reconciliation of the net
cash flow from operating activities to profit/(loss) in the notes to the financial statements.
Required reading
FRS-44 para. 10.
Australia also has additional requirements related to the impact of the goods and services tax
(GST).

Impact of GST on the statement of cash flows
A further exception to the presentation of gross cash flows in Australia applies to the GST that is
payable or recoverable by an entity.
In accordance with para. 10 of Australia-specific Interpretation 1031 ‘Accounting for the Goods
and Services Tax (GST)’, cash flows are to be included in the statement of cash flows ‘on a gross
basis’. This is subject to para. 11, which requires that the ‘GST component of cash flows arising
from investing and financing activities which is recoverable from, or payable to, the taxation
authority to be classified as operating cash flows’.
Required reading
Interpretation 1031 paras 6–18.
The illustrative examples attached to the standard set out cash flow structures that are easy to
follow. In its 2016 financial statements (below), Harvey Norman prepared its operating cash
flows using the direct method, as encouraged by IAS 7 para. 19.

Chartered Accountants
STATEMENT OF CASHProgram
FLOWS FOR THE YEAR ENDED 30 JUNE 2018 Financial Accounting & Reporting
Statement of changes cash flows for the year ended 30 June 2018
CONSOLIDATED
June June
2018 2017
Note $000 $000
Cash Flows from Operating Activities

Net receipts from franchisees 947,058 882,476
Receipts from customers 2,134,595 1,992,891
Payments to suppliers and employees (2,388,310) (2,252,918)
Distributions received from joint ventures 10,125 11,546
GST paid (66,102) (44,621)
Interest received 5,871 4,971
Interest and other costs of finance paid (25,619) (19,420)
Income taxes paid (166,161) (152,454)
Dividends received 2,713 2,669
Net Cash Flows From Operating Activities 28(b) 454,170 425,140
Cash Flows from Investing Activities

Payments for purchases of property, plant and
equipment and intangible assets (93,895) (89,366)
Payments for purchase of investment properties (125,661) (114,752)
Proceeds from sale of property, plant and equipment
and properties held for resale 2,422 28,592
Payments for purchase of units in unit trusts and other
investments (107) (161)
Payments for purchase of equity accounted
investments (4,256) (8,947)
Proceeds from sale of /(payments for purchase of)
listed securities 10,436 (6,537)
Proceeds from insurance claims 2,458 -
Loans granted to joint venture entities, joint venture
partners and unrelated entities (94,882) (7,594)
Net Cash Flows Used In Investing Activities (303,485) (198,765)
Cash Flows from Financing Activities

Proceeds from shares issued 2,072 1,013
Proceeds from Syndicated Facility 210,000 70,000
Dividends paid (267,337) (344,962)
Loans (repaid to) / received from related parties (6,573) 2,075
Repayment of other borrowings (6,266) (15,250)
Net Cash Flows Used In Financing Activities (68,104) (287,124)
Net Increase / (Decrease) in Cash and Cash Equivalents 82,581 (60,749)

Cash and Cash Equivalents at Beginning of the Year 42,882 103,631
Cash and Cash Equivalents at End of the Year 28(a) 125,463 42,882
Theabove
The aboveStatement
Statement of cash
of Cash flows
Flows should
should beinread
be read in conjunction
conjunction with the accompanying
with the accompanying notes. notes.
In the example below,

•• the cash and cash equivalents note (note 28) reconciles the end result of the statement of
cash flows to the amounts on the balance sheet, as required by IAS 7 para. 45
••
72 the reconciliation of net cash flow from operating activities to the net profit is also shown
(which is prepared to meet local financial reporting requirements when the direct method
is used).

NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)

Notes to the financial statements (continued)
CONSOLIDATED
June June
2018 2017
$000 $000
28. CASH AND CASH EQUIVALENTS
(a) Reconciliation to Cash Flow Statement

Cash and cash equivalents comprise the following at end of the year:
Cash at bank and on hand 124,458 65,969
Short term money market deposits 46,086 14,255
170,544 80,224
Bank overdraft (Note 18) (45,081) (37,342)
Cash and cash equivalents at end of the year 125,463 42,882
(b) Reconciliation of Profit After Income Tax to Net Operating Cash Flows
Profit after tax 380,050 452,966
Adjustments for:
Net foreign exchange gains (496) (771)
Bad and doubtful debts 46,064 21,864
Share of net profit from joint venture entities (5,792) (5,200)
Depreciation of property, plant and equipment 65,359 60,710
Amortisation 19,432 17,159
Impairment of equity-accounted investments 20,665 1,148
Impairment loss on repayment of external finance facility - 5,022
Revaluation of investment properties (51,646) (107,382)
Property revaluation increment for overseas controlled entity - (669)
Deferred lease expenses (663) (962)
Provision for onerous leases - 643
Executive remuneration expenses 4,173 4,992
Profit on disposal and sale of property, plant and equipment,
and the revaluation of listed securities (2,329) (6,849)
Movements in provisions (766) 2,229
Changes in assets and liabilities:

(Increase)/decrease in assets:
Receivables (29,595) (72,818)
Inventory (29,738) 165
Other current assets 10,303 (19,175)
Increase/(decrease) in liabilities:
Payables and other current liabilities 56,082 72,238
Income tax payable (26,933) (170)
Net cash flows from operating activities 454,170 425,140
Methods of preparing the statement of cash flows

There are different methods of preparing a statement of cash flows, the most common of which
are the spreadsheet method and the reconstruction method.
Spreadsheet method
The spreadsheet method is an efficient way of preparing a statement of cash flows from the
entity’s trial balance for both the current year and prior year. Once this statement of cash flows’
spreadsheet has been created, using formulas extensively within it will enable an entity to
roll the spreadsheet over from one period to the next. Minimal work will then be required to
update the information and produce the next statement of cash flows. Further, the spreadsheet
formulas can also incorporate built-in checks to ensure that the information is accurate.
Accordingly, the spreadsheet method is generally used by practitioners.
Reconstruction method
Many candidates are likely to be familiar with the use of the reconstruction method for the
preparation of a statement of cash flows from their tertiary studies. This method involves
reconstructing T-accounts or ledger accounts to identify and analyse events and transactions
that involved operating, investing and financing activities during the period.

Further details regarding statement of cash flows can be found in accounting textbooks.
Further reading
•• Deegan, C 2012, Australian financial accounting, Ch. 19.
•• Deegan, C and Samkin, G 2012, New Zealand financial accounting, Ch. 19.
•• Picker, R et al. 2013, Applying International Financial Reporting Standards, Ch. 19.
Unit 2 Introduction to preparing a Statement of Cash Flows

There is a video in myLearning designed to refresh your basic understanding on how to prepare a
statement of cash flows using the:
•• reconstruction (T-accounts) method
•• addition (formula) method
•• spreadsheet method.
It is recommended you watch the video prior to attempting Activity 2.1.
Activity 2.1: Preparing a statement of cash flows

Statement of cash flows: Disclosure

As already covered, certain items must be disclosed within the statement of cash flows
(e.g. disclosure of income tax paid). In addition to the statement of cash flows itself, there are
additional disclosure requirements, including disclosures relating to non-cash transactions,
components of cash and cash equivalents (IAS 7 paras 43–52).
Steps in preparing financial statements under

International Accounting Standards
Learning outcome
There are a number of steps involved in the preparation of a set of financial statements and the
starting point is with an unadjusted trial balance.
Starting with this unadjusted trial balance, the steps to preparing a set of financial statements are:
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6

Prepare the Prepare the Prepare the Prepare the statement Prepare the Prepare the
year-end year-end tax final trial of financial position, statement of notes to the
adjusting entries balance statement of profit or cash flows financial
entries loss and other statements
comprehensive
income and statement

Step 1 – Prepare the year-end adjusting entries

Adjustments to the unadjusted trial balance are commonly required in order to obtain a
final trial balance that complies with International Financial Reporting Standards (IFRS).
Adjustments may include:
•• prepayments or accruals
•• recognition of adjusting events after the reporting period (Unit 2)
•• accounting policies, changes in estimates and errors (Unit 2)
•• tax effect accounting (Unit 4)
•• impairment write downs on assets (unit 10).
Some of these adjustments, such as prepayments and accruals, were covered in your
undergraduate studies. Sources of other adjustments will be discussed in later units as we
progress through the module.
In this unit, we will discuss two areas that may result in adjustments:
•• accounting policies, changes in estimates and errors
•• events after the reporting period.
Step 2 – Prepare the year-end tax entries

The year-end tax entries should always be the final journal entries prepared, as all other entries
may potentially affect the tax calculations. The section on income taxes in Unit 4 will explain the
preparation of these entries and how they affect the financial statements.
Step 3 – Prepare the final trial balance

Once the initial trial balance has been completed, journal entries are prepared for any items that
require adjustment to comply with Accounting Standards. The journal entries are then posted
to the relevant accounts to obtain the final trial balance. The final trial balance is then used
as a basis for preparing the financial statements.
You should note that some year-end entries, such as consolidation journals, are not posted to the
trial balance. This is discussed in the units on business combinations (Unit 15) and accounting
for subsidiaries (Unit 16).
Step 4 – Prepare the statement of financial position, statement

of profit or loss and other comprehensive income, and statement
This unit has discussed the detailed requirements of IAS 1 in relation to the preparation of the
statement of financial position, the statement of profit or loss and other comprehensive income,
and the statement of changes in equity.
We will revisit these requirements at several points throughout the module to expand your
knowledge on how each topic area affects the appearance of the financial statements.
Step 5 – Prepare the statement of cash flows

The statement of cash flows is normally prepared after the three other main statements have
been prepared. This unit has discussed some of the detailed requirements of IAS 7 and this
content is extended further in Activity 2.1 (available on myLearning).

Step 6 – Prepare the notes to the financial statements

The final step in preparing the financial statements is to prepare the necessary notes to the
financial statements. Below is a useful approach in completing this final step:
•• Go to the relevant standard.
•• Find the sections headed ’Disclosures’, focusing on the bold paragraphs.
•• Review the specific disclosure paragraphs.
•• Refer to a set of model financial statements for a suggested layout.
This unit discusses the general IAS 1 requirements related to the notes to the financial
statements, and looks at the knowledge needed to prepare the following notes:
•• Related parties.
•• Events after the reporting period.
•• Accounting policies, changes in estimates and errors.
•• Discontinued operations.
Model financial statements can be found on the websites of many of the large accounting firms.
Note: Only selected notes are prepared in this unit. Other units in this module also cover the
relevant standards’ specific requirements for disclosures of balances, transactions and events
in the notes to the financial statements.
Most of the detailed disclosure and presentation rules for preparing financial statements are
contained in individual standards that prescribe the accounting requirements for different
transactions. For instance, IFRS 16 Leases contains the disclosure requirements for leases.
However, the basic structure of the financial statements is set out in IAS 1.
Activity 2.2: Preparing key financial statements (SPLOCI and SOCE)


Standards that impact disclosures and

adjustments
In this section, we will cover a few of the Accounting Standards and accounting issues that may
result in adjustments to the draft trial balance or in additional financial statement disclosures,
either on the face of or in the notes to the financial statements.
This section does not intend to cover all of the relevant standards – just a few of the important ones.
Accounting policies, changes in accounting estimates

and errors (IAS 8)
Learning outcome
3. Explain and account for changes in accounting policies, revisions of accounting estimates and
errors.
IAS 8 covers the following issues affecting financial reports:

•• Criteria for selecting and changing accounting policies.
•• Accounting and disclosure requirements for:
–– changes in accounting policies
–– changes in accounting estimates
–– corrections of errors.
Selecting accounting policies

IAS 8 para. 5 defines accounting policies as:
the specific principles, bases, conventions, rules and practices applied by an entity in preparing and
presenting financial statements.
Selecting an accounting policy for a class of transactions depends on whether an appropriate

accounting standard exists. IAS 8 para. 7 states:
When an IFRS specifically applies to a transaction, other event or condition, the accounting policy or
policies applied to that item shall be determined by applying the IFRS.
If there is no such standard, IAS 8 requires management to use its judgement in developing an
accounting policy that produces information that is ‘relevant’ and ‘reliable’.
Required reading
The following flow chart demonstrates the selection and application of accounting policies.

Apply the relevant IFRS Must be:

• Relevant to users
• Reliable:
YES – Faithful representation
– Reflect economic substance
over legal form
Is there an IFRS that – Neutral
specifically applies – Prudent
to the transaction, – Complete
event or condition?
(IAS 8 para. 10)
NO
Refer to:
• IFRS dealing with similar/related
Use judgement to issues
develop and apply a policy • The Conceptual Framework
(IAS 8 para. 11)
Consider:
• Recent pronouncements in other
jurisdictions
• Accounting literature
• Accepted industry practices
(Cannot conflict with IAS para. 11
sources)
(IAS 8 para. 12)
Importance of accounting policies

Traditionally, the financial statements contains a summary of significant accounting policies in
note 1. This note assists the user in understanding the bases on which amounts in the financial
statements are determined, by describing (per IAS 1 para. 117):
•• The measurement basis (or bases) used to prepare the financial statements.
•• Other accounting policies used that are relevant to understanding the financial statements.
Accounting standards may allow choices of accounting methods. The application of the
Standards often involves professional judgement, taking into consideration the entity’s specific
circumstances and the accepted practices within their industry. Describing how this judgement
has been exercised provides important information to the user, especially when some users may
not be fully conversant with accounting standards.
With the increase in the number of entities streamlining or decluttering their financial statements
in line with the IASB Disclosure project, accounting policy notes are now often re-ordered, so
that all of the relevant information for a particular account is grouped together. For example, for
property, plant and equipment, the significant accounting policies may be summarised within
the property, plant and equipment note in a set of streamlined financial reports.

Further details on the significant judgements considered by management relating to impairment of financial assets are disclosed in Note 7.
The impairment loss is disclosed in Notes 4 and 7.
(e) Impairment of equity-accounted investments

The Chartered
consolidated entity determines whether there is objective evidence that the investment in the associate Accountants
or joint venture is impaired. If Program
there is such evidence, the consolidated entity calculates the amount of impairment as the difference between the recoverable amount of
the associate or joint venture and its carrying value.
(f) Share-based payment transactions
The consolidated entity measures the cost of equity-settled transactions with employees by reference to the fair value of the equity
instruments at the date at which they are granted.
Example(g)–Make
Accounting
good provisions
policy
This example illustrates
Provisions are recognised the
for theselection and
anticipated costs application
of future of an
restoration of leased accounting
premises. policy:
The provision includes future cost estimates
associated with dismantling and removing the assets and restoring the leased premises according to contractual arrangements. These
future cost estimates are discounted to their present value. The related carrying amounts are disclosed in Note 20.
NOTES TO THE FINANCIAL STATEMENTS
(h) Onerous lease provisions
1. STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES
The provision for onerous lease costs represents the present value of the future lease payments that the consolidated entity is presently
obligated to make in respect of onerous lease contracts under non-cancellable operating lease agreements. This obligation may be reduced
(a) the Corporate
by Information
revenue expected to be earned on the lease including estimated future sub-lease revenue, where applicable. The estimate may vary
… as a result of changes in the utilisation of the leased premises and sub-lease arrangements where applicable. The related carrying amounts
are disclosed in Note 20. Limited (the “Company”) is a for profit company limited by shares incorporated in Australia and operating in
Harvey Norman Holdings
Australia, New Zealand, Ireland, Northern Ireland, Singapore, Malaysia, Slovenia and Croatia whose shares are publicly traded on the
Australian
(iii) Securities
Investment Exchangeand
in associates (“ASX”)
jointtrading under the ASX code HVN.
ventures
(b) associate
An Basis of
is Preparation
an entity over which the consolidated entity has significant influence. Significant influence is the power to participate in the
financial and operating policy decisions of the investee, but does not control or have joint control over those policies.
The financial report has been prepared on a historical cost basis, except for investment properties, land and buildings, derivative financial
instruments,
A listed
joint venture shares
is a type of held
joint for trading andwhereby
arrangement available-for-sale
the partiesinvestments,
that have joint which have
control of been measured athave
the arrangement fair value. Thethe
rights to carrying values
net assets of
of recognised
the assets
joint venture. andcontrol
Joint liabilities that
is the are designated
contractually as hedged
agreed sharingitems in fairofvalue
of control hedges that which
an arrangement, would exists
otherwise
onlybe carried
when at amortised
decisions about the
cost are adjusted to record changes in the fair values attributable
relevant activities require unanimous consent of the parties sharing control.to the risks that are being hedged in effective hedge relationships.
The considerations
The financial report made
is presented in Australian
in determining dollarsinfluence
significant and all values are
or joint rounded
control areto the nearest
similar thousand
to those dollars
necessary ($000) unless
to determine otherwise
control over
stated under the option available to the Company under Australian Securities and Investments Commission Corporations (Rounding in
subsidiaries.
Financial/Directors’ Reports) Instrument 2016/191. The Company is an entity to which this legislative instrument applies.
The consolidated entity’s investments in its associate and joint venture are accounted for using the equity method.
The consolidated financial statements of the Company and its subsidiaries (the “consolidated entity”) for the year ended 30 June 2018 was
authorised
Under for issue
the equity in accordance
method, with a resolution
the investment of theordirectors
in an associate on 28isSeptember
joint venture 2018. at cost. The carrying amount of the
initially recognised
investment is adjusted to recognise changes in the consolidated entity’s share of net assets of the associate or joint venture since the
(c) Statement
acquisition date. of Compliance
The financial
After report
application is a equity
of the general-purpose
method, the financial report,entity
consolidated whichdetermines
has been prepared
whether in accordance
it is necessary with the requirements
to recognise of the Corporations
any impairment loss with
Act 2001,
respect toAustralian Accounting
the consolidated Standards
entity’s and Interpretations,
net investment and complies
in the associates and jointwith other requirements
ventures. of the
At each reporting law.the
date, The financial report
consolidated entity
complies with
determines Australian
whether thereAccounting
is objectiveStandards, as issued
evidence that by the Australian
the investment Accounting
in the associate Standards
or joint venture Board, and International
is impaired. Financial
If there is such evidence,
Reporting
the Standards
consolidated (IFRS),
entity as issued
calculates the by the International
amount of impairmentAccounting Standards
as the difference Board. the recoverable amount of the associate or joint
between
venture and its carrying value.
Australian Accounting Standards and Interpretations that have recently been issued or amended but are not yet effective have not been
adopted by the consolidated entity for the annual reporting period HARVEY
ended NORMAN
30 June HOLDINGS
2018. ForLIMITED | ANNUAL
details on REPORT
the impact 2018accounting 75
of future
standards, refer to page 84.
(d) Basis of consolidation
The consolidated financial statements comprise the financial statements of Harvey Norman Holdings Limited and its controlled entities.
Control is achieved when the consolidated entity is exposed, or has rights, to variable returns from its involvement with the investee and has
Changes in accounting policies

the ability to affect those returns through its power over the investee. Specifically, the consolidated entity controls an investee if and only if
the consolidated entity has all of the following:
 Power over the investee (i.e. existing rights that give it the current ability to direct the relevant activities of the investee)
An entity should select and apply its accounting policies consistently for each accounting period


Exposure, or rights, to variable returns from its involvement with the investee, and
The ability to use its power over the investee to affect its returns
for similarWhen
transactions, other events and conditions.
the consolidated entity has less than a majority of the voting or similar rights of an investee, the consolidated entity considers all
relevant facts and circumstances in assessing whether it has power over an investee, including:
There may beTheinstances wherewith
contractual arrangement it isthenecessary
other vote holdersto change
of the investee an accounting policy. Under IAS 8
 Rights arising from other contractual arrangements
para. 14, an entity can only change its accounting policies if the change:
 The consolidated entity’s voting rights and potential voting rights
The consolidated entity re-assesses whether or not it controls an investee if facts and circumstances indicate that there are changes to one
(a) is required bythree
or more of the anelements
IFRS; oforcontrol. Consolidation of a subsidiary begins when the consolidated entity obtains control over the
subsidiary and ceases when the consolidated entity loses control of the subsidiary.
(b) results in the financial

All intercompany balances and statements providing
transactions, including reliable
unrealised andfrom
profits arising more relevant
intra-group information
transactions, about the
have been eliminated in full.
Unrealised losses are eliminated unless costs cannot be recovered. Financial statements of foreign controlled entities presented in
effects of transactions, other events or conditions on the entity’s financial position, financial
accordance with overseas accounting principles are, for consolidation purposes, adjusted to comply with the consolidated entity’s policy and
performance or cash
generally accepted flows.
accounting principles in Australia.
Non-controlling interests are allocated their share of net profit after tax in the income statement and are presented within equity in the
Accountingconsolidated
for a change infinancial
statement of accounting policy
position, separately depends
from the equity of theon the
owners reason
of the for the
Parent. Losses change.
are attributed to theFor
non- example:
controlling interest even if that results in a deficit balance.
•• A change in inan
A change the accounting
ownership interest ofpolicy resulting
a subsidiary from
(without a change theis initial
in control) application
to be accounted for as an equityof an IFRS must be
transaction.
accounted
(e)
for in accordance with
Summary of Significant Accounting Policies
the specific transitional provisions in that IFRS (IAS 8
para. 19(a)). Usually, the transitional provisions require
(i) Changes in accounting policy, disclosures, standards and interpretations
any change in accounting policy to
be adjusted through retained earnings.
The accounting policies adopted are consistent with those of the previous financial year except as discussed below. The consolidated entity
•• If an IFRS does not include
pronouncements specific
do not have a material transitional
impact on the annualprovisions that
consolidated financial apply
statements toconsolidated
of the that changeentity. Theor the
applied for the first time certain standards and amendments, which are effective for annual periods beginning on or after 1 January 2017.
These new
changeconsolidated
in an accounting policy is voluntary, then the change is applied retrospectively
entity has not early adopted any other standard, interpretation or amendment that has been issued but is not yet effective.
(i.e. calculated as if the new accounting policy had always been applied (IAS 8 para. 19(b)).
Retrospective application requires an entity to adjust the opening balance of each affected
component of equity for the earliest comparative period
HARVEY presented
NORMAN HOLDINGS LIMITED |and other
ANNUAL REPORTcomparative
2018 73
amounts disclosed. This results in the current and comparative financial years being presented
as if the new accounting policy had always been applied (IAS 8 para. 22).
When it is impracticable to determine the retrospective effects of the changes in accounting
policy, the new accounting policy must be applied from the earliest date practicable (IAS 8
paras 23–25).

It can sometimes be difficult to decide whether something constitutes a change in accounting

policy. IAS 8 para. 16 states that the following are not changes in accounting policies:
(a) the application of an accounting policy for transactions, other events or conditions that differ in
substance from those previously occurring; and
(b) the application of a new accounting policy for transactions, other events or conditions that did not
occur previously or were immaterial.
Paragraph 17 goes on to explain that the first time an entity chooses to:
•• revalue property, plant and equipment under IAS 16, or
•• revalue an intangible asset under IAS 38 Intangible Assets,
the revaluation is dealt with as a change in policy under IAS 16 or 38, not under IAS 8.
It is also worth noting the paragraph 30 requirements, that is, where an accounting standard
has been issued but is not yet effective, an entity must state this and assess the potential impact.
This should be disclosed by way of note to the accounts. At present, this would mean entities
would need to consider and disclose the potential impacts of IFRS 9 Financial Instruments,
IFRS 15 Revenue from Contracts with Customers, and IFRS 16 Leases to name a few (which we will
be considering in this module).
Accounting policies versus accounting estimates

Being able to distinguish between accounting policies and accounting estimates is important
as they are disclosed and treated differently under IAS 8.
Accounting policies are the principles by which amounts are recognised and measured. Even
using accounting policies, some amounts in the financial statements are not able to be measured
precisely. This is where estimates come in.
Accounting estimates are the judgements an entity makes in applying an accounting policy.
For example, accounting estimates are often required in the following instances:
•• Estimating future cash flows in determining the fair value of financial assets and liabilities.
•• Estimating the recoverability of trade receivable balances in determining an allowance for
impairment loss – trade receivables.
Accounting estimates
IAS 8 para. 5 defines a change in accounting estimate as:
... 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.
A change in accounting estimate results from new information or developments. This means
that the original estimates were correct at the time they were made (in contrast with ‘errors’,
which are discussed in the next section).
This reflects the fact that, by their nature, estimates cannot be measured with precision.
As listed in IAS 8 para. 32, the following examples may require accounting estimates:
•• Bad debts.
•• Inventory obsolescence.
•• Fair value of financial assets or financial liabilities.
•• Useful lives of depreciable assets.
•• Warranty obligations.

Example – Change in accounting estimates

Note 02
Significant accounting estimates and judgements
…
(vii) Provisions – Long service leave
The Group’s net obligation in respect of long term employee benefits is the amount of future
benefit that employees have earned in return for their service in the current and prior periods.
For long service leave the future benefit is altered to take into account the probability of
reaching entitlement and inflationary increases. These benefits are discounted to determine its
present value. The discount for long service leave is the yield proximate to the reporting date on
the Australian Corporate Bond market. See note 1(v)(ii) & 6(f ).
The emergence of a deep high quality corporate bond market as reported by the Milliman
report commissioned by the G100 group of companies has required ARTC to move from using
the Australian Government Bond rate to the new Australian Corporate Bond rate in line with
the relevant accounting standard (AASB 119). As a result of the change in accounting estimate
from Australian Government Bond rate to the Australian Corporate Bond rate the balance of the
provision was decreased by $0.181m.
Source: Australian Railtrack Corporation 2015, 2015 Annual Report, www.artc.com.au → About ARTC →
Company Reports → Annual Report 2014 / 2015, p. 65, accessed 16 April 2018.
Applying a change in an accounting estimate

Because estimates are correct when they are made, changes in accounting estimates are applied
prospectively.
A change in accounting estimate is applied prospectively in the:
•• Statement of profit or loss and other comprehensive income – in the period of the change,
if it only affects the current period, or in the current and future periods, if the change
affects both.
•• Statement of financial position – by changing the carrying amounts in the period of change.
Example – Accounting for a change in accounting estimate

This example illustrates how to account for a change in accounting estimate.
XYZ Limited (XYZ) has an accounting policy that requires property, plant and equipment be
depreciated over the estimated useful life of the assets. On 1 July 20X1, XYZ acquired a new
machine and estimated its useful life to be 10 years. The asset has been depreciated on this basis.
It is 30 June 20X4 and due to advances in technology, XYZ has estimated that the remaining
useful life of the machine is only a further three years; that is, a revised useful life of six years in
total for the machine instead of its original useful life of 10 years. XYZ will adjust the depreciation
expense recorded over the next three years so that the asset is written down to its residual value
by 30 June 20X7. It would not adjust the depreciation recorded in 20X4 as the reassessment
did not occur until year end. The change in depreciation expense has an impact prospectively
(i.e. in future periods) and not on expenses already recorded.

Prior period errors

In contrast to changes in accounting estimates, prior period errors relate to information that was
available at the time that financial statements were prepared in previous accounting periods.
As defined by IAS 8 para. 5:
Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or
more prior periods arising from a failure to use, or misuse of, reliable information that:
(a) was available when financial statements for those periods were authorised for issue; and
(b) could reasonably be expected to have been obtained and taken into account in the preparation and
presentation of those financial statements.
Errors versus estimates

Care should be taken to distinguish between:
•• errors – which are mistakes that were made by using estimates or judgements in the
preparation of financial statements that were not appropriate at that time, and
•• changes in accounting estimates – which are corrections that are required due to new
information that was not available at the time the financial statements were prepared.
Example – Estimates and errors

This example illustrates the circumstances that would result in a change in an accounting
estimate and a prior period error, and the accounting treatment that should be applied to each.
Background
XYZ Limited (XYZ) calculates its warranty provision based on the number and value of warranty
claims that the entity has dealt with in the past five financial years as a proportion of revenue
earned over that period.
Scenario 1 – change in accounting estimate
In the current financial year, XYZ experiences a higher than expected number of warranty claims
and determines that the warranty provision should be increased as a proportion of revenue.
This is a change in accounting estimate which results from new information or developments
arising from changed circumstances.
It should be accounted for prospectively from the current financial year to reflect the new
circumstances.
Scenario 2 – prior period error
In the current financial year, XYZ identifies that the calculation of the warranty provision at the
end of the prior period was materially incorrect due to an error in the spreadsheet.
This is a prior period error because there was a failure to use, or misuse of, reliable information
that was available in the prior period.
It should be accounted for retrospectively to correct the prior year comparative figures affected
by this calculation error.

Accounting for prior period errors

Prior period errors are adjusted retrospectively in the first set of financial statements issued
after they are identified. In the comparatives, if this is when the error occurred or if the errors
relate to periods before the earliest comparatives were made, the opening balances for the
earliest year of comparison are adjusted.
Retrospective adjustments for errors are accounted for in the same way as changes in
accounting policies. Where a retrospective adjustment is made, an additional comparative
statement of financial position is required (IAS 1 para. 40A).
If retrospective application is ‘impracticable’, the entity shall restate the opening balances for
the earliest period that retrospective restatement is practicable; however, if this is not practical,
restating the comparative information prospectively is permitted (IAS 8 paras 44 and 45).
Disclosures
The disclosure requirements of IAS 8 are detailed in paras 28–30, 39–40 and 49. Generally they
include the nature of the change, impact on line items for each period, and adjustments at the
beginning of the earliest period presented.
Below is a brief summary of basic IAS 8 requirements:
Issue Detail Basic rule under IAS 8
Accounting policy First time application of standard Follow transition requirements.

If not specified, retrospective
Voluntary change Retrospective
Error Material Retrospective, note
Immaterial Prospective
Change in accounting estimate Prospective
Note that all retrospective accounting is required unless impracticable.

Summary – changes
Summary −in accounting
changes policies,
in accounting changes
policies, changes in accounting
in accounting estimates and prior period errors
estimates and prior period errors
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (IAS 8)
Accounting policy – Prior period errors – Accounting estimate –

principles, bases, omissions from or judgements in
misstatements in financial
conventions, rules and applying accounting
statements that arise from
practices applied a failure to use, or misuse policies
of reliable information that
was available or could have
been obtained and taken
into account
Change in accounting Material Change in an

policy errors accounting estimate
Required by IFRS Voluntary change Adjust current Disclose in notes

IAS 8 para. 14(a) provided it results and/or future IAS 8 paras 39
in reliable and periods(s) and 40
more relevant (prospective)
information IAS 8 para. 36
IAS 8 para. 14(b)
Follow specific Retrospective application to Adjust prior Disclose in notes

transitional adjust prior period(s) (if no period(s) IAS 8 para. 49
provisions, where specific transitional provisions (retrospective)
initial application that apply to the change or the IAS 8 para. 42
IAS 8 para. 19(a) change is voluntary)
IAS 8 para. 19(b)
Disclose in notes Disclose in notes Additional statement of financial position

IAS 8 para. 28 IAS 8 para. 29 presented as at the beginning of the
earliest comparative period
IAS1 Presentation of Financial Statements para. 40A

Future developments
In September 2017, the IASB issued exposure draft ED/2017/5 Accounting Policies and
Accounting Estimates which proposes amendments to IAS 8. The objective of the amendments
is to better distinguish accounting policies from accounting estimates.
The distinction is important given changes in accounting policies are generally applied
retrospectively whereas changes in accounting estimates are applied prospectively.
Accounting policies Accounting estimates
Current definition Current definition

The specific principles, bases, Accounting estimates are currently not defined, however a ‘change
conventions, rules and practices applied in accounting estimate’ is defined as:
by an entity in preparing and presenting An adjustment of the carrying amount of an asset or a liability,
financial statements 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
Proposed definition Proposed definition

Accounting policies are the specific Accounting estimates are judgements or assumptions used in
principles, measurement bases, and applying an accounting policy when, because of estimation
practices applied in preparing and uncertainty, an item in financial statements cannot be measured
presenting financial statements with precision
Justification for change: Justification for change:

•• Conventions and rules are vague terms •• Not defining accounting estimate but having a definition for
not used elsewhere in IFRS a change in an accounting estimate obscures the distinction
•• ‘Measurement bases’ rather than ‘bases’ between accounting policies and accounting estimates
aligns with IAS 8 para 35 which states •• Accounting estimates are used in applying accounting policies
that a change in the measurement and the proposed definition confirms this
basis applied is a change in an •• Clarifies that selecting an estimation technique, or valuation
accounting policy technique, used when an item in the financial statements
cannot be measured with precision, constitutes making an
accounting estimate
Activity 2.3: Accounting for changes in accounting policies and estimates


Related party disclosures
Learning outcome
Related party disclosures enable users of financial statements to fully understand the impact
that certain related party relationships and transactions may have on the profit or loss and
financial position of an entity. Therefore, identifying related parties and any related party
transactions is important to ensure that disclosures are made in accordance with IAS 24.
IAS 24 para. 2 states that this Standard is applied in:
(a) identifying related party relationships and transactions;
(b) identifying outstanding balances, including commitments, between an entity and its related parties;
(c) identifying the circumstances in which disclosure of the items in (a) and (b) is required; and
(d) determining the disclosures to be made about those items.
IAS 24 applies to consolidated and separate financial statements, as well as individual financial
statements (IAS 24 para. 3).
Related party relationships

The definition of a ‘related party’ is provided in IAS 24 para. 9. While this definition is factual,
it is important to note that it is the substance of the relationship between parties that determines
whether they are related, and not merely the legal form (IAS 24 para. 10). A party that is related
to an entity can be an individual or another entity.
The following diagram provides examples of where related party relationships do and do not
exist:
• A person (or close family member) who has control of the reporting entity
• A person (or close family member) who has joint control of the reporting entity
• A person (or close family member) who has significant influence over the reporting entity
• Key managers of the reporting entity
• Key managers of the parent entity
DO EXIST
• Parent entities
• Subsidiaries
• Fellow subsidiaries
• Associates or joint ventures of a parent or subsidiary
• A management entity that provides key management personnel services to the
reporting entity
• Two entities simply because they have a common director/key manager

• Two joint venturers simply because they share joint control of a joint venture
• Providers of finance
• Trade unions
• Public utilities
• Customers
DO NOT • Suppliers
EXIST • Franchisors
• Distributors

Example – Related party relationships

This example illustrates the identification of related parties.
Entity A is 100% owned by Mr B who also owns 100% of Entity C. Entity A’s directors are Ms D and
Mr E. Ms D is also a director of Entity F. Entity A and Entity H each own and control 50% of a joint
venture (Entity G).
ENTITY F
Mr B
DIRECTOR 100% 100%

Ms D ENTITY C
ENTITY A
DIRECTORS
Mr E
ENTITY H
50%
50%
ENTITY G
JOINT VENTURE
The following are related parties of Entity A:

•• Mr B, as he has control of Entity A (IAS 24 para. 9(a)(i)).
•• Entity C, as it is also controlled by Mr B (IAS 24 para. 9(b)(vi)).
•• Ms D, as she is a member of the key management personnel (IAS 24 para. 9(a)(iii)).
•• Mr E, as he is a member of the key management personnel (IAS 24 para. 9(a)(iii)).
•• Entity G, as it is a joint venture of Entity A (IAS 24 para. 9(b)(ii)).
The following entities do not have a related party relationship with Entity A:
•• Entity F, as its only connection with Entity A is a common director (IAS 24 para. 11(a)).
•• Entity H, as it shares joint control of Entity G with Entity A (IAS 24 para. 11(b)).
Required reading
Related party transactions

A related party transaction is defined as ‘a transfer of resources, services or obligations between
a reporting entity and a related party, regardless of whether a price is charged’ (IAS 24 para. 9).
Relationships between a parent entity and subsidiaries must be disclosed regardless of whether
there have been any transactions during the reporting period (IAS 24 para. 13).

Disclosures
The disclosure requirements of IAS 24 are detailed in paras 13–27 and include:
•• Disclosure of certain related party relationships.
•• Disclosure of related party transactions and balances.
Important disclosures concerning related party transactions required by IAS 24 include:

•• Key management personnel compensation.
•• The nature of related party relationships, details of related party transactions undertaken
and details of outstanding balances.
Example – Disclosing related party transactions

This example illustrates how to disclose related party transactions to meet the minimum
requirements specified by IAS 24.
During the year ended 30 June 20X3, Generous Limited advanced interest-free unsecured loans
to two of its directors as follows:
Director Amount Date loan was Term of Repayments Purpose of loan
made loan received during
the year
$ $
Andrea Anaconda 50,000 01 January 20X3 2 years 5,000 To acquire a rental

property
Benjamin Boa 4,000 19 April 20X3 2 years Nil To partially fund

a holiday
The following disclosure meets the minimum requirements of IAS 24 paras 18–19 and 24 for
these transactions (comparatives have not been shown although would be required):
During the year ended 30 June 20X3, unsecured loans totalling $54,000 were
advanced to directors. No interest is payable on the loan and repayment in cash
is due within two years from the date the loans were made. At 30 June 20X3, the
balance outstanding was $49,000 and is included in ‘trade and other receivables’.
Activity 2.4: Identifying related parties


Discontinued operations
Learning outcome
Definition of a discontinued operation

IFRS 5 explains how to account for assets held for sale and discontinued operations. IFRS 5
para. 32 defines a ‘discontinued operation’ as:
… a component of an entity that either has been disposed of, or is classified as held for sale, and
(a) represents a separate major line of business or geographical area of operations,
(b) is part of a single co-ordinated plan to dispose of a separate major line of business or geographical
area of operations, or
(c) is a subsidiary acquired exclusively with a view to resale.
A ‘component of an entity’ must be a clearly distinguished operation with separate financial

reporting.
When an asset is held for sale, this means that ‘its carrying amount will be recovered principally
through a sale transaction rather than through continuing use’ (IFRS 5 para. 6). The held for sale
concept is important, therefore, in identifying a discontinued operation.
Where a business operation has been discontinued, the financial results and assets and liabilities
for that operation are presented separately from those of the continuing operations. This
separate presentation allows users of the financial statements to understand the results of the
continuing operations when considering an entity’s future results and operations.
IFRS 5 provides guidance on:
•• Accounting for assets that are ‘held for sale’.
•• Presenting and disclosing discontinued operations.
The concept of ‘held for sale’ in respect of individual assets is discussed Units 6 and 7.
Measuring the assets and liabilities of a discontinued operation

Once an operation qualifies as ‘discontinued’, its assets and liabilities are required to be held
at values that reflect the worth of their imminent disposal. Therefore, they are remeasured at the
lower of their carrying amount and fair value less costs to sell (IFRS 5 para. 15). The exception
to this rule is specific assets that are excluded from the measurement provisions of IFRS 5.
The exclusions are identified in IFRS 5 para. 5.
Presentation of discontinued operations

As discussed above, the results of discontinued operations are presented separately from
those of the continuing operations, in the statement of profit or loss and other comprehensive
income. IFRS 5 contains comprehensive presentation and disclosure rules relating to
discontinued operations.

However, the table below provides the main presentation and disclosure requirements:
Presentation and disclosure requirements for a discontinued operation
Financial statement Present separately for discontinued operations IFRS 5

paragraph
reference
Statement of profit or loss and Profit or loss after tax for the period 33(a)
other comprehensive income Gain or loss after tax on remeasuring or disposal of
assets and liabilities
Statement of profit or loss and Revenue, expenses and profit before tax 33(b)
other comprehensive income Income tax expense on profit or loss for the period
or Gain or loss before tax on remeasuring or disposal of
Notes to the financial statements assets and liabilities
Income tax expense on gain or loss before tax on
remeasuring or disposal of assets and liabilities
Statement of cash flows Net cash flows – presented either in the notes or 33(c)
or financial statements, for the following activities:
Notes to the financial statements •• Operating

•• Investing
•• Financing
Statement of profit or loss and Amount of income from continuing and discontinued 33(d)
other comprehensive income operations attributable to owners of the parent
or
Notes to the financial statements
Statement of financial position Disclose separately, by major class: 38

or •• Assets held for sale
Notes to the financial statements •• Liabilities held for sale
Required reading
IFRS 5 (or local equivalent).
Example – Preparing disclosures for a discontinued operation

This example illustrates how disclosures for a discontinued operation can be presented.
Fur-Mates Limited (Fur-Mates), a distributor of pet food, originally started operations focusing on
rabbit food but later expanded to the more profitable areas of cat and dog food.
Results for the rabbit food line for the period July 20X5–August 20X5 are as follows:
$
Sales revenue 400,000)
Cost of sales (260,000)
Distribution expenses (10,000)
Income tax expense (39,000)
Profit after tax from the rabbit food line 91,000)
The rabbit food line was discontinued in August 20X5 due to disappointing sales. Fur-Mates
sold the rabbit food distribution business and made a $100,000 gain on the sale. The income tax
expense relating to the gain is $30,000.
Any assets connected with the rabbit food line were redeployed elsewhere within Fur-Mates
after the sale.

This information, concerning the discontinued business, could be presented in either of two
ways within the SPLOCI for the year ended 30 June 20X6 to comply with IFRS 5:
1. Include the detail on the face of the SPLOCI.
Discontinued operation $
Revenue 400,000)
Expenses (270,000)
Profit before tax 130,000)
Income tax expense (39,000)
Profit from discontinued operation after tax 91,000)
Gain on sale of discontinued operation 100,000)
Income tax on gain on sale of discontinued operation (30,000)
Gain on sale of discontinued operation after tax 70,000)
2. Include summarised information on the face of the SPLOCI and present the detail in the
notes to the financial statements.
Discontinued operation $
Profit from discontinued operation after tax 161,000
Disclosures
Apart from the disclosure requirements outlined above, there are additional disclosures
specified by IFRS 5 that are detailed in paras 41–42.
Events after the reporting period
Learning outcome
Video resource
See the video on events after reporting period on MyLearning to assist your learning in this topic.
Timing of events
Inevitably, there is a ‘gap’ between the end of the accounting (reporting) period and completion
of the financial statements. Events that occur during this period may need to be reflected in the
financial statements for the period just ended.
IAS 10 provides guidance as to when such events should be reflected in the financial statements
and how to treat them. IAS 10 applies to events that occur after the reporting date and before
the date the financial statements are authorised for issue (IAS 10 para. 3).

Financial
End of statements
reporting authorised
period for issue
20X8 20X8
JUNE SEPTEMBER
30 15
EVENT
?
Accounting for events after the reporting period
There are two types of events that occur after the reporting period. These events are classified
as either:
•• adjusting events
•• non-adjusting events.
Accounting for these types of events is summarised in the following diagram:
Events occurring
after reporting date
Provides evidence of Indicative of conditions that

conditions that existed at arose after reporting date
end of reporting period
‘Adjusting events’ ‘Non-adjusting events’
Adjust financial Disclose nature of financial

statements for period effect of material
just ended non-adjusting events
The difference between an ‘adjusting event’ and a ‘non-adjusting event’ is key to applying
IAS 10, and is discussed below.
Adjusting events
An adjusting event confirms the existence of a condition that existed at the end of the reporting
period, or provides more evidence about such a condition (IAS 10 para. 3(a)). Therefore, the
amounts recognised in the financial statements are adjusted to reflect adjusting events after the
reporting period (IAS 10 para. 8).

Common examples of adjusting events are as follows:

•• Legal disputes and court cases that are settled after the reporting date, but which confirm
the existence of a present obligation (‘a condition’) that existed at the reporting date.
•• Information received after the end of the reporting period that indicates an asset was
impaired at the reporting date – for example, an entity finds out that a customer with a
trade receivables balance at the reporting date went bankrupt after the reporting date
usually confirms that a loss existed at the end of the reporting period.
•• Bonuses or profit shares that were determined after the reporting date, but for which a legal
or constructive obligation existed at the reporting date.
Non-adjusting events
Non-adjusting events are indicative of conditions that arose after the end of the reporting period
and therefore do not relate to a condition that existed at the reporting date (IAS 10 para. 3(b)).
The amounts recognised in the financial statements are therefore not adjusted to reflect these
events (IAS 10 para. 10).
However, material non-adjusting events could influence users of the financial statements.
Therefore, as stated in IAS 10 para. 21, the following relevant information should be disclosed:
(a) Nature of the event.
(b) Estimate of the financial effect, or a statement that such an estimate cannot be made.
Common examples of non-adjusting events are:

•• An abnormally large decline in the fair value of investments.
•• A major business combination.
•• Announcement of a major restructure.
Examples – Adjusting and non-adjusting events

These examples illustrate adjusting and non-adjusting events.
In these examples, assume that the financial reporting period ended at 30 June 20X3 and the
financial statements are due to be issued on 31 August 20X3.
Example 1
At 30 June 20X3, Company A is owed $1,000 by Company B from the sale of goods supplied in
March 20X3. On 12 August 20X3, Company A receives a letter from Company B’s administrators,
which indicates that Company B is likely to enter liquidation and Company A is unlikely to receive
payment for the amount it is owed.
This is an adjusting event. The condition that existed at 30 June 20X3 was that the trade
receivables balance for Company B was probably already impaired.
Example 2
Company X has an investment of shares in a listed company. The fair value of the shares at
30 June 20X3, based on the listed market price at that time, was $2,500. By 30 August 20X3, the
listed market price of the shares fell significantly and the fair value of the investment is $1,700.
This is a non-adjusting event. The shares trade publicly, so the fall in value is assumed to relate to
circumstances that have arisen after the reporting date. This event would only require disclosure
if it is considered to be material.

Example – Determining the treatment of a dividend declared

This example illustrates how a dividend declared after the reporting date is a non-adjusting
event.
Company X finalises its profit for the year ended 30 June 20X6 by mid-July, resulting in a profit
after tax of $5 million. On 22 July 20X6 the directors declare a $1 million dividend in respect of
the year ended 30 June 20X6 and the dividend is paid one week later.
The declaration of the dividend is a non-adjusting event and therefore the dividend and related
liability is not recognised in the financial statements at 30 June 20X6.
However, the notes to the financial statements for the year ended 30 June 20X6 will disclose
details of the $1 million dividend (IAS 1 para. 137).
Required reading
Disclosures
The disclosure requirements of IAS 10 are detailed in paras 17–22.
Activity 2.5: Accounting for events after the reporting period

Quiz


Unit 3: Revenue
Contents
Introduction 3-3
Accrual accounting versus cash accounting 3-3
Income versus revenue 3-4
Relevant standards and interpretations 3-4
Overview of IFRS 15 3-5
Core principle 3-5
The five-step revenue model 3-5
Step 1: Identify the contract(s) with a customer 3-8
Identifying the contract 3-8
Considering the potential combination of contracts 3-10
Step 2: Identify the separate performance obligations 3-13
Step 3: Determine the transaction price 3-17
Variable consideration 3-20
Constraining estimates of variable consideration 3-22
Existence of a significant financing component in the contract 3-24
Non-cash consideration 3-25
Consideration payable to a customer 3-25
Step 4: Allocate the transaction price 3-27
Allocation of a discount 3-28
Allocation of variable consideration 3-29
Step 5: Recognise revenue when a performance obligation is satisfied 3-30
Measuring progress towards complete satisfaction of a performance obligation 3-33
How does revenue recognition under IFRS 15 work when foreign currencies
are involved? 3-33
Disclosure 3-34


Learning outcome
1. Identify, measure and recognise revenue from contracts with customers.
Introduction
Revenue is a crucial number to users of financial statements in assessing a company’s
performance and prospects. Investors often focus on revenue growth and acceleration when
they analyse financial statements, because revenue is often an indication of the activity level and
capacity of an entity.
Revenue is not only one of the most important financial reporting metrics, but it is usually
also the largest item in the statement of profit or loss and other comprehensive income. It is
prominently presented in the financial statements as the very first item in the statement of profit
or loss and other comprehensive income.
Revenue (e.g. sales) has a direct impact on an entity’s financial performance (i.e. profit) and
this makes the recognition and measurement of revenue a critical issue. But how does an entity
determine when to record revenue and how much revenue should be recognised in the profit or
loss?
The sale of goods for cash is relatively simple – the revenue is recognised on the date the goods
are sold and the cash is received. But what happens if the transaction is on credit; or, if the
transaction includes a good and a service, such as a mobile phone with calls and data usage, or
a new car with a service contract? If a service is rendered over an extended period, when is the
revenue recognised?
This unit examines the principles that an entity has to apply to report ‘useful information to
users of financial statements about the nature, amount, timing and uncertainty of revenue and
cash flows arising from an entity’s contracts with a customer’ (IFRS 15 Revenue from Contracts
with Customers para. 1). It discusses the measurement and recognition of revenue and illustrates
how to measure and recognise revenue in a range of circumstances.
Unit 3 Overview video

Accrual accounting versus cash accounting

Accrual accounting shows the effects of transactions and other events and circumstances on a
reporting entity’s economic resources and claims in the periods in which those effects occur,
even if the resulting cash receipts and payments occur in a different period. This is important
because information about a reporting entity’s economic resources and claims, and changes
in its economic resources and claims during a period provide a better basis for assessing the
entity’s past and future performance than information solely about cash receipts and payments
during that period.
Accrual accounting ≠ Cash accounting
Revenue recognised ≠ Cash received

Income versus revenue

The definition of income in the IASB’s Conceptual Framework for Financial Reporting (the
Framework) encompasses both revenue and gains. Revenue arises in the course of the ordinary
activities of an entity, and gains represent other items that meet the definition of income.
Gains include, for example, those arising on the disposal of non-current assets. When gains
are recognised in the statement of profit or loss and other comprehensive income, they are
presented separately as other income, because knowledge of them is useful for the purpose of
making economic decisions (the Framework, paras 74–76).
Income
Revenue Gains (that is, other income)
Income arising in the For example,

course of an entity’s profit on sale of property,
ordinary activities plant and equipment
Relevant standards and interpretations

The following have been superseded by IFRS 15 Revenue from Contracts with Customers:
•• IAS 11 Construction Contracts.
•• IAS 18 Revenue.
•• IFRIC 13 Customer Loyalty Programs.
•• IFRIC 15 Agreements for the Construction of Real Estate.
•• IFRIC 18 Transfer of Assets from Customers.
•• SIC-31 Revenue–Barter Transactions Involving Advertising Services.
IFRS 15 Revenue from Contracts with Customers

IFRS 15 aims to improve the reporting of revenue and overcome the deficiencies of the
superseded revenue standards and interpretations by:
•• providing a more robust framework for addressing revenue recognition issues
•• improving comparability of revenue recognition practices across entities, industries,
jurisdictions and capital markets
•• simplifying the preparation of financial statements by reducing the amount of guidance to
which entities must refer
•• requiring enhanced disclosures to help users of financial statements better understand the
nature, amount, timing and uncertainty of revenue that is recognised.
IFRS 15 has a mandatory effective date for annual reporting periods beginning on or after
1 January 2018. Earlier application is permitted; however, if an entity applies IFRS 15 early,
it shall disclose that fact.
Required reading
Read IFRS 15 paras 5–8 now to understand the scope of IFRS 15.

Overview of IFRS 15
Core principle
The core principle of IFRS 15 is to ‘recognise revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration to which the entity expects to
be entitled in exchange for those goods or services’ (IFRS 5 para. 2).
As the title of IFRS 15 suggests, an entity shall only apply IFRS 15 to a contract if the
counterparty to the contract is a customer. A customer is ‘a party that has contracted with
an entity to obtain goods or services that are an output of the entity’s ordinary activities in
exchange for consideration’ (IFRS 15 para. 6). This is in line with the Framework, which states
that revenue arises in the course of the ordinary activities of an entity (para. 74).
It is important to read the paragraphs in the standard as you progress through the unit to
understand the material in detail. Candidates may also find the application guidance in IFRS 15
Appendix B helpful in exploring the key concepts.
Required reading
Read IFRS 15 paras 1–4 now to understand the objective of IFRS 15, and Appendix A to
understand key definitions.
The five-step revenue model

IFRS 15 introduces a five-step revenue model to determine when to recognise revenue and at
what amount.
IFRS 15 determines that an entity recognises revenue in accordance with the core principle by
applying the following five steps:

Identify the Identify the Determine Allocate the Recognise
contract(s) separate the transaction revenue
with a performance transaction price when a
customer obligations price performance
obligation is
satisfied
The following simple example introduces how to apply the five-step IFRS 15 model. Each step
will be discussed in detail within the unit. Candidates can revisit the examples to test their
understanding, after reading the CSG and required readings from the standard.

Example – Applying the five-step revenue model

On 1 March 20X6 Need-a-Van signed a contract to purchase a delivery vehicle from Good
Vehicles. The agreed purchase price stated in the signed contract is $20,000. This amount
includes two free services of the vehicle. The two free services will be performed six months
and nine months after the delivery of the vehicle to Need-a-Van. The selling price of the vehicle,
excluding the two free services, is $20,350. The service fee for a six-month service is usually
$1,100 and the service fee for a nine-month service is usually $550. Good Vehicles delivered
the vehicle to Need-a-Van on 15 March 20X6 and Need-a-Van paid the full amount due within
10 business days.
Good Vehicles will apply the five-step revenue model to determine when to recognise the
revenue and how much:
Step 1 – Identify the contract(s) with a customer
Good Vehicles signed a contract to sell a delivery vehicle to Need-a-Van.
Step 2 – Identify the separate performance obligations
According to the signed sales contract, Good Vehicles has agreed to the following three
performance obligations:
•• Sale of a delivery vehicle.
•• Six-month service of the delivery vehicle.
•• Nine-month service of the delivery vehicle.
Step 3 – Determine the transaction price
The transaction price is $20,000.
Step 4 – Allocate the transaction price
The transaction price of $20,000 is allocated to the three performance obligations, in proportion
to the relative stand-alone selling prices at contract inception, as follows:
Column 1 Stand‑alone selling Allocate

price transaction
price
$ % $
Sale of a delivery vehicle (20,350 ÷ 22,000 × 20,000) 20,350 92.5 18,500
Six-month service of the delivery vehicle (1,100 ÷ 22,000 × 20,000) 1,100 5 1,000
Nine-month service of the delivery vehicle (550 ÷ 22,000 × 20,000) 550 2.5 500
22,000 100.0 20,000

Step 5 – Recognise revenue when a performance obligation is satisfied

Good Vehicles will recognise revenue when the performance obligations are satisfied, as follows:
15 March 20X6 Sale of a delivery vehicle $18,500
15 September 20X6 Six-month service of the delivery vehicle $1,000
15 December 20X6 Nine-month service of the delivery vehicle $500
It is important to note that none of the steps in the five-step revenue model refers to cash
received. Therefore, the date of receipt of the cash amount has no impact on the timing of the
revenue recognition, and the date of recognition of revenue does not necessarily coincide with
the date of receipt of the related cash.
The following journal entries illustrate the recognition of revenue in terms of the five-step
revenue model, as well as the receipt of the related cash amounts:
Date Account description Dr Cr
$ $
15.03.20X6 Trade receivables 20,000
Revenue from contracts with customers 18,500

Revenue received in advance (liability) 1,500
Recognition of revenue on the sale of delivery vehicle

$ $
25.03.20X6 Bank 20,000
Trade receivables 20,000
Cash received from Need-a-Van in relation to the sale of delivery vehicle

$ $
15.09.20X6 Revenue received in advance (liability) 1,000
Recognition of revenue on six-month service of the delivery vehicle

$ $
15.12.20X6 Revenue received in advance (liability) 500
Revenue from contracts with customers 500
Recognition of revenue on the nine-month service of the delivery vehicle

STEP
1 Step 1: Identify the contract(s) with a customer
Step 1 consists of two parts, namely:
•• Identifying the contract.
•• Considering the potential combination of contracts.
STEP 1
Identify the Considering
Identifying
contract(s)
with a
the
contract
+ the potential
combination
of contracts
customer
Identifying the contract

A contract is defined as ‘an agreement between two or more parties that creates enforceable
rights and obligations’ (IFRS 15 Appendix A).
IFRS 15 para. 9 sets out five criteria for contracts with customers. These criteria must all be met
before a contract can be accounted for under IFRS 15. The following decision tree outlines the
process to determine whether an entity should account for a contract with a customer:
Have the parties to the contract approved the contract (in writing, orally NO
or in accordance with other customary business practices) and are they
committed to perform their respective obligations?
YES
Can the entity identify each party’s rights regarding the goods or NO
services to be transferred?
YES Do not account

for the contract
NO
with the customer
Can the entity identify the payment terms for the goods or under IFRS 15.
services to be transferred?
Therefore no
YES revenue can
be recognised.
Does the contract have commercial substance? NO
(That is, is the risk, timing or amount of the entity’s future cash flows
expected to change as a result of the contract?)
YES
Is it probable* that the entity will collect the consideration to which NO

it will be entitled in exchange for the goods or services that will be
transferred to the customer?
YES
Account for the contract under IFRS 15.

Therefore, proceed to step 2 of the five-step revenue model
* Probable under IFRSs is regarded as more likely than not to occur (that is, greater than 50% likelihood).

STEP
Required reading 1
Read IFRS 15 paras 9–16 now to understand how to identify a contract.
Contract with a customer not meeting paragraph 9 criteria

Where an entity receives consideration from a customer, but the contract with the customer
does not meet all the criteria outlined in IFRS 15 para. 9:
•• the consideration (e.g. cash received) cannot be recognised as revenue. In such case, the
following journal should instead be processed on receipt of the cash:
Dr
Cash
Cr Revenue received in advance (liability)
•• the entity shall recognise the cash received as revenue when either of the following events
has occurred (IFRS 15 para. 15):
–– the entity has no remaining obligation to transfer goods or services to the customer and
all, or substantially all, of the consideration promised by the customer has been received
by the entity and is non-refundable; or
–– the contract has been terminated and the consideration received from the customer is
non-refundable.
The entity will then process the following journal to recognise the revenue:
Dr Revenue received in advance (liability)
Cr Revenue
Under IFRS 15, entities apply the revenue recognition model if at the start of the contract,
it is probable that the entity will collect the consideration to which it expects to be entitled.
IFRS 15 para. 9(e) states ‘In evaluating whether collectability of an amount of consideration is
probable, an entity shall consider only the customer’s ability and intention to pay that amount
of consideration when it is due’. To this effect, entities often perform credit checks to assess
whether a potential customer would be able to settle their debt in the future. This requirement
is designed to prevent entities from applying the revenue model to problematic contracts and
recognising revenue and a large impairment loss at the same time.
Example – Assessing the existence of a contract to sell equipment

Equipt-to-Go enters into an agreement with Factory X to sell Factory X manufacturing
equipment, and consequently receives $100,000 on the same day. In accordance with Step 1 of
the five-step revenue model, Equipt-to-Go identifies the existence of a contract. Equipt-to-Go
considers the following factors:
•• Factory X’s financial resources through performance of a credit process.
•• Factory X’s commitment to the contract, which may be determined based on the importance
of the equipment to factory X’s operations (i.e. the contract has commercial substance).
•• Equipt-to-Go’s prior experience with similar contracts and buyers under similar
circumstances. Equipt-to-Go has been selling similar equipment for five years and it has
previously sold equipment to Factory X.
•• Equipt-to-Go’s intention to enforce the contractual rights in the contract. It has previously
used the legal process to enforce similar contractual rights.
•• The payment terms of the arrangement.
Equipt-to-Go concludes that the paragraph 9 criteria have been met. Equipt-to-go could then
move on to Step 2 of the five-step revenue model.
However, if Equipt-to-Go concludes that it is not probable it will collect the amount to which it
expects to be entitled, then no contract exists and Equipt-to-Go cannot move forward to the
next step of the five-step revenue model to recognise any revenue. If the criteria to identify a
contract are not all met, Equip-to-Go will initially account for any cash collected as a deposit
liability/revenue received in advance. It would then continue to assess the contract to establish if
it meets the criteria in IFRS 15 para. 9.

STEP
1 Considering the potential combination of contracts
An entity often enters into various contracts with the same customer. Where this happens, the
entity has to assess whether these contracts with the same customer should be accounted for
individually in terms of IFRS 15 or whether they should be combined and accounted for as a
single contract.
Required reading
Read IFRS 15 para. 17 to understand when to combine contracts.
The reason for this assessment is to prevent an entity and its customer entering into a number
of legal contracts that manipulate the timing and the amount of revenue recognised. This is
demonstrated in the example below:
Example – Combining contracts

Seatings Limited (Seatings) and their customer Foodie could enter into the following three
separate contracts:
Item sold Delivery date Agreed selling price
$
Product A 1 January 20X8 60,000
Product B 1 June 20X8 25,000
Product C 1 December 20X8 15,000
100,000
However, the Seatings normally sells these three products at the following prices:
Item sold Normal selling price
$
Product A 5,000
Product B 15,000
Product C 80,000
100,000
The following table outlines how revenue would be recognised in the books of Seatings under
both alternatives (i.e. individually or combined) and clearly illustrates that the three contracts
should be combined to eliminate the possible manipulation of revenue recognised:
Date of revenue Amount of revenue Amount of revenue Difference
recognition recognised – three recognised – one
separate contracts combined contract
$ $ $
1 January 20X8 60,000 5,000 55,000
1 June 20X8 25,000 15,000 10,000
1 December 20X8 15,000 80,000 (65,000)
Total 100,000 100,000 –

The following decision tree should be used to assess whether to combine two or more contracts: STEP
1
NO
Are the contracts entered into at or near the same time?
YES
NO Are the contracts entered into with the same customer

(or related parties of the customer)?
YES
Are the contracts are negotiated as a package with a single YES

commercial objective?
NO
Does the amount of consideration to be paid in one contract YES

Combine the
dependant on the price or performance of the other contract? contracts
NO
Are the goods or services promised in the contracts YES

(or some goods or services promised in each of the contracts)
a single performance obligation?
NO
No combination of contracts
Example – Combination of contracts

During November 20X6, Beautiful Homes Builders entered into the following three contracts:
Date of Name of Client Description Contract Normal selling
Contract price price
$ $
14.11.20X6 Mr A D Parker Renovation of kitchen at 75 150,000 50,000

Collingwood Avenue, Hampton. To be
completed in December 20X6
16.11.20X6 Mrs E C Parker Renovation of main bathroom at 75 10,000 35,000

completed in July 20X7
17.11.20X6 Mr A D Parker Construction of a pool at 75 5,000 80,000

completed in September 20X7
Mr and Mrs Parker have agreed to pay the total amount of $165,000 on 31 October 20X7.
To determine when and how much revenue to recognise, Beautiful Homes Builders will apply the
five-step revenue model, as follows:
Beautiful Homes Builders signed three contracts during November 20X6. As part of Step 1,
Beautiful Homes Builders has to assess whether to combine these contracts, and it should use
the decision tree to make its assessment.

STEP
1
Beautiful Homes Builders made the following assessment:
•• The three contracts are entered into at or near the same time, because they are entered into
within the same week.
•• The three contracts are entered into with the same customer (or related parties of
the customer), because Mr A D Parker and Mrs E C Parker are married and therefore
related parties.
•• The contracts are negotiated as a package with a single commercial objective, because the
three contracts all relate to the renovation of the same property at 75 Collingwood Avenue
in Hampton.
Therefore, Beautiful Homes Builders has to combine the three contracts.
Beautiful Homes Buildings would then go on the complete the remaining four steps in the five
step IFRS15 revenue recognition model. These steps are introduced briefly in this example below,
and will be examined in more detail later in the following pages.
According to the three signed contracts, Beautiful Homes Builders has agreed to the following
three performance obligations:
•• Renovation of kitchen.
•• Renovation of main bathroom.
•• Construction of a pool.
Step 3 – Determine the transaction price
The transaction price is $165,000.
The transaction price of $165,000 is allocated to the three performance obligations, as follows:
$
Renovation of kitchen 50,000
Renovation of main bathroom 35,000
Construction of a pool 80,000
165,000

Beautiful Homes Builders will recognise revenue when the performance obligations are satisfied:
$
December 20X6 Renovation of kitchen 50,000
July 20X7 Renovation of main bathroom 35,000
September 20X7 Construction of a pool 80,000
It is important to note that the combination of the three contracts is aligned to the ‘substance
over form principle’ as outlined in the Framework. If the contracts were not combined the
revenue from the three separate contracts would be recognised as follows:
$
December 20X6 Renovation of kitchen 150,000
July 20X7 Renovation of main bathroom 10,000
September 20X7 Construction of a pool 5,000

Step 2: Identify the separate performance obligations STEP

2
Step 2 of the five-step revenue model requires that at the inception of contract, the entity
assesses the goods or services promised in a contract with a customer and identifies the separate
performance obligations. A performance obligation is:
STEP 2 A good or
service (or a
Identify the
bundle of goods
separate
performance
A promise
+ In a
contract + To transfer + or services) that
is distinct
obligations
OR
• A series of
distinct goods
or services
• That are
substantially
the same, and
• That have the
same pattern of
transfer to the
customer
Required reading
Read IFRS 15 paras 22–30 now to understand how to identify the separate performance
obligations.
Read the definition of performance obligation in IFRS 15 Appendix A.
Example – Administrative tasks to set up a contract

Exercise Heaven offers annual gym membership to members under the following terms and
conditions:
•• Joining fee – $600 non-refundable joining fee is payable on the day of entering into the new
gym membership contract. The joining fee is to cover the costs of the administrative tasks in
enrolling a new member.
•• Monthly membership fee – $100 per month, payable in advance.
•• Maximum membership period –12 months. Anyone who wishes to continue their
membership has to enter into a new annual gym membership contract and again pay the
$600 non-refundable joining fee.
On 1 January 20X3, Exercise Heaven entered into a new annual gym membership contract
with Mrs V Lazy. Exercise Heaven has asked for your assistance in determining the revenue to
recognise for January 20X3.
Exercise Heaven entered into a new annual gym membership contract with Mrs V Lazy.
Exercise Heaven only has one performance obligation and that is to provide the use of the gym
to Mrs V Lazy for a period of 12 months. The administrative tasks to enrol a new member are not
a separate performance obligation, because they do not transfer a service to the customer as the
tasks are performed.
Exercise Heaven would then go on to apply the remaining steps of the five-step revenue
recognition model under IFRS 15. These steps are discussed in more detail in the following pages.

STEP
2 Step 3 – Determine the transaction price
The transaction price is $1,800, which consists of the $600 joining fee and $100 per month for
12 months.
The transaction price of $1,800 is allocated to the one performance obligation.
The performance obligation is satisfied over the 12 months and therefore the revenue is
recognised over the 12 months.
The following journal entries illustrate the recognition of revenue in terms of the five-step
revenue model, as well as the receipt of cash amounts, during the month of January 20X3:
$ $
01.01.20X3 Bank 600
Revenue received in advance (liability) 600
Joining fee received on signing the new annual gym membership contract

$ $
01.01.20X3 Bank 100
Revenue received in advance (liability) 100
January gym membership received

$ $
31.01.20X3 Revenue received in advance (liability) 150
Revenue from contracts with customers 150
Recognition of revenue for the month of January ($100 + ($600 ÷ 12 months))

The following decision tree could be used to identify separate performance obligations: STEP
2
Can the customer benefit from the good or service, whether NO
on its own, or with other readily available resources?
YES
The good or service

Does the entity provide a significant service YES is not ‘distinct’
of integrating the goods or services? =
Combine the good
NO or service with other
promised goods or
services until a bundle
Does the good or service significantly modify YES of goods and services
or customise the other goods or services? that is distinct can
be identified
NO
Are the goods or services highly interdependent YES

or highly interrelated?
NO
The good or service is ‘distinct’

=
Separate performance obligation
Example – Customer could benefit from a good or service

Love-a-Phone sells mobile phone contracts. A mobile phone contract consists of a new mobile
phone, access to airtime for phone calls, and access to text messaging. Love-a-Phone also sells
mobile phones and airtime separately. Love-a-Phone is one of three mobile phone providers
in Australia.
On 1 April 20X7, Mr Forgetful enters into a new mobile phone contract with Love-a-Phone. Mr
Forgetful can benefit from the mobile phone on its own, because he could buy airtime from
another mobile phone provider. Mr Forgetful can benefit from the airtime on its own, because he
could continue to use his old mobile phone or buy a mobile phone from another mobile phone
provider. Therefore, the phone and the airtime are distinct, and would be treated as separate
performance obligations under IFRS 15.
Example– Distinct goods or services

The Big Machine sells large specialised manufacturing machinery. Due to the specialised
nature of the manufacturing machinery, The Big Machine also installs this machinery. The Big
Machine is the only entity that has the specialised knowledge to install these types of specialised
manufacturing machinery in Australia and New Zealand.
In Step 2 of the five-step revenue model, The Big Machine needs to identify the separate
performance obligations. The Big Machine will be performing two activities – the sale and the
installation of the specialised manufacturing machinery. Careful consideration should be given
to determine whether these two activities lead to the provision of one or two distinct goods or
services to the customer.
The customer cannot benefit from the specialised manufacturing machinery on its own or
with other readily available resources, because The Big Machine is the only entity that has the
knowledge and expertise to install the specialised manufacturing machinery. In addition, the
specialised manufacturing machinery cannot be used if it is not properly installed and therefore
the goods (specialised manufacturing machinery) and the installation services are highly
interdependent. The sale of the specialised manufacturing machinery and the installation service
should therefore be bundled together as one performance obligation.

STEP
2
Example – Distinct goods or services
Stylish Equipment sells manufacturing machinery. It also installs the manufacturing machinery
for their customers. The installation of the manufacturing machinery can also be done by
registered builders.
In Step 2 of the five-step revenue model, Stylish Equipment needs to identify the separate
performance obligations. Stylish Equipment will be performing two activities – the sale and the
installation of the manufacturing machinery. Careful consideration should be given to determine
whether these two activities lead to the provision of one or two distinct goods or services to
the customer.
The customer can benefit from the manufacturing machinery on its own or with other readily
available resources, because the manufacturing machinery can also be installed by other
registered builders. In addition, the manufacturing machinery and the installation services are
not highly interdependent or highly interrelated. The sale of the manufacturing machinery and
the installation services should therefore be identified as two separate performance obligations.
Example – Distinct goods or services

Programming Delights is a listed IT company that specialises in developing, installing and
maintaining specialised payroll software for companies throughout Australia and New Zealand.
A contract with a customer normally includes the development of specialised payroll software
that would interface with the customer’s system. This specialised interface can take up to six
months to get ready for usage from the time the contract is signed. The specialised software
cannot be redeployed to another customer without significant modification.
Only Programming Delights has the specialised knowledge to complete this type of software
development and installation. Programming Delights provides a detailed user manual and
description of the design of the developed software to the customers, which enables other
software providers to also maintain the software system going forward.
In Step 2 of the five-step revenue model, Programming Delights needs to identify the
separate performance obligations. Programming Delights will be performing three activities –
the development, implementation, and maintenance of the specialised software. Careful
consideration should be given to determine whether these three activities lead to the provision
of one, two or three distinct goods or services to the customer.
Due to the specialised nature of the payroll software, only Programming Delights is able to
implement the developed specialised payroll software that would interface with the customer’s
system. The customer would therefore not be able to benefit from the development of the
payroll software unless Programming Delights also implements the software.
The development and installation of the specialised payroll software are highly interrelated.
The development and installation of the specialised payroll software should therefore be
bundled together as one performance obligation.
The maintenance of the payroll software system is a distinct service, because Programming
Delights and some other software providers can maintain the software system going forward.

Step 3: Determine the transaction price STEP

3
The transaction price is defined in IFRS 15 Appendix A as ‘the amount of consideration to

which an entity expects to be entitled in exchange for transferring promised goods or services to
a customer’.
STEP 3
Amount of
Determine
consideration
the
transaction
Transaction
price = the entity
expects to be
price entitled to
Entities have to consider the following in order to determine the transaction price:
•• terms of a contract (e.g. terms specified in a sales invoice)
•• the entity’s customary business practices (e.g. a settlement discount of 10% if the customer
pays within 30 days).
Required reading
Read IFRS 15 paras 46–49 now to understand determining the transaction price.
Example – Settlement discount

The Shoe Warehouse sells shoes in bulk to small retail stores in major cities across Australia and
New Zealand. On 15 June 20X9, Shoe Warehouse sold shoes to Amazing Shoes in Melbourne
on credit. The shoes were delivered to Amazing Shoes on 20 June 20X9 and the accompanying
invoice indicated that the total sales price was $250,000. The individual sales prices were
obtained from the master price list. The Shoe Warehouse normally provides a settlement
discount of 5% of the invoiced price if the debtor settles the invoice within 30 days of delivery
of the shoes. Amazing Shoes is a regular customer of The Shoe warehouse. Amazing Shoes has
consistently settled its debts within the required 30 days.
The Shoe Warehouse will process the following journal on 20 June 20X9 (date of delivery) in
relation to the sale of the shoes to Amazing Shoes:
$ $
20.06.X9 Trade receivables 237,500
To record the sale to Amazing Shoes
The sales revenue is calculated at the invoice price of $250,000 less the expected settlement
discount of $12,500 ($250,000 × 5%), because the transaction price is the amount of
consideration the entity expects to be entitled to. Based on past experience, Amazing Shoes
will settle its debt within 30 days and therefore the Shoe Warehouse would only be entitled to
$237,500.
Subsequently, if the amount received from Amazing shoes is higher (e.g. if the payment does not
fall within the settlement discount period), any additional revenue could be recognised.

STEP
3
Example – Refund liability
Basketball Gear sells basketball clothes and equipment to retail stores across Australia and New
Zealand. Basketball Gear does not deliver its goods to customers. Customers are required to
pay in cash or via electronic funds transfer on the day of sale, which is also the day on which the
customer picks up the goods from Basketball Gear’s warehouse.
On 12 July 20X1, Basketball Gear sells a number of basketballs, basketball hoops and clothing
to a local sports club for $50,000. The basketball club has 30 days to return any unwanted
items. If the club returns the goods within the 30 days, it will receive a full refund. Based on past
experience with this customer, Basketball Gear estimates that 15% of the goods will be returned
within the allowed 30 days.
Basketball Gear will process the following journal on 12 July 20X1 (date of cash sale and pick up
of goods) in relation to the sale:
$ $
12.07.X1 Cash 50,000
Sales revenue 42,500
Refund liability 7,500
To record the sale less expected refund
Assume that the customer returns 15% of the goods on 31 July 20X1. Basketball Gear will process
the following journal on 31 July 20X1:
$ $
31.07.X1 Refund liability 7,500
Cash 7,500
To record refund to customer
IFRS 15 para. 47 states that a transaction price excludes amount collected on behalf of third
parties. In Australia and New Zealand, this means a transaction price as defined in IFRS 15
excludes the GST collected.
Transaction price ≠ Amounts collected

on behalf of third
parties, for example
the tax office

STEP
3
Example – Goods and services tax (GST)
On 20 November 20X8, A-lot-of-runs Cricket Bats delivered 11 new cricket bats to Cricket
Australia. The accompanying invoice indicated that the total sales price is $110,000, including
GST of 10%. A-lot-of-runs Cricket Bats does not provide any settlement discounts to customers.
A-lot-of-runs Cricket Bats will process the following journal on 20 November 20X8 (date of
delivery) in relation to the sale of the cricket bats to Cricket Australia:
$ $
GST payable 10,000
To record the sale of bats to Cricket Australia
Note: this example is included to show amounts collected on behalf of third parties. GST generally is
beyond the scope of the FIN module.
The transaction price could consist of a fixed consideration, or a variable consideration, or both.
Transaction price
Fixed Variable
consideration consideration
+
OR BOTH
IFRS 15 para. 47 states that the ‘consideration promised in a contract with a customer may
include fixed amounts, variable amounts, or both’.
An entity should consider the effects of all of the following when determining the transaction
price:
Constraining
Variable estimates of
consideration variable
consideration
Existence
Consideration
of a significant
payable to a
financing
customer
component
Non-cash
consideration

STEP
3 Variable consideration
Discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses,
penalties or other similar items could impact the amount of consideration (IFRS 15 para. 50).
Consideration can also be contingent on the occurrence or non-occurrence of a future event.
Variable consideration could originate from any of the following sources (IFRS 15 para. 52):
•• Explicitly stated in the contract.
•• The customer has a valid expectation arising from an entity’s customary business
practices, published policies or specific statements that the entity will accept an amount of
consideration that is less than the price stated in the contract. The entity is expected to offer
a price concession, which could be referred to as a discount, rebate, refund or credit.
•• Other facts and circumstances indicate that the entity intends to offer a price concession to
the customer.
An entity needs to estimate the amount of variable consideration by using either of the
following two methods:
•• Expected value.
•• Most likely amount.
The method selected would depend on which of the two methods the entity expects to better
predict the amount of variable consideration.
Estimation of variable
consideration
The expected value OR The most likely amount
Method Description When to use
Expected value The sum of probability-weighted amounts in An entity has a large number of
a range of possible consideration amounts contracts with similar characteristics
Most likely amount The single most likely amount in a range The contract has only two possible
of possible consideration amounts (i.e. the outcomes (e.g. an entity either achieves
single most likely outcome of the contract) or does not achieve a performance
bonus)
Required reading
Read IFRS 15 paras 50–55 now to understand variable consideration
Example – The expected value

Master Seller enters into a contract with Love-a-Bargain to build an asset for $200,000, with a
performance bonus of $50,000 that will be paid based on the timing of completion. The amount
of the performance bonus decreases by 5% per week for every week beyond the agreed-upon
completion date. The contract requirements are similar to contracts Master Seller has performed
previously, and management believes that such experience is predictive for this contract. Master
Seller concludes that the expected value method is most predictive in this case.
Master Seller estimates that there is a 35% probability that the contract will be completed by the
agreed-upon completion date, a 45% probability that it will be completed one week late, and a
20% probability that it will be completed two weeks late.
In accordance with Step 3 of the five-step revenue model, the transaction price should include
management’s estimate of the amount of consideration to which the entity will be entitled for
the work performed. The total transaction price is $247,875 based on the probability-weighted
estimate below:

STEP
Likely fee % probability $ 3
$250,000 (fixed fee plus full performance bonus) × 35% 87,500
$247,500 (fixed fee plus 95% of performance bonus) × 45% 111,375
$245,000 (fixed fee plus 90% of performance bonus) × 20% 49,000
247,875
Master Seller will update its estimate at each reporting date. This example does not consider the
potential need to constrain the estimate of variable consideration included in the transaction
price.
Assuming this estimate meets the requirements of IFRS15 para. 56 (discussed in the following
pages), the revenue would be recognised via the following journal.
$ $
xx.xx.xx Trade receivables 247,875
To recognise sales revenue from Love-a-Bargain
Example – The most likely amount

Magnificent Buildings enters into a contract to construct a manufacturing facility for Amazing
Creations. The contract price is $500,000 plus a $50,000 award fee if the facility is completed by
a specified date. The contract is expected to take 18 months to complete. Magnificent Buildings
has a long history of constructing similar facilities.
The award fee is binary (i.e. there are only two possible outcomes) and is payable in full upon
completion of the facility. Magnificent Buildings will receive none of the $50,000 award fee if the
facility is not completed by the specified date. Magnificent Buildings believes that, based on its
experience, it is 90% likely that the contract will be completed successfully and in advance of the
target date.
It is appropriate for Magnificent Buildings to use the most likely amount method to estimate the
variable consideration. The contract’s transaction price is therefore $550,000, which includes the
fixed contract price of $500,000 and the $50,000 variable consideration in the form of the award
fee. The estimate should be updated each reporting date.
Assuming this estimate meets the requirements of IFRS15 para. 56 (discussed in the following
pages), the revenue would be recognised via the following journal.
$ $
xx.xx.xx Trade receivables 550,000
To recognise revenue from the Amazing Creations contract

STEP
3 Constraining estimates of variable consideration
When including variable consideration in calculating a transaction price, IFRS 15 para. 56
imposes a constraint on when this variable consideration can be recognised.
The following decision tree should be used to consider the constraining estimates of variable
consideration:
Is the consideration variable?
NO YES
Include the fixed consideration in the Estimate the amount using the expected value
transaction price or most likely value
Is it highly probable that a significant revenue

reversal will not subsequently occur?*
YES NO
Include Do not include

variable variable
consideration in consideration in
transaction price transaction price
* IFRS 5 Non-current Assets Held for Sale and Discontinued Operations defines ‘highly probable’ as significantly more likely
than probable. The standard does not quantify this. An entity has to consider both the likelihood and the magnitude
of the revenue reversal.
Having trouble? The variable consideration constraint is difficult to understand. Watch our

video on paragraph 56 to unpack the concept.
The following factors increase the likelihood or magnitude of a revenue reversal (IFRS 15
para. 57):
Constraining estimates
of variable consideration
consideration highly susceptible to

outside factors (e.g. market volatility,
weather, actions of 3rd parties etc)
long period to resolve uncertainty
limited experience with similar

contracts
price concessions vary, changing

payment terms
contract has large number

and broad range of possible
consideration amounts
Required reading
Read IFRS 15 paras 56–59 now to understand the constraining estimates of variable consideration.

STEP
3
Example – Right of return
The Art House sells modern art pieces to retail stores across Asia Pacific. The Art House delivers
the sold art pieces to the customers. Customers are required to either pay or return the art within
60 days. If customers return the art pieces within 60 days, they will receive a full refund.
On 5 March 20X4, The Art House sold a number of art pieces to Funky Art for $100,000. Based on
past experience with Funky Art, The Art House estimates that 30% of the goods will be returned
within the allowed 60 days.
Because the sales contract allows Funky Art to return the art pieces, the consideration is variable.
Using the expected value method, The Art House estimates that 70% of the art pieces will not
be returned.
The Art House will process the following journal on 5 March 20X4 (date of sale and delivery of
the art pieces) in relation to the sale:
$ $
Revenue from contracts with customers (70% of $100,000) 70,000
Refund liability (30% of $100,000) 30,000
To record sales revenue and expected refund liability
Assume that Funky Art returns 30% of the goods on 15 April 20X4. The Art House will process the
following journal on 15 April 20X4:
$ $
15.04.X4 Refund liability 30,000
Trade receivables 30,000
To record return of sales
Example – Volume discount incentive

On 1 January 20X3, Bottles Galore enters into a contract with A-lot-of-drinks to sell 1,000
colourful bottles for $3 per bottle. If A-lot-of-drinks purchases more than 5,000 bottles in a
calendar year, the sales contract specifies that the price per unit is retrospectively reduced to
$2 per unit. On 1 January 20X3, Bottles Galore estimates that A-lot-of-drinks’ purchases will
not exceed the 5,000 bottle threshold required for the volume discount in the calendar year.
The bottles are delivered to A-lot-of-drinks on 10 January 20X3 and A-lot-of-drinks paid the full
amount due on 1 March 20X3.
Bottles Galore determines that it has significant experience with the sale of these colourful
bottles and with the purchasing pattern of A-lot-of-drinks. Bottles Galore concludes that it is
highly probable that a significant reversal in the cumulative amount of revenue recognised will
not occur when the uncertainty is resolved, that is, when the total amount of purchases is known
by the end of the calendar year.
Bottles Galore will process the following journal on 10 January 20X3:
$ $
To record sale to A-lot-of-drinks

STEP
3 Existence of a significant financing component in the contract
A significant financing component exists in a contract if the timing of the cash flows is more
than 12 months after the date of recognition of the related revenue. If a significant financing
component exists in a contract, the transaction price should be adjusted for the time value
of money.
As per IFRS 15 para. 61, the objective of adjusting the transaction price for a significant
financing component is ‘for an entity to recognise revenue at an amount that reflects the price
that a customer would have paid for the promised goods or services if the customer had
paid cash for those goods or services when (or as) they transfer to the customer (i.e. the cash
selling price)’.
The discount rate used is the rate that would be used in a separate financing transaction
between the entity and the customer. The objective of adjusting the transaction price applies to
both in advance and in arrears.
In the statement of profit or loss and other comprehensive income, an entity should present
the effects of financing (interest revenue or interest expense) separately from revenue from
contracts with customers.
Required reading
Read IFRS 15 paras 60–65 now to understand the existence of a significant component in a
contract.
Example – Significant financing component (interest revenue)

On 1 January 20X1, The Block sells furniture to a customer on credit for $100,000. The furniture
is delivered to the customer on 1 January 20X1. According to the sales agreement the $100,000
is payable on 31 December 20X2. Assume that the present value of the $100,000 is $90,000 on
1 January 20X1 and $96,500 on 31 December 20X1. The Block’s reporting date is 31 December.
The $100,000 is received from the customer on 31 December 20X2.
The Block will prepare the following journals to record revenue for the contract:
$ $
01.01.20X1 Trade receivable 90,000
Recognition of revenue on satisfaction of the single performance obligation to sell and deliver furniture

$ $
Interest revenue 6,500
Recognition of interest revenue for the period 1 January 20X1 to 31 December 20X1

$ $
Recognition of interest revenue for the period 1 January 20X2 to 31 December 20X2

STEP
Date Account description Dr Cr 3
$ $
31.12.20X2 Cash 100,000
Trade receivable 100,000
Accounting for cash received from the customer
Non-cash consideration
If an entity provides goods or services to a customer and the customer promises consideration
in a form other than cash, the entity should measure the non-cash consideration (or promise of
non-cash consideration) at fair value. Fair value is discussed in Unit 6 and in IFRS 13 Fair Value
Measurement.
Required reading
Read IFRS 15 paras 66–69 now to understand non-cash consideration.
Example – Entitlement to non-cash consideration

On 8 September 20X2, Modern Office Furniture sold new office furniture to a large motor vehicle
dealership. The agreed selling price is $80,000. The large motor vehicle dealership promised
to provide a new delivery vehicle with a stand-alone selling price of $75,000 to Modern Office
Furniture as payment for the new office furniture.
Modern Office Furniture will process the following journal on 8 September 20X2:
$ $
To recognise the fair value of non-cash consideration received on sale
As the customer is paying Modern Office Furniture by providing a new delivery vehicle, the
vehicle is non-cash consideration (as discussed in IFRS 15 para. 66). The fair value of the motor
vehicle was $75,000, and this is the amount that should be recognised as revenue, rather than
the $80,000 agreed selling price.
Consideration payable to a customer

IFRS 15 has specific principles around the treatment of consideration payable to a customer.
These payments can be a common feature in certain industries. Examples in the retail sector
include retail cash back offers and free giftcards.
Consideration payable to a customer includes the following:
•• Cash amounts paid or to be paid to customer (e.g. a cash-back offer on an electrical
appliance).
•• Credits.
•• Other items (e.g. a voucher) that can be applied against amounts owed to the entity.

STEP The principles to treat consideration payable to a customer are set out in IFRS 15 para. 70 and
3
are summarised below:
Consideration payable to a customer
General rule Exception

• Treat as reduction • Payment to
in transaction price customer is in
(reduction in exchange for a
revenue) distinct good or
• Recognise when service
entity recognises • Account for it like
revenue and entity other purchases
promises to pay from suppliers
consideration
Required reading
Read IFRS 15 paras 70–72 now to understand consideration payable to a customer.
Example – Consideration payable to a customer

On 10 August 20X3, Solid Machines sold a new manufacturing machine to a large manufacturing
company in Wellington. The agreed selling price is $100,000. Usually, Solid Machine would also
assist with the installation of the manufacturing machine. However, its installation manager
has indicated that Solid Machines’ installation team will only be available to do the installation
in Wellington in three months’ time due to a staff shortage. Solid Machine has agreed to pay
the customer an amount of $5,000 if the customer uses an independent contractor based in
Wellington to install the manufacturing machine.
In this situation, applying the general rule, the transaction price is $95,000.
Once an entity has determined the transaction price under Step 3, it can move on to Step 4 to
allocate the transaction price.

STEP
4 Step 4: Allocate the transaction price
An entity should follow the following process to allocate the transaction price, as determined in
Step 3, to each performance obligation identified in Step 2:
STEP 4
Allocate the
transaction Transaction
price price
Allocating transaction price to performance obligations:
Allocating transaction price to performance obligations

• Allocate based on • Stand-alone
stand-alone selling selling price not
prices at inception observable:
estimate using
methods in para. 79
Is the stand-alone selling price of the performance obligation observable?
YES NO
Determine the stand-alone selling price at Estimate the stand-alone selling price using
contract inception of the distinct good or one of the following
service underlying the performance obligation • Adjusted market assessment approach
in the contract. • Expected cost plus a margin approach, or
• Residual approach (only use as a last resort).
Allocate the transaction price in proportion to the stand-alone selling prices
An entity should consider the following aspects to determine the stand-alone selling price of a
good or service:
•• At what price does the entity sell the promised good or service separately to a customer?
•• At what price does the entity sell the good or service separately in similar circumstances and
to similar customers?
•• What is the contractually stated price? (This price may be, but shall not be presumed to be,
the stand-alone selling price.)
Required reading
Read IFRS 15 paras 73–80 to understand allocating the transaction price.

STEP
4 Further reading
A discussion and examples of methods to estimate stand-alone prices can be found in Unit 3 in
myLearning
Example – Stand-alone selling price

Smart Kids sells academic books and online access to worked examples and activities for
most school subjects. During November 20X6, Bayview School ordered academic books and
online access to worked examples and activities for the 20X7 academic year. The contract price
amounted to $100,000. The stand-alone selling prices for similar customers online is $80,000 for
books and $40,000 for online access to worked examples and activities.
In Step 4 of the five-step revenue model, Smart Kids has to allocate the transaction price to the
two separate performance obligations.
Performance obligation Transaction price allocation $
Academic books 80,000 ÷ 120,000 × 100,000 66,667
Online worked examples 40,000 ÷ 120,000 × 100,000 33,333
100,000
In this transaction, there is an inherent discount of $20,000, which does not relate to a specific
performance obligation and is therefore allocated to all performance obligations on a relative
stand-alone selling price basis.
As part of Step 4 to allocate a transaction price, a number of complicating factors must be

considered. Two of these are addressed below – the allocation of a discount and allocation of
variable consideration.
Allocation of a discount
In entering into a contract with a customer, an entity may provide that customer with a
discount. In order to apply the five-step revenue recognition process under IFRS 15, the
principles for dealing with discounts are discussed in IFRS 15 paras 81–83.
Allocating a discount

• Allocate • If criteria in IFRS 15
proportionately paragraph 82 are
to all performance met and there is
obligations in the observable
contract evidence the
discount relates
to certain
performance
obligations (but
not all performance
obligations),
allocate to the
relevant
performance
obligations only
Required reading
Read IFRS 15 paras 81–83 to understand the allocation of a discount.

Allocation of variable consideration STEP

4
In applying Step 4 of the revenue recognition model, an entity needs to consider the variable
consideration in a contract. The variable consideration must be allocated to performance
obligations. These principles are discussed in IFRS 15 paras 84–85.
Allocating a variable consideration

• Allocate to all • If criteria in IFRS 15
performance paragraph 85
obligations in the are met, allocate
contract to one or more
performance
obligations or one
or more distinct
good/services in a
series
Required reading
Read IFRS 15 para. 85 to understand when to use the exception discussed in the diagram above.
Example – Allocation of variable consideration

On 1 October 20X5 Software Kings makes a sale to a large global telecommunications company
with the following terms and conditions:
•• Contract signed: 1 October 20X5
•• Total contract value: $1,000,000
–– Development of software: $750,000
–– Installation of software and coding to clients system: $50,000
–– First year maintenance and support fee: $200,000
•• Installation date: 30 September 20X6
•• If installation does not happen by 30 September 20X6, a $100,000 rebate will be provided
back to the customer.
Software Kings has performed many of these contracts before and at the time of signing the
contract Software Kings estimated that installation would occur later than 30 September 20X6.
The prices specified above are consistent with the stand-alone selling prices the entity would
charge.
In accordance with Step 2 of the five-step model, Software Kings has determined that two
separate performance obligations exist – development and installation, and maintenance. In
accordance with Step 3 of the five-step revenue model, Software Kings has determined that
the transaction price is $900,000 ($1,000,000 fixed amount in the contract – $100,000 variable
consideration or rebate).
In accordance with Step 4 of the five-step revenue model, the transaction price at inception will
be allocated to the two performance obligations as follows:
•• Development and installation: $700,000 ($750,000 + $50,000 – $100,000)
•• Annual support: $200,000.
The $100,000 rebate is allocated to development and installation as it can be clearly seen that
the variation relates to this part of the contract. This applies the ‘exception’ for allocating the
discount, outlined in our earlier diagram.

STEP
5 Step 5: Recognise revenue when a performance
obligation is satisfied
In the fifth and final step of the revenue model, an entity finally determines when to recognise
revenue.
FIN fact
It should be remembered that all of the five steps are performed at inception of a contract.
Required reading
Read IFRS 15 paras 31–38 now to understand when a performance obligation is satisfied.
The timing of revenue recognition is determined based on whether the entity satisfies the
performance obligation(s) (identified in Step 2) over time or at a point in time.
An entity should start by considering whether the entity satisfies a performance obligation over
time, and if not, it is concluded that the entity satisfies the performance obligation at a point
in time.
STEP 5
Recognise
revenue
when a
performance
obligation is
satisfied
KEY QUESTION: Does the entity transfer control of the asset over time?
YES NO
The entity should recognise revenue over time, The entity should recognise revenue at a point
using a method that depicts its performance in time at which it transfers control of the good
or service to the customer
The following indicators should be considered to determine whether control of an asset has
been transferred:
•• Does the entity have a present right to payment for the asset?
•• Does the customer have legal title to the asset?
•• Has the entity transferred physical possession of the asset to the customer?
•• Does the customer have significant risks and rewards of ownership of the asset?
•• Has the customer accepted the asset?
Example – Transfer of a promised good or service (i.e. an asset) to a customer

On 1 January 20X2, The Great Bus Manufacturer enters into a contract with Seaview Secondary
School (Seaview) to provide three new buses to Seaview over the next six months. The agreed
delivery dates of the buses are as follows:
•• 30 seater bus – 1 March 20X2.
•• 20 seater bus – 1 May 20X3.
•• 10 seater bus – 31 August 20X3.

STEP
In accordance with Step 2 of the five-step revenue model, The Great Bus Manufacturer identified 5
three separate performance obligations –the 30 seater bus, the 20-seater bus and the 10-seater
bus. In accordance with Step 5 of the five-step revenue model, The Great Bus Manufacturer will
recognise revenue at the following dates when it delivers each bus to Seaview:
•• 1 March 20X2
•• 1 May 20X3
•• 31 August 20X3.
Seaview Secondary School will obtain control of the buses at the date of the delivery of the buses.
The following decision tree should be used to determine when and how the entity transfers
control of the asset:
The customer simultaneously receives and consumes the benefits TRUE

provided by the entity’s performance as the entity performs
FALSE
The entity transfers
control over time
The entity’s performance creates or enhances an asset that the TRUE =
customer controls as the asset is created or enhanced The entity should
recognise revenue
FALSE over time, using
a method that
depicts its
The entity’s performance does NOT create an asset with performance
an alternative use to the entity TRUE
and
the entity has an enforceable right to payment
for performance completed to date
FALSE
The entity transfers control

at a point in time
=
The entity should recognise revenue at a point in time at which
it transfers control of the good or service to the customer
Example – Simultaneous receipt and consumption of the benefits of the entity’s

performance
On 1 January 20X4, Payroll Made Easy enters into a contract to provide monthly payroll
processing services to a customer for one year. The customer agrees to pay $900 per quarter on
31 March 20X4, 30 June 20X4, 30 September 20X4 and 31 December 20X4. Payroll Made Easy’s
reporting date is 30 April.
In accordance with Step 2 of the five-step revenue model, Payroll Made Easy identified a single
performance obligation – the promised payroll processing services.
In accordance with Step 5 of the five-step revenue model, Payroll Made Easy determines that
the performance obligation is satisfied over time because the customer simultaneously receives
and consumes the benefits of the entity’s performance in processing each payroll transaction
as and when each transaction is processed. The fact that another entity would not need to
re‑perform payroll processing services for the service that Payroll Made Easy has provided to
date also demonstrates that the customer simultaneously receives and consumes the benefits
of the entity’s performance as the entity performs the services. Payroll Made Easy therefore
recognises revenue over time by measuring its progress towards complete satisfaction of that
performance obligation.

STEP
5
Payroll Made Easy would recognise revenue from this contract as follows:
•• Financial reporting period ending on 30 April 20X4 = $1,200 [($900 × 4 quarters) × (4 months
÷ 12 months)].
•• Financial reporting period ending on 30 April 20X5 = $2,400 [($900 × 4 quarters) × (8 months
÷ 12 months)].
Example – Creates or enhances an asset that the customer controls as the asset is created
or enhanced
Good Construction enters into a contract with a customer to build a new architect-designed
home on a block of land in Sandringham. The customer purchased the block of land a few
months ago and has already demolished the original home.
In accordance with Step 2 of the five-step revenue model, Good Construction identified a single
performance obligation – the construction of a new home.
In accordance with Step 5 of the five-step revenue model, Good Construction determines that
the performance obligation is satisfied over time because Good Construction’s performance
creates or enhances an asset (property in Sandringham) that the customer controls as the asset
(the new home) is created or enhanced. The home is constructed on a block of land owned and
controlled by the customer.
Example – Creates or enhances an asset that is NOT controlled by the customer as the asset
is created or enhanced
Big Developer is developing a multi-unit residential complex in Docklands, Melbourne.
A customer enters into a binding sales contract with Big Developer for a specified unit that is
under construction. Each unit has a similar floor plan and is of a similar size, but other attributes
of the units are different (e.g. the location of the unit within the complex)
The customer pays a 10% deposit upon entering into the contract and the deposit is refundable
only if Big Developer fails to complete construction of the unit in accordance with the contract.
The remainder of the contract price is payable on completion of the contract when the
customer obtains physical possession of the unit. If the customer defaults on the contract before
completion of the unit, Big Developer has the right to retain the deposit.
In accordance with Step 5 of the five-step revenue model, at contract inception, Big Developer
determines whether its promise to construct and transfer the unit to the customer is a
performance obligation satisfied over time or a point in time.
Big Developer determines that the customer does not simultaneously receive and consume
the benefits provided by Big Developer’s performance as Big Developer performs (i.e.
construct the building), because the customer only gets physical possession of the unit on
completion of the building.
Big Developer also determines that its performance does not create or enhance an asset that
the customer controls as the asset is created or enhanced, because the customer does not own
the block of land on which the building is constructed and the customer only gets physical
possession of the unit on completion of the building.
Big Developer further determines that its performance creates an asset with an alternative
use to Big Developer, because it could sell the unit to another buyer/customer. However, Big
Developer determines that it does not have an enforceable right to payment for performance
completed to date because, until construction of the unit is complete, Big Developer only has
a right to the deposit paid by the customer. As Big Developer does not have a right to payment
for work completed to date, its performance obligation is not a performance obligation satisfied
over time. Instead, Big Developer accounts for the sale of the unit as a performance obligation
satisfied at a point in time.

Measuring progress towards complete satisfaction of a performance STEP

5
obligation
Appropriate methods of measuring progress towards complete satisfaction of a performance
obligation include output methods and input methods.
Output Input
methods methods
Appraisals of Labour hours

results achieved
Survey of work Time elapsed

completed
Time elapsed Machine hours

used
Milestones
reached Costs incurred
Units produced
or delivered
In determining the appropriate method for measuring progress, an entity shall consider the
nature of the good or service that the entity promised to transfer to the customer.
Required reading
Read IFRS 15 paras 39–45 now to understand ways to measure progress.
How does revenue recognition under IFRS 15 work when foreign

currencies are involved?
Recognising revenue received in foreign currencies is covered in unit 5 of this Candidate study.
It is governed by IFRS 15 and by IAS 21 The Effects of Changes in Foreign Exchange rates.
IAS 21 paragraph 21 requires an entity to record the transaction in the entity’s functional
currency, using the spot exchange rate at the date of the transaction. IAS 21 tells us that this
date is the date on which the transaction first qualified for recognition in accordance with
the standards.
Recently, IFRIC 22 Foreign currency transactions and Advance Consideration has clarified how
to determine the transaction date for revenue received in advance. For revenue received in
advance, IFRIC 22 tells us the date of the transaction is the initial date when the deferred
revenue liability is recognised. If there are multiple receipts in advance, there will be multiple
transaction dates under IAS 21.
These concepts will be explored further in unit 5.
Further reading
IFRIC 21 Foreign currency transactions and Advance consideration.

Disclosure
IFRS 15 requires a number of disclosures to ensure users are able to understand revenue and
cash flows arising from contracts with customers.
Revenue from contracts with customers must be disclosed separately from other sources of
revenue. Impairment losses from contracts with customers should be disclosed separately from
other impairment losses. Significant judgements made in applying IFRS 15 must be disclosed.
Required reading
Read IFRS 15 paras 110–129 now to understand disclosure requirements.
Further reading
Slater and Gordon Limited, 2018 Annual Report, Notes 3.1.1 and 3.1.2,
https://assets.slatergordon.com.au/downloads/Slater-Gordon-Annual-Report-2018.pdf
Activity 3.1
Activity 3.2
Worked example 3.1

Worked example 3.2

Quiz
Working paper A
You are now ready to complete working paper A of integrated activity 4, to help you
understand how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.

Unit 4: Income taxes
Contents
Introduction 4-3
Tax effect accounting 4-3
Scope 4-4
Overview of IAS 12 4-4
The underlying transaction 4-5
Current tax 4-6
Methodology for calculating and accounting for current tax 4-6
Calculating the current tax liability where the entity has derived a taxable income 4-7
Determining the current tax liability 4-7
Current tax asset versus current tax liability 4-14
Deferred tax 4-15
Methodology for calculating and accounting for deferred tax 4-15
Step 1 – Calculate temporary differences at end of reporting period 4-15
Step 2 – Allocate temporary differences 4-17
Step 3 – Calculate deferred tax balances at the end of the reporting period 4-19
Step 4 – Apply recognition criteria 4-19
Step 5 – Calculate movement in deferred tax balances 4-20
Step 6 – Prepare the journal entry 4-21
Reversals of temporary differences 4-24
Complexities with deferred tax 4-25
Initial recognition exemption for DTAs and DTLs 4-26
Specific recognition exceptions concerning DTAs and DTLs 4-27
Changes in prior year taxes due to errors or estimates 4-27
Other tax effect accounting issues 4-29
Changes in tax rates and tax laws 4-29
Consolidated financial statements 4-29
Presentation 4-30
Offsetting tax balances 4-30
Presenting income tax expense 4-30
Disclosures 4-31
Income tax expense 4-31
Methodology for accounting for income tax expense recognised in profit or loss 4-31
Elements of income tax expense for separate disclosure 4-31
Other disclosure issues 4-32
APPENDIX: Determining the tax base of an asset or liability that gives rise to a temporary
difference 4-33
fin11904_csg_09


Learning outcomes
1. Explain the purpose of tax effect accounting.
2. Calculate and account for current tax.
3. Calculate and account for deferred tax.
4. Explain and account for changes in prior year taxes.
5. Explain and account for income tax expense.
Introduction
This unit deals with the accounting treatment of an entity’s income tax in its financial
statements (also commonly called ‘tax effect accounting’ or ‘tax accounting’), as detailed in
IAS 12 Income Taxes.

Tax effect accounting

The calculation of accounting profit/(loss) for a particular period usually does not equal the
calculation of taxable income/(loss) for that same period. This is because accounting profit/
(loss) is determined under applicable Accounting Standards, whereas taxable income/(loss) is
determined in accordance with the taxation laws of the applicable jurisdiction. For example,
fines are usually not allowed as a deduction for tax purposes but are expensed when
calculating accounting profit/(loss). There is a need to account for these differences in a set of
The purpose of covering IAS 12 in the FIN module is to see how the standard applies to more
common accounting and taxation scenarios. Complex tax situations and their impact on tax
effect accounting are beyond the scope of the FIN module. Accordingly, the approach taken in
this unit is to demonstrate the typical situations likely to be encountered in practice.
The examples throughout this unit are based on a 30% tax rate. The appropriate tax rate will be
stated in worked examples, activities and exam questions.

Scope
IAS 12 applies to accounting for income taxes. It does not apply to other taxes such as property
taxes and value-added taxes, or goods and services tax.
For the purposes of IAS 12, income taxes include:
•• All domestic and foreign taxes based on ‘taxable profits’.
•• Taxes (including withholding taxes) which are payable by a subsidiary, associate or joint
arrangement on distributions to the reporting entity.
Overview of IAS 12
The objective of IAS 12 is to specify the accounting treatment for income taxes. Some key
principles of IAS 12 to understand at this stage of the unit can be summarised as follows:
Key principles of tax effect Points to note

accounting
Time of recording tax effect •• Generally, when preparing the financial statements, tax effect entries are
journal entries recorded after all other journal entries have been recorded
•• Therefore, tax effect entries are recorded on the last day of the reporting
period
The tax liability arising from The current tax liability represents the current balance of income taxes
transactions and events payable to taxation authorities (i.e. the Australian Taxation Office (ATO) and
occurring in the current New Zealand Inland Revenue (IR)) based on the taxable income for the year
reporting period results in
the recognition of a current
tax liability
Temporary differences arise Temporary differences arise when a transaction or event is recognised in
from the expected future tax a different period in the financial statements, rather than when they are
consequences of transactions recognised for taxation purposes
and events occurring in the IAS 12 requires the related tax for a transaction or event to be recognised.
current reporting period Think of this as an accounting matching concept
From a tax viewpoint, the taxation liability occurs in a different period, which
creates a mismatch. This mismatch can be shown as follows:
Interest revenue and 20X6 Interest is assessable

the related tax have REPORTING for tax purposes in this
been recognised for
accounting purposes end period when it is
received
even though there is no
current tax liability in A current tax liability is
respect of the interest recognised in respect of
as it has not yet been the interest
received
To rectify this mismatch, IAS 12 requires the recognition of a deferred tax

asset (DTA) or a deferred tax liability (DTL) for most temporary differences

Key principles of tax effect Points to note

accounting
Temporary differences Think of a DTA as representing income tax that has been paid in advance (like
generally result in the a prepayment of tax). The entity will recover this tax benefit (e.g. by paying a
recognition of a DTA or a DTL lower amount of income tax in a future period)
Think of a DTL as representing the receipt of a tax benefit in advance.
The entity will have to repay this tax benefit (e.g. by paying a higher amount
of income tax in a future period)
Referring to the previous diagram, a DTL would be recognised in the
first reporting period to reflect there was no tax paid on the revenue in the first
period; however, there is tax to be paid in the future when the revenue is received
Interest revenue and 20X6 Interest is assessable

the related tax have REPORTING for tax purposes in this
been recognised for
accounting purposes end period when it is
received
even though there is no
current tax liability in A current tax liability is
respect of the interest recognised in respect of
as it has not yet been the interest
received
The financial The deferred tax

statements need to liability reverses.
reflect there is a future What was a deferred tax
tax liability in respect of liability becomes a
the interest receivable. current tax liability now
A deferred tax liability that the interest has
is recognised been received and is
assessable for tax
purposes
Therefore for temporary differences, it is all a matter of timing
The underlying transaction

The ‘Objective’ paragraph in IAS 12 states that an entity should:
…account for the tax consequences of transactions and other events in the same way that it accounts for
the transactions or other events themselves.…
Accordingly, the approach taken in this unit is that the equity side of a tax effect journal entry
follows the underlying transaction.
A matrix approach to following the underlying transaction helps to prepare tax effect journal
entries correctly:
Where is the underlying Which account within the Tax asset or tax liability
transaction recognised? equity section of the statement
of financial position is the tax Current tax liability DTA or DTL
effect recognised?
In profit or loss (by Income tax expense1 Recognised a current Recognised a

recognising revenue and tax liability where DTA or DTL where
expenses for the year) the underlying the underlying
transaction has transaction gives
As a current year reserve Offset the related tax effect against a current tax rise to a future tax
movement the particular reserve account consequence consequence
As a current year equity Offset the related tax effect against
movement the particular equity account
(e.g. share capital)
Note 1 – Think of income tax expense as an account that matches the tax for the period against the profit
recognised for the period. Expenses are recognised within profit or loss, therefore ‘income tax expense’
relates to the tax effect of transactions recognised in profit or loss.

Required reading
The whole of IAS 12 is required reading for this unit. At specified points, you will be directed to
read certain paragraphs to enable you to progress through this unit.
Read IAS 12 ‘Objective’ paragraph and paras 1–4 before proceeding.
The process of applying IAS 12 for the purposes of this unit is shown as follows:
The process of applying IAS 12
Calculate Calculate Consider Present the item Prepare the

the the if there in the relevant disclosures for
current tax deferred tax are any other part of the the notes to
tax effect financial the financial
accounting statements statements
issues (e.g. current
liabilities,
non-current
liabilities,
expenses)
Current tax
Current tax is defined in IAS 12 para. 5 as ‘the amount of income taxes payable (recoverable) in
respect of the taxable profit (tax loss) for a period’.
Required reading
Read IAS 12 paras 5–6 and 12–14 before proceeding.
Methodology for calculating and accounting for current tax

The calculation of taxable profit/(loss) and the related current tax liability/(asset) is based on
local tax laws.
For the purposes of this unit, the term ‘taxable income/(tax loss)’ will be used in place of
the IAS 12 terminology of ‘taxable profit/(loss)’ when performing the current tax liability/
(asset) calculation, due to the familiarity of Australian and New Zealand candidates with this
terminology in their local tax laws.
In a straightforward situation, the current year taxable income or tax loss is calculated as follows:
Assessable income for tax

Taxable income = – Tax deductions
purposes
Assessable income for tax

Tax loss = Tax deductions –
purposes
Please note that as candidates studying the FIN module reside and practise in a variety of
jurisdictions, the tax treatment to be applied in the FIN module assessment material will always
be stated to avoid confusion.

Calculating the current tax liability where the entity has derived
a taxable income
The process of calculating the current tax liability can be shown as follows:
Accounting profit/(loss) before

+/– Adjustments = Taxable income
income tax
Taxable income × Tax rate = Net tax payable
Net tax payable – Tax offsets/credits = Current tax liability/asset
Determining the current tax liability

The current tax liability is calculated using a reconciliation method that starts with accounting
profit/(loss) before tax and makes a number of adjustments, to arrive at the current tax liability
for the period. A template that assists with this reconciliation method is below.
Worksheet to calculate the current tax liability
Item $ $
Accounting profit before tax
1. Non-temporary difference adjustments
2. Temporary difference adjustments
3. Equity or OCI adjustments affecting taxable income
Taxable income prior to utilising carryforward tax losses
Less: utilisation of carryforward tax losses
Taxable income
Current tax liability @ tax rate
The template provides a methodical approach to recording the tax effect entry to recognise the
current tax liability. The various adjustments to the accounting profit/(loss) after tax figure are
discussed further below.
Adjustments
In many instances, the tax and accounting treatments of items will differ substantially. It is these
adjustments that give rise to the need for tax effect accounting.
The accounting treatment is based on the principles of accrual accounting and the requirements
of the International Financial Reporting Standards (IFRS), while the income tax treatment is
based on the requirements of tax legislation.

The adjustments to the accounting profit/(loss) before tax figure can be grouped into three
broad categories:
1. Non-temporary difference adjustments.
2. Temporary difference adjustments.
3. Equity or OCI adjustments affecting taxable income.
1. Non-temporary difference adjustments – where the accounting and tax

treatments of an item will never be the same
IAS 12 does not provide a name for these types of adjustments but for the purposes of the
FIN module, they will be called non-temporary differences, to distinguish them from temporary
differences. Unlike temporary differences, there is no tax effect accounting for non-temporary
differences in future reporting periods.
Examples of non-temporary differences include:
•• Items included in accounting profit that will never be included in taxable income (e.g. a tax-
free capital gain, non-deductible fines, donations or entertainment expenditure).
•• Items included in taxable income that will never be included in accounting profit
(e.g. government incentives where the allowable tax deduction exceeds actual expenditure).
Example – Where the accounting and tax treatments of an item will never be the same
This example illustrates how to calculate current tax when there is a non-temporary difference
for an item included in the accounting profit.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7. Included in the profit is
$200,000 in entertainment expenses that will never be deductible for tax purposes. The taxable
income was calculated as follows:
Item $
Accounting profit before tax 1,000,000
Non-temporary difference adjustments
Entertainment expenses 200,000
Taxable income 1,200,000
The tax effect journal entry to record the current tax liability is:
$ $
30.06.X7 Income tax expense 360,000
Current tax liability 360,000
Recognition of the current tax liability for the year ended 30 June 20X7 ($1.2 million × 30%)

2. Temporary difference adjustments – where the accounting and tax

treatments of an item are the same but are recognised in different periods
These are income and expense items that are included in accounting profit in one period, and in
taxable income in a different period. Such items give rise to temporary differences. Examples of
temporary differences are provided in the table below:
Tax treatment of common temporary differences
General examples Treatment in current tax Specific examples

liability calculation
New Zealand Australia
Liabilities not tax Add back the accounting Accrued tax and Superannuation
deductible until paid (and expense, subtract the tax accounting fees for contributions (subject to
therefore the expense is deduction services to be performed meeting all other conditions
not deductible) in a future period for deductibility)
Provision for employee Provision for employee
entitlements – holiday entitlements – long
pay, long service leave, service leave, annual leave
bonuses not paid within (deductible when incurred
63 days of balance date which is usually when paid)
Liabilities not tax Add back the accounting Warranty provisions,

deductible until expense, subtract the tax bonuses, other accruals
incurred (and therefore deduction (e.g. estimated audit fees)
the expense is not
deductible)
Asset write-downs not Add back the accounting Allowance for impairment Allowance for impairment
tax deductible until a expense, subtract the tax loss – trade receivables loss – trade receivables –
particular future event deduction – deductible only when bad debt deduction only
debt is written-off as bad when previously brought
Provision for stock to account as income and
obsolescence – only specifically written off
deductible if written as bad
down to market selling
value or realised on
disposal
Costs which are expenses Add back the accounting Expenses relating to an Initial repairs for newly
for accounting but are expense, subtract the tax asset under development acquired assets
capitalised as part of the deduction (if any)
cost of an asset for tax
purposes
Assets written-off for Add back the accounting Plant and equipment Plant and equipment with
tax and accounting at expense, subtract the tax with accelerated tax accelerated tax depreciation
different rates deduction depreciation
Costs capitalised as Add back any accounting Interest capitalised to an Certain prepayments
assets for accounting but expense recognised asset under development
deductible when paid (e.g. amortisation of the that is deductible when
for tax capitalised cost), subtract incurred
the tax deduction
Expenses capitalised as Add back the accounting Premium paid to acquire Certain borrowing costs
assets for accounting expense, subtract the tax leased land that is deductible over the life
but tax deductible over a deduction deductible over the lease of the loan or five years,
different time period period whichever is shorter
Income not yet derived Subtract the accounting Income from certain land Accrued interest income on
for tax revenue, add the tax sales that is not derived a term deposit
revenue for tax purposes until
settlement
Note: The tax treatment of temporary differences in this table is simplified and the examples are not exhaustive.
Temporary differences and their impact on deferred tax are discussed in the section on deferred tax.

Example – Where the accounting and tax treatment of an item are the same but are
recognised in different periods
This example illustrates how to calculate current tax when there is a temporary difference for an
item included in the accounting profit.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7. Included in the profit is
$100,000 in interest revenue that will be assessable for tax purposes when it is received in the
next reporting period. The taxable income was calculated as follows:
Item $
Temporary difference adjustments
Interest revenue (100,000)
Taxable income 900,000
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($900,000 × 30%)
3. Equity or OCI adjustments affecting taxable income – when the underlying
transaction is recognised outside profit or loss
Where adjustments have been accounted for outside profit or loss, the tax consequences of those
adjustments must be accounted for in the same way (i.e. the tax effect will follow the accounting
treatment) (IAS 12 para. 61A).
Required reading
Read IAS 12 para. 61A before proceeding.
3A: Equity adjustments affecting taxable income – when the underlying transaction is
recognised directly in equity
Sometimes a transaction or event is included in the calculation of taxable income; however, it is
not included in the accounting profit but is recognised in equity.
The tax relating to an underlying transaction recognised directly in equity is recorded against
that transaction (IAS 12 para. 61A(b)).

Example – Where the underlying transaction is recognised in equity and is included in

taxable income
This example illustrates how to calculate current tax when there is an item that is deductible for
tax purposes that has been recognised directly in equity.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7. Share issue costs of
$80,000 were debited against the share capital account (the entry was Dr Share capital $80,000,
Cr Cash) as is discussed in Unit 9. These costs are tax deductible. The taxable income was
calculated as follows:
Item $
Equity or OCI adjustments affecting taxable income
Share issue costs (80,000)
$ $
30.06.X7 Income tax expense1 300,000
Share capital2 24,000
Recognition of the current tax liability for the year ended 30 June 20X7 ($920,000 × 30%)
Notes
1. The income tax expense is $300,000 as it is the current tax relating to the underlying transactions that
have been recognised in profit ($1 million × 30%).
2. The share capital issued during the year, net of the share issue costs and related tax effect, will be
disclosed in the statement of changes in equity as was discussed in Unit 2.

3B: OCI adjustments affecting taxable income – when the underlying transaction is disclosed
in other comprehensive income
Sometimes a transaction or event is included in the calculation of taxable income; however, it
is not included in the accounting profit but is disclosed in other comprehensive income (OCI).
In practice this is quite unusual as items disclosed in OCI generally have deferred tax
consequences rather than immediate tax consequences (as discussed in the section on
deferred taxes).
The tax relating to an underlying transaction that is disclosed in OCI is recorded against that
transaction (IAS 12 para. 61A(a)).
Example – Where the underlying transaction is disclosed in OCI and is included in taxable
income
This example illustrates how to calculate current tax when there is an item that is assessable for
tax purposes that has been disclosed in OCI.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7. Disclosed in OCI was
a $60,000 gain relating to the fair value movement on a financial asset. The gain was credited
to the fair value through OCI reserve account (see note 2 below). For tax purposes, this gain is
assessable. The taxable income was calculated as follows:
Item $
Equity or OCI adjustments affecting taxable income
Gain on financial asset disclosed in OCI 60,000
Taxable income 1,060,000
$ $
30.06.X7 Income tax expense1 300,000
Fair value through other comprehensive income reserve2, 3 18,000
Recognition of the current tax liability for the year ended 30 June 20X7 ($1,060,000 × 30%)
Notes
1. The income tax expense is $300,000 as it is the current tax relating to the underlying transactions that
have been recognised in profit ($1 million × 30%).
2. The accounting treatment of assets categorised as fair value through OCI is covered in Unit 9.
3. The $60,000 movement in the fair value through OCI reserve, net of the $18,000 tax effect will be
disclosed in OCI (as was discussed in Unit 2).
FIN fact
Current tax is the current liability owing to the taxation authority in respect of income taxes.
The liability is reduced by any tax payments that have already been made (e.g. company tax
instalments or pay as you go (PAYG) instalments).

Utilisation of carryforward tax losses

Using/recouping carryforward tax losses has the effect of lowering taxable income, which
decreases the current tax liability.
Further discussion of the treatment when a tax loss is first incurred is covered in the section on
deferred tax, which will clarify the two different scenarios in the example below. You may like
to revisit this example after you have studied that section.
Example – Using carryforward tax losses

This example illustrates how to account for the recoupment of a carryforward tax loss incurred in
the previous year.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7 before recouping
$200,000 in carryforward tax losses incurred during the year ended 30 June 20X6. There were
no temporary or non-temporary differences for the year. The taxable income was calculated
as follows:
Item $
Taxable income prior to utilising carryforward tax losses 1,000,000
Less: Utilisation of carryforward tax losses (200,000)
Current tax liability at 30% 240,000
If the carryforward tax losses had not been recognised at 30 June 20X6 as a deferred tax asset:
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($800,000 × 30%) including the
recoupment of a prior period loss that had not previously been recognised as a DTA
If the carryforward tax losses had been recognised at 30 June 20X6 as a deferred tax asset:
$ $
Deferred tax asset 60,000
Recognition of the current tax liability for the year ended 30 June 20X7 ($800,000 × 30%) including the
recoupment of a prior period loss that had previously been recognised as a DTA

Prepare the journal entry to record the current tax liability

Using the current tax liability figure calculated in the worksheet, the journal entry is prepared to
recognise the current tax liability.
The diagram below summarises how to prepare the journal entry:
Two key issues to prepare the tax effect journal entry for
the current tax liability
Issue 1 – Issue 2 –
liability side equity side for underlying
Does the tax impact of transaction
the underlying Determine which bucket
transaction create a to record the tax effect in
current tax liability?
Yes, there is a P/L – Income

CTL
current tax impact tax expense
OCI – Related tax

offset against that
current year reserve
movement e.g. fair
value through OCI
reserve account
Equity – Related tax
offset against the
equity account e.g.
share capital
account
Current tax asset versus current tax liability

A current tax asset may arise where the entity has made payments to the taxation authority
throughout the year in expectation of earning taxable income (e.g. where company tax
instalments or PAYG instalments have been paid in excess of the finalised current tax liability,
which may be $0 where there is a tax loss). To the extent that these payments are refundable by
the taxation authority, a current tax asset rather than a current tax liability would be recognised
by the entity.
Worked example 4.1: Calculating the current tax liability


Deferred tax
Deferred tax in the statement of financial position represents the future tax consequences of past
transactions or events. As discussed earlier:
•• DTA represents income tax that has been paid in advance (like a prepayment of tax). The entity
will recover this tax benefit (e.g. by paying a lower amount of income tax in a future period).
•• DTL represents receiving a tax benefit in advance. The entity will have to repay this tax
benefit (e.g. by paying a higher amount of income tax in a future period).
IAS 12 adopts what is effectively a ‘balance sheet’ approach with temporary differences.
The carrying amount of an asset or liability in the statement of financial position is compared
with its tax base to determine the future tax consequences that must be accounted for under
IAS 12. The tax base is the value that would be attributed to an asset or liability for tax purposes
if a notional ‘tax balance sheet’ was prepared.
As per IAS 12’s ‘Objective’ paragraph, it is inherent in the recognition of an asset or liability that
that asset or liability will be recovered or settled, and this recovery or settlement may give rise
to future tax consequences which should be recognised at the same time as the asset or liability.
Put more simply, if there is a future tax consequence associated with the sale of an asset or
the settlement of a liability, then that future tax must also be recognised on the balance sheet.
For example, users of the financial statements need to be informed that a future sale of asset will
result in a tax liability.
Required reading
Read IAS 12 paras 7–11, 15–18, 24–26, 46–49, 51 and 57–60 before proceeding.
Methodology for calculating and accounting for deferred tax

The following diagram represents the steps in calculating and accounting for deferred tax in a
period at the end of the reporting period:
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6
Calculate Allocate Calculate Apply Calculate Prepare

temporary temporary deferred tax recognition movement journal
differences differences balances criteria in deferred entry
tax
balances
Step 1 – Calculate temporary differences at end of reporting period STEP

1
A temporary difference will result in either an increase or a decrease in tax payable in future
periods.
The following diagram shows how temporary differences are calculated:
Calculating temporary differences at end of reporting period
Carrying amount – Tax base = Temporary difference
Carrying amount
The carrying amount at end of reporting period is the net amount of an asset or liability that is
recorded in the accounting records of the entity, determined in accordance with the relevant
IFRS. The carrying amount is net of any accumulated depreciation/amortisation or allowances
(e.g. an allowance for impairment loss – trade receivables).

STEP Even though the carrying amount may not be apparent, deferred tax should still be accounted
1
for in respect of assets and liabilities that:
•• have a nil carrying amount (e.g. items expensed in profit or loss for accounting purposes but
that are not deductible for tax purposes until a future period), or
•• only exist for tax purposes (e.g. intangibles that are recognised for tax but expensed for
accounting purposes).
Tax base
The tax base at end of reporting period is the amount that is attributed to an asset or liability for
tax purposes by following the requirements of the tax legislation. (Think of this as amount that
would appear if a tax balance sheet was prepared by the entity). Calculation of the tax base is
one of the more challenging aspects of tax effect accounting.
In the FIN module we recommend using either of the following two approaches to determine
the tax base of an asset or liability:
Notional tax balance sheet approach Formula-based approach
Determine the value that would be recognised for Apply the appropriate formula to the asset or liability
the asset or liability if a notional tax balance sheet to determine the tax base
was prepared
You do not have to apply the same approach for each temporary difference. Use the approach
that makes more sense to you.
Example – Calculating temporary differences for an asset and liability

This example illustrates how to calculate a temporary difference in respect of a depreciable
machine and provision for annual leave. The details of the accounting and tax treatment of each
item is below:
Item Accounting treatment Tax treatment
31 Dec 20X8
$
Machine – written down 125,000 The original purchase To calculate the tax base of
value price for the machine was the machine, we need to
$200,000 on 1 Jan 20X6 look at both the machine
The machine is depreciated and the accumulated
on a straight-line basis over depreciation using tax
its useful life of eight years depreciation rate. The tax
base of the machine is equal
to its original cost
The asset is being
depreciated for tax purposes
on a straight-line basis over
five years. The tax written
down value at 31 Dec 20X8
is $80,000
Provision for annual leave (55,000) The provision for Annual leave payments are
annual leave represents deductible for tax when they
entitlements expected to are paid
be paid in the following
12 months

The temporary differences are calculated by subtracting the tax base of the item from its STEP
1
accounting carrying amount as follows:
Calculation of temporary differences
Carrying amount Tax base Temporary difference
$ $ $
Machine – written down value 125,000 80,0001 45,000
Provision for annual leave 55,000 0 2
55,000
Note Tax base calculation

Notional tax balance sheet approach OR Formula-based approach
1 Machine If a tax balance sheet was prepared, the $125,000 carrying amount – $125,000
machine’s $80,000 tax written down future taxable amounts (capped
value would be recognised at the asset’s carrying amount) +
$80,000 in future deductible amounts
2. Provision for If a tax balance sheet was prepared, $55,000 carrying amount – $55,000
annual leave there would not be an employee in future deductible amounts (the
benefits liability for annual leave. accounting balance sheet tells us we
Annual leave is a deduction on a cash are going to pay $55,000 in annual
basis, not carried forward. Therefore leave in the future. When paid, this
the tax base is zero will become a tax deduction. So the
future deductible amount is $55,000
+ $0 future taxable amounts (as a
liability will not be taxable)
Further examples of the tax base of assets and liabilities are provided in IAS 12 paras 7 and 8.
Further examples of tax base calculations

Appendix: Determining the tax base of an asset or liability that gives rise to a temporary
difference
[In addition to the Appendix, further examples are available online in myLearning]
FIN fact
If the accounting carrying amount and the tax base are equal, there will be no temporary
difference and, therefore, no deferred tax balance in relation to the item.
Step 2 – Allocate temporary differences STEP

2
Temporary differences are allocated into:
•• Taxable temporary differences (TTDs) – where tax payable in future periods is increased.
•• Deductible temporary differences (DTDs) – where tax payable in future periods is decreased.
The following diagram outlines the allocation between TTDs and DTDs:
Temporary differences
Deductible temporary Taxable temporary

differences differences
Deferred tax asset DTA Deferred tax liability DTL
Pay tax upfront, tax Get the tax benefit
benefit in the future, upfront, more tax to pay
therefore an asset in the future, therefore a
liability

STEP Once the temporary differences for each asset or liability have been calculated (from Step 1),
2
each temporary difference must be allocated as a taxable temporary difference or deductible
temporary difference using the following allocation rules:
Account Condition Type of Temporary Example

temporary difference
difference gives rise
to….
Asset Carrying amount > TTD DTL Assets with a higher rate of depreciation for
tax base tax than for accounting
Asset Carrying amount DTD DTA Trade receivables net of an allowance for
< tax base impairment loss (as the allowance is not
recognised for tax)
Liability Carrying amount < TTD DTL Certain compound financial instruments
tax base split for accounting purposes (between
liability and equity) but not for tax purposes
Liability Carrying amount > DTD DTA Accounting provisions not deductible for tax
tax base until paid
FIN fact
To apply the deferred tax rules, we need to first determine whether we looking at an asset or
a liability.
From there, we compare the carrying amount to the tax base. This tells us which allocation
rule is relevant, and in turn, whether a DTA or DTL is the result.
Example – Allocating a temporary difference for an asset and liability

This example illustrates how to allocate a temporary difference for a depreciable machine and a
provision for annual leave as follows:
Allocation of temporary differences
Step 1 Applicable Step 2
allocation rule
Carrying Tax base Temporary Taxable Deductible
amount difference temporary temporary
difference (TTD) difference (DTD)
$ $ $ $ $
Machine – 125,000 80,000 45,000 Asset rule: 45,000
written Carrying amount
down value > tax base
Provision 55,000 0 55,000 Liability rule: 55,000
for annual Carrying amount
leave > tax base
Using the allocation rules, the temporary difference for the machine and the provision can be
correctly allocated as either a TTD or DTD:
•• Machine – As this is an asset, and the $125,000 carrying amount is greater than the $80,000
tax base, there is a $45,000 TTD. It is a TTD as more tax will be payable in the future when
the asset is fully depreciated for tax purposes (year 5) but continues to be depreciated for
accounting purposes for a further three years which will not be tax deductible.
•• Provision for annual leave – As this is a liability, and the $55,000 carrying amount is greater
than the $0 tax base, there is a $55,000 DTD. It is a DTD as a tax benefit will be received in
later years when the annual leave is paid in cash.
Further reading
IAS 12 para. 52 and IAS 12 Illustrative Examples – Examples of Temporary Differences.

Step 3 – Calculate deferred tax balances at the end of the reporting STEP
3
period
Calculating the deferred tax balances involves two steps:
•• Calculate the deferred tax liability (DTL) in respect of TTDs.
•• Calculate the deferred tax asset (DTA) in respect of DTDs.
The treatment to be applied to tax losses that have been incurred is covered later in the unit.
Tax rate
Applying the measurement criteria in IAS 12 paras 47–51, deferred tax balances are typically
calculated at the tax rates that are expected to apply in the reporting period when the temporary
difference is expected to reverse.
Calculating DTLs
TTD × Tax rate % = DTL
Calculating DTAs
DTD × Tax rate % = DTA
Example – Calculating a deferred tax balance for an asset and liability

This example illustrates how to calculate a deferred tax balance in respect of the machine and
provision for annual leave by calculating the total temporary differences for TTDs and DTDs and
applying the tax rate.
Calculation of deferred tax balances

amount $ difference temporary temporary
$ $ difference difference
(TTD) (DTD)
$ $
Machine – written down 125,000 80,000 45,000 45,000 0

value
Provision for annual 55,000 0 55,000 0 55,000

leave
Total temporary 45,000 55,000

Step 3 differences
DTL/DTA at 30% 13,500 16,500
The TTD of $45,000 x 30% tax rate = $13,500 DTL

The DTD of $55,000 x 30% tax rate = $16,500 DTA
Step 4 – Apply recognition criteria STEP

4
Once the DTA and DTL balances have been calculated, it will need to be determined whether
they can be recognised in the financial statements. DTAs and DTLs are only recognised after
considering the following:
•• General recognition criteria.
•• Specific recognition exceptions.
Specific recognition exceptions are explained under the heading ‘Complexities with deferred
tax’ later in this unit.

STEP
4 General recognition criteria
DTAs DTLs
A DTA relating to a DTD is only recognised to the A DTL arising from a TTD should be recognised
extent that it is probable that future taxable profit will in all cases unless a specific exception applies
be available against which the DTD can be utilised (IAS 12 para. 15)
(IAS 12 para. 24)
Points to note:
•• ‘Probable’ is not specifically defined in IAS 12, but
is defined in both IFRS 5 Non-current Assets Held
for Sale and Discontinued Operations and IAS 37
Provisions, Contingent Liabilities and Contingent
Assets as ‘more likely than not’
•• If DTDs are expected to reverse in the same
period as TTDs are expected to reverse, and the
TTDs are of greater value than the DTD, then the
DTA relating to those DTDs can be recognised.
For example, $10,000 in tax deductions (from
DTDs) are expected to arise in the same period as
when $15,000 in future income will be assessable
(from TTDs). As the $15,000 TTD is greater than
the $10,000 DTD, a $3,000 DTA relating to the
$10,000 in DTDs can be recognised as an asset
(IAS 12 para. 28)
•• In determining whether it is probable that taxable
profits will be available, an entity can take into
account any tax planning opportunities that will
create taxable profit in appropriate periods
•• Any specific tax attributes in respect of the DTA and
DTL must be considered (e.g. tax rules that may
limit the ability to recover the DTA). For example, in
Australia, capital losses can only be used to offset
capital gains. Therefore, where an asset is expected
to result in a future capital loss (as it has been
impaired), the DTA can only be recognised where
it is probable that sufficient future capital gains
(rather than revenue gains) will be available
STEP
5 Step 5 – Calculate movement in deferred tax balances
The movements in deferred tax balances since the prior period need to be calculated.
The tax effect journal entry reflects only the movements that arise in the current period in the
DTL and DTA balances, as the opening balances in these accounts recognised at the end of
the prior reporting period in the statement of financial position will have been carried forward.
The current period movement to be recorded in the journal entry is calculated as follows:
Closing balance – Opening balance = Movement in DTA/DTL
Example – Calculating a movement in deferred tax balances

This example illustrates how to calculate a movement in the DTA and DTL for the machine and
the provision for annual leave.
As at 31 December 20X7, the closing deferred tax balances were:
•• DTA – $10,500
•• DTL – $9,000
These balances carry forward into the 31 December 20X8 year and are used to determine the
movement of the deferred tax balances that will be recorded in the journal entry:

STEP
Calculation of deferred tax balances 5

amount difference temporary temporary
difference (TTD) difference (DTD)
$ $ $ $ $
Machine – 125,000 80,000 45,000 45,000 0

written down
value
Provision for 55,000 0 55,000 0 55,000

annual leave
Total 45,000 55,000

temporary
differences
DTL/DTA at 13,500 16,500

30%
Less: Opening (9,000) (10,500)

balances
Movement 4,500 6,000
The movement in the DTA and DTL are:

•• $4,500 increase in the DTL from the opening balance of $9,000 which brings the closing
balance at 31 December 20X8 to $13,500
•• $6,000 increase in the DTA from the opening balance of $10,500 which brings the closing
balance at 31 December 20X8 to $16,500
FIN fact
When a temporary difference reverses, the journal entry will reduce the deferred tax balance.
For example, the reversal of a DTA will be recognised by crediting the DTA account. A negative
movement from Step 5 indicates that the deferred tax balance is reversing.
Step 6 – Prepare the journal entry STEP

6
The journal entry is recording the movements in the DTA and DTL for the period so that the
closing deferred tax balances agree with the values calculated at Step 3.
Example – Preparing the journal entry to recognise the movement in the deferred tax
balances
The tax effect journal entry to record the deferred tax asset and deferred tax liability from the
preceding example is:
$ $
31.12.X8 Deferred tax asset (DTA) 6,000
Deferred tax liability (DTL) 4,500
Income tax expense 1,500
Recognition of the movement in the deferred tax balances at 31 December 20X8
Notes
1. Notice that the net movement in the deferred tax balances is recognised in income tax expense. This is
because the underlying transactions were recognised in profit, and not in other comprehensive income
or equity.

FIN fact
As DTAs and DTLs are statement of financial position items, last period’s closing balance will carry
forward. Therefore, the journal entry is simply recording the movement in the DTA and DTL to
arrive at the closing balance that will be included in the statement of financial position.
Worked example 4.2: Calculating current and deferred tax: an overview

Calculating deferred tax – When the underlying transaction is disclosed in other

comprehensive income
Required reading
Read IAS 12 paras 61A–65 before proceeding.
IAS 12 para. 61A requires current and deferred taxes to be recognised outside profit or
loss where these taxes relate to items that are recognised outside profit or loss (in other
comprehensive income or directly in equity). IAS 12 paras 62 and 62A outline examples of these
items including:
•• A change in carrying amount arising from the revaluation of property, plant and equipment
(see Unit 7).
•• Exchange differences arising from the translation of the financial statements of a foreign
operation (see Unit 5).
•• An adjustment to the opening balance of retained earnings resulting from either a change in
accounting policy that is applied retrospectively, or the correction of an error (see Unit 2).
The 6-step process also applies to determining the journal entry for the deferred tax when the
underlying transaction is disclosed in other comprehensive income.
Example – Deferred tax balance arising on items disclosed in OCI

This example illustrates the treatment of deferred tax arising from the revaluation of a parcel
of land.
A company purchases a parcel of land on 30 June 20X5 for $400,000. The tax base of the land is
equal to its original purchase price of $400,000.
The land is revalued for the first time at 30 June 20X8, resulting in a credit to the revaluation
surplus of $100,000, by recording this journal entry:
$ $
30.06.X8 Land 100,000
Revaluation surplus (reserve account within equity) 100,000
To record the revaluation of the land which will be disclosed in OCI
The 6-steps to calculate a deferred tax balance as at 30 June 20X8 are applied in the same
way as described in the previous example. A difference arises when allocating the temporary
difference as a TTD or DTD in the worksheet. Since, this temporary difference has arisen due to
the revaluation through OCI, IAS 12 para 61A(a) requires the related tax to also be disclosed in
OCI and recognised directly against the revaluation surplus account.
As a result, when allocating the temporary difference as a TTD, it is recorded in a separate column
as a TTD (OCI). This will assist with recording the journal entry to the correct accounts and
complying with IAS 12.61A(a).

Carrying Tax base Temporary Allocation rule TTD TTD

amount difference (OCI)
$ $ $ $ $
Land – revalued 500,000 400,000 100,000 Asset rule: Carrying 100,000

amount > tax base
Total temporary 100,000

differences
DTL/DTA at 30% 30,000
Less: Opening balances 0
Movement 30,000
Therefore, the journal to record the deferred tax on this revaluation is as follows:
$ $
30.06.X8 Revaluation surplus (reserve account within equity)1, 2 30,000
DTL 30,000
To record the DTL in relation to items recognised outside profit or loss where the movement in the
revaluation surplus (net of tax) will be disclosed in OCI
Notes
1. The debit is not taken to income tax expense as the underlying transaction was accounted for outside
profit or loss.
2. The tax relating to transactions accounted for outside profit or loss must be separately identified, as the
related tax must be separately disclosed (IAS 12 para. 81(a), (ab)).
Calculating deferred tax – When the underlying transaction is recognised

directly in equity
Again, the same 6-step process applies to determine the journal entry for the deferred tax when
the underlying transaction is recognised directly in equity.
Example – Deferred tax balances arising on transaction recognised directly in equity

This example illustrates the treatment of deferred tax arising from share issue costs.
A company issues $5 million in share capital on 30 June 20X8 and incurs $200,000 in share
issue costs that have been debited to the share capital account following the requirements of
IFRS 9. (Note: the journal entry for the share issue costs was debit share capital $200,000 and
credit cash $200,000.) The $200,000 share issues costs will be deductible for tax purposes in the
30 June 20X9 year.
The 6-steps to calculate a deferred tax balance as at 30 June 20X8 are applied in the same way.
A difference arises when allocating the temporary difference as a TTD or DTD in the worksheet.
Since, this temporary difference has arisen due to the share issue costs being capitalised into
equity (rather than being expensed in the profit or loss), IAS 12 para 61A(b) requires the related
tax to also be disclosed in equity to follow the underlying transaction.
As a result, when allocating the temporary difference as a DTD, it is recorded in a separate
column as a DTD (equity). This will assist with recording the journal entry to the correct accounts
and complying with IAS 12.61A(b).

Carrying Tax base Temporary Allocation DTD DTD

amount $ difference rule $ (equity)
$ $ $
Share issue costs 01 200,0002 200,000 No applicable 200,0003

rule
Total temporary 200,000

differences
DTL/DTA at 30% 60,000
Less: Opening balances 0
Movement 60,000
Notes
1. The carrying amount of the share issue costs is $0 as this amount is offset against equity, and not
included as an asset or liability.
2. The tax base of the share issue costs represents the future tax deduction available of $200,000.
3. The $200,000 in future tax deductions for share issue costs will make future tax payments smaller.
Accordingly, the $200,000 is a DTD.
Therefore, the journal to record the deferred tax on the share issue costs is:
$ $
30.06.X8 DTA 60,000
Share capital 1
60,000
To record the DTA in relation to share issue costs recognised directly in equity
Notes
1. The credit is not taken to income tax expense as the underlying transaction was accounted for outside
profit or loss. Instead, the credit relating to the future tax deductions for the share issue costs is taken to
share capital in accordance with IAS 12.61A(b).
Worked example 4.3: Calculating deferred tax assets and liabilities

Reversals of temporary differences

As the term suggests, temporary differences are just that – temporary. This means that at some
point the temporary difference will reverse. When a temporary difference reverses:
•• If a DTL had been recognised in respect of the temporary difference in an earlier reporting
period, the movement for the year will be debited to the DTL account.
•• If a DTA had been recognised in respect of the temporary difference in an earlier reporting
period, the movement for the year will be credited to the DTA account.

The diagram below summarises the two key issues to consider when preparing the journal
entry to recognise deferred tax:
Two key issues to prepare the tax effect journal entry for
deferred tax
Issue 1 – Issue 2 –
asset or liability side equity side for underlying
Does the tax impact of transaction
the underlying Determine which bucket
transaction create a to record the tax effect in
deferred tax asset or
deferred tax liability?
P/L – Income
Yes, there is a tax expense
DTA
future tax impact
(temporary DTL OCI – Related tax
difference) offset against that
current year reserve
movement e.g.
revaluation surplus
account
Equity – Related tax
offset against the
equity account e.g.
share capital
account
Complexities with deferred tax

Required reading
Read IAS 12 paras 15, 19–22, 24, 27–31 and 32A–37 before proceeding.
Incurring tax losses

Under IAS 12, the carrying forward of tax losses, subject to satisfying the recognition criteria,
gives rise to a DTA. Tax losses generally do not give rise to a tax refund.
DTA arising from a tax loss incurred in the current year

Where the entity incurs a tax loss in the current year, a DTA, rather than a current tax asset, will
arise. This is because the tax loss gives rise to a future tax deduction and therefore it will lower
future tax.
For the purposes of this unit, the DTA relating to the tax loss to be carried forward and used
against future taxable income is calculated as follows:
Accounting profit/(loss)
+/– Adjustments = Tax loss
before tax
Tax loss × Tax rate = DTA
Unused tax losses can commonly be carried forward to future tax periods and be utilised
(offset) against future taxable income. For the purposes of the FIN module, assume that all
requirements of the applicable tax law have been satisfied when calculating and recognising the
carryforward tax losses.

Recognition criteria for DTA in respect of tax losses

For unused tax losses, a DTA should only be recognised to the extent that it is probable that
future taxable profit will be available against which the unused tax losses and unused tax
credits can be utilised (IAS 12 para. 34).
In assessing this probability, the following are some of the considerations for DTAs relating to
tax losses (IAS 12 paras 35–36):
•• Whether there is convincing evidence that sufficient taxable profit will be available to utilise
the unused tax losses.
•• Whether the entity has sufficient TTDs that will increase the entity’s taxable profits before
the unused tax losses expire.
For example:
–– In Australia, tax losses do not have an expiry date, although there are tests that may
limit an entity’s ability to utilise carryforward tax losses.
–– In New Zealand, tax losses can be carried forward indefinitely subject to meeting
minimum shareholder continuity requirements.
•• Whether the unused tax losses have arisen from events or transactions that are unlikely
to recur.
Tax losses
The journal to recognise a DTA in respect of a current period loss is as follows:

$ $
xx.xx.xx DTA XX
Income tax expense XX
Recording recognition of the tax effect of current period losses
Worked example 4.4: Accounting for carryforward tax losses

Initial recognition exemption for DTAs and DTLs

Applying IAS 12 paras 15(b) and 24(b), DTAs and DTLs are not recognised on initial recognition
of assets or liabilities unless they arise from either:
•• A transaction that is accounted for as a business combination.
•• A transaction that affects accounting profit or taxable income at the time of initial recognition.
Where the initial recognition exception applies, an entity does not recognise subsequent
changes in the unrecognised balance (e.g. as the asset is depreciated).
Example – A transaction where the deferred tax consequences are not recognised at the
time of initial recognition
This example illustrates accounting for a motor vehicle when Australian tax law limits the
deductible amount.
An Australian entity acquires a motor vehicle costing $75,000.
The $75,000 amount is recognised and depreciated for accounting purposes but the taxable
deductions will be limited to the luxury car limit of $57,581.
As the initial acquisition of the car affects neither accounting profit nor taxable income (because
the entry was debit car and credit cash), the deferred tax consequences of the $17,419 difference
would not be recognised.

Specific recognition exceptions concerning DTAs and DTLs

DTAs and DTLs should not be recognised in respect of the following:
•• Initial recognition of goodwill (IAS 12 para. 15(a)).
•• Investments in subsidiaries, branches, associates and joint arrangements where it is
probable that the temporary difference will continue to exist into the foreseeable future
(IAS 12 paras 39 and 44).
Changes in prior year taxes due to errors or estimates

The rules and principles regarding changes to prior year errors and estimates are contained in
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (discussed in Unit 2).
There may be a number of estimates and/or minor errors within the calculation of the current
tax liability in the financial statements for a particular period as:
•• The financial statements are prepared for reporting purposes shortly after year end
where auditors of the financial statements seek to detect material errors, omissions
or misstatements.
•• Income tax returns are commonly prepared after the financial statements are issued.
The concept of materiality does not apply in relation to the preparation of tax returns.
Therefore:
•• More rigorous calculations may be performed in respect of complex transactions or events
when preparing the income tax return. This may result in the identification of different
or additional tax adjustments to those identified at the time the financial statements
were prepared.
•• Any changes in estimates or errors identified in the current tax liability calculations would
be corrected during the preparation of the tax return after the end of the reporting period.
These events can be shown in a timeline diagram as follows:
End of Authorised End of

reporting for issue reporting
period period
20X5 20X5 20X6

JUNE SEPT JUNE
30 12 30
IAS 12 tax calculation and

Detailed tax calculations
journal entries performed for
for income tax return
inclusion in 30 June 20X5
detect an error
financial statements
In the timeline above, an error has been discovered after the accounts have been authorised
for issue. To correct this prior period error, a journal entry needs to be recorded to correct the
current tax liability (IAS 12 para. 12). Correspondingly, if the error is:
•• Immaterial – this journal entry will recognise a current year tax entry in the 30 June 20X6
•• Material – this journal entry will make a retrospective adjustment (usually through
opening retained earnings) that will be disclosed in the 30 June 20X5 comparative financial
statements (IAS 8 para. 42).

The journal entry to correct the error should follow the same accounting treatment as the
original underlying transaction. In practice, the most common errors you are likely to encounter
relate to the tax treatment of items recognised in profit or loss.
Example – Prior year error in current tax liability

This example illustrates the journal entry to correct the current tax liability when immaterial
errors are discovered in the tax calculation after the prior year financial statements have
been issued.
Flex-It Limited (Flex-It) finalises and lodges its income tax return for the year ended 30 June 20X5
on 1 December 20X5.
When preparing the tax return, two immaterial errors were discovered. The errors resulted in
the current tax liability in the 30 June 20X5 financial statements being incorrect. Details of these
errors are as follows:
Errors in 30 June 20X5 current tax liability calculation
Error Impact on taxable Impact on current tax

income liability (change in
taxable income × 30%
tax rate)
Dividend revenue Decreases taxable $24,000 decrease

(had been treated as assessable for tax purposes) income by $80,000
Fine Increases taxable $54,000 increase

(had been treated as tax deductible) income by $180,000
Net adjustment to current tax liability $30,000 increase
Neither of the underlying transactions was accounted for outside profit or loss, and they are not
material. The adjustment to the current tax liability can therefore be recognised by adjusting the
income tax expense.
Therefore, the journal entry to correct the errors is:
$ $
To record the increase in the current tax liability arising from the correction of the immaterial errors
relating to the year ended 30 June 20X5
If the errors were material, Flex-It would need to account for the errors retrospectively and adjust
the comparatives as required by IAS 8 para. 42.
If an error relates to an item that did not go through profit and loss, for example, the tax effect of
share issue costs recognised in equity, the correction follows the original underlying transaction.
Worked example 4.5: Accounting for an underprovision of income tax


Other tax effect accounting issues
Required reading
Read IAS 12 paras 38–45, 46–49 and 60 before proceeding.
Changes in tax rates and tax laws

Proposed changes in tax rates and tax laws cannot be applied when calculating current or
deferred tax balances, even if the change is to be applied retrospectively. For example, a
government announcement of a proposed change in the company tax rate for the 2016 year
end would not be sufficient to allow deferred tax balances to be measured at that revised rate.
A change in tax rate or tax law needs to be either enacted or substantially enacted by the end of
the reporting period before it impacts on tax effect accounting.
For a tax rate or tax law change to be substantively enacted, legislation would have to be
introduced into the Parliament, and there would have to be majority support for its passage
though all Houses of that Parliament.
Where the rate of tax applicable to a deferred tax balance (or current tax balance) changes,
that balance must be remeasured at the reporting date if the legislation has been enacted or
substantively enacted by the end of the reporting period. This is because the balances should be
valued at the tax rates that are expected to apply to the period when the asset is realised or the
liability is settled.
There is a similar impact where a tax law changes with prospective effect and the revised tax
law has been enacted or substantively enacted by the end of the reporting period. Current and
deferred tax balances at the reporting date must be measured based on the revised tax law.
Consolidated financial statements

Consolidated financial statements include the financial statements of the parent entity and the
entities it controls. Tax effect accounting entries should be prepared for each entity on a stand-
alone basis and the consolidation then performed in accordance with IFRS 10 Consolidated
Financial Statements.
Consolidation journal entries are made to produce the consolidated figures without altering the
amounts actually recorded in the general ledger of the individual entities within the group.
In addition to the normal consolidation adjustments (e.g. to eliminate intragroup transactions),
tax effect accounting adjustments will be required to account for differences in the carrying
amounts of assets and liabilities in the consolidated financial statements against those of the
individual entities (e.g. where the assets or liabilities are carried at cost in the single-entity
financial statements but at fair value in the consolidated financial statements).
Accordingly, consolidation adjustments may give rise to temporary differences requiring DTAs
and DTLs to be recognised. The accounting for consolidations and the tax effect accounting
implications flowing therefrom are discussed further in Unit 16.

Presentation
Required reading
Read IAS 12 paras 71–77 before proceeding.
There are three main issues to consider after completing the tax effect journal entries for the
year as follows:
•• Offsetting tax balances.
•• Separately presenting the income tax expense for the year.
•• Providing disclosures within the financial statements (covered in the next section).
Offsetting tax balances

Applying IAS 12 para. 74, DTAs and DTLs should be offset (i.e. netted) in the statement of
financial position when:
•• The entity has a legally enforceable right to offset current tax assets against current tax
liabilities.
•• The DTAs and DTLs relate to income taxes levied by the same taxation authority on either:
–– the same taxable entity
–– the different taxable entities whose management intends either to settle current tax
assets and liabilities on a net basis, or to realise the assets and settle the liabilities
simultaneously.
Applying IAS 12 para. 71, current tax liabilities and assets should be offset in the statement of
financial position when:
•• The entity has a legally enforceable right to offset the recognised amounts.
•• The entity’s management intends either to settle on a net basis or to settle the liability and
realise the asset simultaneously.
An entity will normally have a legally enforceable right to set off a current tax asset against
a current tax liability when they relate to income taxes levied by the same taxation authority,
and the taxation authority permits the entity to make or receive a single net payment
(IAS 12 para. 72).
For example:
•• In Australia, the above conditions are normally satisfied for income tax payments made to
the ATO.
•• In New Zealand, the above conditions are normally satisfied for income tax payments made
to IR.
In practice, creating a journal that separately records both the DTA and the DTL is recommended.
The offset can be completed as a separate step in the calculation process. As deferred tax
balances generally relate to individual assets or liabilities; they are commonly only offset
against each other for financial statement preparation purposes.
Presenting income tax expense

The income tax expense relating to profit or loss from ordinary activities is required to
be presented as part of the statement of profit or loss and other comprehensive income
(IAS 12 para. 77).

Disclosures
Required reading
Read IAS 12 paras 79–86 before proceeding.
Income tax expense

Income tax expense is one of the key IAS 12 disclosures and comprises current income tax
expense and deferred income tax expense. Income tax expense commonly equals the aggregate
of the current tax liability and the movement in deferred tax balance calculations for the
period. Disclosure of the components of income tax expense is required by IAS 12 paras 79 and
80. A breakdown of the journal entries made to the income tax expense account is therefore
required but may be presented in various ways. It is common in practice for an entity to disclose
the component of income tax expense that has been recognised in profit or loss.
Methodology for accounting for income tax expense recognised in

profit or loss
This section only covers income tax expense recognised in profit or loss, and assumes tax
related to items disclosed in other comprehensive income or recognised directly in equity can be
separately identified for disclosure purposes.
The following diagram shows the elements of income tax expense recognised in profit or loss.
Current income tax expense +/– Deferred income tax expense = Income tax expense
Elements of income tax expense for separate disclosure

The following diagram represents the steps in identifying the components of income tax expense.
STEP 1 STEP 2 STEP 3
Identify Identify Offset current

current deferred income tax
income tax income tax expense and
expense expense deferred
income tax
expense
Step 1 – Identify current income tax expense

Current income tax expense is the sum of the income tax expense that has been recorded when
making journal entries to the current tax liability (excluding the tax effect of any transactions
accounted for outside profit or loss).
Step 2 – Identify deferred income tax expense

Deferred income tax expense is the sum of the income tax expense that has been recorded when
making journal entries that affect the DTA or DTL accounts (excluding the tax effect of any
transactions accounted for outside profit or loss).
Step 3 – Offset current income tax expense and deferred income tax expense
The sum of the current income tax expense and deferred income tax expense are added together
to give the income tax expense recognised in profit or loss.

Other disclosure issues

Other disclosure requirements include:
•• The aggregate of current and deferred tax relating to items charged/credited to equity.
•• Income tax relating to each component of other comprehensive income.
•• A reconciliation of income tax expense and accounting profit multiplied by the applicable
tax rate.
•• The amount recognised as a DTA and the nature of evidence supporting its recognition.
Required reading
Read the remaining paragraphs from IAS 12.
Activity 4.1: Accounting for income taxes

Quiz
Working papers I and J

You are now ready to complete working papers I and J of integrated activity 4, to
understand how this topic relates to the financial reports. You can complete this activity
You should complete this activity for tax when you have completed Unit 16.

APPENDIX: Determining the tax base of an asset or liability that gives rise to a temporary
difference
Asset
Unit 4 – Core content

Formula-based approach Notional tax balance sheet approach
(as per IAS 12 paras 7 and 8) (as per IAS 12 para. 5)
Apply the appropriate formula to the asset or liability to determine the tax base Determine the value that would be recognised for the asset or liability if a notional tax balance
sheet was prepared
Paragraph 7 Paragraph 5 definition

The tax base of an asset is the amount that will be deductible for tax purposes against any The tax base of an asset or liability is the amount attributed to that asset or liability for tax
taxable economic benefits that will flow to an entity when it recovers the carrying amount of purposes
the asset
Formula
Asset tax base = carrying amount – future taxable amounts1 + future deductible amounts
1
IAS 12 focuses on the future tax consequences of recovering an asset only to the extent of
its carrying amount at the reporting date. Accordingly, the future taxable amounts value is
capped at the asset’s carrying amount at the reporting date
Page 4-33
Facts Journal entries for the accounting Formula-based approach Notional tax balance sheet
Page 4-34
transactions during the year approach
Example 1
Depreciating asset
Accounting
•• Opening balance: $120,000 (cost $150,000 – $30,000 Dr Depreciation expense $30,000 The tax base is $50,000 The tax base is $50,000
accumulated depreciation) Cr Accumulated depreciation $30,000 = $90,000 carrying amount – $90,000 If a notional tax balance sheet was
•• Depreciation expense for the year: $30,000 future taxable amounts (capped at prepared, the depreciating asset’s
Depreciation of equipment
•• Closing balance: $90,000 the asset’s carrying amount at the $50,000 tax written down value
OR
Tax reporting date) + $50,000 in future would be recognised (cost $150,000
deductible amounts – $100,000 tax depreciation
•• Tax depreciation is deductible for tax purposes deductions claimed to date)
•• Opening tax written down value $100,000 (cost $150,000 –
$50,000 tax depreciation deductions claimed to date)
•• Tax depreciation for the year $50,000
•• Closing tax written down value $50,000 (cost $150,000 –
$100,000 tax depreciation deductions claimed to date)
Example 2
Trade receivables
Accounting
•• Opening balance: $0 Dr Trade receivables $400,000 The tax base is $400,000 The tax base is $400,000
•• Revenue recognised: $400,000 Cr Revenue $400,000 = $350,000 carrying amount – If a notional tax balance sheet was
•• Cash received from customers: $0 Sales revenue recognised $0 future taxable amounts (as the prepared:
•• Allowance for impairment loss: $50,000 recognised revenue has already been assessed OR trade receivables of $400,000 would
for tax purposes) + $50,000 in future be recognised
•• Closing balance: $350,000 (net) deductible amounts1
Dr Impairment loss expense $50,000
Tax 1
The $50,000 allowance for
Cr Accumulated impairment losses – The $50,000 allowance for impairment impairment loss would not be
•• $400,000 is assessable for tax purposes trade receivables $50,000 loss will result in a tax deduction when recognised because a tax deduction
•• The $50,000 allowance for impairment loss will only be the receivables are actually written off only arises when the receivables are
Impairment of trade receivables
deductible for tax purposes when the debt is actually actually written off
written off

Liability
Formula-based approach (as per IAS 12 paras 7 and 8) Notional tax balance sheet approach (as per IAS 12 para. 5)
sheet was prepared
Unit 4 – Core content

Paragraph 8 Paragraph 5 definition
The tax base of a liability is its carrying amount, less any amount that will be deductible The tax base of an asset or liability is the amount attributed to that asset or liability for
for tax purposes in respect of that liability in future periods. In the case of revenue which tax purposes
is received in advance, the tax base of the resulting liability is its carrying amount, less any
amount of the revenue that will not be taxable in future periods
Formula (general rule for liabilities)

Liability tax base = carrying amount – future deductible amounts + future taxable amounts1
1
The future taxable amounts value for a liability for the purposes of the FIN module under IAS 12 is
assumed to be $0
Example 3
Provision for employee entitlements
Accounting
•• Opening balance: $200,000 Dr Expense $300,000 The tax base is $0 The tax base is $0
•• $300,000 expensed for the year Cr Provision (liability) $300,000 = $240,000 carrying amount – If a notional tax balance sheet
•• $260,000 paid during the year Employee entitlements expense $240,000 in future deductions for this OR was prepared, the liability for the
•• Closing balance: $240,000 liability when the entitlements are provision would not be recognised
paid + $0 future taxable amounts as the tax deduction will only be
Tax recognised for tax purposes when
Dr Provision (liability) $260,000
•• A tax deduction arises when employee entitlements the entitlement is paid
Cr Cash $260,000
are paid
Payment of employee entitlements
Page 4-35
Liability
Page 4-36
Formula-based approach (as per IAS 12 paras 7 and 8) Notional tax balance sheet approach (as per IAS 12 para. 5)
sheet was prepared
Formula (exception to liability rule for revenue received in advance)
Revenue received in advance tax base = carrying amount – amount of revenue not taxable in
future periods
Example 4
Unearned income
Accounting
•• Opening balance: $0 Dr Cash $80,000 The tax base is $0 The tax base is $0
•• $80,000 received from a customer during the year but has Cr Revenue received in advance = $80,000 carrying amount – $80,000 If a notional tax balance sheet was
not yet been recognised for accounting purposes (liability) $80,000 that will not be assessable in the prepared, the liability for revenue
•• Closing balance: $80,000 Revenue received in advance future (as the $80,000 was assessable OR received in advance would not
Tax that cannot yet be recognised for for tax purposes when received) be recognised as the amount
accounting purposes has already been assessed for
•• The revenue is assessable when received tax purposes
•• [In a later reporting period when the revenue is recognised
for accounting purposes, there will be no further taxation
of the $80,000 as it was assessed for tax purposes
when received]

Unit 5: Foreign exchange
Contents
Introduction 5-3
Accounting for foreign currency 5-3
Functional currency 5-4
Presentation currency 5-4
Foreign currency transactions and balances 5-5
Understanding key terms 5-5
Initial recognition of foreign currency transactions 5-5
Reporting at subsequent reporting dates 5-5
Recognising exchange differences 5-6
Translation of financial statements 5-8
Determining the functional currency 5-8
Translating from the functional to the presentation currency 5-9
Disclosures 5-13
fin11905_csg_07


Learning outcomes
1 Explain and account for foreign currency transactions and balances.
3. Explain and account for the translation of financial statements of an entity from its
functional currency to its presentation currency.
Introduction
It is quite common for entities to conduct their business activities in foreign currencies or
in foreign locations. With the revenues generated, assets purchased and investments made
overseas, entities have an increased exposure to foreign currencies and are increasingly affected
by fluctuating foreign exchange (FX) rates.
IAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to account for foreign
currency transactions and balances, and discusses how to determine an entity’s functional
currency and translate financial statements into an entity’s presentation currency.
This unit examines the application of IAS 21.

Accounting for foreign currency

Accounting for the effects of changes in foreign exchange rates on transactions and balances
is an integral step in the preparation of financial statements.
Where an entity undertakes foreign currency transactions, its financial statements must
appropriately reflect the economic consequences of such transactions in its presentation currency.
As per para. 3, IAS 21 shall be applied:
(a) in accounting for transactions and balances in foreign currencies, except for those derivatives
transactions and balances that are within the scope of IFRS 9 Financial Instruments;
(b) in translating the results and financial position of foreign operations that are included in the
financial statements of the entity by consolidation or the equity method; and
(c) in translating an entity’s results and financial position into a presentation currency.

Functional currency
A foreign currency transaction is initially recorded by an entity in its functional currency.
The functional currency is the currency of the primary economic environment in which the
entity operates, normally where it primarily generates and expends cash. Determining an
entity’s functional currency is discussed later in this unit.
Presentation currency
An entity may present its financial statements in any currency (IAS 21 para. 38). In practice, for
many entities the local currency is the presentation currency. An entity’s presentation currency
may be prescribed by local regulatory requirements.
IAS 21 The Effects of changes in

Foreign Exchange Rates
IAS 21 defines functional currency

and presentation currency.
The Standard then splits up into
two sets of rules
Transactions Translations
Foreign currency Subsidiary’s functional currency

 
Functional currency Group presentation currency
e.g. buy inventory from our supplier in Italy e.g. translate the financial report of our
 French subsidiary from euros €
Pay in euros €, record transaction in our 
ledger in dollars $ into dollars $
Important concept: Important concept:

Monetary or Non-monetary? Make the balance sheet balance
Accounting: Accounting:
Gain or loss to P&L Balancing figure to FCTR
DO NOT USE FCTR (Equity, OCI)
IAS 21 paras 23-24 IAS 21 paras 38-47

Foreign currency transactions and balances
Learning outcome
1. Explain and account for foreign currency transactions and balances.
Understanding key terms

IAS 21 para. 8 provides a list of definitions of the key terms involved in accounting for the
effects of changes in foreign exchange rates. The definitions that are particularly important
to understand are:
•• Closing rate.
•• Exchange difference.
•• Foreign operation.
•• Functional currency.
•• Monetary items.
•• Presentation currency.
•• Spot exchange rate.
Initial recognition of foreign currency transactions

To recognise a foreign currency transaction, the spot exchange rate (the exchange rate for
immediate delivery) between the functional currency and the foreign currency is applied to the
foreign currency amount (IAS 21 paras 8 and 21) at the date that the transaction first qualifies
for recognition in accordance with International Financial Reporting Standards (IFRS).
Reporting at subsequent reporting dates
Monetary items
‘assets and liabilities to be received or paid in a fixed
Non-monetary items
or determinable number of units of currency’
IAS 21 para. 8
Recognise at spot rate Recognise at spot rate

Re-translate at closing rate Do not re-translate at closing rate
Gains & losses to P&L
• inventory
• trade payables • property, plant and equipment
• trade receivables • prepaid rent
• cash • capitalised development costs
• loans • brands, goodwill
The following table summarises how to translate foreign currency denominated items at each
reporting date (IAS 21 para. 23).
Reporting at the end of subsequent reporting periods
Item Translation method
Foreign currency monetary items Use the closing rate (the spot exchange rate at the end
of the reporting period)
Non-monetary items that are measured in terms of Use the exchange rate at the date of the transaction
historical cost in a foreign currency
Non-monetary items that are measured at fair value in Use the exchange rates at the date when the fair value
a foreign currency was measured

Recognising exchange differences

The following table summarises how to recognise exchange differences relating to monetary
items (IAS 21 para. 28).
Recognition of exchange differences
Exchange differences Recognition method
•• On the settlement of monetary items Recognise in profit or loss in the period in which
OR they arise
•• On translating monetary items at rates different
from those at which they were translated on initial
recognition during the period or in a previous
financial report
Example – Accounting for a foreign currency asset purchase

This example illustrates how to account for foreign currency purchases by recording the initial
purchase, subsequent payments and any retranslations required at reporting dates by applying
IAS 21.
On 1 July 20X3, the executive committee of Coolsac Limited (Coolsac) approved the purchase
of a new machine used in the production of handbags. The handbags will be sold as accessories
in Coolsac’s stores. The machine was purchased from a manufacturer located in Illinois, USA for
US$12 million.
The key milestones in the purchase contract are:
•• Customisation (which will take three months from order).
•• Delivery, installation and preparation for use (taking a further three months).
An initial deposit of US$6 million is due at the completion of the machine’s customisation, with
the balance of US$6 million due when delivery, installation and preparation for use is complete.
Under the terms of the purchase contract, Coolsac incurred the liability to pay at the time of
purchasing the machine, but cash payments are not due until the milestone dates.
Exchange rates
Dates A$ US$
01.07.X3 1.00 0.90
30.09.X3 1.00 0.92
31.12.X3 1.00 0.93
Coolsac has a 30 June year end.

IAS 21 para. 21 deals with initial recognition and states that the transaction should be recognised
using the spot exchange rate at the date of the transaction.
Coolsac incurred the US$12 million liability at the time of entering the contract to build the
machine on 1 July 20X3, when the exchange rate was 0.90.
The first journal entry is for the recognition of the machine asset and the liability incurred on
entering the contract on 1 July 20X3 (US$12 million ÷ 0.90). As the machine has not yet been
built, it is common practice to use a capital work in progress account.
A$ A$
01.07.X3 Capital work in progress (WIP) 13,333,333
Payables 13,333,333
To record entering into the contract for the acquisition of the machine

As the machine is to be paid for in instalments, exchange differences are likely to arise when
the payments are made. IAS 21 para. 28 covers the treatment of exchange differences arising on
the settlement of monetary items.
The second journal entry is to recognise the payment of US$6 million on completion of the first
milestone on 30 September 20X3 (US$6 million ÷ 0.92), and reduction of the payable as the first
half of the liability is being settled (13,333,333 ÷ 2). The difference of A$144,928 between these
two amounts (A$6,666,667 – A$6,521,739) is a foreign exchange gain recognised in profit or loss.
A$ A$
30.09.X3 Payables 6,666,667
Cash 6,521,739
Foreign exchange gain 144,928
To record the payment of first instalment of the machine
The third journal entry is to recognise the final payment of US$6 million on completion of the
second milestone on 31 December 20X3 (US$6 million ÷ 0.93), and reduction of the payable as
the second half of the liability is being settled (A$13,333,333 ÷ 2). The difference of A$215,053
between these two amounts (A$6,666,666 – A$6,451,613) is a foreign exchange gain recognised
in profit or loss. The payable has not been restated since its initial recognition as this only occurs
at reporting dates.
A$ A$
31.12.X3 Payables 6,666,666
Cash 6,451,613
Foreign exchange gain 215,053
To record the payment of final instalment of the machine
The last journal entry transfers the capital WIP to property, plant and equipment (PPE) at
31 December 20X3, as the machine is now installed and ready for use. As the capital WIP is a
non‑monetary item, it is not restated at the year end.
$ $
31.12.X3 PPE (machine used in handbag production) 13,333,333
Capital WIP 13,333,333
To record the transfer of the machine from WIP to PPE on completion
Required reading

Translation of financial statements
Learning outcomes
3. Explain and account for the translation of financial statements of an entity from its functional
currency to its presentation currency.
While an entity must record its foreign currency items in its functional currency, it must present
its financial statements in a single currency, known as the ‘presentation currency’.
Foreign operations, such as subsidiaries and branches, often have to translate their financial
statements from their functional currency into the presentation currency of the reporting entity
to facilitate the preparation of consolidated financial statements.
IAS 21 para. 39 specifies the method for translating financial statements from the functional
currency into the presentation currency, which is covered later in this unit.
Determining the functional currency

An entity must determine its functional currency according to its primary economic
environment. This may not be its local currency (the currency of the country in which it resides).
IAS 21 paras 9–11 set out the primary, secondary and additional indicative factors that
management should consider when determining the functional currency of foreign operations.
The following table summarises these factors.
Factors to consider in determining functional currency
Primary indicative factors
•• The currency that mainly influences sales prices for the entity’s goods and services (this will often be the
currency in which sales prices are denominated and settled) (IAS 21 para. 9(a)(i))
•• The currency of the country whose competitive forces and regulations mainly determine the sales price of
the entity’s goods and services (IAS 21 para. 9(a)(ii))
•• The currency that mainly influences labour, material and other costs of providing goods and services (this
will often be the currency in which the costs are denominated and settled) (IAS 21 para. 9(b))
Secondary indicative factors
•• The currency in which funds from financing activities (i.e. issuing debt and equity instruments) are
generated (IAS 21 para. 10(a))
•• The currency in which receipts from operating activities are usually retained (IAS 21 para. 10(b))
Additional indicative factors
•• Whether the activities of the foreign operation are conducted as an extension of the reporting entity or
autonomously (IAS 21 para. 11(a))
•• Whether transactions with the reporting entity are a high or low proportion of the foreign operation’s
activities (IAS 21 para. 11(b))
•• Whether cash flows from the foreign operation directly affect the cash flows of the reporting entity and are
readily available for remittance to it (IAS 21 para. 11(c))
•• Whether cash flows from the foreign operation are sufficient to service existing and normally expected debt
obligations without funds from the reporting entity (IAS 21 para. 11(d))
There may be instances where the indicative factors are mixed and the functional currency
is not obvious. In such cases, management uses its judgement to determine the functional
currency that best represents the economic effects of the underlying transactions, events and
circumstances. Management must give priority to the primary indicators, because the secondary
and additional indicators are not linked to the primary economic environment in which the
entity operates and only provide supporting evidence (IAS 21 para. 12).

As an entity’s functional currency reflects its underlying transactions, events, and conditions; it is
not changed unless there is a change in those transactions, events or conditions (IAS 21 para. 13).
Activity 5.1: Determining the functional currency of a foreign operation

Translating from the functional to the presentation currency

Where the functional currency of a foreign operation is different from the presentation currency
of the reporting entity, the foreign operation must translate its financial statements from its
functional currency to the reporting entity’s presentation currency (IAS 21 para. 38).
Translating results and financial position

The following table summarises the rules for translating an entity’s financial results and
financial position balances (IAS 21 paras 39 and 40).
Translation of results and financial position
Item Appropriate translation rate
Assets and liabilities Closing rate (spot exchange rate at reporting date)
Income and expenses Exchange rate at date of transaction

If items occur regularly throughout the period, an average rate can be used unless
the exchange rate fluctuates significantly
Translating equity balances

IAS 21 is not explicit on the translation of equity balances when translating from the functional
to presentation currency. An approach can be established, drawing on the principles contained
elsewhere in IAS 21. The following table summarises the rules commonly applied in practice
when translating an entity’s equity balances.
Translation of equity balances
Item Appropriate translation rate
Share capital
•• Pre-acquisition •• Spot exchange rate in force at the date of acquisition

•• Post-acquisition movements •• Spot exchange rate in force at the dates the amounts were
(e.g. new share issue) originally recognised in equity
Reserves
•• Pre-acquisition balance •• Spot exchange rate in force at the date of acquisition

•• Post-acquisition transfers •• Spot exchange rate in force at the dates the amounts
(e.g. transfers to/from retained earnings) transferred were originally recognised in equity
•• Post-acquisition movements •• Spot exchange rate in force at the date the movement
(e.g. movement in revaluation surplus) was recognised
Retained earnings
•• Pre-acquisition balance •• Spot exchange rate in force at the date of acquisition

•• Cumulative post-acquisition movements •• Not independently translated – carried forward from
previous year’s translations and current year’s translated
profit from the statement of profit or loss
Distributions from retained earnings
•• Dividends •• Spot exchange rate on the date of payment or declaration

•• Transfers to/from reserves •• Spot exchange rate in force at the dates that the amounts
transferred were originally recognised in equity

Recognising foreign exchange translation differences

Foreign exchange translation differences arise because different exchange rates are applied to
different balances. To recognise these differences:
•• Calculate the exchange difference as a balancing item after the determination of all
translated balances.
•• Do not include the exchange difference in profit or loss. Instead, disclose the exchange
difference as a separate component of other comprehensive income (OCI) (IAS 21
para. 39(c)).
Entities will often recognise foreign exchange translation differences in a foreign currency
translation reserve in the financial statements.
As noted in IAS 21 para. 47, any goodwill arising on the acquisition of a foreign operation and
any fair value adjustments arising from the acquisition are treated as assets and liabilities of
the foreign operation, and are expressed in the functional currency of the foreign operation.
They are translated in the manner set out above. Accounting for the acquisition of an entity
is discussed in the unit on business combinations.
Bringing the rules together

Distinguishing between when to apply the foreign currency transaction rules and when to
apply the translation rules can sometimes be confusing. In practice, an entity often has to apply
both sets of rules from IAS 21.
Example – Applying foreign currency transaction and financial statement translation rules
This example illustrates how and when the foreign currency transaction and financial statement
translation rules under IAS 21 are applied.
Dinkum Limited (Dinkum) is an Australian subsidiary of a United Kingdom group, Union Jack
Limited. Dinkum was incorporated on 1 July 20X4. Its functional currency is Australian dollars
and its presentation currency is pounds sterling.
Exchange rates during the year ended 30 June 20X5 were as follows:
Exchange rates
AUD NZD GBP
01.07.X4 1 1.07 0.47
15.05.X5 1 1.08 0.52
30.06.X5 1 1.12 0.48
Average rate for the year ended 30 June 20X5 1 1.06 0.50

Dinkum is affected by two very

different sets of rules under IAS 21
Dinkum sells inventory to a customer in Dinkum’s results are reported in GBP

New Zealand for NZ$5,000 on 15.05.X5. (its presentation currency)
Payment is received in July 20X5
There were A$6,000 in other sales that
occurred evenly over the year Translation of financial statements
into the presentation currency
Foreign currency transaction

Paragraphs 38–47:
Assets and liabilities at closing rates
Income and expenses at transaction dates
Apply paragraphs 20–37 and 50 (Average rate may be applied where
Transaction translated to transactions are regular and a stable
functional currency exchange rate throughout the period)
Exchange differences to the
foreign currency translation reserve
(FCTR) (movement disclosed in other
Use the spot rate per IAS 21 para. 21 comprehensive income)
15.05.X5 Dr Trade receivables $4,630
Cr Sales revenue $4,630
(Recognition of sales revenue)
Sales revenue is not remeasured
(only certain assets and liabilities can
be a monetary item)
Trade receivables is a monetary item
(para. 16) Remeasure at 30 June to
NZ$5,000 ÷ 1.12 = $4,464
30.06.X5 Dr Foreign $166 See next page for detailed diagram
exchange loss
Cr Trade receivables $166
(Remeasure trade receivable
and recognise loss in profit
or loss)

Dinkum Limited Dinkum Limited

Functional currency: AUD Functional currency: AUD
Statement of financial position Statement of profit and loss for the
as at 30 June 20X5 year ended 30 June 20X5
Assets – current A$ A$
Bank 6,000 Sales revenue* 10,630

Trade receivables 4,464 Cost of sales ( 4,000)
Total assets 10,464 Gross profit 6,630
Net assets 10,464 Foreign exchange loss ( 166)
======
Net profit 6,464
Equity
Share capital 4,000

Retained earnings 6,464
Total shareholders’ equity 10,464 *Includes A$6,000 in other sales
======
Dinkum Limited Dinkum Limited

Presentation currency: GBP Presentation currency: GBP
Statement of financial position Statement of profit and loss for the
as at 30 June 20X5 year ended 30 June 20X5
Assets – current £ £
Bank 2,880 Sales revenue 5,408

Trade receivables 2,143 Cost of sales ( 2,000)
Total assets 5,023 Gross profit 3,408
Net assets 5,023 Foreign exchange loss ( 80)
=====
Net profit 3,328
Equity
Share capital 1,880 (Use average rates apart from 15.05.X5

FCTR (balancing figure) (185) rate for the New Zealand sale and
Retained earnings 3,328 30.06.X5 to translate the foreign exchange
Total shareholders’ equity 5,023 loss recognised on that date)
=====
(Use closing rates for assets and liabilities;

spot rate when originally recognised for
share capital and translated 20X5 profit
for retained earnings)
Activity 5.2: Translating from the functional currency to the presentation currency

Disclosures
The disclosure requirements of IAS 21 are detailed in paras 51–57.
An entity is required to disclose the value of exchange differences recognised (para. 52) and
narrative notes related to the functional/presentation currency (paras 53–57).
An entity also has to clearly disclose the presentation currency in accordance with IAS 1
Presentation of Financial Statements para. 51 (d).
Quiz
Now that you have completed Units 1–5, you are ready to integrate these topics and attempt the
first integrated activity. These activities help to prepare you for professional practice and the
FIN Module exam.
Integrated activity 1
The integrated activity is available online in myLearning.
Working paper B
You are now ready to complete working paper B of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity


Unit 6: Fair value measurement
Contents
Introduction 6-3
Why is IFRS 13 needed? 6-3
Purpose of this unit 6-3
Scope of IFRS 13 6-4
Measuring fair value 6-4
Definition 6-4
Step 1 – Determine the asset or liability to be measured 6-4
Step 2 – Measure fair value using an exit price 6-5
Step 3 – In the principal (or most advantageous) market 6-6
Step 4 – Between market participants 6-8
Step 5 – Based on the highest and best use for non-financial assets 6-9
Step 6 – Using an appropriate valuation technique 6-11
Step 7 – Based on inputs from the fair value hierarchy 6-13
Step 8 – To arrive at a fair value measurement 6-15
Considerations specific to liabilities and an entity’s own equity instruments 6-16
Liabilities 6-16
An entity’s own equity instruments 6-16
Measuring fair value for liabilities and own equity 6-16
Preparing IFRS 13 disclosures 6-17
fin11906_csg_04


Learning outcome
1. Explain and identify the key principles of fair value measurement, along with the related
Introduction
IFRS 13 Fair Value Measurement establishes a single framework or hierarchy for measuring fair
value. This unit outlines the principles of fair value measurement and their general application.
Why is IFRS 13 needed?

Similar to IAS 12 Income Taxes, the standard that provides the framework for accounting for
income taxes, IFRS 13 provides a single framework to which other accounting standards refer
for fair value measurement and disclosure.
A range of accounting standards require, or provide as an option, the use of a fair value
measurement basis. These standards include:
•• IAS 16 Property, Plant and Equipment.
•• IAS 36 Impairment of Assets – in relation to recoverable amount determined using fair value
less costs of disposal.
•• IAS 38 Intangible Assets.
•• IAS 39 Financial Instruments: Recognition and Measurement.
•• IFRS 3 Business Combinations.
•• IFRS 9 Financial Instruments.
For example, under IFRS 3, when a parent acquires a subsidiary, most assets and liabilities
of the acquired entity are required to be measured at fair value at the acquisition date. When
a standard requires or permits a fair value measurement, that standard relies on IFRS 13 for
its measurement.
Purpose of this unit

The aim of this unit is to enable you to determine what needs to be considered when measuring
a fair value. In practice, measuring fair value may require considerable experience and the
exercise of professional judgement involving the application of complex valuation techniques.
The focus of this unit is on the application of the IFRS 13 framework to the fair value
measurement process. The emphasis is not on calculating a correct dollar value.


Scope of IFRS 13
Not all fair value accounting under IFRS is covered by IFRS 13. For example, the requirements
of IFRS 13 do not apply to:
•• Measurement and disclosure requirements under:
–– IFRS 2 Share-based Payment.
–– IFRS 16 Leases.
–– Standards that utilise a similar basis to fair value but that are not fair value, such
as IAS 2 Inventories (when net realisable value is applied) and IAS 36 (in relation to
recoverable amount determined using value in use).
•• Disclosure requirements under:

–– IAS 19 Employee Benefits (for plan assets measured at fair value).
–– IAS 36 (in relation to recoverable amount determined using fair value less costs
of disposal).
Required reading
Measuring fair value
Definition
IFRS 13 para. 9 defines ‘fair value’ as ‘the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the measurement
date’. The definition is therefore based on a hypothetical transaction.
The process of measuring fair value under the Standard can be performed in eight steps, as
shown in the following diagram:
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6 STEP 7 STEP 8

Determine Measure In the Between Based on Using an Based on To arrive at a
the asset fair value principal market the highest appropriate inputs fair value
or liability using an (or most participants and best valuation from the measurement
to be exit price advantageous) use for technique fair value
measured market non-financial hierarchy
assets
STEP
1
Step 1 – Determine the asset or liability to be measured
assets
A fair value measurement is for a particular asset or liability (IFRS 13 para. 11). This draws out
two key points when considering an orderly transaction between market participants:
1. What the particular item is, is dependent on its unit of account.
2. Factoring in any characteristics of the asset or liability that market participants would
consider when pricing the item.

Unit of account STEP

1
A ‘unit of account’ is defined in Appendix A of IFRS 13 as ‘the level at which an asset or liability
is aggregated or disaggregated in a standard for recognition purposes’. For example, a parcel
of land may be the unit of account under IAS 16, while a fleet of delivery vehicles may be the
unit of account under IAS 16, and a cash-generating unit (CGU) comprising assets and liabilities
could be the unit of account under IAS 36.
A fair value measurement is performed on a consistent basis with its unit of account.
For example, the fair value of a CGU will be measured when there is an indication of
impairment (under IAS 36) that the carrying amount of the CGU may exceed its recoverable
amount (covered in Unit 10).
Characteristics of the asset or liability

In determining an asset’s or a liability’s fair value, an entity factors in the characteristics of the
asset or liability that a market participant would take into account when pricing the asset or
liability at the measurement date.
Examples of characteristics that should be factored in when measuring the fair value of an
asset include:
•• The condition and location of the asset.
•• Any restrictions on the sale and use of the asset.
Example – Characteristics of a liability

This example illustrates how the characteristics of a liability may impact its fair value.
Company X has corporate bonds on issue that pay a fixed rate of interest of 8% per annum. The
bonds were issued two years ago and will mature in three years’ time. The 8% fixed interest rate is
a characteristic of the liability.
Assume that the government’s official risk-free interest rate has been falling for the past
12 months and, at 30 June 20X5, is at an historic low of 2%. Companies with a risk profile similar
to that of Company X are able to issue corporate bonds with a fixed interest rate of 5% and a
maturity of three years.
Market participants would price a liability with a high fixed interest rate at a higher fair value
than a similar liability with a lower fixed interest rate. Therefore, if Company X is measuring the
fair value of the corporate bonds at 30 June 20X5, the 8% fixed interest will be factored into
its measurement, as the interest rate is a characteristic of the liability that a market participant
would incorporate into the valuation.
Step 2 – Measure fair value using an exit price STEP

2

assets
Fundamental to the standard is an ‘exit price’ approach to measuring fair value. In this
approach, the entity is looking at the valuation from a market participant perspective, an
outsider’s view, and not from within the entity.

STEP Market-participant view

2
Entity-specific view
The fair value definition refers to an exchange in an orderly transaction. Therefore, this exit
price must be based on what would occur in an orderly transaction.
For a transaction to be orderly it must:
•• assume exposure to the market for a period before the measurement date to allow for
marketing activities that are usual and customary for transactions involving such assets or
liabilities, and
•• be based on market participants who are motivated, but not forced or otherwise compelled,
to transact for the asset or liability.
Example – Fair value measurement at initial recognition

This example illustrates how the cost of an asset at initial recognition may not represent its
fair value.
Company X acquired the assets of an existing business, which resulted in a business combination
under IFRS 3.
As the business was struggling financially, Company X was able to negotiate a low price for the
business’s assets. Of the total consideration paid by Company X for the business, the purchase
agreement allocated a cost of $500,000 for a particular piece of equipment. Given the condition
of the asset and if it was marketed in the usual manner, the fair value would be measured
at $700,000.
Under IFRS 3, plant and equipment acquired in a business combination must be measured at
fair value on initial recognition. Therefore, Company X will recognise the equipment at $700,000
when accounting for the business combination. (Note: The unit on business combinations
(Unit 15) explains how the accounting occurs.)
STEP
3 Step 3 – In the principal (or most advantageous) market
assets
A key principle of IFRS 13 is the concept of measuring the fair value in the principal market or,
in the absence of a principal market, in the most advantageous market. An exhaustive search of
all possible markets is not necessary, but the entity should take into account all information that
is reasonably available.

Principal market STEP

3
The principal market is the market with the greatest volume and level of activity for the asset or
liability being measured. The market where the entity would normally enter into a transaction
to sell the asset, or transfer the liability, is presumed to be the principal market, unless there is
evidence to the contrary.
The principal market must be available to, and accessible by, the entity at the measurement
date. Access to a market is viewed from the perspective of the entity in question:
1. Which markets can the entity access?
2. The principal market is the market with the greatest volume and activity even if the entity
has historically not transacted in that market.
For example, if an entity could sell an equity instrument on both an overseas stock exchange
and a domestic exchange, the overseas exchange will be the principal market if it has the
greatest volume of trades for that equity instrument. The fair value of the equity instrument will
be measured by reference to prices on the overseas stock exchange.
Most advantageous market (only used where there is no principal market)

There may be some occasions when the principal market for an asset or liability cannot be
determined (e.g. information allowing a determination on what market has the greatest volume
and level of activity is not reasonably available). In such situation, the transaction is assumed
to take place in the most advantageous market for that item. The most advantageous market
is where the amount received to sell the asset is maximised, or the amount paid to transfer the
liability is minimised.
Identify the most advantageous market
Only consider if there is no principal market for the
asset or liability
Asset Liability
Identify potential markets Identify potential markets
• The most advantageous • The most advantageous
market maximises the market minimises the
amount received to sell amount that would be
the asset paid to settle the
• Subtract transport costs liability
• Subtract transaction • Add transaction costs
costs
Identify which is the most
advantageous market
This does not give the fair value!

It simply identifies the most advantageous
market and then you apply the fair value
measurement principles

STEP
3
Example – Identifying the most advantageous market for an asset
This example illustrates how to identify the most advantageous market for an asset. An entity
would only follow these steps when there is no principal market for the asset.
Company X is measuring the fair value of a particular asset and has determined there is no
principal market for it.
It has identified two possible markets:
Market A Market B
$ $
Selling price 100,000 110,000
Sales commission (10,000) (25,000)
Delivery costs (4,000) (5,000)
Net proceeds 86,000 80,000
Market A is the most advantageous market as the amount received to sell the asset is maximised
after factoring in transaction and transport costs ($86,000 is higher than $80,000).
The measurement of the fair value of this asset is covered in a later example in this unit.
STEP
4 Step 4 – Between market participants
assets
A fair value measurement should be based on the assumptions of market participants (i.e. it is
not an entity-specific measurement). Market participants are buyers and sellers in the principal
(or the most advantageous) market for the asset or liability.
Market participants are:
•• Independent of each other (not related parties).
•• Knowledgeable, having a reasonable understanding of the asset or liability and the
transaction using all available information, including information that might be obtained
through due diligence efforts that are usual and customary.
•• Able to enter into a transaction for the asset or liability.
•• Willing to enter into a transaction for the asset or liability (i.e. they are motivated but not
forced or otherwise compelled to do so)

STEP
4
Example – Assumptions of market participants in measuring fair value
This example illustrates how the assumptions of market participants are relevant when
measuring fair value.
Company X is measuring the fair value of an investment property. It acquired the property as it is
confident that a new rail station will be built in the area in the future, which will convert it into a
vibrant business hub.
Despite its confidence, Company X should factor in the assumptions that market participants
would make when pricing the property. For example, in applying a suitable valuation technique,
a market participant would factor in the risk that the rail station will not be built in the coming
years when measuring the property’s fair value.
STEP
Step 5 – Based on the highest and best use for non-financial assets 5

assets
The valuation premise for a non-financial asset is based on its highest and best use from a
market participant’s perspective, which may differ from its current use within the entity.
This means that the entity’s own intentions (e.g. to develop an asset) are not relevant when
measuring fair value.
It is assumed that market participants would maximise the value of the asset or group of assets,
either by using the asset in its highest and best use or by selling it to another market participant
that would use the asset in its highest and best use (IFRS 13 para. 27).
Appendix A to IFRS 13 defines the highest and best use as:
The use of a non-financial asset by market participants that would maximise the value of the asset or the
group of assets and liabilities (e.g. a business) within which the asset would be used.
The highest and best use of an asset must be a use that market participants would consider:
•• physically possible (e.g. building a car manufacturing plant on a small piece of land would
not be physically possible)
•• legally permissible (e.g. zoning restrictions prevent a nightclub being developed on a
particular site)
•• financially feasible (e.g. building a luxury hotel in a remote location may not be
economically sound).
When considering a use that is financially feasible, market participants take into account
whether the use of an asset that is physically possible and legally permissible would generate
a satisfactory investment return after taking into account the costs of converting the asset to
that use.
An entity’s current use of a non-financial asset is presumed to be its highest and best use unless
market or other factors suggest that a different use by market participants would maximise the
asset’s value (IFRS 13 para. 29).

STEP
5
Highest and best use for non-financial assets
Entity-specific view Market-participant view

(consider existing use and alternatives)
Existing use
Use must be physically possible,

legally permissible and financially
feasible
The entity needs to determine whether the highest and best use of the asset provides maximum
value to market participants either:
•• on a stand-alone basis (e.g. freehold land), and therefore the fair value measurement will be
calculated at the individual asset level, or
•• in combination with other complementary assets (e.g. a specialised piece of machinery used
on a production line that operates in conjunction with other assets), and therefore the fair
value measurement will be calculated on a combined asset basis.

STEP
5
Example – Determining the highest and best use for a non-financial asset
This example illustrates how to identify the highest and best use for a non-financial asset.
Company X owns a plane that is used to operate charter services for large corporations. The
plane is carried at value in its financial statements.
Company X has two feasible options for the plane:
1. Continue to use the plane for charter flights.
When used for charter services, the value of the plane is $4 million at the reporting date.
2. Refurbish the cabin as a luxury plane.
Refurbishment is estimated to cost $1 million. The plane would then have a value of $6
million. There is strong global demand from celebrities and business tycoons who are keen
to own their own luxury plane.
Company X has not commenced any planning to refurbish the plane by the reporting date, but is
giving this option careful consideration and has consulted with a US company that specialises in
such refurbishments.
As option 2 is feasible, the plane’s existing use value is not the only basis considered when
determining the value.
Fair value of the plane based on its highest and best use
Use for charter flights Refurbished as a luxury plane
Value $4,000,000 $6,000,000
Less costs of refurbishment 0 ($1,000,000)
$4,000,000 $5,000,000
Fair value is $5,000,000
From a market participant’s perspective, the plane’s highest and best use is if it were refurbished.
Source: Adapted from IFRS 13 Fair Value Measurement Illustrative Examples, January 2012, accessed on 9 April 2018
STEP
Step 6 – Using an appropriate valuation technique 6

assets
In bringing together these concepts, the standard explains that when a price for an identical
asset or liability is not observable, an entity measures fair value using another valuation
technique (IFRS 13 para. 3).
The Standard does not specify the use of a particular valuation technique as it is a matter of
professional judgement; however, para. 61 requires an entity to apply a valuation technique:
•• that is appropriate in the circumstances
•• for which sufficient data is available
•• for which the use of relevant observable inputs is maximised
•• for which the use of unobservable inputs is minimised.

STEP Three widely used valuation techniques are outlined in IFRS 13, para. 62. However, these
6
techniques are more of an overall approach, whereas practitioners will apply specific valuation
methods. The three valuation techniques are as follows:
IFRS 13 Definition Typical inputs Specific Items that may be

overall (assumptions) valuation valued using this
valuation methods technique
technique
Market A valuation technique The fair value and yield to For example, •• Real estate
approach that uses prices and other maturity on a corporate matrix pricing •• Financial
relevant information bond that is frequently and market instruments
generated by market traded on an active pricing based such as swaps,
transactions involving market that has a similar on recent debt securities
identical or comparable credit quality to the transactions and equity
(i.e. similar) assets, instrument being valued instruments
liabilities or a group of
•• Certain
assets and liabilities, such
intangible
as a business
assets where
there is
an active
market for a
homogenous
asset (e.g. a taxi
licence)
Cost A valuation technique Estimated costs using For example, •• Tangible assets
approach that reflects the amount quantity surveyors and depreciated such as plant
that would be required builders, remaining useful replacement cost and equipment
currently to replace the life estimates reflecting method •• Infrastructure
service capacity of an physical and economic/ assets
asset (often referred to as technological factors (e.g. bridges)
current replacement cost)
Income Valuation techniques that Discount rate, income For example, •• A cash-
approach convert future amounts stream (e.g. rentals, discounted cash generating unit
(e.g. cash flows or income royalties, sales, remaining flow method •• Intangible
and expenses) to a single economic life) and multi-period assets that
current (i.e. discounted) For a financial excess earnings generate an
amount. The fair value instrument, inputs may Black-Scholes- income stream
measurement is include current share Merton option (e.g. royalties)
determined on the basis price, risk-free interest pricing model
of the value indicated rate, time until option
by current market expiration and option
expectations about those strike price
future amounts
An awareness of these overall valuation techniques, rather than a practical application of

specific techniques, is required for the purposes of this module.

As indicated in the table above, inputs are used in applying a particular valuation technique. STEP
6
These inputs effectively represent the assumptions that market participants would use to make
pricing decisions, including assumptions about risk. Inputs may also include price information,
volatility factors, specific and broad credit data, liquidity statistics, and all other factors that
have more than an insignificant effect on the fair value measurement.
IFRS 13 distinguishes between observable inputs, which are based on market data obtained
from sources independent of the entity, and unobservable inputs, which reflect the entity’s own
view of the assumptions market participants would apply.
The Standard specifies that regardless of which valuation technique is being applied by
an entity for measuring fair value, it should maximise observable inputs and minimise
unobservable inputs.
Example – Identification of a suitable valuation technique

This example illustrates how to identify a suitable valuation technique to measure fair value.
Company X has acquired a subsidiary, NewHope Limited (NewHope), in a business combination.
One of NewHope’s assets that has been identified is a brand name. NewHope’s brand is a critical
part of its business, attracting many new customers as well as creating brand loyalty with
existing customers.
Because there has been a business combination, IFRS 3 requires the brand name to be measured
at fair value at the date Company X gained control of the subsidiary. Under IAS 38, NewHope is
not permitted to recognise the brand name in its own general ledger.
To value the brand name, an income approach is the most appropriate valuation technique
because the brand name generates inflows in the form of sales, and therefore an income
approach aligns with the nature of the asset’s benefits.
A market approach would not be appropriate as the brand name is unique to the business and
therefore comparable assets will not exist in the market.
A cost approach would also not be appropriate as the value of the brand name cannot be easily
replicated through a replacement cost calculation and would involve the extensive use of
unobservable inputs.
(The unit on intangible assets (Unit 8) explains why NewHope could not recognise this asset in its
own records.)
STEP
Step 7 – Based on inputs from the fair value hierarchy 7

assets
The fair value hierarchy categorises the inputs used in a valuation technique into three levels.
The most reliable evidence of fair value is a quoted price (unadjusted) in an active market for
identical assets and liabilities (Level 1). When this price is available, the hierarchy specifies that
it must be used without adjustment, except in certain specified (and limited) circumstances
(IFRS 13 para. 77).
When a quoted price in an active market is not available, entities need to use a valuation
technique to measure fair value that is appropriate in the circumstances, maximises the use of
relevant observable inputs (Level 2) and minimises the use of unobservable inputs (Level 3)
(IFRS 13 para. 67).

STEP The classification of inputs within the fair value hierarchy is shown below:
7
Classification of inputs within the fair value hierarchy
Level 1 input
Is there a
quoted (Quoted prices (unadjusted) in
No Has the No
price for an active markets for identical assets
price been or liabilities that the entity can access
identical item adjusted?
Yes Yes at the measurement date)
in an active
market? Examples:
• Quoted prices for shares listed on
the New Zealand Stock Exchange
• Commodities such as gold and
crude oil
Level 2 input
(Inputs other than quoted prices
included within Level 1 that are
Are there any observable for the asset or liability,
No
significant either directly or indirectly)
unobservable Examples:
inputs? Yes
• Interest rates
• Valuation multiples
• Price per square metre
Level 3 input
(Unobservable inputs for the asset or
liability)
Examples:
• Forcast cash flows
• Estimated useful life of an asset
Source: Adapted from KPMG 2011, ‘First Impressions: Fair value measurement’, available at www.kpmg.com/Global/en/
IssuesAndInsights/ArticlesPublications/first-impressions/Documents/First-impressions-fair-value-measurement.pdf,
accessed 16 April 2018.
In some cases, the inputs used to measure fair value may be categorised within different levels
of the fair value hierarchy. In such instances, the fair value measurement is categorised in its
entirety, based on the lowest level input that is significant to the measurement. This is relevant
for certain disclosures required by IFRS 13.
Example – Categorisation of inputs into the fair value hierarchy

This example illustrates how an input used in a technique to measure fair value is categorised
within the fair value hierarchy.
Company X has a fixed-rate borrowing that is measured at fair value but is not quoted on a
market. A discounted cash flow technique was used to measure the fair value of the contractual
cash flows under the borrowing and two particular inputs were included within the calculation
of the discount rate that was applied in the measurement:
Item Category of input Reason
The time value of money based on a Level 2 As the intervals of the yield curve can
yield curve observable at commonly be corroborated by observable market
quoted intervals for listed fixed-rate data (borrowings quoted on active
borrowings markets are the market evidence), it is
a Level 2 input

STEP
Item Category of input Reason 7
Credit risk of Company X Level 3 The input cannot be corroborated
by market evidence and is based on
management’s assumptions on the
entity’s own credit risk and therefore it
is a Level 3 input
Source: Adapted from: PWC 2015, ‘In depth – A look at current financial reporting issues’, www.pwc.co.za/
en/assets/pdf/indepth-ifrs-13-questions-and-answers-march-2015.pdf, accessed 16 April 2018.
STEP
Step 8 – To arrive at a fair value measurement 8

assets
The final step is arriving at the dollar value for the item being measured at fair value.
Whether a complex valuation technique is applied or a more straightforward measurement
technique is used, IFRS 13 para. 24 states that:
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction in the principal (or most advantageous) market at the measurement date under current
market conditions (i.e. an exit price) regardless of whether that price is directly observable or estimated
using another valuation technique.
In measuring this exit price from a market participant’s perspective, IFRS 13 specifies the
treatment for certain costs:
Cost Included or excluded in Reason for treatment

fair value measurement
Transport costs Included They are relevant to fair value where location, for
example, is a characteristic of an asset (IFRS 13
para. 26)
Transaction costs Excluded They are entity-specific and can differ depending on
how a transaction is structured. They are a feature of
the transaction rather than a characteristic of the asset
or liability being measured (IFRS 13 para. 25)

STEP
8
Example – Measuring fair value
This example illustrates how to measure fair value for an asset and extends on the earlier
example that looked at the situation when there is no principal market for an asset.
Company X is measuring the fair value of a particular asset and has determined that there
is no principal market for it. It has identified two possible markets:
Column 1 Market A Market B*
$ $
Selling price 100,000 110,000
Sales commission (10,000) (25,000)
Delivery costs (4,000) (5,000)
Net proceeds 86,000 80,000
Market A is identified as the most advantageous market as the amount received to sell the
asset is maximised after factoring in transaction and transport costs.
However, when measuring fair value within Market A (the most advantageous market),
transaction costs are ignored. Accordingly the fair value is $96,000 ($100,000 – $4,000).
* The fact that the corresponding value in Market B of $105,000 ($110,000 – $5,000) is higher than the
$96,000 fair value in Market A is irrelevant. Market B was not identified as the most advantageous market
for the asset. Consequently, fair value is not measured in that market.
Considerations specific to liabilities and an entity’s own

equity instruments
Measuring fair value for liabilities and an entity’s own equity instruments can be difficult as
quoted prices are often not available for the transfers of such items. IFRS 13 provides specific
guidance in these circumstances. An awareness of these requirements, rather than performing
a valuation, is required for this unit.
Liabilities
The definition of fair value as it relates to liabilities is based on the liability being transferred
rather than settled. Therefore, IFRS 13 requires the assumption that the liability will be
transferred to a market participant at the measurement date. Its fair value must also reflect non-
performance risk – the risk that the entity will not fulfil an obligation, including (but not limited
to) the entity’s own credit risk.
An entity’s own equity instruments

An example of when a fair value must be measured for an entity’s own equity instruments
is in a business combination. The entity may issue shares as all or part of the consideration
transferred to acquire a business (covered in Unit 15). As required by IFRS 3, the fair value of
these equity instruments is measured by the entity issuing the securities, as this is integral in
determining whether goodwill is recognised in the business combination.
Measuring fair value for liabilities and own equity

In comparison to assets, active markets for liabilities and equities are less likely to exist as a
result of contractual and legal obligations preventing their transfer.
When debt and equity securities are quoted on an active market, the market acts as an exit
price mechanism for the investor rather than the issuer. Where a quoted transfer price (Level 1
input) is not available for a liability or own equity instrument, IFRS 13 looks to the flipside of

the transaction and requires the fair value to be measured from the perspective of a market
participant that holds the identical item as an asset.
The valuation perspective under IFRS 13 of a liability or an entity’s own equity measurement
can be explained as follows:
Quoted price for transfer

of an identical or YES
Use quoted price
similar liability/own
equity instrument?
NO
Identical instruments
held as an asset by
another party?
YES NO
Value from the perspective Value from the perspective

of market participant of market participant
that holds the asset that owes liability or
issued equity instrument
Use quoted price Quoted price in an active

YES
(adjusted for market for identical
differences) instrument held as asset?
NO
Use an appropriate valuation technique
Source: Adapted from KPMG June 2011, First impressions: Fair value measurement, p. 15, accessed 16 April 2018,
www.kpmg.com, search for ‘fair value measurement’.
Preparing IFRS 13 disclosures

Disclosures under IFRS 13 are extensive and are grouped under para. 91(a) between recurring
and non-recurring disclosures. Paragraph 93 explains the difference between recurring and non-
recurring disclosures as follows:
•• Recurring disclosures are those that other accounting standards require or permit in the
statement of financial position at the end of each reporting period (e.g. if the fair value
measurement of property is re-measured annually under IAS 16).
•• Non-recurring disclosures are those that other accounting standards require or permit in
the statement of financial position in particular circumstances (e.g. in the event of a business
combination under IFRS 3).
In addition, para. 91(b) requires disclosure of the effect of the measurement for the
reporting period on profit or loss or other comprehensive income where recurring fair value
measurements use significant Level 3 inputs.
For items measured in the statement of financial position at fair value after initial recognition,
para. 93(b) requires an entity to disclose, by class of asset or liability, the level in the fair value
hierarchy at which the fair value measurement is categorised. Professional judgement may need
to be exercised to determine the significance of the inputs to the fair value measurement.

The table below outlines the key IFRS 13 disclosures:
Summary of IFRS 13’s disclosure requirements
Recurring Non- recurring
General disclosure requirements
Fair value at the end of the period
Reasons for the measurement
General disclosures relating to the fair value hierarchy
The level of the fair value hierarchy in which the valuation falls*
The policy for determining when transfer between levels of the

hierarchy are deemed to have occurred
Reasons for transfers between different levels of the hierarchy
A description of the valuation techniques and inputs used in fair value

measurements categorised within Levels 2 and 3 of the hierarchy*
Fair value hierarchy disclosures specific to Level 3 valuations
Quantitative information about significant unobservable inputs in fair

value measurements*
A reconciliation of changes in fair value movements, disclosing

separately changes attributable to:
–– Total gains or losses recognised in profit or loss and the line item
in which they are recognised
–– Total gains or losses recognised in other comprehensive income
and the line item in which they are recognised
–– Purchases, sales, issues and settlements
–– Transfers into or out of Level 3
Total gains or losses included in profit or loss attributable to the change

in unrealised gains or losses for measurements within Level 3
A description of the valuation processes used for Level 3 measurements
A narrative description of sensitivity analysis for Level 3 measurements
The effect of altering an unobservable input where to do so would

change the fair value significantly
Other disclosure requirement
For non-financial assets where highest and best use differs from current
use, an explanation of why this is the case
* Disclosure also required for assets and liabilities not measured at fair value but for which fair value is disclosed in
the financial statements
Adapted from: Grant Thornton, IFRS News, October 2011, Grant Thornton website, accessed 16 April 2018,
www.grantthornton.com.au/globalassets/1.-member-firms/australian-website/technical-publications/ifrs/gtil_2011_ifrs-
mews-ifrs-13-special-edition.pdf accessed 16 April 2018.
Example – Disclosure of recurring fair value measurements

This example illustrates how an entity may present disclosures under IFRS 13 paras 93(a) and (b)
at the end of the reporting period for assets and liabilities with recurring fair value measurement
requirements.
The table below categorises a company’s classes of assets and liabilities measured at fair value by
the levels in the fair value hierarchy based on the source of inputs.

30 June 20X3
Recurring fair value measurements at the end of the reporting
period using:
Item Quoted prices in Significant Significant Total

active markets for other unobservable
identical assets or observable inputs
liabilities inputs
(Level 1) (Level 2) (Level 3)
$’000 $’000 $’000 $’000
Assets
Equity securities: classified

as fair value through other
comprehensive income 220 – – 220
Investment property: unit in high-

rise apartment block – 1,000 – 1,000
Investment property: factory – – 2,000 2,000
Property: owner-occupied – – 3,000 3,000
Total assets 220 1,000 5,000 6,220
Liabilities
Forward exchange contracts used

for hedging – (100) – (100)
Contingent consideration arising

from business combination – –) (450) (450)
Total liabilities – (100) (450) (550)
In making these disclosures, the preparer would have given consideration to assets and liabilities
with inputs in multiple levels of the fair value hierarchy where those inputs were significant
to the item’s fair value. An item is classified in the hierarchy based on the level of the lowest
significant input. Focusing on the disclosure of the two investment properties, assume that:
•• The fair value of the unit in the high-rise apartment block involved the use of a Level 3
input to allow for a specific characteristic such as a custom-designed kitchen. A Level 2
input involved the use of observable prices for similar properties recently sold in the same
building. Overall, this property has been categorised as a Level 2 input, as this level is more
significant in measuring its fair value under a valuation technique using the market approach
than the Level 3 input.
•• The factory is classified separately (IFRS 13 para. 94) from the high-rise apartment block
unit, due to its different nature, characteristics and risk. It is being held for rental returns
and long-term capital appreciation, and therefore a valuation technique using an income
approach is appropriate in measuring fair value. A Level 2 input in measuring its fair value is
market rent per square metre for similar industrial properties in a similar location. However,
Level 3 inputs, such as cash flow forecasts using the company’s own data and yields based
on management’s expectations, are more significant in arriving at fair value. Therefore, the
factory is categorised as a Level 3 input in the table.
Activity 6.1: Measuring fair value of non-financial assets

Quiz


Unit 7: Property, plant and equipment
Contents
Introduction 7-3
Defining property, plant and equipment 7-4
Scope exclusions 7-4
Differentiating PPE classes 7-4
Recognition of items as PPE 7-5
Accounting for PPE during its useful life 7-6
Measurement at recognition 7-6
Measurement of cost 7-8
Subsequent costs 7-10
Measurement after initial recognition 7-11
Depreciation 7-16
Impairment 7-17
Compensation for impairment/loss of an asset 7-17
Derecognition 7-17
Non-current assets held for sale and discontinued operations 7-18
Disclosures for PPE, borrowing costs and non-current assets held for sale 7-19
Disclosures for PPE 7-19
Disclosures for borrowing costs 7-19
Disclosures for non-current assets held for sale 7-20
fin11907_csg_04


Learning outcomes
Introduction
Regardless of the industry sector in which an entity operates, it most likely will have property,
plant and equipment (PPE). PPE is non-financial tangible assets that are used in an entity’s
business operations during more than one period.
The amount to be recognised for the asset and the impact on profit or loss via depreciation
charges or impairment charges over the life of the asset and on disposal/derecognition need to
be correctly determined to accurately reflect the asset’s use in the business over its useful life.
This unit considers the recognition, measurement, classification, derecognition and disclosure
requirements for non-current assets recognised by an entity as PPE.
A current asset is defined in IAS 1 Presentation of Financial Statements para. 66 as follows:
An entity shall classify an asset as current when:
(a) it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
(b) it holds the asset primarily for the purpose of trading;
(c) it expects to realise the asset within twelve months after the reporting period; or
(d) the asset is cash or a cash equivalent (as defined in IAS 7) unless the asset is restricted from being
exchanged or used to settle a liability for at least twelve months after the reporting period.
Paragraph 66 further states that all other assets shall be classified as non-current.
In this unit, unless stated to the contrary, PPE are considered to be classified as non-current assets.
The unit also covers situations where borrowing costs can be capitalised as part of the cost of
a non-current asset, and addresses the implications of non-current assets that are held for sale.
Since a standard may require or permit an asset to be measured at fair value, the calculation
and disclosure requirements for fair value measurement, as applicable to non-financial tangible
assets, is also covered.
This unit examines the application of the following standards:
•• IAS 16 Property, Plant and Equipment.
•• IAS 23 Borrowing Costs.
•• IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations.
•• IFRS 13 Fair Value Measurement.


Defining property, plant and equipment
Learning outcome
PPE is defined in IAS 16 para. 6 as:

... tangible items that:
(a) are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes; and
(b) are expected to be used during more than one period.
PPE does not include assets that are classified as investment properties in accordance with
IAS 40 Investment Property. Investment properties are discrete assets that are independent of
an entity’s principal business activities. Their unique characteristics make them different from
PPE assets, which have a distinct connection to, and are an essential element of, an entity’s
business activities.
IAS 40 prescribes specific accounting and disclosure requirements for certain types of property
held for investment, as opposed to property held for resale or occupied by the owner.
IAS 40 para. 5 defines an investment property as:
... property (land or a building – or part of a 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:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.
This unit does not consider non-current assets classified as investment property.
Scope exclusions
IAS 16 deals with the accounting and disclosure requirements for most non-financial tangible
assets. The exclusions that are covered in other standards are identified in IAS 16 para. 3:
This Standard does not apply to:
(a) property, plant and equipment classified as held for sale in accordance with IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations;
(b) biological assets related to agricultural activity (see IAS 41 Agriculture);
(c) the recognition and measurement of exploration and evaluation assets (see IFRS 6 Exploration for
and Evaluation of Mineral Resources); or
(d) mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources
However, this Standard applies to property, plant and equipment used to develop or maintain the
assets described in (b)–(d).
Differentiating PPE classes

The distinction between items of PPE is important when determining the appropriate classes for
measurement after initial recognition and for disclosure purposes.

Example – Differentiating between items of PPE

This example illustrates the distinction between items of PPE.
A factory that a drinks company constructs/acquires to manufacture its goods in would be
classified as property; the automated production line that bottles the product would be
classified as plant; and a forklift used in the factory would be classified as equipment.
Property
The factory building
Plant
The automated production line
Equipment
The forklift
Recognition of items as PPE

IAS 16 para. 7 requires that the cost of an item of PPE must only be recognised as an asset when:
(a) it is probable that future economic benefits associated with the item will flow to the entity;
and
(b) the cost of the item can be measured reliably.
An entity is required to use judgement when applying the recognition criteria for PPE.
For example, para. 8 identifies that items such as spare parts and servicing equipment usually
do not meet the criteria for recognition as PPE, and so are usually classified as inventory
(e.g. spare parts inventory) and expensed as consumed. However, it is possible for major spare
parts to qualify as PPE when an entity expects to use them for more than one period. Similarly,
if the spare parts relate specifically to an asset held by the entity, the costs of those parts are
accounted for as PPE.

IAS 16 does not specify what constitutes an item of PPE, and judgement is required in
applying the recognition criteria to an entity’s specific circumstances (para. 9). For example,
should an aircraft be classified as a single asset or should the components be recognised
separately? To answer this question, an analysis of what will happen to that asset in the future
is required. If the asset has a number of distinct components with different useful lives, then the
components will need to be accounted for separately to record correctly the pattern of benefits
consumed. In the case of an aircraft, the separate components may consist of the engines, the
fuselage of the aircraft and the internal fittings.
Example – Aircraft components are recognised separately

This example illustrates the different components that may need to be separately recognised.
Required reading
Accounting for PPE during its useful life
Learning outcomes
Measurement at recognition
Where an asset can be recognised, IAS 16 para. 15 requires it to be initially measured at cost.
Paragraph 6 defines cost as:
… 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 or, where applicable, the amount attributed
to that asset when initially recognised in accordance with the specific requirements of other IFRSs,
e.g. IFRS 2 Share-based Payment.

Elements of cost
IAS 16 para. 16 states that the cost of an item of PPE comprises:
•• Its purchase price, including any import duties and non-refundable purchase taxes
(e.g. GST) incurred, after deducting any trade discounts or rebates.
•• Directly attributable costs.
•• An initial estimate of the costs of dismantling and removing the asset and restoring the site.
Directly attributable costs are costs that are needed to bring an asset to the location and
condition necessary so that it can operate in the manner intended by management.
If the purchase price and any directly attributable costs are denominated in a foreign currency,
then they are recorded by translating the foreign currency amount using the spot exchange rate
at the date of the transaction, in accordance with the requirements of IAS 21 The Effect of Changes
in Foreign Exchange Rates. This is classified as a foreign currency transaction and is covered in the
unit on foreign exchange. The asset needs to be recorded in the functional currency of the entity.
The initial estimate of the costs of dismantling and removing the asset and restoring the
site is determined under IAS 37 Provisions, Contingent Liabilities and Contingent Assets and is
included in the cost of the asset, in accordance with IAS 16. IAS 37 essentially requires that
these estimated costs be discounted back to present value at the time of initial recognition of the
PPE. The change over time in the value of the provision resulting from unwinding the discount
is discussed further in the unit on accounting for provisions. It does not impact the amount
recognised in PPE.
Example – Situations where the costs of dismantling and removing an asset or restoring a
site must be capitalised as part of the original cost of an item of PPE
This example illustrates when the cost of an asset needs to include a dismantling/restoration
provision.
The construction of an
offshore oil platform, where
the law requires the platform
to be removed at the end of
the oil extraction.
The use of land for mining or

farming activities where the
land must be restored to its
former state at the end of the
period of use.

Inclusions and exclusions of costs

The following costs are to be included as directly attributable costs (IAS 16 para. 17):
•• Employee benefit costs arising directly from the construction or acquisition of the item of PPE.
•• Costs of site preparation.
•• Initial delivery and handling costs.
•• Installation and assembly costs.
•• Costs of testing whether the asset is functioning properly.
•• Professional fees.
Note that IAS 23 requires that borrowing costs (which include interest) be capitalised as part of
the cost of a qualifying asset, as discussed later in this unit.
Expenditure on the following is not to be included in the cost of PPE (IAS 16 paras 19 and 20):
•• Costs of opening a new facility.
•• Costs of introducing a new product or service (including costs of advertising and
promotional activities).
•• Costs of conducting business in a new location or with a new class of customer (including
costs of staff training).
•• Administration and other general overhead costs.
•• Costs incurred while an item capable of operating in the manner intended by management
has yet to be brought into use or is operated at less than full capacity.
•• Initial operating losses, such as those incurred while demand for the item’s output builds up.
•• Costs of relocating or reorganising part or all of an entity’s operations.
Measurement of cost
Once the elements of the cost of an item of PPE have been identified, these amounts need to be
measured. In most situations this will be simple to determine; however, deferred payment of
the consideration and asset trade-ins can complicate the calculation.
IAS 16 para. 23 states that the cost of an item of PPE is the cash price equivalent at the
recognition date.
Specific matters to consider are:
•• Deferred payment of the consideration – if payment is deferred beyond normal credit terms,
interest will need to be recognised in profit or loss unless it can be capitalised in accordance
with IAS 23 (i.e. only where the asset is a qualifying asset as defined by IAS 23).
•• A non-monetary asset, or a combination of non-monetary and monetary assets, may be
exchanged to acquire an item of PPE. For example, an old asset may be traded in as part of
the consideration to acquire a replacement PPE asset, as often applies with motor vehicles.
Paragraphs 24–25 specify how to measure the cost in this situation.
•• The value of PPE acquired under a finance lease is measured in accordance with IFRS 16
Leases. This is discussed further in Unit 12.
•• A government grant may reduce the amount recognised for PPE under IAS 20 Accounting
for Government Grants and Disclosure of Government Assistance.
Capitalisation of borrowing costs on a qualifying asset

When determining the cost of an item of PPE, the possibility of capitalising borrowing costs
should also be considered.
IAS 23 requires borrowing costs to be capitalised into the cost of PPE in certain situations where
the asset is a ‘qualifying asset’.
A qualifying asset is defined in para. 5 as ‘an asset that necessarily takes a substantial period
of time to get ready for its intended use or sale’. In practice, ‘a substantial period of time’ is
considered to be 12 months or more.

Paragraph 7 provides further guidance as to what types of assets may be regarded as qualifying
assets, and makes clear that qualifying assets do not include those that are ready for their
intended use or sale at the time of acquisition.
Borrowing costs are defined in para. 5 as ‘interest and other costs that an entity incurs in
connection with the borrowing of funds’. Paragraph 6 clarifies that ‘interest’ is the interest
expense calculated using the effective interest rate method (discussed further in the unit on
financial instruments) and what ‘other costs’ constitute borrowing costs.
Paragraph 8 requires that borrowing costs, to the extent that they are directly attributable to the
acquisition, production or construction of a qualifying asset, are capitalised. Only borrowing
costs that would have been avoided had the expenditure on the qualifying asset not been made
are able to be capitalised under this standard.
IAS 23 outlines two types of borrowing costs eligible for capitalisation:
•• Funds borrowed specifically for the purpose of obtaining a qualifying asset (para. 12).
•• Funds borrowed generally and used for the purpose of obtaining a qualifying asset
(para. 14).
Capitalisation of borrowing costs:

•• Commences on the date at which the entity first meets all of the following conditions
(para. 17):
(a) it incurs expenditures for the asset;
(b) it incurs borrowing costs; and
(c) it undertakes activities that are necessary to prepare the asset for its intended use or sale.
•• Is suspended when active development of a qualifying asset is halted for extended periods
(para. 20).
•• Ceases when substantially all of the activities necessary to prepare the qualifying asset for
its intended use or sale are complete (para. 22).
Example – Capitalisation of borrowing costs on a qualifying asset

This example illustrates the calculation of borrowing costs to be capitalised on a qualifying asset.
To increase its production capacity, Smart Limited (Smart) signed a $3,000,000 contract with
Binns Limited for a new manufacturing plant that will produce plastic mouldings for use in the
car manufacturing industry. The contract was signed on 1 March 20X2.
The terms of the contract were as follows:
•• 20% paid on signing the contract.
•• 70% paid on delivery.
•• 10% paid three months after delivery.
The plant was delivered on 1 January 20X3 and installation was completed on 31 March 20X3.
To help fund the acquisition of the manufacturing plant, Smart obtained a bank loan for
$2,000,000 on 1 January 20X3. The loan has a term of two years, with a fixed rate of interest of
5.5% per annum.
To determine whether the borrowing costs are capitalised in the cost of the plant, it must be
determined whether the plant is a qualifying asset.
The contract was signed on 1 March 20X2 and the plant was ready for use on 31 March 20X3.
It took 13 months to get the plant ready for use, which is reasonable to assume is a substantial
period of time as it exceeds 12 months; it is therefore a qualifying asset.
The commencement date for capitalisation is the date when Smart first met all the conditions
in IAS 23 para. 17. The contract was signed (i.e. activities were underway) and expenditure was
first incurred on the asset on 1 March 20X2; however, borrowing costs were first incurred on
1 January 20X3. The commencement date of the capitalisation of borrowing costs is therefore
1 January 20X3.

Capitalisation of borrowing costs
Period Calculation $
01.01.20X3 – 31.03.20X3 $2,000,0001 × 5.5% × 3 ÷ 12 27,500
1. Although the total expenditure on the plant at 1 January 20X3 is $2,700,000 ($600,000 on signing the
contract + $2,100,000 on delivery), only $2,000,000 of this has been financed by the loan.
Required reading
Summary - initial measurement of PPE
Initially Purchase Directly Initial Capitalised

measure
at cost
= price + attributable
condition/
+ estimate of
dismantling,
+ borrowing
costs
location removal and
(IAS 16 para. 15) (IAS 16 para. 16(a)) costs restoration (IAS 23 para. 8)
costs
(IAS 16 paras 16(b)
and 17) (IAS 16 para. 16(c)/
linked to IAS 37
for recognition and
measurement)
Certain
exclusions
from cost
(IAS 16 paras 19
and 20)
Subsequent costs
The need to repair or replace an item of PPE may require an entity to consider how to account
for subsequent expenditure on PPE. IAS 16 para. 12 refers to the recognition principle set out
in para. 7 to assess whether subsequent costs should be capitalised or expensed. Day-to-day
servicing costs are generally expensed as repair and maintenance expenses. Further guidance
about when to capitalise versus when to expense is provided in paras 13 and 14.
One approach is to capitalise subsequent costs when they either:
•• Extend the useful life of an asset.
•• Improve the asset’s quality of output.
•• Reduce the operating costs associated with the use of the asset.
It is common for major components of an asset to require replacement at regular intervals;

therefore, the components are accounted for as separate assets (as discussed earlier) and are
depreciated separately over their respective useful lives.

Example – Accounting for components as separate assets

This example illustrates how separate components of an asset may need to be separately
recognised.
Seats in an aircraft may require replacement several
times during the life of the aircraft fuselage; hence,
they are accounted for as separate assets.
Expenditure on the replacement of components of an asset that increase the economic

benefits to be derived from that asset must be distinguished from expenditure on repairs and
maintenance of the asset. When components are replaced and the costs are capitalised, the parts
replaced (i.e. the existing components) must be derecognised to avoid double-counting.
Measurement after initial recognition

Subsequent to initial recognition, an entity has the option of carrying assets under either
the cost model or the revaluation model, as prescribed in IAS 16 para. 29. These models are
discussed below.
The selection of the cost model or the revaluation model is an accounting policy decision.
The Standard prescribes that the policy must be applied to an entire class of PPE, rather than
to individual assets (para. 36). An entity may elect to adopt the cost model of measurement for
some classes of PPE and the revaluation model for other classes of PPE.
Paragraph 37 defines a class of PPE as ‘a grouping of assets of a similar nature and use in an
entity’s operations’, and provides the following examples: land, land and buildings, machinery,
ships, aircraft, motor vehicles, furniture and fixtures, and office equipment.
Under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors para. 14(b), after an
entity has elected which model it will apply to a particular class of assets, it can change from
cost to revaluation or vice versa if the change will result in an overall improvement in the
relevance and reliability of information about the entity’s financial performance and position.
Changes in accounting policies are discussed in Unit 2.
Cost model
IAS 16 para. 30 requires that all items of PPE measured under the cost model be carried at cost
less any accumulated depreciation and any accumulated impairment losses.
Revaluation model
In many cases, the calculation of an asset’s carrying amount by reference to its cost may not be
a true reflection of the current value of the asset. Therefore, IAS 16 provides entities with the
option of adopting the revaluation model for classes of PPE. Under the revaluation model, items
of PPE are revalued to fair value.

For the revaluation model to be adopted, IAS 16 para. 31 requires that the fair values of the
assets in question can be measured reliably.
IAS 16 para. 6 defines fair value as:
... the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
This definition is consistent with the definition of fair value in IFRS 13. All accounting standards
defer to IFRS 13 for fair value measurement issues, as discussed in the unit on fair value
measurement.
Where the revaluation model is used to measure a class of PPE, IAS 16 para. 31 requires that
revaluations be made with sufficient regularity to ensure that the carrying amount of each
asset in the class does not differ materially from its fair value at the reporting date. Therefore,
there may be no requirement for annual revaluations to be made. The frequency of revaluations
depends on the changes in fair value and is discussed in more detail in para. 34.
IAS 16 paras 39 and 40 contain the principles for applying the revaluation model. These
paragraphs refer to individual items of PPE. Therefore, even though the revaluation model is
applied to classes of assets, the accounting under the model is applied on an asset-by-asset basis.
Applying the revaluation model

There are four steps to applying the revaluation model.
Step 1 – Restate or eliminate accumulated depreciation

Either proportionally restate accumulated depreciation (IAS 16 para. 35(a)), or eliminate it
against the gross carrying amount of the asset (IAS 16 para. 35(b)). Unless otherwise stated, the
elimination method is the method adopted in this module.
The pro forma journal entry for the elimination method is as follows:

$ $
xx.xx.xx Accumulated depreciation XXX
PPE XXX
Reversal of accumulated depreciation on the revaluation of the PPE
Step 2 – Calculate the amount of revaluation increment/decrement

Calculate the amount of revaluation increment/decrement (i.e. the difference between the net
amount (from Step 1) and the revalued fair value amount of asset) (IAS 16 para. 35).
Step 3 – Classify the revaluation adjustment

Classify the revaluation adjustment from Step 2 as revaluation increment or decrement and,
as per IAS 16 para. 42, consider the tax accounting implications of IAS 12 Income Taxes. For the
purposes of the FIN module, it is assumed that a revaluation increment or decrement does not
alter the tax base of the asset. A temporary difference arises resulting in the recognition of a
deferred tax asset or deferred tax liability.
Step 4 – Prepare adjusting journal entries

To prepare the correct journal entries, consider whether there is a previous revaluation
increment or decrement relating to the asset. The exact journal entries will depend upon the
facts of each case.

Example – Revaluation of PPE

This example illustrates the journal entries for the revaluation of an item of PPE.
Assume a tax rate of 30%.
Revaluation increment with no previous revaluation decrement
On 1 May 20X3 an item of PPE is revalued for the first time. Its carrying amount after the
elimination of depreciation (as per step 1) is $100,000. The fair value of the asset is $150,000.
The journal entry to record the revaluation increment is as follows:
$ $
01.05.X3 PPE 50,000
Revaluation surplus (equity account)* ($50,000 × (1 – 30%)) 35,000
DTL ($50,000 × 30%) 15,000
Being the revaluation increment for PPE
* Disclosed in OCI.
Revaluation decrement with no previous revaluation increment
On 1 May 20X3 an item of PPE is revalued for the first time. Its carrying amount after the
elimination of depreciation (as per step 1) is $100,000. The fair value of the asset is $70,000.
The journal entry to record the revaluation decrement and tax is as follows:
$ $
01.05.X3 Revaluation expense (profit or loss) 30,000
DTA* ($30,000 × 30%) 9,000
PPE 30,000
Income tax expense ($30,000 × 30%) 9,000
Being the revaluation decrement for PPE recognised in profit or loss
* Recognised to the extent that realisation is probable (IAS 12 para. 24).
Revaluation increment with previous revaluation decrement

On 1 May 20X3 an item of PPE is revalued. Its carrying amount after the elimination of
depreciation (as per step 1) is $100,000. The fair value of the asset is $120,000. A revaluation
decrement of $50,000 had previously been recognised in relation to this asset and it had been
assessed that realisation of the resulting DTA was probable.
$ $
01.05.X3 PPE 20,000
Revaluation income (profit or loss) 20,000
DTA ($20,000 × 30%) 6,000
Being the revaluation increment for PPE with a previous revaluation decrement
decrement of $50,000 had previously been recognised in profit or loss in relation to this asset
and it had been assessed that realisation of the resulting DTA was probable.


$ $
01.05.X3 PPE 60,000
DTA ($50,000 × 30%) 15,000
Revaluation surplus (equity account)* ($10,000 × (1 – 30%)) 7,000
DTL ($10,000 × 30%) 3,000
Being the revaluation increment for PPE with a previous revaluation decrement
* Disclosed in OCI.
Revaluation decrement with previous revaluation increment
increment of $40,000 had previously been recognised in relation to this asset.
$ $
01.05.X3 Revaluation surplus (equity account) ($30,000 × (1 – 30%)) 21,000
DTL ($30,000 × 30%) 9,000
PPE 30,000
Being the revaluation decrement for PPE with a previous revaluation increment
increment of $20,000 had previously been recognised in relation to this asset.
$ $
01.05.X3 Revaluation surplus (equity account) ($20,000 × (1 – 30%)) 14,000
DTL ($20,000 × 30%) 6,000
Revaluation expense (profit or loss) ($30,000 – $20,000) 10,000
DTA* (($30,000 – $20,000) × 30%) 3,000
Income tax expense (($30,000 – $20,000) × 30%) 3,000
PPE 30,000
Being the revaluation decrement for PPE with a previous revaluation increment
* Recognised to the extent that realisation is probable (IAS 12 para. 24).
Required reading
IFRS 13 para. 9.

Pro forma journal entries for revaluation of property, plant and equipment
Revaluation increment
No previous revaluation decrement recognised Previous revaluation decrement recognised

in profit or loss in profit or loss
Disclose in other comprehensive income (disclosure Recognise in profit or loss to the extent that it reverses
purposes only) and accumulate in revaluation surplus a decrement previously recognised in profit or loss
account (IAS 16 para. 39) (IAS 16 para. 39)
Pro forma journal entry: Pro forma journal entry:
Date Account description Dr Cr Date Account description Dr Cr

$ $ $ $
XX.XX.XX PPE XXX XX.XX.XX PPE XXX
XX.XX.XX Revaluation surplus1 XXX XX.XX.XX Revaluation income1 XXX
XX.XX.XX Deferred tax liability XXX XX.XX.XX Revaluation surplus3 XXX

(DTL)
XX.XX.XX Deferred tax asset (DTA)
2
XXX
Revaluation increment for PPE
XX.XX.XX DTL XXX
1. Net of related tax
XX.XX.XX Income tax expense XXX
Revaluation increment for PPE with a previous revaluation

decrement
1. Revaluation expense reversed

2. Recognised to the extent realisation is probable
3. Net of related tax
Revaluation decrement
No previous revaluation increment recognised Previous revaluation increment recognised

in revaluation surplus in revaluation surplus
Recognise in profit or loss (IAS 16 para. 40) Disclose in other comprehensive income (disclosure
purposes only) to the extent that it reverses a previous
revaluation surplus amount (IAS 16 para. 40)

$ $ $ $
XX.XX.XX Revaluation expense XXX XX.XX.XX Revaluation surplus1 XXX
XX.XX.XX DTA 1
XXX XX.XX.XX DTL XXX
XX.XX.XX PPE XXX XX.XX.XX Revaluation expense XXX
XX.XX.XX Income tax expense XXX XX.XX.XX DTA XXX
Revaluation decrement for PPE XX.XX.XX Income tax expense XXX
1. Recognised to the extent realisation is probable XX.XX.XX PPE XXX
Revaluation decrement for PPE with a previous revaluation

increment
1. Net of related tax on the amount recognised in other


Depreciation
Depreciation is defined in IAS 16 para. 6 as:
... the systematic allocation of the depreciable amount of an asset over its useful life.
Depreciation is expensed in profit or loss unless it is included in the carrying amount of another
asset. For example, where machinery is used on a production line, the machinery depreciation
will be part of the cost of inventory and will be capitalised in the cost of inventory to the
extent that the inventory is still on hand at period end. The entry to record this would be:
DR Inventory WIP; CR Accumulated depreciation.
Depreciation is allocated over an asset’s useful life, which is defined in IAS 16 para. 6 as:
(a) The period over which an asset is expected to be available for use by an entity; or
(b) The number of production or similar units expected to be obtained from the asset by an entity.
Depreciation commences when an asset is available for use by the entity (i.e. when it is in the
location and condition necessary for it to be capable of operating in the manner intended by
management), and ceases at the earlier of the date when the asset is:
•• Reclassified as being held for sale under IFRS 5.
•• Derecognised (e.g. sold or scrapped).
Depreciation does not cease when an asset becomes idle or is retired from active use unless the
asset is fully depreciated. However, the depreciation charge can be zero where the depreciation
method is based on usage during periods of non-production (IAS 16 para. 55).
Depreciation is calculated on the depreciable amount, which is defined in para. 6 as ‘the cost of
an asset, or other amount substituted for cost, less its residual value’. This definition means that
a class of PPE measured at fair value is still subject to depreciation.
Depreciation method
Each entity is required to select the method, on an asset-by-asset basis, that most closely reflects
the expected pattern of consumption of benefits (IAS 16 para. 60). A variety of depreciation
methods can be used and IAS 16 para. 62 identifies the following depreciation methods:
•• Straight-line method – this results in a constant charge over the asset’s useful life (provided
that the residual value does not change).
•• Diminishing balance method – this results in a decreasing charge over the asset’s useful life.
•• Units of production (usage) method – this results in a charge based on the expected use
or output.
IAS 16 para. 61 requires a review of the depreciation methods applied to all assets to be
conducted at the end of the annual reporting period (as a minimum). If there is a significant
variation in the asset’s pattern of consumption, the method of depreciation must be adjusted
to reflect this change.
Where an annual review results in a change of depreciation rate, depreciation method, or
useful life, the effect must be accounted for as a change in an accounting estimate. Under IAS 8,
changes in accounting estimates are recognised prospectively, meaning that the effect of the
change is included in profit or loss in the:
•• Period of the change, if it only affects the current period.
•• Current and future years, if the change affects both the current and future years.
No adjustments should be made to amounts already recorded in current or previous years.
Summary of depreciation
Depreciation commences when the asset is in the location and condition necessary for it to
operate in the manner intended by management; it is allocated over the asset’s useful life to the
entity; it ceases at the earlier of reclassification as held for sale or when the asset is derecognised
(IAS 16 para. 55).

Steps in the depreciation method
Determine the depreciable amount of the asset (IAS 16 para. 50).
Determine the useful life by assessing the asset’s expected utility to the entity and
consider the:
• Expected usage of the asset.
• Expected physical wear and tear.
• Technical or commercial obsolescence.
• Legal restrictions (IAS 16 paras 56−57).
The depreciation method applied should reflect the expected pattern of benefits that will
be enjoyed by the entity from using the asset (IAS 16 paras 60 and 62). Common methods
include straight-line, diminishing balance and units of production.
Prepare the depreciation journal entry to recognise depreciation in profit or loss unless
it is included in the carrying amount of another asset (IAS 16 para. 48).
Review residual values, useful lives and depreciation methods at least annually at each
year end. Any change is accounted for as a change in an accounting estimate in
accordance with IAS 8 (IAS 16 paras 51 and 61).
Impairment
The requirements of IAS 36 Impairment of Assets, as discussed in the unit on impairment of
assets, should be applied in determining and accounting for impairment of an asset. PPE cannot
have a carrying amount higher than the asset’s recoverable amount.
Compensation for impairment/loss of an asset

If compensation is recoverable in relation to the impairment, loss or giving up of an asset, it
should be included within profit or loss when receivable (IAS 16 para. 65).
Derecognition
Under IAS 16 para. 67, an item of PPE should be derecognised from the statement of financial
position when:
•• it is disposed of
•• no future economic benefits are expected from its use or disposal.
A gain or loss on disposal should be recognised in profit or loss upon derecognition as

the difference between the net disposal proceeds, if any, and the asset’s carrying amount
(IAS 16 para. 71).

Any balance in relation to the asset recorded in the revaluation surplus account may be
transferred to retained earnings upon derecognition of that item of PPE. However, transfers
from the revaluation surplus to retained earnings are not made through profit or loss
(IAS 16 para. 41).
Activity 7.1: Accounting for property, plant and equipment

Non-current assets held for sale and discontinued operations

IFRS 5 contains specific requirements for assets held for sale, and for the presentation and
disclosure of discontinued operations (discontinued operations is covered in the unit on
presentation of financial statements). The focus in this unit is on the financial reporting
requirements when an entity’s intention in holding an individual asset or group of assets alters.
A non-current asset is classified as held for sale when its recovery is expected to result
principally through a sale transaction, rather than through continuing use.
When a non-current asset is classified as held for sale, it is:
•• Measured at the lower of its carrying amount and fair value less costs to sell (IFRS 5 para. 15).
•• No longer depreciated (IFRS 5 para. 25).
•• Classified separately from other assets on the statement of financial position (IFRS 5 para. 38).
IFRS 5 provides guidance on the recognition of impairment losses and reversals, and the
accounting implications where there is a change to a plan of sale.
Required reading

Disclosures for PPE, borrowing costs and non-current

assets held for sale
Disclosures for PPE

The disclosure requirements for PPE are specified in IAS 16 paras 73–79. Key aspects of the
disclosure requirements for each class of PPE include:
•• The measurement bases used for determining the gross carrying amount.
•• The depreciation method used.
•• The useful lives or the depreciation rates used.
•• The gross carrying amount and the accumulated depreciation (aggregated with
accumulated impairment losses) at the beginning and end of the reporting period.
•• A detailed reconciliation of the carrying amount at the beginning and end of the reporting
period, which includes (where applicable):
–– Additions.
–– Reclassification to assets held for sale.
–– Acquisitions through business combinations.
–– Increments or decrements arising from revaluations.
–– Impairment losses and/or reversal of previous impairments losses.
–– Depreciation.
–– Net exchange differences arising on translation from a functional currency to the
presentation currency.
–– Other changes.
Key aspects of the disclosure requirements for PPE stated at revalued amounts include:
•• The date of the revaluation.
•• Whether an independent valuer was used.
•• For each revalued class of PPE, the carrying amount that would have been recognised if the
cost model had been applied.
•• Certain details concerning the revaluation surplus.
•• The valuation techniques and inputs used to develop fair value measurements (IFRS 13
para. 91(a)).
•• For recurring fair value measurements using significant unobservable inputs, the effect of
the measurements on profit or loss or other comprehensive income for the period (IFRS 13
para. 91(b)).
Required reading
IFRS 13 para. 91.
Disclosures for borrowing costs

The limited disclosure requirements for borrowing costs are specified in IAS 23 para. 26.
An entity is required to disclose the following:
•• Borrowing cost capitalised during the period.
•• Capitalisation rate used to determine the borrowing costs.

Disclosures for non-current assets held for sale

The disclosure requirements for non-current assets held for sale are specified in IFRS 5
paras 30–42.
ITL Limited’s 2015 annual report provides an example of the practical application of the IFRS 5
Further reading
ITL Limited and Controlled Entities 2015, 2015 Annual Report, Consolidated balance sheet (p. 22)
and Note 12 (for disclosures concerning assets held for sale, p. 45).
Quiz
Working paper C
You are now ready to complete working paper C of integrated activity 4, to understand

Unit 8: Intangible assets
Contents
Introduction 8-3
Identifying key characteristics of intangible assets 8-3
Defining an intangible asset 8-3
Recognition of intangible assets 8-4
Measurement, amortisation and derecognition of intangible assets 8-5
Initial measurement of cost for intangible assets 8-5
Internally generated intangible assets prohibited from recognition 8-8
Accounting for intangible assets after initial recognition 8-8
Amortisation of intangible assets 8-13
Derecognition 8-14
Summary - intangible assets 8-15
Disclosures 8-16
fin11908_csg_03


Learning outcomes
1. Identify and explain the key characteristics of an intangible asset, including whether it can
be recognised for financial reporting purposes.
Introduction
Intangible assets are similar to tangible assets (e.g. property, plant and equipment) in that
they contribute to an entity’s operations in current and future accounting periods. However,
intangible assets are non-monetary assets without physical substance and do not possess
concrete features like other assets, but they can demonstrate specific characteristics such as
control (i.e. by denying other parties access) and economic benefits through their use.
IAS 38 Intangible Assets prescribes the accounting and disclosure requirements for intangible
assets.
The definition of an intangible asset is quite broad and captures intangible assets ranging
from intellectual property (e.g. registered patents) to franchising agreements acquired from
external parties. Some intangible assets may be contained in or on a physical substance such
as a compact disc (e.g. computer software), legal documentation or film. Therefore, an entity
may need to exercise judgement to determine if an asset that incorporates both intangible and
tangible elements should be treated as a tangible asset under another accounting standard
(e.g. IAS 16 Property, Plant and Equipment) or as an intangible asset under IAS 38. An entity
may acquire different types of intangible assets either separately or as part of the acquisition of
other businesses.
Some intangible assets are not governed by IAS 38 as they are covered by other standards.
These include intangible assets held for sale in the ordinary course of business (IAS 2 Inventories
and IAS 11 Construction Contracts), financial assets (IAS 32 Financial Instruments: Presentation)
and goodwill acquired in a business combination (IFRS 3 Business Combinations).

Identifying key characteristics of intangible assets
Learning outcome
1. Identify and explain the key characteristics of an intangible asset, including whether it can be
recognised for financial reporting purposes.
Defining an intangible asset

An intangible asset is defined in IAS 38 para. 8 as ‘an identifiable non-monetary asset without
physical substance’.
IAS 38 paras 9 and 10 set out the principal characteristics of an intangible asset
(i.e. identifiability, control over a resource, and existence of future economic benefits). These
characteristics are explained below.

Identifiability
An intangible asset must be identifiable to distinguish it from goodwill. IAS 38 para. 12 states
that an asset is identifiable if it either:
(a) is separable, i.e. is capable of being separated or divided from the entity and sold, transferred,
licensed, rented or exchanged, either individually or together with a related contract, identifiable
asset or liability, regardless of whether the entity intends to do so; or
(b) arises from contractual or other legal rights, regardless of whether those rights are transferable or
separable from the entity or from other rights and obligations.
Control
Like other assets, an intangible asset must be controlled by the entity. IAS 38 para. 13 defines
this concept as the power to obtain the future economic benefits flowing from the underlying
resource and to restrict the access of others to those benefits.
Usually this characteristic will flow from legal rights. In the absence of legal rights it is difficult
to demonstrate control.
Future economic benefits

Intangible assets must be expected to provide future economic benefits to the entity.
The benefits can be presented in many ways, including:
•• Revenue from the sale of products or provision of services.
•• Cost savings.
•• Other benefits resulting from the use of the asset (IAS 38 para. 17).
Recognition of intangible assets

An intangible asset is recognised if it has the three essential characteristics of an intangible asset
and it satisfies the recognition criteria under IAS 38 para. 21:
(a) it is probable that the expected future economic benefits that are attributable to the asset will flow
to the entity; and
(b) the cost of the asset can be measured reliably.
These recognition criteria mirror the recognition criteria for an asset from the Conceptual
Framework for Financial Reporting para. 4.44.
The ‘probable’ concept is assessed by management based on internal/external evidence and
their best estimates of the future economic benefits arising from the intangible asset over its
useful life.
For separately acquired intangible assets, the ‘probable’ recognition criterion is always
considered to be satisfied (IAS 38 para. 25). In most cases, where consideration is in the form of
cash or other monetary assets, the cost of separately acquired intangible assets can be measured
reliably (IAS 38 para. 26).
Required reading

Measurement, amortisation and derecognition of

intangible assets
Learning outcome
Initial measurement of cost for intangible assets

An intangible asset is initially measured at cost (IAS 38 para. 24). Intangible assets may be
acquired from other entities or may be internally generated.
Intangible assets acquired from other entities

An intangible asset may be acquired from other entities through any of the following ways:
•• Separate acquisition (IAS 38 paras 25–32).
•• Acquisition as part of a business combination (IAS 38 paras 33–43) (covered in Unit 15).
•• Acquisition by way of a government grant (IAS 38 para. 44).
•• Exchange of assets (IAS 38 paras 45–47).
The following diagram presents an overview of the initial measurement of cost for separately
acquired intangible assets.
Initial measurement of cost for a separately acquired intangible asset
Purchase Directly attributable costs Initial cost

price IAS 38 recognised
IAS 38 para. 27(b) IAS 38
para. 27(a) para. 24
Include Include Exclude
• Import duties • Costs of employee • Costs of introducing a new

and benefits (as defined in product or service (including costs
non-refundable IAS 19) arising directly of advertising and promotional
purchase taxes from bringing the asset activities)
to its working condition
• Deduct trade • Costs of conducting business in a
discounts and • Professional fees arising new location or with a new class
rebates directly from bringing of customer (including costs of
the asset to its working staff training)
condition
• Administration and other general
• Costs of testing overheads
whether the asset is
• Costs incurred while an asset
functioning properly capable of operating in the
IAS 38 para. 28 manner intended by management
has yet to be brought into use
• Initial operating losses, such as
those incurred while demand for
the asset’s output builds up
IAS 38 paras 29-30

Internally generated intangible assets

Determining whether internally generated intangible assets meet the IAS 38 key characteristics
and recognition criteria can be a challenge, as it can be difficult to establish whether an
internally generated intangible asset will generate expected future economic benefits and can
be measured reliably. Therefore, additional requirements apply to all internally generated
intangible assets.
The development of internally generated intangible assets is classified into two phases – a
research phase and a development phase.
Research phase
Research is defined in IAS 38 para. 8 as ‘original and planned investigation undertaken with the
prospect of gaining new scientific or technical knowledge and understanding’.
IAS 38 para. 56 provides the following examples of research activities:
(a) activities aimed at obtaining new knowledge;
(b) the search for, evaluation and final selection of, applications of research findings or other
knowledge;
(c) the search for alternatives for materials, devices, products, processes, systems or services;
and
(d) the formulation, design, evaluation and final selection of possible alternatives for new or improved
materials, devices, products, processes, systems or services.
An intangible asset is not recognised as the view is that an entity cannot demonstrate that an
identifiable intangible asset exists that will generate future economic benefits. Expenditure on
the research phase must be expensed when it is incurred (IAS 38 para. 54).
Development phase
Development is defined in IAS 38 para. 8 as:
… the application of research findings or other knowledge to a plan or design for the production of new
or substantially improved materials, devices, products, processes, systems or services before the start of
commercial production or use.
IAS 38 para. 59 provides the following examples of development activities:

(a) design, construction and testing of pre-production or pre-use prototypes and models;
(b) design of tools, jigs, moulds and dies involving new technology;
(c) design, construction and operation of a pilot plant…; and
(d) design, construction and testing of a chosen alternative for new or improved materials, devices,
products, processes, systems or services.
IAS 38 para. 57 states that an intangible asset arising from the development phase can be
recognised if, and only if, an entity is able to demonstrate all of the following:
(a) the technical feasibility of completing the intangible asset so that it will be available for use or sale;
(b) its intention to complete the intangible asset and use or sell it;
(c) its ability to use or sell the intangible asset;
(d) how the intangible asset will generate probable future economic benefits. Among other things,
the entity can demonstrate the existence of a market for the output of the intangible asset or the
intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
(e) the availability of adequate technical, financial and other resources to complete the development
and to use or sell the intangible asset; and
(f) its ability to measure reliably the expenditure attributable to the intangible asset during its
development.
Where an entity demonstrates that all of the above criteria are met, an intangible asset is
recognised, as these criteria indicate that there are probable future economic benefits and that
the cost can be measured reliably.

Example – Recognising internally generated intangible assets

This example illustrates the recognition and measurement of an internally generated intangible
asset.
Funkid Limited (Funkid) has been working for a number of years on the development of a new
sun cream that only has to be applied every 24 hours and maintains the appropriate level of sun
protection during that time. The project commenced in October 20X3 and $1.3 million had been
spent on the project up to the 30 June 20X4 year end.
At 30 June 20X4, Funkid has made significant progress on the development of the cream,
although the inclusion of an expensive ingredient resulted in concerns as to whether the project
would be commercially feasible.
After spending an additional $550,000 during the six months to 31 December 20X4, Funkid has
identified a substitute ingredient that reduces the cost of the sun cream so that it will be able
to be marketed at a similar price to other sun creams. The prototype cream has been trialled
on a number of volunteers and several companies have expressed an interest in the sun cream.
The management of Funkid determined that the requirements of IAS 38 para. 57 were met at
this point.
Funkid incurred a further $300,000 during the six months ended 30 June 20X5 improving the
texture and scent of the sun cream based on feedback from volunteers who had trialled the
prototype. The cream is not yet available for sale; however, it is expected that the product will be
launched in October 20X5 ready for the summer.
An intangible asset will be recognised in relation to the development expenditure when the
criteria in IAS 38 para. 57 are met. The criteria are met on 31 December 20X4, and therefore the
costs of $300,000 incurred after this date will be capitalised as an intangible asset.
Under IAS 38 para. 71, costs previously expensed cannot be reinstated as part of the cost of an
asset when recognition criteria are met at a later date. On this basis, the $1.3 million that would
have been expensed in prior years and the $550,000 that has been expensed in the current year
cannot be capitalised into the cost of the intangible asset.
Cost of an internally generated intangible asset

The cost of an internally generated intangible asset comprises all directly attributable costs
incurred from the date when the intangible asset first meets all of the recognition criteria
(IAS 38 para. 65).
Directly attributable costs for internally generated assets are those necessary to create, produce
and prepare the asset to be capable of operating in the manner intended by management. These
costs are broadly consistent with those outlined for separately acquired assets, but are described
in more detail in IAS 38 paras 66–67.
Expenditure previously recognised as an expense cannot be reinstated as part of the cost of an
intangible asset when the recognition criteria are met at a later date (IAS 38 para. 71).
Website development costs

SIC Interpretation 32 Intangible Assets – Web Site Costs (SIC-32) provides guidance, within the
context of IAS 38, for entities that incur costs specifically for the development and operation of
its own website.
The website arising from development is recognised as an intangible asset if the recognition
criteria in IAS 38 paras 21 and 57 are met. The entity must be able to demonstrate how the
website will generate probable future economic benefits for it to be recognised as an intangible
asset. If the website is purely for business promotion and if orders cannot be placed through the
website, then the criteria would not be met and the development costs must be expensed in the
period in which they are incurred (SIC-32 para. 8).
Required reading
SIC-32 paras 1–10.

Worked example 8.1: Classifying and recognising intangible assets

Internally generated intangible assets prohibited from recognition

IAS 38 has identified some internally generated intangible assets that do not meet the
recognition criteria:
•• Internally generated goodwill cannot be recognised as an intangible asset. IAS 38 considers
that internally generated goodwill cannot be separated from operations nor does it
arise from contractual or legal rights, and thus will not satisfy the identifiability criteria.
In addition, many factors are beyond the control of an entity and affect the calculation of
goodwill, which makes it difficult to measure its cost reliably (IAS 38 paras 48–50).
•• Internally generated brands, mastheads, publishing titles, customer lists and items similar
in substance are specifically identified as intangible assets that cannot be recognised.
This is because IAS 38 considers that they cannot be clearly separated from the cost of the
development of an entity’s business as a whole (IAS 38 paras 63–64).
When an entity is acquired in a business combination, previously unrecognised intangible

assets of the acquiree are recognised at the date of the business combination. Identifiable
intangible assets are recognised and measured at fair value at the acquisition date
(IAS 38 para. 33). This is covered in more detail in the unit on business combinations.
Accounting for intangible assets after initial recognition

Intangible assets satisfying the recognition criteria are initially recognised at cost (IAS 38
para. 24). Subsequently, an entity will choose, on a class of asset basis, between the cost and the
revaluation models (IAS 38 para. 72).
Under the cost model, the intangible asset, after initial recognition, is carried in an entity’s
financial statements at its cost less accumulated amortisation and any accumulated impairment
losses (IAS 38 para. 74).
Under the revaluation model, the intangible asset, after initial recognition, is carried at a
revalued amount, being its fair value at the date of revaluation less any subsequent accumulated
amortisation and any accumulated impairment losses. Fair value is measured with reference
to an active market (IAS 38 para. 75). IFRS 13 Fair Value Measurement para. 9 and IAS 38 para. 8
define fair value as:
... the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
The factors that need to be considered when determining fair value are discussed in the unit on
fair value measurement.
It is difficult to apply the requirements of the fair value definition to most intangible assets due to
their unique nature and thin market conditions. IAS 38 acknowledges this issue and states that an
active market could exist for selected intangible assets such as for freely transferable taxi licences,
fishing licences or production quotas (IAS 38 para. 78), but cannot exist for intangible assets such
as brands or trademarks, as each asset is unique. Consequently, IAS 38 requires the following:
•• An intangible asset is carried at cost less accumulated amortisation and impairment losses if
no active market exists for the intangible asset and the class of intangible assets to which it
belongs has adopted the revaluation model (IAS 38 para. 81).
•• If an active market no longer exists, the carrying amount of the intangible asset is its most
recent revaluation by reference to the active market less any subsequent accumulated
amortisation and impairment losses (IAS 38 para. 82).
•• If the fair value of an intangible asset can be measured by reference to an active market
at a subsequent measurement date, the revaluation model is applied from that date
(IAS 38 para. 84).

Applying the revaluation model

There are four steps to applying the revaluation model.
Step 1 – Either proportionally restate accumulated amortisation (IAS 38 para. 80(a)), or
eliminate it against the gross carrying amount of the asset (IAS 38 para. 80(b)). Unless otherwise
stated, the elimination method is the method adopted in this module.
The following is a pro forma journal entry for the elimination method:

$ $
XX.XX.XX Accumulated amortisation XXX
XX.XX.XX Intangible asset XXX
Elimination of accumulated amortisation against the gross carrying amount on the revaluation of the
intangible asset
Step 2 – Calculate the amount of revaluation increment/decrement, being the difference

between the net amount (from step 1) and the fair value amount of the asset at the revaluation
date (IAS 38 para. 75).
Step 3 – Classify the revaluation adjustment from step 2 as revaluation increment or decrement
and consider the tax accounting implications of IAS 12. For the purposes of the FIN module, it
is assumed that a revaluation increment or decrement does not alter the tax base of the asset.
A temporary difference arises resulting in the recognition of a deferred tax asset or deferred
tax liability.
Step 4 – Prepare adjusting journals.
Example – Revaluation of intangible assets

This example illustrates the journal entries for the revaluation of intangible assets.
Assume a tax rate of 30%.
Revaluation increment with no previous revaluation decrement
On 1 May 20X3 Plenty More Limited (PM), a New Zealand company supplying fresh fish revalued
its hoki fishing quota for the first time. The carrying amount after the elimination of amortisation
(as per step 1 in applying the revaluation model) is $200,000. Fair value of the asset is $300,000.
The journal entry to record the revaluation increment is:
$ $
01.05.X3 Intangible asset – fishing quota 100,000
Deferred tax liability (DTL) ($100,000 × 30%) 30,000
Revaluation surplus* ($100,000 × (1 – 30%)) 70,000
Being the revaluation increment for intangible asset – fishing quota

* Disclosed in OCI.
Revaluation decrement with no previous revaluation increment

On 1 May 20X3 PM revalued its hake fishing quota for the first time. Its carrying amount after the
elimination of amortisation (as per step 1 in applying the revaluation model) is $200,000. Fair
value of the asset is $140,000.

The journal entry to record the revaluation decrement is:

$ $
01.05.X3 Revaluation expense 60,000
Deferred tax asset (DTA)* ($60,000 × 30%) 18,000
Intangible asset – fishing quota 60,000
Being the revaluation decrement for intangible asset – fishing quota recognised in profit or loss
* Recognised to the extent that realisation is probable.
Revaluation increment with previous revaluation decrement

On 1 May 20X4 PM revalued its ling fishing quota. Its carrying amount after the elimination of
amortisation (as per step 1 in applying the revaluation model) is $300,000. Fair value of the asset
is $360,000. A revaluation decrement of $150,000 had previously been recognised in relation to
this asset and it had been assessed that realisation of the resulting DTA was probable.
This journal should include:
$ $
DTA ($60,000 × 30%) 18,000
Being the revaluation increment for intangible asset – fishing quota with a previous revaluation
decrement
On 1 May 20X4 PM revalued its gemfish fishing quota. Its carrying amount after the elimination of
amortisation (as per step 1 in applying the revaluation model) is $150,000. Fair value of the asset is
$240,000. A revaluation decrement of $75,000 had previously been recognised in profit or loss in
relation to this asset and it had been assessed that realisation of the resulting DTA was probable.
$ $
Revaluation income 75,000
DTA ($75,000 × 30%) 22,500
Revaluation surplus* ($15,000 × (1 – 30%)) 10,500
DTL ($15,000 × 30%) 4,500
Being the revaluation increment for intangible asset – fishing quota with a previous revaluation
decrement
* Disclosed in OCI.

Revaluation decrement with previous revaluation increment

On 1 May 20X4 PM revalued its squid fishing quota. Its carrying amount after the elimination of
amortisation (as per step 1) is $100,000. Fair value of the asset is $70,000. A revaluation increment
of $40,000 had previously been recognised in relation to this asset.
$ $
01.05.X4 Revaluation surplus* ($30,000 × (1 – 30%)) 21,000
DTL ($30,000 × 30%) 9,000
Being the revaluation decrement for intangible asset – fishing quota with a previous revaluation
increment
* Disclosed in OCI.
On 1 May 20X4 PM revalued its red cod fishing quota. Its carrying amount after the elimination of
amortisation (as per step 1 in applying the revaluation model) is $100,000. Fair value of the asset
is $70,000. A revaluation increment of $20,000 had previously been recognised in relation to this
asset.
$ $
01.05.X4 Revaluation surplus* ($20,000 × (1 – 30%)) 14,000
DTL ($20,000 × 30%) 6,000
Revaluation expense ($30,000 – $20,000) 10,000
DTA** (($30,000 – $20,000) × 30%) 3,000
Income tax expense (($30,000 – $20,000) × 30%) 3,000
Being the revaluation decrement for intangible asset – fishing quota with a previous revaluation
increment
* Disclosed in OCI.
** Recognised to the extent that realisation is probable.
The revaluations should be made with such regularity so that the book value is not materially
different to the fair value at the end of the reporting period (IAS 38 para. 75).

Pro forma journal entries for revaluation of intangible assets

Revaluation increment
No previous revaluation decrement recognised in Previous revaluation decrement recognised in

profit or loss profit or loss
Disclose in other comprehensive income (disclosure Recognise in profit or loss to the extent that it reverses
purposes only) and accumulate in revaluation surplus a decrement previously recognised in profit or loss
account (IAS 38 para. 85) (IAS 38 para. 85)

$ $ $ $
XX.XX.XX Intangible asset XXX XX.XX.XX Intangible asset XXX
XX.XX.XX Deferred tax liability XXX XX.XX.XX Revaluation income1 XXX

(DTL)
XX.XX.XX Deferred tax asset XXX
XX.XX.XX Revaluation surplus1 XXX (DTA)2
Revaluation increment for intangible asset XX.XX.XX Income tax expense XXX
1. Net of related tax on the amount recognised in other XX.XX.XX Revaluation surplus3 XXX
XX.XX.XX DTL XXX
Revaluation increment for intangible asset with a

previous revaluation decrement
1. Revaluation expense reversed.

2. Recognised to the extent that realisation is probable.
Revaluation decrement
No previous revaluation increment recognised in Previous revaluation increment recognised in

revaluation surplus revaluation surplus
Recognise in profit or loss (IAS 38 para. 86) Disclose in other comprehensive income (disclosure
purposes only) to the extent that it reverses a previous
revaluation surplus amount (IAS 38 para. 86)

$ $ $ $
XX.XX.XX Revaluation expense XXX XX.XX.XX Revaluation surplus1 XXX
XX.XX.XX DTA1 XXX XX.XX.XX DTL XXX
XX.XX.XX Intangible asset XXX XX.XX.XX Revaluation expense XXX
XX.XX.XX Income tax expense XXX XX.XX.XX DTA XXX
Revaluation decrement for intangible asset XX.XX.XX Income tax expense XXX
1. Recognised to the extent realisation is probable XX.XX.XX Intangible asset XXX
Revaluation decrement for intangible asset with a

previous revaluation increment


Amortisation of intangible assets

Whether an intangible asset is amortised depends upon whether the asset’s useful life is finite
or indefinite. An intangible asset has an indefinite useful life when there is no foreseeable limit
to the period over which it is expected to generate net cash inflows (IAS 38 para. 88).
An intangible asset with an indefinite useful life is not amortised (IAS 38 para. 107) but is still
subject to an impairment review in accordance with IAS 36 Impairment of Assets (IAS 36), at least
on an annual basis and when indicators of impairment exist (IAS 38 para. 108). An intangible
asset with a finite useful life is amortised (IAS 38 para. 89) and IAS 38 para. 90 provides a list
of factors that management should consider when determining the useful life of an intangible
asset. It is also subject to the requirements of IAS 36 (IAS 38 para. 111). The requirements of
IAS 36 are covered in the unit on impairment of assets.
In addition to an impairment review, intangible assets with indefinite useful lives must be
reviewed each year to determine whether events and circumstances still support the use of
an indefinite useful life. If not, then the change to a finite life is accounted for as a change in
accounting estimate in accordance with IAS 8 (IAS 38 para. 109). Accounting for a change in
accounting estimate is discussed in the unit on presentation of financial statements.
Key definitions relating to the amortisation of intangible assets follow:
Key definitions relating to the amortisation of intangible assets
Term Definition
Amortisation Systematic allocation of the depreciable amount of an intangible asset over its
useful life (IAS 38 para. 8)
Depreciable amount Cost of an asset, or other amount substituted for cost, less its residual value (IAS 38
para. 8)
Residual value Estimated amount that an entity would currently obtain from disposal of the asset,
after deducting the estimated costs of disposal, if the asset were already of the age
and in the condition expected at the end of its useful life (IAS 38 para. 8)
Residual value of an intangible asset with a finite useful life is assumed to be
zero unless:
•• there is an active market for the asset
•• the residual value can be determined by reference to that market, and
•• it is probable that such a market will exist at the end of the asset’s useful life
Alternatively, a residual value can arise when there is a commitment by a third
party to purchase the asset at the end of its useful life (IAS 38 para. 100)
Useful life Period over which an asset is expected to be available for use by an entity, or the
number of production or similar units expected to be obtained from the asset by
an entity (IAS 38 para. 8)
When an intangible asset arises from contractual or legal rights, useful life cannot
exceed the period of the contractual or legal rights, including renewal periods only
if the renewal does not involve significant cost, but may be shorter depending on
the period over which the entity expects to use the asset (IAS 38 para. 94)
The process for amortisation of an intangible asset with a finite life, including key
considerations is shown in the following flow chart.

Process for amortisation of an intangible asset with a finite life
Commence amortisation when the intangible asset is in the location and condition
necessary for it to operate in the manner intended by management. It ceases at the
earlier of: the date when the intangible asset is reclassified as held for sale and the date
when the intangible asset is derecognised (IAS 38 para. 97).
Determine the depreciable amount of the intangible asset and decide how it will be
allocated on a systematic basis over its useful life (IAS 38 para. 97).
Ensure the amortisation method applied reflects the expected pattern of benefits that
will be enjoyed by the entity from using the intangible asset. Choose from straight-line,
diminishing balance, and unit of production methods (IAS 38 para. 98). If a pattern of
benefits cannot be determined, use the straight-line method (IAS 38 para. 97).
Review the amortisation period and amortisation method at least at each financial year
end. Any changes are accounted for as a change in an accounting estimate in accordance
with IAS 8 (IAS 38 para. 104).
Prepare the journal entry to recognise amortisation in profit or loss unless it is included in
the carrying amount of another asset (IAS 38 para. 99).
Worked example 8.2: Accounting for research and development costs

Derecognition
The carrying amount of an intangible asset is derecognised when:
•• it is disposed, or
•• no future economic benefits are expected from its use or disposal (IAS 38 para. 112).
Any related gain or loss is recognised in profit or loss at the time of derecognition (not classified
as revenue) (IAS 38 para. 113) and is calculated as the difference between net disposal proceeds,
if any, and the carrying amount of the intangible asset (IAS 38 para. 113). The consideration
receivable on disposal is recognised initially at its fair value. If payment for the intangible asset
is deferred, the consideration is recognised initially at the cash price equivalent. The difference
between the nominal amount of the consideration and the cash price equivalent is recognised
as interest revenue in accordance with IFRS 9.
If the revaluation model has been adopted, the cumulative amount in revaluation surplus for
the intangible asset may be transferred to retained earnings (not through profit or loss):
•• when the asset is derecognised, or
•• as the asset is used by the entity during its useful life subject to specific calculations (IAS 38
para. 87).

Activity 8.1: Accounting for intangible assets

Summary - intangible assets
Intangible asset An intangible asset can be generated:

DEFINITION
• As a separate acquisition
• Identifiable • As an acquisition as part of a business combination
• Non-monetary • Internally
• Without physical substance • As an acquisition by way of a government grant
IAS 38 para. 8 • By exchange of assets
Principal characteristics Recognition Prohibition on

recognition (unless
• Identifiability • Probable future economic benefits acquired as part of
• Control • Cost can be measured reliably a business
• Future economic benefits IAS 38 para. 21 combination):
CRITERIA
IAS 38 para. 10 • internally

generated
goodwill
• internally
generated brand
Research costs must be Specific recognition criteria for items names, etc.
expensed in development phase IAS 38 paras 48
IAS 38 para. 54 IAS 38 para. 57 and 63
MEASUREMENT
Initial Subsequent
Recognise at cost Accounting policy choice (class by
IAS 38 para. 24 class basis)
IAS 38 para. 72
ACCOUNTING
Cost Revaluation
MODEL
Cost less accumulated amortisation Fair value (measured by reference to

and accumulated impairment losses an active market) less accumulated
IAS 38 paras 74 and 111 amortisation and impairment losses
IAS 38 paras 75 and 111
IFRS 13 paras 9, 24 and 27
Finite Indefinite
USEFUL LIFE
Amortise over useful economic life No amortisation, review at least

IAS 38 para. 97 annually for impairment
IAS 38 paras 107–108

Disclosures
The key disclosure requirements of IAS 38 are detailed in paras 118–128.
The disclosure requirements of IAS 38 are necessary so users of financial statements can
understand an entity’s exposure to and accounting for its intangible assets during a particular
accounting period.
In summary, an entity must disclose the following:
1. General information for each class of intangible assets, distinguishing between internally
generated and other intangible assets (IAS 38 paras 118–123), with details of:
–– useful life information
–– amortisation methods used
–– carrying amount movements
–– a reconciliation of the carrying amount at the beginning and end of the period.
2. For intangible assets measured using the revaluation model (IAS 38 paras 124–125), with
details of:
–– valuation information including fair value assumptions and date of revaluation
–– carrying amount of revalued intangible assets and the carrying amount that would have
been recognised if the cost method had been applied
–– revaluation surplus movements.
3. Research and development expenditure recognised as an expense during the period (IAS 38
paras 126–127).
Quiz

Unit 9: Financial instruments
Contents
Part A 9-3
Introduction 9-3
IFRS 9 Financial Instruments 9-4
Common terms and concepts 9-5
Navigating this unit 9-6
Financial instruments 9-6
Financial instruments: meeting the definition 9-8
Derivatives 9-12
Distinguishing financial liabilities from equity 9-13
Compound financial instruments 9-15
Measurement of financial instruments 9-18
Initial recognition 9-18
Initial measurement 9-18
Subsequent measurement 9-19
Treatment of gains, losses, dividends and interest arising from financial instruments 9-21
Classification of financial instruments 9-23
Classification of financial liabilities 9-24
Amortised cost 9-24
Fair value through profit or loss 9-24
Classification of financial assets 9-25
Contractual cash flow characteristics of the financial asset (the SPPI test) 9-26
The business model used for managing financial assets 9-28
Designation at FVTPL 9-30
Equity investments 9-30
Summary – measurement of financial assets and liabilities 9-31
Interest recognition 9-32
Derecognition and reclassification 9-35
Derecognition of a financial liability 9-35
Derecognition of a financial asset 9-35
Reclassification of financial instruments 9-37
Part B 9-39
Hedge accounting 9-39
The hedged item, hedged risk and the hedging instrument 9-40
Overview of hedge accounting 9-41
Types of hedging relationship 9-42
Hedge accounting process 9-44
Fair value hedges 9-49
Cash flow hedges 9-51
Impairment of financial assets 9-59
Expected credit losses 9-60
The general approach to impairment 9-61
The simplified approach to impairment 9-62
Purchased or originated credit-impaired approach 9-62
Low credit risk operational simplification 9-63
Significant increase in credit risk 9-66
Recognition of ECLs in the financial statements 9-67

Disclosure 9-69
Overview of requirements 9-69
Classes of financial instruments for disclosure purposes 9-69
Appendix 1 – Definitions of common terms and concepts 9-70
Appendix 2 – Derivatives 9-75

Net settling 9-76
Embedded derivatives 9-77

Learning outcomes
1. Explain and identify financial instruments and the principles for classifying them as
financial assets, financial liabilities or equity instruments of the issuer.
2. Account for financial assets, financial liabilities and equity instruments of the issuer
(including derivatives).
This unit has been split into two sections for ease of
candidate study. Part A covers definitions, classification,
measurement and derecognition of financial instruments.
Part B covers hedging, impairment and disclosure of
financial instruments.
Part A
Introduction
Financial instruments are held by most entities, for example, in the form of cash, trade
receivables, trade payables, loans or more complex financing structures. Understanding how to
identify and account for financial instruments is crucial to your role as a Chartered Accountant.
Although International Accounting Standards on financial instruments have existed since 1995,
Accounting Standards in Australia were only introduced in 2004, as the usage of more complex
financial instruments increased.

There are now a number of standards that apply to financial instruments, as follows:
Standard Description
IAS 32 Financial instruments: Presentation Defines financial instruments and contains principles for classifying
and presenting financial instruments
IAS 39 Financial Instruments: Recognition Contains the principles for recognising and measuring financial
and Measurement instruments. Also contains the rules for hedge accounting
IFRS 7 Financial Instruments: Disclosures Contains the principles for disclosure of financial instruments,
and explains the significance of financial instruments for an
entity’s financial position and performance. Also explains the risks
associated with those instruments
IFRS 9 Financial Instruments Replaces IAS 39, effective for reporting periods beginning on
or after 1 January 2018. Contains principles for recognising and
measuring financial assets and liabilities. Also contains principles
for impairment, hedge accounting and derecognition
IFRS 13 Fair Value Measurement Defines fair value and provides a framework for determining fair
value when another Standard requires or permits the use of fair
value measurement
The majority of the Chartered Accountants Program studies in financial instruments concentrate
on the requirements of IFRS 9. The first part of this unit will focus on the requirements of
IFRS 9 to classify, measure and account for financial instruments. The second part will focus on
hedging and impairment of financial instruments. At the end of the unit we will briefly examine
the disclosure requirements of IFRS 7. The fair value standard, IFRS 13, is covered in Unit 6.
IFRS 9 Financial Instruments

IFRS 9 was issued to replace to IAS 39 primarily to address perceived deficiencies in IAS 39,
which were believed to have contributed to the magnitude of the global financial crisis in 2008.
These deficiencies were principally related to the delayed recognition of credit losses on loans
and other financial instruments.
In addition, IFRS 9:
•• Adopts a more principles-based approach to classification of financial instruments that is
based on the entity’s business model and the nature of cash flows rather than the rules-
based approach in IAS 39.
•• Introduces a forward-looking expected credit loss model, rather than the backward-looking
incurred loss model in IAS 39.
•• Aligns hedge accounting requirements more closely with an entity’s risk management
practices, particularly with regard to non-financial risks (e.g. commodity risks).
•• Removes the recognition in profit or loss of the impact of changes in an entity’s own credit
risk on the value of their liabilities.
Due to its principles-based approach, significantly more judgement is required to apply the
requirements of IFRS 9 compared to IAS 39. This unit will focus primarily on the requirements
of IFRS 9 and IAS 32, with a small section on IFRS 7.

IFRS 9 and IAS 32 apply to all types of financial instruments entered into by all entities, apart
from the following exceptions:
IFRS 9 IAS 32
•• Interests in subsidiaries, associates and joint •• Interests in subsidiaries, associates and joint
ventures accounted for under IFRS 10 Consolidated ventures accounted for under IFRS 10 Consolidated
Financial Statements, IAS 27 Separate Financial Financial Statements, IAS 27 Separate Financial
Statements or IAS 28 Investments in Associates and Statements or IAS 28 Investments in Associates and
Joint Ventures Joint Ventures
•• Employers’ rights and obligations under employee •• Employers’ rights and obligations under employee
benefit plans to which IAS 19 Employee Benefits benefit plans to which IAS 19 Employee Benefits
applies applies
•• Rights and obligations under an insurance •• Rights and obligations under an insurance
contract as defined in IFRS 4 Insurance Contracts, contract as defined in IFRS 4 Insurance Contracts,
except when the rights and obligations meet except when the rights and obligations meet
the definition of a financial guarantee contract, the definition of a financial guarantee contract,
although there are elections available as to which although there are elections available as to which
accounting standard applies accounting standard applies
•• Financial instruments, contracts and obligations •• Financial instruments, contracts and obligations
under share-based payment transactions to which under share-based payment transactions to which
IFRS 2 Share-based Payments applies IFRS 2 Share-based Payments applies
•• Financial instruments issued by an entity that

meet the definition of equity or are required to be
classified as equity under IAS 32
•• Rights and obligations under leases to which

IFRS 16 Leases applies, although there are some
aspects of leases that are covered by IFRS 9
•• A forward contract between an acquirer and a

selling shareholder to buy or sell an entity that will
result in a business combination within the scope
of IFRS 3 Business Combinations
•• Some loan commitments, although aspects of

these require the application of IFRS 9
•• Rights to payments to reimburse an entity for

expenditure required to settle a liability recognised
as a provision under IAS 37 Provisions, Contingent
Liabilities and Contingent Assets
•• Rights and obligations within the scope of IFRS 15

Revenue from Contracts with Customers that are
financial instruments
Common terms and concepts

To understand financial instruments and the application of the relevant accounting standards,
it is necessary to understand the different terms used to describe these instruments. Appendix 1
to this unit contains a list of some of the more common terms and concepts. These are shown
in bold in the material the first time they are used. Appendix 2 to this unit contains further
information about derivatives.
Required reading
IFRS 9 Appendix A Defined terms.

Navigating this unit

Throughout this unit you will find examples that illustrate the principles explained in the
material. In addition, you will have the opportunity to apply your knowledge by working
through a case study for Fly-by-day, a regional airline. It is recommended that you treat this
case study as a series of mini activities that you can attempt as you work through the unit to
confirm your understanding.
Financial instruments
Learning outcome
1. Explain and identify financial instruments and the principles for classifying them as financial
assets, financial liabilities or equity instruments of the issuer.
A financial instrument is defined in IAS 32 para. 11 as ‘any contract that gives rise to a
financial asset of one entity and a financial liability or equity instrument of another entity’.
As per the definition, a financial instrument is made up of a number of components, as follows:
•• a contract (i.e. an agreement between two or more parties)
•• a financial asset, and
•• a financial liability or equity instrument.
Required reading
IAS 32 paras 11, 15–16, 28 and 35–40.
A financial asset is a contractual right arising from a past transaction that provides future
economic benefit to an entity and results in a financial liability or equity of another entity. The
following are financial assets as defined in IAS 32:
Financial asset Example
Cash Bank account
Contractual right to receive cash or another financial Trade receivables, or investments in bonds or
asset convertible notes
Equity shares in another entity Investments in listed shares
Contractual right to exchange financial instruments Purchased call or put options, which an entity would
under potentially favourable conditions only exercise if conditions were in their favour
Contract that may or will be settled in the entity’s own These types of financial assets are not covered in the
equity instruments and is: FIN module
(i) a non-derivative for which the entity is or may
be obliged to receive a variable number of the
entity’s own equity instruments
(ii) a derivative that will or may be settled other than
by the exchange of either a fixed amount of cash
or another financial asset for a fixed number of
the entity’s own equity instruments

A financial liability is a type of contractual obligation arising from a past event that is expected
to result in an outflow of economic benefits and results in a financial asset of another entity.
The following are financial liabilities as defined in IAS 32:
Financial liability Example
Contractual obligation to deliver cash or another Trade payables, borrowings, financial guarantees or
financial asset to another entity issuance of bonds
Contractual obligation to exchange financial assets Written call or put options, which another entity
or financial liabilities under potentially unfavourable would exercise under conditions favourable to them
conditions (i.e. unfavourable to you)
Contract that will or may be settled in the entity’s own Issue of a convertible note by an entity that converts
equity instruments and is: to a fixed value of shares of the entity (e.g. $5,000
(i) a non-derivative for which the entity is or may worth of ordinary shares). The number of shares
be obliged to deliver a variable number of the received will, however, vary (e.g. if the share price is
entity’s own equity instruments $2 the holder will receive 2,500 shares; if the share
price is $1.60 the holder will receive 3,125 shares)
(ii) a derivative that will or may be settled other than
by the exchange of either a fixed amount of cash
or another financial asset for a fixed number of
the entity’s own equity instruments
An equity instrument is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities. Shares issued by a company will be an equity instrument of
that company.
Example – Equity instruments

On 1 November 20X6, Sfoglia Limited (Sfoglia) issued 1 million ordinary shares for $2 million as a
private placement to an institutional investor. $200,000 in share issue costs were incurred on the
date of the transaction. At 31 December 20X6, Sfoglia declared a 15c per share dividend, payable
on 15 March 20X7.
For the year ended 30 June 20X7, the following journal entries would have been prepared to
recognise these transactions with respect to the private placement:
Date Description Dr Cr
$ $
01.11.20X6 Cash at bank 2,000,000
Ordinary share capital [equity] 2,000,000
Being recognition of the share issue in equity
$ $
01.11.20X6 Ordinary share capital 200,000
Cash at bank 200,000
Being recognition of share issue costs [refer para. 35 of IAS 32]
$ $
31.12.20X6 Dividend paid [equity] 150,000
Dividend payable 150,000
Being recognition of the dividend payable when declared

$ $
15.03.20X7 Dividend payable 150,000
Being recognition of the payment of the dividend to the institutional investor
Financial instruments: meeting the definition

To meet the definition of a financial instrument, a contract must result in a financial asset of one
entity, and a financial liability or equity of another. This is illustrated in the table of examples below:
Example – Financial instruments definition

Contract Financial instrument
Contract for Chopsters Limited (Chopsters) enters into a contract to purchase inventory from a
purchase of supplier, Big Smoke Limited (Big Smoke). The inventory has been delivered, which
inventory on credit results in inventory being recognised on Chopsters’ statement of financial position
as well as trade payables (being the amount owing for the inventory). Big Smoke
has recognised trade receivables (being the amount owing by Chopsters for the
inventory) and sales
Chopsters Big Smoke
Inventory – non-financial asset Trade receivables – financial asset

Trade payables – financial liability Sales – income
Loan issued by a Chopsters is in the process of expanding its business and part-funds the expansion
bank with a loan from Safe Bank. Chopsters recognises the loan with Safe Bank as a
liability as well as the cash received in the bank account it holds with Safe Bank.
Safe Bank recognises the loan it has made to Chopsters as well as the bank account
Chopsters holds with it
Chopsters Safe Bank
Loan from Safe Bank – financial liability Loan to Chopsters – financial asset
Cash – financial asset Borrowings – financial liability
Shares issued by a Chopsters raises the remainder of the funds it needs for the expansion of its
company business by conducting a rights issue to its existing shareholders. Wealthy
Superfund is one of the investors who takes up its entitlement under the rights
issue and recognises the additional investment in its statement of financial
position
Chopsters Wealthy Superfund
Shares issued – equity Investments – financial asset
It is important to note in the example above that the inventory contract itself is not a financial
instrument as it does not result in a right or obligation of either party to receive, deliver or
exchange a financial asset. It is the resulting impacts on trade payables and trade receivables
that are financial instruments.
Below is an extract from the Woolworths 2016 Annual Report, which shows clearly each of the
financial instruments it holds as at 26 June 2016.

Financial asset
Refer detail in note extracts below
Not a financial asset
Generally assets held for sale are

non-financial assets
}
Not a financial asset
Refer detail in note extract below
Financial liability
Not a financial liability – statutory obligation

imposed by Government and not contractual
Not a financial liability –

constructive rather than
contractual obligations
} Trade and other receivables

from external parties are a
financial asset
Prepayments are not a financial

asset as they are settled through
the delivery of services, not cash

Derivatives and listed equity

securities are financial assets
Investments in associates are

specifically excluded from IFRS 9
Financial liability
Only a financial liability if it arises
from a contract e.g. rent accrual
Unearned income is not a financial

liability as it is settled through
the delivery of services, not cash
} Equity instruments


Apply your knowledge

Identification of financial instruments
Fly-by-day Airlines Limited (Fly-by-day) is a regional airline based in Dubbo, NSW which operates
flights to 45 airports throughout Australia. It also has operations in New Zealand, based in Nelson.
Fly-by-day has been listed on the Australian Secruities Exchange for a number of years.
You are the Senior Accountant reporting to Sarah March, the chief financial officer (CFO). Sarah
has asked you to provide some information, which will be included in a paper for the board, that
explains which items on the statement of financial position IAS 32 will apply to and why. They are
especially focused on the following items:
•• Cash at bank.
•• Trade receivables.
•• Fair value of hedging derivatives.
•• Inventory – consumable spares.
•• Prepayments.
•• Deferred tax assets.
•• Goodwill.
•• Trade payables.
•• Unearned revenue from passengers.
•• Borrowings.
•• Provisions for employee benefits.
Answer
You review the items listed and provide the following explanation for inclusion in the board paper:
Item Does IAS 32 Explanation
apply?
Cash at bank Yes Cash at bank is a financial asset – a contractual right to obtain
cash from the bank and a corresponding financial liability of
the bank
Trade receivables Yes These are contractual rights to receive cash from another
entity. There will be a corresponding financial liability in the
other entity’s books
Fair value of hedging Yes The fair value of a contract that will result in the receipt or
derivatives payment of cash or another financial asset with another entity
Inventory – consumable No This is not a financial asset as there is no contract in place.

spares Future economic benefit is obtained through the use of the
spares in the maintenance of aircraft, rather than to receive
cash or another financial asset from another entity
Prepayments No These are not a financial asset as the economic benefit of

prepayments is realised through the receipt of services or
goods, rather than the receipt of a financial asset
Deferred tax assets No These are not a contractual right to receive a financial asset,
but rather relate to a statutory obligation imposed by the
Government, and accordingly, these are not a financial asset
Goodwill No The economic benefit of goodwill is achieved through the

opportunity to earn increased profits, rather than through a
contractual right to receive cash or another financial asset.
Accordingly, it is not a financial asset
Trade payables Yes These are a contractual obligation to deliver cash to another
entity and accordingly is a financial liability

Item Does IAS 32 Explanation

apply?
Unearned revenue from No This is a contractual obligation to deliver services to customers

passengers (i.e. flights) rather than a financial asset. Accordingly, this is not
a financial liability
Borrowings Yes These are a financial liability as they involve a contractual

obligation to deliver cash or another financial asset to another
entity
Provisions for employee No Provisions are a constructive obligation (i.e. one that arises out
benefits of an entity’s actions) rather than a contractual obligation and
may be settled through the delivery of services rather than a
financial asset (e.g. permitting staff not to work for a period
of time whilst still paying them). Accordingly, these are not a
financial liability
Derivatives
A derivative ‘derives’ its value from underlying financial instruments, commodities, prices or
an index. They are widely used by entities to manage financial risk. Key features of a derivative
are that:
•• Its value changes based on changes in value of an agreed underlying asset.
•• It requires little or no net initial investment.
•• It is settled at a future date.
Appendix 2 to this unit contains further information and examples of common derivative

Derivatives
Sarah, the CFO, wants you to start working on how the financial instruments Fly-by-day enters into
should be classified. But before you start on this task, Sarah confirms with you that understanding
which instruments are derivatives and which are not is important.
To make sure you are both in agreement, she provides you with a list of contracts and asks you to
identify which ones are derivatives accounted for under IFRS 9 and why.
•• Interest rate swap.
•• FX forward rate contract (FX forward).
•• Contract to buy jet fuel in six months’ time.
•• Futures contract to buy USD in three months’ time.
•• Short-term debt securities issued by Fly-by-day.
•• Futures contract to buy jet fuel in six months’ time with physical delivery.
•• Rental contract with rental increases based on consumer price index (CPI).
•• Contract to purchase USD to pay an invoice tomorrow.
•• Call option over interest rates.

Answer
Contract Financial Derivative? Explanation
instrument?
Interest rate swap Yes Yes The value of an interest rate swap is based on an
underlying notional value and the relevant interest
rates in the contract. It has no initial net investment
FX forward Yes Yes The value of a forward FX contract is based on an

amount of currency to be purchased or sold and an
agreed exchange rate. It has no initial net investment
Contract to buy No No This is a contract for the delivery of goods and

jet fuel in six accordingly is not a financial instrument or a derivative
months’ time (specifically excluded as the contract is entered into
for the purpose of delivering a non-financial item (jet
fuel) in accordance with Fly-by-day’s expected usage
requirements)
Futures contract Yes Yes The value of the futures contract is based on an
to buy USD in amount of currency to be purchased in the future.
three months’ There is minimal initial net investment, although
time movements in the value of the contract are settled
daily
Short-term debt Yes No This is a contract to repay an amount of money on

securities specified terms. It is not a derivative
Futures contract No No This is effectively the same as the contract to buy jet
to buy jet fuel in fuel as described above, just transacted via a futures
six months’ time exchange rather than direct with a supplier (so not a
with physical financial instrument or derivative for the same reasons
delivery as above). However, if the contract was habitually
settled net in cash, an entity shall apply IFRS 9 to it and
may designate it as a derivative
Rental contract No Yes This is not a financial instrument as it is a contractual

with rental right to occupy space in a building. However, the value
increases based of the contract is derived from a base rate with a CPI
on CPI index applied, so it is a derivative
Contract to Yes No This is a contract to acquire cash in a foreign currency.

purchase USD Spot contracts that settle within two business days are
to pay an invoice defined under IFRS 9 as regular way contracts which
tomorrow are specifically excluded from being recognised as
derivatives
Call option over Yes Yes This is a contract with a small initial investment whose
interest rates value is derived from an underlying notional amount
and interest rate
The only derivatives Fly-by-day needs to be concerned about with regard to the application of IFRS 9
are those that are also financial instruments as IFRS 9 does not apply to derivatives that are not financial
instruments
Distinguishing financial liabilities from equity

The classification of financial instruments as a liability or equity has a significant impact on
the amount of net assets presented by an entity, and thus on an entity’s gearing, debt ratios
and reported earnings. Determining whether a financial instrument should be classified as a
financial liability or equity can often be difficult.

The critical feature in distinguishing between the two is the existence of a contractual obligation
of the issuer of the financial instrument to the holder to:
•• deliver cash
•• deliver another financial instrument, or
•• exchange another financial instrument with the holder under conditions potentially
unfavourable to the issuer.
Where such a contractual obligation exists, the financial instrument is likely to be a financial
liability.
The key factor for classification is the discretion of the issuer to make payments to the holder.
If the issuer has a contractual obligation to make payments to the holder, it is likely that the
financial instrument is a liability not equity.
Example – Classification of financial instruments

Ordinary shares Generally classified as equity by the issuer as ordinary shares represent the
residual interest in their net assets. They are perpetual and dividend payments
are made at the full discretion of the company, so there is no contractual
obligation
Debt Debt instruments issued by an entity are generally classified as financial

liabilities as they carry contractual obligations to repay the principal amount in
addition to interest payments
Preference shares While many preference shares receive a ‘fixed’ dividend, it is still likely that
this is entirely at the discretion of the company and, accordingly, is not a
contractual obligation (even if ordinary share dividends cannot be paid
until preference share dividends are paid). However, some features may
lead preference shares to be classified as financial liabilities. These include
mandatory dividend payments, redemption at the holder’s request and
conversion at the holder’s option to a fixed value (variable number) of ordinary
shares (a condition potentially unfavourable to the issuer)

Liabilities and equity
Following the favourable acceptance of your report, Sarah advises you that the board is considering
raising $20 million of additional capital to fund aircraft purchases. The board is thinking about a
couple of financial instruments, but is not sure how these instruments will impact the company’s
Sarah has asked you to advise which category of the statement of financial position the following
funding options will be classified in (i.e. financial liability or equity).
•• Bank loan – this would be arranged with Fly-by-day’s bank. The loan would incur interest at
5% per annum. The principal would be repaid on maturity in 10 years.
•• Preference shares – dividend rate fixed at 6% per annum. If Fly-by-day does not declare
a preference share dividend in any year, it is not permitted to pay dividends to ordinary
shareholders. Fly-by-day is prohibited from paying dividends on its ordinary shares until any
missed dividends on the preference shares are paid.

Answer
Bank loan
Fly-by-day has a contractual obligation to make principal and interest payments to the bank.
It has no discretion over this obligation and accordingly, the bank loan would be classified as a
financial liability.
Preference shares
There is no contractual obligation on the part of Fly-by-day to make a dividend payment each
year. The only obligations regarding dividends are that:
•• The dividend is at a specified rate.
•• If a dividend is declared, Fly-by-day has to pay the dividend to preference shareholders
before it pays dividends to ordinary shareholders.
•• If no dividend is declared, these payments have to be ‘caught up’ before payments can be
made to ordinary shareholders.
In addition, the shares have no maturity date, so there is no contractual obligation to repay the
principal amount invested by holders. Accordingly, these preference shares will be classified
as equity as they are not a financial liability.
Compound financial instruments

From the issuer’s perspective, some non-derivative financial instruments contain characteristics
of both a financial liability and equity. These types of instruments are called compound
Example – Convertible note that is a financial liability

Some notes provide for final repayment either in cash or conversion into the equivalent value
of the issuer’s shares, depending on the share price at the time. This means that the number
of shares received by the holder will be variable, but their value will be fixed. This type of
convertible note is a financial liability as the issuer has a contractual obligation to deliver cash
during the life of the note (as scheduled interest payments) and either cash or another financial
asset of the same value at maturity.
Example – Convertible note that is a compound financial instrument

A note that is convertible, either mandatorily or at the holder’s option, into a fixed number of the
issuer’s ordinary shares has the legal form of a debt contract. However, its substance is that of
two instruments:
(a) Financial liability – there is a contractual obligation to deliver cash by making scheduled
payments of interest and principal, which exists as long as the note is not converted.
(b) Written call option – grants the holder of the note the right to convert it into a fixed number
of the issuer’s ordinary shares. The value of these shares (and thus the value received by the
holder) will change based on the share price at the time. (Given that the face value of the
note has already been determined, this represents a ‘fixed for fixed’ derivative that is not a
liability under IAS 32 and is therefore an equity instrument.)
Under IAS 32, compound financial instruments must be classified separately into their liability
and equity components, and accounted for separately by the issuer. The issuer is required to
determine the fair value of the financial liability at the date of its initial recognition. The amount
allocated to the equity component is the residual amount of the compound instrument. These
initial values of each component may not be subsequently revised.

The following figure illustrates how the fair value of a compound instrument is allocated into
its components:
Step 1: Fair value of

compound instrument Step 2: Fair value of liability
Determine fair value of the Determine the fair value of the
compound instrument as a liability component at the issue
LIABILITY
whole (generally the issue price) date (i.e. the present value of the
contracted future interest and
principal cash flows)
Step 3: Balance equity

Deduct fair value of the liability
component from the fair value
EQUITY of the compound instrument as
a whole. The resulting residual
amount represents fair value of
the equity component
FIN fact
Only the issuer accounts for the instrument as a compound financial instrument. The investor
will recognise a financial asset (and there is no split accounting).
These components are then separately accounted for as per the normal requirements for liability
or equity instruments. This is often termed ‘split accounting’. The liability will be accounted for
under IFRS 9 and the equity component under IAS 32.

Compound financial instruments
Sarah comes to you again with an alternative funding proposal she’s just received to issue convertible
notes at their face value of $20 million. These would pay interest at 5% per annum until they mature
in eight years. On maturity, the noteholders have the option of converting their holding to ordinary
shares of Fly-by-day. The noteholders will receive a fixed number of shares. The effective interest rate
for a similar note without a conversion feature would be 7%, which would give a discounted value of
the notes of $17,611,481.
Sarah wants to know how these should be treated under the Accounting Standards.
Answer
Fly-by-day has a contractual obligation to make interest payments annually at a specified rate,
and to repay the notes at maturity. These characteristics are those of a financial liability.
However, the convertible notes also contain a conversion feature whereby the noteholder can
elect to either receive cash at maturity or a fixed number of shares. The choice they make will
depend on the share price at the time and whether conversion of the notes to ordinary shares
provides them with a greater return than receiving cash. The nature of this conversion feature
does not fall within the definition of a liability and accordingly should be classified as equity.
This means the convertible notes are what is called a compound financial instrument.
The liability and equity components need to be valued and accounted for separately.
In order to value the liability portion, we need to discount the known cash flows of the note at
the effective interest rate of 7%. You have advised that this amounts to $17,611,481. This is the
fair value of the liability component of the note. The difference between this amount and the
issue price of $20 million is $2,388,519. This becomes the fair value of the equity component.

The journal entry for booking it would be:
$ $
xx.xx.xx Cash at bank 20,000,000
Convertible notes (liability component) 17,611,481
Convertible notes reserve (equity 2,388,519

component)
Being recognition of the issuance of convertible notes
The liability component will then be accounted for under IFRS 9. In this case, it will be classified
as measured at amortised cost covered later in the unit. The equity component is recognised on
the statement of financial position in equity.
On the day of potential note conversion, the value of the liability component will have reached
$20 million. The accounting treatment would depend on whether the holder elected to convert
to shares or receive cash. If shares were issued, the relevant amount of the liability would be
derecognised and the amount of equity increased by the same amount. If the holder elected to
receive cash the liability would be derecognised against a reduction in cash. The amount in the
equity reserve remains in equity. The relevant journals would be as follows:
Shares issued on conversion date
$ $
xx.xx.xx Convertible notes (liability component) 20,000,000
Equity (equity component) 20,000,000
Convertible notes reserve 2,388,519
Equity 2,388,519
Being recognition of the issuance of shares on conversion of the convertible notes and transfer of the
reserve to equity
Shares not issued on conversion date

$ $
xx.xx.xx Convertible notes (liability component) 20,000,000
Cash 20,000,000
Being recognition of the redemption of the convertible notes
Conversion into a fixed or variable number of shares


Measurement of financial instruments
Learning outcome
2. Account for financial assets, financial liabilities and equity instruments of the issuer (including
derivatives).
Before reviewing how financial instruments are classified, it is helpful to understand how they
are measured under IFRS 9.
Required reading
IFRS 9 paras 3.1.1, 5.1–5.4.1 and 5.7.1–5.7.3
Initial recognition
IFRS 9 provides that an entity shall recognise a financial asset or liability on its statement of
financial position when, and only when, it becomes a party to the contractual provisions of
the instrument.
Example – Trade receivables

A company that sells crockery to restaurants recognises a trade receivable on its statement of
financial position when it has a legal right to receive cash from the restaurant to which it has
made a sale. This usually occurs when the crockery has been delivered and the invoice issued to
the customer.
Example – Firm commitments

A company that places an order for coffee beans will not recognise the payable on its statement
of financial position until it has received the coffee beans and been invoiced for the amount due.
Until that point, it is a firm commitment only and is not recognised because at least one of the
parties has not performed under the agreement.
Example – Forward contracts

A forward contract to purchase a financial asset (e.g. foreign currency) is recognised as an asset
or liability as soon as the entity becomes a party to it, rather than on the date of settlement.
These contracts are often entered into at zero cost. Initially there may be nothing to recognise,
even though subsequent changes in fair value would be recognised.
Initial measurement
IFRS 9 para. 5.1.1 specifies that financial assets and financial liabilities shall be initially
measured at fair value plus or minus transaction costs, unless they have been classified as a
financial asset or financial liability at fair value through profit or loss (FVTPL), in which case,
transaction costs are expensed.
Generally, the fair value is the cost or consideration given or received for the asset or liability.
Transaction costs are costs directly attributable to the acquisition, issue or disposal of a financial
asset or liability (e.g. fees and commissions payable to brokers), but do not include financing or
internal administrative costs.

FIN fact
Remember when recognising financial liabilities at amortised cost, the liability recognised on
the statement of financial position will be reduced by the amount of transaction costs.
Subsequent measurement
Under IFRS 9 the two bases under which financial assets and financial liabilities can be
measured after initial recognition are fair value and amortised cost.
Fair value Amortised cost
The price that would be received to sell an asset or Calculated as the initial amount recognised:
paid to transfer a liability in an orderly transaction minus any principal repayments
between market participants at the measurement
date plus or minus cumulative amortisation (interest)
using the effective interest method
The change in fair value is recognised either in other
comprehensive income or profit or loss depending on minus any write-down for impairment or
the classification of the instrument (see below) uncollectability (financial assets only)
Fair value
The fair value of financial assets and liabilities is determined in accordance with IFRS 13.
The price used to measure financial assets and liabilities may be directly observable, as in an
active market with quoted prices, or may be determined using valuation techniques if no active
market exists.
Transaction costs associated with transferring the financial asset or liability are not to be included
in the subsequent measurement of fair value as they are not a characteristic of the asset or
liability, but are specific to the transaction itself. This topic is discussed in more detail in Unit 6.
Amortised cost
IFRS 9 requires that interest on financial assets and liabilities shall be measured using the
effective interest method (EIM). The effective interest rate is the internal rate of return of
the financial asset or liability, that is, it is the rate that exactly discounts the estimated future
cash flows through the expected life of the instrument to the net carrying amount at initial
recognition.
Example – Effective interest rate

A company obtains a bank loan with the following features:
•• Loan amount: $1,000,000
•• Loan term: 1 January 20X7 to 31 December 20Y0 (4 years)
•• Interest rate: 6%
•• Initial transaction costs directly attributable to the loan: $50,000
•• There is no principal repayment over the life of the loan. The full amount of $1,000,000 is
repaid on 31 December 20Y0
The amount of interest paid on the loan each year is $60,000. However, due to the initial
transaction costs paid, this will not necessarily be the same as the amount recognised in profit or
loss each year under the EIM.
The initial amount of the loan that will be recognised in the financial statements is $950,000
(being the loan amount less the transaction costs). The effective interest rate that provides a
constant yield-to-maturity between the loan amount recognised and the amount repaid in
four years is 7.4926%.

Cash Cash Net

inflows outflows cash flow
$ $ $
1 Jan 20X7 1,000,000 (50,000) 950,000
31 Dec 20X7 (60,000) (60,000)
31 Dec 20X8 (60,000) (60,000)
31 Dec 20X9 (60,000) (60,000)
31 Dec 20Y0 (1,060,000) (1,060,000)
Excel formula =
Effective interest rate 7.4926% XIRR (net cash flow,
dates)
Please note that in the FIN module assessment, the effective interest rate will be provided
and candidates will not be required to calculate it. The table above is provided only for your
information and further understanding.
The effective interest rate is applied to a financial asset or liability to calculate the amounts that
should be recognised on the statement of financial position.
Example – The application of EIM to amortised cost measurement

This example shows how to calculate the financial liability amounts to be recognised each year,
using data from the effective interest rate example above.
The following table incorporates the amortised cost formula and shows the annual cash flow and
interest accrual to determine the year-end amortised cost of the loan.
Starting loan balance = loan
of $1,000,000 – transaction
costs of $50,000 = $950,000
Interest accrued = opening
loan balance of $950,000
Opening Principal Interest Interest accrued Closing
× effective interest rate of
balance repayments payments using EIM balance
7.4926% = $71,180 (this is the
$ $ $ $ $
interest expense recognised in
the profit or 1loss
Janeach
20X7year) – 950,000
31 Dec 20X7 950,000 (60,000) 71,180 961,180
31 Dec 20X8 961,180 (60,000) 72,017 973,197
31 Dec 20X9 973,197 (60,000) 72,918 986,115
31 Dec 20Y0 986,115 (1,000,000) (60,000) 73,885 0
Closing loan balance = opening loan balance of

$950,000 – interest payments of $60,000 + interest
accrued of $71,180 = $961,180
The interest accrued using the effective interest method (EIM) is calculated by applying the
effective interest rate of 7.493% to the opening loan balance in each year.

The amount that will be recognised each year as the loan balance in the statement of financial
position will be the closing loan balance. The interest expense recognised in the statement of
profit or loss and other comprehensive income (SPLOCI) will be the interest accrued using EIM
rather than the actual interest payment of $60,000. Journal entries are as follows:
$ $
01.01.X7 Cash at bank 1,000,000
Bank loan 1,000,000
Being recognition of the bank loan as at 1 January 20X7
$ $
01.01.X7 Bank loan 50,000
Cash at bank 50,000
Being recognition of transaction costs relating to the loan as at 1 January 20X7
$ $
31.12.X7 Interest expense (P&L) 71,180
Bank loan 11,180
Cash at bank 60,000
Being recognition of interest expense on the bank loan as at 31 December 20X7
Treatment of gains, losses, dividends and interest arising from

financial instruments
The following table shows the treatment of dividends, interest, gains and losses that arise from
Item Treatment
Dividends or interest Recognised as income in profit or loss in the hands of the holder of the financial
received on owned asset
instruments
Dividends or interest paid If instrument classified as a financial liability, recognised as an expense in profit
on issued instruments or loss. If instrument classified as an equity instrument, recognised as a change
in equity
Transaction costs Recognised as a deduction from equity to the extent they are directly attributable
on issuing equity to the equity transaction that otherwise would have been avoided
instruments
Transaction costs on Allocated to the liability and equity components of the instrument in proportion to
issuing compound the allocation of proceeds
instruments
Gains and losses Generally follows the classification of the financial instrument. (There are a number
of exceptions to this that will be discussed throughout this unit)


Measurement
After reviewing the various funding alternatives received, Ben Scorby, the group treasurer of Fly-by-
day, considers the 10-year bank loan with a 5% interest coupon as a better instrument to use as he
believes there will be greater appetite from lenders for this type of instrument. However, he is unsure
of the difference it will make if it is measured at fair value or amortised cost.
He has asked you to provide him with the impact on the earnings of Fly-by-day for the first three
years under each measurement basis, assuming the loan is issued on 1 July 20X7. He expects
transaction costs to be 2% of the notes issued, and interest coupons will be paid annually. The
effective interest rate will be 5.2623%.
Answer
Measurement basis Initial measurement Subsequent measurement
Fair value Initial measurement will be at fair Subsequent measurement will

value be at fair value, which will be
Transaction costs of $400,000 determined at each reporting
(being $20 million × 2%) will date. The change in fair value will
be expensed as the loan will be be recognised in profit or loss
classified as FVTPL as the loan will be classified as
FVTPL
Amortised cost Initial measurement will be at fair Subsequent measurement will

value be at amortised cost. Interest
Transaction costs of $400,000 expense will be calculated based
(being $20 million x 2%) will be on the EIM – refer below for
deducted from the fair value of calculation
the loan when it is recognised
as a liability on the statement of
financial position
Opening Principal Interest Interest accrued Closing

balance repayments payments using EIM (amount balance
recognised in P&L)
$ $ $ $ $
1 Jul 20X7 19,600,000
30 Jun 20X8 19,600,000 – (1,000,000) 1,031,411 19,631,411
30 Jun 20X9 19,631,411 – (1,000,000) 1,033,064 19.664,475
30 Jun 20Y0 19,664,475 – (1,000,000) 1,034,804 19,699,279
From a profit or loss perspective, the primary difference between amortised cost and fair value is
the timing of recognition of transaction costs (ignoring the impact of fair value changes). If the
loan is classified as FVTPL, transaction costs are recognised initially as an expense. If the loan is
classified as amortised cost, transaction costs are recognised over the life of the loan, so the total
expense is the same under each classification.

Classification of financial instruments
Learning outcome
1. Explain and identify financial instruments and the principles for classifying them as financial
assets, financial liabilities or equity instruments of the issuer.
IFRS 9 uses a principles-based approach for classifying financial assets, instead of the rules-
based approach adopted by IAS 39. Compared to IAS 39, the most significant differences arise
in relation to financial assets. The classification of financial liabilities is largely the same in
IFRS 9 as in IAS 39.
For all financial assets and liabilities, there are three main categories of classification:
•• Fair value through profit or loss (FVTPL).
•• Fair value through other comprehensive income (FVTOCI).
•• Amortised cost.
The following summarises the measurement and classification criteria for each. These criteria
will be explained further in the following material:
Financial assets Financial liabilities

FVTPL (fair value) FVTPL (fair value)
Cash flows not Initial designation Held for trading Initial designation
SPPI*
OR
Business model to
sell financial asset
FVTOCI (fair value)
Cash flows Initial designation

SPPI of equity
AND investment not
Business model to held for trading
collect contractual
cash flows and sell
financial asset
Amortised cost Amortised cost

(using effective interest method) (using effective interest method)
Cash flows Apply if not FVTPL

solely SPPI
AND
Business model to
collect contractual
cash flows
* SPPI stands for solely payments of principal and interest
Required reading
IFRS 9 paras 4.1–4.2, 5.7.5, 5.7.7 and 5.7.10–5.7.11

Classification of financial liabilities

Under IFRS 9 there are two classifications available for financial liabilities:
Amortised cost
The default position for financial liabilities is to categorise them as amortised cost. Liabilities
in this category are initially recognised at fair value less transaction costs and subsequently
measured at amortised cost using the EIM.
Interest measured using the EIM is recognised as an expense. Any gains or losses shall be
recognised in profit or loss when the financial liability is derecognised and through the
amortisation process. Foreign exchange gains and losses (if the liability is a monetary item
under IAS 21 The Effects of Changes in Foreign Exchange Rates) are recognised in profit or loss.
Fair value through profit or loss

There are two primary reasons why a liability can be classified as FVTPL – the liability is held
for trading (HFT) or it is initially designated as FVTPL by the entity. These are explained in
further detail below:
•• A HFT liability is a liability that is:
–– Incurred for the purpose of repurchasing or repaying in the near term
–– Part of a portfolio where there is an actual pattern of short-term profit taking, or
–– A derivative financial instrument (except those in effective hedging relationships – this
is explained later in this unit).
•• Initially designated by the entity as FVTPL. This is a one-time option on initial classification
of a financial liability and is irrevocable until the liability is derecognised. A liability may be
designated as FVTPL if any of the following conditions is met:
–– The designation eliminates or significantly reduces a measurement or recognition
inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise
arise from measuring assets or liabilities, or recognising the gains and losses on them on
different bases.
–– A group of financial liabilities, or financial assets and financial liabilities is managed and
their performance evaluated on a fair value basis in accordance with a documented risk
management or investment strategy of the entity’s key management personnel.
–– The contract is a hybrid contract that contains an embedded derivative that
significantly modifies the cash flows otherwise required by the contract. Practical
application is beyond the scope of the FIN module.
Example – Designation at FVTPL

Big Bank Limited has an investment in bonds that is classified at FVTPL. This means that changes
in the fair value of the asset are recognised in profit or loss. It has funded this investment using
a bank loan that would normally be measured at amortised cost. In order to avoid measurement
mismatch, Big Bank can designate the loan liability as measured at FVTPL. This will give it the
same measurement basis as the bond investment which will mean that the economic substance
of the two transactions are recognised appropriately in the financial statements.

Financial liabilities classified as FVTPL are initially and subsequently recognised at fair value.
Changes in fair value are recognised as follows:
•• For HFT financial liabilities, gains or losses on changes in fair value are recognised in profit
or loss in the period in which they occur.
•• For financial liabilities initially designated as FVTPL, the change in the fair value of the
liability attributable to changes in the issuer’s credit risk is taken to other comprehensive
income (OCI). The remaining amount of the change in the fair value of the liability is
recognised in profit or loss in the period in which it occurs. The recognition of changes in
credit risk in OCI may seem a little counter-intuitive. A reduction in an issuer/borrower’s
creditworthiness will reduce the fair value of financial instruments issued by them. This
provision in IFRS 9 ensures the resulting gain is recognised in OCI rather than profit or loss.
It is useful to note that one of the reasons for designating financial liabilities as FVTPL is to
reduce an accounting mismatch. If taking the change in credit risk in OCI enlarges or creates
an accounting mismatch, then these gains or losses should be taken to profit or loss rather
than OCI.
Classification of financial assets

Under IFRS 9 there are three classifications available for financial assets:
•• Fair value through other comprehensive income (FVTOCI).
The following flow chart illustrates the process for determining the category of a financial asset.
Choose to designate at
Designation FVTPL to eliminate
as FVTPL accounting mismatch? FVTPL
NO YES
FVTPL
Instrument Cash flows solely payments

NO YES YES
cash flow of principal and interest Is it held for trading (HFT)?* FVTPL
characteristics (SPPI) on specified dates
YES NO
Business model Financial assets held Choose to designate

for managing to collect contractual
financial assets at FVTOCI?**
cash flows
YES NO
NO YES
Objective to collect
contractual cash flows and
sell financial assets
YES NO
Amortised Cost FVTOCI FVTPL FVTOCI

(Equity investment)
* Refer definition in Appendix A.

** Election only available for investments in equity instruments
(e.g. an investment in shares in BHP).

It can be seen from the flowchart that the characteristics of an asset’s cash flows (i.e. whether
they are principal and interest payments or not) and how a business manages those assets
(i.e. whether the objective is to receive cash flows, sell the assets for profit or both) are extremely
important in determining how they will be classified and accounted for.
In particular, these two criteria will determine:
•• how the assets are measured following initial recognition (fair value or amortised cost), and
•• for assets measured at fair value, where revaluation gains and losses are recognised (profit
or loss or OCI).
As discussed earlier, under IFRS 9 the category of a financial asset is determined using a
principles-based rather than a rules-based approach. To this end, there are two primary criteria
for determining how financial assets should be classified (and therefore whether they will be
measured at either amortised cost or fair value):
•• The contractual cash flow characteristics of the financial asset.
•• The entity’s business model for managing financial assets.
Contractual cash flow characteristics of the financial asset

(the SPPI test)
The first criterion for classifying financial assets involves assessing the contractual cash flow
characteristics of the financial asset, that is, whether the contractual cash flows are solely
payments of principal and interest on the principal outstanding. This test is performed for each
individual financial asset acquired.
Contractual cash flow characteristics
Payments of principal Payments of interest

On specified dates
on the principal
outstanding
This assessment is often called the SPPI test.

Principal is defined as the fair value of the financial asset at initial recognition. The fair value
may change over the life of the asset (e.g. if there are repayments of principal).
Interest is defined as consideration for the:
•• time value of money
•• credit risk associated with the principal amount outstanding during a particular period
of time
•• other basic lending risks and costs (e.g. liquidity risk and administrative costs)
•• profit margin.
In assessing financial instruments, the focus should be on what the interest is compensating for,
rather than on how much it is.
Some instruments do not legally bear interest, for example, trade receivables. In these cases, the
SPPI test is still met as the principal is the amount resulting from the sales transaction, and there
is no significant financing component, so the interest is deemed to be zero.
The SPPI test is applied on an instrument-by-instrument basis in the currency in which the
financial asset is denominated.
Most basic lending arrangements having features that represent payments of principal and
interest will pass the SPPI test and accordingly are measured at amortised cost.

Example – Fixed rate loan

ABC bank issues a $1 million loan to a As long as the interest rate reflects compensation for
customer. The loan is repayable over five years the time value of money and credit risk for the term
with a fixed interest rate of 5.5%. Principal and of the loan, the contractual cash flows of the fixed
interest payments are made monthly in arrears rate loan are SPPI and the loan receivable can be
categorised at amortised cost
Example – Floating rate loan

Regional bank issues a $5 million floating rate The floating interest rate will only be regarded as
loan to a customer. The loan is repayable over being appropriate compensation for the time value of
10 years in three-monthly instalments. The money if the frequency of the reset rate is consistent
interest rate is reset every six months and is with the period over which the floating interest rate is
based on the 6-month bank bill swap rate determined. In this case despite the fact that payments
(BBSW) plus a margin are made quarterly, the interest rate used is the 6-month
BBSW, and the interest rate is reset every six months.
This means the contractual cash flows are SPPI and the
loan can be categorised at amortised cost
However, some financial assets have cash flows that may not represent payments of principal
and interest. Examples are:
Equity Notes convertible Interest payments in

instruments Derivatives into a fixed number different currency than
of shares principal amount

The SPPI test
Fly-by-day invests its surplus cash in a portfolio of short-term debt instruments. Ben, the group
treasurer, wants to understand the implications of IFRS 9 on this portfolio and whether there will be
any volatility introduced into earnings due to their classification.
Ben asks you to consider whether the following will pass the SPPI test:
•• AUD bank bills.
•• Deposits with banks.
•• Investments in ASX-listed shares.
•• Options on Australian Government bonds.
•• Bonds convertible into a fixed number of ordinary shares of the issuer at maturity.
•• New Zealand Government short-term bonds.
Answer
Instrument Pass SPPI Explanation
test?
AUD bank bills Yes These are contracts that require the investment of a
discounted amount (e.g. $95) and the repayment of the face
value of the bill (e.g. $100) on maturity, which represents the
principal and interest thereon
Deposits with banks Yes These are contractual obligations requiring repayment from
a bank of principal and the interest on the principal at an
agreed interest rate

Instrument Pass SPPI Explanation

test?
Investments in ASX listed No Shares do not contractually deliver payments on specified

shares dates and accordingly do not meet the SPPI test
Options on Australian No Options are derivatives that fail the SPPI test as cash flows
Government bonds do not represent payments of principal and interest on the
principal outstanding
Bonds convertible into a No Since the amount received on maturity is variable (based on
fixed number of ordinary the share price at the time), the cash flows do not represent
shares of the issuer at solely payments of principal and interest on the principal
maturity amount outstanding
New Zealand Government Yes These give rise to cash flows on specified dates that are solely
short-term bonds principal and interest on the principal amount outstanding
Those financial instruments that fail the SPPI test will be classified as FVTPL (unless an election for FVTOCI
for equity investments is available, which is discussed later in this unit). This means any subsequent
movements in fair value will be recognised in profit or loss. The instruments that pass the SPPI test can
then be assessed to determine their classification under the business model test. Depending on this, they
will be classified at amortised cost, FVTOCI or FVTPL
The business model used for managing financial assets

The second criterion for classifying financial assets is the entity’s business model. This criteria is
only used where the cash flows of the instrument meet the SPPI test.
The business model reflects how an entity manages its financial assets in order to generate
cash flows, and determines whether cash flows are collected contractually, arise from selling
the financial asset, or both. This test is performed for groups of financial assets at a portfolio or
business level.
Business model for managing financial assets
Solely to collect Collect contractual Solely to sell

contractual cash flows cash flows and sell financial assets
financial assets
Amortised Cost FVTOCI FVTPL
If the entity manages its financial assets solely to collect contractual cash flows, the assets may
be measured at amortised cost (assuming other criteria are met).
If the entity has a business objective of realising fair value changes in financial assets from the
sale of the assets before their contractual maturity rather than collecting contractual cash flows,
the financial assets cannot be held at amortised cost.
An entity’s business model is determined at a level that reflects how groups of financial assets
are managed together to achieve a particular business objective. An entity may have more than
one business model for managing its financial instruments and so this assessment does not need
to occur at the entity level.

Example – An entity with two different business models

A financial institution has a retail banking business and an investment banking business. The
retail bank has a business model the objective of which is to collect contractual cash flows from
its loan assets. The investment bank has a business model the objective of which is to realise fair
value changes in loan assets through their sale prior to maturity.
The retail bank may be able to recognise its loan assets at amortised cost, whereas the
investment bank’s financial assets will not qualify for this treatment.
The business model used by an entity is a matter of fact that can be observed in the way an
entity is managed and in the information provided to management. It is not a matter of choice
or assessment. Evidence can be obtained from:
•• How the performance of the business model and the financial assets within it are evaluated
and reported.
•• The risks that impact performance of the business model and how those risks are managed.
•• How the managers of the business are compensated.
Business models are likely to remain unchanged for extended periods of time. A change in
the method of generating cash flows from an asset does not impact on the classification of the
financial asset. However, when evaluating a new financial asset, an entity will have regard to
how cash flows were realised in the past.
Example – Trade receivables

Archibalds sells art supplies to schools on credit. It typically offers its customers 30 days to make
full payment following delivery of the goods.
The financial asset is Archibalds’ trade receivables. Archibalds is collecting cash in accordance
with the contractual cash flows of the trade receivables, and has no intention of disposing of
the receivable. Accordingly, since Archibalds is managing its trade receivables solely to collect
contractual cash flows, it meets the business model test to classify its trade receivables at
amortised cost.
Example – Liquidity portfolio

Billy Bugs Industries (Billy Bugs) has surplus cash that it invests in a portfolio of short-term debt
securities for liquidity purposes. Cash received from the maturity of securities is reinvested or
used to meet the cash flow needs of the business. Securities may be sold prior to their maturity
to reinvest in higher yielding securities or to better match its cash flow requirements. In the
past, these sales have been frequent and significant in value and this is expected to continue in
the future.
The objective of the Billy Bugs business model is to maximise Billy Bug’s return on the liquidity
portfolio and to ensure cash is available to meet the company’s day-to-day cash flow needs.
It achieves this objective by collecting contractual cash flows and selling financial assets.
Accordingly, Billy Bugs meets the business model test to classify its liquidity portfolio at FVTOCI.
Example – Trading portfolio

Big Bank Limited (Big Bank) has a trading desk that buys and sells bonds for the purpose of
generating a profit for the business. Trading is frequent. On occasion, bond interest payments are
also received by Big Bank, although this is incidental to the earnings of the trading desk.
The objective of Big Bank is to generate returns from selling financial assets. Accordingly,
Big Bank meets the business model test to classify its bond trading desk assets at FVTPL.

Designation at FVTPL
An entity may, at initial recognition, choose to designate a financial asset as measured at FVTPL
if doing so eliminates or significantly reduces a measurement or recognition inconsistency
(often referred to as an ’accounting mismatch’) that would otherwise arise from measuring
assets and liabilities on different bases.
Equity investments
Investments in shares in another entity are generally classified as FVTPL as they fail the SPPI
test. However, as long as the investment is not held for trading, an entity may make an election
on initial recognition to present subsequent changes in fair value in OCI. This is an irrevocable
election by an entity and is made on an instrument-by-instrument basis.
Dividend revenue on the financial asset is still recognised in profit or loss. All gains and losses
(including those relating to foreign exchange) are recognised in an account in OCI and remain
there permanently even when the asset is derecognised.

Business model
Ben, the group treasurer, understands that the SPPI test is not the only factor that will dictate how
much volatility is introduced to the P&L from the cash portfolio. He understands it also depends on the
business model Fly-by-day uses.
Ben lets you know that the short-term debt instruments are ‘plain vanilla’, which means they comply
with the SPPI test. The portfolio is held for liquidity purposes and the cash inflows (interest and
principal repaid on maturity) from the investments will be used to fund the cash outflows of the
business. Fly-by-day will sell investments prior to maturity if the need arises due to unplanned cash
needs and also to actively manage the return on the portfolio. The performance of the portfolio is
monitored including gains and losses from the sale of the investments.
Ben asks for your advice on how the portfolio will be classified under IFRS 9.
Answer
In this situation, it is clear that the investments that make up the cash portfolio are not managed
solely to collect contractual cash flows. The following evidence supports this:
•• The fact that the investments may be sold prior to maturity is inconclusive as the frequency
and value of sales is not known. An entity may have a business model objective of holding
financial assets to collect contractual cash flows and still have an expectation of selling some
of those assets prior to maturity;
•• The performance of the portfolio is measured using both the returns from the investments
held and the gains and losses from the sale of the investments. It appears from this that
the objective of the portfolio is to maximise its return as well as meet Fly-by-day’s everyday
liquidity needs, and that selling investments as well as collecting contractual cash flows is
integral to this.
The evidence suggests that the investment portfolio should be classified as FVTOCI. This means
that gains and losses in fair value of the investments will be posted to OCI instead of profit
or loss.
Activity 9.1: Classification of financial instruments

Unit 9 video – Classification


Summary – measurement of financial assets and

liabilities
The following table summarises the measurement of financial assets and liabilities based on
their classification under IFRS 9.
Classification Initial Subsequent Gains/Losses Interest and

measurement measurement dividends
Financial Amortised cost Fair value + Amortised cost + Profit or loss Use EIM to
asset transaction impairment test only when asset recognise
costs derecognised interest
revenue in
profit or loss
FVTOCI Fair value + FV OCI (refer to OCI Use EIM to

transaction video to refresh recognise
costs knowledge) until asset interest
is derecognised then revenue in
cumulative amount is profit or loss
transferred to profit
or loss
FVTOCI – equity Fair value + FV OCI (and never Profit or loss

investments where transaction reclassified to profit
election is made to costs or loss)
present changes in
FV in OCI
FVTPL Fair value* FV Profit or loss Interest

revenue
recognised in
profit or loss as
part of change
in fair value
Financial Amortised cost Fair value – Amortised cost Profit or loss only Use EIM to
liability transaction when liability recognise
costs derecognised interest
expense in
profit or loss
FVTPL – initial Fair value* FV Amount is attributable Interest

designation to change in credit expense is
risk – OCI (and never recognised in
reclassified to profit profit or loss
or loss) as part of the
Remaining gain or loss change in fair
– profit or loss value
FVTPL – HFT Fair value* FV Profit or loss Interest

expense is
recognised in
profit or loss
as part of the
change in fair
value
* Transaction costs are recognised as an expense for these categories.

Interest recognition
For interest-bearing financial instruments, interest should be accrued to appropriately reflect
the amount earned or owed for the relevant reporting period. The fair value of an interest-
bearing financial instrument measured at FVTOCI or FVTPL will include interest accrued but as
yet unpaid.
Paragraph 5.7.11 of IFRS 9 requires that the amounts recognised in profit or loss are the same
for FVTOCI assets as if they were measured at amortised cost. This means that interest revenue
will be recognised under the EIM for instruments measured at amortised cost and instruments
measured at FVTOCI.
Accordingly, the change in fair value for FVTOCI instruments recognised in OCI at each reporting
date will reflect the change in fair value, excluding interest earned or accrued on the instrument.
IFRS 9 does not provide specific guidance on the treatment of interest on financial instruments
measured at FVTPL. For instruments of this nature, changes in fair value (which includes accrual
of interest) are recognised in profit or loss. Accordingly, there is no requirement for interest to
be calculated or recognised separately from gains or losses in fair value. For the purposes of the
FIN module, interest on FVTPL instruments should be recognised based on the interest coupon
of the instrument. Interest should be recognised in the same account as changes in fair value.
Worked example 9.1: Recognition of interest


Financial instrument accounting
The accounting system of Fly-by-day has been updated to incorporate the changes for IFRS 9. You
want to check that the amounts being posted for the year ended 30 June 20X7 are correct and are
going to the right accounts.
To do this, you select the following three transactions with different classifications:
•• A $4 million bank loan taken out on 1 July 20X6 amortising over three years with principal
repayments of $1,333,333 on 30 June of each year, interest coupons at 5% and an effective
interest rate of 5.823%. It incurred an initial arranging fee of 1.5% of the loan amount and is
classified as amortised cost.
•• An option to acquire an equity investment in a small travel agent in Newcastle. It was acquired in
a prior year for $500,000 and the group treasurer, Ben, has assessed its fair value to be $600,000
at 30 June 20X7. Because it is a derivative, it is classified as FVTPL.
•• Fly-by-day has a portfolio of short-term debt securities which have been classified as FVTOCI.
Details concerning the portfolio for the year ended 30 June 20X7 are as follows1:
$
1 July 20X6 Opening balance 25,200,000
Interest revenue (effective interest method) 800,000
Coupon receipts (750,000)
Fair value adjustment on short-term debt securities2 430,000
Fair value of securities sold 3
(3,200,000)
30 June 20X7 Closing balance 22,480,000
Notes
1. Assume that the current year transactions all occurred on 30 June 20X7 for the purposes of recording journal entries.
2. Includes $40,000 current year change in fair value of securities sold during the year.
3. These securities were originally acquired for $3,000,000 in the prior reporting period, resulting overall in a $200,000
cumulative gain when sold at fair value for $3,200,000.

An extract of the bank loan profile is shown here:

Years Opening Principal Interest Interest accrued Closing
balance repayments payments using EIM balance
$ $ $ $ $
1 July 20X6 3,940,000*
30 June 20X7 3,940,000 (1,333,333) (200,000) 229,781 2,636,448
30 June 20X8 2,636,448 (1,333,333) (133,333)** 153,758 1,323,540
* $4 million loan less $60,000 transaction costs ($4 million × 1.5%)

** ($4 million loan less $1,333,333 repayment) × 5% coupon interest rate
You will now need to prepare the journal entries for these transactions so you can check them
against the general ledger.
Answer
Bank loan (financial liability)
$ $
01.07.20X6 Cash at bank 4,000,000
Bank loan [financial liability at amortised cost] 4,000,000
Being recognition of receipt of the bank loan
$ $
01.07.20X6 Bank loan 60,000
Cash at bank 60,000
Being recognition of the transaction costs associated with the bank loan
$ $
30.06.20X7 Bank loan 1,333,333
Cash at bank 1,333,333
Being principal repayment on the bank loan at 30 June 20X7
$ $
30.06.20X7 Interest expense 229,781
Bank loan 29,781
Being recognition of interest expense and payment on the bank loan for the year ended 30 June 20X7,
calculated using the EIM [$3,940,000 × 5.832% EIR = $229,781 interest expense; $4,000,000 × 5% coupon =
$200,000 interest coupon paid]

Option (derivative – financial asset)

$ $
30.06.20X7 Other financial assets – derivatives 100,000
Gain on derivatives [profit or loss] 100,000
Being revaluation of the option to acquire an equity investment at 30 June 20X7 to fair value
Short-term debt securities (financial asset)

$ $
30.06.20X7 Cash at bank 750,000
Short-term debt securities [financial asset] 50,000
Being interest revenue calculated using the EIM on the short-term debt securities portfolio for the year ended
30 June 20X7 and the coupon receipt of $750,000
$ $
30.06.20X7 Short-term debt securities 430,000
FVTOCI reserve [OCI] 430,000
Being revaluation of the short-term debt securities portfolio to fair value at 30 June 20X7, recognised in OCI
$ $
30.06.20X7 Cash at bank 3,200,000
Short-term debt securities 3,200,000
Being recognition of disposal of securities in the short-term debt securities portfolio
$ $
30.06.20X7 FVTOCI reserve [OCI] 200,000
Change in fair value of derecognised 200,000

investments [profit or loss]
Being reclassification of the cumulative gain on the securities that were sold during the year ended 30 June
20X7 ($3,200,000 disposal proceeds less $3,000,000 cost of acquisition)
Activity 9.2: Basic accounting comparing FVTPL and FVTOCI

Activity 9.3: Basic accounting under amortised cost


Derecognition and reclassification
Learning outcome
Derecognition refers to the removal of a previously recognised financial asset or financial

liability from an entity’s statement of financial position.
Required reading
IFRS 9 paras 3.2.1–3.2.6, 3.3.1–3.3.4 and 5.6
Derecognition of a financial liability

A liability is derecognised when it is extinguished (i.e. when the obligation specified in the
contract is discharged, cancelled or expires).
An exchange of an existing financial liability for a new one with substantially modified terms,
or a substantial modification to the terms of a financial liability are treated as an extinguishment
of the existing liability and recognition of a new financial liability. Substantial modification of
terms occurs when the present value of the remaining original cash flows is more than 10%
different from the modified cash flows.
Example – Modified terms

Easybits has an existing loan with five years remaining until maturity. Due to a restructure of
its financing facilities it wishes to extend the term of the loan to 10 years, although the interest
rate on the loan will remain the same. This is a substantial modification of the terms of the loan,
resulting in a derecognition of the original loan and a recognition of the new loan.
Derecognition of a financial asset

The derecognition rules that are applicable to a financial asset are more complex than those
for a financial liability. In general terms, a financial asset is derecognised when the holder’s
contractual rights to its cash flows expire, or the asset is transferred in such a way that all the
risks and rewards of ownership are substantially transferred.
Establishing whether a financial asset is transferred looks to the substance of a transaction
(rather than its legal form) and involves applying a combination of tests:
•• Risks and rewards tests seek to establish if, after the transfer, an entity continues to be
exposed to the risks of ownership and/or continues to enjoy the benefits of ownership.
•• Control tests seek to establish which entity controls the asset and can direct how the benefits
of the asset are realised.
IFRS 9 contains a decision tree that steps through the process for derecognising financial assets.
This shows that the tests are applied in a hierarchy, so that the control tests are only applied when
the entity has neither transferred nor retained substantially all risks and rewards or ownership.
In summary, after some preliminary steps there are three main questions:
Step 1 Step 2 Step 3
Preliminary
Steps Have rights Have risks Has
expired or and rewards control been
been been retained?
transferred? transferred?

In order for derecognition to be available for a financial asset, all the following criteria need to
be fulfilled:
•• The rights to receive cash flows from the asset have expired (e.g. at the end of a loan term)
or been transferred (e.g. by sale or assignment).
•• Substantially all the risks and rewards of ownership of the asset have been transferred.
•• The entity no longer has control of the asset (i.e. no practical ability to make a unilateral
decision to sell the asset to a third party).
Most financial assets are derecognised because they are disposed of, or because they expire at
the end of their life. There are some more complex arrangements that an entity may enter into
(e.g. securitisation) where meeting the criteria can be the subject of much judgement. These
arrangements will not be explored further in this unit.
Preliminary Consolidate all subsidiaries (including any SPE)

[Paragraph 3.2.1]
Determine whether the derecognition principles

below are applied to a part or all of an asset
(or group of similar assets) [Paragraph 3.2.2]
Step 1 Have the rights to the cash flows

YES Derecognise
from the asset expired?
the asset
[Paragraph 3.2.3(a)]
NO
Has the entity transferred its rights to

receive the cash flows from the asset?
[Paragraph 3.2.4(a)]
NO
Has the entity assumed an obligation to Continue to

pay the cash flows from the asset that NO
YES recognise
meets the conditions in paragraph 3.2.5? the asset
[Paragraph 3.2.4(b)]
YES
Step 2 Has the entity transferred substantially

all risks and rewards? YES Derecognise
[Paragraph 3.2.6(a)] the asset
NO
Has the entity retained substantially Continue to

YES
all risks and rewards? recognise
[Paragraph 3.2.6(b)] the asset
NO
Step 3 Has the entity retained control of the asset? NO Derecognise

[Paragraph 3.2.6(c)] the asset
YES
Continue to recognise the asset to the extent

of the entity’s continuing involvement
Adapted from IFRS 9 Financial Instruments para. B3.2.1, July 2014, accessed on 26 April 2018, www.aasb.gov.au/admin/
file/content105/c9/IFRS9_BC_7-14.pdf


Derecognition of a financial asset
Sarah comes to you with a new proposal to sell a portfolio of underperforming trade receivables to
a third party, Logical Factoring Company. Fly-by-day will receive cash up front for the sale. Once the
sale is completed, Logical will deal directly with the debtors in collecting the trade receivables and will
have no rights against Fly-by-day should a debtor default.
Sarah is writing a paper for the board and wants to know if this arrangement will qualify for
derecognition under IFRS 9.
Answer
The derecognition principles are applied to the entire portfolio of underperforming trade
receivables being sold. The decision tree in IFRS 9 is applied to determine if these assets qualify
for derecognition.
Step 1 – have the rights under the asset expired or been transferred?
In this case, Fly-by-day will no longer have any rights to receive cash flows from the trade
receivables, and accordingly, the rights under the asset have been transferred.
Step 2 – have the risks and rewards of asset ownership been transferred?
Following the sale of the trade receivables to Logical, Fly-by-day will no longer have any rights
to receive cash flows from the debtor (i.e. no rewards of asset ownership). In addition, Fly-by-
day will no longer be exposed to the primary risk of the trade receivables, which is credit risk,
as Logical will be collecting the funds from the debtor and will be exposed to the risk of debtor
default. Accordingly, substantially all the risks and rewards of the asset have been transferred.
This means that the portfolio of underperforming trade receivables can be derecognised
under IFRS 9. The trade receivables will be removed from the statement of financial position in
exchange for cash. Any difference between the two amounts will be recognised in profit or loss.
Reclassification of financial instruments

Generally, once a financial instrument is classified into a category on initial recognition,
it remains in that category until it is derecognised. However, if an entity changes its business
model for managing financial assets, it must reclassify the affected financial assets. Previously
recognised gains, losses or interest may not be restated. Financial liabilities cannot be reclassified.
A change in an entity’s business model will only occur when an entity either begins or ceases
to perform an activity that is significant to its operations (e.g. acquisition or disposal of a
business line). Accordingly, changes to an entity’s business model are expected to be very
infrequent and determined by an entity’s senior management.
Reclassification is applied prospectively from the reclassification date. Previously recognised gains,
losses or interest are not impacted by the reclassification. The following requirements apply:
Reclassification Measurement at reclassification Gain or loss on
difference
Amortised cost to FVTPL FV measured at reclassification date Profit or loss
FVTPL to amortised cost FV at reclassification date becomes gross carrying amount N/A
Amortised cost to FVTOCI FV measured at reclassification date OCI
FVTOCI to amortised cost FV measured at reclassification date. Cumulative gain or N/A
loss previously recognised in an account in OCI is adjusted
against FV at reclassification date – asset now measured as
if it had always been measured at amortised cost
FVTPL to FVTOCI FV N/A
FVTOCI to FVTPL FV. Cumulative gain or loss previously recognised in N/A
an account in OCI is reclassified to profit or loss as a
reclassification adjustment


Reclassification of a financial asset
Ben, the group treasurer, is considering changing the business model by which a portion of the cash
portfolio is managed. Fly-by-day has a portfolio of investments that are currently managed solely to
collect contractual cash flows, and accordingly are classified as amortised cost. He wants to move
this portfolio into the rest of the cash portfolio which is managed to collect contractual cash flows
and sell financial assets. This will give the treasury team more flexibility in managing its short-
term investments.
Ben wants to understand the implications of this from an IFRS 9 perspective and how the
accounting will change for this portfolio. The current amortised cost of the assets is $1 million,
and the fair value is $1.1 million.
Answer
A reclassification of financial assets can only occur when the business model for managing those
assets has changed. This has occurred in this case as Fly-by-day has changed the way this group
of assets will be managed from solely to collect contractual cash flows to collecting contractual
cash flows and selling the assets.
Interest revenue that has been earned on these assets to date cannot be reclassified.
There is a $100,000 difference between the amortised cost of the assets and the fair value. As the
assets will now need to be recognised at fair value, this amount will be recorded as a credit in the
FVTOCI reserve in OCI.
Going forward, these assets will be accounted for in the same way as the rest of the cash portfolio.
$ $
xx.xx.xx Short-term investments – FVTOCI 1,100,000
FVTOCI reserve [OCI] 100,000
Short-term investments – amortised cost 1,000,000
Being recognition of the gain on reclassification of short-term investments from amortised cost to FVTOCI
Working paper D
You are now ready to complete working paper D of integrated activity 4, to understand

Part B
Hedge accounting
Learning outcome
Most organisations are subject to financial risks that may impact on the profit or loss their
business generates.
Changing
commodity
prices impact
the amount paid
for inventory
Changing Changing
interest raes FX rates impact
impact interest the amount paid
expense on a for a piece of
floating rate imported
loan ORGANISATION equipment
These risks may be managed by various means, including the use of financial instruments to
reduce the risk. Derivatives are the primary tool entities use to hedge financial risks such as
interest rate risk, foreign exchange risk and commodity price risk. In this section, a risk will be
referred to as a hedged risk.

The hedged item, hedged risk and the hedging instrument

The concepts of a hedged item, hedged risk and a hedging instrument are critical to an
understanding of hedge accounting.
In the FIN module

Hedged risk you will be told
The risk relating to what type of
the hedged item derivative is being
that the entity used as hedging
chooses to manage instrument
Hedging
instrument
Hedged item Typically a derivative
Think of this as the is the hedging
real transaction instrument. Think of this
that is subject to as the tool that is used
a type of risk to manage the hedged
risk on the
hedged item
A hedged item can be:

•• A recognised asset or liability (financial or non-financial).
•• An unrecognised firm commitment (a binding agreement with specified quantity, price
and date/s).
•• A highly probable forecast transaction (uncommitted but anticipated future transaction).
•• A net investment in a foreign operation (not covered in FIN218).
Example – Hedged items and hedged risk

Category of hedged item Hedged item (transaction) Hedged risk
Recognised asset USD-denominated trade receivables Foreign exchange risk – the risk
that receivables will decrease in
value in AUD due to movements in
exchange rates
Recognised liability An AUD floating rate loan Interest rate risk – the risk that
interest payments will increase due
to increases in interest rates
Unrecognised firm An order has been received to Commodity price risk – the risk that
commitment deliver 10,000 tonnes of iron ore to the price of iron ore will fall prior to
an offshore customer at the iron ore the delivery date
price on the delivery date.
Highly probable forecast An Australian company forecasts Foreign exchange risk – the risk
transaction €1 million in inventory purchases for that the inventory will cost more
the next six months. in AUD due to movements in
exchange rates

Economic relationship between the hedged item and the hedging instrument
Hedging is a strategy that an entity may use to manage a specific risk.
IFRS 9 requires there to be an economic relationship between the hedged item and the hedging
instrument with the expectation that the value of the hedging instrument and the value of
the hedged item would move in the opposite direction because of the same risk, which is the
hedged risk.
The diagram below shows an example of a hedging strategy:
Wheat price rises Commodity price risk Wheat price falls

of the wheat price rising
for a flour mill
W
Gain e pur heat
h cha
on t ative a ses
at v che re Lo
Wheases deri dging ) (hedaper on ss
r c h (he ment der the
pu more ru
g
item ed ivat
are nsive inst ) (h iv
e
exp dged inst edging e
rum
(he m) ent)
ite
A hedge enables an entity to create certainty about uncertain

future events (the hedged risk).
Hedge accounting can be applied when a risk has been economically hedged
FIN fact
Hedge accounting is optional. Subject to satisfying certain requirements, an entity can
choose to designate a hedging relationship between a hedging instrument and a hedged
item for the hedged risk.
Overview of hedge accounting

The purpose of the hedge accounting provisions in IFRS 9 is to ensure that the accounting
matches the economic substance of the underlying transactions (i.e. the hedging instrument and
hedged item) that have been designated in a hedging relationship.
This looks like an economic relationship
Commodity price risk

of the wheat price rising
for a flour mill
Hedged item Hedging instrument

Wheat purchase order Wheat futures contract
The flour mill can designate a hedging relationship between

the hedged item and hedging instrument

In general,
•• Hedge accounting can only be applied if certain eligibility and qualification criteria are satisfied.
•• The accounting for the hedged item and hedging instrument in a designated hedge
relationship is recorded in a different way to the normal classification and measurement
rules for financial instruments.
–– The accounting modifies the normal basis for recognising gains and losses (or revenues
and expenses) on associated hedging instruments and hedged items, so that both are
recognised in the statement of profit or loss and other comprehensive income in the
same reporting period.
–– Hedge accounting effectively matches the hedged item with the hedging instrument
to reflect the economic relationship, and eliminates or reduces the volatility in the
statement of profit or loss and other comprehensive income.
•• Without hedge accounting, all derivatives are classified as FVTPL and all revaluation gains and
losses are recognised in profit or loss.
Required Reading
IFRS 9 paras 6.1.1–6.1.2, 6.2.1–6.2.3 and 6.3.1–6.5.12
Unit 9 video – Hedging

Types of hedging relationship

IFRS 9 specifies three types of hedging relationships, as follows:
•• Fair value hedge.
•• Cash flow hedge.
•• Hedge of a net investment in a foreign operation.
Types of hedging relationships under IFRS 9
Hedge of a net investment

Fair value hedge Cash flow hedge in a foreign operation
(beyond the scope
of the FIN module)
This unit focuses on the first two types of hedging relationships.

To properly understand how hedging relationships are accounted for, one must first
understand these two different hedging relationships.
Fair value hedge

A fair value hedge is defined in IFRS 9 para. 6.5.2(a) as:
…a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised
firm commitment, or a component of any such item, that is attributable to a particular risk and could
affect profit or loss.
In a fair value hedge, the risk being hedged is the change in the value of the hedged item.

A fair value hedge can be designated in respect of the following hedged items:
Hedged items in a fair value hedge relationship
Value of an FX risk of an
Value of a Value of a
unrecognised unrecognised
recognised asset recognised liability
firm commitment firm commitment
Example – Designating a fair value hedge relationship

Alpha has an investment in DeltaCo’s corporate bonds that have been classified as FVTOCI. Alpha
receives fixed interest of 4% per annum on these corporate bonds.
If market interest rates rise, the fair value of Alpha’s investment in DeltaCo’s corporate bonds will
fall, as market participants may choose to invest in more attractive investments than DeltaCo’s
corporate bonds.
If Alpha wishes to manage the interest rate risk on its DeltaCo corporate bonds (a recognised
asset), it could create an economic hedge by using a derivative (such as a forward rate
agreement) and designate a fair value hedge relationship.
Cash flow hedge

A cash flow hedge is defined in IFRS 9 para. 6.5.2(b) as:
…a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated
with all, or a component of, a recognised asset or liability (such as all or some future interest payments
on variable-rate debt) or a highly probable forecast transaction, and could affect profit or loss.
In a cash flow hedge, the entity does not hedge the asset, the liability or the highly probable
forecast transaction itself, but rather the potential variable cash flows that any of those items
might generate, provided that they ultimately impact on profit or loss.
A cash flow hedge can be designated in respect of the following hedged items:
Hedged items in a cash flow hedge relationship
Cash flows of a
FX risk of an
Cash flows of a Cash flows of a highly probably
unrecognised firm
recognised asset recognised liability forecast
commitment
transaction
Example – Designating a cash flow hedge relationship

Beta is a company that sells bicycles. As part of the recent expansion of its premises it borrowed
$1 million from its local bank. The loan has floating interest coupons payable every six months.
If market interest rates rise, Beta will pay more interest on the loan, and if they fall, Beta will pay
less interest. Beta has a risk that its interest rate cash flows will increase if interest rates increase.
If Beta wishes to manage the interest rate risk on its loan (a recognised liability), it could create
an economic hedge by using a derivative (such as an interest rate swap that converts its floating
interest rate payments to fixed payments) and designate a cash flow hedge relationship.

Hedge accounting process

To determine whether hedge accounting may be applied, there are a number of steps
an entity must go through, as shown in the figure below.
Step What is the risk

1 management strategy?
Identify the risk

to be hedged
What is the risk

Identify the
Step Identify the management objective Step
hedging
2 hedged item? that links item and 3
instrument?
instrument?
NO Rebalancing/
Step Is the hedge
4 effective? discontinuation
YES
Step Apply the correct

5 accounting treatment
Fair value Cash flow

hedge hedge
Preliminary step – Documentation at the inception of the hedging relationship

The shaded boxes in the flowchart must be formally documented at the inception of the
designation of the hedging relationship. The following items should be included in the
hedge documentation:
•• The risk management objective.
•• Why the hedge is being undertaken (strategy).
•• The hedging instrument.
•• The hedged item.
•• The risk being protected against.
•• The type of hedge (e.g. fair value or cash flow).
•• How hedge effectiveness will be assessed (including potential sources of ineffectiveness
and how the hedge ratio will be determined – discussed at Step 4).
A failure to document this information at the inception of the hedging relationship means that
hedge accounting under IFRS 9 cannot be applied (IFRS 9 para. 6.4.1(b)).

Step 1 – Risk management strategy, objectives and identification of risks

An entity’s risk management strategy identifies the risks to which an entity is exposed and how
the entity will respond to those risks. It is normally established at the highest level at which
the entity determines how to manage risk and then cascaded down through the entity through
policies that contain more specific guidelines. A risk management strategy is generally in place
for a longer period of time and may include some flexibility in order to provide management
with the ability to react to changing circumstances.
Example – Managing currency risk changed

Valueplus Aviation (Valueplus) has identified that it is exposed to the risk of changing exchange
rates on its USD expenses, which primarily relates to jet fuel purchases. In order to manage that
risk, it has a risk management strategy to hedge up to 80% of its monthly USD forecast expenses.
In contrast, the risk management objective is set at the level of the individual hedging
relationships and will specify how a particular hedging instrument will be used to hedge
a particular exposure that has been designated as a hedged item. This will also include
consideration of whether the hedge is a cash flow or fair value hedge. Accordingly, a
risk management strategy may involve many different hedging relationships whose risk
management objective relate to executing the overall risk management strategy.
Example – Executing a risk management strategy

Valueplus currently has a monthly exposure of approximately USD2 million. It has entered into
FX forward contracts that mature at the end of each month. These contracts hedge USD1.6
million of the monthly exposure, which is the maximum permitted under Valueplus’ policy (80%).
A dramatic fall in the price of crude oil has reduced the forecast monthly USD expenses to
USD1.5 million. This has resulted in Valueplus being overhedged and in breach of its policy.
Accordingly, Valueplus decides to reduce its FX forward contracts so they cover USD1.2 million of
its monthly USD expenses.
The risk management strategy has not changed but the execution of that strategy has changed.
The risk management objective in relation to the original USD2 million monthly expenses has
also changed.
Step 2 – Eligible hedged items

To qualify for hedge accounting, the hedging relationship must only be between eligible hedged
items and eligible hedging instruments.
An eligible hedged item must be a contract with a party external to the entity. It must also be
reliably measurable. Hedged items include a recognised asset or liability, an unrecognised firm
commitment and a highly probable forecast transaction.
A hedged item can be a single item such as a contract to buy 10,000 barrels of oil. IFRS 9 also
permits the hedged item to be a group of items (e.g. a number of iron ore sales transactions
occurring within a month) or a component of an item or group of items. The focus in the FIN
module is on the hedged item being a single item.
Ineligible hedged items

There are some items that do not qualify as hedged items, including:
Firm commitment to Transactions in Inflation risk

Credit
acquire a business a company’s own (unless specified in
risk
(except FX risk) equity the contract)

Step 3 – Eligible hedging instruments

A hedging instrument is a designated instrument whose fair value or cash flows is expected to
offset the changes in the fair value or cash flows of the eligible hedged item.
The following are eligible hedging instruments:
•• Derivatives (other than net written options) can be used as hedging instruments provided
they are:
–– designated by the entity for the entirety of their duration to maturity
–– with a party external to the entity.
•• Non-derivative financial assets may be designated as hedging instruments. Non-derivative
financial liabilities measured at FVTPL may also be designated as hedging instruments if
they are held for trading.
The focus in the FIN module is on using a derivative as a hedging instrument.

Hedging instruments
Ben Scorby, the group treasurer, wants to discuss with you the hedging rules.
Ben talks to you about an exposure and hedging recommendation he has received from a bank
Fly-by-day uses frequently for derivative transactions. He wants you to check if the hedging
instrument recommended and the proposed hedging strategy would qualify under IFRS 9.
Here is the information he has received:
Fly-by-day exposure Proposed hedging instrument
•• Interest rate risk on a $3 million floating rate Interest rate swap that pays fixed and receives
AUD denominated bank loan – policy indicates floating interest rates for $1.5 million notional
that 50% of debt should be fixed rate principal
Answer
$3 million floating rate loan
The exposure here is to the adverse changes in AUD interest rates. Derivative instruments
are permissible under IFRS 9 to be used to hedge this interest rate exposure – so an interest
rate swap will qualify under IFRS 9. In addition, it is permissible to hedge only part of the total
exposure. So an interest rate swap that covers the risk of $1.5 million of the $3 million loan will
hedge 50% of the interest rate risk, which will enable the company to comply with its policy.

Step 4 – Hedge effectiveness

The principles of hedge effectiveness assessment can be summarised in the following diagram:
Hedge effectiveness
Economic relationship Economic hedging ratio

Credit risk does not
between hedged
item and hedging
dominate value
changes
=
instrument Accounting hedge ratio
Qualitative and/or quantitative assessment
A hedging relationship qualifies for hedge accounting only if it meets all of the following hedge
effectiveness requirements:
•• There is an economic relationship between the hedged item and the hedging instrument.
•• The effect of credit risk does not dominate the value changes that result from that economic
relationship.
•• The hedge ratio satisfies certain requirements. Hedge ratio is explained further below.
Hedge effectiveness is the extent to which changes in the fair value or cash flows of the hedging
instrument offset changes in the fair value or cash flows of the hedged item.
Hedge ineffectiveness, however, is the extent to which the changes in the fair value or cash
flows of the hedging instrument are greater or less than those on the hedged item.
It is common for there to be some hedge ineffectiveness from an accounting perspective while
still satisfying the principles of the hedge effectiveness assessment. Accounting for fair value
and cash flow hedges under Step 5 illustrates this.
Economic relationship
As explained earlier, it is generally expected that the values of the hedged item and the
hedging instrument will move in opposite directions because of the hedged risk. Accordingly,
it would be expected that the underlying risks of the hedged item and hedging instrument are
economically related.
Effect of credit risk

Even if there is an economic relationship between the hedged item and the hedging instrument,
the level of offset may become erratic due to changes in the credit risk of either the hedged item
or the hedging instrument.
Hedge effectiveness will not be met if the effect of credit risk dominates the value changes in the
economic relationship between the hedged item and the hedging instrument.
Example – The impact of changes in credit risk on hedge effectiveness

Klonks Oil Refinery hedges its purchases of crude oil in one year’s time by entering into a
forward contract with Island Bank, which is rated AA. Following a financial crisis in Asia, Island
Bank suffers a severe deterioration in its credit standing, which is reduced to BBB. This increased
risk that Island Bank will not be able to honour the contract has an impact on the value of the
forward contract that outweighs the effect of changes in the crude oil price on the forward
contract. This hedging relationship will no longer be effective as the fair value of the forward
contract is impacted by the change in credit standing of Island Bank. With the change in
credit standing, credit risk comes to dominate the hedging relationship and the hedge is no
longer effective.

Hedge ratio
The hedge ratio is the ratio between the quantity of the hedged item and the quantity of the
hedging instrument. The ratio documented for hedge accounting purposes is established by
looking at the amount of the hedging instrument actually used to economically hedge the
required amount of the hedged item. The ratio is set to maximise the effectiveness of the hedge
and is often 1:1, but may not always be.
Example – Hedge ratio

On 21 October 20X8 Cluster places a purchase order for a new machine costing USD900,000 to
be delivered and paid for in four months’ time.
On the same day as placing the order, Cluster designates a cash flow hedging relationship
between the FX risk on the unrecognised firm commitment with an FX forward contract (the
hedging instrument) to buy USD900,000 for AUD1,200,000 in four months’ time.
The hedge ratio is 1:1 as the quantity of the hedged item is USD900,000 and the quantity of the
hedging instrument is also USD900,000.
Assessment of hedge effectiveness

IFRS 9 contains no prescriptive measures of hedge effectiveness. An entity should use a method
that captures the relevant characteristics of the hedging relationship, including any sources of
hedge ineffectiveness. The method used can be qualitative or quantitative, and details should be
included in the documentation of the hedging relationship at the inception of the hedge.
•• Qualitative assessment: This may involve an assessment of the critical features of the
hedged item and the hedging instrument (e.g. term, nominal value, underlying price index
or instrument). If they match or are closely aligned, it may be possible for an entity to
conclude that the fair values or cash flows will move in opposite directions because of the
same risk, and accordingly an economic relationship exists and the hedge is effective.
•• Quantitative assessment – if the critical terms are not closely aligned, there may be a level of
uncertainty around the extent of offset. In this case, an entity may only be able to conclude
on effectiveness by undertaking a quantitative assessment (e.g. dollar offset or regression
analysis). Practical application of quantitative assessment is beyond the scope of the
FIN module.
Assessments of hedge effectiveness should be made at the inception of the hedge and on an
ongoing basis (at least at every reporting date). Effectiveness cannot be assumed just because
critical terms match. The assessment relates to expectations of hedge effectiveness and therefore
is only forward-looking.
Example – Assessment of hedge effectiveness – qualitative assessment

Cluster prepares its annual financial statements on 31 December 20X8. At that date it performs
a qualitative assessment of hedge effectiveness on the cash flow hedge relationship relating to
the future cash flow to be paid for the new machine. It documents that the hedging relationship
is expected to continue to be effective as the term and nominal value of the hedging instrument
are equal and opposite to those of the hedged item. Additionally there has been no change in
the credit risk of the issuer of the hedging instrument.

Consequences of ineffectiveness following initial hedge recognition – rebalancing/

discontinuation
Measurement of retrospective (or past) hedge ineffectiveness is recorded in the profit or loss in
accordance with how the hedge is accounted for, and is dealt with in the next section.
Following initial recognition of a hedging relationship, effectiveness is also assessed
prospectively on an ongoing basis and at least at every reporting date. Once assessed, there
are a number of actions an entity can take to deal with prospective hedge ineffectiveness,
as follows:
•• Continue hedge accounting and recognise any hedge ineffectiveness in the profit or loss.
•• Rebalance the hedge ratio.
•• Derecognise the hedge either partially or fully.
Only an awareness of these actions is required for the FIN module.

Discontinuation of a hedge is not voluntary and is only permitted if the risk management
objective has changed; there is no longer an economic relationship between the hedged item
and the hedging instrument; or, credit risk is dominating the hedge relationship.
Step 5 – Accounting for designated hedges

Under IFRS 9 an entity may apply hedge accounting to hedging relationships that meet the
qualifying criteria.
Fair value hedges

When a hedging relationship is designated as a fair value hedge:
•• the normal classification rules for the hedged item are suspended
•• any gain or loss on the hedged item is recognised in profit or loss
•• any gain or loss on the hedging instrument is recognised in profit or loss.
Accordingly, any hedge ineffectiveness is automatically presented in profit or loss (as the net
debit or credit from recognising the fair value movement on both the hedged item and hedging
instrument).
Accounting for a fair value hedge relationship

The table below shows the operation of fair value hedge accounting.
Accounting choice Hedged item Hedging instrument Overall impact on profit

or loss
Designated fair Fair value movements Fair value movements on To the extent that the
value hedge on the hedged item the hedging instrument hedge is ineffective, there
relationship are recognised in profit (derivative) are recognised will be a net difference
or loss (including fair in profit or loss recognised in profit or
value movements on loss (e.g. if a gain on the
an unrecognised firm hedged item exceeded
commitment – e.g. a a loss on the hedging
purchase order) instrument)
Example An $80,000 gain on the A $70,000 loss on the A net $10,000 gain is
fair value movement on a fair value movement on recognised in profit or loss
purchase order the derivative hedging (hedge ineffectiveness)
instrument

To appreciate the impact of designating a fair value hedge relationship, it is helpful to consider
the accounting treatment if an entity did not choose to apply hedge accounting. Assume a
derivative was entered into to manage the risk on the specific item
Accounting choice Hedged item Hedging instrument Overall impact on profit

or loss
If hedge accounting •• If the hedged item is Fair value movements on There would be volatility
is not applied a recognised asset or the hedging instrument in profit or loss due to
liability then only those (derivative) are recognised the differing accounting
classified as FVTPL will in profit or loss treatment for the hedged
have changes in fair item and the hedging
value recognised in profit instrument
or loss (e.g. if recognised
at amortised cost then no
fair value movements are
recognised)
•• If the item is an
unrecognised firm
commitment (e.g. a
purchase order), no
changes in its fair
value are recognised
as the unrecognised
firm commitment itself
would not yet qualify
for recognition in the
Example A purchase order is There is a $70,000 loss on A $70,000 loss is

not recognised on the the fair value movement on recognised in profit or loss
statement of financial the derivative Volatility arises in profit
position. There is no impact or loss when hedge
recognised in profit or accounting is not applied,
loss if there is a fair value even though the risk has
movement relating to the been economically hedged
purchase order via the derivative
The process for accounting for a fair value hedge can be broken down into the following steps:
Hedging instrument Hedged item
Step 1 Step 3
Determine the fair value of the hedging Determine the gain or loss on the hedged
instrument at the reporting date item that is attributable to the hedged risk
Step 2 Step 4
Recognise the change in fair value in Adjust the carrying amount of the hedged
profit or loss since the last reporting date: item and recognise any gain or loss in
Dr/Cr Hedging instrument profit or loss:
Cr/Dr Gain or loss on hedging Dr/Cr Hedged item

instrument Cr/Dr Gain or loss on hedged item

Cash flow hedges

In a cash flow hedge the focus is on the change in the fair value of the hedging instrument and
how much of this change may be recognised in a reserve account rather than P&L.
In a cash flow hedge, the effective portion of the fair value change in the hedging instrument is
recognised in the cash flow hedge reserve (CFHR) with the current year movement in the CFHR
disclosed in OCI.
Note: The concept of cash flow hedging can be difficult to understand. You may wish to review
the explanation above after working through the ‘May-Son’ example below.
The ‘lower of’ test
In a cash flow hedge, the effective portion of the hedge that can be deferred to the CFHR is
limited to the lesser of (in absolute amounts) the:
•• cumulative gain or loss on the hedging instrument from inception of the hedge, and
•• cumulative change in fair value of the hedged item from inception of the hedge.
This can be referred to as the ‘lower of’ test.

The ineffective portion is the balancing figure in the cash flow hedge reserve journal entry and
is recognised in profit or loss.
The ‘lower of’ test is applied to work out where the change in the value of the hedging instrument
should be recognised – in the CFHR or P&L. This can be illustrated as follows:
ging Hed
Hed ment g
Item ed
Hedged Hedging t r u
Ins 50
Item Instrument 40 He
ged Inst dging
50 50 Hed rum
Item e
50 60 nt
For an item being hedged If the fair value change of the If the fair value change of the
that moves by 50, a hedging hedging instrument (derivative) hedging instrument (derivative) is
instrument (derivative) that is less (e.g. 40), this is less more (e.g. 60), then the additional
changes in fair value by the same economically effective, but no change compared to the change in
amount (i.e. 50) perfectly offsets amount will be recognised in fair value of the hedged item (i.e. 10)
the fair value change of the item profit or loss will be recognised in profit or loss.
being hedged Think of this as being over-hedged
Where the change in value of the hedging

instrument is recognised using the ‘lower of’ test
Fair value movement of Fair value movement Cash flow hedge reserve Profit or loss
hedged item of hedging instrument
(derivative)
Debit/(Credit) Debit/(Credit) Debit/(Credit) Debit/(Credit)

50 (50) 50 -
50 (40) 40 -
50 (60) 50 10 loss*
(50) 50 (50) -
(50) 40 (40) -
(50) 60 (50) (10) gain*
* This is because the change in value of the hedging instrument is greater than the amount recognised in the CFHR – the
difference is recognised in P&L

FIN fact
Correctly applying the ‘lower of’ test is critical to correctly accounting for a cash flow hedge.
When applying the test, you must interpret the information provided to calculate the
cumulative values since the inception of the hedge rather than just the movement since the
last reporting date.
Treatment of the balance in the CFHR for a qualifying hedge relationship

The balance in the CFHR remains in equity until the end of the qualifying hedging relationship,
at which time it is:
Recognised in profit or loss OR Used to adjust the initial carrying value

of the asset or liability
When the hedged item affects profit or loss (i.e. when When the hedged item is a forecast transaction that
the hedged item is sold, settled or otherwise realised) results in the recognition of a non-financial asset (e.g.
inventory) or a non-financial liability.
Accounting for a cash flow hedge relationship

The process for accounting for a cash flow hedge can be broken down into the following steps:
Cash flow hedge accounting
Hedged item Hedging instrument and recognition of CFHR balance
Step 1 – Current fair value
Apply normal IFRS standards to Determine the fair value of the hedging instrument at the
account for the hedged item e.g. IAS 21 reporting date
(FX), IAS 16 (PP&E), IAS 2 (Inventory)
There will be no entries to initially

record for a firm commitment
or a highly probable forecast
transaction
Determine the fair value of the hedged
item at the reporting date (whether
recognised or not)
Step 2 – Cumulative change in value since inception
Determine the cumulative change Determine the cumulative change in fair value of the hedging
in fair value of the hedged item instrument since inception of the hedge
since inception of the hedge
Step 3 – CFHR balance
Apply the ‘lower of’ rule (IFRS 9 para. 6.5.11) to determine the balance
that can be recognised in the CFHR. The CFHR balance is the lower of:
•• The cumulative gain or loss on the hedging instrument
from inception of the hedge, AND
•• The cumulative change in fair value of the hedged item
from inception of the hedge
Use absolute values (i.e. change negatives to positives)
Step 4 – Change in value since last reporting date

Determine since the last reporting date the:
•• change in fair value of the hedging instrument, and
•• change in value of the CFHR required to achieve the balance
calculated in Step 3

Cash flow hedge accounting

Hedged item Hedging instrument and recognition of CFHR balance
Step 5 – CFHR journal entry
Prepare the journal entry to recognise the fair value of the hedging
instrument at the reporting date:
Dr/Cr Hedging instrument – this is the movement in the hedging
instrument since the last reporting date calculated at Step 4
Cr/Dr CFHR (effective portion) – this is the movement in the CFHR
since the last reporting date calculated in Step 4 to bring the CFHR to
the ‘lower of’ balance calculated in Step 3
Hint: If the hedging instrument is an asset then the balance in
the CFHR will be a credit (and vice versa)
If the journal entry balances then there is no hedge ineffectiveness.

If the journal entry does not balance then recognise:
Cr/Dr Gain or loss on hedging instrument (ineffective portion
– profit or loss)
Step 6 – Has cash flow been recognised?
Determine if the cash flow being hedged is recognised in the current period as an asset or liability
(e.g. inventory or PPE), or impacts profit or loss (e.g. sales or interest payments). This means the hedging
relationship has now finished and the hedging instrument will be settled. If so, move to Step 7
Step 7 – Reclassification of CFHR balance
Settle the hedging instrument with the counterparty (eg Dr Cash,
Cr Hedging Instrument)
Depending on the cash flow being hedged, reclassify the
accumulated amount calculated in Step 3 against:
The value of the asset / Profit or loss

liability (if the cash flow
(if the cash flow is OR impacts P&L)
recognised as an asset
or liability)
Dr/Cr CFHR Dr/Cr CFHR

Cr/Dr The asset or liability Cr/Dr Gain or loss on hedging
instrument reclassified to
profit or loss
This entry gives effect to the purpose of the hedge by

matching the effective hedging instrument movement with
the cash flow being hedged

Example – Cash flow hedge accounting

May-Son has received a sales order from a customer in Singapore on 29 May 20X7. The sale is
denominated in Singapore dollars (SGD) and totals SGD4,000,000. May-Son’s functional currency
is the Australian dollar (AUD).
May-Son has a risk management strategy of minimising the risk relating to foreign currency
cash flows. In accordance with this strategy and to create certainty over the AUD value of
the cash flow, May-Son hedges the cash to be received from the customer from the invoiced
sale. It entered into an FX forward contract to be settled net in cash on 15 July 20X7 when the
customer is expected to pay the invoiced amount upon recognition of the sale. The FX forward
contract specifies that May-Son will sell SGD4,000,000 for AUD3,603,604 based on a forward
exchange rate of AUD1 = SGD1.11. The FX forward contract settled on 15 July 20X7, which was
the date the sale was recognised and the customer paid the invoice.
All required hedge documentation was in place at the inception of the hedge when a cash flow
hedge relationship was designated between the firm commitment and the FX forward contract.
The hedge was effective for its entire term.
The following information pertaining to the cash flow hedge was obtained from May-Son’s
treasury department:
Changes in the value of the future cash flow of SGD4,000,000
Date Spot rate Forward Fair value Cumulative Change in

exchange rate of the firm change in fair value
to 15.07.X7 commitment fair value of the firm
of the firm commitment
commitment since last
since inception reporting date
AUD AUD AUD
29.05.X7 AUD1=SGD1.12 AUD1=SGD1.11 3,603,604 0 0
30.06.X7 AUD1=SGD1.15 AUD1=SGD1.14 3,508,772 (94,832) (94,832)
15.07.X7 AUD1=SGD1.18 AUD1=SGD1.18 3,389,831 (213,773) (118,941)
Changes in the fair value of the hedging

instrument
Date Fair value of Change in fair

the FX forward value of the FX
contract* forward contract
since last
reporting date
AUD AUD
29.05.X7 0 0
30.06.X7 104,000 asset 104,000
15.07.X7 213,773 asset 109,773
* These values are provided and cannot be derived from the other information in the table.
Journal entries to be recognised over the life of the hedging relationship:
29 May 20X7
Hedged item
Step 1 – The fair value of the firm commitment is $3,603,604. There is no entry to be recognised
as the firm commitment does not result in the recognition of a transaction in the financial
statements.

Hedging instrument
Step 1 – When the FX forward contract was entered into on 29 May 20X7, it had a fair value of
zero and accordingly, there is no transaction to be recognised.
30 June 20X7
Hedged item
Step 1 – the fair value of the firm commitment is $3,508,772. There is no entry to recognise
Hedging instrument
$ $
30.06.20X7 FX forward contract [statement of financial 104,000

position]
Cash flow hedge reserve [equity]* 94,832
Gain on hedging instrument (ineffectiveness) 9,168

[P&L]
To measure the FX forward contract asset at fair value. The effective portion of the hedge is recognised in the
CFHR (disclosed in OCI); the ineffective portion in profit or loss
*Disclosed in OCI
Step 1 – the FX forward contract is a derivative and must be measured at fair value, which at
30 June 20X7 is a $104,000 asset.
Step 2 – the cumulative change in fair value of the cash flow being hedged since inception of the
hedge is $94,832 (being $3,508,772 – $3,603,604, and also provided in the table). The cumulative
change in fair value of the FX forward since its inception is $104,000 (being the fair value of
$104,000 – $0).
Step 3 –
Amount to be recognised in the CFHR at 30 June 20X7
Apply the ‘lower of’ test

(in absolute terms, i.e. make negative values positive)
Cumulative gain or loss on the Cumulative gain or loss on the
hedged item* since the beginning hedging instrument* since the
of the hedge beginning of the hedge
(*the future cash flow to be (*the FX forward contract)
received from the customer)
$94,832 $104,000
This is the lower value and

is the amount to be
recognised in the CFHR
Step 4 – since the last reporting date, the change in value of the FX forward is $104,000 Dr
(since this is the first period of the hedge, this is the same as its cumulative change in value
since inception).
The balance in the CFHR at the last reporting date is zero. The balance it needs to be at 30 June
20X7 is $94,832 Cr (from Step 3 – a credit because the value of the FX forward is a debit), so the
change in value required is $94,832 Cr.
Step 5 – the journal entry is therefore to Dr the FX forward by $104,000 and Cr the CFHR
by $94,832.
Does the journal entry balance at this stage? No. There is a debit of $104,000 and a credit of
$94,832. This means there is hedge ineffectiveness, so the difference of $9,168 Cr must be
recognised in P&L.
Step 6 – the cash flow being hedged has not yet been recognised in P&L, so no further journal
entries are required.

15 July 20X7
Hedged item
Step 1 – the hedged item transaction is now recognised and impacts P&L (sales revenue).
$ $
15.07.20X7 Cash 3,389,831
Sales revenue 3,389,831
Being recognition of sale and receipt of cash from Singapore customer at the FX spot rate (SGD4,000,000 ÷ 1.18)
Hedging instrument
$ $
15.07.20X7 FX forward contract [statement of financial 109,773

position]
Cash flow hedge reserve [equity]* 118,941
Loss on hedging instrument (ineffectiveness) [P&L] 9,168
To measure the FX forward contract asset at fair value. The effective portion of the hedge is recognised in the
CFHR (disclosed in OCI); the ineffective portion in profit or loss
*Disclosed in OCI
Step 1 – the FX forward contract is a derivative and must be measured at fair value, which at
15 July 20X7 is a $213,773 asset.
Step 2 – the cumulative change in fair value of the cash flow being hedged since inception
of the hedge is $213,773 (being $3,389,831 – $3,603,604, and also provided in the table).
The cumulative change in fair value of the FX forward since its inception is also $213,773 (being
the fair value of $213,773 – $0).
Step 3 –
Amount to be recognised in the CFHR at 15 July 20X7
Apply the ‘lower of’ test

(in absolute terms, i.e. make negative values positive)
Cumulative gain or loss on the Cumulative gain or loss on the
hedged item* since the beginning hedging instrument* since the
of the hedge beginning of the hedge
(*the future cash flow to be (*the FX forward contract)
received from the customer)
$213,773 $213,773
Both values are the same

therefore $213,773 is the amount
to be recognised in the CFHR
Step 4 – since the last reporting date (30 June 20X7), the change in value of the FX forward is
$109,773 Dr (since the asset has increased in value from $104,000 to $213,773).
The balance at 30 June 20X7 (the last reporting date) in the CFHR is $94,832 Cr (from the journal
entry above at 30 June 20X7). The balance it needs to be at 15 July 20X7 is $213,773 Cr (from
Step 3), so the change in value required is $118,941 Cr.
Step 5 – the journal entry is therefore to Dr the FX forward by $109,773 and Cr the CFHR
by $118,941.
Does the journal entry balance at this stage? No. There is a debit of $109,773 and a credit of
$118,941. This means there is hedge ineffectiveness, so the difference of $9,168 Dr must be
recognised in P&L.

Step 6 – the cash flow being hedged has been recognised in P&L in the current period as sales
revenue (ie on 15 July 20X7).
Step 7 – the FX forward contract was an asset and will be settled on 15 July 20X7 by May-Son
receiving cash of $213,773.
$ $
15.07.20X7 Cash 213,773
FX forward contract 213,773
Being settlement of the FX forward contract asset, settled net in cash
The hedging relationship has now finished, so the accumulated amount in the CFHR
($213,773 Cr) needs to be reclassified to P&L since the cash flow being hedged was recognised
in P&L. IFRS 9 para 6.5.11(d)(ii) requires the reclassification of the CFHR balance to profit or loss
to correspond with the timing of the profit or loss impact of the hedged cash flow from the
customer, that is, when the sale is recognised.
$ $
15.07.20X7 CFHR 213,773
Gain on hedging instrument reclassified to profit 213,773

or loss [P&L]
Being reclassification of CFHR balance on settlement of the hedge from equity to profit or loss
Overall impact of the cash flow hedging relationship
What did the cash flow hedge relationship achieve?
Cash received from

AUD$3,389,831
the customer
Cash received when the FX
AUD$213,773
forward contract was settled
This is equivalent to SGD4 million
Total $3,603,604
÷ 1.11 forward exchange rate
The cash receipt from the customer
was locked in at AUD$3,603,604
Key points to note about cash flow hedges:

•• They are used to manage the variability in cash flows for a hedged item.
•• A highly probable forecast transaction can only be designated as a hedged item in a cash flow hedge
relationship but not in a fair value hedge relationship.
•• The normal IFRS accounting rules are applied to the accounting for the hedged item.
•• Special rules are applied when accounting for the hedging instrument (‘lower of’ rule and reclassification
of the CFHR balance).

The hedging relationships explained in this unit can be summarised as follows:
Hedge Fair value hedge Cash flow hedge
Hedged Value of Cash flows of

items recognised asset recognised asset
Value of Cash flows of

recognised liability recognised liability
FX risk of unrecognised FX risk of unrecognised

firm commitment firm commitment
Value of unrecognised Cash flows of highly

firm commitment probable forecast
transaction
Worked example 9.2: Hedge accounting for a cash flow and fair value hedge

Impairment of financial assets
Learning outcome
In changing the methodology for recognising impairment of financial assets, the IASB has
sought to address a key concern that arose during the global financial crisis. During the
financial crisis, the recognition of credit losses on financial assets was delayed due to the
application of the IAS 39 impairment model based on incurred losses (i.e. credit losses were
recognised only when a credit event had occurred). This resulted in a mismatch between the
recognition of income from the financial asset (spread evenly over the life of the asset) and the
recognition of impairment losses, which generally were recognised at a later date.
IFRS 9 incorporates a forward-looking expected loss model into its requirements in an effort
to overcome the shortcomings of impairment under IAS 39. IFRS 9 anticipates that credit
losses will be recognised prior to a financial asset becoming credit-impaired or an actual
default occurring.
Required Reading
IFRS 9 para. 5.5.
A credit loss occurs when an entity receives lower cash flows than the amount that is
contractually due to it.
IFRS 9 requires an entity to recognise a loss allowance in the statement of financial position for
expected credit losses on:
•• Financial assets measured at amortised cost or FVTOCI in accordance with para. 4.1.2
or 4.1.2A of IFRS 9.
•• Lease receivables.
•• Contract assets – under IFRS 15 Revenue from Contracts with Customers contract assets are
defined as an entity’s right to consideration in exchange for goods or services that the entity
has transferred to a customer when that right is conditional on something other than the
passage of time (e.g. the entity’s future performance).
•• Loan commitments that are not measured at FVTPL.
•• Financial guarantee contracts that are not measured at FVTPL.
This means that a loss allowance is not recognised for:

•• financial assets measured at FVTPL, or
•• equity instruments measured at FVTOCI.
An impairment gain or loss will be recognised in profit or loss for the amount of the expected
credit loss that is required to adjust the loss allowance at the reporting date to the amount
required under IFRS 9.
The effect of the impairment provisions of IFRS 9 is to ensure changes in expected credit losses
are recognised in profit or loss.
FIN fact
For financial assets measured at FVTPL, the market’s expectations of the impact of expected
credit losses on future cash flows is already recognised in profit or loss, and accordingly,
a separate loss allowance is not required.

Expected credit losses

A credit loss is the difference between all contractual cash flows that are due to an entity and all
cash flows the entity expects to receive, all discounted at the original effective interest rate of the
financial instrument.
The difficulty with this definition is measuring the cash flows the entity expects to receive.
In approaching this problem, entities should take the following into account:
•• The period over which to estimate expected credit losses (ECLs). Entities must consider the
maximum contractual period over which the entity is exposed to risk, including extension
options exercisable by the borrower, the term of contractual commitment under financial
guarantees, and undrawn loan commitments.
•• Unbiased probability-weighted outcomes. Although entities do not need to take into
account every possible scenario, they need to take account of the possibility that a credit loss
will occur, even if that possibility is low (as opposed to being the most likely outcome).
•• The time value of money. Expected cash flows are discounted to the reporting date using
the effective interest rate determined at initial recognition, or the current effective interest
rate if the financial asset has a variable interest rate.
•• Reasonable and supportable information. Entities need to consider all information
that is reasonably available at the reporting date without undue cost and effort. This
information will include information about past events, informed by an analysis of current
conditions and forecasts of future economic conditions. Entities should regularly review
the methodology and assumptions used to estimate ECLs to reduce differences between
estimates and actual credit loss experience.
•• Collateral. Estimates of ECLs must reflect the cash flows expected to be received from
collateral and other credit enhancements that are part of the contractual terms of the financial
asset, even if these cash flows are realised beyond the contractual maturity of the contract.
In measuring ECLs, entities may use practical expedients such as a provision matrix for trade
receivables.
Example – Practical expedients

Easybits Industries (Easybits) has historically experienced the following credit loss rates on its
trade receivables:
Not past due 1%
0–30 days past due 2%
> 180 days past due 25%
All of its customers come from similar geographical regions and experience economic conditions
in a similar way, so Easybits does not sub-categorise its trade receivables for the purposes of
assessing ECLs. Easybits has reviewed current and forecast economic conditions and does not
believe these will have any material impact on its historical loss experience. Accordingly, Easybits
intends to use its historical loss experience to estimate ECLs on trade receivables for its current
reporting period.
Lifetime ECLs are the expected credit losses that result from all possible default events over the
expected life of a financial asset. This means that an entity needs to estimate the probability of
default occurring over the contractual life of the financial asset.
Twelve-month ECLs are a portion of lifetime ECLs. They represent only the loss arising from
possible default events for the next 12 months after the reporting date.

Example – Measuring ECLs

Easybits’ liquidity portfolio includes a $1 million investment in a debt instrument that matures in
five years. Easybits estimates that the probability of default over the lifetime of the investment is
10%, while the probability of default over the next 12 months is only 3%. Easybits estimates that
the total loss on this investment in the event of a default would be $500,000.
Accordingly, Easybits would measure its 12-month expected credit loss as 3% × $500,000
= $15,000. If it were to recognise a lifetime credit loss, it would calculate this as 10% × $500,000
= $50,000.
In applying the IFRS 9 requirements, an entity can use one of the following approaches,
as applicable:
•• The general approach – applied to most loans and debt securities.
•• The simplified approach – applied to most trade receivables.
•• The purchased or originated credit-impaired approach.
•• Low credit risk operational simplification.
The general approach to impairment

The following diagram summarises the general approach:
Stage 1 Stage 2 Stage 3
Loss 12-month Lifetime Lifetime

Allowance… expected credit expected credit expected credit
losses Significant losses Objective losses
increase in evidence of
Effective credit risk impairment
interest rate Gross carrying Gross carrying Net carrying
applied to… amount amount amount
Improvement Change in credit risk since initial recognition Deterioration
Adapted from Deloitte IFRS e-learning module IFRS 9 (4) Impairment, accessed on 26 April 2018,
www.deloitteifrslearning.com/description.asp?id=ifrs94_v15&mod=ifrs
Under the general approach there are a number of stages in recognising expected credit losses:
•• Initial recognition of the financial asset. No loss allowance for expected credit losses
recognised as the asset is initially recognised at fair value, thereby incorporating the credit
risk of the asset.
•• Each reporting date:
–– Stage 1: If there is no significant increase in credit risk since initial recognition, entities
provide for expected credit losses that may result from default events possible within
the next 12 months (i.e. ’12-month expected credit losses’).
–– Stage 2: If there has been a significant increase in credit risk since initial recognition,
entities provide for expected credit losses that may result from default events possible
over the entire expected life of the financial instrument (i.e. ‘lifetime expected
credit losses’).
In addition, if there is objective evidence of impairment of the financial asset, Stage 3

applies, whereby interest on the financial asset is calculated based on the gross carrying
amount of the asset adjusted for any loss allowance (i.e. the net carrying amount) (thus
reducing the income recognised from the asset).

Under the general approach, an entity recognises a loss allowance based on either 12-month
ECL or lifetime ECL, depending on whether there has been a significant increase in credit risk
since initial recognition. Accordingly, an entity is required to monitor the change in credit
risk of financial assets at each reporting date.
In stages 1 and 2, interest recognition and impairment are de-coupled as interest recognition
is based on the gross carrying value of the financial asset despite the fact that the asset has
been impaired.
In Stage 3, interest recognition is re-coupled with the asset impairment and is based on
the amortised cost of the financial asset, which is the gross carrying value adjusted for any
loss allowance.
The simplified approach to impairment

The simplified approach does not require the tracking of changes in credit risk, but instead
requires the recognition of lifetime ECLs at all times (i.e. Stage 2 recognition).
The simplified approach applies to trade receivables and contract assets, as long as they do not
contain a significant financing component.
It is worth noting that for trade receivables and contract assets due within 12 months, the
12-month ECL is the same as the lifetime ECL anyway.
An entity may also apply the simplified approach to the following assets if it chooses as its
accounting policy to measure the loss allowance as an amount equal to lifetime credit losses:
•• Trade receivables that contain a significant financing component.
•• Contract assets that contain a significant financing component.
•• Lease receivables.
FIN fact
A contract asset is the right to consideration in exchange for goods or services that
is conditional on something other than the passage of time (i.e. performance of
another obligation). This is unlike a trade receivable which is an unconditional right to
receive consideration.
Purchased or originated credit-impaired approach

A financial asset is credit-impaired when one or more events that have a detrimental impact
on the estimated future cash flows of that financial asset have occurred. Evidence of credit-
impairment includes:
•• Significant financial difficulty of the issuer or borrower.
•• A breach of contract (e.g. default or past due event).
•• The lender has granted to the borrower a concession, due to borrower’s financial difficulty,
that the lender would not otherwise consider.
•• It is probable the borrower will enter bankruptcy or other financial reorganisation.
•• The disappearance of an active market for that financial asset because of financial
difficulties.

For a financial asset that is considered to be credit-impaired on acquisition or origination:

•• The fair value at initial recognition already takes into account lifetime ECLs so there is no
need for an additional 12-month ECL allowance.
•• The effective interest rate is calculated by taking into account the initial lifetime ECLs in the
estimated cash flows.
•• The only credit loss required to be recognised is any change to the lifetime ECL that was
incorporated into the initial fair value of the asset.
Example – Credit-impaired assets

Chocolate Factoring has recently acquired a portfolio of non-performing trade receivables from
Meltdown Limited to provide Meltdown with some much-needed cash. The receivables in the
portfolio are in breach of their credit terms, all are past due, and the fair value of the portfolio
acquired by Chocolate Factoring reflects the expected credit losses.
Chocolate Factoring considers this to be a portfolio of credit-impaired financial assets as at least
one event has occurred that has had a detrimental impact on the estimated future cash flows
of these receivables (i.e. a past due event). At future reporting dates, Chocolate Factoring will
only recognise any change in lifetime ECL compared to that incorporated into the initial fair
value recognised.
Low credit risk operational simplification

If a financial asset is determined to have low credit risk at the reporting date, an entity can
assume that the credit risk has not increased significantly since initial recognition, and
accordingly can continue to recognise a loss allowance of 12-month ECL.
In order to make such a determination, an entity may apply its internal credit risk ratings or
other methodologies using a globally comparable definition of low credit risk. It may also use
external credit ratings, in which case a financial asset rated ‘investment grade’ is an example
of an asset with low credit risk.
IFRS 9 indicates that a financial asset is considered to have low credit risk if:
•• There is a low risk of default by the borrower.
•• The borrower has a strong capacity to meet its contractual cash flow obligations in the
near term.
•• Adverse changes in economic and business conditions in the longer term may, but not
necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations.
A financial asset is not considered to carry low credit risk merely due to the existence of
collateral, or because a borrower has a lower risk of default than the risk inherent in an entity’s
other financial assets or lower than the credit risk of the jurisdiction in which the entity operates.
Example – Low credit risk simplification

Easybits Industries (Easybits) has an investment in a three-year corporate bond issued by
Hardcore Limited (Hardcore). The bond had a credit rating of BBB when it was acquired on
20 May 20X4. On 28 October 20X6 the bond lost its investment grade credit rating and was
downgraded to BB+. Despite the credit rating downgrade, Easybits does not consider that a
two-notch reduction in the credit rating is a significant increase in the credit risk of the asset.
The bond is due for maturity in less than six months and Easybits believes Hardcore has a strong
capacity to meet its contractual obligations. Accordingly, Easybits continues to recognise a
12-month ECL for this financial asset.

The following flowchart illustrates the application on a reporting date of the impairment
requirements combining all three approaches:
Is the financial asset a YES Calculate a

purchased or originated credit-adjusted
credit-impaired financial asset? interest rate and
recognise a loss
NO allowance for
changes in
lifetime ECL
Is the simplified approach for
trade receivables, contract assets
and lease receivables applicable?
NO
Does the financial asset YES Is low credit risk

have a low credit risk at the simplification
reporting date? applied?
YES NO
NO YES
Has there been a significant Recognise

NO
increase in credit risk since 12-month ECL
initial recognition? and calculate
interest revenue
YES on gross
carrying amount
(Stage 1)
Recognise lifetime ECL (Stage 2)
AND
Is the financial asset a YES Calculate

credit-impaired financial asset? interest
revenue on
NO amortised cost
(Stage 3)
Calculate
interest
revenue on
gross carrying
amount
(Stage 2)
Adapted from IFRS 9 Financial Instruments Illustrative Examples, July 2014, accessed on 24 April 2018
www.aasb.gov.au/admin/file/content105/c9/IFRS9_IE_7-14.pdf


Impairment
The CFO, Sarah March, is concerned about the new rules for impairment and how complicated they
will be to implement, even though Fly-by-day only has a few different types of financial assets.
She asks you to explain how IFRS 9 will apply for each of the following financial assets:
•• Cash at bank.
•• Cash portfolio (measured at FVTOCI).
•• Trade receivables (maximum payment terms are 90 days).
•• Fair value of derivative assets used for hedging.
Answer
Financial Do IFRS 9 Approach Application of IFRS 9
Asset impairment adopted
provisions
apply?
Cash at bank Yes General approach This is an asset held at amortised cost since cash
with low credit flows (the balance of the account and interest on
risk operational the account) are solely principal and interest on the
simplification principal, and it is held in order to collect contractual
cash flows (repayment of the balance or a portion
of it when required). Accordingly, the impairment
provisions of IFRS 9 apply. As our primary bank
is rated AA+, it has a very low risk of default, and
we have a strong expectation that, going forward,
the bank would be able to meet any withdrawals
we made. This means we can apply the low credit
risk operational simplification and we just have to
calculate the 12-month ECL. Given our confidence in
our bank, we could assume this to be zero
Cash Yes General approach These assets are held at FVTOCI and accordingly the
portfolio potentially with impairment provisions of IFRS 9 apply. The approach
low credit risk we adopt will depend on the quality of assets
operational held. If high quality (investment grade) we could
simplification adopt the low credit risk approach (as with cash at
bank), which means we just have to calculate the
12-month ECL. If not high quality, we would need
to adopt the general approach. This would require
an initial calculation of 12-month ECL, but also
ongoing monitoring to determine if there has been
a significant increase in credit risk and lifetime ECL is
required to be calculated
The 12-month ECL calculation (under either
approach) will require us to determine a probability
of default in the next 12 months together with a
lifetime loss given that default for each investment
asset we hold
Trade Yes Simplified Trade receivables are held at amortised cost and
receivables approach IFRS 9 permits us to adopt a simplified approach
in applying the impairment provisions. This means
we are not required to track credit risk of the trade
debtor and can just recognise lifetime ECL. Since our
trade receivables are all due within 90 days, lifetime
is only 90 days anyway. In addition, we can use a
provision matrix based on our historical experience
of credit losses

Financial Do IFRS 9 Approach Application of IFRS 9

Asset impairment adopted
provisions
apply?
Derivative No N/A These are derivatives which are measured at

assets FVTPL. This means that the fair value will already
incorporate the market’s expectations of the impact
of expected credit losses. Accordingly, separate
recognition of a loss allowance is not required
Significant increase in credit risk

The assessment of whether a financial asset has experienced a significant increase in credit risk
is crucial to establishing the point at which an entity switches from using 12-month ECLs to
using lifetime ECLs to measure a loss allowance.
A significant increase in credit risk is based on the change in risk of default that has occurred
since initial recognition of the asset. It is important to note that this is not the same as an
increase in the amount of expected credit losses. Significant judgement is required in the
assessment of whether an increase in credit risk is significant, and the assessment should be
based on reasonable and supportable information.
IFRS 9 does not provide a definition of default for the purposes of determining whether the
risk of default has changed significantly. Accordingly, an entity will need to establish its own
policies for determining what it considers to be a default.
The standard provides a non-exhaustive list of indicators an entity should consider
in determining whether a significant change in credit risk has occurred. These are
summarised below:
External Changed
market external
indicators credit rating
Increased credit risk Adverse Adverse

of other financial operating economic
instruments results conditions
Adverse Adverse change in

Internal price
indicators environment value of collateral
changes
Further details on these can be obtained from IFRS 9 para B5.5.17.

There are a number of operational simplifications and presumptions an entity may make in
assessing significant increases in credit risk:
•• Low credit risk operational simplification (as discussed previously).
•• If forward-looking information is not available without undue cost or effort, an entity may
use past due information to determine whether there have been significant increases in
credit risk. There is an assumption in IFRS 9 that credit risk has increased significantly when
contractual payments are more than 30 days past due. This assumption can be overturned if
the entity has reasonable and supportable information to the contrary.
•• The change in risk of a default occurring in the next 12 months may often be used as an
approximation for the change in risk of a default occurring over the remaining life.

•• The assessment may be made on a collective basis or at the level of the counterparty.
Lifetime credit losses are generally expected to be recognised before a financial instrument
becomes past due as credit risk has likely increased significantly prior to that date.
However, an entity may not be able to identify changes in credit risk for individual financial
instruments and may choose to recognise lifetime ECLs on a collective basis. To do this,
an entity can group financial instruments on the basis of shared credit risk characteristics
(e.g. instrument type, credit risk ratings, collateral type, industry, geographical location).
A significant increase in credit risk relates to the change in probability of default rather than to
the absolute probability of default. At any given moment in time, two financial assets may have
the same absolute probability of default but one may have increased or decreased significantly
since initial recognition whereas the other may not have.
The probability of default tends to be higher the longer the expected life of a financial asset.
For example, the risk of default in relation to a 10-year AAA rated bond is higher than that of a
5-year AAA rated bond.
These two concepts link together when considering how the probability of default for a
financial asset changes over time. If the probability of default remains constant over time, it is
likely that the credit risk has increased as it would be expected that the probability of default
would reduce as an instrument gets nearer to maturity.
The probability of default may also be impacted by the timing of payments. If there are
significant payment obligations close to maturity (e.g. for a corporate bond) the risk of default
may not necessarily decrease over time.
Recognition of ECLs in the financial statements

The recognition of ECLs in the financial statements can be summarised as follows:
Asset at amortised cost Asset at FVTOCI Unrecognised asset

(e.g. financial guarantee)
Profit or loss Expected credit loss Expected credit loss Expected credit loss
recognised as impairment recognised as impairment recognised as impairment
gain/loss gain/loss gain/loss
Other N/A At each reporting date N/A

comprehensive changes in expected credit
income losses are isolated and
transferred from OCI to P&L
as an impairment gain/loss
Balance sheet Loss allowance included in Fair value already reflects Loss allowance recognised
amortised cost expected credit losses as a provision
At each reporting date, an entity recognises the movement in the loss allowance as an
impairment gain or loss in the SPLOCI.
The carrying amount of financial assets measured at amortised cost includes the loss allowance
relating to that asset.
Assets measured at FVTOCI are recognised at fair value with changes in fair value recognised
in OCI. Changes in fair value include a number of factors, including the change in credit risk of
the asset. At reporting date, the amount relating to the change in credit risk is transferred from
OCI to profit or loss.
For financial assets that are unrecognised (e.g. loan commitments yet to be drawn, financial
guarantees), a provision for loss allowance is created in the statement of financial position to
recognise the loss allowance.

Example – Recognition of credit losses

Easybits Industries (Easybits) manages its liquidity by investing in a range of short-term debt
instruments. On 26 July 20X6 it purchased a one-year debt instrument with a fair value of
AUD500,000, which is classified as FVTOCI. The instrument carries an interest rate of 4.5%, and
has a 4.5% effective interest rate. The asset was not credit-impaired when purchased.
On 31 December 20X6 (the reporting date) the fair value of the instrument had fallen to
AUD480,000 as a result of changes in market interest rates. Easybits determines there has
not been a significant increase in credit risk since initial recognition and that ECL should be
measured at 12-month ECL, which amounts to AUD25,000.
The journal entries that should occur on 31 December 20X6 are:
$ $
31.12.X6 FVTOCI reserve 20,000
Financial asset [FVTOCI] 20,000
Being recognition of the change in fair value of the financial asset at 31 December 20X6
$ $
31.12.X6 Impairment loss [profit or loss] 25,000
FVTOCI reserve 25,000
Being recognition of the loss allowance for the financial asset at 31 December 20X6
Activity 9.4: Integrated financial instruments activity


Disclosure
Required reading
IFRS 7 paras 6–42
Overview of requirements
IFRS 7 disclosures encompass two broad areas. Under IFRS 7 entities are required to disclose
information that enables users to understand and evaluate:
•• The significance of financial instruments to an entity’s financial position and performance.
•• The nature and extent of risks arising from financial instruments to which the entity is
exposed, and how these are managed.
Broadly, IFRS 7 achieves the first of these by mandating the specific disclosure of information
that is based on accounting records and classifications. These disclosures are detailed but
relatively straightforward.
As to the second, IFRS 7 attempts to provide users with an ‘inside view’ of the risks to which an
entity is exposed. This requires the entity’s management to disclose information based on how it
views these financial risks, with a minimum standard of information being required by IFRS 7.
Because there are many different ways to view and report risk, and much of this information is
not directly available in the accounting system, providing these IFRS 7 disclosures can be quite
challenging for entities.
In addition, IFRS 13 requires disclosure of the valuations techniques and inputs used to measure
the fair value of financial instruments, as well as the effect of fair value measurements using
Level 3 inputs on profit or loss or other comprehensive income for the period.
Classes of financial instruments for disclosure purposes

Some of the IFRS 7 disclosures are required to be made by ‘class of financial instrument’, taking
into account the nature and characteristics of those financial instruments. A class of financial
instrument may require the disaggregation or aggregation of items at a more detailed level
than that which is presented in the statement of financial position or in the financial instrument
categories under IFRS 9. Significant judgement may be required to achieve an appropriate
balance between the quantity and depth of information that is disclosed, and the usefulness of
the information.
The classes used will therefore vary between different entities, but often are similar to those
for common financial instruments covered earlier in the unit. For example, an entity’s classes
of financial instruments might include cash and cash equivalents, trade receivables, corporate
bonds, government bonds, futures, options, listed equities and loans.
Further reading
The preparation of disclosures relating to financial instruments is beyond the scope of this unit.
An example of financial instrument is contained in the Woolworths 2016 annual report, available at
wow2016ar.qreports.com.au/xresources/pdf/wow16ar-financial-report.pdf, accessed 26 April 2018.
Working paper E
You are now ready to complete working paper E of integrated activity 4, to understand

Appendix 1 – Definitions of common terms and concepts

Common financial instruments
Type of instrument Features
Bank bills A short-term money market security with maturities generally ranging from 30 to
180 days. Generally offered at a discount to its expected value when it matures
Bonds Debt securities that are issued for a period greater than one year (and up to
30 years) for the purpose of raising capital. The most common bonds are those
issued by governments and corporations. Bonds involve a repayment of principal
amount (sometimes called face value) at the maturity date, and (usually) payments
of interest at a fixed rate (sometimes called coupons) over the term of the bond
The interest rate on a bond is determined by the perceived repayment ability of the
borrower. The fair value of a bond may also change based on market interest rates
and inflation in an inverse relationship (i.e. higher market interest rates compared to
the interest rate on the bond and inflation lead to lower bond prices)
Cash and cash ‘Cash and cash equivalents’ is an accounting concept that includes cash on hand,
equivalents demand deposits and short-term, highly liquid investments that are readily
convertible to known amounts of cash and subject to an insignificant risk of
changes in value
Convertible bonds or Types of corporate bonds that can be converted into ordinary or preference shares
notes of the issuer at some point in the future, usually at the option of the holder
Debt securities At their most basic, debt securities are written promises to repay debts on specified
terms. Sometimes called interest-bearing securities, they come in a variety of
forms, two of the most common being bonds and notes. They are generally
tradeable securities
Derivative Collective term for an instrument with the following features:

•• Its value changes according to changes in value of an agreed underlying asset,
index or security (such as bonds, commodities, currencies, interest rates, market
indices or shares)
•• It requires no initial net investment or an initial net investment that is smaller
than would be required for other types of contracts that would be expected to
have a similar response to changes in market factors
•• It is settled at a future date
Derivatives may be traded directly between counterparties (over-the-counter
(OTC)) and tailored specifically to their individual needs, or on an exchange
with standard terms and conditions such as contract size, maturity date and the
underlying asset (exchange-traded)
Forward rate agreement A financial instrument used to hedge interest rate risk, and is based on a
(FRA) notional principal amount. In that sense, it is similar to an interest rate swap.
FRAs are relatively simple, short-term (up to one year) OTC instruments with one
settlement date
Futures A futures contract is a legally binding agreement to buy or sell a commodity or

financial asset at a fixed price at a specific time in the future.
All futures contracts have the following features:
•• standardised
•• traded on an exchange
•• prices are quoted
•• settlement is through a clearing house
Loans Advances of money from lenders to borrowers over a period of time, with
repayment of the principal amount either at intervals during the loan period or at
the end of the loan. Interest rates that apply to loans may be fixed or variable. In
contrast to debt securities, loans are not tradeable

Common financial instruments
Type of instrument Features
Notes Short-term to medium-term debt securities, usually maturing within five years or
less. Interest rates that apply to notes may be fixed or variable
Options A contract conveying to the option holder the right (not the obligation) to buy or
sell a specified asset at a fixed price before or at a future expiration date. The price
of an option is called a premium
There are two types of options:
•• A call option confers on the holder the right to buy (i.e. call) the underlying asset
at a fixed price
•• A put option confers on the holder the right to sell (i.e. put) the underlying asset
at a fixed price
A European option is exercisable only on the option’s expiry date. An American
option is exercisable at any time up to the option’s expiry date
Ordinary shares Residual ownership in a company. Ordinary shares give the holder an entitlement
to a share of any dividends issued by the company, and the right to vote in its
annual general meetings. Shares may be traded either privately or on an exchange
(if the company is listed), and the value determined by market forces
Preference shares A form of shares issued by a company where, depending on the terms of the share
issue, the holders are usually entitled to a fixed dividend before dividends are paid
to ordinary shareholders, but do not usually have voting rights. In the event of a
company winding up, preference shares rank above ordinary shares
Swaps An OTC contract between two parties to exchange multiple payments over periods
greater than one year (and up to 15 years) based on a notional principal amount
The most common form of swap is an interest rate swap. This involves the exchange
of fixed and floating interest payments based on a notional principal amount and is
generally entered into as a hedge against interest rate risk
Swaps may also be cross-currency, which involves an exchange of interest
payments in one currency for interest payments in another currency based on the
respective notional principal amounts
Trade payables Amounts owing by an entity for goods and services it has received on credit.
Also referred to as accounts payable
Trade receivables Amounts that are due to an entity from another entity for goods and services it
supplied on credit. Also referred to as accounts receivable
Finance and accounting terms
Term Non-accounting definition
Bank bill swap rate The rate at which banks in Australia commonly lend to each other. It is derived from
(BBSW) a compilation and average of market rates of bank bills supplied daily by Australian
banks for specific maturities up to six months
Basis risk The risk that two different financial instruments in a hedging strategy will not
experience exactly offsetting price or rate movements
Bid price The price that a buyer is willing to pay for shares
Dividends or distributions Portion of an entity’s earnings that is distributed to its shareholders (or a class
thereof ). Often expressed in terms of an amount per share
Exchange Organised marketplace where securities, commodities, derivatives and other

financial instruments are traded. May also be called ‘stock exchange’, ‘futures
exchange’ etc. based on the type of instrument(s) being traded
Gains/losses Increase/decrease in the value of an asset, or decrease/increase in the value of

a liability

Finance and accounting terms
Term Non-accounting definition
Interest Charge exacted on money that is borrowed, or income received for money that
is lent. Usually expressed as an annual percentage of the principal or notional
amount. In accounting terms, interest is treated separately from any gain or loss
Net settlement In relation to a derivative, a payment settlement system within a contract where
only the net differential is transferred between the two parties to conclude the
contract
Nominal value Stated value of an issued security, sometimes known as face value or par value. The
nominal value of a security remains fixed for the duration of its life, in contrast to
its market value, which varies. For example, a bond may have a nominal value of
$1,000 (being the amount repaid at maturity), but will be issued, and traded, at a
different market value based on its terms, market interest rates, inflation, and so on
Notional value Total value of a leveraged position’s assets at the current price. (Leverage is the use
of financial instruments or borrowings to increase the exposure to an investment,
increasing the potential risk and return on the investment.) Often used in the
derivatives markets because a very small amount of money can be used to control
a large position. As an example, one S&P 500 Index* futures contract obligates the
buyer to purchase 250 units of the S&P 500 Index (or settle in cash). If the index
is trading at $1,000, the futures contract equates to an investment of $250,000
(250 × $1,000). Therefore, $250,000 is the notional value underlying the futures
contract, as compared to its actual value, which would be substantially lower
Offer price The price that a seller is willing to accept for shares. Also referred to as ask price
Settlement date The date that an asset is delivered to or by an entity. Generally, financial instruments
‘settle’ within a few days of the trade date
Spot price The current price at which a particular item can be bought or sold
Trade date The date that an entity commits itself to purchase or sell an asset
Transaction costs Under IFRS 9, transaction costs are incremental costs that are directly attributable
to the acquisition, issue or disposal of a financial asset or liability
An incremental cost is one that would not have been incurred if the entity had not
acquired, issued, or disposed of the financial instrument
Underlying item In derivatives, the index, security or other asset – such as shares or commodities –
on which the contract is based
* Standard & Poor’s 500, which is a stock market index of the top 500 US companies
Terms relating to financial instruments
Term Definition
Amortised cost The amount at which the financial asset of liability is measured at initial recognition
minus principal amount repayments, plus or minus the cumulative amortisation
(using the effective interest rate method) of any difference between that initial
amount and the maturity amount minus (for financial assets) any reduction for
impairment or uncollectability
Compound financial A financial instrument that contains both a financial liability and an equity
instrument component from the issuer’s perspective
Credit loss The difference between all contractual cash flows that are due to an entity in
accordance with the contract and all the cash flows that the entity expects to
receive (i.e. all cash shortfalls), discounted at the original effective interest rate
Credit risk The risk that one party to a financial instrument will cause a financial loss for the
other party by failing to discharge an obligation

Term Definition
Effective interest rate The effective interest rate is the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument or, when
appropriate, through a shorter period to the net carrying amount of the financial
asset or liability
Effective interest rate A method of calculating amortised cost and interest income or interest expense
method (EIM) using the effective interest rate of a financial asset or financial liability (or group of
financial assets or financial liabilities)
Embedded derivative A feature within a host non-derivative contract such that the cash flows associated
with that feature behave in a similar fashion to a stand-alone derivative. An
embedded derivative causes some or all of the cash flows that otherwise would
be required by the contract to be modified based on a specified interest rate,
security price, commodity price, foreign exchange rate, index of prices or rates, or
other variable
In the same way that derivatives must be accounted for at fair value in the
statement of financial position with changes recognised in the statement of
comprehensive income, so too must some embedded derivatives. IFRS 9 requires
that an embedded derivative be separated from its host contract and accounted for
as a derivative in certain prescribed circumstances
Equity instrument Any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities
Fair value The price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date
Financial asset Any asset that is:

•• cash
•• an equity instrument of another entity
•• a contractual right to
–– receive cash or another financial asset from another entity
–– exchange financial instruments with another entity under conditions that are
potentially favourable
•• a contract that will or may be settled in the entity’s own equity instruments is a
financial asset if it is:
–– a non-derivative for which the entity is or may be obliged to receive a
variable number of its own equity instruments
–– a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity’s
own equity instruments
Financial guarantee A contract that requires the issuer to make specified payments to reimburse the
contract holder for a loss it incurs because a specified debtor fails to make payment when
due in accordance with the original or modified terms of a debt instrument
Financial instrument Any contract that gives rise to both a financial asset of one entity and a financial
liability or equity instrument of another entity
Financial liability Any liability that is:

•• a contractual obligation to
–– deliver cash or another financial asset to another entity
–– exchange financial instruments with another entity under conditions that are
potentially unfavourable
•• a contract that will or may be settled in the entity’s own equity instruments
where the contract is either a non-derivative for which the entity may have to
deliver a variable number of own equity instruments, or a derivative that will be
settled other than by exchange of a fixed amount of a financial asset for a fixed
number of own equity instruments

Term Definition
Financial liability at fair A financial liability that

value through profit (a) meets the definition of held for trading
or loss
(b) upon initial recognition is designated by the entity as at fair value through
profit or loss in accordance with ifrs 9 para. 4.2.2 or 4.3.5
(c) is designated either upon initial recognition or subsequently as at fair value
through profit or loss in accordance with ifrs 9 para. 6.7.1
Held for trading A financial asset or liability that is:

(a) acquired or incurred principally for the purpose of selling or repurchasing it in
the near term
(b) on initial recognition, part of a portfolio of identified financial instruments
that are managed together and for which there is evidence of a recent actual
pattern of short-term profit-taking
(c) a derivative (except for a derivative that is a designated and effective hedging
instrument)
Hybrid contract A contract that includes a non-derivative host and an embedded derivative. An
example is a convertible debt instrument which combines an interest-bearing debt
instrument (a non-derivative) with an option on equity shares (a derivative)
Insurance contract A contract under which one party (the insurer) accepts significant insurance risk
from another party (the policyholder) by agreeing to compensate the policyholder
if a specified uncertain future event (the insured event) adversely affects the
policyholder
Past due A financial asset is past due when a counterparty has failed to make a payment
when that payment was contractually due
Regular way contracts Contracts for the purchase or sale of financial assets that require delivery of the
assets within the time frame generally established by regulation or convention in
the marketplace concerned

Appendix 2 – Derivatives
Derivatives ‘derive’ their value from underlying financial instruments, commodities, prices or
an index and are widely used by entities to manage risk.
Examples of common derivatives are in the following table:
Common derivatives
Derivative Definition and explanation
Forward rate A contract that places an obligation on one party to buy a financial instrument,
contract commodity or currency, and another party to sell that instrument, commodity or currency
at a specified future date. Also called a ‘forward’. Forwards are OTC financial instruments,
whereby the terms of the contract are determined by the buyer and seller
As a forward involves an obligation to make an exchange, the value of the contract may be
either positive or negative to the holder if the price of the underlying item changes during
the term of the forward
Futures These are a form of forward contract traded on a formal exchange. As such, futures have
standardised terms to facilitate trading. They are often ‘closed’ by making an offsetting
trade on the exchange, or settled in cash without taking or making delivery of goods
Option A contract that gives the buyer/holder the right, but not the obligation, to buy or sell a
specified quantity of a commodity or other instrument at a specific price (exercise price
or strike price) at or within a specific period of time, regardless of the market price of that
instrument. There are many different types of options, but the two most common are put
options and call options (see below)
The seller/writer of the option is in the opposite position to the buyer, in that they have
the obligation to deliver or purchase the underlying item (or settle in cash) if the option is
‘exercised’ by the buyer
Unlike many other derivatives, for the buyer there is an initial price (or premium) for
purchasing the option. The buyer’s potential loss is limited to this amount, because if
the movement in the value of the underlying item is unfavourable from the buyer’s
perspective, they simply will not exercise the option and it will ‘expire’. Therefore, for the
option holder, the value of the option cannot be less than zero. For the seller, the potential
loss is unlimited and the value of the option may be negative
Call option An instrument that gives the buyer/holder the option to buy an underlying item at a
specific price (exercise or strike price). The option becomes more valuable to the buyer/
holder as the market price of the underlying item goes up, and less valuable as the price
goes down. When the market price is above the exercise price, it is said to be ‘in the money’.
For example, if the market price of a security is $7, the holder of a call option on that
security with a strike price of $5 could exercise the option and buy the security from the
option writer for $5, being $2 below the current market value
If the market price is below $5, the option is ‘ out of the money’ and would not be exercised
by the holder as it would be cheaper to buy the security on the market
Put option An instrument that gives the buyer/holder the option to sell the underlying item at a
specific price (exercise or strike price). The option becomes more valuable as the price of
the underlying item falls, and less valuable as the price goes up. When the market price is
below the exercise price, it is said to be ‘in the money’. For example, if the market price of
a security is $7, the holder of a put option on that security with a strike price of $9 could
exercise the option and sell the security to the option writer for $9, being $2 above the
current market value
If the market price is above $9, the option is ‘out of the money’ and would not be exercised
by the holder as they would be better off selling the security on the market
Swap Exchange of streams of payments over time according to specified terms. The most
common types of swaps are interest rate swaps and currency swaps (see below)

Common derivatives
Derivative Definition and explanation
Interest rate swap Swap in which the two counterparties agree to exchange interest rate flows over a period,
but without any principal being exchanged. Typically, one party agrees to pay a fixed
interest rate on a specified principal amount (notional principal) on a specified series of
payment dates, and the other party pays a floating rate on the notional principal based on
a market benchmark interest rate on those payment dates. The value of the swap to both
parties will change depending on the movement in the market benchmark interest rate
after the swap commences. For example, if the market benchmark interest rate goes up,
the swap party paying the fixed rate of interest will be better off as they will receive higher
interest payments going forward, while their obligations will not change – for them, the
swap will have positive value. In contrast, the swap will have negative value to the party
paying the floating rate. Often, interest rate swaps are net settled
Currency (foreign Swap that involves the exchange of a series of cash flows in one currency (e.g. US dollars)
exchange (FX)) for a series of cash flows in another currency (e.g. Japanese yen) on a specified schedule of
swap dates between two parties
The value of the swap will change depending on the movement in the relative values of
the currencies, and can be either positive or negative for either party at any given time
Under IFRS 9, derivatives are held for trading financial instruments and are measured at fair
value through profit or loss, unless they are designated hedging instruments in a hedging
relationship.
They are used predominantly as a means of managing financial risk that entities become
exposed to through their day-to-day operations.
Example – Derivative
George Miller grows wheat. He is concerned about the price he will obtain for this year’s crop.
The current price of wheat is $5.50 per bushel and the standard contract size in the futures
market is 5,000 bushels. George hopes the price will rise by the time he wants to sell his wheat
crop in six months. He has 500,000 bushels to sell. The market expects the price of wheat to be
$6.00 per bushel in six months.
George could take no action now and just hope the price increases by the time he comes to sell
his wheat. Another option is to hedge his price risk by selling the wheat forward in the futures
market so that he locks in a selling price of $6.00 per bushel. To do this he would sell 100 futures
contracts for delivery at $6.00 per bushel in six months’ time.
In six months, the price may fall lower than $6.00 per bushel. In this case, George has made more
on his wheat than if he hadn’t hedged his price risk. On the other hand, the price may rise to
above $6.00 per bushel. George would have been better off if he hadn’t hedged, but he thinks
the cost of the certainty he has created through hedging is worth paying to ensure he does not
receive less than $6.00 per bushel.
Net settling
If an entity enters into contracts to buy or sell non-financial items for the purpose of receipt
or delivery of those items in accordance with the entity’s normal business requirements, these
contracts are outside the scope of IFRS 9.
However, if the contracts can be settled net in cash or another financial instrument, an entity
may designate the contract as a derivative and IFRS 9 shall apply to it. The ability to settle net in
cash may not be explicit in the terms of the contract, but an entity may have a practice of settling
similar contracts net in cash. This may be done by entering into offsetting contracts or by selling
the contract before its exercise or lapse.

Example – Net settling

Black Sheep Coal Mines (Black Sheep) enters into a futures contract to sell 50,000 tonnes of
coal in four months for a fixed price. Black Sheep frequently manages its coal price risk in this
manner, and has a practice of settling such contracts net in cash by entering into an offsetting
buy contract close to settlement date. Black Sheep accounts for this futures contract as a
financial instrument.
If Black Sheep were in the practice of delivering coal in settlement of the contract, then the
contract would not be a financial instrument and would be outside the scope of IFRS 9.
Embedded derivatives
An embedded derivative is a component of a hybrid contract that also includes a non-derivative
host. The effect is that some of the cash flows of the contract vary in a way similar to a stand-
alone derivative.
Examples of embedded derivatives are provided below.
•• A lease contract contains a provision for rentals to increase each year in line with inflation.
The entire lease contract is a hybrid contract containing a lease contract host and an
embedded derivative of the adjustment for inflation
•• A company in Australia sells iron ore in USD to a company in China with a functional
currency of Renminbi. The hybrid contract is the entire sale contract. The host contract is the
sales contract and the embedded derivative is the foreign exchange USD/CNY forward rate
implicit in the contract.
Embedded derivatives are not covered in detail in this unit.


Unit 10: Impairment of assets
Contents
Introduction 10-3
Scope of IAS 36 10-3
Key concepts 10-4
What is an impairment loss 10-4
Impairment loss rules may be applied to an individual asset or to a cash generating
unit (CGU) 10-4
When to undertake impairment testing under IAS 36 10-5
Determining whether there is any indication that an asset may be impaired 10-5
Determining the recoverable amount 10-6
Determining whether to assess impairment at an individual asset level or at a CGU level 10-7
Accounting for an impairment loss under IAS 36 – individual assets 10-8
Determining and accounting for impairment losses under IAS 36 – CGUs and goodwill 10-9
Identifying a CGU 10-10
Consistency in determining the carrying amount and recoverable amount for a CGU 10-10
Complications with CGUs 10-12
Reversal of an impairment loss under IAS 36 10-15
Reversal of an impairment loss for an individual assets 10-16
Reversal of an impairment loss in a CGU 10-19
Other complications 10-20
Interim financial reporting and impairment 10-20
Existence of a non-controlling interest and the impact on goodwill impairment 10-20
Disclosures 10-20
fin11910_csg_03


Learning outcomes
Introduction
The value of an entity’s assets may fluctuate, particularly in challenging economic times.
Because of the risk of overstatement of assets, corporate regulators, including the Australian
Securities and Investments Commission (ASIC), often focus on compliance with IAS 36
Impairment of Assets. As per ASIC’s media release:
The recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant
and equipment continues to be an important area of focus.
(Source: ASIC 2017, (Attachment to 16-428MR: ASIC calls on directors to apply realism and clarity to
financial reports), media release, December, accessed 16 April 2018, http://asic.gov.au/about-asic/media-
centre/find-a-media-release/2016-releases/16-428mr-asic-calls-on-preparers-to-focus-on-useful-and-
meaningful-financial-reports/)
The main purpose of IAS 36 is to ensure that the carrying amount of an asset does not exceed its
recoverable amount in the statement of financial position. The standard requires the recognition
of an impairment loss when this occurs.

Scope of IAS 36
Paragraphs 2–5 of IAS 36 identify the scope of the standard, which can be summarised
as follows:
Assets in scope of Assets out of scope of IAS 36 include:

IAS 36 include:
• Financial assets (limited exceptions) IFRS 9
• Property,
plant and These other
equipment • Certain contract assets with customers IFRS 15
standards
• Identifiable establish
• Inventories IAS 2
intangible their own
assets valuation
• Deferred tax assets IAS 12 rules
• Goodwill
• Non-current assets (or disposal groups)
classified as held for sale IFRS 5
FIN fact
An impairment loss is never allocated to a liability. Only assets can be impaired.
Required reading
IAS 36.

Key concepts
This section outlines some key concepts from IAS 36 that are critical to calculating and
accounting for an impairment loss.
What is an impairment loss

An impairment loss is defined in IAS 36 para. 6 as the amount by which the carrying amount
of an asset or a cash-generating unit exceeds its recoverable amount.
The method for calculating impairment loss can be shown as follows:
Carrying Recoverable Impairment

amount amount loss
Higher of*
Fair value less

costs of disposal Value in use
(FVLCOD) (VIU)
* It is not always necessary to determine both an asset’s fair value less costs of disposal and its value in use.
If either of these amounts exceeds the asset’s carrying amount, the asset is not impaired and it is not
necessary to estimate the other amount (IAS 36 para 19).
Impairment loss rules may be applied to an individual asset or

to a cash generating unit (CGU)
The rules in IAS 36, which will be explained in detail in this unit, determine whether there is an
impairment loss either for an individual asset or for a cash-generating unit (CGU).
This can be illustrated as per the diagram below:
Application of impairment loss rules
Individual asset CGU (e.g. a division of a business)

A CGU is defined as…the smallest identifiable
group of assets that generates cash inflows that are
largely independent of the cash inflows from other
assets or groups of assets
The limousine is an individual asset that The factory is a CGU as the factory assets work
generates cash inflows from being hired together to generage cash inflows
An impairment loss is recognised for the factory

An impairment loss is recognised for the CGU if it is impaired. The CGU impairment loss is
limousine if it is impaired then allocated to the individual factory assets

When to undertake impairment testing under IAS 36

An entity is required to conduct impairment tests on its assets to determine whether it has
incurred any impairment losses. However, this does not mean that all its assets need to be
tested every reporting period.
The general rule under IAS 36 para. 9 states that an entity needs to assess at each reporting date
whether there is any indication that an asset may be impaired. If there is an indication that an
asset may be impaired, the entity has to estimate the recoverable amount of the asset. If there is
no indication that an asset may be impaired, the entity is not required to make a formal estimate
of the recoverable amount of that asset.
When to test for impairment
All assets within the scope of IAS 36

At the end of the reporting period is there
any indication of impairment for an asset Additional rules for certain assets
(IAS 36 para. 9)?
Yes No
Estimate the Identifiable Goodwill

recoverable amount of No action to intangible assets Perform impairment
the asset to determine be taken • Intangible assets test annually following
whether there is an with an indefinite life rules detailed later in
impairment loss • Intangible assets the unit
that are not yet (IAS 36 para. 10(b))
ready for use
(e.g. capitalised
development costs)
Perform impairment test
annually which may be
at any time during an
annual period, provided
it is performed at the
same time every year
(IAS 36 para. 10(a))
Determining whether there is any indication that an asset may

be impaired
It may be quite obvious from simply looking at a particular asset, or knowing its history,
that it is no longer worth what it was previously. IAS 36 provides a list of indications that
management should, at a minimum, consider when assessing whether there is any indication
of impairment of an asset.
Under IAS 36 para. 12, indications of impairment may come from the following two sources
of information:
•• External sources.
•• Internal sources.
From these sources of information, the entity needs to consider the following when assessing
whether there is any indication of impairment:

External sources Internal sources
•• Significant decline in the market value of an asset •• Evidence of obsolescence or physical damage
•• Significant changes that adversely affect the entity of an asset
in the technological, market, economic or legal •• Significant change in the use of an asset that
environment in which it operates adversely affects the entity
•• Increases in market interest rates or other market •• Declining economic performance, which might be
rates of return that are likely to affect the discount indicated by larger than expected maintenance
rate used to assess the present value of the future costs or lower than expected profits, from the use
cash flows from the asset of an asset
•• When the carrying amount of the entity’s net assets
exceeds the market capitalisation of the entity
Determining the recoverable amount

The recoverable amount of an asset is defined in IAS 36 paras 6 and 18 as the higher of its fair
value less costs of disposal (FVLCOD) and value in use (VIU).
When measuring either FVLCOD or VIU, the following definitions apply:
•• FVLCOD – the definition of fair value in IAS 36 para. 6 replicates the fair value definition in
IFRS 13 Fair Value Measurement (see Unit 6).
•• VIU – IAS 36 para. 6 defines VIU as ‘…the present value of the future cash flows expected
to be derived from an asset or cash-generating unit’.
Note that although IAS 36 paras 18–57 set out the requirements for measuring recoverable
amount for ‘an asset’, these provisions apply equally to an individual asset or CGU.
Fair value less costs of disposal

The following should be considered when calculating FVLCOD:
•• IFRS 13 is applied in measuring fair value for the purposes of the FVLCOD calculation.
Measuring fair value under IFRS 13 is covered in Unit 6.
•• ‘Legal fees, stamp duty or similar transaction taxes, costs of removing the asset and direct
incremental costs’ to bring the asset into a saleable condition, are deducted in measuring
FVLCOD (IAS 36 para. 28).
•• Costs that arise after the sale of an asset are not direct incremental costs (e.g. taxation
consequences, termination benefits under IAS 19 Employee Benefits, and ‘costs associated
with reducing or reorganising a business following the disposal of an asset’) (IAS 36
para. 28).
Value in use (VIU)

IAS 36 provides detailed requirements for calculating VIU. Typically this is performed by
applying a discounted cash flow approach. (Performing a VIU calculation is beyond the scope
of the FIN module.)
The elements listed below must be reflected in a VIU calculation, as specified in IAS 36 para. 30:
(a) an estimate of the future cash flows the entity expects to derive from the asset;
(b) expectations about possible variations in the amount or timing of those future cash flows;
(c) the time value of money, represented by the current market risk-free rate of interest;
(d) the price for bearing the uncertainty inherent in the asset; and
(e) other factors, such as illiquidity, that market participants would reflect in pricing the future cash
flows the entity expects to derive from the asset.

Any projections based on budgets or forecasts should ‘cover a maximum period of five years,
unless a longer period can be justified’. Projections for periods beyond the budgets or forecasts
are extrapolated using ‘steady or declining growth’ rates for subsequent years, unless another
rate can be justified (IAS 36 para. 33).
Further reading
IAS 36 Appendix A.
Determining whether to assess impairment at an individual asset

level or at a CGU level
Determining whether to assess impairment at an individual asset level or at a CGU level
depends on the circumstances, as illustrated in the diagram below:
Conducting impairment test at the individual level or the CGU level
Does the individual asset generate cash inflows

that are largely independent from the cash inflows
from other assets or groups of assets?
Yes No
Determine the recoverable amount for the Determine the recoverable amount at the
individual asset (IAS 36 para. 22) CGU level (IAS 36 paras 65–103) unless
The individual asset’s FVLCOD The individual asset’s VIU can be

can be determined and it is higher estimated to be close to the amount
than the individual asset’s carrying measured for its FVLCOD (IAS 36
amount (which means that the para. 22(b))
individual asset is not impaired)
(IAS 36 para. 22(a))
Recognise any impairment loss at

the individual asset level (this would
be rare given this asset does not
Adapted from: Grant Thornton 2014, Impairment of Assets: A generate largely independent
guide to applying IAS 36 in practice, accessed 16 April 2018, cash flows)
www.grantthornton.com.au.
This unit will look first at accounting for an impairment loss for an individual asset and then
look at how the rules are applied for assets within a CGU.

Accounting for an impairment loss under IAS 36 –

individual assets
Learning outcome
The process for recognising an impairment loss calculated for an individual asset is shown
as follows:
Recognising an impairment loss for an individual asset (IAS 36 paras 60-61)
Does the impairment loss relate to an

asset measured on a revaluation basis
(e.g. under IAS 16)?
No Yes
Recognise the impairment loss Does a revaluation surplus already exist

immediately in profit or loss for this asset?
No Yes
Recognise the impairment loss Recognise the impairment loss:

as a revaluation decrement in IAS 36 • As a reversal of the revaluation
profit or loss para. 60 – surplus in respect of that asset
follow the rules (and disclosed in OCI)
for revaluation
decrements in • With any remaining
Units 7 impairment loss recognised as
and 8 a revaluation decrement in
profit or loss
Adapted from: Grant Thornton 2014, Impairment of Assets:

A guide to applying IAS 36 in practice, accessed 16 April 2018,
Example – Recognising an impairment loss for an individual asset

This example illustrates how to calculate and recognise an impairment loss for an
individual asset.
Cumquat owns equipment that has a carrying amount of $400,000 at the reporting date.
There are indications of impairment for this asset. In addition, its FVLCOD has been measured
at $340,000 and its value in use is estimated at $370,000.
The equipment’s recoverable amount is its $370,000 value in use, as this is higher than the
$340,000 FVLCOD.
The impairment loss is $30,000 ($400,000 carrying amount – $370,000 recoverable amount).
The journal entry to recognise the impairment loss under the cost model is as follows:

$ $
xx.xx.xx Impairment losses 30,000
Accumulated depreciation and impairment losses – 30,000

equipment
To record impairment loss

Refer to Units 7 and 8 for the journal entry to recognise a revaluation decrement for an asset
measured on a revaluation basis.
Subsequent depreciation/amortisation
‘After the recognition of an impairment loss, the depreciation (amortisation) charge for the
asset shall be adjusted in future periods to allocate the asset’s revised carrying amount, less its
residual value (if any), on a systematic basis over its remaining useful life’ (IAS 36 para. 63).
As the carrying value of the asset has been reduced, future depreciation/amortisation charges
will be lower. This applies to assets measured at cost or on a revaluation basis. Accounting
for a change in depreciation/amortisation is discussed in Units 7 and 8.
Summary of recognition of impairment loss for an individual asset

The key steps involved in recognising an impairment loss for an individual asset can be
summarised as follows:

Are there If yes, Is the asset If yes, calculate Recognise
indictions of determine impaired? impairment loss impairment
impairment? the asset’s (carrying (carrying loss
recoverable amount > amount –
amount recoverable recoverable
amount) amount)
Worked example 10.1: Accounting for impairment of an individual asset

Determining and accounting for impairment losses

under IAS 36 – CGUs and goodwill
Learning outcome
It is common to have some assets that, while necessary to run a business, do not individually
generate cash inflows. For instance, in a manufacturing environment, the machinery used to
produce the inventory may be directly linked to the cash that is generated from the sale of
the manufactured goods. However, some items of machinery may work in conjunction with
other assets to produce the inventory. This machinery does not of itself generate a direct cash
inflow. Similarly, the head office of a manufacturing operation would not individually generate
cash inflows.
IAS 36 para. 66 requires that when it is not possible to identify an individual asset’s recoverable
amount, its recoverable amount must be determined in the context of the CGU to which the
asset belongs.
Recall that the definition of a CGU from IAS 36 para. 6 is:
… the smallest identifiable group of assets that generates cash inflows that are largely independent
of the cash inflows from other assets or groups of assets.
Accordingly, an impairment loss is generally calculated at the CGU level rather than for
individual assets within the CGU.

The accounting for an impairment loss calculated for a CGU can be shown as follows:
Impairment loss (calculated for a CGU)

e.g. $100,000
The CGU impairment loss is allocated to the relevant individual assets within the CGU (following IAS 36 rules)
Asset 1 Asset 2 Asset 3

Reduced Reduced Reduced
by by by
$70,000 $20,000 $10,000
The impairment loss journal entry reduces the carrying amount of the individual assets
within the CGU by the appropriate amount
Identifying a CGU
The following are key to identifying a CGU:
•• The requirement to identify the ‘smallest identifiable group of assets’ – for example, this
may mean drilling down below divisional management reporting lines to determine cash
inflows at a specific product or service level.
•• The generation of cash inflows rather than requiring the CGU to produce a net cash inflow.
You will find guidelines for, and useful examples of, the identification of CGUs in IAS 36
paras 67–73 and in IAS 36 Illustrative Example 1.
These guidelines and examples are a useful reference; however, the identification of a CGU
still requires professional judgement. In practice, management should document the factors
and internal management reporting structure that support how the entity’s CGUs have
been identified.
The focus in the FIN module is on the calculation and recognition of an impairment loss for
a CGU rather than the identification of an entity’s CGUs.
Consistency in determining the carrying amount and recoverable

amount for a CGU
IAS 36 para. 75 requires that the carrying amount of a CGU is determined on a basis consistent
with the determination of the recoverable amount.
When assessing whether there is an impairment loss, it is not necessary to calculate both the
FVLCOD and the VIU for a CGU. As a minimum, only one of these two values is required
if that value exceeds the CGU’s carrying amount. Please note that in the FIN module, a
CGU’s recoverable amount will always be stated and you will not be required to perform the
calculation of a CGU’s FVLCOD and VIU.
IAS 36 does not specify how the recoverable amount of a CGU should be determined.
Determining the recoverable amount of a CGU requires professional judgement to be applied
and decisions to be made, including decisions on:
•• how the cash flows are generated by the CGU – as this is relevant to the calculation of
VIU calculation
•• how the CGU will be sold (e.g. will a purchaser buy the inventory along with the non-
current assets of the CGU) – as this impacts the measurement of FVLCOD.

To ensure consistency in determining if there is an impairment loss, you will need to consider
how to calculate the carrying amount of the CGU based on the information provided for the
CGU’s recoverable amount.
Consistency can be demonstrated by considering the following examples.
Example – Applying consistency when determining the carrying amount and recoverable
amount for a CGU
This example illustrates how consistency is needed when determining the carrying amount and
recoverable amount for a CGU.
Stellar has two CGUs, Meteor and Comet, both of which are being tested for impairment.
Meteor– the recoverable amount has been determined on a VIU basis
The VIU for Meteor was determined by including the present value of the future cash flows
relating to Meteor’s:
•• assets within the scope of IAS 36
•• trade receivables
•• inventory
•• less trade payables.
The carrying amount of the Meteor CGU will be calculated by including the carrying amount
of the Meteor’s:
•• trade receivables
•• inventory
•• less trade payables.
The VIU and carrying amount of the Meteor CGU are consistent when the two values are
compared to determine if there is an impairment loss for the Meteor CGU.
Comet– the recoverable amount has been determined by calculating its FVLCOD
The FVLCOD for Comet was determined by including the fair value of its inventory as
management assessed that a purchaser would buy Comet’s inventory as well as its other assets.
Therefore, the FVLCOD was measured as Comet’s:
•• inventory.
The carrying amount of the Comet CGU will be calculated by including the carrying amount
of Comet’s:
•• inventory.
The FVLCOD and carrying amount of the Comet CGU are consistent when the two values are
compared to determine if there is an impairment loss for Comet.

The impairment loss for the CGU can only be applied to assets within the scope
of IAS 36
Despite the fact that the recoverable amount and carrying amount of a CGU may include values
for balance sheet items such trade receivables, inventory and trade payables, an impairment loss
for a CGU can only be allocated to assets within the scope of IAS 36. Therefore, the following
items cannot be impaired under IAS 36:
Item Reason
Trade receivables Expected credit losses on trade receivables are recognised under IFRS 9
Trade receivables cannot be impaired under IAS 36 as they are outside the scope of IAS 36
Inventory Inventory is carried at the lower of cost and net realisable value under IAS 2
Inventory cannot be impaired under IAS 36 as it is outside the scope of IAS 36
Trade payables Trade payables are a financial liability. Liabilities are not impaired and cannot have
impairment losses allocated to them
IAS 36 only applies to those assets within its scope
FIN fact
A CGU’s carrying amount and recoverable amount should be calculated on the same basis,
with the same inclusions and exclusions. Consistency of the two calculations is the key issue.
Complications with CGUs

1. Assessing goodwill for impairment
It is not possible to determine the recoverable amount of goodwill on its own as goodwill does
not produce cash flows independently of other assets. Therefore, goodwill is always tested for
impairment at a CGU level.
IAS 36 para. 80 requires that goodwill be allocated to each acquirer’s CGU, or groups of
CGUs, that are expected to benefit from the synergies of the business combination to which
the goodwill relates. Note that CGUs cannot be larger than an operating segment as defined
by IFRS 8 Operating Segments.
If there are assets that constitute a CGU (or group of CGUs) to which goodwill has been
allocated that require impairment testing, IAS 36 para. 97 requires that those assets be tested for
impairment before the CGU (or group of CGUs) containing the goodwill is tested.
Impairment of goodwill when preparing consolidated financial statements is explained in
Unit 16.
2. Corporate assets
Corporate assets are assets other than goodwill that do not independently generate cash inflows
but are integral to the cash flows generated by a CGU, along with those of other CGUs. An
example of a corporate asset is a company’s head office.
When testing a CGU for impairment, IAS 36 para. 102(a) requires that corporate assets, or a
relevant portion thereof, be allocated to the CGU under review on ‘a reasonable and consistent
basis’. Where an allocation cannot be made on such a basis, IAS 36 para. 102(b) provides
appropriate guidance.

Example – Determining an impairment loss for a CGU with a corporate asset

This example illustrates the concept of how a corporate asset is allocated to a CGU when
determining whether there is an impairment loss for the CGU.
Head office supports:

• The paper division (60%)
• The plastics division (40%)
There are indicators of impairment for the plastics division CGU,

but none for the highly profitable paper division CGU
40% of the head office’s carrying amount is allocated to the plastics division CGU
when determining the impairment loss for the plastics division CGU
A portion of the impairment loss for the plastics There is no impairment loss in respect of the
division CGU is allocated to the head office asset head office relating to its 60% support for the
because of its 40% support to this division paper division CGU, as that CGU is not impaired
Allocating an impairment loss for a CGU

The allocation process for an impairment loss in relation to a CGU can be explained as follows:
Allocating an impairment loss to individual assets within a CGU
(IAS 36 paras 104-105)
• Reduce any goodwill

STEP
1
Only allocate the
remaining impairment
• Allocate any remaining impairment loss to other assets in loss to other assets in
the CGU (including corporate assets) on a pro-rata basis the CGU that are in the
STEP BUT scope of IAS 36 e.g. no
2 impairment loss would
be allocated to
inventory
No asset can be reduced below the HIGHEST of:
• Its FVLCOD (if measurable)
• Its VIU (if determinable)
FLOOR • $0

Example – Allocating an impairment loss against the assets in a CGU

This example illustrates how to allocate an impairment loss calculated for a CGU.
A $600,000 impairment loss has been determined for the Merryvale CGU.
Details of the CGU’s assets are provided in the table below. It has also been determined that
Merryvale’s property has a FVLCOD of $1.8 million; however, the recoverable amount for other
individual assets within the CGU cannot be estimated.
Allocation of impairment loss
CGU asset Carrying Proportion Allocation of Revised
details amount impairment carrying
$ loss amount
$ $
Property1 2,000,000 200,000 1,800,000
Plant and 700,000 $700,000/($700,000 + $300,000) × $400,000 280,000 420,000

equipment
Licence 300,000 $300,000/($700,000 + $300,000) × $400,000 120,000 180,000
Total 3,000,000 600,000 2,400,000

impairment
loss
1. If a proportionate allocation of the $600,000 impairment loss were made to the property, then the carrying amount
of the property would be reduced by $400,000 ($2 million / $3 million × $600,000) to $1.6 million. This would reduce
the property below the floor prescribed by IAS 36 para. 105 as the property cannot be reduced below the $1.8 million
FVLCOD. Therefore only $200,000 of the total impairment loss can be allocated to the property and the $400,000
remaining impairment loss (i.e. $600,000 – $200,000) is allocated to the remaining assets of the CGU.
The journal entry to recognise the impairment loss is as follows:

$ $
xx.xx.xx Impairment loss 600,000
Accumulated depreciation and impairment losses 200,000

– property
Accumulated depreciation and impairment losses 280,000

– plant and equipment
Accumulated amortisation and impairment losses 120,000

– licence
To record the allocation of the CGU impairment loss
FIN fact
IAS 36 para. 105 specifies a floor for an impairment loss allocated to an individual asset
within a CGU. The asset cannot be written down below this floor.

Summary of recognition of impairment loss for a CGU

The key steps involved in recognising an impairment loss for a CGU can be summarised
as follows:
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6 STEP 7

Are there If yes, Determine the Is the CGU If yes, calculate Allocate Recognise
indications of determine the CGU’s carrying impaired? impairment loss impairment impairment
impairment? CGU’s amount (carrying (carrying loss on a loss
(if the CGU recoverable (including its amount > amount – proportionate
contains amount share of any recoverable recoverable basis to CGU
goodwill the corporate amount) amount) assets within
CGU will assets) the scope of
be tested Calculate on a IAS 36 (apply
annually for consistent basis IAS 36 para.
impairment) 105 floor limits)
Worked example 10.2: Accounting for impairment for a simple CGU

Worked example 10.3: Accounting for impairment for a CGU with goodwill
Reversal of an impairment loss under IAS 36
Learning outcome
An entity which has recorded an impairment loss may find that the indicators that initially
required the asset or CGU to be impaired have reversed in a subsequent reporting period.
Therefore, IAS 36 para. 110 requires that:
An entity shall assess at the end of each reporting period whether there is any indication that an
impairment loss recognised in prior periods for an asset other than goodwill may no longer exist
or may have decreased.
Watch out for the need to reverse an impairment loss in a later reporting period
An
IAS 36 para. 111 requires an entity to consider external and impairment
internal sources of information that indicate that an impairment loss for goodwill
loss recognised in prior periods (either for an individual asset or cannot be
a CGU) may no longer exist or may have decreased reversed (IAS 36
para. 124)
Has the situation changed during the current reporting period? Consider…
External source of information Internal

Internalsource
sourceof
ofinformation
information
For example, a sustained increase during E.g. capital
For example, expenditure
capital incurred
expenditure during
incurred during
the reporting period in the selling price the
thereporting
reportingperiod
periodthat
thatimproves
improvesanan
of a CGU’s product asset’s
asset’sperformance
performance

The conditions for reversing an impairment loss are restrictive with IAS 36 para. 114,
specifying that:
An impairment loss recognised in prior periods for an asset other than goodwill shall be reversed if,
and only if, there has been a change in the estimates used to determine the asset’s recoverable amount
since the last impairment loss was recognised. If this is the case, the carrying amount of the asset shall,
except as described in paragraph 117, be increased to its recoverable amount. That increase is a reversal
of an impairment loss.
The amount of an impairment loss reversal is restricted by the requirements of IAS 36 (which
are explained below).
Reversal of an impairment loss for an individual assets

The diagram below illustrates the process for reversing an impairment loss for an
individual asset:
Reversing an impairment loss for an individual asset (IAS 36 paras 117-120)
At the end of the reporting period is there any

indication for reversing an impairment loss that
was recognised in a prior period?
No Yes
No action to be taken Calculate the recoverable amount for the asset
Yes
Would the reversal of the impairment loss cause

No the new carrying amount to exceed the asset’s
carrying amount (after depreciation/amortisation)
had no impairment loss been initially recognised?
Yes
Is the asset measured on a Is the asset measured on a

revaluation basis? revaluation basis?
IAS 36
No para. 119 –
follow the rules
Yes for revaluation Yes No
increments in
Units 7
and 8
Recognise the impairment Recognise the impairment Apply the ceiling:

loss reversal in profit or loss loss reversal: Recognise the impairment
• In profit or loss to the loss reversal up the asset’s
extent that it was initially carrying amount (after
recognised in profit or loss depreciation/amortisation)
• With any remaining had no impairment loss
revaluation increment been initially recognised
recognised in the
revaluation surplus
account (disclosed in OCI)


Example – Reversing an impairment loss for an individual asset

This example illustrates an impairment loss reversal for an individual asset.
Facts
•• An asset has a cost of $12,000.
•• It is being depreciated over four years on a straight-line basis.
•• At the end of year one:
–– It has a carrying amount of $9,000 ($12,000 cost – $3,000 accumulated depreciation).
–– There are indications of impairment and the recoverable amount for the asset is
determined to be $6,000, which results in the recognition of a $3,000 impairment loss
($9,000 carrying amount – $6,000 recoverable amount).
–– The remaining useful life is assessed at three years.
•• At the end of year two
–– The asset has a carrying amount of $4,000 ($6,000 at the end of year one – $2,000
depreciation for year two).
–– The indications of impairment that gave rise to the impairment loss has been eliminated,
and the recoverable amount has been determined. This enables an impairment loss
reversal to be recognised.
–– If the impairment loss at the end of year one had not been recognised, the carrying
amount would have been $6,000, calculated as follows:
Year Opening carrying Depreciation Closing carrying
amount amount
$ $ $
End of year 1 12,000 3,000 9,000
End of year 2 9,000 3,000 6,000
Scenario 1 – The recoverable amount is $5,000 at the end of year 2

Applying IAS 36 para. 117 at the end of year 2, the asset’s carrying amount cannot be increased
above the lower of:
•• its $5,000 recoverable amount, and
•• its $6,000 carrying amount, as if the impairment loss had not occurred.
As $5,000 is the lower of these two values, the impairment loss reversal is $1,000 ($5,000 ceiling
for reversal of the impairment loss – $4,000 actual carrying amount at the end of year two).
This situation can be shown as follows:
Notional carrying amount (the asset’s carrying amount

$6,000
(after depreciation) as if there had been no impairment loss)
Ceiling $5,000 Recoverable amount
Impairment loss reversal
$4,000 Actual carrying amount

The following journal entry would be recorded.

$ $
xx.xx.xx Accumulated depreciation and impairment losses 1,000
Impairment reversal – gain 1,000
To record reversal of impairment loss
Scenario 2 – The recoverable amount is $8,000 at the end of year 2

Applying IAS 36 para. 117 at the end of year 2, the asset’s carrying amount cannot be increased
above the lower of:
•• its $8,000 recoverable amount, and
•• its $6,000 carrying amount, as if the impairment loss had not occurred.
As $6,000 is the lower of these two values, the impairment loss reversal is $2,000 ($6,000 ceiling
for reversal of the impairment loss – $4,000 actual carrying amount at the end of year two).
This situation can be shown as follows:
$8,000 Recoverable amount
Ceiling $6,000 Notional carrying amount (the asset’s carrying amount

(after depreciation) as if there had been no impairment loss)
Impairment loss reversal
$4,000 Actual carrying amount
The following journal entry would be recorded.

$ $
xx.xx.xx Accumulated depreciation and impairment losses 2,000
Impairment reversal – gain 2,000
To record reversal of impairment loss
Subsequent depreciation and amortisation

When the carrying value of an asset has been increased as a result of an impairment loss
reversal, any future depreciation or amortisation charges will increase (refer to Units 7 and 8 for
the appropriate accounting treatment).

Reversal of an impairment loss in a CGU

If the impairment loss was recorded on a CGU, rather than an individual asset, the reversal is
allocated to the assets of the CGU (except for goodwill) pro rata with the carrying amounts of
the assets. The reversal is then regarded as the reversal of an impairment loss for individual
assets and accounted for as per the journal entry above (IAS 36 para. 122).
The process for reversing an impairment loss in a CGU is explained below:
Reversing an impairment loss for a CGU (IAS 36 paras 122-123)
At the end of the reporting period is there any

indication for reversing an impairment loss for a
CGU that was recognised in a prior period?
No Yes
No action to be taken Calculate the recoverable amount for the CGU

and compare with the CGU’s carrying amount to
determine the amount ofYesthe reversal of the
impairment loss for the CGU
Impairment
loss reversal on
goodwill is not
permitted
(IAS 36 Allocate the impairment loss reversal to the
para. 124) individual CGU assets on a pro-rata basis
Ceiling
Calculation of the
Would the allocated reversal of the impairment ceiling value: the
loss cause the new carrying amount of any asset’s notional
individual asset to exceed the lower of that asset’s: carrying amount at the
1. recoverable amount, and end of the reporting
2. carrying amount (after depreciation/ period (after
amortisation), had no impairment loss been depreciation/
Yes
initially recognised (‘the ceiling’)? amortisation) as if
there had been no
No Yes impairment loss
Recognise the impairment loss reversal in profit or • Limit the allocation of the impairment reversal
loss for the individual asset for that individual asset to the lower of 1. and 2.
• Allocate the excess that would otherwise have
been allocated to the asset on a pro rata basis
to the other assets of the CGU so that no
individual asset exceeds the ‘ceiling’

Activity 10.1: Accounting for impairment and subsequent reversal for a CGU
FIN fact
IAS 36 specifies a ceiling for an impairment loss reversal for individual assets (para. 117) and
assets within a CGU (para. 123). The reversal cannot result in the individual asset be written
up above a specified value.

Other complications
Interim financial reporting and impairment

Where an entity must prepare an interim financial report, IAS 36 applies to that interim report.
Sometimes, an assessment will be made and an impairment loss will be recognised at the
interim date, yet additional information is available by year end that changes that assessment
and indicates that the loss could be reversed. IFRIC 10 Interim Financial Reporting and Impairment
provides guidance in this situation.
IFRIC 10 was originally written to the old financial instruments standard IAS 39 Financial
Instruments: Recognition and Measurement. It provides clarity on the application of the IAS 36
principles to interim financial reports. IFRIC 10 has now been amended for IFRS 9, as IFRS 9
has its own expected credit loss model (discussed further in Unit 9). Under IFRIC 10, an
entity cannot reverse impairment losses on goodwill recognised in interim reports, even if
circumstances change by the end of the full year reporting period. This is the same treatment
as specified in IAS 36 para. 124, which prohibits the reversal of an impairment loss on goodwill.
Further reading
IAS 36 Illustrative Example 4.
IFRIC 10 paras 3–9.
Existence of a non-controlling interest and the impact on goodwill

impairment
Where a non-controlling interest (NCI) in relation to a parent’s investment in a subsidiary arises
in accordance with IFRS 10 Consolidated Financial Statements (discussed in Unit 16) and the
entity uses the ‘partial goodwill method’ in accordance with IFRS 3 Business Combinations (as
described in Unit 15) to recognise goodwill, the amount of goodwill needs to be grossed up to
include a notional amount of goodwill that is attributable to the NCI when testing the goodwill
for impairment. An example of the calculation of this impairment of goodwill issue is outlined
in Unit 16.
Disclosures
The disclosure requirements of IAS 36 are located in paras 126–137.
Required reading
IAS 36 Illustrative Example 9.
Activity 10.2: Impairment and ethical implications

Quiz

Unit 11: Provisions (including employee
benefit entitlements), contingent liabilities
and contingent assets
Contents
Introduction 11-3
Provisions (other than employee benefits) 11-3
Recognising provisions 11-4
Distinguishing provisions from other liabilities 11-4
Measuring provisions 11-4
Applying recognition and measurement rules 11-5
Decommissioning, restoration and similar liabilities 11-6
Employee benefits 11-7
Recognising and measuring employee benefits 11-7
Contingent liabilities 11-14
Contingent assets 11-15
Disclosures 11-16
fin11911_csg_04


Learning outcomes
Introduction
IAS 37 Provisions, Contingent Liabilities and Contingent Assets prescribes the accounting and
disclosure requirements for provisions and provides guidance on when and how to disclose
contingent liabilities and contingent assets.
Some provisions are not governed by IAS 37, as they fall under other standards. These include
employee benefits, including termination benefits, which are covered by IAS 19 Employee Benefits.
All provisions, however, have one thing in common: they are based on estimates of future cash
flows and, therefore, their measurement and recognition are subject to significant professional
judgement.
As a result, they are susceptible to over-optimism, over-cautiousness or error. Common
problems that may arise with provisions include:
•• Using provisions for profit smoothing (i.e. debiting or crediting a provision, with
a corresponding credit or debit to profit, to achieve the profit outcome desired by
management).
•• Increasing provisions to cover any possible future liability.
•• Creating ‘big bath’ provisions – a term used to describe the practice of recognising certain
expenses immediately (i.e. debit expense, credit provision) and thus making future profits
appear stronger.

Provisions (other than employee benefits)
Learning outcome
A provision is defined as ‘a liability of uncertain timing or amount’ (IAS 37 para. 10). Examples

of typical provisions include provisions for:
•• Warranty costs.
•• Decommissioning and restoration.
•• Restructuring costs.

Recognising provisions
A provision exists and must be recognised when all of the following criteria are met:
(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle
the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision shall be recognised (IAS 37 para. 14).
Critical to the recognition of a provision is the requirement for there to be a present obligation.
A past event that leads to a present obligation is called an obligating event. An obligating event
is an event that creates a legal or constructive obligation, and therefore the entity has no realistic
alternative to settling the obligation created by the event. This is the case only:
•• where the settlement of the obligation can be enforced by law, or
•• in the case of a constructive obligation, where the event (which may be an action of
the entity) creates valid expectations in other parties that the entity will discharge
the obligation.
A constructive obligation arises if past practice creates a valid expectation on the part of a third
party, for example, a retail store that has a long-standing policy of allowing customers to return
goods within a specified period.
The fact that an entity is under a legal obligation to do something in the future does not create a
present obligation. For example, a realistic alternative for an entity may be for it to dispose of an
asset before the legal obligation relating to the asset arises. Examples 6, 11A & 11B in Part C of
the guidance on implementing IAS 37 provides further illustration of this point.
Distinguishing provisions from other liabilities

Provisions can be distinguished from other liabilities (e.g. accruals and trade payables) due to
the uncertainty concerning the timing or amount of the future expenditure required for their
settlement. It is important to correctly determine whether a present obligation is a provision or
a liability, as both measurement and disclosure requirements may differ.
Required reading
Worked example 11.1: Recognising provisions

Measuring provisions
Having determined that a provision should be recognised, the next step is to measure it.
In practice, this can be one of the most difficult and contentious areas of financial reporting for
the entity.
The amount recognised must be the best estimate of the expenditure required to settle present
obligations at the reporting date, taking into account the risks and uncertainties that surround
the events and circumstances affecting the provision. It should reflect the amount that an entity
would rationally be required to pay to settle the obligation at the reporting date, or to transfer to
a third party at that time (IAS 37 paras 36 and 37).
The amount of the provision is estimated using the judgement of management, supplemented
by experience of similar transactions and, in some cases, reports from independent experts.
Events after the reporting date should also be considered (IAS 37 para. 38).

If settlement is expected to occur after more than one year, and the effect of the time value of
money is material, the amount should be discounted using a pre-tax rate specific to the liability.
The discount rate is not adjusted for risks that have already been taken into account in the cash
flow estimates (IAS 37 paras 45–47).
Note that gains from the expected disposal of assets are not included in the measurement of the
provision (IAS 37 para. 51).
At each reporting date, the provision needs to be remeasured and adjusted to reflect the current
best estimate. If the provision is measured using discounted cash flows, the carrying amount of
the provision will increase each year to reflect the passage of time and, hence, the unwinding of
the discount. This increase is recognised as a borrowing cost and treated as an expense (IAS 37
paras 59 and 60).
Worked example 11.2: Measuring provisions

Applying recognition and measurement rules

IAS 37 provides guidance on how to apply the recognition and measurement rules for specific
matters.
Future operating losses

Provisions shall not be recognised for future operating losses as the entity does not have a
present obligation as a result of a past event (IAS 37 para. 63).
Onerous contracts
As per IAS 37 para. 10:
An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it.
An onerous contract meets the three criteria for recognising a provision and, therefore,
a provision should be recognised for the unavoidable costs under the contract. The unavoidable
costs reflect the least net cost of exiting the contract, which is the lower of the cost of fulfilling
it and any compensation or penalties arising from failure to fulfil it (IAS 37 paras 66 and 68).
Restructuring provisions
Restructuring is a program, planned and controlled by management, which materially changes
the scope of a business undertaken by an entity or the manner in which that business is
conducted (IAS 37 para. 10).
As per IAS 37 para. 70, restructuring may occur due to:
•• the sale or termination of a portion of the entity’s business
•• a relocation of business activities from one country or region to another
•• a change in management structure.
A provision for restructuring costs can only be recognised where the three recognition criteria
are met (IAS 37 para. 71).
A constructive obligation to restructure only arises where management has developed a formal
plan for the restructure and has communicated that plan to those affected. The mere intention
of management to carry out such a plan is not enough for a provision to be recognised (IAS 37
para. 72).

A restructuring provision shall only include expenditure that is necessarily entailed by the
restructuring. As per IAS 37 paras 80–83, a restructuring provision does not include any items
which are associated with the ongoing activities of the entity, such as:
•• Retraining or relocating continuing staff.
•• Marketing.
•• Investment in new systems and distribution networks.
•• Identifiable future operating losses up to the date of restructure.
•• Gains on the expected disposal of assets.
Decommissioning, restoration and similar liabilities

IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities contains guidance
on accounting for changes in decommissioning, restoration and similar liabilities that have
previously been recognised both as part of the cost of an item of property, plant and equipment
under IAS 16 Property, Plant and Equipment and as a provision (liability) under IAS 37.
An example would be a liability recognised by the operator of a coal mine for costs it expects
to incur in the future for restoring the site when the mining has been completed. Due to the
typically long interval between the obligation for the liability arising (on creation of the mine)
and the ultimate settlement of the liability (at the end of the mine’s life), there is a large degree
of subjectivity in accounting for such provisions.
IFRIC 1 addresses changes to the amount of the liability subsequent to its initial recognition.
Such changes can arise from the following:
(a) a change in the estimated outflow of resources embodying economic benefits (e.g. cash flow)
required to settle the obligation;
(b) a change in the current market-based discount rate as defined in paragraph 47 of IAS 37 (this
includes changes in the time value of money and the risk specific to the liability), and
(c) an increase that reflects the passage of time (also referred to as the unwinding of the discount).
(IFRIC 1 para. 3)
In relation to item (c) above, IFRIC 1 para. 8 requires the effect of the unwinding of the discount
to be recognised in profit or loss as a finance cost, as it occurs regardless of the model used to
account for property, plant and equipment.
Many entities account for property, plant and equipment using the cost model, whereby an
increase in the provision arising under (a) and (b) above is capitalised as part of the cost of the
related asset and depreciated over the remaining life. A decrease in the provision is deducted
from the cost of the asset but is restricted to the asset’s carrying value; any excess is recognised
immediately in profit or loss.
Where entities account for property, plant and equipment using the revaluation model (fair
value), a change in the liability arising under (a) or (b) above does not affect the valuation of the
item for accounting purposes. The effect of the change in the liability is treated consistently with
the revaluation surplus or deficit previously recognised on that asset, where:
•• An increase in the liability is recognised as an expense in profit or loss, except to the extent
of a revaluation surplus relating to that asset, when it will reduce the revaluation surplus.
•• A decrease in the liability is recognised as an increase in the revaluation surplus relating to
the asset, except to the extent that it reverses a revaluation deficit that has previously been
recognised in profit or loss.
•• A decrease in the liability that exceeds the carrying amount that would have been
recognised had the asset been carried under the cost module, the excess is recognised
immediately as income in profit or loss.
Required reading
IFRIC 1 paras 1–8.

Employee benefits
Employee benefits are defined in IAS 19 para. 8 as:
… all forms of consideration given by an entity in exchange for service rendered by employees or for
the termination of employment.
IAS 19 does not provide a definition of the term ‘employee’; however, it specifies that
employees include ‘directors and other management personnel’ and that an employee may
provide services to an entity on a full-time, part-time, permanent, casual or temporary basis
(para. 7). In practice, it can be difficult to distinguish employees from contractors, and this is
an issue where there are related regulations (e.g. pay-as-you-go (PAYG) withholding tax in
Australia, or pay as you earn (PAYE) obligations in New Zealand).
The following table shows the different types of employee benefits.
Types of employee benefits
Employee benefit Examples
Short-term (IAS 19 para. 9) •• Wages, salaries and social security contributions

•• Paid annual leave and paid sick leave
•• Profit-sharing and bonuses (if payable within 12 months of the
end of the period)
•• Non-monetary benefits (e.g. medical care, housing, cars and free
or subsidised goods or services) for current employees
Other long-term (IAS 19 para. 153) •• Long service leave or sabbatical leave

(Note: these are other than •• Jubilee or other long-service benefits
post‑employment benefits) •• Long-term disability benefits
•• Profit-sharing, bonuses and deferred compensation
Termination benefits (IAS 19 para. 159) •• The entity’s decision to terminate an employee’s employment
before the normal retirement date
•• An employee’s decision to accept voluntary redundancy
Post-employment (IAS 19 para. 26) •• Pensions and other retirement benefits

(outside the scope of this module) •• Post-employment life insurance
•• Post-employment medical care
Employee benefits may be based on a number of sources, including enterprise agreements,

legislative requirements or informal practices giving rise to a constructive obligation to
the employee.
Employee benefits can be provided to either employees and/or their dependants. They may
be settled by payments or the provision of goods or services made directly to the employee,
or to their spouse, children or other dependants, or to others such as insurance companies.
IAS 19 governs the recognition, measurement and disclosure requirements relating to employee
benefits. It applies to all employee benefits except for those within the scope of IFRS 2 Share‑based
Payment. The requirements of IFRS 2 are discussed in the unit on share-based payments.
Recognising and measuring employee benefits

The main requirement of the Standard is that an employer must recognise a liability when
employees have provided services for which benefits will be paid in the future. An expense
is required to be recognised when the entity consumes the economic benefits relating to the
service provided by the employee.

Short-term employee benefits

IAS 19 para. 8 defines ‘short-term employee benefits’ as:
... employee benefits (other than termination benefits) that are expected to be settled wholly before
twelve months after the end of the annual reporting period in which the employees render the
related service.
As these benefits are due within 12 months of the reporting date, they are measured on an
undiscounted (nominal) basis and recognised as both a liability (net of any amount already
paid) and an expense (unless permitted to be recognised in the cost of an asset) (IAS 19
para. 11).
Short-term paid absences

An entity may pay employees for absences for various reasons (e.g. sick leave or jury service)
(IAS 19 para. 14).
Key terms in relation to short-term paid absences are listed below:
•• Accumulating – paid absences that can be carried forward and used in future periods if the
current period’s entitlement is not used in full.
•• Vesting – employees are entitled to a cash payment for unused entitlement on leaving
the entity.
•• Non-vesting – employees are not entitled to a cash payment for unused entitlement on
leaving the entity.
The expected cost of an accumulating paid absence is recognised when the employee performs a
service that increases their right to future paid absences. This rule applies regardless of whether
the entitlement is vesting or non-vesting. However, a non-vesting entitlement is only included
as a liability at reporting date if it is probable the entity will be required to pay the employee for
the entitlement in the future.
The expected cost of a non-accumulating paid absence is recognised when the absences occur
(IAS 19 para.13).
The following decision tree can be applied to determine when a short-term paid absence should
be recognised.
Accumulating benefit
Yes No
Vesting Recognise when

absences occur
Yes No
Recognise when Recognise when employee

employee renders renders service but consider
service probability of employee leaving
before entitlements used
An issue that arises on the measurement of employee benefits relates to the ‘on-costs’ associated
with employment. On-costs can include superannuation or KiwiSaver obligations, payroll tax
and workers’ compensation premiums. The compensated absences should be recognised based
on the expected cost to the entity, which therefore includes the on-costs related to the payment.

Application of recognition and measurement rules for short-term benefits
Employee benefit Recognition and measurement
Annual leave Annual leave is an accumulating absence. Recognition occurs when the employee
renders the service that increases their entitlement to future compensated
absences (IAS 19 para. 13). The benefit is measured at the expected cost of the leave
entitlement (IAS 19 para. 16)
If the entity does not expect an employee to take their leave entitlement within
12 months, then the entity measures the leave entitlement by applying the rules for
long-term liabilities
Sick leave Sick leave is recognised as a liability in two situations:

•• Where the sick leave is accumulating and vesting (i.e. the employee is entitled to
the leave either throughout their employment or when they finish employment),
or
•• Where the sick leave is accumulating and non-vesting and it is anticipated the
employee will take the accrued sick leave in the future
There is an assumption in IAS 19 that an employee uses the most recent sick leave
accrued first, and only uses sick leave accrued from previous years if they need more
sick leave than their current year entitlement. In other words, unused entitlements
give rise to a liability only when it is probable that sick leave taken in the future
will be greater than entitlements that will accrue in the future. When making
this assessment, employees should be considered on a group basis, rather than
considering individual employees. This situation is illustrated in IAS 19 para. 17
Most employees are entitled to accumulating and non-vesting sick leave and
generally do not exceed their sick leave entitlements in any one reporting period.
As a result, sick leave entitlements are generally not recognised as a liability, but
recognised as an expense when taken by the employee
Profit-sharing and bonus A liability is recognised for profit-sharing and bonus plans in accordance with IAS 19
plans para. 19 when:
•• The entity has a present legal or constructive obligation (i.e. established by
past practice) or otherwise has no realistic alternative but to settle the liability
as a result of past events, and
•• A reliable estimate of the obligation can be made
A reliable estimate can be made when at least one of the following conditions
is met (IAS 19 para. 22):
•• There are formal terms in the plan for determining the amount of the benefit
•• The entity determines the amounts to be paid before the financial statements
are signed off
•• Past practice gives clear evidence of the amount of the entity’s obligation
If the profit-sharing and bonus payments are not due wholly within 12 months
after the end of the reporting period, they are accounted for as ‘other long-term
employee benefits’ (IAS 19 para. 24)
Non-monetary benefits IAS 19 is unclear as to how the costs of non-monetary benefits (e.g. interest-free
loans, discounts on products purchased from the employer, or use of motor
vehicles) should be measured. One approach is to measure the expense based on
the net cost to the employer. For example, when a manufacturing company sells
goods to employees at less than cost, an expense should be recognised equal to the
difference between the selling price and the marginal production cost. Given the
lack of guidance, other approaches may be considered by entities accounting for
these non-cash forms of remuneration
Example – Calculating a provision for sick leave

This example illustrates how to measure a provision for sick leave.
Piper Limited (Piper) is a snowboard manufacturing company with 200 employees who are each
entitled to 10 days of sick leave per year. Unused sick leave can be carried forward for one year.
As at 30 June 20X3, the average unused entitlement was three days per employee.

The expectation for the year ended 30 June 20X4 is that 180 employees will take 10 or less
days of sick leave. The remaining 20 employees will take an average of 12 days of sick leave for
the year.
Based on these facts, the liability for sick leave would be calculated as:
•• Zero for the 180 employees who are expected to take 10 or less days per year.
•• 20 × (12 – 10) = 40 days for the 20 employees whose entitlement of two days carried forward
will be used in the year ended 30 June 20X4.
Therefore, a liability that should be recognised at 30 June 20X3 for 40 days, which is the sick
leave in excess of the annual entitlement that employees are expected to utilise in the following
period.
The liability will be measured by reference to the expected cost.
Required reading
IAS 19 paras 8–24 (Definitions of employee benefits only in para. 8).
Other long-term employee benefits

Other long-term employee benefits include items that are not expected to be settled wholly
before 12 months after the end of the reporting period in which the relevant service is rendered.
Generally, other long-term employee benefits should be recognised at the present value (PV)
of the estimated future cash outflows to be made by the employer for services provided by
employees up to the reporting date.
The discount rate used in the PV calculation is the market yield at reporting date on high-
quality corporate bonds. Where there is not a deep market in such bonds, the market yields on
government bonds are used to discount amounts.
Australia
A 2015 research commissioned by the Group of 100 and Actuaries Australia, and conducted by
actuarial firm Milliman Australia (Milliman), concluded that Australia now has a sufficiently
deep market in high quality corporate bonds and so corporate bond rates should be used
to discount long-term employee obligations. To support the report, Milliman will regularly
publish periodic yield curves that will be available for use in valuing employee liabilities.
Further reading
CA ANZ 2015, ‘Employee discount rates and AASB 119’, Accounting and Assurance News Today,
www.charteredaccountants.com.au → News & media → Newsletter → Archive → 05 June 2015.
New Zealand
It is generally agreed that New Zealand does not have a sufficiently active and liquid market
for high-quality corporate bonds, and so the market yield on the appropriate government
bonds is used to discount amounts denominated in New Zealand currency. The bonds must be
consistent with the currency that the liability is to be settled in, and the estimated term of the
liability (IAS 19 para. 83). The Treasury of New Zealand publishes a table of risk-free discount
rates that can be used.
Please note that for the purposes of the FIN module only, candidates will be provided with the
appropriate rates in a given scenario when answering a question.
Long service leave

The most common other long-term employee benefit is long service leave (LSL). The calculation
for LSL is simpler than the calculation of other long-term benefits due to the higher level of
certainty of the service value for the employee.

An example of how to calculate LSL is shown below.
Example – Calculating long service leave liabilities

This example illustrates how to calculate an LSL liability.
The financial controller at Piper Limited (Piper) has been provided with the following information
about an employee, Ms D:
•• Ms D earns $99,000 per year, including her superannuation contributions. She has worked
at Piper for five years and will be entitled to 13 weeks LSL after 15 years.
•• Ms D’s salary is anticipated to increase at 5% per year, including inflation and promotions.
•• Employees in the company usually take their LSL after 17 years’ employment; therefore, Ms D
is expected to be paid her LSL in 12 years, as she has already worked for Piper for five years.
•• The appropriate bonds with a period to maturity of approximately 12 years have a rate of 6%
per year.
•• Employees in the company who have been employed for five years have a 30% probability
of remaining with the company until they are entitled to their LSL.
To calculate the LSL liability for Ms D, a series of four steps should be followed:
Step 1: Calculate the ‘service value’ for Ms D
The service value is the employee’s salary at reporting date plus any employee-related costs
(e.g. superannuation), multiplied by the proportion of LSL entitlement they have accrued
through service provided to the reporting date. Ms D’s service value is:
$99,000 × 5 ÷ 15 × 13 ÷ 52 = $8,250
Note: Dividing by 52 converts the annual salary to a weekly salary.

Step 2: Inflate the service value to the anticipated future cash flow when the LSL is taken
Note: The date that Ms D is entitled to the LSL is not important; it is when she is expected to take
the leave that dictates when the cash flow will take place. Ms D’s anticipated future cash flow,
based on her employment to date, is:
$8,250 × (1.05)12 = $14,816
or
$8,250 × 1.7959 = $14,816
Step 3: Discount the cash flow to present value using the appropriate rate
The discounted cash flow is:
$14,816 ÷ (1.06)12 = $7,364
or
$14,816 ÷ 2.012 (using compound value tables factor) = $7,364
or
$14,816 × 0.497 (using present value tables factor) = $7,364
Step 4: Multiply the cash flow by the probability that Ms D will receive her LSL benefit (i.e. will still be
employed when her LSL becomes payable) to calculate the LSL liability
Ms D’s LSL benefit is therefore:
$7,364 × 30% = $2,209
Note: This can be combined into one equation as follows:

LSL liability = current salary × years of service × entitlement rate × growth in salary factor ×
discount factor × probability:
$99,000 × 5 × (1 ÷ 15 × 13 ÷ 52) × (1.05)12 ÷ (1.06)12 × 0.3 = $2,209

In accordance with IAS 19 para. 156, when recognising an expense to record the LSL obligation,
the total expense must be allocated between:
•• Service cost.
•• Net interest.
•• Remeasurement of the liability.
Service cost comprises:

•• Current service cost, being the increase in the present value of the entitlement earned
during the year.
•• Past service cost being the changes in the present value of entitlements due to a change
in legislation or workplace agreement conditions (e.g. LSL becoming payable at a rate of
13 weeks after 10 years, not 15 years) or a curtailment (a significant reduction by the entity
in the number of employees covered by a plan), and any gain or loss on settlement.
Net interest is the movement in benefit due to the unwinding of discount factors applied to
previous periods (i.e. the previous year’s liability multiplied by the discount rate).
Remeasurement of the liability may include actuarial gains and losses arising from a change
in assumptions in relation to discount rates, retention rates, expected salary increases and the
like. For example, if the probability of an employee receiving their LSL benefit changed from
30% to 25% then part of the movement in the liability would not be due to current service
but to changes in the actuarial assumptions, and would be disclosed as a remeasurement of
the liability.
Required reading
IAS 19 paras 156–171.
Activity 11.1: Calculating employee benefit liabilities

Termination benefits
Another common employee benefit arises when employee services are terminated. This type of
employee benefit differs from those considered previously: it is the termination, rather than the
service by the employee that gives rise to the obligation.
The requirements for recognising and measuring a termination benefit liability are provided in
IAS 19 paras 165–170. IAS 19 is used rather than IAS 37, which deals with other costs incurred
in a restructure.
Recognising termination benefits

To recognise a liability for termination benefits, an entity must be demonstrably committed
to either terminating the employment of employees before their normal retirement date or
providing termination benefits as a result of an offer made to encourage voluntary redundancy.
In accordance with IAS 19 para. 165, a liability and expense for termination benefits should be
recognised at the earlier of the following dates:
(a) when the entity can no longer withdraw the offer of those benefits; and
(b) when the entity recognises costs for a restructuring that is within the scope of IAS 37 and involves
the payment of termination benefits.
Further guidance on the date at which the entity can no longer withdraw the offer of benefits is
provided in IAS 19 paras 166–167.
Measuring termination benefits

Measurement of a termination benefit depends on when the termination will occur. If payment
is expected to be less than 12 months from reporting date, then the liability is calculated based

on the nominal value of benefits in the same way as other short-term benefits. If payment
is expected to be more than 12 months from the reporting date, the liability is calculated by
discounting the estimated cash flows in the same way as other long-term benefits.
Where voluntary redundancies are offered, the measurement of the termination benefits will
also require an estimation of the number of employees expected to accept the offer. However,
where uncertainty exists regarding the number of employees who may accept voluntary
redundancy, a contingent liability may exist, disclosure of which may be required under IAS 37
para. 28 (discussed later in this unit).
Example – Identifying liabilities for redundancy

This example illustrates when and how to recognise a termination benefit.
ClickOnMe Limited (ClickOnMe) recently acquired 100% of StickOnMe Limited (StickOnMe), with
an acquisition date of 15 March 20X3. ClickOnMe has a financial year end of 30 June.
On 15 June 20X3, the chief executive officer (CEO) of ClickOnMe advised that, following the
acquisition, the following redundancies would occur:
•• ClickOnMe: 10 administrative employees from head office, with an average annual salary
of $50,000 and an average of five years’ service. These redundancies were as a result of the
acquisition.
•• StickOnMe: 20 distribution employees from the Hamilton branch, with an average annual
salary of $30,000 and an average of four years’ service. These redundancies were in
accordance with a decision made by the StickOnMe board before the acquisition and would
have occurred even had the acquisition not gone ahead.
The redundancy package for each employee will be four weeks’ pay for each year of service.
The CEO of ClickOnMe expects the redundancies of StickOnMe employees to be completed
by 31 July 20X3.
In addition, 10 employees of StickOnMe were offered voluntary redundancy on the same terms
as the forced redundancies. These employees had an average annual salary of $40,000 and an
average of 10 years’ service. Management was uncertain as to how many of these employees
would accept the offer.
The board of ClickOnMe only decided on 15 June 20X3 that ClickOnMe employees would
be made redundant, and as at 30 June 20X3 had not yet held discussions with employee
representatives or made any public announcement. A public announcement was subsequently
made on 11 July 20X3.
The redundancy liability that should be recognised at 30 June 20X3 is calculated as follows:
(i) StickOnMe
Four weeks pay = $30,000 ÷ 52 × 4 = $2,308 per person per year
Redundancy liability = $2,308 × 4 years service × 20 employees = $184,640
The voluntary redundancies will not be recognised as a liability at 30 June 20X3 because
there is uncertainty as to the number of employees that will accept the offer. A disclosure
as a contingent liability under IAS 37 para. 86 may be required.
(ii) ClickOnMe
There is no redundancy liability that can be recognised.
ClickOnMe was not demonstrably committed to the redundancies of its employees at
30 June 20X3. Under IAS 19, a detailed formal plan needed to exist before the reporting
date for a present obligation to arise for the redundancies. Discussions with employee
representatives had not occurred as at 30 June 20X3 and it is possible that the eventual
number and terms of the redundancies could vary significantly from the original proposal.
As the announcement by directors was made on 11 July 20X3, there is no obligation as at
30 June 20X3.

Contingent liabilities
Learning outcome
A contingent liability is defined in IAS 37 para. 10 as:

(a) 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 control
of the entity; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required
to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.
A contingent liability is not recognised in the financial statements; however, disclosure is

required, unless the possibility of an outflow of benefits is remote (IAS 37 paras 27–28).
The above definition considers three broad circumstances when a contingent liability arises.
The table considers each of these in turn:
Part of contingent liability Explanation Example

definition
Para. 10(a) – possible obligation not There is no present obligation; Where an entity is jointly and
wholly within control of the entity however, a future event may create severally liable for an obligation,
an obligation for the entity such as in a partnership between
two parties shared on a 60:40
basis. The 40% obligation that is
The future event must not be expected to be met by the other
wholly within the control of the partner is an example of a possible
entity obligation to the 60% partner
Para. 10(b)(i) – present obligation There is a present obligation A legal claim against an entity in
arising from a past event where resulting from an earlier event, but which the entity concludes that it is
settlement is not probable the probability of an outflow is 50% liable but it is likely to successfully
or lower defend the case
Para. 10(b)(ii) – present obligation There is a present obligation An entity is being sued and it is
arising from a past event where resulting from an earlier event; unsure whether it will be able to
the amount cannot be reliably however, estimates of the outflow successfully defend the case. If it
measured required to settle the obligation are is unsuccessful, the amount of any
difficult to measure damages are uncertain
(Note that these situations are
considered to be rare)
Unit 15 discusses the importance of the distinction between the sub-categories of contingent
liabilities. Certain contingent liabilities are recognised when performing the accounting for a
business combination.

Example – Contingent liability versus provision

This example illustrates the distinction between a contingent liability and a provision.
A company is undergoing a tax audit. It has received independent advice that there are no issues,
but the local tax authority has expressed concern about some of the deductions the company
has claimed. Given the concerns expressed by the tax authority about the deductions claimed,
a contingent liability should be disclosed as there is a possible obligation that will only be
determined at a later stage in the tax audit.
The mere fact of undergoing a tax audit does not, of itself, mean that there is a contingent
liability or a provision. If the local tax authority has not expressed any specific concerns, the
possibility of an obligation arising is remote; therefore, no disclosure or recognition of a provision
is required.
On the other hand, if the company is undergoing a tax audit and has received independent
advice that there is a problem with some of the deductions claimed by the company, then the
likelihood of the company having to pay additional tax can be assessed as probable. In this
case, a provision should be recognised rather than a contingent liability being disclosed. The
requirements of IAS 37 para. 14 would be satisfied.
Contingent assets
Learning outcome
A contingent asset is defined in IAS 37 para. 10 as:

… a possible asset 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 control of
the entity.
A contingent asset arises where the entity may receive an inflow of economic benefits. As per
IAS 37 paras 31–34, if the inflow is:
•• Virtually certain, then the asset is not contingent and should be recognised, normally
as a receivable.
•• Probable, then a contingent asset is disclosed.
•• Possible, but not probable, then no disclosure is required.
A contingent asset cannot be recognised as an asset in the statement of financial position.

An example of a contingent asset that would require disclosure is a court case brought by
an entity where the chance of a judgement in favour of the entity is uncertain but probable.
Activity 11.2: Provisions, contingent liabilities and contingent assets


Disclosures
The key disclosure requirements of IAS 37 are located in the following paragraphs:
•• Provisions: paras 84, 85, 87 and 88.
•• Contingent liabilities: paras 86, 87, 88 and 91.
•• Contingent assets: paras 89, 90 and 91.
IAS 37 para. 92 provides some relief from compliance with the disclosure requirements where:
... some or all of the information … can be expected to prejudice seriously the position of the entity in a
dispute with other parties on the subject matter of the provision, contingent liability or contingent asset.
Where this exemption is applicable, the general nature of the dispute, together with the fact and
reason why the information has not been disclosed, must be stated in the financial report.
IAS 19 does not require specific disclosures for short or long-term employee benefits or
termination benefits; however, other Standards may require further disclosures.
Quiz
Working paper F
You are now ready to complete working paper F of integrated activity 4, to understand

Unit 12: Leases
Contents
Introduction 12-3
Background of IFRS 16 12-4
IFRS 16 overview 12-5
Scope of IFRS 16 12-6
Navigating IFRS 16 12-6
Identifying a lease 12-7
Understanding the characteristics of a lease 12-7
Does the contract contain a lease? 12-7
Lessee accounting 12-8
Recognition of the lease 12-9
Initial measurement of the lease liability 12-9
Initial measurement of right-of-use asset 12-11
Subsequent measurement 12-12
Other issues for lessees 12-13
Recognition exemptions for certain leases 12-14
Complex issues for lessees 12-15
Presentation and disclosure for lessees 12-16
Lessor accounting 12-16
Classifying a lease as an operating or a finance lease 12-17
Accounting for a finance lease 12-19
Accounting for operating lease 12-20
Presentation and disclosure for lessors 12-21
Sale and leaseback transactions 12-21
Tax effect implications of leases 12-24
fin11912_csg_09


Learning outcomes
1. Discuss the characteristics of a lease.
2. Explain and account for lease transactions (for lessees).
3. Explain and account for lease transactions (for lessors).
4. Explain and account for sale and leaseback transactions.
Introduction
Leasing is a common way for entities to obtain the use of assets without having to purchase the
assets outright. It is therefore an important source of medium- and long-term finance. For the
purposes of the FIN module, this unit will cover the accounting for lease contracts but will not
extend to cover the accounting for subleases and lease modifications.
IFRS 16 Leases prescribes the accounting and disclosure requirements for leases for both lessees
and lessors. IFRS 16 replaces the current treatment of accounting for leases under the existing
Accounting Standard IAS 17 Leases. The application of IFRS 16 to an entity with a 30 June
annual reporting year end is as follows:
IFRS 16 implementation for an entity

with a 30 June annual year end
1 January 2019 1 July 2019 30 June 2020
First year the entity applies

IFRS 16
IFRS 16 applies to annual

reporting periods commencing
on or after 1 January 2019
An entity can adopt IFRS 16 early; however, if it does it must also apply IFRS 15 Revenue from
Contracts with Customers on or before it adopts IFRS 16.

Transitioning to IFRS 16 has major implications for lessees, as it permits a lessee to choose
between two approaches when first applying IFRS 16:
Year ended 30 June 2020

The retrospective lease The modified retrospective

transition approach lease transition approach
1 July 2018 30 June 2019 30 June 2020 1 July 2018 30 June 2019 30 June 2020
30 June 2020 30 June 2020

comparative comparative
Apply IFRS 16 Apply IFRS 16
financial statements financial statements
apply IFRS 16 apply IAS 17
Timing of adjustment to opening retained earnings to transition to IFRS 16
The selected transition approach must be applied consistently to an entity’s leases
The FIN module will not examine the IFRS 16 transition approaches.

Background of IFRS 16
One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet.
Sir David Tweedie, Former Chairman of the IASB, April 2008, accessed 16 April 2018,
www.pwc.com/gx/en/communications/pdf/communications-review-april-2017.pdf
The IFRS 16 project was started as a joint project between the International Accounting
Standards Board (IASB) and the US Financial Accounting Standards Board. It was the boards’
original intention to develop a fully converged Standard; however, ultimately the two boards
chose different models. It took the IASB 10 years to develop and finalise IFRS 16.
The need for a new leasing standard

The key reasons for developing a new leasing standard are explained below:
Reason Explanation
A significant source of finance In 2014 the estimate of ‘off balance sheet’ lease commitments
was not recognised on the approximated US$3 trillion for listed companies reporting under IFRS or US
statement of financial position Generally Accepted Accounting Principles (GAAP)
An analysis by region revealed long-term lease liabilities were understated
by 32% of entities in Asia/Pacific, 26% in Europe and 22% in North America
Source: IFRS Foundation 2016, IFRS 16 Leases – Project Summary and Feedback
Statement, accessed 16 April 2018, www.ifrs.org

Reason Explanation
Lack of comparability in financial The accounting for a lease by lessees under IAS 17 differed between
statements entities and often by industry or region
Compound this difference in accounting treatment with the accounting
treatment that applies when an entity borrows funds to purchase an asset
outright. In that situation, the asset and liability are both recognised on the
statement of financial position. Ultimately, an entity is gaining economic
benefits from the use of an underlying asset. The accounting treatment
should not vary significantly when finance is used to obtain the benefits
from the use of an asset
As a result, market analysts and investors were not able to properly
compare entities that borrow to buy assets with those that lease assets
without having to make adjustments that involve significant estimates
This lack of comparability is in contrast with one of the IFRS Foundation’s
objectives in their mission statement, which states:
IFRS Standards bring transparency by enhancing the international
comparability and quality of financial information, enabling investors and
other market participants to make informed economic decisions
(Source: IFRS Foundation, www.ifrs.org)
IFRS 16 adopts a balance sheet approach, whereas the accounting treatment for a lessee under
IAS 17 was based on categorising the lease either as a finance lease (recognised on balance
sheet) or an operating lease (not recognised on balance sheet). This lease categorisation
required the exercise of significant professional judgement, with varying approaches taken
in practice and resulted in significantly different accounting treatment for the lessee as
explained below:
Category of lease Explanation Lessee accounting treatment
Finance lease A lease that transfers substantially A leased asset and lease liability are
all the risks and rewards of recognised on the statement of financial
ownership position
Interest expense and depreciation of the
leased asset are recognised in profit or loss
Operating lease Any other lease Operating lease expenses are expensed when
incurred over the life of the lease
IFRS 16 overview
IFRS 16 was developed to address the problems of off–balance sheet financing and lack of
comparability in financial statements. The treatment for most leases under IFRS 16 is that the
lessee must now recognise a right-of-use asset and lease liability on the statement of financial
position. The impact of this accounting treatment extends beyond journal entries. Applying this
accounting methodology has implications for an entity in areas such as:
•• Financial ratios and performance metrics (e.g. gearing ratios, return on capital employed,
and earnings before interest, tax, depreciation and amortisation (EBITDA)).
•• Loan covenants, as adverse movements in financial ratios may cause an entity’s loan
covenant to be breached. Loan covenants would need to be renegotiated with lenders to
prevent adverse impacts, such as higher interest rates and the potential for borrowings to be
immediately repaid.
•• Employee incentive (bonus) schemes and share-based payment arrangements, which could
be adversely impacted by reductions in profit.

Interestingly, lessor accounting under IFRS 16 is largely consistent with that under IAS 17, that
is, by accounting for a lease as either an operating or a finance lease.
The focus in this unit is on accounting for new lease transactions under IFRS 16 rather than how
an entity applies the transitional provisions of IFRS 16 for existing leases as it moves from the
IAS 17 accounting requirements.
Required reading
Read IFRS 16 paras 1–4 and 9–21 before proceeding.
Scope of IFRS 16
IFRS 16 applies to most common types of leases; however, there are various exclusions from its
scope, including:
•• Rights held by a lessee under a licensing agreement (e.g. for the use of a patent or copyright
accounted for under IAS 38 Intangible Assets).
•• Licenses for the use of intellectual property granted by a lessor (e.g. use of software, music
and trademarks accounted for under IFRS 15 Revenue from Contracts with Customers).
•• Leases to explore for or use minerals, oil and natural gas.
Navigating IFRS 16
The table below maps the key parts of IFRS 16 that will be covered in this unit. It also outlines
the paragraphs that details lease accounting, which should be read as you progress through
this unit:
Key part of IFRS 16 Paragraphs (required reading)
Definitions Appendix A
Objective and scope Paras 1–4
Recognition exemptions Paras 5–8
Identifying a lease Paras 9–17
Lease term Paras 18–21
Lessee accounting
•• Recognition and measurement Paras 22–46
•• Presentation and disclosure Paras 47–60
Lessor accounting
•• Classification of leases Paras 61–66
•• Finance leases – recognition and measurement Paras 67–80
•• Operating leases – recognition and measurement Paras 81–87
•• Presentation and disclosure Paras 88–97
Sale and leaseback transactions Paras 98–103
Candidates may also find the application guidance in IFRS 16 Appendix B helpful in exploring
the key concepts.

Identifying a lease
Understanding the characteristics of a lease

A lease is defined in IFRS 16 as:
A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period
of time in exchange for consideration
The two parties to a lease are:

•• The lessee – the entity that obtains the right to use an underlying asset for a period of time
in exchange for consideration.
•• The lessor – the entity that provides the right to use an underlying asset for a period of time
in exchange for consideration.
Typically, the lessor has legal title of the asset, and the lease agreement will:
•• assign the right to use an asset for a specified time
•• specify payment amounts and dates
•• specify whether legal ownership will pass to the lessee at the end of the lease
•• specify other contractual obligations, including responsibility for maintenance and
insurance of the asset.
Does the contract contain a lease?

An entity must determine whether a contract is a lease or contains a lease under IFRS 16.
A contract is a lease or contains a lease if the contract conveys the right to control the use of an
identified asset for a period of time in exchange for consideration. The flowchart below illustrates
the points where an entity will need to apply judgement. For each of the decision points in the
flowchart, there are additional explanations and guidance given in IFRS 16 Appendix B.
Is there an identified asset? No
Yes
Does the customer have the right to obtain

substantially all of the economic benefits from use of No
the asset throughout the period of use?
Yes
Does the customer, the supplier, or neither party,

Customer have the right to direct how and for what purpose the Supplier
asset is used throughout the period of use?
Neither
Does the customer have the right to operate

the asset throughout the period of use, without
Yes
the supplier having the right to change those
operating instructions?
No
Did the customer design the asset in a way that

predetermines how and for what purpose the asset No
will be used throughout the period of use?
No
Yes
The contract contains a lease The contract does not contain a lease
Adapted from IFRS 16 Appendix B para. B31.

Example – Identifying a lease

This example illustrates how to identify a lease under IFRS 16.
Aqua Limited is currently planning the set-up of a new administration centre. It has received a
proposal for a five-year rental contract for office space from Lordover Limited and Aqua needs to
determine how the contract would be classified.
Under the terms of the arrangement, Aqua will have exclusive rights to the second and third
floors in an identified office block during the life of the contract. Lordover will be responsible for
any general building maintenance.
The contract contains a lease of office space as:
•• Is there an identified asset – Aqua has the right to use the identified floors for five years, and
this is explicitly identified in the contract.
•• Substantially all of the economic benefits from use over the contract term – Aqua has exclusive
rights to the office space over the contract term.
•• Right to direct how and for what purpose the asset is used – Aqua can decide how and for what
purposes the office space is used during the contract.
Worked example 12.1: Identifying a lease under IFRS 16

Further reading
IFRS 16 Appendix B – Application guidance paras B9–B31.
Lessee accounting
Lessee accounting has changed significantly with the introduction of IFRS 16. This diagram
provides an overview of the key aspects a lessee will consider when accounting for a lease.
Analyse
the lease
contract
Does a
recognition No Recognise the lease on the Apply appropriate
exemption statement of financial position accounting
apply? treatment
Exemption — short-term Prepare
asset lease appropriate
Yes OR presentation
Exemption — low-value and
asset lease disclosures

A lessee entering into a lease contract for the use of an underlying asset will analyse the lease
agreement, which will determine its accounting treatment. The general accounting treatment for
a lessee reflects that, at the start of a lease, the lessee obtains both a right-of-use asset and a lease
liability. Later in this unit, we will consider exemptions from this general accounting treatment.
Required reading
Read the definitions of the following terms from IFRS 16 before proceeding:
• Commencement date of the lease.
• Economic life.
• Fixed payments.
• Inception date of the lease.
• Initial direct costs.
• Interest rate implicit in the lease.
• Lease incentives.
• Lease payments.
• Lease term.
• Lessee’s incremental borrowing rate.
• Residual value guarantee.
• Unguaranteed residual value.
Required reading
Read IFRS 16 paras 22–38 before proceeding.
Recognition of the lease

The lease is initially recognised on the statement of financial position as follows:
Right-of-use asset Lease liability
Initial recognition on the statement of financial position
Initial measurement of the lease liability

To determine the value of the right-of-use asset to initially recognise, the value of the lease
liability must first be calculated. The measurement is performed as follows:
Lease liability – initial measurement at commencement date
Amounts expect- Purchase option Penalties for

Fixed payments Variable lease ed to be payable exercise price termination of
less any lease payments that under residual where lessee lease (but only
incentives are based on value guarantees is reasonably where lease
receivable an index or rate certain to term reflects early
exercise termination)
Discounted at interest rate implicit in the lease

(if not known then use the lessee’s incremental borrowing rate)
Adapted from: Grant Thornton 2016, Major reforms to global lease accounting, accessed 16 April 2018,
www.grantthornton.ie/globalassets/1.-member-firms/ireland/insights/publications/grant-thornton---ifrs-16-leases-
special-edition.pdf.

Example – Identifying the interest rate to apply when measuring the lease liability
This example illustrates how to identify the interest rate that a lessee should apply to determine
the lease liability at the commencement date of the lease.
Re-read the definitions of ‘interest rate implicit in the lease’ and the ‘lessee’s incremental
borrowing rate’ to assist in understanding this scenario.
Boaty-Mac Limited is a lessee that enters into a lease arrangement for a ship from Deep Pockets
Limited.
The lease contract does not specify the interest rate implicit in the lease and Boaty-Mac does not
know the initial direct costs that Deep Pockets incurred in entering into the lease.
Boaty-Mac has to estimate its own incremental borrowing rate and does so by calculating an
interest rate that reflects:
•• the interest rate that would be charged if Boaty-Mac was to borrow over a similar term for an
asset of a similar value to the right-of-use asset embodied in the ship
•• the security it would need to provide to obtain such a borrowing
•• a similar economic environment
Boaty-Mac determines its incremental borrowing rate to be 8% and uses this when calculating
the lease liability at the commencement date and the interest expense on the lease liability.
[In the FIN module the interest rate implicit in the lease and/or the lessee’s incremental
borrowing rate will be stated. You will not have to perform these calculations.]
Example of items to be included in the initial measurement of the lease liability at the
commencement date:
Item Included? Explanation
Yes or No
Monthly lease payments under a three-year lease term Yes This is a fixed payment
Lease payments that will increase in line with increases in Yes This is a variable lease payment
the consumer price index that is based on an index
A fixed final payment that will result in the transfer of the Yes This is a purchase option which
legal ownership of the underlying asset at the end of the the lessee is reasonably certain
lease. The payment is considerably lower than the estimated to exercise
value of the underlying asset at the end of the lease term
and the lessee is intending to make this payment
Reimbursement of agent's commission to be made by the Yes This is a lease incentive receivable
lessor to a lessee relating to a premises under a lease
Substantial penalties to be paid for early termination No The lessee intends to use the
of a lease; however, the lessee intends to complete the underlying asset for the lease
lease term term and therefore termination
penalties would not apply
Legal costs incurred by the lessee for reviewing a No These will be included in the initial
lease contract measurement of the right-of-use
asset but are not included in the
lease liability
Compensation to be paid by a lessee to the lessor if the Yes This is a residual value guarantee
value of the underlying asset is below a specified amount at
the end of the lease†
†
It expects it will pay this compensation based on how it has used similar assets in the past.

Example – Calculating the lease liability at the commencement date

This example illustrates how to calculate the lease liability at the commencement date.
Alpha Limited (Alpha) leases some equipment from Beta Limited (Beta) under an agreement that
meets the definition of a lease under IFRS 16.
Under the terms of the lease, Alpha will make five annual payments of $10,000 commencing on
30 June 20X3.
When the lease expires on 30 June 20X8 Alpha has the option to pay $15,000, which would
result in legal title to the underlying asset being transferred from Beta to Alpha. As at the
commencement date, Alpha does not intend to pay this amount.
The interest rate implicit in the lease is 10%.
Calculation of lease liability at the commencement date
Year Date Payment PV factor PV cash flow

$ $
0 30 June 20X3 10,000 1.0000 10,000
1 30 June 20X4 10,000 0.9091 9,091
2 30 June 20X5 10,000 0.8264 8,264
3 30 June 20X6 10,000 0.7513 7,513
4 30 June 20X7 10,000 0.6830 6,830
5 30 June 20X8* –
Lease liability 41,698
* Note: The $15,000 optional payment is excluded from the lease liability calculation at the commencement
date as Alpha is not reasonably certain to exercise the purchase option.
Unit 12 Present value calculations in the FIN module

Initial measurement of right-of-use asset

The initial measurement of the right-of-use asset at the commencement of the lease can be
shown as follows:
Right-of-use asset – initial measurement at commencement date
Estimated costs
Lease liability to dismantle/ Lease
(amount Prepaid lease Initial
remove/ incentives
initially payments direct costs
restore (link to received
measured) Unit 11)
Adapted from: Grant Thornton 2016, Major reforms to global lease accounting, accessed 16 April 2018,
www.grantthornton.ie/globalassets/1.-member-firms/ireland/insights/publications/grant-thornton---ifrs-16-leases-
special-edition.pdf.

Example – Prepaid lease payment

This example illustrates a prepaid lease payment.
Charlie Limited is a lessee that enters into a lease arrangement for a machine from Delta Limited.
Charlie signs the lease agreement on 13 March 20X8 and pays $10,000 as a lease payment to
Delta. The machine is delivered to Charlie on 13 April 20X8, which is the lease commencement
date. The lease liability is measured at $420,000 on 13 April 20X8.
Charlie’s right of use asset is $430,000, comprising the $420,000 lease liability measured at the
commencement date and the $10,000 prepaid lease payment.
Lease liability
Calculating the lease liability is very similar to amortised cost calculations for financial
instruments (covered in Unit 9):
Lease liability – subsequent measurement
Any reassessment of the lease liability,

Initial Lease lease modifications and revised
measurement Interest payments in-substance fixed lease payments
of lease liability made (practical application of this aspect is
beyond the scope of the FIN module)
Right-of-use asset
The subsequent measurement of the right-of-use asset can be shown as follows:
Right-of-use asset – subsequent measurement
Three options for measurement
1 2 3
Fair value model under IAS 40

Cost model under Revaluation model under IAS 16
Investment Property
IAS 16 Property, Plant (application to leases is beyond
(application to leases is beyond
and Equipment (IAS 16) the scope of the FIN module)
the scope of the FIN module)
Recognise any
impairment losses under IAS 36
Impairment of Assets
Depreciation
Ownership will transfer/ Other situations
purchase option will
be exercised
Depreciate from the Depreciate from the

commencement date to commencement date
end of useful life of the to the earlier of:
underlying asset • the end of the useful life
of the right-of-use asset
• the end of lease term
Worked example 12.2: Accounting for a lease by a lessee


Other issues for lessees

1. Variable lease payments
The treatment of variable lease payments depends on the basis on which the lease payment
varies. The treatment can be summarised as follows:
Variable lease payments (lessee)
Based on an index or rate Based on any other variable In-substance fixed payments
(IFRS 16 paras 27(b) and 28) (IFRS 16 para. 38(b)) (IFRS 16 para. 27(a) and B 42)
• Included in the • Not included in the • Included in the
measurement of the measurement of the measurement of the
lease liability lease liability lease liability because
• The payments are • Recognised in profit or in substance they are
unavoidable as uncertainty loss when the event or unavoidable
relates to the measurement condition that triggers
of the liability rather than that event occurs
to its existence
Note that remeasurement of For example, the lessee has
the lease liability is beyond the choice to either exercise a
the scope of the FIN module purchase option to acquire
the underlying asset or extend
the lease term. The lower of
For example, variable lease For example, variable lease the discounted cash outflows
payments that are based on a payments that are based on a is the in-substance fixed
benchmark market interest percentage of sales revenue, payment as one of the
rate or market rental rate output or asset usage two options will be taken
2. Separation of lease and non-lease components

A contract may contain a lease that includes an agreement to purchase other goods or services
(i.e. non-lease components such as cleaning or maintenance). For these contracts, the non-lease
components are identified and accounted for separately from the lease component.
However IFRS 16 para. 15 permits a lessee to make an accounting policy election, by class of
underlying asset, to account for both components as a single lease component. Lessees that do
not make this election are required to allocate the consideration in the contract to the lease and
non-lease components on a relative standalone price basis.
3. Implications of an option to extend a lease

The definition of ‘lease term’ includes the period of time covered by an option to extend the lease
if the lessee is ‘reasonably certain’ to exercise that option. Reasonable certainty is not defined
in the accounting standards, therefore the lessee will need to exercise professional judgement
when considering their intentions relating to an option to extend the lease term. When there
is reasonable certainty, the lease payments for this extension period will be included in the
measurement of the lease liability, with a corresponding adjustment to the right-of-use asset.

Example – Determining the impact of an option to extend a lease

This example illustrates when an option to extend a lease is included in lease payments.
Scenario 1 – Immediate Limited (Immediate) enters into a lease contract for a retail premises
for a period of five years. The lease contract contains an option to extend the lease for a further
five years. Based on both the costs it incurred to fit out the premises and its business prospects,
Immediate is reasonably certain that it will extend the lease when the option arises.
In this scenario, the present value of the lease payments for the second period of five years will be
included in the calculation of the initial measurement of the lease liability.
Scenario 2 – LaterOn Limited (LaterOn) enters into a lease contract for a retail premises for a
period of seven years. The lease contract contains an option to extend for a further seven years.
At the commencement of the lease, LaterOn is uncertain whether it will extend the lease when
the option arises.
In this scenario, the present value of the lease payments for the second period of seven years will
not be included in the calculation of the initial measurement of the lease liability.
[If, after commencing the lease, LaterOn’s intentions change and there is reasonable certainty of
exercising the option, the lease liability is remeasured with a corresponding adjustment to the
right-of-use asset (IFRS 16 paras 39–43); however these calculations are beyond the scope of the
FIN module.]
Recognition exemptions for certain leases

IFRS 16 permits two optional recognition exemptions: short-term leases and low-value assets.
If the exemption is used, lease payments generally are expensed on a straight-line basis over the
lease term.
Required reading
Short-term lease
The lease has a term of 12 months or less from the commencement date. A purchase option in
the lease agreement excludes the use of this exemption.
This exemption is an accounting policy choice which must be applied for each class of
underlying asset.
Example – Accounting for a short-term lease

This example illustrates how to account for a short-term lease contract.
YoghurtDaze Limited enters into a lease contract with PlentyOfShops Limited for the lease of
a shop for its yoghurt business. The contract contains an option to extend the lease at the end
of the lease period. The shop becomes available after the previous tenant has left the premises.
YoghurtDaze will lease the shop for the summer tourist season.
YoghurtDaze does not intend to exercise the optional extension clause beyond the summer
period as its business drops dramatically once the weather cools down.
YoghurtDaze will expense the lease payments over the three-month summer period.
If YoghurtDaze leases other retail premises, it must elect to use the short-term lease exemption
for all of its retail premises where the lease term is 12 months or less.

Low-value assets
The assessment of whether an asset is low value applies to when the asset was new. According
to the IASB, it was thinking of an asset with a new value of under US$5,000 at the time of
reaching its decisions on this exemption (Basis of Conclusions para. 100). Typically this
exemption applies to items such as computers, phones and office equipment.
This exemption is an accounting policy choice, which can be made on a lease-by-lease basis.
Example – Accounting for a low-value asset

This example illustrates how to account for the lease of a low-value asset.
CallCentre Limited enters into a lease contract with PCsRUS Limited for the lease of 40 computers
for its call centre business. The lease contract contains a purchase option and CallCentre
is reasonably certain it will exercise the option at the end of the three-year lease term. The
computers have an expected useful life of four years. If purchased outright, the cost of each
computer at the lease commencement is $3,000.
CallCentre elects to account for the lease as a low-value asset lease. Accordingly, CallCentre will
expense the lease payments over the three-year lease term. Subsequently, it will account for the
computers under IAS 16 Property, Plant and Equipment if it exercises the purchase option at the
end of the three-year lease term.
Complex issues for lessees

Lease contracts can be very complicated in practice and IFRS 16 establishes the accounting
treatment for various complexities. Accounting for these more complex issues is beyond the
scope of the FIN module; however, a brief overview is provided below to raise awareness of
these issues.
Required reading
Complex issues for lessees Overview
Reassessing the lease liability The lease liability may need to be re-calculated if there is a change, including a
change to the:
•• lease term
•• future lease payments (e.g. changes made based on a market rent review)
•• intention to exercise a purchase option
Lease modifications The modification may need to be accounted for as a separate lease.
For example, when the modification adds the right to use an additional
underlying asset along with the use of the asset specified in the original
lease contract

Presentation and disclosure for lessees

Required reading
The presentation and disclosure requirements of IFRS 16 for lessees are extensive. Key
requirements include:
•• Depreciation and interest expense (interest expense can be disclosed within finance costs).
•• Expense relating to short-term leases.
•• Expense relating to low-value assets.
•• Right-of-use assets (disclosed separately from other assets, either in the statement of
financial position or notes).
•• Lease liabilities (disclosed separately from other liabilities, either in the statement of
financial position or notes).
•• Statement of cash flows disclosures for the principal component of the lease liability, interest
on the lease liability and short-term lease payments, and payments for low-value assets.
Further reading
IASB 2016, IFRS 16 Leases – Effects Analysis, Appendix C Effects on a company’s financial statements:
illustrative examples, accessed 16 April 2018, www.ifrs.org/Current-Projects/IASB-Projects/Leases/
Documents/IFRS_16_effects_analysis.pdf
Lessor accounting
Accounting for a contract that is identified as a lease under IFRS 16 is essentially the same as
that under the existing IAS 17. Leases are classified as either operating leases or finance leases,
in accordance with their substance rather than their legal form.
This diagram provides an overview of the key aspects a lessor will consider when accounting
for a lease.
Classify each lease Apply appropriate accounting Prepare appropriate

as a finance or treatment if classified as a presentation and
operating finance lease disclosures
lease
Apply appropriate accounting
treatment if classified as a
operating lease
Required reading
Read the definitions of the following terms from IFRS 16 before proceeding:
• Fair value.
• Finance lease.
• Gross investment in the lease.
• Net investment in the lease.
• Operating lease.
• Lease term.
• Lessee’s incremental borrowing rate.
Required reading

Classifying a lease as an operating or a finance lease

A lease is classified at its inception by the lessor as either a finance lease or an operating lease:
•• A finance lease ‘transfers substantially all the risks and rewards incidental to ownership
of an underlying asset’ to the lessee (IFRS 16). The legal title of the asset may or may not be
transferred to the lessee by the end of the lease term.
•• An operating lease is a lease other than a finance lease where the lessor retains
‘substantially all the risks and rewards incidental to ownership of the underlying asset’.
The classification of a lease is based on the substance of the transaction rather than the legal
form of the contract. The classification determines its accounting treatment (IFRS 16 para. 63).
When classifying a lease, ask this question:
Where do the risks and rewards incidental to ownership of the underlying asset
substantially reside?
The risks and rewards incidental to ownership of an underlying asset must be considered when
establishing the substance of the lease and therefore its classification, as shown in the table.
Risks and rewards incidental to ownership of an underlying asset (IFRS 16 Appendix B para. B53)
Risks Rewards
Possibility of losses from idle capacity Expectation of profitable operation over the economic
Possibility of losses from technological obsolescence life of the underlying asset
Variations in returns caused by changing economic Expectation of gain from an appreciation in value or
conditions realisation of a residual value
The following table summarises typical situations and indicators to look for when classifying
a lease:
Typical situations and indications when classifying a lease (IFRS 16 para. 63)
Normally leads to finance lease classification May lead to finance lease classification
Examples of situations that individually or in Indicators of situations that individually or in

combination would normally lead to a lease being combination could lead to a lease being classified as a
classified as a finance lease: finance lease:
•• The lease transfers ownership of the asset to the •• If the lessee can cancel the lease, the lessor’s losses
lessee by the end of the lease term associated with the cancellation are borne by the
•• The lessee has the option to purchase the asset lessee
at a price that is expected to be sufficiently lower •• Gains or losses from the fluctuation in the fair value
than the fair value at the date the option becomes of the residual accrue to the lessee (e.g. in the
exercisable for it to be reasonably certain, at the form of a rent rebate equalling most of the sales
inception of the lease, that the option will be proceeds at the end of the lease)
exercised (often called a ‘bargain purchase’ option) •• The lessee has the ability to continue the lease for
•• The lease term is for the major part of the asset’s a secondary period at a rent that is substantially
economic life even if title is not transferred lower than market rent (IFRS 16 para. 64)
•• At the inception of the lease, the present value
of the lease payments amounts to at least
substantially all of the fair value of the leased asset
•• The leased assets are of such a specialised nature
that only the lessee can use them without major
modifications
The above situations and indicators are not always conclusive. If it is clear from other features of
the lease that it does not transfer substantially all the risks and rewards incidental to ownership,
then classify the lease as an operating lease (IFRS 16 para. 65).

The accounting treatment for a lessor under IFRS 16 can be summarised as follows:
Lease classification for a lessor
Finance lease Operating lease

Statement of financial position of lessor Statement of financial position of lessor
• Underlying asset is not recognised • Underlying asset is recognised
• Lease receivable is recognised
Lessor is Recognises:
Lessor is Lease payments effectively • Operating lease
providing represent: renting the asset payments as revenue
finance • Finance income on to the lessee • Depreciates
to the lessee the lease receivable the underlying asset
• Reduction in the
lease receivable
The classification between operating and finance lease does not apply to the lessee. The lessee
will apply the appropriate accounting explained earlier in this unit (e.g. recognise a right-of-use
asset and lease liability, short-term lease accounting, or low-value asset accounting)

Accounting for a finance lease

The following section describes the accounting treatment for a finance lease for a lessor. For the
purposes of the FIN module, we will not consider manufacturer or dealer leases. Instead, the
focus is on a lessor other than a manufacturer or dealer, for example, a finance company.
Initial recognition
The lease receivable recognised by the lessor as an asset at the commencement of the lease is
determined by first calculating the gross investment in the lease. The calculation of the asset to
be recognised in the statement of financial position can be shown as follows:
Gross investment
in the lease
Lease payments
receivable by the
lessor
Discounted
The value of the
using the The net
lease receivable
interest rate investment
recognised in
implicit in the in the lease
the statement
lease
Unguaranteed of financial
residual value position at the
accruing to the commencement
lessor date
The lease receivable

can also be calculated as
The fair value of

the underlying
asset
Any initial direct

costs of
the lessor
Lease payments
receivable by the
lessor
Amounts Purchase option Penalties for

Fixed payments Variable lease expected to be exercise price termination of
less any lease payments that payable under where lessee lease (but only
incentives are based on residual value is reasonably where lease
receivable an index or rate guarantees certain to term reflects early
exercise termination)
Notice how the lease payments receivable by the lessor are equivalent to the lease payments
payable by the lessee covered earlier in the unit.

A lessor will account for lease payments under a finance lease as follows:
Lease payments are split between
Finance income on the lease receivable Reduction in the lease receivable (reduces the
recognised based on a constant periodic rate of principal of the asset balance)
return (using the interest rate implicit in the lease)
The calculations are very similar to those for financial assets categorised and measured
at amortised cost that were covered in Unit 9
Accounting for operating lease

The accounting entries for an operating lease are relatively straightforward. An operating lease
is effectively a rental agreement for an underlying asset. Accounting for an operating lease can
be summarised as follows:
Accounting for an operating lease
• The underlying asset • Initial direct costs incurred • Recognise lease payments
subject to the operating by a lessor are added to the as income
lease is classified by its carrying amount of the • Recognise on a straight-line
nature in the statement of underlying asset basis over the lease term,
financial position • These costs are expensed unless another systematic
• Depreciate the asset over the lease term on basis is more appropriate
consistent with the the same basis as the
depreciation applied to lease income
similar assets of the entity
Example – Accounting for an operating lease

This example illustrates the accounting for operating lease payments.
Deep Pockets has entered into a lease agreement with Regi-Star Limited for a five-year rental
contract for an office building that Deep Pockets owns. The office has a remaining useful life of
15 years.
Deep Pockets classifies the lease as an operating lease as the risks and rewards incidental to
ownership of the office remain with Deep Pockets.
The company receives a $20,000 lease payment for the month of May 20X6 from Regi-Star and
records the following journal entry:
$ $
31.05.X6 Cash 20,000
Operating lease income 20,000
To record the operating lease payment received from Regi-Star for May 20X6
Note that Regi-Star would recognise a right-of-use asset and lease liability in respect of the lease
contract.

Worked example 12.3: Accounting for a lease by a lessor

Presentation and disclosure for lessors

Required reading
The presentation and disclosure requirements of IFRS 16 for lessors are extensive. Key
requirements include:
•• Finance income on the net investment in a lease.
•• A maturity analysis of the lease receivable for finance leases.
•• A maturity analysis of future lease payments to be received for operating leases.
•• Lease income for operating leases.
Sale and leaseback transactions

A sale and leaseback transaction may be used by an entity to unlock cash flow, which an entity
can then use to pursue other business strategies. Previously under IAS 17, sale and leaseback
transactions were also often entered into as a means of improving a company’s ratios (e.g. the
return on assets ratio), particularly when the leaseback part of the transaction for the underlying
asset was kept off the balance sheet as an operating lease.
The accounting under IFRS 16 is significantly different from that in IAS 17. The IFRS 16
accounting treatment depends on whether the transfer of the asset to the lessor qualifies as a
‘sale’ under IFRS 15.
The focus in the FIN module is where the transaction is classified as a sale under IFRS 15,
based on fulfilling the performance obligations (as covered in Unit 3). Determining whether the
transaction constitutes a sale may require significant professional judgement. In practice, it is
anticipated that sale and leaseback transactions will generally not be recognised as a sale under
IFRS 15 as control of the asset will usually remain with the lessee.
Required reading
A sale and leaseback transaction may be depicted as follows:
Sale
– transfer Asset
of ownership
for the Cash
Seller-lessee underlying asset Buyer-lessor
Leaseback
Lease payments – lease contract
Right-of-use for underlying asset

The accounting treatment of sale and leaseback transactions under IFRS 16 can be summarised
as follows:
Sale and leaseback accounting
Transfer of the asset is a sale under IFRS 15 Transfer of the asset is not a sale
Seller-lessee Buyer-lessor Seller-lessee Buyer-lessor

1. The asset is 1. Classifies the lease 1. The asset is not 1. A financial asset
de-recognised as an operating or de-recognised equal to the
2. A lease liability finance lease 2. A financial liability transfer proceeds
is recognised depending on the equal to the is recognised
substance of the transfer proceeds
3. A right-of-use asset transaction
is recognised in is recognised
proportion to the 2. Applies the
asset’s previous relevant accounting
carrying amount requirements to
that relates to the the lease
right of use retained
4. A gain or loss is
recognised to the
extent of the rights
transferred to the
buyer-lessor
Adjustments are required if the sale IFRS 9 accounting requirements are

is not at fair value or where the lease applied by both parties
payments are not at market rates (application to sale and leaseback transactions
(beyond the scope of the FIN module) is beyond the scope of the FIN module)
A challenging aspect of sale and leaseback accounting is determining the values of the right-
of-use asset and the gain or loss to be recognised (items 3 and 4 in the diagram above) for the
seller-lessee where the transfer is a sale.

Example – Determining the values for the initial accounting for the lessee where the
transfer is a sale
This example illustrates how to determine the values of the right-of-use asset and the gain or loss
to be recognised (items 3 and 4 in the preceding diagram) for the seller-lessee where the transfer
is a sale.
Facts
Carrying amount of asset before sale: $1.5 million
Sale consideration (at fair value): $2 million
Lease liability: $1.8 million
Measurement of the right-of-use asset Notional gain on sale

Carrying amount of Lease liability Sale consideration Carrying amount
asset
  
before sale
  × ______________________
   
    
Sale consideration at fair value
at
   fair value  −    

of asset before sale
$1.8 million $2 million − $1.5 million
$1.5 million   $2 million   
× __________
= $500,000
= $1.35 million right-of-use asset
This asset reflects the rights that have been retained by
the seller-lessee
Portion of the gain not recognised Portion of the gain recognised (the balance)
Lease liability Sale consideration
Notional gain ×    
    
______________________
at
   fair value  − lease liability
    
Notional gain × _____________________________
   
 
$1.8 million
  $2 million   
__________
$500,000 ×
$2 million − $1.8 million
___________________
$500,000 ×   
 
$2 million 
  
= $450,000
= $50,000 gain on sale
This portion of the gain cannot be recognised because
it reflects the rights that have been retained by the This portion of the gain is recognised because it reflects
seller-lessee the rights that have been transferred to the buyer-lessee

$ $
xx.xx.xx Cash 2,000,000
Right-of-use asset 1,350,000
Asset 1,500,000
Lease liability 1,800,000
Gain on sale 50,000
(Recording sale of asset, entering into the leaseback transaction and gain recognised in profit or loss)

Tax effect implications of leases

Lease accounting may give rise to tax effect implications under IAS 12 Income Taxes. Based
on a practical interpretation of IAS 12, the carrying amount of a lease can be determined by
calculating the net lease asset or net lease liability and comparing this with the tax base to
establish the value of any temporary difference. This practical interpretation is applied in the
FIN module when calculating temporary differences for leases.
The temporary difference is multiplied by the applicable tax rate to determine the deferred tax
asset (DTA) or deferred tax liability (DTL). Recognition of the DTA or DTL follows the rules
covered in Unit 4.
[Note that in the FIN module, the taxation treatment of a lease will always be stated to enable
any temporary differences to be determined.]
Activity 12.1 provides an opportunity to calculate the deferred tax balance relating to a lease.
Activity 12.1: Accounting for a lease by a lessee and lessor

Quiz
Working paper G
You are now ready to complete working paper G of integrated activity 4, to understand

Unit 13: Earnings per share (EPS)
Contents
Introduction 13-3
Earnings per share 13-3
Importance of EPS 13-3
Scope of IAS 33 13-4
Basic and diluted EPS 13-4
Calculating EPS 13-4
Basic EPS 13-4
Diluted EPS 13-11
EPS for continuing and discontinued operations 13-17
Summary – calculating EPS 13-18
Disclosures 13-20
EPS presentation and disclosure requirements 13-20
Summary – disclosing EPS 13-21
fin11913_csg_03


Learning outcomes
1. Explain the requirements for disclosing earnings per share (EPS) information, including
which entities need to include EPS information.
Introduction
Earnings per share (EPS) is an indicator that measures an entity’s profitability relative to the
number of issued shares of that entity.
As a component of the price/earnings ratio, it is used for business valuation and as an indicator
of whether shares are expensive or cheap. It allows comparisons of relative profitability
between different entities in the same reporting period, and between different reporting periods
for the same entity.
IAS 33 Earnings per Share prescribes the principles for the determination and presentation of
EPS. It recognises that EPS data may have limitations due to the different accounting policies
being applied in the calculation of earnings (i.e. the numerator in the EPS calculation); however,
it focuses on the number of issued shares (i.e. the denominator in the EPS calculation) on the
basis that a consistently determined denominator enhances financial reporting.
In your role as a Chartered Accountant, it is likely you will be required to calculate EPS
and present EPS information as part of preparing financial statements, and/or apply your
understanding of EPS to interpret an entity’s performance.

Earnings per share
Learning outcome
1. Explain the requirements for disclosing earnings per share (EPS) information, including which
entities need to include EPS information.
Importance of EPS
EPS is considered to be one of the most important indicators of profitability and is widely
used in the investment community. One of the reasons for its prominence is that it measures
profitability from an investor’s perspective. EPS is also used to calculate the price/earnings ratio,
a key indicator of both profitability and share price.
While EPS is useful in comparing a company’s profitability between different financial periods,
and to other companies in the same reporting period, it does have some limitations.
EPS does not take into account the capital contribution of ordinary shareholders; that is, the
amount a company receives in issuing the ordinary shares on issue. For example, if Company A
and Company B both earn profits of $1.5 million each and both have one million ordinary
shares outstanding during the financial period, each company would have the same EPS of
$1.50 per share. However, if Company A issued its shares at $1 each and Company B at $0.50

each, then clearly Company B has produced a better return on the capital from ordinary
shareholders.
Scope of IAS 33
IAS 33 applies to the following entities:
•• Entities that have their ordinary shares (or potential ordinary shares) traded in a public market.
•• Entities that file, or are in the process of filing, financial statements with a securities
commission for the purpose of issuing ordinary shares in a public market (IAS 33 para. 2).
Where consolidated and separate financial statements are prepared and presented together, EPS
is only required to be presented for the consolidated information (IAS 33 para. 4).
Any other entities that choose to disclose EPS must apply IAS 33 (IAS 33 para. 3).
Basic and diluted EPS

IAS 33 requires the presentation of two EPS figures with equal prominence:
•• Basic EPS – calculated using the weighted average number of ordinary shares outstanding.
•• Diluted EPS – calculated by including, in addition to the weighted average number
of ordinary shares, the future impact of dilutive potential ordinary shares (e.g. from
convertible notes, warrants and options) where these would result in a lower EPS than the
basic EPS calculated.
Required reading
Calculating EPS
Learning outcome
An ordinary share is defined in IAS 33 para. 5 as ‘an equity instrument that is subordinate to all
other classes of equity instruments’. On this basis, it is the substance of an equity instrument,
not its description that characterises it as an ordinary share for the purposes of the EPS
calculation.
Basic EPS
Basic EPS is calculated by dividing profit (or loss) attributable to ordinary equity holders of the
parent entity (the numerator) by the weighted average number of ordinary shares outstanding
(the denominator) during the period (IAS 33 para. 10), as follows:
Profit or loss attributable to ordinary equity holders of the parent entity

Weighted average number of ordinary shares outstanding during the period
Earnings
The ‘earnings’ used as the numerator in calculating EPS is the profit or loss attributable to the
parent entity.
As the EPS calculation relates to ordinary shareholders, earnings are adjusted for the effects of
any preference shares classified as equity.

Under IAS 33 para. 12, the numerator is determined after adjusting profit or loss attributable
to the parent entity for the following items after tax regarding preference shares classified
as equity:
•• Preference share dividends.
•• Differences arising on the settlement of preference shares.
•• Other effects of preference shares.
Example – Calculating basic EPS with preference shares classified as equity

This example illustrates adjusting earnings for preference shares classified as equity.
Big Limited has a profit after tax of $350,000. It has 1,000,000 ordinary shares and 200,000
non-cumulative preference shares on issue during the financial year. The preference shares are
classified as equity. Big paid a preference share dividend of $24,000.
Ignore any tax effects.
Weighted average number of
Basic earnings ÷ = Basic EPS
ordinary shares
$326,000 ÷ 1,000,000 = $0.33
The profit after tax is adjusted for the preference share dividend, as it would be accounted for as
a dividend in accordance with IAS 32 para. 35.
Preference shares classified as liabilities

In certain circumstances preference shares may be classified as liabilities, as per IAS 32 Financial
Instruments: Presentation. Where this is the case, the dividends and income tax expense would be
included as expenses (IAS 32 para. 35 and IAS 12 Income Taxes para. 58) when determining the
profit for the year, and no adjustment would be necessary.
Example – Calculating basic EPS with preference shares classified as a liability

This example illustrates accounting for preference shares that are classified as a liability.
Large Limited has a profit after tax of $350,000. It has 1,000,000 ordinary shares and 200,000
non-cumulative preference shares on issue during the financial year. The preference shares are
classified as a liability. Large paid a preference share dividend of $24,000.
Weighted average number of
Basic earnings ÷ = Basic EPS
ordinary shares
$350,000 ÷ 1,000,000 = $0.35
There is no adjustment to basic earnings for the preference share dividend as it would be
accounted for as an expense (i.e. it has already been deducted in calculating profit after tax).
Cumulative versus non-cumulative preference shares

Cumulative preference shares are those for which dividends accumulate; that is, if dividends
are not paid in the financial year they are due, the obligation to pay the dividends is carried
forward to later years.
Dividends on cumulative preference shares are deducted from profit used for calculating EPS,
whether the dividend has been declared or not. Correspondingly, the profit is not adjusted for
dividends on cumulative preference shares paid in the current financial period in respect of
previous periods (IAS 33 para. 14(b)).

Preference shares issued at a discount or premium

Where preference shares are issued at a discount or premium, this is considered to be
compensation for below or above-market dividend rates. The discount or premium is amortised
to retained earnings using the effective interest rate method (defined in IFRS 9 Financial
Instruments Appendix A and discussed in the unit on financial instruments), and is treated as a
preference dividend for the purposes of calculating earnings per share (IAS 33 para. 15).
Repurchase of preference shares

Where preference shares are repurchased, the excess of the fair value of the consideration paid
over the carrying amount of the preference shares is charged to retained earnings and should be
deducted in calculating profit or loss attributable to ordinary equity holders of the parent entity
(IAS 33 para. 16).
Convertible preference shares

Convertible preference shares may not be converted at the fair value of the ordinary shares.
This can happen where a company offers an improved conversion rate or cash payment to
induce holders to convert their convertible preference shares early (IAS 33 para. 17).
Where conversion is not at the fair value of the ordinary shares, the difference is deducted in
calculating profit or loss attributable to ordinary equity holders of the parent entity for the
purposes of calculating EPS.
Fair value of ordinary shares Fair value of ordinary shares Loss deducted from profit or
– =
issued at conversion issuable under original terms loss for calculating EPS
Example – Convertible preference shares

This example illustrates accounting for convertible preference shares not converted at fair value.
Small Limited has 100,000 convertible preference shares on issue, convertible in four years time
at two ordinary shares for each convertible preference share held. With the ordinary shares
trading at $2.50 each, Small offers to convert the preference shares early at three ordinary shares
for each convertible preference share held.
If all 100,000 preference shareholders convert their preference shares, the loss will be calculated
as follows:
Expense on conversion of convertible preference shares
Item $
Fair value of ordinary shares at conversion (100,000 × 3 × $2.50) 750,000
Fair value of ordinary shares issuable under original terms (100,000 × 2 × $2.50) (500,000
Loss deducted from profit or loss for the purposes of calculating EPS 250,000
Number of shares
Having discussed the numerator for basic EPS, the denominator is now considered.
An entity might issue or buy back ordinary shares during a financial period, or holders of
convertible instruments may convert those instruments to ordinary shares. For this reason, EPS
is calculated using a weighted average of the number of ordinary shares outstanding during
the financial period to provide a more accurate measure of the profit earned for each share
(IAS 33 para. 19).
The weighted average number of ordinary shares outstanding during the period is the number
of ordinary shares outstanding at the beginning of the period, adjusted by the number of
ordinary shares bought back or issued during the period multiplied by a time-weighting factor
(IAS 33 para. 20).

Time-weighting factor
The time-weighting factor is based on the number of days that the shares are outstanding as a
proportion of the total number of days in the period (usually 365).
Inclusion of new shares

Shares are generally included in the calculation of the weighted average number of ordinary
shares from the date consideration is receivable (IAS 33 para. 21).
Examples of dates for inclusion in the weighted average number of ordinary shares
Circumstances of ordinary share issue Date included for EPS calculation
For cash Date cash is receivable
On voluntary reinvestment of dividends or preference shares Date dividends are reinvested
On the conversion of a debt instrument Date that interest ceases to accrue
In place of interest or principal on other financial instruments Date that interest ceases to accrue
In exchange for the settlement of a liability Settlement date
As consideration for the acquisition of a non-cash asset Date when the acquisition is recognised
For the rendering of services As the services are rendered
The following is an example of how the time-weighting factor is used to calculate the weighted
average ordinary shares outstanding.
Example – Calculating the weighted average number of ordinary shares

This example illustrates accounting for changes in the ordinary shares outstanding.
Bede Limited (Bede) has a 30 June year end. On 1 July 20X1 Bede had 2,000,000 ordinary shares
on issue. On 1 January 20X2 it issued a further 1,000,000 ordinary shares.
The weighted average number of ordinary shares at 30 June 20X2 is calculated as:
Weighted average number of ordinary shares
Details Period Days in Number of Cumulative Weighted average

period shares shares number of
ordinary shares
At beginning of period 01.07.20X1– 184 2,000,000 2,000,000 1,008,2191

31.12.20X1
Ordinary share issue 01.01.20X2– 181 1,000,000 3,000,000 1,487,6711

30.06.20X2
365 2,495,8901
Note
1. 2,000,000 × 184 ÷ 365
The weighted average number of ordinary shares to be used in the EPS calculation is 2,495,890.
Refer to IAS 33 Illustrative examples – Example 2 for another example of calculating the weighted
average number of ordinary shares.
Changes in outstanding shares without a corresponding change in resources

In the example above, the issue of shares during the financial period was assumed to be in
exchange for corresponding resources (i.e. the shares were issued for cash or some other
consideration).

However, certain types of share issues do not result in a corresponding change in resources.
For example:
•• A capitalisation (dividend reinvestment) or bonus issue.
•• A rights issue with a bonus element.
•• A share split.
•• A reverse share split (share consolidation – IAS 33 para. 27).
Impact on the weighted average number of ordinary shares

Under IAS 33 para. 26:
The weighted average number of ordinary shares outstanding during the period and for all periods
presented shall be adjusted for events, other than the conversion of potential ordinary shares, that have
changed the number of ordinary shares, outstanding without a corresponding change in resources.
This means that the weighted average number of ordinary shares would be adjusted for the
bonus element of a share issue that does not result in a corresponding change in resources,
as if those shares had always been on issue. This is done so that EPS is not distorted from period
to period for issues that do not result in additional resources.
Bonus share issue

In a bonus share issue, existing shareholders are issued shares for no consideration in proportion
to their existing shareholding (e.g. one ordinary share for every four ordinary shares held).
The bonus issue does not change the total equity as no consideration is received. IAS 33 para. 28
requires the number of shares outstanding before the bonus issue to be increased, as though
the bonus issue had occurred at the beginning of the earliest period presented. This means that
comparatives are also adjusted as if the bonus shares had always been on issue.
The adjustment factor is calculated by reference to the proportionate change in the number of
ordinary shares outstanding. For example, in a bonus issue where shareholders receive one new
share for every four shares held (one-for-four), the adjustment factor is:
(4 + 1) = 5
4 4 or 1.25
To adjust EPS for the current period, the weighted average number of ordinary shares before
the bonus issue is multiplied by the adjustment factor, thus increasing the weighted average
number of shares on issue. This has the effect of decreasing EPS.
Conversely, to adjust EPS for the prior periods, the EPS previously calculated should be divided
by the adjustment factor. This also has the effect of decreasing EPS.
Example – Bonus issue

This example illustrates accounting for a bonus element.
At 1 July 20X1 Breght Limited had 4,800,000 ordinary shares on issue. On 1 April 20X2 the
company made a bonus issue of one ordinary share for every three ordinary shares held.
The weighted average number of shares outstanding for the year ended 30 June 20X2 is
Weighted average number of shares outstanding for the year ended 30 June 20X2
Details Period Days in Number of Cumulative Bonus Weighted

period shares number of adjustment average
shares factor number of
ordinary
shares
At beginning 4*
01.07.X1–31.03.X2 274 4,800,000 4,800,000 4,804,384
of period 3
Bonus issue 01.04.X2–30.06.X2 91 1,600,000** 6,400,000 1,595,616
365 6,400,000

(1 + 3) = 4
* Bonus adjustment factor = 3 3
= 1
** Bonus issue 4,=
800, 000 # 3 1, 600, 000
Note: The resulting weighted average number of shares outstanding could be derived by simply
adding the original shares on issue to the bonus issue (4,800,000 + 1,600,000), as IAS 33 para. 28
requires the number of ordinary shares before the bonus issue to be adjusted as if the bonus
issue had always existed. However, calculating the adjustment factor is important when taking
into account other changes in ordinary shares during the period.
Refer to IAS 33 Illustrative examples – Example 3 for another example of calculating for bonus
issues.
Worked example 13.1: Calculating basic EPS including a bonus share issue
Rights issues
In a rights issue, the entity offers existing shareholders additional shares in proportion to their
holdings, usually at a discount to the current market value. When offered at a discount to the
current market value, a rights issue has a bonus element.
The shares outstanding immediately before the rights issue are adjusted to reflect this bonus
element as if those shares had always been on issue. This is done as follows:
Rights issue adjustment factor

Where such a bonus element exists, the adjustment factor as shown in IAS 33 Appendix A
para. A2 is applied:
Fair value per share immediately before the exercise of rights

Theoretical ex-rights fair value per share
Theoretical ex-rights fair value per share

The theoretical ex-rights fair value per share (the denominator in the above formula) is
determined as follows:
Fair value of all oustanding shares + Proceeds from the

before the exercise of rights exercise of rights
Number of shares outstanding after the exercise of rights
To adjust EPS for the current period, the weighted average number of ordinary shares before
the rights issue is multiplied by the adjustment factor, increasing the weighted average number
of shares on issue. This has the effect of decreasing EPS.
Conversely, to adjust EPS for prior periods, the EPS previously calculated should be divided by
the adjustment factor. This also has the effect of decreasing EPS.
Example – Rights issue

This example illustrates accounting for a rights issue including a bonus element.
At 1 July 20X1, Grimt Limited had 22,000,000 ordinary shares on issue. On 1 December 20X1
Grimt made a rights issue of one share for every five held, at a price of $1.50 per share. The share
price on 1 December 20X1 was $2.20 per share. All shareholders took up the rights issue.
The formula is used to calculate the theoretical ex-rights fair value per share:
Fair value of all outstanding shares + Proceeds from the
Theoretical ex-rights fair = before the exercise of rights exercise of rights
value per share Number of shares outstanding after the exercise of rights

(22, 000, 000 # 2.20) + (22, 000, 000 ' 5 # $1.50)

=
22, 000, 000 + (22, 000, 000 ' 5)
= $2.08
The theoretical ex-rights fair value per share is then used to calculate the rights issue adjustment
factor:
Fair value per share
Theoretical ex-rights fair
before the exercise of ÷ = Adjustment factor
value per share
rights
$2.20 ÷ $2.08 = 1.06
The weighted average number of shares outstanding for the year ended 30 June 20X2 is
Weighted average number of shares outstanding for the year ended 30 June 20X2
Details Period Days in Number of Cumulative Rights Weighted

period shares number of issue average
shares adjustment number of
factor ordinary
shares
At beginning of 01.07.X1–30.11.X1 153 22,000,000 22,000,000 1.06 9,775,233

period
Rights issue 01.12.X1–30.06.X1 212 4,400,000 26,400,000 15,333,699
365 25,108,932
Refer to IAS 33 Illustrative examples – Example 4 for another example of calculating EPS where
there has been a rights issue.
Worked example 13.2: Calculating basic EPS with a rights issue

Contingently issuable ordinary shares

A company may agree to issue ordinary shares in the future for little or no cash or other
consideration, on the satisfaction of certain conditions. These shares are known as ‘contingently
issuable ordinary shares’ (IAS 33 para. 5).
Contingently issuable ordinary shares are often associated with the acquisition of a business,
where part of the purchase consideration is only transferred where certain targets or conditions
are met.
For the purposes of calculating basic EPS, contingently issuable ordinary shares are only
included from the date all necessary conditions are met (IAS 33 para. 24).
Partly paid ordinary shares

Partly paid ordinary shares are treated as a fraction of an ordinary share to the extent that they
are entitled to participate in dividends during the period (IAS 33 Appendix A para. A15).
Required reading
IAS 33 Appendix A paras A1-A2, A15.
IAS 32 para. 35.
Activity 13.1: Calculating basic EPS


Diluted EPS
Defining diluted EPS
Diluted EPS is a measure of earnings per share taking into account the effects of all dilutive
potential ordinary shares (IAS 33 para. 32). However, before discussing how to calculate diluted
EPS there are some key terms to consider:
Potential ordinary shares

IAS 33 para. 5 defines a potential ordinary share as ‘a financial instrument or other contract that
may entitle its holder to ordinary shares’.
The diluted EPS calculation assumes that an entity’s convertible securities have been converted
to ordinary shares. It therefore presents to investors a ‘worst case scenario’ of the dilutive
impact on shareholders’ earnings of converting such securities.
Common types of convertible securities include:
•• Convertible notes/debt.
•• Convertible preference shares.
•• Share options.
•• Warrants.
Potential ordinary shares are only used in the diluted EPS calculation if they are ‘dilutive’. This
means potential ordinary shares that are ‘anti-dilutive’ are ignored.
Dilutive potential ordinary shares

Under IAS 33 para. 41:
Potential ordinary shares shall be treated as dilutive when, and only when, their conversion to ordinary
shares would decrease EPS or increase loss per share from continuing operations.
This means that a potential ordinary share will be dilutive if:
Change in earnings due to conversion Basic EPS/ (loss per share) from
Increase in number of ordinary shares on conversion 1 continuing operations
Calculating diluted EPS

To calculate diluted EPS, the numerator and denominator in the basic EPS calculation are
adjusted for the impact of converting all dilutive potential ordinary shares:
•• Earnings are adjusted to remove income or expenses related to the potential ordinary
shares.
•• Shares outstanding are adjusted to assume the conversion of dilutive potential ordinary
shares.
When determining whether particular potential ordinary shares are dilutive, each issue is
considered separately. Each type of potential ordinary share is considered in sequence from the
most dilutive (i.e. lowest earning per incremental share) to the least dilutive (i.e. highest earning
per incremental share), as the sequence may affect whether or not the potential ordinary shares
are dilutive. This is considered in more detail below.
Earnings for diluted EPS

Earnings in the diluted EPS calculation are adjusted to remove any income or expenses in the
basic EPS earnings figure that would not exist if the dilutive potential ordinary shares had been
converted to ordinary shares.

Therefore, when calculating diluted EPS (as per IAS 33 para. 33), the earnings is the amount
used in the basic EPS, adjusted for the after-tax effect of the following:
•• Dividends or other items relating to dilutive potential ordinary shares that have been
deducted in arriving at the profit or loss attributable to ordinary equity holders of the
parent entity for the purposes of determining basic EPS.
•• Any interest recognised in the period relating to dilutive potential ordinary shares.
•• Any other changes in income or expenses resulting from the conversion of dilutive potential
ordinary shares.
Examples of other changes in income or expenses include:

•• Transaction costs and discounts accounted for in line with the effective interest method
(IAS 33 para. 34).
•• Flow-on costs arising from changes in profit (e.g. a reduction in interest paid on
convertible debt) will increase profit, which may in turn increase profit-related bonuses
(IAS 33 para. 35).
Weighted average number of ordinary shares – diluted EPS

The weighted average number of ordinary shares for the calculation of diluted EPS reflects the
assumed conversion of all convertible instruments that are assessed as dilutive.
Thus the denominator in the calculation for diluted EPS is the weighted average number of
ordinary shares outstanding during the period (as determined for the basic EPS), plus the
weighted average number of dilutive potential ordinary shares that would be issued on the
conversion of all the dilutive potential ordinary shares into ordinary shares (IAS 33 para. 36).
Rules for adding dilutive potential ordinary shares

As the dilutive potential ordinary shares have not actually converted to ordinary shares, the
number included in the denominator is based on assumptions about the amounts and timing
of conversions.
Therefore, there are some specific rules that govern the calculation:
•• Conversion is deemed to have happened at the beginning of the period or, if later, at the
date of issue of the potential ordinary shares (IAS 33 para. 36).
•• The calculation is performed independently for each financial period; that is, the number
of dilutive potential ordinary shares is recalculated each period (IAS 33 para. 37).
•• Dilutive potential ordinary shares are weighted for the period they are outstanding. They
are included in the diluted EPS calculation only for the portion of the period they are
outstanding; that is, until they lapse, or are cancelled or converted (IAS 33 para. 38).
•• If actual conversion happens during the financial period, the potential ordinary shares
are included in the calculation of diluted EPS from the beginning of the period to the
conversion date, and from the conversion date the resulting ordinary shares are included
in the calculation of both basic and diluted EPS (IAS 33 para. 38).
•• Where the terms of the instruments have more than one conversion rate, the most
advantageous to the holder is used (IAS 33 para. 39).

The diluted EPS implications of a number of common types of potential ordinary shares will
now be considered:
Convertible debt
Convertible debt is a financial instrument that may be settled in cash or redeemed for a
specified number of ordinary shares. The conversion terms often vary depending on a range
of factors, including the timing of conversion and the share price.
Impact of convertible debt on diluted EPS calculation (IAS 33 para. 50)
Item from basic EPS Adjustment
Profit or loss attributable to ordinary equity holders Add back interest charged (net of tax) in respect of the
liability component of the convertible debt
Weighted average number of ordinary shares Increase for effect of conversion

Note: This is the maximum number of ordinary shares
convertible under the agreement
Example – Diluted EPS with convertible debt

This example illustrates calculating the diluted EPS for potentially dilutive convertible debt.
A company has an after-tax profit attributable to the parent entity of $1,500,000. Throughout the
year the company has the following equity instruments on issue:
•• 5,000,000 ordinary shares.
•• $1,000,000 of convertible notes, convertible at $1 of debt for two ordinary shares with an
effective interest rate of 9%. Assume for the purposes of this example that $90,000 is the
annual interest expense on the liability component of the convertible debt.
Calculating basic EPS (rounded to two decimal places)
Basic earnings ÷ Weighted average number of ordinary shares = Basic EPS
$1,500,000 ÷ 5,000,000 = $0.30

Calculating diluted EPS (rounded to two decimal places)
Weighted average number of shares for
Diluted earnings ÷ = Diluted EPS
calculating diluted EPS
7,000,000
$1,590,000 ÷ = $0.23
(5,000,000 + (1,000,000 × 2))
Diluted earnings is basic earnings adjusted by adding the interest on the convertible notes.
The weighted average number of shares used to calculate the diluted EPS is the weighted
average number of ordinary shares adjusted for the impact of the convertible notes.
Note: The convertible notes are ‘dilutive’ because their impact reduces the basic EPS.
Convertible preference shares

Depending on the terms of the convertible preference shares, they may be classified as equity,
a financial liability or have elements of both, in accordance with IAS 32. Therefore, they are
treated similarly to convertible debt in calculating diluted EPS.

Impact of convertible preference shares on diluted EPS calculation (IAS 33 para. 50)
Item from basic EPS Adjustment
Profit or loss attributable Add back dividends

to ordinary equity Note: If the preference shares are classified as equity, the dividend would have been
holders deducted to calculate basic EPS. If the preference shares are classified as liabilities,
the dividend would have been classified as interest and charged in calculating profit
or loss.
Weighted average Increase for effect of conversion

number of ordinary Note: This is the maximum number of ordinary shares convertible under the
shares agreement
Options and warrants

Options, warrants and their equivalents are defined as financial instruments that give the holder
the right to purchase ordinary shares (IAS 33 para. 5).
If the issue price for an option or warrant is less than the market price of the shares the holder
is entitled to acquire, then it is likely that the option or warrant will be exercised at some point
in time (i.e. the options or warrants are ‘in the money’). Therefore, options and warrants are
deemed to be dilutive if the issue price results in ordinary shares being issued at less than the
average market price during the period.
IAS 33 para. 45 states:
For the purpose of calculating diluted earnings per share, an entity shall assume the exercise of dilutive
options and warrants of the entity. The assumed proceeds from these instruments shall be regarded as
having been received from the issue of ordinary shares at the average market price of ordinary shares
during the period. The difference between the number of ordinary shares issued and the number of
ordinary shares that would have been issued at the average market price of ordinary shares during the
period shall be treated as an issue of ordinary shares for no consideration.
Impact of options/warrants on diluted EPS
Options/warrants exercised
Shares issued at average Shares issued at

market price during period no consideration
No impact on diluted Dilutive; therefore, include

EPS calculation in diluted EPS calculation
Determining average market price

Guidance on determining the average market price of ordinary shares is provided in IAS 33
Appendix A paras A4–A5, and an average of weekly or monthly closing price is usually
adequate. However, the method used from period to period should be consistent.

Example – Diluted EPS with options

This example illustrates calculating the impact of options on diluted EPS.
A company has a profit attributable to ordinary shareholders of $1,200,000. The weighted
average number of ordinary shares outstanding for the year was 2,000,000.
The company also has 1,000,000 options outstanding. The options are exercisable at a price of
$7.50 per share. The average market price for ordinary shares during the period was $10.00.
Calculating basic EPS (to two decimal places):
Basic earnings ÷ Weighted average number of ordinary shares = Basic EPS
$1,200,000 ÷ 2,000,000 = $0.60
Calculating diluted EPS:

Conversion of options
Item Calculation Number
Weighted average number of ordinary shares 1,000,000

under option
Proceeds from conversion of options 1,000,000 × $7.50 = $7,500,000
Weighted average number of ordinary shares that $7,500,000 ÷ $10 750,000

would have been issued at average market price
Ordinary shares deemed to be issued for no 250,000

consideration
Weighted average number of shares for

Diluted earnings ÷ = Diluted EPS
calculating diluted EPS
2,250,000
$1,200,000 ÷ = $0.53
(2,000,000 + 250,000)
Note: Options are always dilutive because there is no corresponding impact on the profit.
Share-based payments
Share-based payment arrangements relate to the exchange of goods or services for shares or
options, including employee share options, and are governed by IFRS 2 Share-Based Payments.
This is covered in more detail in Unit 14.
An equity-settled share-based payment (e.g. an option), can be a potential ordinary share which
would need to be included when calculating diluted EPS.
Contingently issuable ordinary shares

Examples of contingently issuable ordinary shares include:
•• Shares that may be issued as part of a business combination (IAS 33 para. 7(c)).
•• Performance-based employee share options (IAS 33 para. 48).
As discussed above, contingently issuable ordinary shares are excluded from the calculation
of basic EPS until all conditions have been met. They are then included from the date the
conditions were met.
However, contingently issuable ordinary shares are included in the calculation of diluted EPS
from the beginning of the period or, if later, from the date of the contingent share agreement.

Where conditions have not been satisfied, the number of contingently issuable shares must
be calculated based on the number of shares that would be issuable if the end of the financial
period were the end of the contingency period (IAS 33 para. 52).
Two examples of circumstances where the issue of shares is dependent on conditions being met
in future periods follow:
•• If the share issue depends on meeting future profit targets, calculate the number of shares
that would be issued if profit at period end has met the required profit (IAS 33 para. 53).
•• If the share issue depends on future share prices, calculate the number of shares that would
be issued if the share price at period end is the contingency price (IAS 33 para. 54).
The examples above assume the contingently issuable ordinary shares are dilutive.
The following diagram summarises the treatment of contingently issuable shares:
Treatment of contingently issuable shares
Are conditions met NO

at period end?
YES
Would conditions be met

YES assuming period end is the end
of the contingency period?
NO
Include in diluted shares

from beginning of period Exclude from diluted shares
(or issue date, if later)
Dealing with multiple convertible instruments

The objective of calculating diluted EPS is to disclose the most dilutive position.
Where a company has several types of potential ordinary shares on issue, careful consideration
of the order in which each instrument is considered is necessary to determine whether it
is dilutive.
Each issue of potential ordinary shares will have a different dilutive effect in dollars/cents per
share. Therefore, the order in which these are considered can affect whether they are dilutive,
and consequently affect the final diluted EPS figure.
To determine the most diluted EPS, the impact of each issue of potential ordinary shares on
the overall EPS calculation is considered in turn, with the most dilutive being considered first
(IAS 33 para. 44).
The term ‘most dilutive’ means the lowest earnings per incremental share, calculated as:
Adjustment to profit or loss as result of issue of shares

Number of shares that would be issued

An example of a calculation dealing with multiple convertible instruments can be found in

IAS 33 Illustrative examples – Example 9.
Required reading
IAS 33 Appendix A paras A3–A9 and A16, Illustrative examples – Example 9.
Activity 13.2: Calculating diluted EPS

EPS for continuing and discontinued operations

Where an entity has a discontinued operation, it needs to calculate both the basic and diluted
EPS amounts for that discontinued operation. This can be presented in either the statement
of profit or loss and other comprehensive income, or in the notes (IAS 33 para. 68).
This means the following EPS amounts will be presented:
•• Basic EPS.
•• Diluted EPS.
•• Basic EPS – continuing operations.
•• Diluted EPS – continuing operations.
•• Basic EPS – discontinued operation.
•• Diluted EPS – discontinued operation.
When results are segmented between continuing and discontinued operations, there may be a
profit in continuing operations and a loss in discontinued operations, or vice versa. In this case,
there will be positive and negative EPS amounts presented (IAS 33 para. 69).

Summary – calculating EPS

Basic EPS (IAS 33 para. 9)
Profit or loss attributable to ordinary Weighted average number of ordinary

equity holders of the parent entity
(basic earnings) ÷ shares outstanding during the period
(IAS 33 para. 19)
(IAS 33 para. 12)
Use profit or loss attributable to the Use the number of shares outstanding at
parent entity for: the beginning of the period adjusted by
• Continuing operations the number of ordinary shares bought
• Discontinued operations back or issued during the period
• Continuing and discontinued (IAS 33 para. 20)
operations
Calculate the time-weighting factor based

Adjust for the impact of preference shares on the number of days the shares are
classified as equity. outstanding as a proportion of the total
Exclude the after-tax impact of: number of days in the period (usually 365)
• Preference share dividends
• Diﬀerences arising on the settlement
of preference shares
• Other eﬀects of preference shares
Adjust for changes in outstanding shares

without a corresponding change in
resources (e.g. a bonus share issue)
(IAS 33 para. 27)

Diluted EPS (IAS 33 para. 30)
Basic earnings adjusted for the effects of Weighted average number of ordinary
all dilutive potential ordinary shares
(IAS 33 para. 31) ÷ shares adjusted for the effects of all
dilutive potential ordinary shares
(IAS 33 para. 31)
Use profit or loss attributable to the Identify potential ordinary shares

parent entity used in the basic EPS
calculation for:
• Continuing operations
• Discontinued operations
• Continuing and discontinued
operations Determine if potential ordinary shares are
dilutive, (i.e. if their conversion would
decrease EPS or increase loss per share)
Adjust for the earnings impact of the

dilutive potential ordinary shares
For example, exclude the after-tax Adjust the number of ordinary shares for
impact of: any dilutive potential ordinary shares
• Interest expense on convertible notes based on assumptions about the amounts
• Dividends on convertible preference and timing of conversions
shares (IAS 33 paras 36−40)
(IAS 33 para. 33)
Worked example 13.3: Calculating basic and diluted EPS for continuing and discontinued
operations

Disclosures
EPS presentation and disclosure requirements

The key presentation and disclosure requirements for EPS are contained in IAS 33
paras 66–73A, and summarised as follows:
Presentation
•• In the statement of profit or loss and other comprehensive income:
–– Basic EPS for continuing operations.
–– Diluted EPS for continuing operations.
–– Basic EPS for profit or loss attributable to the parent entity.
–– Diluted EPS for profit or loss attributable to the parent entity.
•• Basic and diluted EPS are to be given equal prominence.
•• Diluted EPS is to be provided for all periods if it is reported for at least one period, even if it
is the same as basic EPS (IAS 33 para. 67).
•• The statement of profit or loss and other comprehensive income, or the notes must include:
–– Basic EPS for each discontinued operation.
–– Diluted EPS for each discontinued operation (IAS 33 para. 68).
•• The basic and diluted EPS are to be presented even if the amounts are negative (IAS 33
para. 69).
Disclosures
•• Numerators for basic EPS and diluted EPS calculations, together with a reconciliation to
profit or loss attributable to the parent entity (IAS 33 para. 70(a)).
•• The weighted average number of shares used as the denominator in the basic EPS and
diluted EPS calculations, together with a reconciliation to each other (IAS 33 para. 70(b)).
•• Instruments that were not included in the EPS calculations because they are presently
antidilutive, but which could potentially dilute earnings per share in the future (IAS 33
para. 70(c)).
•• A description of ordinary share or potential ordinary share transactions that occurred
after the end of the reporting period that would have significantly changed the number
of outstanding shares (IAS 33 para. 70(d)).

Summary – disclosing EPS

Basic and diluted EPS
Disclosure of basic and diluted EPS is required as follows:
In the statement of profit or loss and other comprehensive income (IAS 33 para. 66)
Earnings per share (includes both continuing and discontinued operations)
Basic EPS xx
Diluted EPS xx
Earnings per share from continuing operations
Basic EPS xx
Diluted EPS xx
Either in the statement of profit or loss and other comprehensive income or notes to the
financial statements for each discontinued operation (IAS 33 para. 68)
From discontinued operations
Basic EPS xx
Diluted EPS xx
Quiz


Unit 14: Share-based payments
Contents
Introduction 14-3
Share-based payments 14-3
Share-based payment transactions 14-3
Identifying SBP transactions 14-3
Accounting for SBP transactions 14-4
Disclosures for SBP transactions 14-15
fin11914_csg_04

Page 14-2 Worked examples – Unit 14

Learning outcome
Introduction
Share-based payments
A share-based payment (SBP) is an arrangement whereby an entity settles a transaction with
shares, share options, or a cash figure linked to the value of shares. Share plans and share option
schemes often form part of employee remuneration packages, and some entities also use such
schemes to pay suppliers for goods and/or services.
An example of such an arrangement is one that existed between the social networking utility
Facebook and David Choe, the American graffiti artist who decorated the walls of Facebook’s
original headquarters in 2005. He was offered a cash payment of US$60,000 for his work but
instead opted to take shares in Facebook. It has been reported that these shares were worth
between US$200 million and US$500 million when Facebook made its initial public offering
(IPO) in May 2012.
Difficulties with accounting for such schemes include valuing the SBP and establishing when
it should be recognised in an entity’s financial statements.
IFRS 2 Share-based Payment provides guidance on the recognition and measurement of SBP
transactions.
An entity shall apply IFRS 2 in accounting for all SBP transactions.

Share-based payment transactions
Learning outcome
Identifying SBP transactions

An SBP arrangement is defined in IFRS 2 Appendix A as an agreement between the entity and
another party that entitles the other party to receive:
(a) cash or other assets of the entity for amounts that are based on the price (or value) of equity
instruments (including shares or share options) of the entity or another group entity, or
(b) equity instruments (including shares or share options) of the entity or another group entity
provided the specified vesting conditions, if any, are met.
An SBP transaction is defined in IFRS 2 Appendix A as a transaction in which the entity:

(a) receives goods or services from the supplier of those goods or services (including an employee)
in a share-based payment arrangement, or
(b) incurs an obligation to settle the transaction with the supplier in a share-based payment
arrangement when another group entity receives those goods or services.

Scope of IFRS 2
IFRS 2 applies in accounting for SBP transactions, including those that are settled by another group
entity on behalf of the entity receiving or acquiring the goods or services (IFRS 2 para. 3A).
IFRS 2 does not apply to transactions:
•• with an employee (or other party) in their capacity as a holder of equity instruments of the
entity (IFRS 2 para. 4)
•• in which the entity acquires goods as part of the net assets acquired in a business
combination, as defined by IFRS 3 Business Combinations, or the contribution of a business
on the formation of a joint venture, as defined by IFRS 11 Joint Arrangements (IFRS 2 para. 5)
•• in which the entity receives or acquires goods or services under a contract within the scope
of IAS 32 Financial Instruments: Presentation or IFRS 9 Financial Instruments (IFRS 2 para. 6).
Other key definitions in IFRS 2

IFRS 2 Appendix A provides other key definitions relevant to SBP transactions of relevance
to the coverage in this unit, including:
•• Cash-settled share-based payment transaction.
•• Equity-settled share-based payment transaction.
•• Fair value.
•• Grant date.
•• Market condition.
•• Measurement date.
•• Performance condition.
•• Service condition.
•• Vest.
•• Vesting conditions.
•• Vesting period.
IFRS 2 uses the term ‘fair value’ differently from the way in which it is defined in IFRS 13 Fair
Value Measurement, and therefore, when accounting for SBP transactions, the measurement
prescribed in IFRS 2 should be used.
Required reading
IFRS 2 (or local equivalent) and Appendix A – Defined terms.
Worked example 14.1: Identifying types of share-based payments

Accounting for SBP transactions

The accounting treatment of an SBP transaction depends on its method of settlement. There are
three methods of settlement for SBP transactions:
1. Equity-settled.
2. Cash-settled.
3. Choice of settlement.
Equity-settled SBP transactions

For the purposes of this unit, an equity-settled SBP transaction is one in which an entity receives
goods or services as consideration for its own equity instruments (IFRS 2 Appendix A).

The pro forma journal entry to record an equity-settled SBP transaction is as follows:

$ $
xx.xx.xx Expense/asset* xx
Equity* xx
Record equity-settled SBP transaction
* Account descriptions should be adapted to suit each specific equity-settled SBP transaction.
The issues associated with recording this journal in the financial statements are:
•• How should the expense or asset be measured?
•• When should the expense or asset be recognised?
For the remainder of this unit it is assumed that an equity-settled SBP is granted to employees
with the debit side of the transaction recognised in profit or loss as an expense.
Measuring equity-settled SBP transactions

The entity shall measure the goods or services received and the corresponding increase
in equity, directly, at the fair value of the goods or services received, unless the fair value cannot
be estimated reliably. Where the fair value cannot be estimated reliably, the goods or services
received and the corresponding increase in equity shall be measured, indirectly, by reference
to the fair value of the equity instruments granted (IFRS 2 para. 10).
The fair value of goods or services received from a supplier can usually be measured reliably.
For SBP transactions with employees, the fair value of the services received cannot usually
be measured reliably, and therefore the transaction is measured by reference to the fair value
of the equity instruments measured at the grant date.
IFRS 2 paras 16–18 provide further guidance on determining the fair value of equity instruments
granted.
Recognising equity-settled SBP transactions

The period in which an equity-settled SBP transaction is recognised depends on whether or not
there are vesting conditions for the equity instruments granted.
If the equity instruments vest immediately (i.e. there are no vesting conditions), the expense and
corresponding increase in equity are recognised at fair value at the grant date (IFRS 2 para. 14).
Where there are vesting conditions in place, the expense and corresponding increase in
equity are recognised over the vesting period (IFRS 2 para. 15), as illustrated by the following
timeline diagram.
Grant date Vesting date
Vesting period
(vesting conditions attached)
Recognise the expense and increase

in equity over the vesting period

Vesting conditions
The diagram below shows the different types of vesting conditions:
Vesting conditions
Service conditions Performance conditions

(required to complete a specified period (complete a specified period of service
of service) and meet specified performance targets)
Market conditions Non-market conditions

(related to the market price of (not related to the market price of
the entity’s equity instruments) the entity’s equity instruments)
Reflected in grant-date Not reflected in grant-date

fair value fair value
IFRS 2, Implementation guidance IG Example 1A, scenarios 1 and 2 provide an example of a

grant of share options with a service condition.
Market conditions relate to the market price of an entity’s equity instruments – for example,
achieving an annual increase in share price over a period of years. Market conditions are taken
into account when estimating the fair value per equity instrument at measurement date (grant
date). The fair value per equity instrument is not revised over the vesting period for a market
condition (IFRS 2 para. 21). This is because the probability of achieving or failing to achieve the
market condition by the end of the vesting period is reflected in the measurement of the fair
value per equity instrument at the grant date.
Over the vesting period, the expense recognised is based on this fair value per equity
instrument at grant date irrespective of whether or not the market condition is satisfied
(e.g. even if the target annual increase in the share price is not achieved); however, if there
is a service period it must be satisfied. Accordingly, over the vesting period at each reporting
date, the entity performs a ‘true up’ or adjustment to reflect revised estimates of the number of
equity instruments expected to vest (e.g. reflecting employee departures).
Example – Grant of share options with a market condition

This example illustrates the application of IFRS 2 para. 21 for transactions with a performance
condition that relates to the market price of an entity’s equity instruments.
On 1 July 20X3 Coco Limited granted 20,000 share options to a senior executive. The share
options are conditional on the executive remaining in the company’s employ until at least 30
June 20X6. Coco’s share price on 1 July 20X3 was $17.50. The share options cannot be exercised
unless Coco’s share price increases to at least $25 by 30 June 20X6. If this market condition is met,
the share options can be exercised at any time between 30 June 20X6 and 30 June 20X9.
Using an option pricing model, the fair value of each share option has been estimated at $3 on
1 July 20X3 and reflects the possibility that the share price target might not be achieved.

Provided the executive satisfies the service condition, the remuneration expense for the three
years and the amounts accumulated in equity would be as follows:
Year end date Calculation Remuneration Equity balance
expense for period
$ $
30.06.X4 20,000 × $3 × 1/3 years 20,000 20,000
30.06.X5 20,000 × $3 × 2/3 years – $20,000 20,000 40,000
30.06.X6 20,000 × $3 × 3/3 years – $40,000 20,000 60,000
The remuneration expense is recognised regardless of whether the market condition (i.e. the
achievement of the share price target) is achieved at 30 June 20X6 (IFRS 2 para. 21).
The journal entry to recognise the remuneration expense for the year ended 30 June 20X4 is:
$ $
30.06.X4 Remuneration expense 20,000
Equity1 20,000
To record the remuneration expense relating to issuing 20,000 share options after one year of the
three‑year vesting period
1. IFRS 2 is not prescriptive on the accounting for the credit to equity in respect of an equity-settled share-based
payment. One common approach in practice is to put the credit to a share-based payment reserve until the award has
been settled and then make a transfer to share capital (although this is not permitted in some countries due to local
legislation), other reserves or retained earnings.
Adapted from: IFRS 2 Implementation guidance IG Example 5.
Non-market conditions (e.g. target earnings per share (EPS)) are not related to the market
price of an entity’s equity instruments. Non-market conditions are not taken into account when
estimating the fair value per equity instrument at measurement date (grant date). The fair value
per equity instrument at grant date is recognised as an expense over the vesting period based
on the best available estimate of the number of equity instruments expected to vest. The number
expected to vest is revised at each period end as necessary (IFRS 2 paras 19–20).
Example – Grant of shares with a non-market condition

This example illustrates the application of IFRS 2 paras 19–20 for transactions with a performance
condition that is not related to the market price of an entity’s equity instruments.
On 1 July 20X3 Coco Limited granted 1,000 shares to each of its 100 employees, conditional on
the employee remaining in the company’s employ until at least 30 June 20X6. The shares have
a fair value of $7.50 at grant date and no dividends are expected to be paid over the three-
year period.
The following vesting conditions are attached to the shares:
•• The shares will vest on 30 June 20X4 if Coco’s earnings have increased by at least 20%.
•• The shares will vest on 30 June 20X5 if Coco’s earnings have increased by at least 16% per
year averaged across the two-year period.
•• The shares will vest on 30 June 20X6 if Coco’s earnings have increased by at least 12% per
year averaged across the three-year period.
20X4
Five employees have left by 30 June 20X4 and Coco’s earnings have increased by 17%. On this
date Coco’s management expects that earnings will increase at a similar rate in the next year,
and that the shares will vest on 30 June 20X5. Management also expects that an additional three
employees will resign during the year ending 30 June 20X5.

The calculation of remuneration expense for the year ended 30 June 20X4 is as follows:
Year Calculation Remuneration Equity balance
expense for period
$ $
30.06.X4 921 employees × 1,000 shares × $7.50 × 345,000 345,000

1/22 years
1. 100 employees – 5 actual departures in 20X4 year – 3 anticipated departures in 20X5 year means that shares are
expected to vest in relation to 92 employees.
2. At 30 June 20X4 management expects that the shares will vest at 30 June 20X5.
20X5
At 30 June 20X5 Coco’s earnings had increased by 13% over the previous year. Four employees
left during the year.
At 30 June 20X5 Coco’s management expects that earnings will increase enough in the next year
so that the shares will vest on 30 June 20X6. Management also expects that an additional two
employees will resign during the year ending 30 June 20X6.
The calculation of remuneration expense for the year ended 30 June 20X5 is as follows:
expense for period
$ $

1/2 years

2/32 years - $345,000
1. 100 employees – 5 actual departures in 20X4 year – 4 actual departures in 20X5 year – 2 anticipated departures in
20X6 year means that shares are expected to vest in relation to 89 employees.
2. The average increase in earnings over the 20X4 and 20X5 years is 15% ((17% + 13%)/2). As this is below the required
minimum of 16% the shares do not vest on 30 June 20X5. Management now expects that the shares will vest on
30 June 20X6.
20X6
Another three employees left during the year ended 30 June 20X6 and Coco’s earnings increased
by 9%.
The average increase in earnings over the 20X4–20X6 years is 13% ((17% + 13% + 9%)/3) and
therefore achieves the required minimum of 12%. Accordingly, the shares vest at 30 June 20X6.
expense for period
$ $

1/2 years

2/3 years – $345,000
30.06.X6 881 employees × 1,000 shares × $7.50 – 215,000 660,000

$445,000
1. 100 employees – 5 actual departures in 20X4 year – 4 actual departures in 20X5 year – 3 actual departures in 20X6
year means that shares vest in relation to 88 employees.
Adapted from: IFRS 2, Implementation guidance IG Example 2.
Cancellation/settlement of equity-settled SBP transactions

If a grant of equity instruments is cancelled or settled during the vesting period, the amount
that would have been recognised in profit or loss over the remaining vesting period is
accelerated and recognised as an expense immediately (IFRS 2 para. 28).

Required reading
IFRS 2 Implementation guidance IG Examples 1A, 2 and 5.
Worked example 14.2: Measuring an equity-settled share-based payment transaction with

a service condition
Cash-settled SBP transactions

A cash-settled SBP transaction is one ‘in which an entity acquires goods or services by incurring
a liability to transfer cash or other assets to the supplier of those goods or services for amounts
that are based on the price (or value) of equity instruments’ (IFRS 2 Appendix A).
As cash will actually be transferred on settlement, a liability must be recorded in the financial
statements.
The pro forma journal entry to record a cash-settled SBP transaction is as follows:

$ $
xx.xx.xx Expense/asset* xx
Liability* xx
Record cash-settled SBP transaction
* Account descriptions should be adapted to suit each specific cash-settled SBP transaction.
Again, the issues associated with recording this journal in the financial statements are:
•• How should the expense or asset be measured?
•• When should the expense or asset be recognised?
Measuring cash-settled SBP transactions

The goods/services acquired and the liability are measured at the fair value of the liability.
The liability is remeasured to fair value at the end of each reporting period and on the date
of settlement. Any changes to fair value are reported in profit or loss (IFRS 2 para. 30).
Recognising cash-settled SBP transactions

If there are conditions attached to the cash-settled SBP – for example, employees must complete
a specified period of service – the expense will be recognised over the vesting period (IFRS 2
para. 32), with the liability remeasured at each reporting date.
Where the cash-settled SBP vests immediately, it is assumed that the goods/services have
already been received, and therefore the expense and liability will be recognised immediately
(IFRS 2 para. 32).
Example – Cash-settled SBP transactions

This example illustrates how to calculate the amounts to be recognised in a cash-settled SBP
transaction.
Spitfire Limited set up a cash-settled SBP scheme for its 30 senior employees on 1 July 20X2.
Each of the senior employees has been offered a cash bonus based on the value of 2,000
shares. To qualify for the bonus, each of the employees must stay in Spitfire’s employment until
30 June 20X5, when the bonus will be paid. The amount paid will be equal to the value of the
2,000 shares at 30 June 20X5.

Relevant details at the end of each of the three years of the vesting period are provided in the
following table:
Spitfire’s cash-settled SBP scheme period end details
Year end date Share price Number of employees who Number of employees
$ have left during the year expected to leave in the
future
30.06.X3 6.50 2 4
30.06.X4 7.25 3 1
30.06.X5 7.50 0 –
The liability is remeasured at each period end until it is settled. The liability is calculated as the
number of employees expected to remain in employment until the bonus is paid multiplied
by the number of shares on which the bonus is based multiplied by the fair value of the shares.
This is spread over the three-year vesting period.
Recognition of cash-settled SBP scheme
Year end date Liability calculation Liability Expense

$ $
30.06.X3 ((30 – 2 – 4) × 2,000 × $6.50) × 1/3 104,000 104,000
30.06.X4 ((30 – 2 – 3 – 1) × 2,000 × $7.25) × 2/3 232,000 128,000
30.06.X5 ((30 – 2 – 3) × 2,000 × $7.50) 375,000 143,000
IFRS 2 Implementation guidance IG Example 12 provides a further example of a cash-settled

SBP transaction.
Required reading
IFRS 2 Implementation guidance IG Example 12.

Summary - SBP transaction measurement - equity-setteled and cash-settled
Share-based payment transaction measurement

SETTLEMENT
TYPE
Equity-settled Cash-settled
(IFRS 2 para. 30)
TRANSACTION
With supplier With employee

(IFRS 2 para. 10) (IFRS 2 para. 11)
At fair value of goods At fair value of equity At fair value

or services received instruments granted* of liability
(measured at date (measured at grant
goods or services date)
received)
MEASUREMENT
If fair value of goods

or services received
cannot be estimated
reliably then use the
fair value of equity
instruments granted*
* Fair value takes account of market conditions
Remeasured to fair
REMEASUREMENT
value at end of each

reporting period
and settlement date
with changes in fair
value recognised in
profit or loss

Summary - SBP transaction recognition - equity-settled and cash-settled
Share-based payment transaction recognition

SETTLEMENT
TYPE OF
Equity-settled Cash-settled
Do vesting Do vesting
conditions exist? conditions exist?
NO YES NO YES
VESTING CONDITIONS
Vest Vesting Vest Vesting

immediately conditions immediately conditions
apply apply
Market Non-market
conditions conditions
Recognise Recognise Recognise Recognise Recognise

immediately over the over the immediately initially and over
RECOGNITION
(IFRS 2 para. 14) vesting period vesting period (IFRS 2 para. 32) vesting period
irrespective of based on best at fair value
whether market estimate of the to recognise the
condition is number of equity services received
satisfied instruments (IFRS 2
(IFRS 2 para. 21) expected to vest paras 32–33)
(IFRS 2 para. 19)
Activity 14.1: Accounting for a cash-settled share-based payment transaction

Transactions with a choice of settlement

An SBP transaction in which there is a choice of settlement means that the transaction can
be settled in cash or by equity instruments issued by an entity, at the choice of either the entity
or counterparty (supplier/employee).
The accounting treatment for these transactions depends on which party has the choice
of settlement.

Where the entity has a choice of settlement

In cases in which the entity has the choice of settlement, the accounting treatment is determined
by whether the entity has an obligation to deliver cash. IFRS 2 provides the following guidance:
•• Treat as a cash-settled SBP transaction if, and to the extent that, the entity has incurred
a liability to settle in cash (IFRS 2 para. 42).
•• Treat as an equity-settled SBP transaction if, and to the extent that, no such liability has been
incurred (IFRS 2 para. 43).
Consideration would be given to factors such as an entity’s stated policy/past practice

in determining whether it has an obligation to deliver cash (IFRS 2 para. 41).
Where the counterparty has a choice of settlement

In substance, in cases in which the counterparty has the choice of settlement, a compound
financial instrument has been granted, which includes a debt component and an equity
component.
The debt component is measured at fair value at the measurement date (grant date). The equity
component is the difference between the fair value of the goods and services received and the
fair value of the debt component (IFRS 2 para. 35).
Example – SBP transaction with choice of settlement

This example illustrates the application of IFRS 2 paras 36–37 for SBP transactions with
employees, where the employee has the choice of settlement.
On 1 July 20X4, Harboard Limited grants an employee the right to elect to receive on 30 June
20X7 either 20,000 shares or a cash payment equal to 18,000 shares, provided that they are still
employed by Harboard at that date.
The share price during the vesting period is as follows:
Relevant share price
Date Share price

$
01.07.X4 3.75
30.06.X5 4.00
30.06.X6 4.10
30.06.X7 4.25
Harboard estimates that the fair value of the share alternative at grant date is $3.60 per share.
At grant date, the fair value of the share alternative is $72,000 ($3.60 × 20,000). The fair value of
the cash alternative is $67,500 ($3.75 × 18,000). Therefore, the fair value of the equity component
of the compound instrument is $4,500 ($72,000 – $67,500).
The equity component is recognised through profit or loss over the three-year vesting period
($4,500 ÷ 3 = $1,500 per annum).
The liability component based on the 18,000 shares is remeasured to fair value at each
period end.

Summary - SBP with a choice of settlement
Share-based payment with a choice of settlement
Choice of settlement
Entity has Counterparty

choice has choice
WHO HAS THE CHOICE?
Does the entity have

an obligation to
deliver cash or other
assets?
(IFRS 2 para. 41)
YES NO
TREATMENT
Treat as Treat as Treat as a compound

cash-settled equity-settled financial instrument
(IFRS 2 para. 42) (IFRS 2 para. 43) (IFRS 2 para. 35)
Group and treasury share transactions

IFRS 2 paras 3A and 43A–43D address how certain types of SBP transactions among group
entities should be accounted for – that is, as equity-settled or as cash-settled transactions – and
the accounting treatment in a subsidiary’s financial statements for SBP transactions involving
the parent’s equity instruments.
Impact of employee share options on earnings per share

Options granted under an SBP transaction need to be considered when calculating diluted
earnings per share (EPS), which is covered in the unit on earnings per share.
For share options and other SBP arrangements that come within the scope of IFRS 2, the issue
and exercise price must be increased by the fair value of goods or services to be provided in the
future under the share option or SBP arrangement (IAS 33 Earnings per Share para. 47A).

The accounting treatment of employee share options depends on the terms of the options, as
detailed in the following table:
Impact of employee share options on EPS
Fixed or determinable terms Performance-based terms
Treat the same as other options – even though they Treat the same as contingently issuable shares
may be contingent on vesting
Include the employee share options in the weighted Include the employee share options in the weighted
average number of ordinary shares outstanding from average number of ordinary shares outstanding from
the date the options were granted the date the options were granted
Include in the calculation of diluted EPS if dilutive Include in the calculation of diluted EPS if dilutive and
if the conditions in the contract would be met if the
period end were the contract period end
Adjust the weighted average number of ordinary Adjust the weighted average number of ordinary
shares outstanding during the period by the number shares outstanding during the period by the number
of actual shares to be issued, less the number of shares of ordinary shares that would be issued for free, if
that would have been issued for the same proceeds at the period end conditions were the contract end
the average market price for the period conditions
Required reading
IFRS 2 Implementation guidance IG Example 13.
Disclosures for SBP transactions

The key disclosure requirements for SBP transactions are detailed in IFRS 2 paras 44–52, and are
designed to enable users of financial statements to understand:
•• The nature and extent of SBP arrangements that existed during the period.
•• How the fair value of the goods or services received, or the fair value of the equity
instruments granted, during the period was determined.
•• The effect of SBP transactions on an entity’s profit or loss for the period and on its financial
position.
Quiz

Page 14-16 Worked examples – Unit 14

Introduction to Units 15–17
(Business combinations, accounting for subsidiaries,
joint arrangements and investments in associates)
Learning outcome
At the end of this introduction you will be able to:
1. Identify the appropriate classification for investments as subsidiaries, associates or joint
arrangements.
Introduction
Investment in another entity can be undertaken for a variety of reasons: to take advantage of
synergies, to diversify, for growth, or to eliminate competition. For example, South African
retailer Woolworths Holdings Limited acquired 100% of the Australian retailer David Jones
Limited in a $2.2 billion takeover. The combined business accelerated the implementation
of Woolworths’ strategies, and the resulting synergies have resulted in significant earnings
growth.
When acquiring 100% of an entity, the position of control is obvious, and the two sets of
accounts are consolidated under IFRS 10 Consolidated Financial Statements. However, in many
situations, determining control, joint control or significant influence requires considerable
professional judgement. These decisions are vital to the financial reports, as decisions about
control lead to different accounting and reporting requirements. Units 15–17 aim to help
candidates navigate situations where such decisions are required, and account for the various
investments.
As a Chartered Accountant working in a business environment that is becoming more global,
you will need to understand how to account for different levels of power an entity has over
another.
Classification of investments
We have previously covered accounting for relatively minor investments in ordinary shares in
Unit 9. This included ‘Fair value through OCI’ financial assets, which are accounted for under
IFRS 9 Financial Instruments.
Units 15–17 will cover the accounting treatment where the investment is more significant,
giving rise to:
•• Control (investment in subsidiaries).
•• Joint control (joint ventures or joint operations).
•• Significant influence (investment in associates).
fin11915-17csg_intro_03
Unit 15 – Core content Page 15-i

It helps to have a clear vision of the flow of concepts covered in the upcoming units. The
thought process to be applied to determine the appropriate accounting treatment based on the
classification of the investment can be represented as follows:
Determine the level of power the investor

has over the investee
Classify
Classify
thethe
investment
I(nvestmentbased
based
on on
thethe
level
level
of power
of power
Accounting
Classify thetreatment
I(nvestment is determined
based on the
by
the classification
level ofofpower
the investment
A simple summary of the accounting method associated with various levels of power is shown
below.
Investment
Accounting for
a financial asset,
IFRS 9
U9
Significant influence
Equity accounting, IAS 28
r
we
po
U17
sed
rea
Joint control
Inc
Joint venture – equity accounting, IAS 28

Joint operation – assets, liabilities, revenue and
expenses, IFRS 11
U17
Control
Consolidation – IFRS 10
U16
The following detailed flow chart sets out the process of classifying investments for financial
reporting purposes and the accounting method to use for each classification. The relevant CSG
units and Accounting Standards are also noted.
More detail on each accounting requirement is given in the relevant unit.
Page 15-ii Introduction to Units 15–17

combina
ess ti
in U15
on
s
Bu
s
Does the investor gain
control in the business
combination?
IFRS 3 Business
for subs
ing id
Combinations
nt U16 YES
ou
iar NO
Acc
Consolidation ies
nts and investments
in accordance
eme
with IFRS 10
g U17
in a
Disclosures per ran sso
IFRS 12 t ar cia
n te
oi Does the investor have joint control?
s
J
IFRS 11 Joint Arrangements instrum

cial e
YES NO an U9
nt
Fin
s
Classify the joint arrangement Does the investor have Account for
in accordance with IFRS 11 significant influence over the NO the investment in
investee? accordance with
IFRS 9
IAS 28 Investments in
JOINT Associates and Joint Ventures Disclosures per
OPERATION IFRS 7
Account for assets, YES
liabilities, revenue
and expenses in JOINT INVESTMENT
accordance with VENTURE IN ASSOCIATE
IFRS 11
Disclosures per
IFRS 12
Equity accounting in
accordance with IAS 28
Disclosures per IFRS 12
Notice how the degree of power is mutually exclusive; for example, there cannot be both control
and significant influence exerted by an investor over another entity.
Introduction to Units 15–17 Page 15-iii

The key terms in the flow chart can be explained as follows:
Key terms in the flow chart
Term Explanation
Associate An entity over which the investor has significant influence
Control An investor controls an investee when the investor is exposed, or has rights, to
variable returns from its involvement with the investee, and has the ability to affect
those returns through its power over the investee
Joint arrangement An arrangement over which two or more parties have joint control
Joint control The contractually agreed sharing of control of an arrangement, which exists only when
decisions about the relevant activities require the unanimous consent of the parties
sharing control
Joint operation A joint arrangement whereby the parties that have joint control of the arrangement
have rights to the assets and obligations for the liabilities relating to the arrangement
Joint venture A joint arrangement whereby the parties that have joint control of the arrangement
have rights to the net assets of the arrangement
Significant influence The power to participate in the financial and operating policy decisions of the
investee. It is not, however, control or joint control of those policies
Subsidiary An entity that is controlled by another entity
As you progress through the last three units of the CSG, please remember to revisit these
diagrams to help you determine the correct accounting treatment.
Page 15-iv Introduction to Units 15–17

Unit 15: Business combinations
Contents
Introduction 15-3
Links to other units 15-3
Identifying a business combination 15-4
What is a business combination? 15-4
Parent controls a subsidiary 15-5
Determining control and accounting for a business combination in the books of the acquirer 15-5
Acquisition method 15-5
Application of IFRS 10 in determining whether control exists 15-6
Definition of control 15-6
Analyse the facts to determine whether control exists 15-7
Explanation of terms in the flow chart 15-9
Acting as principal or agent 15-10
If control under IFRS 10 cannot be determined 15-11
Tax effect implications of business combination adjustments 15-17
Deferred or contingent consideration 15-18
Gain from a bargain purchase 15-22
Accounting subsequent to the initial accounting 15-22
Measurement period adjustments 15-23
Adjustments after the measurement period 15-24
Other accounting issues subsequent to the business combination 15-24
Contingent liabilities 15-24
Contingent consideration 15-25
Summary - acquisition method of accounting for business combinations 15-27
Disclosures 15-28
fin11915_csg_04


Learning outcomes
Introduction
It is common for an entity to obtain control of another business. This transaction is known as
a business combination. IFRS 3 Business Combinations prescribes the accounting and disclosure
requirements for business combinations.
A business combination can be a complex transaction and it is critical that it is accounted for
correctly, as users of a financial report are likely to find this information important. They will be
particularly interested to know the value of the purchase consideration and the amount of any
goodwill paid for the acquired entity.
The focus in this unit is where one entity (the acquirer) obtains control of another entity
(the acquiree) by acquiring all or some of its equity, which results in a parent–subsidiary
relationship. This unit goes through the accounting requirements for a business combination
step by step.

Links to other units

The following diagram identifies the key linkages between this unit and two others in the FIN
module, and the accounting standards relevant to the subjects covered in these units.
Unit 15
• A business combination requires
one entity to control another
• The key focus is on calculating
the goodwill or gain from a bargain
purchase in a business combination
(IFRS 3 Business Combinations)
(IFRS 10 Consolidated Financial
Statements)
Unit 6 Unit 16
Many of the inputs to the business The goodwill or gain from a
combination accounting under IFRS 3 bargain purchase is recognised in the
are required to be measured at fair value consolidated financial statements
(IFRS 13 Fair Value Measurement) (IFRS 10 Consolidated Financial Statements)

Identifying a business combination
Learning outcome
What is a business combination?

A ‘business’ is defined in IFRS 3 Appendix A as:
An integrated set of activities and assets that is capable of being conducted and managed for the
purpose of providing a return in the form of dividends, lower costs or other economic benefits directly
to investors or other owners, members or participants.
This definition is dependent on the three elements that make up a business – input, process and
output. As explained in IFRS 3 Appendix B, input is the economic resource (e.g. assets) to which
a process is applied (e.g. an operational process) to provide output (e.g. a dividend) to benefit
stakeholders.
A ‘business combination’ arises where an ‘acquirer obtains control of one or more businesses’
(IFRS 3 Appendix A). IFRS 3 is applied when accounting for business combinations.
The following are examples of business combinations:
•• One entity purchasing another entity by acquiring its equity.
•• One entity purchasing a business from another entity by acquiring all or some of the net
assets.
•• The merger of two previously unrelated entities.
•• The establishment of a new entity to control previously unrelated entities.
IFRS 3 does not apply to:

•• Transactions that involve the formation of a joint arrangement.
•• The acquisition of an asset or group of assets that do not constitute a business.
•• A combination of entities under common control.
Example – Identifying a business combination

This example illustrates how to identify a business combination.
Mercury Limited acquired all of Neptune’s inventory when Neptune sold its assets as part of its
liquidation. Mercury will make a substantial profit from this inventory, which it will use to acquire
new plant and equipment. These new assets will lower Mercury’s operating costs.
Despite the flow-on benefits of the inventory purchase to Mercury’s business, the inventory
acquisition is not a business combination. This is because acquiring one type of asset does not
represent an acquisition of a business.

Parent controls a subsidiary

A parent–subsidiary relationship arises where one entity (the acquirer) obtains control
of another entity (the acquiree) by acquiring all or some of its equity. An example of such
acquisition is Permira’s acquisition of I-MED Radiology Network Pty Limited for $1.25 billion.
Required reading
IFRS 3 paras 2–3, Appendix A Defined terms and Appendix B Application guidance para. B7.
Further reading
Evans S 2018, ‘I-MED Radiology eyes more acquisitions after 1.25b sale to Permira’, Australian
Financial Review, available at www.afr.com/business/banking-and-finance/private-equity/
imed-radiology-eyes-more-acquisitions-after-125b-sale-to-permira-20180128-h0pf5z, accessed
26 April 2018.
Determining control and accounting for a business

combination in the books of the acquirer
Learning outcomes
Acquisition method
The acquisition method of accounting for business combinations as prescribed by IFRS 3 is
applied to a business combination. This method can be worked through as a series of steps, as
outlined below:
Step 1 – Identify the acquirer (the entity with control)

Identify the Determine Recognise and Measure the Recognise and
acquirer (the the measure at consideration measure the
entity with acquisition acquisition date transferred goodwill or gain
control) date the identifiable from a bargain
assets acquired purchase
and the liabilities
assumed, as well
as any non-
controlling
interest (NCI) in
the acquiree

To identify the acquirer in a business combination, IFRS 3 requires there to be control, which is
determined under IFRS 10 Consolidated Financial Statements (IFRS 10). The linkages between the
two Standards in determining control can be shown as follows:
A business combination is a transaction

or other event in which an acquirer
obtains control of one or more businesses
IFRS 3 requires that a transaction or event
has occurred that relates to a ‘business’
There must be control for there to be a

business combination (determined by
Return to IFRS 3 to account analysing control in IFRS 10)
for the business combination once
control has been determined
IFRS 3 uses the term ‘acquirer’ and

‘acquiree’ (IFRS 10 uses the terms
‘investor’ and ‘investee’)
One of the combining entities

in the business combination must be
identified as the acquirer
The acquirer is the entity

that gains control
Application of IFRS 10 in determining whether control exists

Only one investor can control an investee (IFRS 10 para. 16). In many cases, control will be
obvious; however, in complex situations, determining whether control exists may require
thoroughly analysing the facts and exercising considerable professional judgement.
An investor that holds the majority of voting rights, in the absence of any other factors, controls
the investee (IFRS 10 Appendix B Application guidance para. B6).
Definition of control
IFRS 10 para. 5 states:
An investor, regardless of the nature of its involvement with an entity (the investee), shall determine
whether it is a parent by assessing whether it controls the investee.
In defining ‘control [of an investee]’ IFRS 10 Appendix A states:

An investor controls an investee when the investor is exposed, or has rights, to variable returns from
its involvement with the investee and has the ability to affect those returns through its power over
the investee.
FIN fact
An investor that holds ≥ 50% of voting rights, in the absence of any other factors, controls the
investee.

This definition can be broken down into three key elements (IFRS 10 para. 7), as illustrated in
the diagram below:
Elements of control
An investor controls an investee if and only if the investor has all the following:
Exposure, or rights, to The ability to use its power over

Power over the investee variable returns from its the investee to affect the
(Paras 10–14) involvement with the investee amount of the investor’s returns
(Paras 15 and 16) (Paras 17 and 18)
Control
Analyse the facts to determine whether control exists

In determining whether there is control, the three elements of control can be broken down into
five sub-steps.
Step 1(a) – Identify the investee
STEP 1(a) STEP 1(b) STEP 1(c) STEP 1(d) STEP 1(e)
Identify the Identify the Determine Determine Determine
investee relevant whether the whether the whether the
activities of investor has investor has investor has the
the investee power over exposure, or ability to use its
the investee rights, to variable power over the
returns from investee to affect
the investee its own returns
Typically the investee is a separate entity (and that is our focus in this module).
Step 1(b) – Identify the relevant activities of the investee
Where it is not clear whether control of an investee is held through voting rights, a critical step
is identifying the relevant activities of the investee. Relevant activities are defined in IFRS 10
Appendix A as ‘activities of the investee that significantly affect the investee’s returns’.
Decisions affecting returns include those that relate to key strategic aspects of an investee’s
operations, such as operating, financial and capital policies, and appointing or terminating key
management personnel and determining their remuneration.

Step 1(c) – Determine whether the investor has power over the investee
In practice, this is often the most critical sub-step in determining control.

This sub-step relates to the first element of control, which analyses the power relationship
between an investor and an investee. Power arises from the investor’s existing rights, which
gives it the ability to direct the investee’s relevant activities.
The conceptual flow chart below illustrates how to determine whether an investor has power
over an investee:
Flow chart: How to determine whether an investor has power over an investee
Does the investor have power over the investee?
Determine whether the investor’s rights provide ability to direct relevant activities
Directed by voting rights Directed by contracts
Does the investor own >50% YES YES Does the investor have
of substantive voting rights? power over structured entity?
NO NO
YES
Is there de facto control?
NO
Do substantive potential YES

voting rights give
controlling power?
NO
Power
Do other contractual
agreements, or some
combination of contracts, Unclear Consider factors in
voting rights and potential IFRS 10 paras B18−B20
voting rights provide
controlling power?
NO
No power
Adapted from: PwC (2011), p. 5

Explanation of terms in the flow chart

The table below explains key terms in the flow chart:
Key terms in the flow chart
Term Explanation
Investor rights Different types of rights, either individually or in combination, can give an investor power
to direct the relevant activities, including:
•• Direction by voting rights – both current and potential (e.g. through options held)
•• Direction by other rights (including by contract) – typically arises from contractual
arrangements that may involve a structured entity (outside the scope of this module)
Substantive When assessing power, only substantive rights are considered

voting rights To be substantive, rights need to be exercisable when decisions about the direction
of activities that significantly affect returns need to be made. The holder of these
substantive rights needs to have the practical ability to exercise and benefit from them
Protective rights (often known as veto rights) alone do not give control
De facto control An entity can control another entity with less than a majority of the voting rights. Factors
to consider when determining whether an entity has de facto control include:
•• Size of the holding relative to the size, dispersion and voting pattern of other vote
holders
•• Potential voting rights
•• Other contractual rights
•• Any other facts that may indicate whether the investor has the current ability to
direct the investee’s relevant activities
Example – Identifying power over an investee arising from de facto control

This example illustrates how de facto control may exist.
Jelly Limited holds 47% of the ordinary shares of Trifle Limited. Trifle’s relevant activities are
directed by voting rights conferred by ordinary shares. The remaining 53% of the shares are
owned by thousands of other unrelated investors, none of whom individually own more than
2% of the investee. There are no arrangements for the other shareholders to consult one another
or act collectively. Past experience indicates that few of the other owners actually exercise their
voting rights.
Jelly has power over Trifle due to its de facto control. This is because Jelly’s voting power is
sufficient to provide the practical ability to unilaterally direct Trifle’s relevant activities (IFRS 10
para. B41). A large number of other shareholders would have to act collectively to outvote the
investor. There are no mechanisms in place to facilitate any such collective action.
Step 1(d) – Determine whether the investor has exposure, or rights, to variable returns from the
investee
This sub-step reflects the second element of control, which analyses the variability of returns.
A return may still be considered variable even if it is fixed under a contract – for example, fixed

performance fees for managing an investee’s assets are still considered variable as the investor
is exposed to the investee’s risk of non-performance (IFRS 10 para. B56).
Returns may be positive, negative, or both positive and negative. Examples include dividends
or other distributions, tax benefits, residual interests in the investee’s assets and liabilities,
and an investor’s ability to use the investee’s assets in combination with its own to achieve
economies of scale.
Step 1(e) – Determine whether the investor has the ability to use its power over the investee to
affect its own returns
The link between power over an investee and exposure to variable returns from involvement
with the investee is essential to having control. An investor that has power over an investee,
but cannot benefit from that power, does not control that investee.
Returns are often an indicator of control: the greater an investor’s exposure to the variability
of returns from its involvement with an investee, the greater the incentive for the investor to
obtain rights that give the investor power.
Acting as principal or agent

Step 1(e) centres on whether the investor with decision-making rights is acting as a principal
or an agent (IFRS 10 para. 18). The principal-agent relationship is an arrangement in which one
entity appoints another to act on its behalf, for example, when an agent acts on behalf of the
principal. Accordingly, power resides with the principal and not with its agent, as shown in the
diagram below:
Use of the Use of the

power to delegated
generate power for the
returns for benefit of
itself others
Principal Agent
(can control) (cannot control)
Decision-maker
The investor (decision-maker)
has the ability to use
its power to affect the amount
of its returns
To determine whether a decision-maker is acting as principal or agent, the following factors

should be considered:
•• The scope of decision-making authority.
•• Any rights held by other parties (e.g. removal/kick-out rights).

•• The remuneration to which the decision-maker is entitled.

•• The exposure of the decision-maker to the variability of returns from other interests it holds
in the investee.
If a single party holds kick-out rights that can remove a decision-maker without cause, then the
decision-maker is acting as an agent and not a principal (IFRS 10 para. B65).
Example – Determining whether the investor acts as principal or agent

This example illustrates how an investor uses its power as an agent.
Sable Fund Managers (Sable) establishes, markets and provides ongoing management to the
Azure Investment Fund (Azure). The fund provides investment opportunities to many investors.
Sable has a 3% ownership interest in Azure. Azure’s governing agreement requires Sable to make
decisions that are in the best interests of the investors; however, it has broad decision-making
discretion.
Sable receives a market-based fee equal to 2% of the fund’s assets under management plus 10%
of the fund’s profits if a specified profit is achieved.
The investors can remove Sable by a simple majority vote if Sable breaches its contract.
Sable acts as agent and therefore does not control Azure because:
•• Its remuneration is at market rates.
•• Although its minor investment holding does create an exposure to variability of returns,
it is insufficient to indicate that Sable is acting as principal.
The kick-out rights held by the other investors are protective rights which cannot provide them
with control over Azure.
Adapted from: IFRS 10 Application example 14A.
If control under IFRS 10 cannot be determined

In the unlikely event that IFRS 10 does not clearly indicate which of the combining entities in a
business combination is the acquirer, the guidance in IFRS 3 Appendix B paras B14–B18 should
be applied, as it considers other factors, such as the relative size of the combining entities
(which usually indicates that the acquirer is the larger entity).
Required reading
IFRS 10 paras 5–18, Appendix A Defined terms, Appendix B Application guidance paras B5–B28,
B34–B50, B55–B61 and B64–B67.
IFRS 3 paras 4–7; Appendix B Application guidance paras B13–B18.

Example – Identifying the acquirer in a business combination

This example illustrates how to identify the acquirer in a business combination.
JUPITER
100%
ordinary shares
PLUTO
100%
preference shares
SATURN
Jupiter Limited (Jupiter) purchased 100% of the ordinary share capital of Saturn Limited
(Saturn) from Pluto Limited (Pluto) and replaced Pluto’s directors with its own. Saturn operates a
profitable transport business that complements Jupiter’s medical equipment business, achieving
cost savings for Jupiter.
Pluto retains its preference shares in Saturn. These preference shares, which are all owned by
Pluto, give it the right to a fixed dividend each year before any dividends can be declared on
Jupiter’s ordinary shares. The preference shares do not have voting rights except on matters that
directly affect their rights.
Applying the five sub-steps to determine whether there is control:
1. Saturn is the investee.
2. The relevant activities are those involved in Saturn’s transport business.
3. Jupiter has power over Saturn because it controls all of the substantive voting rights in the
investee. The voting rights on the preference shares held by Pluto are not substantive as their
voting rights cannot direct the relevant activities of Saturn.
4. Jupiter is exposed to variable returns from Saturn, such as dividends on the ordinary shares.
5. Jupiter, acting as the principal, can use its power to direct Saturn, which will affect its own
returns.
Therefore, Jupiter is the acquirer in the business combination because it controls Saturn.
Worked example 15.1: Determining whether an investor has control

Having determined that an acquirer has gained control in a business combination, the
remainder of the acquisition method under IFRS 3 is applied.

Step 2 – Determine the acquisition date

and the liabilities
assumed, as well
as any non-
controlling
interest (NCI) in
the acquiree
The determination of the acquisition date is important as it impacts the amount of goodwill or gain
from a bargain purchase. To correctly calculate the amount of goodwill or gain from a bargain
purchase, the items listed below must be recognised and measured at the acquisition date:
•• Consideration transferred.
•• Identifiable assets acquired and liabilities assumed.
•• Any NCI.
•• Any previously held equity interest owned by the acquirer in the acquiree (for a business
combination that is achieved in stages).
The acquisition date is the date the acquirer gains control of the acquiree. This is generally when
the consideration is legally transferred in return for acquiring the assets and assuming any
liabilities of the acquiree.
Example – Determining the acquisition date

This example illustrates how to identify the acquisition date in a business combination.
On 15 February 20X5, Bombe Limited signed an agreement to purchase 100% of Alaska Limited.
The consideration consists of a cash payment of $5 million to Alaska and the issue of 100,000
Bombe shares to former shareholders of Alaska.
The purchase agreement specifies that the acquisition date is 1 May 20X5. However, with effect
from 15 February 20X5, Bombe can remove any of Alaska’s directors and appoint directors of
its choice. On 1 April 20X5 Bombe removes all of the existing directors of Alaska and appoints
directors of its choice. On 1 May 20X5 Bombe receives ownership of all of the shares in Alaska,
pays the cash consideration and issues the shares.
The fair value of Bombe’s shares at the various dates are as follows:
Fair value of Bombe’s shares
Date Fair value per share
15 February 20X5 $5.20
1 April 20X5 $5.25
1 May 20X5 $5.30
The acquisition date is 15 February 20X5 – the date on which Bombe first obtained the power to
govern Alaska’s financial and operating policies through its ability to remove and appoint all of
the members of Alaska’s board. Accordingly, Bombe’s journal entry to record the 100,000 share
issue on 1 May 20X5 will value the shares at the acquisition date fair value of $5.20 per share.
Adapted from: IFRS Foundation: Training Material for the IFRS® for SMEs (version 2013-05)
Required reading
IFRS 3 paras 8–10 and 18.

Step 3 – Recognise and measure at acquisition date the identifiable assets acquired and the
liabilities assumed, as well as any NCI in the acquiree

and the liabilities
assumed, as well
as any non-
controlling
interest (NCI) in
the acquiree
IFRS 3 sets out the recognition and measurement principles relating to the acquiree’s
identifiable assets acquired, liabilities assumed and any NCI in a business combination.
Keep in mind that the acquisition method results in recognising a value for goodwill. It is only
when there is a business combination that goodwill can be recognised as an asset, as IAS 38
Intangible Assets prohibits the recognition of internally generated goodwill (covered in Unit 8).
Goodwill is defined in IFRS 3 Appendix A as:
An asset representing the future economic benefits arising from other assets acquired in a business
combination that are not individually identified and separately recognised.
Therefore, a business combination is a rare opportunity for an entity to recognise goodwill

as an asset. Goodwill is effectively a ‘residual asset’ once all other individually identified and
separately recognised assets are recorded. Consequently, IFRS 3 is getting the acquirer to
‘freshen up’ the values of the acquiree’s net assets before any goodwill can be calculated and
recognised for the business combination.
The IFRS 3 recognition and measurement principles include a number of exemptions and
variations to the general recognition and measurement principles contained in The Conceptual
Framework for Financial Reporting (the Framework) and other IFRSs.
FIN fact
There may be assets such as brand names that are recognised when calculating the amount
of goodwill acquired in a business combination. This is even though a particular Accounting
Standard may prohibit the acquiree from recognising the asset in its own financial statements.
When an acquirer does not obtain ownership of all of the equity of the acquiree, the equity that
was not acquired is an NCI. For example, when 80% of a subsidiary is acquired, the 20% not
acquired by the parent is recognised as the NCI. IFRS 3 requires an acquisition-date value to be
placed on the NCI in order to calculate the goodwill acquired.

The following diagram summarises these recognition and measurement rules.
At the acquisition date the acquirer recognises separately from goodwill, these items of the acquiree
(IFRS 3 paras 10–14)
Identifiable assets acquired

Liabilities assumed NCI in the acquiree
(tangible and intangible)
Assets acquired and liabilities assumed must meet the definitions of For each business combination,
‘assets’ and ‘liabilities’ in the Conceptual Framework an acquirer can choose to value
any NCI (IFRS 3 para. 19 and
E.g. expected future costs such as restructuring costs cannot be
Appendix B paras B44–B45) at:
included in the calculation of liabilities assumed
• fair value (used in the full
goodwill method)
General measurement rule OR
Identifiable assets acquired and liabilities assumed are measured at fair • the NCI’s share of the
value at the acquisition date (IFRS 3 para. 18) acquiree’s fair value of
identifiable net assets (used in
the partial goodwill method)
Specific recognition rule for Specific recognition rule for
intangible assets contingent liabilities
Recognise identifiable intangible Even though the acquiree
assets acquired intangible assets would never recognise a
at fair value (IFRS 3 para. 13 and contingent liability in its own
IAS 38 paras 33–34) financial statements under
IAS 37, the accounting for a
business combination is
Examples of intangible assets different
recognised in a business Where a contingent liability of
combination (even if acquiree the acquiree is a present
had previously expensed obligation arising from a past
these costs) event that can be reliably
Brand names, trademarks, measured, its fair value is
customer lists, recognised, e.g. in relation to a
royalty agreements, patented law suit against the acquiree
technology and computer (IFRS 3 paras 22–23)
software (IFRS 3 Appendix B The fair value reflects market
paras B31–B34) participant expectations about
all possible cash flows, rather
than simply the likely or
expected maximum or
minimum cash flows
Exception for employee

benefit liabilities
The IFRS 3 fair value rule
doesn’t apply − the normal
IAS 19 Employee Benefits rules
apply (IFRS 3 para. 26)
Specific recognition and measurement rules for income taxes

Where the book value of assets acquired and liabilities assumed in a
business combination is different from their fair value, a tax effect
adjustment is required (IFRS 3 paras 24–25)
IAS 12 Income Taxes (IAS 12) requires corresponding deferred tax
assets and deferred tax liabilities to be recognised on the fair value
adjustments of assets and liabilities (IAS 12 para. 19)

Example – General measurement rule

This example illustrates the general measurement rule in IFRS 3 para. 18.
Mercury Limited gained control of Neptune Limited by acquiring all of its equity.
At the acquisition date, Neptune owns the following two assets, which have a fair value that
differs from the carrying amount in its financial statements:
Item Carrying amount at acquisition Fair value at acquisition date
date
$ $
Inventory 300,000 400,000
Plant and equipment 2,700,000 2,900,000
When applying IFRS 3 to calculate goodwill, the consolidated financial statements will
recognise:
•• Inventory of $400,000.
•• Plant and equipment of $2,900,000.
Explanation
IAS 2 Inventories requires inventory to be measured at the lower of cost and net realisable value;
however, IFRS 3 overrules this when accounting for a business combination.
[Unit 16 will explain that a consolidation journal entry will be recorded to recognise these fair
value adjustments in the consolidated financial statements. Later in this unit an acquisition
analysis will illustrate how these fair value adjustments are treated when goodwill is calculated.]
Example – Specific recognition rule for intangible assets

This example illustrates how an unrecognised intangible asset is recognised in a business
combination.
Mercury gained control of Neptune by acquiring all of its equity.
At the acquisition date, Neptune’s business had successful products that traded under the ‘Out
of This World’ brand name. IAS 38 para. 63 prohibits Neptune from recognising an internally
generated brand name in its financial statements.
A fair value of $800,000 was measured for this brand name at the acquisition date.
When applying the acquisition method of accounting for the business combination under IFRS 3,
a fair value of $800,000 will be attributed to Neptune’s brand name.
[In Unit 16, a consolidation journal entry will recognise the brand name asset in the consolidated
financial statements. Note that IAS 38 para. 63 still prohibits Neptune from recognising the brand
name in its own financial statements.]

Example – Recognition of a contingent liability

This example illustrates how a contingent liability is recognised in a business combination.
Mercury gained control of Neptune by acquiring all of its equity.
At the acquisition date Neptune was defending a lawsuit involving an employee who slipped
in the factory while wearing inappropriate footwear. Neptune had not recognised the liability
on its statement of financial position because its lawyers advised that they were highly likely
to successfully defend the claim. Neptune determined that there was a present obligation,
but payment of a claim was not considered probable. It had correctly disclosed the matter in
its notes to its financial statements as a contingent liability under IAS 37 Provisions, Contingent
Liabilities and Contingent Assets. A fair value of $300,000 was measured for this contingent
liability at the acquisition date.
Although IAS 37 only permits note disclosure for a contingent liability, IFRS 3 overrules this when
specified requirements are met. Therefore, Mercury will recognise a fair value of $300,000 for
this contingent liability at the acquisition date when accounting for the business combination
under IFRS 3.
IFRS 3 still considers the item to be a contingent liability but the Standard is effectively taking
a practical view of the situation because Mercury would have factored in this law suit when
determining how much it was willing to pay to gain control of Neptune.
[In Unit 16, a consolidation journal entry will recognise the contingent liability in the
consolidated financial statements. IAS 37 still prohibits Neptune from recognising the contingent
liability in its own financial statements.]
Tax effect implications of business combination adjustments

As mentioned in the previous diagram, there may be tax effect implications if fair value
adjustments are made when accounting for a business combination.
Unless stated to the contrary, the FIN module assumes that a temporary difference will arise
under IAS 12 Income Taxes where there is a fair value adjustment in determining the fair value of
the identifiable net assets when accounting for a business combination.
covered in Unit 4.
Required reading
IFRS 3 paras 10–14, 18–19, 21–26, 51–52, Appendix B ‘Application guidance’ paras B31–B34,
B44–B45.
IAS 12 para. 19.
IAS 38 paras 33–34.

Step 4 – Measure the consideration transferred

and the liabilities
assumed, as well
as any non-
controlling
interest (NCI) in
the acquiree
The consideration transferred to gain control of the acquiree is not limited to cash paid. IFRS 3
identifies that there can be three different components to the consideration transferred as
shown below:
Consideration transferred
Measured under IFRS 3 para. 37 as the aggregate of the fair values of:
Liabilities the acquirer Equity interests the

Assets the incurred to the former owners acquirer issued to the former
acquirer transferred of the acquiree owners of the acquiree
FIN fact
Acquisition related costs are not included within the consideration transferred. They are expensed
(IFRS 3 para. 53).
Deferred or contingent consideration

The consideration transferred may not always be settled at the acquisition date. However,
the fair value of the deferred and/or contingent consideration at the acquisition date must be
included in the consideration transferred calculation.

For the purposes of the FIN module, deferred and/or contingent consideration is confined
to situations that give rise to a liability. In order to measure the appropriate fair value, the
following rules are applied:
Deferred consideration Contingent consideration

For example, a cash payment due For example, a payment due based on
12 months after the acquisition date the acquiree meeting an earnings target
or reaching a specified share price
Apply IFRS 13 to measure the fair value
Discount the future payment Discount the expected future payment

back to the acquisition date back to the acquisition date
Typically the acquirer’s incremental As this can be complex, the fair value of
borrowing rate is used as the contingent consideration will be
discount factor provided in the FIN module
Required reading
IFRS 3 paras 37–40, 53.
IAS 32 para. 35.
IFRS 9 Appendix A (definition of transaction costs).
Step 5 – Recognise and measure the goodwill or gain from a bargain purchase

and the liabilities
assumed, as well
as any non-
controlling
interest (NCI) in
the acquiree
This is the final step in applying the acquisition method. The diagram below summarises some
of the key concepts covered so far:
Apply the IFRS 3 acquisition

The acquisition method views
method to the business
the business combination from
combination (determines
the perspective of the acquirer
goodwill or gain from a bargain
(parent)
purchase)
The parent will prepare

consolidated financial The goodwill or gain from a
statements for the group in bargain purchase is recognised
accordance with IFRS 10 in the consolidated financial
(covered in Unit 16) statements (covered in Unit 16)

Goodwill may relate to:

•• The ability of the acquiree to earn a higher rate of return on an assembled collection of net
assets than it would expect to earn from those net assets if they were operating separately.
•• Anticipated synergies between the acquirer and the acquiree.
Goodwill is recognised at the acquisition date and is measured as follows:
Fair value of the Fair value of Acquisition Acquisition

Goodwill = consideration
transferred
+ Value of
any NCI + the acquirer’s
previously held
date
identifiable
date
liabilities
equity interest assets
in the acquiree at
acquisition date Both measured in accordance
(only if the business with IFRS 3
combination is
achieved in stages) Referred to as fair value of
identifiable net assets (FVINA)
Full versus partial goodwill method for valuing the NCI

When not all of the equity interests in the acquiree are acquired (i.e. where a partly owned
subsidiary is acquired), the goodwill formula requires a value to be placed on the NCI at the
acquisition date.
IFRS 3 permits the full or partial goodwill method to be applied for each business combination
where there is a partly owned subsidiary as explained in the following diagram:
Valuing the NCI under the full or partial goodwill method
There is a choice of measurement

of the NCI in the acquiree at the
acquisition date when accounting for
the business combination
Full goodwill method Partial goodwill method

Measure the NCI at fair value at the Measure the NCI at its proportionate
acquisition date share of the FVINA at the
(For the purposes of the FIN module this acquisition date
value will always be provided)
Both of these methods are demonstrated

in Worked example 15.2

Example – Calculating goodwill

This example illustrates how to calculate goodwill and draws on fair value adjustments covered
in earlier examples.
On 30 June 20X5, Mercury Limited gained control of Neptune Limited by acquiring all of its
equity for a cash consideration of $2,500,000.
At the acquisition date the recorded net assets of Neptune were:
Net assets at 30 June 20X5
Item Neptune
$
Issued capital (1,000,000 shares) 1,000,000
Total equity/net assets 1,500,000
Neptune’s identifiable assets acquired and liabilities assumed were recorded at fair value except
for the following items:
Item Carrying amount at Fair value at
acquisition date acquisition date
$ $
Inventory 300,000 400,000
Plant and equipment 2,700,000 2,900,000
Brand name 0 800,000
Contingent liability 0 300,000
The tax rate is 30%.

Goodwill is calculated as follows:
Acquisition analysis – calculation of goodwill
Goodwill acquired in Neptune at 30 June 20X5
Item $ $
Consideration transferred 2,500,000
Net assets acquired
Book value of net assets 1,500,000
Fair value adjustments (net of tax):
Inventory (($100,000) × (1 – 30%)) 70,000
Plant and equipment (($200,000) × (1 – 30%)) 140,000
Brand name (($800,000) × (1 – 30%)) 560,000
Contingent liability (($300,000) × (1 – 30%)) (210,000)
Fair value of identifiable net assets (FVINA) 2,060,000
Goodwill acquired 440,000

FIN fact
Always include a value for the NCI at the acquisition date as part of the goodwill calculation when
a partly owned subsidiary is acquired.
•• If the NCI is measured at fair value, the full goodwill method is being used.
•• If the NCI is calculated as its share of the FVINA, the partial goodwill method is being used.
Worked example 15.2: Calculate goodwill when a partly owned subsidiary is acquired
in a business combination
Gain from a bargain purchase

Occasionally, an acquirer will make a gain from a bargain purchase which is akin to negative
goodwill. This is the reverse of the situation depicted in the preceding diagram, where the gain
is equal to the FVINA minus the sum of the three items in the first box.
The treatment required before the gain can be recognised for the business combination is
as follows:
Reassess the amounts Any gain remaining after this

Calculate the gain from a recognised and measured in reassessment is immediately
bargain purchase Steps 3-5 of the acquisition recognised in profit or loss and
method (IFRS 3 para. 34) attributed to the acquirer (that
is, no amount is allocated to any
NCI) (IFRS 3 para. 36)
This process of re-examining the calculation could possibly identify an asset impairment when
reassessing asset fair values. Assuming this re-examination identified that an asset of the acquiree
needed to be written down, this will revise the initial calculation of the gain from a bargain purchase
Required reading
IFRS 3 paras 32–36.
Worked example 15.3: Calculate a gain from a bargain purchase

Accounting subsequent to the initial accounting
Learning outcome
IFRS 3 sets out rules for the accounting of certain issues after the acquisition date. Several of the
important matters are covered in this section. The emphasis is on how the goodwill calculation
may be impacted; however, the discussion could equally apply to a gain from a bargain
purchase.

Measurement period adjustments

Generally, the goodwill calculated at the acquisition date remains unchanged after that
time and is recognised as an asset in the consolidated financial statements. However, IFRS 3
recognises that the initial accounting for a business combination may be performed on a
provisional basis at the end of a reporting period; for example, when a business combination
occurs just before a reporting date.
Adjustments that alter the provisional goodwill value are called measurement period
adjustments. The measurement period is the time from the acquisition date that ends at the
earlier of either:
•• the date the acquirer receives the information it was seeking
•• the date the acquirer learns that the information it was seeking cannot be obtained, or
•• twelve months from the acquisition date.
The diagram below explains the accounting treatment of measurement period adjustments:
Measurement period adjustments
Goodwill is calculated at
the acquisition date as
per Step 5 (known as the
provisional calculation
when considering
measurement period
adjustments)
No, new facts/circumstances
during the measurement period
Is there new information Not a measurement

Make measurement period
obtained during the period adjustment.
adjustments by retrospectively
measurement period No change to the business
adjusting goodwill at the YES NO
AND the facts/circum- combination accounting,
acquisition date for the new
stances existed at the therefore, goodwill is not
information (IFRS 3 para. 45)
acquisition date? changed.
E.g. an asset acquired in the
business combination is
impaired post-acquisition – the
Examples of measurement period adjustments: accounting under the relevant
accounting standard is applied
• Changes to the consideration transferred (including contingent
(in this case IAS 36 Impairment
consideration)
of Assets)
• Assets or liabilities in existence at the date of acquisition that
were not recognised
• Assets or liabilities in existence at the date of acquisition that
were recognised at values other than the measurement basis
specified in IFRS 3
• A contingent liability in existence at the date of acquisition is
re-measured for new information obtained
Implications of retrospective adjustment:

• Adjust comparative financial statements to reflect the revised
values including goodwill
• Changes to fair values may also require tax effect adjustments
• Depreciation or amortisation may need to be adjusted if fair
values are altered (covered in Unit 16)

Example – Measurement period adjustment

This example illustrates how a measurement period adjustment alters the provisional goodwill
value measured for a business combination.
Tartan Limited gained control of Spots Limited by acquiring all of its equity in a business
combination that occurred on 31 May 20X5. Goodwill of $800,000 was recognised in the
consolidated financial statements at 30 June 20X5 in respect of this business combination.
The $800,000 goodwill calculation included an estimated fair value for one of Spots’ intangible
assets. Due to new information obtained in September 20X5 that was not available at the
acquisition date, it was determined that the asset’s fair value should have been measured at a
value $500,000 higher than in the original calculation.
The after-tax impact of this measurement period adjustment is a $350,000 ($500,000 × (1 – 30%))
increase to the fair value of the identifiable net assets acquired in Spots. Correspondingly, the
goodwill recognised for the business combination is reduced by $350,000 to $450,000 ($800,000
provisional goodwill – $350,000 after tax measurement period adjustment).
FIN fact
The amount of goodwill calculated at the acquisition date might change in the 12 months after
the acquisition date … if there is a measurement period adjustment.
Adjustments after the measurement period

After the end of the measurement period, the acquirer can only adjust the business combination
accounting (including the goodwill) if there has been an error. Any error is accounted for
retrospectively under IAS 8 Accounting Policies, Changes in Accounting estimates and Errors as
covered in Unit 2.
Required reading
Other accounting issues subsequent to the business combination

IFRS 3 prescribes the accounting treatment for the following:
•• Contingent liabilities.
•• Contingent consideration.
The treatment of these matters are discussed below.
Contingent liabilities
For the purposes of the FIN module, a contingent liability recognised in a business combination
is remeasured at each reporting date to the best estimate of the expenditure required to settle
the present obligation under IAS 37 para. 36.
•• Where the reporting date falls within the measurement period, this will result in the
goodwill being adjusted (as explained in the diagram on measurement period adjustments).
•• Where the reporting date falls after the measurement period ends, this will result in the
subsequent adjustment being recognised in profit or loss.

Contingent consideration
If additional information is obtained about facts and circumstances relating to contingent
consideration that existed at acquisition date, these are accounted for as measurement period
adjustments where they fall within the measurement period (as explained in the diagram on
measurement period adjustments).
However, events that occur after the acquisition date – for example, meeting an earnings target
or reaching a specified share price – are not measurement period adjustments. Changes in
the fair value of contingent consideration that are not measurement period adjustments are
accounted for as follows:
Changes in contingent consideration that are not measurement period adjustments
Classification of Contingent consideration Recognition of change in fair IFRS 3 para.

contingent consideration remeasured? value reference
Equity No Not required as not remeasured 58(a)
A financial asset or liability Yes Recognised in profit or loss 58(b)(i)
A non-financial asset or Yes Recognised in profit or loss 58(b)(ii)

liability
Example – Change in contingent consideration

This example illustrates the accounting for changes in contingent consideration relating to an
event occurring after the acquisition date.
Major Limited gained control of PeeWee Limited by acquiring all of its equity on 1 July 20X5.
The purchase consideration payable by Major to PeeWee’s shareholders was as follows:
•• $1,000,000 payable in cash at the acquisition date.
•• $500,000 payable in cash on 1 January 20X6 if PeeWee’s profit for the first six months
following the acquisition achieved a targeted amount.
At the acquisition date, the fair value of the contingent consideration was measured at $400,000
and was recognised as a liability in Major’s general ledger.
Business combination accounting
The consideration transferred that is used in the calculation of goodwill on the business
combination will be measured at $1,400,000. It does not change whether the profit target is
achieved or not as this is an event that occurs after the acquisition, which is not a measurement
period adjustment.
Major’s general ledger
Entry at acquisition date
$ $
01.07.X5 Investment in PeeWee 1,400,000
Cash 1,000,000
Payable (contingent consideration) 400,000
To record the investment in PeeWee upon gaining control of the subsidiary

Entry six months later when the profit is determined

(i) Profit target is achieved
An amount of $500,000 will be paid to PeeWee’s former shareholders and the following journal
entry will be recorded:
$ $
01.01.X6 Payable (contingent consideration) 400,000
Fair value movement on contingent 100,000

consideration1
Cash 500,000
To record the payment of the additional consideration due to PeeWee achieving the profit target, with
the $100,000 expense recognised in profit or loss
1. IFRS 3 para. 58(b)(i) does not specify the account within profit or loss to use for this debit entry; however, this account
description is used in practice.
(ii) Profit target is not achieved

No additional amount will be paid to PeeWee’s former shareholders and the following journal
entry will be recorded:
$ $
01.01.X6 Payable (contingent consideration) 400,000
Gain on contingent consideration 400,000
To derecognise the liability for the contingent consideration as the profit target was not achieved, with
the gain recognised in profit or loss
Required reading
IFRS 3 paras 54, 56 and 58.

Summary - acquisition method of accounting for

business combinations
Step 1
Control determined under IFRS 10 Consolidated Financial Statements
Identify the acquirer
Step 2
The date the acquirer gains control of the acquiree
Determine the
acquisition date
Step 3 Assets and liabilities of the acquiree are generally measured at fair value
NCI measured for each business combination at fair value (full goodwill method) or
Recognise and measure, proportionate share of fair value of identifiable net assets (partial goodwill method)
at acquisition date,
the identifiable assets Special rules set by IFRS 3 Business Combinations:
acquired and the liabilities
assumed, as well as any Recognition rule
non-controlling interest Contingent liabilities
(NCI) in the acquiree
Both recognition and measurement rules

Income taxes
Employee benefits
Step 4 Aggregate of the fair value of:

• Assets transferred by the acquirer
Measure the consideration
transferred • Liabilities incurred by the acquirer to the former owners of the acquiree
• Equity interests issued by the acquirer to the former owners of the acquiree
The consideration may include contingent and/or deferred consideration
Step 5 Goodwill – allocation and impairment prescribed by IAS 36 Impairment of Assets

Gain from a bargain purchase – recognise in profit or loss in year of acquisition
Recognise and measure
the goodwill or gain from
a bargain purchase Goodwill Fair value Fair value of Acquisition Acquisition
(gain from
a bargain = of the
consideration
+ Value of
any NCI + the acquirer’s
previously held
date
identifiable
date
liabilities
purchase) transferred equity interest assets
in the acquiree at
acquisition date
Both measured in accordance
(only if the business
with IFRS 3
combination is
Referred to as fair value of
achieved in stages)
identifiable net assets (FVINA)
Subsequent • The measurement period ends as soon as the acquirer receives the information it was seeking or
measurement obtains more information that was previously not obtainable. The measurement period cannot exceed
and accounting one year from the acquisition date
• Measurement period adjustments alter goodwill/gain from a bargain purchase when it subsequently
becomes known that: the cost of acquisition needs adjusting; assets or liabilities in existence at the
date of acquisition were not recognised; and assets or liabilities in existence at the date of acquisition
were recognised at values other than the measurement basis specified in IFRS 3
• Special rules for the subsequent accounting, which do not alter goodwill/gain from a bargain purchase,
are: contingent liabilities and contingent consideration
Activity 15.1: Accounting for a business combination


Disclosures
Due to the significance of a business combination to the economic entity, both at acquisition and
because of the anticipated long-term benefits, disclosures are extensive.
The information disclosed enables users of the financial statements to:
... evaluate the nature and financial effect of a business combination that occurs either:
(a) during the current reporting period; or
(b) after the end of the reporting period but before the financial statements are authorised for issue
(IFRS 3 para. 59).
IFRS 3 paras B64–B67 detail these disclosures.

Information is also disclosed that enables users of the financial statements to evaluate the
financial effects of adjustments recognised in the current reporting period that relate to business
combinations that occurred in the period or previous reporting periods (IFRS 3 para. 61). IFRS 3
para. B67 details these disclosures.
Required reading
IFRS 3 paras 59–63 and Appendix B Application guidance paras B64–B67.
Quiz

Unit 16: Accounting for subsidiaries
Contents
Introduction 16-3
Extra support with this unit 16-4
1. Integrated activity 16-4
2. Adaptive learning lesson 16-4
Tax effect implications of consolidated accounting 16-4
What is consolidation? 16-5
Consolidation process 16-8
Step 1 – Determine whether control exists 16-8
Preparing consolidated financial statements 16-8
Step 2 – Determine whether consolidated financial statements need to be presented 16-8
Step 3 – Ensure that the subsidiary’s accounting policies, reporting date and
presentation currency are consistent with the parent’s 16-9
Step 4 – Prepare all necessary consolidation eliminations and adjustments 16-10
Step 4(a) – Perform an acquisition analysis 16-11
Step 4(b) – Prepare any business combination valuation reserve entries 16-12
Step 4(c) – Eliminate the investment asset 16-17
Step 4(d) – Eliminate intragroup transactions and balances 16-18
Step 4(e) – Prepare the NCI allocations 16-23
Step 4(e)(i) – Calculate the NCI percentage 16-24
Step 4(e)(ii) – Calculate the NCI allocation 16-24
Step 4(e)(iii) – Record the NCI allocation 16-26
Step 5 – Prepare the consolidated financial statements 16-26
Separate financial statements 16-27
Assessing goodwill for impairment for partly owned subsidiaries 16-27
Consolidating a foreign subsidiary 16-30
Accounting for movements in investments 16-32
Acquisition of additional investment (step acquisition) 16-32
New issue of shares by a subsidiary 16-32
Disclosures 16-33


Learning outcomes
4. Account for movements in the parent’s interest in a subsidiary
Introduction
When a parent entity has control over another entity, that entity is a subsidiary. The
consolidated financial statements of the parent and its subsidiaries (the group) are presented
as those of a single economic entity. Whether a Chartered Accountant is the preparer, auditor
or interpreter of consolidated financial statements, knowledge of accounting for subsidiaries is
critical to understanding and explaining the financial results and position of a group.
This unit explains the ongoing accounting requirements when a parent controls one or more
subsidiaries. It outlines the necessary steps to account for subsidiaries and prepare consolidated
financial statements. It follows on from the unit on business combinations; therefore, it is
recommended that you complete that unit first.

The five relevant Standards covered in this unit are as follows:
Standards relevant to accounting for subsidiaries

Standard Deals with
IFRS 10 Consolidated Financial The principles related to the presentation and preparation of consolidated
Statements financial statements when an entity controls one or more other entities
IFRS 3 Business Combinations The accounting for a business combination (in the context of this unit, the
acquisition of a subsidiary)
IFRS 12 Disclosure of Interests The disclosure requirements applying to subsidiaries (in the context of
in Other Entities this unit)
IAS 12 Income Taxes The tax effect of consolidation adjustments. (The worked examples and
activities in this unit assume that the entities are not part of a tax-consolidation
group)
IAS 21 The Effects of Changes The translation of a foreign subsidiary (covered in Unit 5) before applying the
in Foreign Exchange Rates procedures for the preparation of consolidated financial statements

Extra support with this unit

Accounting for subsidiaries can be a challenging area. Revisiting the flowcharts and tables
in Unit 15 will help candidates as they work through this unit. Also, to assist candidates in
developing their skills, there are two additional resources to support this unit, as follows:
1. Integrated activity
Integrated activity 3 is based on a relatively straightforward scenario and provides an
opportunity for candidates to ‘dip in and dip out’ with their learning as they proceed through
the consolidation process outlined in this unit. It is not necessary to wait until the end of this
unit to attempt this integrated activity and, for some people, it might be a refresher from
university studies.
2. Adaptive learning lesson

This unit includes an adaptive learning lesson, which is designed to develop candidates’
knowledge and understanding of accounting for subsidiaries and accounting for business
combinations (covered in the previous unit). It allows the learner to explore the consolidation
entries when either the full goodwill or partial goodwill method is applied.
The adaptive learning tool offers a number of benefits. For example, if the learner is unable
to successfully complete part of the task, guidance is provided to help the learner to proceed
with the task at hand. When completed, the lesson can be attempted again but with a new fact
pattern, enabling knowledge to be re-applied in a different scenario.
The adaptive learning lesson is available on myLearning and is launched with one click from
the Unit 16 page.
Tax effect implications of consolidated accounting

Unless stated to the contrary, the FIN module assumes that a temporary difference will arise
under IAS 12 where the carrying amount of an asset or liability is adjusted on consolidation
(including consequential consolidation adjustments that reverse such an adjustment).
covered in Unit 4.

What is consolidation?
Learning outcomes
Consolidation is the process of presenting the financial statements of all entities within a group
as those of a single economic entity.
A summary of the key principles of consolidation is tabled below. It would be helpful for
candidates to have a basic understanding of the principles before proceeding with their study of
the consolidation process.
Key principles of Points to note

consolidation
Owner is called ‘the The parent is the entity that has gained control in the business combination
parent’
Acquired entity is called The subsidiary may be wholly owned or partly owned by the parent
‘the subsidiary’ If the subsidiary is partly owned, a non-controlling interest (NCI) will need to be
recognised in the consolidated financial statements
The parent's and the Consolidation is a line-by-line aggregation process

subsidiary's trial balances Even if a subsidiary is only partly owned by the parent, 100% of the subsidiary’s
at the current reporting trial balance values are used
date are added across in a
consolidation worksheet Think of the consolidation worksheet as sitting outside an entity’s normal
accounting system. For example, a parent and its subsidiary may use XEROTM
accounting software to operate their general ledgers
When the consolidation is prepared, the trial balances of each entity are
downloaded to a spreadsheet. This spreadsheet is the consolidation worksheet
where the consolidation journal entries are recorded. Therefore, the consolidation
journal entries never alter the general ledger of either the parent or the subsidiary
A consolidation worksheet may look like this:
Consolidation worksheet for the year ended 30 June 20X6
Parent Subsidiary Consolidation journal entries Consolidated

trial balance
Journal Dr Cr Journal
$ $ ref. $ $ ref. $
Statement
of profit or
loss
Sales 4,000,000 2,900,000 3 1,000,000 5,900,000

revenue

Key principles of Points to note

consolidation
Consolidation entries are Consolidation journal entries are recorded on the consolidation worksheet and
made to many different may be made to accounts within the statement of financial position and the
accounts statement of profit or loss and other comprehensive income
Consolidation journal entries do not alter the general ledger of the parent or
the subsidiary. Rather, they must be posted into the consolidation worksheet at
each reporting period. This means that consolidation journal entries do not carry
forward to the next accounting period (unlike asset and liability balances within
the general ledger that do). As such, a current year consolidation journal entry
may need to reflect a transaction or an event that happened in an earlier year
For example, three years of amortisation for an asset recognised in a business
combination where the business combination occurred several years ago. The
consolidation journal entry would record the prior two years’ amortisation expense
against the opening retained earnings account while the current year’s charge
would be recorded to amortisation expense within the statement of profit or loss
and other comprehensive income
Goodwill of the subsidiary Goodwill is calculated by performing an acquisition analysis (which is covered in
acquired in the business the unit on business combinations)
combination is recognised The goodwill is not separately shown in the general ledger of the parent. It is
as an asset only through a consolidation entry that the goodwill asset is recognised in the
consolidated financial statements
The parent’s investment As the consolidated financial statements show the economic entity as one entity,
asset in the subsidiary is the parent’s investment asset in the subsidiary would be an internal investment, so
eliminated it must be eliminated
This is achieved through a consolidation journal entry, using the values from the
acquisition analysis that calculated the goodwill from the business combination
Video resource
The consolidation journal entry also has the effect of removing the parent’s share
of the subsidiary’s pre-acquisition earnings and reserves, as the net assets of the
subsidiary are included in the consolidated financial statements
Refer to the Unit 16 page on myLearning for a video demonstration of why
eliminating the investment asset avoids double counting
An NCI is recognised if The NCI is part of the economic entity and is considered to be a contributor of
the parent does not own equity. It is shown in the equity section of the statement of financial position
100% of the subsidiary within the consolidated financial statements
It may help to think that the economic entity (group) can include 100% of the
subsidiary’s net assets in the consolidated financial statements, despite only partly
owning the subsidiary, because it recognises an NCI within equity
Subsidiary’s equity in consolidated
Parent’s share
75%
NCI
25%
Intragroup transactions If transactions occur within the economic entity, they must be eliminated through
are eliminated consolidation journal entries to avoid double-counting
FIN fact
Consolidation journal entries do not alter the general ledger of the parent or the subsidiary.
Therefore, consolidation journal entries do not carry forward to the next accounting period.
As such, a current year consolidation journal entry may need to reflect a transaction or an event
that happened in an earlier year.

One of the key effects of the consolidation journal entries is that the parent’s share of post-
acquisition earnings and reserves remain in the consolidated financial statements. Remember
that the shareholders of the parent will be particularly interested to know how a subsidiary has
performed since the parent gained control of it.
The diagram below is an example of a group structure which we will use to briefly apply some
of the key principles tabled above.
MIC ENT
O NO IT
Y
EC IM
RO
PR
S
E
60%
Acquisition
date 1 July 20X5
NCI
40%
C
S
A
RL
ET
Other
shareholders
40% NCI
Applying the principles of consolidation to the diagram above, we can determine that:
•• Primrose is the parent.
•• Scarlet is the subsidiary.
•• There is a 40% NCI in Scarlet. We do not need to know detailed information about the
NCI. It could be one shareholder owning 40% of Scarlet, or multiple shareholders whose
ownership interests total 40%.
•• The economic entity/group comprises Primrose, Scarlet and the 40% NCI.
•• Therefore, the consolidated financial statements will:
–– show 100% of post-acquisition earnings and reserves that Primrose has earned from
Scarlet since it gained control of the subsidiary on 1 July 20X5 and allocate 40% of them
to the NCI
–– recognise within equity that there is a 40% NCI in Scarlet.
Required reading
IFRS 10 Appendix A ‘Defined terms’ and Appendix B para. B86.

Consolidation process
The consolidation process can be worked through as a series of steps, as outlined below:
STEP
1 Step 1 – Determine whether control exists
Determine Determine Ensure that the Prepare all Prepare the
whether control whether subsidiary’s necessary consolidated
exists consolidated accounting consolidation financial
financial policies, eliminations and statements
statements need reporting date adjustments
to be presented and presentation
currency are
consistent with
the parent’s
The process of determining whether control exists (Step 1) was covered in Unit 15 on business
combinations, where it was established that a business combination required the parent entity
to have gained control of the subsidiary in an acquisition. IFRS 10 defines ‘control’ and specifies
the three elements that must be present for control to exist (IFRS 10 para. 7).
Required reading
Consolidated financial statements are prepared when there is control. Therefore, control is
not only required when the business combination occurs but also needs to be assessed on an
ongoing basis. It must also be reassessed if there is any indication of a change to any of the three
key elements of control (IFRS 10 para. 8).
Preparing consolidated financial statements

Paragraph 4 of IFRS 10 requires a parent entity to present consolidated financial statements.
However, in certain circumstances a parent can be exempted from this obligation if specific
requirements are met – for example, an intermediate parent (that is also a reporting entity) may
not be required to prepare consolidated financial statements. (These exceptions are beyond the
scope of the FIN module and will not be further discussed.)
STEP
2 Step 2 – Determine whether consolidated financial statements need
to be presented
currency are
consistent with
the parent’s

Once it has been established that the investor has control (and is therefore a parent), it must STEP
2
be determined whether consolidated financial statements should be presented or if an
exemption applies.
Australia-specific
According to AASB 10 Consolidated Financial Statements para. Aus4.2, there is no exemption
available for the ultimate Australian parent company if either the parent or the group (or both)
are reporting entities.
Required reading
IFRS 10 para. 4.
Step 3 – Ensure that the subsidiary’s accounting policies, reporting STEP

3
date and presentation currency are consistent with the parent’s
currency are
consistent with
the parent’s
A parent that is required to prepare consolidated financial statements may need to make certain
adjustments as part of the consolidation process to ensure the subsidiary’s accounting policies
and presentation currency are consistent with its own financial statements. It may also need to
adjust the subsidiary’s reporting date to align it with that of its own.
Accounting policies
Consolidated financial statements should be prepared using uniform accounting policies for
like transactions and other events with similar circumstances (e.g. where an overseas subsidiary
adopts a different inventory valuation method that is not permitted under IFRS), requiring
consolidation adjustments to achieve uniformity among the entities in the group.
Example – Achieving uniform accounting policies

This example illustrates how uniform accounting policies can be achieved by recording a
consolidation journal entry.
On 1 July 20X4, an entity acquires a subsidiary that is not a reporting entity. The subsidiary
recognises revenue from the provision of services in its management accounts when cash is
received. This type of revenue only started to be earned by the subsidiary after the business
combination. The consolidated financial statements comply with the revenue recognition
requirements specified by IFRS 15 Revenue from Contracts with Customers.
The accounting policy for revenue recognition should be consistent throughout the consolidated

STEP An analysis of the subsidiary’s revenue recognition under both methods reveals:
3
Subsidiary’s revenue recognition
Date Recognition when IFRS 15 recognition Difference

cash is received method
$ $ $
30.06.X5 100,000 90,000 10,000
30.06.X6 80,000 60,000 20,000
Ignoring tax, the consolidation entry required to achieve uniform accounting policies is:
$ $
30.06.X6 Opening retained earnings1 10,000
Revenue - services2 20,000
Deferred revenue3 30,000
To achieve a uniform accounting policy by applying the IAS 18 revenue recognition basis to the subsidiary
Notes
1. Last year’s revenue is reduced by $10,000 on consolidation, lowering that year’s consolidated profit.
2. By debiting revenue, the current year profit is reduced by $20,000 as required.
3. Deferred revenue of $30,000 should be recognised as a liability at 30 June 20X6, as the cash received to date
of $180,000 exceeds the $150,000 revenue recognised to date under IFRS 15 by $30,000.
Presentation currency
If an entity’s functional currency differs from the group’s presentation currency, the entity’s
financial statements need to be translated into the group’s presentation currency to enable
consolidation. Translation of financial statements from the functional currency to the
presentation currency is discussed in the unit on foreign exchange.
Reporting date
The reporting dates of subsidiaries should generally be aligned with those of the parent. In the
event that the reporting date of a subsidiary is different from that of its parent, the subsidiary
must make adjustments to its reporting cycle to enable consolidation.
Required reading
IFRS 10 paras 19–20, Appendix B Application guidance paras B87 and B92–B93.
STEP
4 Step 4 – Prepare all necessary consolidation eliminations and
adjustments
currency are
consistent with
the parent’s

Step 4 includes the identification, calculation and preparation of the consolidation entries. STEP
4
This step is usually the most complicated step in the preparation of consolidated financial
statements; however, identifying the issues that consolidation journal entries need to address
should make this step easier. To achieve this, Step 4 can be broken down into five sub-steps.
STEP
Step 4(a) – Perform an acquisition analysis 4a
Perform an Prepare any Eliminate the Eliminate Prepare the
acquisition business investment intragroup NCI allocations
analysis combination asset transactions
valuation and balances
reserve entries
Accounting for a business combination, including how to perform an acquisition analysis to

calculate goodwill or a gain from a bargain purchase under IFRS 3 is discussed in Unit 15.
The table below identifies the acquisition analysis information (from sub-step 4(a)) that flows
into the other sub-steps of Step 4, with each explained in detail in the discussion of relevant
sub‑step:
Information from the Consolidation journal entries affected Step 4 sub-step

acquisition analysis
Goodwill calculation Wholly owned subsidiary

•• Elimination of the investment asset Step 4(c)
Partly owned subsidiary
•• Full goodwill method
Business combination valuation reserve (BCVR) entry Step 4(b)
Allocation of a portion of the goodwill to the NCI Step 4(e)
•• Partial goodwill method
Elimination of the investment asset Step 4(c)
Acquisition date fair value BCVR entry to recognise the acquisition date fair value Step 4(b)
adjustments adjustments
Depreciation or amortisation entries after the acquisition date Step 4(b)
relating to these fair value adjustments
Consideration transferred Elimination of the investment asset entry as the consideration Step 4(c)
transferred is recognised within this asset
Gain from a bargain Elimination of the investment asset entry to enable the gain Step 4(c)
purchase to be recognised

STEP
4b Step 4(b) – Prepare any business combination valuation reserve
entries
reserve entries
IFRS 3 generally requires identifiable assets acquired and liabilities assumed to be recorded at
fair value at the acquisition date. Depending on the circumstances, these adjustments will be
recognised in the subsidiary’s general ledger or as a consolidation entry. In the FIN module, the
approach taken to recording these fair value adjustments via a consolidation entry is to use a
BCVR account. Candidates may have been taught a different approach in their university studies,
but provided the same end result is achieved, various methods are accepted in the exam.
Think of the BCVR account as a consolidation suspense account that is used to process certain
fair value adjustments arising prior to the acquisition date. After processing all consolidation
entries, the balance in the BCVR should always be $0 because this account can never contain
post-acquisition movements.
FIN fact
Acquisition-date fair value adjustments to assets that are depreciated or amortised will also
require consolidation entries (including tax effect entries) for depreciation/amortisation.
A timeline will help you to calculate the depreciation/amortisation expense.
FIN fact
Think of the BCVR account as a consolidation suspense account that is used to process certain fair
value adjustments arising prior to the acquisition date.

The following diagram explains how acquisition-date fair value adjustments are recorded. STEP
4b
Acquisition-date fair value adjustments
Recognise in the subsidiary’s general ledger Recognise in consolidation entries
For example, the item cannot be recognised in the

For example, subsidiary uses the fair value method to
subsidiary’s records due to the application of another
account for plant and equipment and an item of Accounting Standard such as inventory revaluation, a
plant requires a fair value adjustment contingent liability or an internally generated
intangible asset
Use the revaluation surplus account Use the business combination valuation
Recognise the fair value adjustment in the reserve (BCVR) account
subsidiary’s revaluation surplus account (net of tax) – Recognise the fair value adjustment in a
For example, Dr Plant and equipment, Cr Deferred consolidation entry to the BCVR (net of tax)
tax liability, Cr Revaluation surplus – For example, Dr Brand name, Cr Deferred tax
liability, Cr BCVR
Ongoing adjustments post-acquisition Ongoing adjustments post-acquisition

If the subsidiary has recognised the fair value adjustment If the fair value adjustment was recognised in a
in its own general ledger, ongoing accounting such as consolidation entry, ongoing accounting such as
depreciation will also be recorded by the subsidiary (no depreciation or amortisation will also be recorded as a
consolidation entries are required) consolidation entry (and related tax effect)
For example, Depreciation adjustment – Dr Depreciation For example, Amortisation adjustment – Dr Amortisation
expense, Cr Accumulated depreciation expense, Dr Opening retained earnings, Cr Accumulated
Related tax effect – Dr Deferred tax liability, Cr Income amortisation
tax expense Related tax effect – Dr Deferred tax liability, Cr Opening
retained earnings, Cr Income tax expense
When the item is sold/realised/settled When the item is sold/realised/settled

Year of sale – If the subsidiary has recognised the fair Year of sale – If the fair value adjustment was recognised
value adjustment in its own general ledger, the subsidiary in a consolidation entry, in the year when the item is
will record the appropriate entries for example, when the sold/realised/settled, the impact of the acquisition date
asset is sold (no consolidation entries are required) fair value is taken to the relevant account in profit or loss
(and related tax effect).
Subsequent years – no entries are required as the sale
was correctly accounted for in the prior year in the For example, Sale of brand name – Dr Profit on sale, Dr
Opening retained earnings (for prior year amortisation),
subsidiary’s general ledger
Cr BCVR
Related tax effect – Dr BCVR, Cr Opening retained
earnings (for prior year tax effect on amortisation
adjustments), Cr Income tax expense
Subsequent years – the acquisition date fair value
adjustment is adjusted in a consolidation entry to
opening retained earnings (net of the tax effect)
For example, Prior year sale of brand name – Dr Opening
retained earnings, Cr BCVR
Acquisition-date fair value adjustments always form part of the pre-acquisition

reserves of the subsidiary and must be eliminated even when the item is no
longer recognised on the statement of financial position, for example after asset
is sold
As the fair value adjustment is part of the acquisition analysis it must be
eliminated so that the correct goodwill/gain from a bargain purchase is
recognised
Pre-acquisition revaluation surplus must be eliminated Pre-acquisition BCVR must be eliminated every year
every year
– Elimination of the investment asset Step 4(c) –
– Elimination of the investment asset Step 4(c) – eliminate the parent’s share of the BCVR
eliminate the parent’s share of the revaluation surplus
– Allocate to the NCI Step 4(e) – allocate the NCI’s share
– Allocate to the NCI Step 4(e) – allocate the NCI’s share of the BCVR
of the revaluation surplus

STEP
4b
Recognition of goodwill/gain from a bargain purchase
Goodwill/gain from a bargain purchase is calculated in the acquisition analysis.
Goodwill
The table below summarises how goodwill is recognised in the consolidated financial statements:
Recognition of goodwill in the consolidated financial statements
Degree of Measurement Goodwill In which Impact on Impact on NCI

ownership of the NCI in calculation consolidation elimination of allocations
the goodwill entry is the the investment (Step 4(e))
calculation goodwill asset asset
recognised? (Step 4(c))
Wholly owned Not applicable Goodwill = The goodwill Goodwill is one No impact as
subsidiary as the Consideration asset is line within the there is no NCI
subsidiary is transferred less recognised elimination of
wholly owned FVINA within the the investment
elimination of the entry
investment entry
Partly owned
subsidiary
(i) Full goodwill The NCI is Goodwill = The goodwill The parent’s The NCI’s share
method measured at (Consideration asset is share of of the BCVR
fair value transferred + fair recognised in a the BCVR is is debited in
value of NCI) separate entry debited in the the NCI entry
less DR Goodwill elimination of (effectively
the investment allocates to the
FVINA CR BCVR entry NCI its share of
(The goodwill (The goodwill the goodwill)
asset recognised asset includes an
is higher than amount relating
that under the to the parent
partial method and an amount
as it includes an relating to the
amount that NCI)
relates to the NCI)
(ii) Partial The NCI is Goodwill = The goodwill Goodwill is one No impact as
goodwill measured at its (Consideration asset is line within the no goodwill is
method proportionate transferred + recognised elimination of allocated to the
share of the NCI’s % share of within the the investment NCI
subsidiary’s FVINA) elimination of entry
fair value of less the investment
identifiable net entry
assets (FVINA) FVINA
(The goodwill
(The goodwill asset is all
asset recognised attributable to
is the proportion the parent)
attributable to
the parent only)
FIN fact
Any goodwill acquired in a business combination will be recognised in the statement of financial
position every time consolidated financial statements are prepared.

Summary - full versus partial goodwill method STEP

4b
An entity that acquires less than 100% of another entity can choose whether to apply either the
full or partial goodwill methods when accounting for the business combination.
The key differences between the full and partial goodwill methods when consolidating a
partly‑owned subsidiary are shown below:
Full Partial
goodwill goodwill
Goodwill is recognised Goodwill is not recognised

via the BCVR account via the BCVR
Goodwill is recognised
as the balancing item
within the elimination
of investment asset entry
Consideration transferred Consideration transferred

+ Fair value of NCI + NCI's % share of FVINA
– FVINA – FVINA
= Goodwill = Goodwill
The goodwill value is The goodwill value

apportioned so a share is not apportioned
can be allocated to the as all of it is attributable
NCI within the NCI to the parent
allocation entry.
NCI's share of goodwill
= fair value of NCI
– (NCI's % share × FVINA)
Goodwill asset in the consolidated financial statements

is higher under the full goodwill method as a portion
of the asset recognised is attributable to the NCI
Gain from a bargain purchase

As explained in Unit 15, IFRS 3 para. 34 requires that:
•• A gain from a bargain purchase is immediately recognised in profit or loss.
•• In the case of a partly owned subsidiary, any amount of gain from a bargain purchase
is attributed to the parent (i.e. no amount of the gain is allocated to the NCI regardless
of whether the full or partial goodwill method is used to measure the NCI at the
acquisition date).
A gain from a bargain purchase is recognised as a credit within the elimination of the
investment asset entry (see Step 4(c)). In future reporting periods the gain is credited to opening
retained earnings as part of the elimination of investment asset entry.

STEP
4b
Example – Recognising a gain from a bargain purchase
This example illustrates how to recognise a gain from a bargain purchase that has been
calculated in an acquisition analysis.
On 1 July 20X4, Jupiter Limited purchased 100% of the ordinary issued shares of Pluto Limited for
a cash consideration of $580,000. Pluto’s business was in a declining market and its shareholders
were willing to accept Jupiter’s offer at a $20,000 discount to its net asset value. Any impairment
losses have been recognised in Pluto’s financial statements.
At the acquisition date the fair value of the recorded net assets of Pluto were:
Net assets at 1 July 20X4
Item $
Issued capital (400,000 shares) 400,000
Total equity/net assets 600,000
Acquisition analysis – gain from a bargain purchase in Pluto at 1 July 20X4
Item $
Consideration transferred 580,000
Fair value of identifiable net assets (FVINA) 600,000
Gain from a bargain purchase (20,000)
When Jupiter’s consolidated financial statements are prepared at 30 June 20X5, the elimination
of investment asset entry will recognise this gain in profit or loss as the acquisition occurred
during the current year.
$ $
30.06.X5 Share capital 400,000
Opening retained earnings 200,000
Gain from a bargain purchase* 20,000
Investment in Pluto 580,000
To eliminate Jupiter’s share of the pre-acquisition equities of Pluto, which are reflected in the cost of the
investment
* Credited to opening retained earnings in future reporting periods.

Note that there is no deferred tax liability to be recognised on the gain from a bargain purchase
(IAS 12 para. 39)
FIN fact
A gain from a bargain purchase is recognised in the consolidated profit in the year of acquisition.
The gain will be recognised as a credit to opening retained earnings when future years’
consolidated financial statements are prepared.

Step 4(c) – Eliminate the investment asset STEP

4c
reserve entries
The parent’s statement of financial position will include an asset, being the investment in
the subsidiary.
Appendix B para. B86 of IFRS 10 requires both the carrying amount of the parent’s investment
in each subsidiary and the parent’s portion of equity of each subsidiary, to be eliminated.
Elimination of the investment asset through a consolidation journal entry is required because:
•• The consolidated financial figures represent the group, comprising a parent and its
subsidiaries. As it is not possible for an entity to show an investment in itself, the investment
asset in the parent’s records must be eliminated on consolidation.
•• When a parent acquires shares in a subsidiary, it is effectively gaining access to its relevant
share of the identifiable net assets of that subsidiary – hence the line-by-line inclusion of all
assets and liabilities of the subsidiary in the consolidation worksheet. The pre-acquisition
equity balances in the subsidiary’s records represent the other side of the net assets equation
and thus must be removed to avoid double counting.
•• Eliminating the parent’s share of pre-acquisition equities means that the parent’s share of
post-acquisition earnings and reserves remains in the consolidated financial statements.
•• Depending on the goodwill method applied, this consolidation entry recognises the
goodwill from the business combination as an asset.
FIN fact
The balance in the investment in subsidiary account should always be $0 after processing all
consolidation entries.
FIN fact
The acquisition analysis is reflected in the elimination of investment asset entry. This entry is
prepared every time consolidated financial statements are prepared.
Required reading
IFRS 10 Appendix B Application guidance paras B86 and B88.
Worked example 16.1: Recording entries to the BCVR account to recognise a fair value
adjustment for an asset
Worked example 16.2: Eliminating the investment asset at the acquisition date
Worked example 16.3: Preparing consolidation journal entries after the acquisition date

STEP
4d Step 4(d) – Eliminate intragroup transactions and balances
reserve entries
All intragroup assets, liabilities, equity, income, expenses and cash flows must be eliminated
in full in the consolidated financial statements. Profits or losses resulting from intragroup
transactions that are recognised in assets, such as inventory and fixed assets, must also be
eliminated in full.
IFRS 10 requires the elimination of intragroup transactions to be made in full as the NCI is
recognised in the consolidated financial statements as being part of the economic entity. The NCI
is adjusted to reflect its share of unrealised profits or losses on eliminated intragroup transactions
(this is covered in Step 4(e)).
Where there is an elimination adjustment required on a profit or loss arising from an intragroup
transaction, IAS 12 is applied to recognise any temporary difference.
FIN fact
When you alter profit on consolidation, a tax effect consolidation entry is generally required.
Common intragroup transactions or balances requiring elimination are:

•• Receivables/payables and associated interest.
•• Sales and purchases.
•• Unrealised profit/loss on inventory transfer.
•• Unrealised profit/loss on transfer of property, plant and equipment.
•• Dividends.
A visual representation of the relevant consolidation issues for each of these intragroup
transactions is presented in the five diagrams following.
For the purpose of these illustrations:
•• P is the parent.
•• S is the subsidiary.
•• P holds a 60% interest in S.
•• The year end is 30 June.
•• Any tax and NCI impacts are not considered.
Intragroup receivables/payables and associated interest

Often, transactions are not settled in cash but rather are charged to a current or loan account
(receivable or payable) recorded in the general ledger of each of the entities. If an entity is
recording the transactions accurately and in the same financial reporting period, then the
receivables and payables should be equal and must be eliminated in the consolidated financial
statements. Similarly, any related interest expense and interest revenue must also be eliminated.
For example, consider a scenario in which P makes a loan of $100,000 at 10% interest per annum
to S on 1 January 20X3.
This transaction will give rise to a $100,000 receivable in P’s accounting records and a
corresponding $100,000 payable in S’s accounting records. The loan will also result in interest
income of $5,000 being recorded by P during the six months to 30 June 20X3, and interest
expense of the same amount being recorded by S during that period.

These transactions are illustrated in the diagram below, including the consolidation journal STEP
4d
entries (shown to the right):
Group Consolidation journal entries
Loan of $100,000 at
10% interest per annum
advanced on 01.01.X3 $ $
P
30.06.X3 Loan payable 100,000
$5,000 interest due
on 30.06.X3 Loan receivable 100,000
$5,000 60% ownership $100,000
interest loan Being elimination of intragroup loan
S Date Account description Dr Cr

$ $
30.06.X3 Interest revenue 5,000
Interest expense 5,000
Being elimination of intragroup interest on loan
As the loan and resultant interest are transactions that take place between entities within a
group, they are required to be eliminated when preparing consolidated financial statements.
FIN fact
The balance in the intragroup receivables and payables should always be $0 after processing all
consolidation entries.
Intragroup sales and purchases

Intragroup sales and purchases must be eliminated because they are not transactions with
external parties.
For example, consider a scenario where P makes sales of $50,000 to S during the year ended
30 June 20X3. S, in turn, makes sales of $250,000 to P during that period.
These transactions are illustrated in the diagram below, including the consolidation journal
entry (shown to the right):
Group Consolidation journal entry

Intragroup sales during $ $
the year ended 30.06.X3
P 30.06.X3 Sales revenue 300,000
Cost of sales 300,000

$250,000 60% ownership $50,000
sales sales Being elimination of intragroup sales during the year
As the sales and resultant purchases are transactions that take place between entities within a
group, they are required to be eliminated when preparing consolidated financial statements.
Note here that the direction of sale does not matter as the elimination entry simply totals
the sales and eliminates the whole of the intragroup transaction from the consolidated
This consolidation journal entry is recorded on the assumption that the inventory that was
transferred internally via the intragroup sales, has all been sold outside the group by year end.
If some of this inventory is still on hand at year end, an additional consolidation journal entry
will be required to eliminate any unrealised profit.

STEP
4d
Unrealised profit/loss on inventory transfer
From a consolidation perspective, profits and losses are not realised until there has been a
transaction (i.e. sale) to an entity outside the group, or the asset is consumed within the group.
For example, consider a scenario in which S purchases inventory from an external supplier for
$50 on 1 May 20X2. S then sells that inventory to P on 15 June 20X2 for $80, generating a profit
of $30 (i.e. $80 – $50). P subsequently sells the inventory to an external party on 1 August 20X2
for $140, generating a profit of $60 (i.e. $140 – $80).
These transactions are illustrated in the diagram below:
Group
P 4 Inventory sold to external

party for $140 during 20X3
3 Group unrealised
profit is $30 at
30.06.X2 5 Group realises a
$80 60% ownership
$90 profit ($140 − $50)
2 S sold inventory inventory
in 20X3
to P for $80 in 20X2
and it is still on hand
at 30.06.X2
1 Inventory cost S
$50 in 20X2
This transaction will have an impact on the consolidation process in both the 20X2 and 20X3 years.
First, consider its impact on the 20X2 consolidation process. At 30 June 20X2, the inventory is
still held by the group. As a result of this intragroup sale, the carrying amount of inventory
and profit are both overstated by $30 from the group’s perspective. The inventory is currently
recorded by P at $80, but the cost of the inventory to the group was $50. The profit of $30
generated by S on the sale to P is considered unrealised profit from the group’s perspective at
30 June 20X2. A consolidation adjustment is required at 30 June 20X2 to eliminate the unrealised
profit and reduce the carrying amount of the inventory. The consolidation journal entry for the
unrealised profit is as follows:
Consolidation journal entry

$ $
30.06.X2 Cost of sales 30
Inventory 30
Being elimination of unrealised profit in closing inventory
Now consider the impact of the transaction on the 20X3 consolidation process. The inventory
is sold to an external party during the 20X3 financial year, and as a result the profit that was
considered to be unrealised in 20X2 from the group’s perspective has now been realised.
The total profit from the group’s perspective in relation to this sale is $90 (being $140 – $50).
As the amount of profit recognised by P on the sale to the external party is $60, a consolidation
adjustment is required in 20X3 to increase profit by $30. There will be a corresponding
adjustment required to opening retained earnings to reflect the fact that the profit was
unrealised at 30 June 20X2. The consolidation journal entry to recognise that the unrealised
profit has now been realised is as follows:

Consolidation journal entry STEP

4d
$ $
30.06.X3 Opening retained earnings 30
Cost of sales 30
Being elimination of unrealised profit in opening inventory that was sold during the year
Unrealised profit/loss on transfer of property, plant and equipment

Elimination adjustments are also required when other assets, such as property, plant and
equipment, are transferred between entities within the group, as unrealised profits and losses
may arise on the transfer. In these situations, it is necessary to eliminate any unrealised profit
or loss. Intragroup losses may indicate an impairment that requires separate recognition in the
consolidated financial statements (IFRS 10 para. B86(c)).
Where the asset is depreciable, it may also be necessary to make ongoing depreciation
adjustments, which will reflect the different depreciable values of the asset by both the
transferee and the transferor. As the asset is being consumed through its use within the group,
the depreciation consolidation adjustment processed each year of the asset’s remaining useful
life represents a realisation of part of the unrealised profit.
For example, consider a scenario in which S purchases a depreciable asset from an external
supplier for $120 on 1 July 20X1. The useful life of the asset at that time is assessed to be
six years. S then sells that depreciable asset to P on 1 July 20X2 for $160. As the carrying amount
of the asset at that time was $100 ($120 cost – $20 accumulated depreciation), S generated a
profit of $60 (i.e. $160 – $100). P holds the asset until the end of its useful life and depreciates the
asset over its remaining useful life of five years.
These transactions are illustrated in the diagram below:
Group
4 Group unrealised profit

is $60 at 30.06.X3
($160 − $100)
P 3 Useful life of the asset
has five years remaining
2 S sold depreciable No change to this
asset to P for $160 assessment when
at 01.07.X2 when the $160 60% ownership acquired by P
carrying amount asset
was $100 (12 months
after S acquired the asset)
1 Original cost of
asset is $120 on
S
01.07.X1
Useful life assessed
at six years
This transaction will have an effect on the consolidation process over a number of years,
commencing in 20X3 and continuing over the remaining useful life of the asset.
First, consider the impact on the 20X3 consolidation process. As a result of the intragroup sale,
the carrying amount of the depreciable asset and profit are both overstated from the group’s
perspective. The depreciable asset was initially recorded by P at $160, but the carrying amount
from the group’s perspective at the date of sale was $100. The profit of $60 generated by S on
the sale to P is considered unrealised profit from the group’s perspective at 30 June 20X3.

STEP A consolidation adjustment is required at 30 June 20X3 to eliminate the unrealised profit and
4d
reduce the carrying amount of the depreciable asset, as follows:

$ $
30.06.X3 Profit on sale of asset 60
Asset 40
Accumulated depreciation - asset 20
Being elimination of unrealised profit on depreciable asset sale and reinstate the original accumulated
depreciation
A further consolidation adjustment will be required at 30 June 20X3 to adjust the depreciation
expense that P has recognised. P will record a depreciation expense of $32 ($160 ÷ 5) for the
20X3 year. From the group’s perspective, the depreciation expense should be $20 ($120 ÷ 6)
based on the initial cost and useful life of the asset to the group. Therefore, a consolidation
adjustment is required at 30 June 20X3 to reduce the depreciation expense by $12, as follows:

$ $
30.06.X3 Accumulated depreciation - asset 12
Depreciation expense 12
Being adjustment to the depreciation recognised by the group
For the remaining useful life of the asset, consolidation adjustments will be required to carry
forward the entry, to eliminate the original unrealised profit and adjust for the cumulative effect
of depreciation.
Intragroup dividends
Parent entities often receive dividends from subsidiaries, which must be eliminated on
consolidation. The amount eliminated is calculated by reference to the ownership interest of the
immediate parent of the subsidiary paying the dividend.
For example, consider a scenario in which S declared and paid a dividend of $10,000 during the
year ended 30 June 20X3. Of this dividend, $6,000 was paid to P.

This transaction is illustrated in the diagram below: STEP

4d
Group
P
Subsidiary declared and
paid a $10,000 dividend
$6,000 60% ownership
dividend
paid
A consolidation adjustment will be required at 30 June 20X3 to eliminate the $6,000 dividend
revenue in P’s accounting records and the corresponding $6,000 dividend paid in S’s accounting
records, as follows:

$ $
30.06.X3 Dividend revenue 6,000
Dividend paid 6,000
Being elimination of the dividend paid by S that P has recognised as revenue
If a dividend has not been paid by the reporting date, the intragroup receivable and payable
relating to the dividend will also require elimination.
It is assumed that there is no tax effect resulting from the elimination of dividends due to
intragroup dividends being exempt from assessability under the prevailing tax laws.
Required reading
IFRS 10 Appendix B Application guidance para. B86(c).
Worked example 16.4: Eliminating intragroup transactions

Step 4(e) – Prepare the NCI allocations STEP

4e
reserve entries

STEP NCI is the equity in a subsidiary that is not attributable, directly or indirectly, to the parent.
4e
As 100% of a subsidiary’s assets, liabilities, income and expenses are included in the
consolidated financial statements under the line-by-line consolidation process, in instances
where the group does not wholly own a subsidiary, the NCI is recognised within equity to
reflect the economic substance of the subsidiary’s ownership.
The NCI can be shown diagrammatically as follows:
Company A
80%
20%
Company B NCI
Required reading
IFRS 10 para. 22 and Appendix B Application guidance paras B94–B95.
The preparation of the NCI allocations can be broken down into three sub-steps, as illustrated
below:
Step 4(e)(i) – Calculate the NCI percentage

STEP 4(e)(i) STEP 4(e)(ii) STEP 4(e)(iii)
Calculate Calculate the Record the NCI
the NCI NCI allocation allocation
percentage
The NCI is considered to be a contributor of capital to the economic entity. To the extent
that the equity of a subsidiary is not attributable to the parent, this will represent the NCI’s
ownership interest. Referring to the previous example of Companies A and B, there is a 20%
NCI percentage.
Step 4(e)(ii) – Calculate the NCI allocation

percentage
The NCI’s allocation of equity can be calculated as shown in the table below:
Component NCI
Current year profits or losses 
Current year dividends 
Share capital, opening retained earnings and reserves 
Under IFRS 10, 100% of a subsidiary’s equity (comprising both pre-acquisition and post-
acquisition balances) is initially included in the consolidation worksheet on a line-by-line basis.
Through a combination of the pre-acquisition investment asset elimination entry and the NCI
allocation, the remaining equity balances reflect the parent’s entitlement to each subsidiary’s
post-acquisition retained earnings and reserves. This method will therefore show what the
subsidiary has contributed to the group since control was obtained.

NCI allocation of current year profits, post-acquisition opening retained STEP

4e
earnings and reserves
In calculating the NCI allocation of current year profits, post-acquisition opening retained
earnings and reserves, IFRS 10 does not provide explicit guidance on its determination.
The approach taken in this unit when calculating adjustments when allocating to the NCI is:
N OMIC ENT
IT
E CO Y
60%
Parent
NCI
Adjust NCI (and tax effect) for. . . Don’t adjust NCI for. . .
• Depreciation and amortisation re • Intragroup revenue/expenses
fair value adjustment at eliminated on consolidation with
DO acquisition of subsidiary DON’T
no unrealised profit impact
• The group sold an asset or (e.g. interest)
settled a liability of a subsidiary • Impairment of goodwill
that was the subject of a fair (partial goodwill method)
value adjustment on acquisition
• Impairment of goodwill
(full goodwill method)
UPSTREAM SALES DOWNSTREAM SALES

• Unrealised profits in • Unrealised profits recognised
subsidiary’s general ledger in parent’s general ledger,
on inventory (consider eliminated on consolidation
opening and closing inventory) (e.g. inventory or non-current
• Unrealised profits in asset sales)
subsidiary’s general ledger
for non-current assets sales
(consider prior year and
current year as well as
consequential depreciation
impact)
Video resource
See the video on unrealised profits on inventory sales on myLearning.

STEP
4e Step 4(e)(iii) – Record the NCI allocation
percentage
The NCI is shown as a single line item in the equity section of the consolidated statement of
financial position.
FIN fact
The balance in the BCVR should always be $0 after processing all consolidation entries because
this account can never contain post-acquisition movements.
FIN fact
The balance in the share capital account should only be the parent’s own share capital after
processing all consolidation entries. The parent’s share of the subsidiary’s share capital must be
eliminated and the amount, if any, that belongs to an NCI is allocated to the NCI.
Worked example 16.5: Calculating the non-controlling interest

STEP
5 Step 5 – Prepare the consolidated financial statements
currency are
consistent with
the parent’s
The consolidated financial statements consist of the following:

•• Consolidated statement of profit or loss and other comprehensive income.
•• Consolidated statement of financial position.
•• Consolidated statement of changes in equity.
•• Consolidated statement of cash flows.
•• Notes to the consolidated financial statements.
The consolidated statement of profit or loss and other comprehensive income, statement of
financial position and statement of changes in equity are prepared based on the output from the
consolidation worksheet.
Key statements from the Harvey Norman Holdings Limited’s 2016 Annual report were
displayed in Unit 2. Refer to these now to identify that they are consolidated financial
statements. For example, you will notice that there is a non-controlling interest in the equity
section of the statement of financial position.

Further reading
KPMG 2017, ‘KPMG Example Public Company Limited: Guide to annual reports – Illustrative
disclosures 2016–17’.
Review the layout of the key consolidated statements in this example report.
Australia-specific
Where a parent of a consolidated group that prepares consolidated financial statements does
not prepare separate financial statements for the parent entity, reg. 2M.3.01 of the Corporations
Regulations 2001 requires consolidated financial statements to include certain disclosures about
the parent, including:
•• Profit or loss.
•• Total comprehensive income.
•• Equity separated between issued capital and individual reserve balances.
•• Current assets, total assets, current liabilities and total liabilities.
•• Guarantees provided in support of a subsidiary’s debts.
•• Contingent liabilities.
•• Contractual commitments for the acquisition of property, plant and equipment.
•• Comparative information for the previous period.
Separate financial statements

If the parent of the group presents separate financial statements in addition to the
consolidated financial statements, then the requirements (including disclosure requirements)
under IAS 27 Separate Financial Statements are followed for the preparation of the separate
In these separate financial statements, investments in subsidiaries, associates and jointly
controlled entities are accounted for at cost or in accordance with IFRS 9.
Assessing goodwill for impairment for partly owned subsidiaries

It is not possible to determine the recoverable amount of goodwill on its own as goodwill does
not produce cash flows independently of other assets. Therefore, goodwill is always tested for
impairment at a cash generating unit (CGU) level, as explained in Unit 10.
Recognising an impairment loss on goodwill for a partly owned subsidiary differs depending
on whether the full or partial goodwill method is applied.
Where the partial goodwill method is used to measure goodwill, the amount of goodwill needs
to be grossed up to include a notional amount of goodwill that is attributable to the NCI when
testing the goodwill for impairment (in accordance with IAS 36 Appendix C para. C4).
The issue can be illustrated by considering an example.

Example – Recognising a CGU impairment loss for a partly owned subsidiary

This example illustrates how to calculate and recognise a CGU impairment loss where there are
partly owned subsidiaries.
Peacock is the parent of numerous subsidiaries. Subsidiaries Alzir and Beid are separate CGUs for
the purposes of IAS 36, and there are indications of impairment at 30 June 20X8.
Acquisition details
Subsidiary/CGU Ownership Goodwill method applied to Goodwill arising

interest the business combination on acquisition
$
Alzir 80% Full goodwill method 500,000
Beid 70% Partial goodwill method 420,000
The goodwill that arises from each business combinations relates only to that particular
subsidiary, rather than benefiting other entities in the Peacock group.
Assume that the only identifiable assets of each subsidiary are plant and equipment with
carrying amounts as follows:
Carrying amount of identifiable assets at 30 June 20X8
CGU Plant and equipment

$
Alzir 700,000
Beid 800,000
For the purposes of the annual impairment testing of goodwill, the value in use for each CGU has
been determined as follows:
Value in use at 30 June 20X8
CGU $
Alzir 300,000
Beid 1,300,000
A fair value less costs of disposal cannot be measured for each CGU. Accordingly, the recoverable
amount for each CGU is its value in use.
To determine the carrying amount of each CGU, the carrying amount of the goodwill is added to
the carrying amount of identifiable assets for each subsidiary. The impairment loss can then be
determined as follows:
Carrying amount of each CGU at 30 June 20X8
CGU Goodwill Goodwill Carrying CGU carrying Recoverable Impairment

arising on gross up amount of amount amount loss
acquisition (a) required for identifiable (a) + (b) + (c) (value in use) (d) – (e)
impairment assets (c) = (d) (e)
testing (b)
$ $ $ $ $ $
Alzir 500,000 0 700,000 1,200,000 300,000 900,000
Beid 420,000 180,0001 800,000 1,400,000 1,300,000 100,000
Note 1 – As the partial goodwill method had been used for the business combination accounting for Beid,
the carrying amount of goodwill in Beid must be grossed up to reflect 100% of goodwill: $420,000 ÷ 70%
= $600,000. This adds $180,000 to the goodwill arising on the acquisition, effectively attributing a value for
goodwill to the 30% NCI.
This grossing up is a notional calculation, so that there is matching of like for like. The plant and equipment
value is a 100% amount; however, the goodwill value under the partial goodwill method is calculated as
belonging only to the parent and is therefore a 70% value.

It may seem there would be no impairment loss for the Beid CGU if the calculation were
performed without grossing up the goodwill. The carrying amount of the Beid CGU would be
$1,220,000 (i.e. $420,000 goodwill and $800,000 plant and equipment). With a recoverable
amount of $1,300,000 being higher than this carrying amount, this would suggest there is no
impairment loss. However, this approach is not in accordance with IAS 36 as it is not comparing
the grossed up value with the recoverable amount.
The impairment loss for each CGU, as correctly calculated in the table above, is first allocated to
that CGU’s goodwill and then, if there is a remaining impairment loss, it is allocated to the other
assets in the CGU (in this case plant and equipment) on a pro rata basis in accordance with IAS 36
para. 104. The impairment loss allocation for the Alzir CGU is as follows:
Alzir – allocation of impairment loss
Asset Carrying amount Allocation of Revised carrying

impairment loss amount
$ $ $
Goodwill (full goodwill method) 500,000 (500,000) 0
Plant and equipment 700,000 (400,000) 300,000
1,200,000 (900,000) 300,000
The $100,000 impairment loss allocation for the Beid CGU is performed differently. Only $70,000
of this impairment loss for goodwill is actually recognised because the $100,000 impairment
loss calculated was based on 100% values using a notional grossed up value for goodwill. The
$30,000 difference ($100,000 – $70,000) is not allocated to Beid’s plant and equipment as it
results only from this notional calculation required by IAS 36.
The CGU impairment losses are recognised through consolidation journal entries as the goodwill
is only recognised as a separate asset when the consolidated financial statements are being
prepared (as explained in Step 4 of the consolidation process).
$ $
30.06.X8 Impairment loss 900,000
Accumulated impairment losses – goodwill 500,000
Accumulated depreciation and impairment losses – 400,000

plant and equipment
To recognise the impairment loss for the Alzir CGU to reduce the goodwill to a revised carrying amount of
$0 and the plant and equipment to a carrying amount of $300,000
$ $
30.06.X8 Impairment loss 70,000
Accumulated impairment losses – goodwill 70,000
To recognise the impairment loss for the Beid CGU to reduce the goodwill to a revised carrying amount of
$350,000

Consolidating a foreign subsidiary

The unit on foreign exchange covers the translation of foreign operations financial
statements and should be attempted before working through this section. That unit contains
a table of applicable exchange rates to apply when translating functional currency to
presentation currency.
When a parent holds an interest in a foreign subsidiary, the normal consolidation procedures
apply. However, when calculating amounts to be recorded in consolidation journals,
consideration must be given to foreign currency translation and related measurement
issues. In the FIN module only the consolidation of a wholly owned foreign subsidiary will
be considered.
An investment in a foreign subsidiary has an impact on the application of Step 4 of the
consolidation process, as discussed below.
FIN fact
The goodwill acquired from a business combination involving the acquisition of a foreign
subsidiary is treated as an asset of the foreign subsidiary. The goodwill must be translated at the
spot rate at reporting date whenever consolidated financial statements are prepared.
Perform an acquisition analysis, prepare any BCVR entries and eliminate the
investment asset (Steps 4(a)–(c))
One fundamental issue when accounting for a foreign subsidiary is the treatment of goodwill
and fair value adjustments arising on acquisition.
IAS 21 para. 47 requires any goodwill arising on the acquisition of a foreign operation, and any
fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition
of that foreign operation, to be treated as assets and liabilities of the foreign operation. Such
balances are therefore expressed in the functional currency of the foreign operation and are
subject to translation into the group’s presentation currency each period. Assuming that
exchange rates move from what they were at the acquisition date, when preparing a later
consolidation this will mean:
•• There will be a foreign currency translation reserve (FCTR) balance within a fair value
adjustment entry because the BCVR is translated at the historical rate, while the asset,
accumulated depreciation and deferred tax balances are translated at the spot rate at the
reporting date.
•• Subsequent depreciation or amortisation adjustments arising from fair value adjustments
also have an FCTR balance because the depreciation or amortisation, being an expense, is
translated at the average exchange rate for the period, while the accumulated depreciation
or amortisation is translated at the closing rate at the reporting date.
•• There will be an FCTR balance within the elimination of investment entry, because parts of
the entry are translated at the historical rate while any goodwill, being considered an asset
of the subsidiary, is translated at the spot rate at the reporting date.
Required reading
IAS 21 para. 47.
Eliminate intragroup transactions and balances (Step 4(d))

Neither IAS 21 nor IFRS 10 provide specific guidance on the appropriate exchange rate to be
used when eliminating intragroup transactions between the parent and the foreign subsidiaries.
The approach adopted in this unit and commonly used in practice is as follows:
•• Intragroup sales and purchases and other intragroup revenue and expenses are eliminated
using the exchange rate applicable at the transaction date (or, if applicable, the average
exchange rate).

•• Unrealised profits or losses on inventory and other asset transfers are eliminated using
the exchange rate applicable at the transaction date. There is no further requirement to
re‑translate any asset or liability components of this consolidation journal entry to the
period end rate.
•• Dividends declared are eliminated using the exchange rate applicable at the declaration date.
•• Intragroup payables and receivables are eliminated using the closing rate.
Tax-effect entries are calculated using the tax rate of the country holding the asset, rather than
the rate applicable to the entity that recognised the unrealised profit. This is because IAS 12
requires the recognition of a temporary difference since the tax base of the asset is different
from its carrying amount.
Further reading
Consolidating a foreign subsidiary

Accounting for movements in investments
Learning outcome
4. Account for movements in the parent’s interest in a subsidiary.
This section covers two types of movements in a parent’s interest in a controlled entity:
•• The acquisition of an additional investment whereby an associate becomes a subsidiary
(a step acquisition).
•• The new issue of shares by a subsidiary.
Accounting for movements in a parent’s interest in a controlled entity can be a complicated

process with many possible scenarios. This section establishes the key principles for identifying
the issues that may arise in accounting for the types of movements listed above.
Acquisition of additional investment (step acquisition)

Acquisitions of additional interests that result in a change in the classification of an investment
from an associate to a subsidiary are not addressed in either IFRS 10 or IAS 28 Investments in
Associates and Joint Ventures.
IFRS 3 paras 41 and 42 specify the accounting treatment for a business combination achieved in
stages, which is commonly referred to as a step acquisition.
IFRS 3 requires the acquirer to remeasure its previously held interest in the acquiree at fair
value at acquisition date, being the date control was achieved. Any difference between the
carrying amount and the fair value of the previously held interest must be recognised in profit
or loss. Any amount that was previously recognised in other comprehensive income, and that
would be reclassified to profit or loss in the event of a disposal, is reclassified to profit or loss.
Once the parent has gained control of the acquiree, it will need to include the acquiree in its
consolidated financial statements, or commence preparing consolidated financial statements
if it has no other subsidiaries.
Required reading
Further reading
Accounting for movements in investments – step acquisitions
New issue of shares by a subsidiary

A subsidiary may issue additional shares to new or existing shareholders to raise further equity.
Any change in the parent’s ownership interest of a subsidiary after control has been obtained
is accounted for as transactions with equity holders in their capacity as equity holders.
Accordingly, there is no adjustment to profit or loss as a consequence of any changes in the
parent’s ownership interest where control is maintained.
A share issue transaction will result in an increase in the net assets of the subsidiary, with a
corresponding increase in its contributed equity. There is no change to the retained earnings
and reserves of the subsidiary. After the share issue, the retained earnings and reserves
attributed to the parent entity and the NCI must reflect the parent’s ownership interest after the
issue of the shares.
Required reading
IFRS 10 para. 23 and Appendix B Application guidance para. B96.

Disclosures
The disclosures concerning a consolidated group are found in IFRS 12. This Standard also
applies to disclosures for interests in joint arrangements and associates, which are covered
in Unit 17. While IFRS 12 also applies to interests in unconsolidated structured entities, these
disclosures are beyond the scope of this unit.
There are two main types of disclosures for interests in subsidiaries, as outlined in the
table below:
Disclosures for interests in subsidiaries
Type of disclosures Disclosures include
Significant judgements and An explanation of the significant judgements and assumptions made in
assumptions determining whether the entity controls another entity
Interests in subsidiaries Information about:

•• Group composition
•• Nature of risks associated with an entity’s interest in consolidated structured
entities, including restrictions on use of assets or ability to settle liabilities
•• Non-controlling interests
•• Change in ownership of a subsidiary during the reporting period that does
not result in loss of control
•• Details of subsidiaries for which loss of control occurred during the
reporting period
Required reading
IFRS 12 paras 7–9, 10–13, 18–19.
Adaptive learning lesson: The consolidation process

Quiz
Remember to attempt Integrated activity 3

Integrated activity 3 – how a consolidation worksheet works



Unit 17: Equity Accounting
Contents
Introduction 17-3
Differences between the equity method and the consolidation method 17-4
Applying the equity method 17-5
Complexities with equity accounting 17-14
Changes in ownership interests 17-14
Consolidating a foreign associate or joint venture 17-14
Recognising the tax effect of the equity carrying amount of the investment 17-14
Impairment of the investment in associate or joint venture 17-14
Discontinuing equity accounting 17-14
Significant influence and joint control 17-16
Identifying associates: significant influence 17-16
Establishing when joint control exists 17-17
Disclosures – interests in joint arrangements and investments in associates 17-18
fin11917_csg_05


Learning outcomes
1. Explain and account for an investment using the equity method.
Introduction
The diagram below is from the Introduction to Units 15-17. Now that you have covered
business combinations, it is worth reviewing the connections between the different units and
different Accounting Standards.
combina
ess ti
in U15
on
s
Bu
s
Does the investor gain
control in the business
combination?
IFRS 3 Business
for subs
ing id
Combinations
nt U16 YES
ou
iar
NO
Acc
ies
Consolidation
nts and investments

in accordance
eme
with IFRS 10
g U17
in a
Disclosures per
rran sso
IFRS 12 t a cia
n te
oi Does the investor have joint control?
s
J
IFRS 11 Joint Arrangements instrum

cial e
YES NO an U9
nt
Fin
s
Classify the joint arrangement Does the investor have Account for
in accordance with IFRS 11 significant influence over the NO the investment in
investee? accordance with
IFRS 9
IAS 28 Investments in
JOINT Associates and Joint Ventures Disclosures per
OPERATION IFRS 7
Account for assets, YES
liabilities, revenue
and expenses in JOINT INVESTMENT
accordance with VENTURE IN ASSOCIATE
IFRS 11
Disclosures per
IFRS 12
Equity accounting in
Disclosures per IFRS 12
Unit 9 discussed investments that fell under IFRS 9 Financial Instruments. Units 15 and 16 looked
at situations where control was established under IFRS 3 Business combinations, and consolidated
financial statements were prepared in accordance with IFRS 10 Consolidated Financial Statements.
This unit examines equity accounting. Equity accounting is applied in two different situations:
1. Investments in associates, where significant influence is established under
IAS 28 Investments in associates and Joint Ventures.
2. Joint ventures, where joint control is established under IFRS 11 Joint Arrangements.

Financial Associate: Significant Subsidiary:

asset influence IAS 28 control IFRS 3
IFRS 9 Joint Venture: joint and consolidation
control IFRS 11 IFRS 10
The unit will start by examining how to apply the equity method of accounting, first by
introducing the differences between equity accounting and consolidations, and then by walking
through the equity method step-by-step.
Later sections discuss why you need to apply the equity method, and analyse the factors that
need to be considered when establishing significant influence under IAS 28 and joint control
under IFRS 11.

Differences between the equity method and the consolidation

method
The reasons why we use the equity method are similar to why we consolidate: to present the
post-acquisition movements in retained earnings and reserves of the acquired entity. The
appearance of the two methods in the financial statements is quite different. The consolidation
method is covered in Unit 16.
Key differences between the equity method and the consolidation method
Considerations Equity method Consolidation method
Equity method used for

Consolidation method used
associates
for subsidiaries
(with significant influence)
(with control)
and joint ventures
IFRS 3 and 10
(with joint control IAS 28)
Accounting method applied Single-line Line-by-line aggregation

(investment in associate) (each asset, liability, equity
item, revenue and expense is
consolidated)
Adjustments Most equity accounting adjustments Consolidation adjustments

are recorded against: can be made against most
•• investment in associate/investment accounts, leading to a line-by-line
in joint venture (statement of aggregation
financial position)
•• ‘share of associate’s profit after tax’
or ‘share of joint venture’s profit after
tax’ (SPLOCI)
Proportion of investee’s The investor’s share of the associate or 100% of a subsidiary’s balances
balances recognised joint venture’s post-acquisition earnings are included in the consolidated
and reserves are recognised and financial statements and 100%
generally the investor’s share of inter- of inter-entity transactions are
entity transactions are eliminated eliminated, with appropriate
adjustments to reflect any non-
controlling interest

View the video on myLearning for a more detailed explanation of the similarities and
differences between the equity method of accounting and consolidations.
Unit 17 Equity accounting – the basics

Applying the equity method

The equity method of accounting is generally based on the investor’s ownership interest in an
associate or joint venture. Ownership interest is the percentage of equity held in an associate or
joint venture, directly or indirectly, by the investor.
The step-by-step process detailed below can be used when applying the equity method.
Required reading
IAS 28 paras 10–11, 16 and 27.
Step 1 – Ensure consistent accounting policies and reporting dates

Ensure Determine Prepare all
consistent where to necessary
accounting apply the equity
policies and equity accounting
reporting dates method journals and
adjustments
required by
IAS 28
IAS 28 para. 35 requires the investor’s financial statements to be prepared using uniform
accounting policies for like transactions and other events in similar circumstances. If an
associate or joint venture uses accounting policies other than those adopted by the investor,
appropriate adjustments must be made when using that entity’s financial statements
(IAS 28 para. 36).
In the event that the reporting date of the associate or joint venture is different to that of the
investor, adjustment for significant transactions or events to align the financial statements with
those of the investor should be made. If this is impractical, a maximum difference of three
months between the end of reporting periods is permissible (IAS 28 para. 34).
Required reading
IAS 28 paras 33–36.

Step 2 – Determine where to apply the equity method

adjustments
required by
IAS 28
It is important to determine where to record the equity method journal entries and to identify
whether there are further accounting requirements in respect of the investment in the associate
or joint venture under IAS 27 Separate Financial Statements.
Application of the equity method
Accounts prepared by Where is the equity Nature of the equity Does IAS 27 also apply?
the investor method applied? journal entries
The investor prepares In the consolidated Equity journal entries are If the parent entity itself
consolidated financial financial statements notional (i.e. recorded holds the investment
statements as it is a in the consolidation in the associate or joint
parent entity in a group worksheet only) venture, then it applies
IAS 27 in its separate
In the parent’s separate
financial statements,
the investment can be
accounted for:
•• at cost, or
•• in accordance with
IFRS 9 Financial
Instruments, or
•• by applying the equity
accounting method in
The investor does not In the investor’s own Equity journal entries are No
prepare consolidated separate financial permanent (i.e. recorded
financial statements as it statements in the general ledger)
is not a parent entity in
a group
The activity for this unit assumes that the investor is a parent entity; that is, it prepares
consolidated financial statements. Therefore, the equity journal entries are recorded through the
consolidation worksheet as notional entries. The journal entries will need to reflect current year
movements in retained earnings and reserves as well as post-acquisition movements of prior
years, given that these notional entries do not carry forward from previous years.
Required reading
IAS 28 paras 2, 4 and 44.
IAS 27 para. 10.

Step 3 – Prepare all necessary equity accounting journals and adjustments

required by IAS 28

adjustments
required by
IAS 28
Similar to a business combination, an investor is required to determine the amount of any

goodwill or negative goodwill at the acquisition date (IAS 28 para. 32).
Its treatment is summarised in the following table:
Amount How is the amount Is an equity Equity accounting treatment

calculated? accounting entry
required to remove
the amount from the
investment cost?
Goodwill Investment cost No Any goodwill is not separately

less recognised and remains in the
carrying amount of the investment.
Investor’s share of the net The goodwill amount is not tested
fair value of the investee’s separately for impairment, nor is
identifiable assets and liabilities it amortised
Negative Investor’s share of the net Yes The negative goodwill is recognised
goodwill fair value of the investee’s as income in the determination of
identifiable assets and liabilities the entity’s share of the associate’s
less or joint venture’s profit or loss in the
year of acquisition. A corresponding
Investment cost adjustment is made to the equity
carrying amount
Therefore, goodwill/negative goodwill must be calculated at acquisition date because if there

is negative goodwill, an equity accounting entry must be recorded to recognise the amount
as income.
Example – Calculation of goodwill and negative goodwill

This example illustrates how to calculate goodwill and negative goodwill when an investor gains
significant influence over an investee. In the case of negative goodwill, an equity accounting
entry will need to be recorded.
On 1 July 20X4, Brave purchased 40% of the ordinary issued shares of Timid Limited and gained
significant influence over the investee. Brave must equity-account the investment in this
associate under IAS 28.
At the acquisition date the recorded net assets of Timid were:
Net assets of Timid at 1 July 20X4
Item $
Issued capital (400,000 shares) 400,000
Total equity/net assets 440,000

Timid’s identifiable assets acquired and liabilities assumed were recorded at fair value except
for an unrecorded brand name which had a fair value of $100,000 and an estimated remaining
useful life of five years.
(i) If Brave paid $250,000 for the investment
Calculation of goodwill
Goodwill acquired in Timid at 1 July 20X4
Item $ $
Cost of investment 250,000
Assets acquired
Book value of net assets 440,000
Fair value adjustment re brand name net of tax

(($100,000) × (1 – 30%)) 70,000
Share of FVINA acquired (40%) 204,000
Goodwill acquired that is included in the investment cost 46,000
The $46,000 in goodwill is included in the cost of the investment in Timid and does not
require an equity accounting journal entry to be recorded.
(ii) If Brave paid $150,000 for the investment
Calculation of negative goodwill
Negative goodwill on the acquisition of Timid at 1 July 20X4
Item $ $
Cost of investment 150,000
Assets acquired
Book value of net assets 440,000
Fair value adjustment re brand name net of tax

(($100,000) × (1 – 30%)) 70,000
Share of FVINA acquired (40%) 204,000
Negative goodwill that is included in the investment cost (54,000)
The ($54,000) in negative goodwill is included in the cost of the investment in Timid.
When the equity accounting entries are recorded for the first reporting period, the ($54,000)
will be recognised as income in the determination of the entity’s share of the associate’s
profit or loss (IAS 28 para. 32(b)).
$ $
30.06.X5 Investment in Timid 54,000
Share of associate’s profit after tax 54,000
To recognise the negative goodwill as income in the year that Brave acquired its interest in Timid
Required reading
IAS 28 para. 32

Equity accounting journal entries

The equity method involves the subsequent measurement of the carrying amount of the
investment at an amount that includes the post-acquisition movements of the associate or
joint venture. The investor’s share of post-acquisition movements in the retained earnings and
reserve balances is recorded by raising equity accounting journal entries.
This procedure within the equity accounting process is the most time-consuming. It can be
broken down into four sub-steps:
Sub-step 3a – Record the investor’s share of current year profits or losses of the associate
or joint venture
The investor recognises its share of the investee’s profit/(loss) for the financial period.
IAS 1 Presentation of Financial Statements para. 82(c) requires the share of the profit or loss
of associates and joint ventures accounted for using the equity method to be disclosed as
a separate line item in the statement of profit or loss and other comprehensive income.
To facilitate ease of disclosure, the equity journal entry to record this share of profit or loss may
be made to an account called ‘share of associate’s/joint venture’s profit after tax’.
Required reading
IAS 1 para. 82(c).
Sub-step 3b – Record the investor’s share of post-acquisition movements in reserves and

opening retained earnings in the associate or joint venture
If there has been a post-acquisition movement in the associate’s opening retained earnings
and/or reserves, the investor’s share of these movements must also be recognised (IAS 28
para. 10). A common example of a post-acquisition reserve movement is a credit to a revaluation
surplus following the upward revaluation of an asset to fair value under IAS 16 Property,
Plant and Equipment.
Current year reserve movements require disclosure. IAS 1 para. 82A requires that the current
year share of other comprehensive income of associates and joint ventures, accounted for
using the equity method, be disclosed as a separate line item in other comprehensive income.
To facilitate ease of disclosure, the equity journal entry to record the current year share of a
revaluation surplus may be made to an account called ‘share of associate’s/joint venture’s
revaluation surplus’.
FIN fact
The equity carrying amount of the investment is increased or decreased to recognise the
investor’s share of post-acquisition profits and post-acquisition reserve movements.
Required reading
IAS 1 para. 82A.
IAS 28 para.10.

Sub-step 3c – Eliminate the effect of current year dividends paid or declared by the associate
or joint venture
Dividends distributed by an investee and recognised as income by the investor in the current
period must be eliminated to avoid double-counting, as the dividend amount has effectively
been included through the equity journal entries recorded in sub-steps 3a and/or 3b above.
FIN fact
The equity accounting method includes the investor’s share of post-acquisition closing retained
earnings in the equity carrying amount of the investment. As dividends are paid from profits
included within closing retained earnings, they must be subtracted – otherwise we would be
double-counting these profits.
Sub-step 3d – Record adjustments to the share of associate’s or joint venture’s profits or losses
as required
In recognising the investor’s share of the associate’s current year results and post-acquisition
movements in opening retained earnings, it may be necessary to make the following adjustments:
1. Negative goodwill on acquisition.
If, on acquisition of the associate or joint venture there is negative goodwill, the amount
is recognised as income in the year the investment was acquired in determining the share
of the investee’s profit or loss with a corresponding adjustment to the investment carrying
amount (refer to earlier example).
2. Fair value and depreciation adjustments.
A depreciation or amortisation adjustment is required if a fair value adjustment to depreciable
or intangible assets forms part of the acquisition analysis in the associate or joint venture.
If the carrying amount of an asset is less than its fair value at acquisition date, a notional
adjustment to the asset must be made as part of the acquisition analysis. In addition, if
the carrying amount has not subsequently been revalued or recognised in the books of
the associate or joint venture, any depreciation or amortisation on the asset is understated
from the point of view of the investor. In this case, an adjustment is needed to recognise
additional depreciation or amortisation, which will result in a reduction in the investor’s
share of the associate’s or joint venture’s profits.
If the carrying amount of an asset is more than its fair value at acquisition date, a notional
adjustment to the asset will be required in the acquisition analysis. If an impairment has
not been recognised in the books of the associate or joint venture, an adjustment will be
required to reduce the depreciation or amortisation, which will result in an increase in the
investor’s share of the associate’s or joint venture’s profits.
3. Elimination of unrealised profits and losses on transactions between the investor and the
associate or joint venture.
IAS 28 para. 28 requires that adjustments must be made to eliminate unrealised profits and
losses on transactions between the associate or joint venture and the investor.
Where a transaction results in a profit

Irrespective of whether the transaction is ‘upstream’ or ‘downstream’, an adjustment
is made to eliminate the investor’s share in the investee’s profits resulting from these
transactions, so the entity’s financial statements include the transaction only to the extent of
the unrelated investor’s interest. Such adjustments may be required on the sale of inventory
or non-current assets, which may be depreciable. Where depreciable non-current assets are
transferred between entities, consequential depreciation adjustments will also be required.

Example – Upstream versus downstream transaction

This example illustrates the equity accounting entries for upstream and downstream transactions.
Bossy Boots owns 45% of Agreeable and exerts significant influence over the investee.
The ownership structure is as follows:
Bossy Boots
45% Significant
ownership influence
Agreeable
Both companies manufacture footwear.

Profit after tax for the year ended 30 June 20X8:
•• Agreeable: $800,000.
•• Bossy Boots: $2,000,000.
The tax rate is 30%.
Scenario 1: Associate sells to investor – upstream sale
Bossy Boots
45% Upstream
ownership sale
Agreeable
During the year, Agreeable sold running shoes to Bossy Boots. This is an upstream sale. The cost
to Agreeable was $200,000 and the selling price was $280,000, resulting in $80,000 profit. Bossy
Boots has not sold any of this inventory by 30 June 20X8. Under the equity accounting method
of accounting, this profit is unrealised and cannot be recognised by Bossy Boots until the shoes
are sold to an unrelated party.
The simplest way to eliminate the unrealised profit existing at 30 June 20X8 is when calculating
the investor’s share of the associate’s profit for the year.
Item Calculation
Current year profit after tax 800,000
Less unrealised profit in closing inventory (56,000)

($80,000 × (1 – 30%))
Adjusted current year profit 744,000
Bossy Boots’ 45% interest 334,800

If Bossy Boots had sold all of the running shoes, it would recognise $360,000 ($800,000 × 45%)
as its share of the associate’s profit for the year. However, as the running shoes are still owned
by Bossy Boots, only $334,800 can be recognised, which would be recorded in this equity
accounting journal entry:
$ $
30.06.X8 Investment in associate 334,800
Share of associate’s profit after tax 334,800
To record Bossy Boots’ share of Agreeable’s profit for the year ended 30 June 20X8
Scenario 2: Investor sells to associate – downstream sale
Bossy Boots
45% Downstream
ownership sale
Agreeable
During the year, Bossy Boots sold boots to Agreeable. This is a downstream sale. The cost to Bossy
Boots was $400,000 and the selling price was $520,000, resulting in a $120,000 profit. Agreeable
has not sold any of this inventory by 30 June 20X8.
In this situation, it is Bossy Boots’ profit, not Agreeable’s profit, which needs to be adjusted. This is
because Bossy Boots has recognised 100% of the profit on the sale of boots in its general ledger.
IAS 28 only permits the profit to be recognised to the extent of the unrelated interest, which in
this case is 55% (1 – 45%). Therefore, 45% of the $120,000 profit must be eliminated and can only
be recognised when the boots are sold by Agreeable to an unrelated party.
Included in Bossy Boots’ $2,000,000 profit after tax is a profit after tax of $84,000 (($120,000 ×
(1 – 30%)) on the sale of the boots to Agreeable. Because the sale was made by the investor to
the associate, $37,800 (45% of the $84,000 profit) is unrealised and needs to be eliminated as an
equity accounting adjustment. Under the equity method of accounting the downstream profit is
eliminated by adjusting the relevant accounts of the investor line by line, as follows:
$ $
30.06.X8 Revenue1 234,000
Cost of sales2 180,000
Income tax expense 3

16,200
Investment in associate4 37,800
To record the adjustment for the transfer of inventory from Bossy Boots to
Agreeable, being the current year downstream unrealised profit
This journal entry will be reversed in the next reporting period, assuming Agreeable sells the
boots in that period.

Notes
1. $520,000 × 45% = $234,000. Bossy Boots’ revenue is overstated, as 45% of the $520,000 transfer made to Agreeable is
considered unrealised (as it is still unsold) and therefore needs to be eliminated.
2. $400,000 × 45% = $180,000. Bossy Boots’ cost of sales is also overstated and requires an equivalent adjustment.
3. ($234,000 – $180,000) × 30% = $16,200. As the profit before tax has been reduced by $54,000, a corresponding
reduction in income tax expense is required.
4. ($234,000 – $180,000) × (1 – 30%) = $37,800. The net effect of these adjustments reduces the carrying amount of
Bossy Boots’ investment in Agreeable.
FIN fact
When there is an unrealised profit, draw a diagram to determine who made the sale.
The unrealised profit is captured in the seller’s profit. Then apply the appropriate equity
accounting treatment depending on whether it is an upstream or a downstream unrealised profit.
Where a transaction results in a loss

If the transaction results in a loss, it may indicate evidence of a decline in the net realisable value
of the asset or the impairment of the asset subject to the transaction. If so, para. 29 requires the
loss on downstream transactions to be recognised in full and a loss on upstream transactions to
be recognised to the extent of the investor’s share.
Tax effect implications of certain equity accounting adjustments

Step 3 of applying the equity accounting method outlines four sub-steps requiring equity
accounting journal entries. The view taken for the purposes of the FIN module, reflecting
common practice, is that certain equity accounting adjustments should be recorded on an
after‑tax basis.
IAS 28 does not specify that income tax consequences under IAS 12 Income Taxes are required
when applying the equity method; however, IAS 28 para. 26 states that:
Many of the procedures that are appropriate for the application of the equity method are similar to the
consolidation procedures described in IFRS 10. Furthermore, the concepts underlying the procedures
used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition
of an investment in an associate or a joint venture.
As covered in the unit on accounting for subsidiaries, IFRS 10 Appendix B Application

guidance para. B86(c) provides guidance on tax effect adjustments. It requires IAS 12 to be
applied to temporary differences that arise from the elimination of profits and losses resulting
from intragroup transactions when preparing consolidated financial statements. Similarly, as
covered in the unit on business combinations, IFRS 3 requires deferred tax assets or liabilities
to be recognised on the restatement of assets and liabilities to fair value when performing the
acquisition accounting for a business combination.
Accordingly, when applying the equity method, adjustments specified in sub-step 3d points 2
and 3 should be recorded on an after-tax basis.
Required reading
IAS 28 paras 26 and 28–31.
Activity 17.1: Accounting for an investment in an associate under the equity method of
accounting

Complexities with equity accounting

This section outlines a number of complexities that can arise with equity accounting, however
practical application of these issues is beyond the scope of the FIN module.
Changes in ownership interests

In this unit we only consider the accounting treatment applicable if an entity’s ownership
interest in an associate or a joint venture is reduced but the entity continues to apply the equity
method. The entity must reclassify to profit or loss the proportion of the gain or loss that
had previously been recognised in other comprehensive income relating to the reduction in
ownership interest if that gain or loss would be required to be reclassified to profit or loss on
the disposal of the related assets or liabilities (IAS 28 para. 25).
Consolidating a foreign associate or joint venture

When an entity holds an interest in a foreign associate or joint venture, the normal equity
accounting procedures outlined apply. However, when calculating the amounts to be recorded
in the equity accounting journals, consideration must be given to foreign currency translation
issues as covered in the unit on foreign exchange.
Recognising the tax effect of the equity carrying amount of the

investment
On application of the equity method, there will be a difference between the original cost of the
investment and the equity-accounted carrying amount of the investment. This can give rise to a
temporary difference which is accounted for under IAS 12 Income Taxes.
Impairment of the investment in associate or joint venture

After the application of the equity method, including recognising the associate’s or joint
venture’s losses, the entity needs to determine whether it is necessary to recognise any
additional impairment loss on its investment.
IAS 28 provides specific guidance on assessing objective evidence of impairment of the
investment in the associate or joint venture. IAS 36 Impairment of Assets is applied to account for
an impairment loss.
Discontinuing equity accounting

Under IAS 28, the equity method of accounting must be discontinued in either of the following
situations:
1. The investor no longer significantly influences the investee.
In this situation, the investor must measure at fair value any investment retained in the
former associate or joint venture. The investment is then accounted for in accordance with
IFRS 9. Any difference between the fair value of the remaining investment, along with any
proceeds from disposing of part of the investment and the equity carrying amount at the
date when significant influence was lost, is recognised in profit or loss (IAS 28 para. 22(b)).

2. The investor’s share of the investee’s losses reduces the carrying amount of the
investment to below $0.
In this situation, the equity method must be discontinued and the investment recorded as
$0 (IAS 28 para. 38). A liability for additional losses is recognised by the investor only in
limited circumstances. When the investor resumes the application of equity accounting,
it must not recognise its share of profits until these offset its share of losses not recognised
(IAS 28 para. 39).
Required reading
IAS 28 paras 22, 25 and 38–43.
Determining the guidance to follow when accounting for joint arrangements

and investments where the investor has significant influence
Accounting treatment is applied under

NO IFRS 9 Financial Instruments
Does the investor have significant

influence over the investee?
Equity method of accounting is applied

YES under IAS 28 unless there is scope
exclusion
NO
START Does a joint

HERE arrangement exist?
YES
Accounting treatment for the party

Does the party to the joint that participates in but does not
arrangement have joint control? NO share in joint control is specified in
IFRS 11 paras 23 and 27
YES
Accounting for underlying
JOINT assets and liabilities applied
OPERATION by joint operator
under (IFRS 11 para. 20)
Is the arrangement a joint
operation or a joint venture?
Equity method of accounting
JOINT is applied under IAS 28 unless
VENTURE there is scope exclusion
(IFRS 11 para. 24)
Note: If an investor has control over an entity, then IFRS 10 Consolidated Financial Statements is applied.

Significant influence and joint control
Learning outcome
This section will explore:

•• the concepts of significant influence, under IAS 28, and
•• classification as a joint venture (with joint control) under IFRS 11.
The principles around the requirements of joint control or significant influence within each
standard must be satisfied, prior to applying equity accounting.
Identifying associates: significant influence

IAS 28 para. 3 defines an associate as ‘an entity over which the investor has significant
influence’. Understanding and applying the definition of significant influence is therefore the
key factor in determining application of equity accounting under IAS 28. Key paragraphs of the
standard in determining significant influence are outlined in the diagram below:
IAS 28 para. 5
20% or more voting
power of investee =
IAS 28 para. 3
presume significant
ASSOCIATE: ‘an entity
influence
over which the investor
has significant influence’
IAS 28 para. 6
notes indicators of
significant influence
IAS 28 para. 7
potential voting rights
must be considered in
deciding if there is
significant influence
Required reading
IAS 28 paras 3 and 5–9.

Example: Establishing significant influence

Bam-bam Limited (Bam-bam) acquired 18% of Teeny Tiny Limited (Teeny Tiny) on 1 April 20X7,
with commensurate voting rights. Bam-bam is guaranteed one of the six seats on the board of
directors, where key operational and strategic decisions for Teeny Tiny are made. Bam-bam’s
wholly owned subsidiary, Slamdunk Limited, holds a further 5% of the shares in Teeny Tiny.
You have been asked to determine if Bam-bam has significant influence over Teeny-Tiny at
30 June 20X7.
Applying the requirements of IAS 28 para.5, Bam-bam’s direct shareholding would not be
presumed to result in significant influence as it is under 20%. However, this paragraph requires
Bam-bam to also consider indirect shareholdings. By including the voting rights held by
Slamdunk, this results in Bam-bam achieving more than 20% of the voting rights, which is
presumed to be significant influence, unless evidence can be shown to the contrary.
The seat Bam-bam holds on the board of directors further demonstrates Bam-bam’s influence,
as it is one of the indicators noted in IAS 28 para.6. As such, we would conclude Bam-bam has
significant influence over Teeny Tiny, and apply equity accounting as required by IAS 28 para.16.
Establishing when joint control exists

Two kinds of joint arrangements are covered by IFRS 11: joint operations, and joint ventures.
Joint venture is defined by IFRS 11 Appendix A as ‘a joint arrangement whereby the parties
that have joint control of the arrangement have rights to the net assets of the arrangement’.
IFRS 11 distinguishes joint ventures from joint operations, as each of these arrangements is
accounted for differently. Once an arrangement is classified as a joint venture by IFRS 11, it is
accounted for using the equity method in IAS 28.
Joint control is a common feature of both joint ventures and joint operations.
Joint control is defined as ‘the contractually agreed sharing of control of an arrangement, which
exists only when decisions about the relevant activities require the unanimous consent of the
parties sharing joint control’.
IFRS 11 Appendix B para. B10 provides the following flow chart to assess whether there is
joint control:
Assessing whether there is joint control
Does the contractual arrangement give all the

NO
parties, or a group of parties, control of the
arrangement collectively?
YES Outside the scope of IFRS 11
Do decisions about the relevant activities*

require the unanimous consent of all the NO
parties, or a group of parties, that collectively
control the arrangement?
YES
The arrangement is jointly controlled

and is therefore a joint arrangement
* Relevant activities are described in IFRS 10, Appendix A as activities that significantly affect the
Unit 17 – Corereturns
contentof the entity (for IFRS 11 purposes this means the arrangement). Page 17-17
In practice, once joint control is established, the arrangement is then classified as a joint
operation, or joint venture, using the flow chart in IFRS 11 para. B33.
Accounting for joint operations, and distinguishing between joint ventures and joint operations,
is beyond the scope of the FIN module.
Required reading
IFRS 11 paras 4–5, Appendix A Defined terms and Appendix B, Application guidance paras B2–B4.
Further reading
IFRS 11 Illustrative examples 1 and 2 for situations that distinguish a joint venture from a joint
operation.
FIN fact
The investment in the associate/JV is initially measured at cost.
Disclosures – interests in joint arrangements and

investments in associates
The key disclosure requirements concerning interests in joint arrangements and investments in
associates are found in IFRS 12 Disclosure of Interests in Other Entities paras 20–23, with the detail
specified in Appendix B Application guidance paras B12–B20.
These disclosures include:
•• Paragraph 7(b) – significant judgements and assumptions made in determining whether
there is joint control of an arrangement or significant influence over another entity.
•• Paragraphs 21(a)(i) and (a)(ii) – the name, ownership interest and nature of the relationship
between the entity and the joint arrangement or associate.
•• Paragraphs 21(b)(ii) and B12–B13 – summarised financial information for each joint venture
or associate that is material to the entity.
•• Paragraph 22(c) – the unrecognised share of losses of the associate or joint venture.
In addition, IAS 1 requires disclosure of the following:

•• Share of the profit or loss of associates and joint ventures accounted for using the equity
method.
•• Share of the other comprehensive income of associates and joint ventures accounted for
using the equity method.
Required reading
IFRS 12 paras 7, 20–23 and Appendix B Application guidance paras B12–B20.
IAS 1 paras 82(c) and 82A.
Quiz
Working paper H
You are now ready to complete working paper H of integrated activity 4, to understand

Table 1: Compound amount of $1 (the future value of $1)
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 1.0100 1.0200 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000 1.1100 1.1200 1.1300 1.1400 1.1500 1.1600 1.2000 1
2 1.0201 1.0404 1.0609 1.0816 1.1025 1.1236 1.1449 1.1664 1.1881 1.2100 1.2321 1.2544 1.2769 1.2996 1.3225 1.3456 1.4400 2
Financial tables
3 1.0303 1.0612 1.0927 1.1249 1.1576 1.1910 1.2250 1.2597 1.2950 1.3310 1.3676 1.4049 1.4429 1.4815 1.5209 1.5609 1.7280 3
4 1.0406 1.0824 1.1255 1.1699 1.2155 1.2625 1.3108 1.3605 1.4116 1.4641 1.5181 1.5735 1.6305 1.6890 1.7490 1.8106 2.0736 4
5 1.0510 1.1041 1.1593 1.2167 1.2763 1.3382 1.4026 1.4693 1.5386 1.6105 1.6851 1.7623 1.8424 1.9254 2.0114 2.1003 2.4883 5
6 1.0615 1.1262 1.1941 1.2653 1.3401 1.4185 1.5007 1.5869 1.6771 1.7716 1.8704 1.9738 2.0820 2.1950 2.3131 2.4364 2.9860 6
7 1.0721 1.1487 1.2299 1.3159 1.4071 1.5036 1.6058 1.7138 1.8280 1.9487 2.0762 2.2107 2.3526 2.5023 2.6600 2.8262 3.5832 7
8 1.0829 1.1717 1.2668 1.3686 1.4775 1.5938 1.7182 1.8509 1.9926 2.1436 2.3045 2.4760 2.6584 2.8526 3.0590 3.2784 4.2998 8
9 1.0937 1.1951 1.3048 1.4233 1.5513 1.6895 1.8385 1.9990 2.1719 2.3579 2.5580 2.7731 3.0040 3.2519 3.5179 3.8030 5.1598 9
10 1.1046 1.2190 1.3439 1.4802 1.6289 1.7908 1.9672 2.1589 2.3674 2.5937 2.8394 3.1058 3.3946 3.7072 4.0456 4.4114 6.1917 10
Present and future value tables
11 1.1157 1.2434 1.3842 1.5395 1.7103 1.8983 2.1049 2.3316 2.5804 2.8531 3.1518 3.4785 3.8359 4.2262 4.6524 5.1173 7.4301 11
12 1.1268 1.2682 1.4258 1.6010 1.7959 2.0122 2.2522 2.5182 2.8127 3.1384 3.4985 3.8960 4.3345 4.8179 5.3503 5.9360 8.9161 12
13 1.1381 1.2936 1.4685 1.6651 1.8856 2.1329 2.4098 2.7196 3.0658 3.4523 3.8833 4.3635 4.8980 5.4924 6.1528 6.8858 10.699 13
14 1.1495 1.3195 1.5126 1.7317 1.9799 2.2609 2.5785 2.9372 3.3417 3.7975 4.3104 4.8871 5.5348 6.2613 7.0757 7.9875 12.839 14
15 1.1610 1.3459 1.5580 1.8009 2.0789 2.3966 2.7590 3.1722 3.6425 4.1772 4.7846 5.4736 6.2543 7.1379 8.1371 9.2655 15.407 15
16 1.1726 1.3728 1.6047 1.8730 2.1829 2.5404 2.9522 3.4259 3.9703 4.5950 5.3109 6.1304 7.0673 8.1372 9.3576 10.748 18.488 16
17 1.1843 1.4002 1.6528 1.9479 2.2920 2.6928 3.1588 3.7000 4.3276 5.0545 5.8951 6.8660 7.9861 9.2765 10.761 12.468 22.186 17
18 1.1961 1.4282 1.7024 2.0258 2.4066 2.8543 3.3799 3.9960 4.7171 5.5599 6.5436 7.6900 9.0243 10.575 12.375 14.463 26.623 18
19 1.2081 1.4568 1.7535 2.1068 2.5270 3.0256 3.6165 4.3157 5.1417 6.1159 7.2633 8.6128 10.197 12.056 14.232 16.777 31.948 19
20 1.2202 1.4859 1.8061 2.1911 2.6533 3.2071 3.8697 4.6610 5.6044 6.7275 8.0623 9.6463 11.523 13.743 16.367 19.461 38.338 20
FT-1
Table 2: Present value of $1
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696 0.8621 0.8333 1
2 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.8116 0.7972 0.7831 0.7695 0.7561 0.7432 0.6944 2
Financial tables
3 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7312 0.7118 0.6931 0.6750 0.6575 0.6407 0.5787 3
4 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6587 0.6355 0.6133 0.5921 0.5718 0.5523 0.4823 4
5 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5935 0.5674 0.5428 0.5194 0.4972 0.4761 0.4019 5
6 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5346 0.5066 0.4803 0.4556 0.4323 0.4104 0.3349 6
7 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4817 0.4523 0.4251 0.3996 0.3759 0.3538 0.2791 7
8 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4339 0.4039 0.3762 0.3506 0.3269 0.3050 0.2326 8
9 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3909 0.3606 0.3329 0.3075 0.2843 0.2630 0.1938 9
10 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3522 0.3220 0.2946 0.2697 0.2472 0.2267 0.1615 10
11 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505 0.3173 0.2875 0.2607 0.2366 0.2149 0.1954 0.1346 11
12 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186 0.2858 0.2567 0.2307 0.2076 0.1869 0.1685 0.1122 12
13 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2897 0.2575 0.2292 0.2042 0.1821 0.1625 0.1452 0.0935 13
14 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633 0.2320 0.2046 0.1807 0.1597 0.1413 0.1252 0.0779 14
15 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394 0.2090 0.1827 0.1599 0.1401 0.1229 0.1079 0.0649 15
16 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176 0.1883 0.1631 0.1415 0.1229 0.1069 0.0930 0.0541 16
17 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978 0.1696 0.1456 0.1252 0.1078 0.0929 0.0802 0.0451 17
18 0.8360 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799 0.1528 0.1300 0.1108 0.0946 0.0808 0.0691 0.0376 18
19 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635 0.1377 0.1161 0.0981 0.0829 0.0703 0.0596 0.0313 19
20 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784 0.1486 0.1240 0.1037 0.0868 0.0728 0.0611 0.0514 0.0261 20
FT-2
Table 3: Compound amount of annuity of $1
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 1.0000 1.0200 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000 1.1100 1.1200 1.1300 1.1400 1.1500 1.1600 1.2000 1
2 2.0100 2.0200 2.0300 2.0400 2.0500 2.0600 2.0700 2.0800 2.0900 2.1000 2.1100 2.1200 2.1300 2.1400 2.1500 2.1600 2.2000 2
Financial tables
3 3.0301 3.0604 3.0909 3.1216 3.1525 3.1836 3.2149 3.2464 3.2781 3.3100 3.3421 3.3744 3.4069 3.4396 3.4725 3.5056 3.6400 3
4 4.0604 4.1216 4.1836 4.2465 4.3101 4.3746 4.4399 4.5061 4.5731 4.6410 4.7097 4.7793 4.8498 4.9211 4.9934 5.0665 5.3680 4
5 5.1010 5.2040 5.3091 5.4163 5.5256 5.6371 5.7507 5.8666 5.9847 6.1051 6.2278 6.3528 6.4803 6.6101 6.7424 6.8771 7.4416 5
6 6.1520 6.3081 6.4684 6.6330 6.8019 6.9753 7.1533 7.3359 7.5233 7.7156 7.9129 8.1152 8.3227 8.5355 8.7537 8.9775 9.9299 6
7 7.2135 7.4343 7.6625 7.8983 8.1420 8.3938 8.6540 8.9228 9.2004 9.4872 9.7833 10.089 10.405 10.730 11.067 11.414 12.916 7
8 8.2857 8.5830 8.8923 9.2142 9.5491 9.8975 10.260 10.637 11.028 11.436 11.859 12.300 12.757 13.233 13.727 14.240 16.499 8
9 9.3685 9.7546 10.159 10.583 11.027 11.491 11.978 12.488 13.021 13.579 14.164 14.776 15.416 16.085 16.786 17.519 20.799 9
10 10.462 10.950 11.464 12.006 12.578 13.181 13.816 14.487 15.193 15.937 16.722 17.549 18.420 19.337 20.304 21.321 25.959 10
11 11.567 12.169 12.808 13.486 14.207 14.972 15.784 16.645 17.560 18.531 19.561 20.655 21.814 23.045 24.349 25.733 32.150 11
12 12.683 13.412 14.192 15.026 15.917 16.870 17.888 18.977 20.141 21.384 22.713 24.133 25.650 27.271 29.002 30.850 39.581 12
13 13.809 14.680 15.618 16.627 17.713 18.882 20.141 21.495 22.953 24.523 26.212 28.029 29.985 32.089 34.352 36.786 48.497 13
14 14.947 15.974 17.086 18.292 19.599 21.015 22.550 24.215 26.019 27.975 30.095 32.393 34.883 37.581 40.505 43.672 59.196 14
15 16.097 17.293 18.599 20.024 21.579 23.276 25.129 27.152 29.361 31.772 34.405 37.280 40.417 43.842 47.580 51.660 72.035 15
16 17.258 18.639 20.157 21.825 23.657 25.673 27.888 30.324 33.003 35.950 39.190 42.753 46.672 50.980 55.717 60.925 87.442 16
17 18.430 20.012 21.762 23.698 25.840 28.213 30.840 33.750 36.974 40.545 44.501 48.884 53.739 59.118 65.075 71.673 105.931 17
18 19.615 21.412 23.414 25.645 28.132 30.906 33.999 37.450 41.301 45.599 50.396 55.750 61.725 68.394 75.836 84.141 128.117 18
19 20.811 22.841 25.117 27.671 30.539 33.760 37.379 41.446 46.018 51.159 56.939 63.440 70.749 78.969 88.212 98.603 154.740 19
20 22.019 24.297 26.870 29.778 33.066 36.786 40.995 45.762 51.160 57.275 64.203 72.052 80.947 91.025 102.444 115.380 186.688 20
FT-3
Table 4: Present value of annuity $1
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696 0.8621 0.8333 1
2 1.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591 1.7355 1.7125 1.6901 1.6681 1.6467 1.6257 1.6052 1.5278 2
Financial tables
3 2.9410 2.8839 2.8286 2.7751 2.7232 2.6730 2.6243 2.5771 2.5313 2.4869 2.4437 2.4018 2.3612 2.3216 2.2832 2.2459 2.1065 3
4 3.9020 3.8077 3.7171 3.6299 3.5460 3.4651 3.3872 3.3121 3.2397 3.1699 3.1024 3.0373 2.9745 2.9137 2.8550 2.7982 2.5887 4
5 4.8534 4.7135 4.5797 4.4518 4.3295 4.2124 4.1002 3.9927 3.8897 3.7908 3.6959 3.6048 3.5172 3.4331 3.3522 3.2743 2.9906 5
6 5.7955 5.6014 5.4172 5.2421 5.0757 4.9173 4.7665 4.6229 4.4859 4.3553 4.2305 4.1114 3.9975 3.8887 3.7845 3.6847 3.3255 6
7 6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.3893 5.2064 5.0330 4.8684 4.7122 4.5638 4.4226 4.2883 4.1604 4.0386 3.6046 7
8 7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.9713 5.7466 5.5348 5.3349 5.1461 4.9676 4.7988 4.6389 4.4873 4.3436 3.8372 8
9 8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.9952 5.7590 5.5370 5.3282 5.1317 4.9464 4.7716 4.6065 4.0310 9
10 9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 7.0236 6.7101 6.4177 6.1446 5.8892 5.6502 5.4262 5.2161 5.0188 4.8332 4.1925 10
11 10.368 9.7868 9.2526 8.7605 8.3064 7.8869 7.4987 7.1390 6.8052 6.4951 6.2065 5.9377 5.6869 5.4527 5.2337 5.0286 4.3271 11
12 11.255 10.575 9.9540 9.3851 8.8633 8.3838 7.9427 7.5361 7.1607 6.8137 6.4924 6.1944 5.9176 5.6603 5.4206 5.1971 4.4392 12
13 12.134 11.348 10.635 9.9856 9.3936 8.8527 8.3577 7.9038 7.4869 7.1034 6.7499 6.4235 6.1218 5.8424 5.5831 5.3423 4.5327 13
14 13.004 12.106 11.296 10.563 9.8986 9.2950 8.7455 8.2442 7.7862 7.3667 6.9819 6.6282 6.3025 6.0021 5.7245 5.4675 4.6106 14
15 13.865 12.849 11.938 11.118 10.380 9.7122 9.1079 8.5595 8.0607 7.6061 7.1909 6.8109 6.4624 6.1422 5.8474 5.5755 4.6755 15
16 14.718 13.578 12.561 11.652 10.838 10.106 9.4466 8.8514 8.3126 7.8237 7.3792 6.9740 6.6039 6.2651 5.9542 5.6685 4.7296 16
17 15.562 14.292 13.166 12.166 11.274 10.477 9.7632 9.1216 8.5436 8.0216 7.5488 7.1196 6.7291 6.3729 6.0472 5.7487 4.7746 17
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.3719 8.7556 8.2014 7.7016 7.2497 6.8399 6.4674 6.1280 5.8178 4.8122 18
19 17.226 15.678 14.324 13.134 12.085 11.158 10.336 9.6036 8.9501 8.3649 7.8393 7.3658 6.9380 6.5504 6.1982 5.8775 4.8435 19
20 18.046 16.351 14.877 13.590 12.462 11.470 10.594 9.8181 9.1285 8.5136 7.9633 7.4694 7.0248 6.6231 6.2593 5.9288 4.8696 20
FT-4

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Financial Accounting

Candidate Study Guide

Suggested module plan viii

Candidate support and special consideration xiv

Unit 1: Financial reporting 1–1

Unit 2: Presentation of financial statements 2–1

Unit 3: Revenue 3–1

Unit 4: Income taxes 4–1

Unit 5: Foreign exchange 5–1

Unit 6: Fair value measurement 6–1

Unit 7: Property, plant and equipment 7–1

Unit 8: Intangible assets 8–1

Unit 9: Financial instruments 9–1

Unit 10: Impairment of assets 10–1

Unit 11: Provisions (including employee benefit entitlements),

Unit 12: Leases 12–1

Unit 13: Earnings per share (EPS) 13–1

Unit 14: Share-based payments 14–1

Introduction to Units 15–17 15–i

Unit 15: Business combinations 15–1

Unit 16: Accounting for subsidiaries 16–1

Unit 17: Equity accounting 17–1

Present and future value tables FT–1

The material is delivered in two modes:

•• Details and access to virtual classrooms.

Response to candidate feedback

Introduction Page iii

How is the FIN module taught?

Assessment Contribution Details

Online assessment 20 marks Three (3) online assessments.

100 marks You must achieve 50 marks or more overall,

To pass the module, you must:

Learning resources and supports

•• Adaptive learning lesson.

Prescribed reading material

Introduction Page vii

Suggested module plan

WEEK 1 Unit 1 (8 hrs) Fin. Reporting

commencing Unit 2 (3 hrs) up to end of

WEEK 3 Unit 3 (8 hrs) ONLINE ASSESSMENT 1

WEEK 6 Unit 9 Part B (6 hrs)

11 March Leases/EPS INTEGRATED

Page viii Introduction

Account for Demonstrate the accounting treatment by using a set of accounts

Advise Communicate appropriately the recommended course of action based on an analysis

Apply Use established methods/tools/procedures to resolve relatively straightforward

Appraise Assess the value or quality of something; or assess its performance

Assess Decide the value of something in a particular context

Calculate Ascertain or determine by mathematical processes, usually by the ordinary rules

Classify Place objects/concepts into appropriate categories using an established tool/

Compare Critically consider two or more things, emphasising their similarities

Contrast Critically consider two or more things, emphasising their differences

Demonstrate A practical explanation of how something works or is performed

Describe Present a detailed account of something focusing on depth of knowledge

Design Develop a procedure/process or course of action based on a selection of the optimum

Discuss Present a detailed account offering an interpretation of something or focusing

Distinguish Separate one from the other by distinct difference

Examine Inspect something in detail and investigate the implications

Interpret Make clear the meaning of something and its implications

List Note or itemise in point form

Outline Go through and identify briefly the main features of something

Plan Prepare a detailed proposal for doing or achieving something

Prepare Follow established procedures/methods to create a report of financial information