P2 Current Issues Essential Knowledge

1. Introduction
The P2 exam will contain at least one requirement dealing with current issues. This is an area which can cover many different issues, including: Recently issued or revised financial reporting standards Discussion papers and exposure drafts Recent developments in international harmonisation Current business issues which impact financial reporting.

This document takes each of these and provides a brief description of the current issue and an indication of past questions which can be used as guidance. Past questions are available in ACCA approved study texts. NB: The focus of this document is on international financial reporting standards. However, for students attempting other variants of the paper, the issues discussed are still relevant as issues are usually tested conceptually rather than requiring detailed knowledge of a particular standard, discussion paper or exposure draft.

2. Recently issued and revised financial reporting standards

The examiner has stated that he would like to test recently issued and revised standards as soon as possible. For this sitting there are two major revisions to standards which are likely to be tested.

2.1 IAS 1 (Revised) technical summary

IAS 1 sets overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content. It is effective for accounting periods beginning on or after 1 January 2009. It is the first phase of a wider project on Presentation of Financial Statements and part of the long term convergence project with the US standard setter, FASB. IAS 1 does not change the recognition, measurement or disclosure of specific transactions and other events required by other IFRSs. CHANGES IN TITLES OF FINANCIAL STATEMENTS
The revised standard changes the names of some of the financial statements:

the balance sheet will be referred to as a statement of financial position; the cash flow statement as a statement of cash flows; and IAS 1 (Revised) introduces the concept of a statement of comprehensive income.

The change in titles is not mandatory and an entity may use different titles in the financial statements.

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STATEMENT OF FINANCIAL POSITION The revised standard requires an entity to disclose comparative information for the previous period as before. However, it introduces a new requirement to include a statement of financial position as at the beginning of the earliest comparative period whenever the entity: retrospectively applies an accounting policy; makes a retrospective restatement of items in its financial statements; or reclassifies items in its financial statements.

This means that it will have to present three statements of position (balance sheets) when it applies a prior year adjustment.

STATEMENT OF COMPREHENSIVE INCOME IAS 1 now gives a choice of whether to present income and expenses in one or two statements: a) b) in one statement of comprehensive income; or in two statements (a separate income statement and a statement of comprehensive income).

If a) is chosen, this will effectively combine the income statement and the statement of recognised gains and losses into one statement. Using the two statement approach, the statement of comprehensive income will continue to show separately the components of non-owner changes in equity that are not allowed to go to profit or loss, e.g.: actuarial gains and losses on defined benefit pension schemes (per paragraph 93A of IAS 19 Retirement benefits); changes in revaluation surpluses (per IAS 16 Property, plant and equipment); exchange gains and losses from translating foreign operations (under IAS 21 Foreign exchange rates); gains on revaluing available-for-sale investments (under IAS 39 Financial instruments: measurement); and

STATEMENT OF CHANGES IN EQUITY IAS 1 requires an entity to present all owner changes in equity in a statement of changes in equity. The total of non-owner changes in equity is taken as a total figure from the statement of comprehensive income to the statement of changes in equity. OTHER COMPREHENSIVE INCOME - RECLASSIFICATION ADJUSTMENTS Reclassification adjustments are the amounts reclassified to profit or loss in the current period that were previously recognised in other comprehensive income (previously known as recycling of gains and losses).
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IAS 1 revised allows entities to present reclassification adjustments either in the statement of comprehensive income or in the notes. An entity who presents reclassification adjustments in the notes, presents the components of other comprehensive income after any related reclassification adjustments. Examples of reclassification adjustments are e.g.: cumulative exchange gains and losses on disposal of foreign subsidiaries, revaluation gains on disposal of available-for-sale investments or when a cash flow hedge affects profit or loss. PRES ENT AT I O N O F DI VI DENDS IAS 1 now requires dividends to owners and related amounts per share to be presented in the statement of changes in equity or in the notes. The presentation of such disclosures in the statement of comprehensive income is not permitted.

2.1.2. IAS 1 (Revised) Exam issues

The most likely area from IAS 1 (Revised) which could appear in the exam is the Statement of Comprehensive Income. It is important to understand both the rationale behind reporting performance in a single performance statement and the benefits of enhancing comparability between companies presentation of gains and losses. Another key issue which emerges from IAS 1 (Revised) is the treatment of different types of gains and losses. Previous accounting treatments differentiated between realised gains and losses (reported in net profit) and recognised gains and losses (reported in equity). The new treatment requires that all gains and losses are included in the comprehensive income of the entity, thus promoting the concept of an all-inclusive measure of performance. A related issue is that of recycling, or as it is now referred to under IAS 1 (Revised) reclassification adjustments. This is when a gain or loss which has previously been reported as part of equity is recognised within profit for the year. Recycling was once uncommon, but has become a routine accounting treatment, especially when accounting for financial instruments. The way that companies report financial performance is an area of interest to the examiner. Past papers have tested this area, notably in a question on the June 2005 3.6 paper, in which students were asked to describe why a single statement of financial performance is being developed, and to discuss the treatment of gains and losses. Students are advised to attempt this question and to carefully review the examiners answer.

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2.2 IFRS 3 (Revised) and IAS 27 (Revised)

The revisions to these two standards represent a fundamental change in the approach to group accounting. The changes summarised below are far reaching and should be read in conjunction with detailed examples of the application of the new rules (which will be available in good quality, latest edition P2 INT study texts).

2.2.1 IFRS 3 (Revised) the main changes

EFFECTIVE DATE The implementation date is periods commencing 1 January 2009. Optional earlier implementation is permitted but no earlier than periods beginning on or after 30 June 2007. ACQUISITION-RELATED COSTS All acquisition-related costs, including finders fees, advisory, legal, accounting, valuation, and other professional or consulting fees; and general administrative costs, must be recognised as expenses in the year of the acquisition. COSTS INCURRED TO ISSUE DEBT OR EQUITY SECURITIES These will be recognised in accordance with IAS 39 Financial Instruments: Recognition and Measurement. This means that costs of share issues are not capitalised into the cost of investment, (consistent with previous treatment under IFRS 3). CONTINGENT CONSIDERATION IFRS 3(Revised) requires the consideration for the acquisition to be measured at fair value at the acquisition date. This includes the fair value of any contingent consideration payable. This is hugely significant as it means that the contingent consideration is measured according to the probability if its future occurrence. For example, if there is a 25% likelihood of $1 million contingent consideration being paid, then a cost of $250,000 would be recognised as part of the cost of investment at the date of acquisition. STEP ACQUISITIONS Where the acquirer has a pre-existing equity interest in the entity acquired the equity interest may be accounted for as a financial instrument in accordance with: IAS 39, IAS 28/31as an associate or joint venture using the equity method, or IAS 31 as a jointly controlled entity using the proportionate consolidation method If the acquirer increases its equity interest sufficiently to achieve control (described in IFRS 3(Revised) as a business combination achieved in stages), it must remeasure its previously-held equity interest in the acquiree at acquisition-date fair value and recognise the resulting gain or loss, if any, in profit or loss.

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Once control is achieved all other increases and decreases in ownership interests are treated as transactions among equity holders and reported within equity (see below). Goodwill does not arise on any increase, and no gain or loss is recognised on any decrease. GOODWILL The acquirer recognises goodwill at the acquisition date, measured as the difference between: A. The aggregate of: a) the acquisition-date fair value of the consideration transferred; b) the amount of any non-controlling interest (NCI) in the entity acquired; and c) in a business combination achieved in stages, the acquisition date fair value of the acquirers previously-held equity interest in the entity acquired; and B. The net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed, both measured in accordance with IFRS 3(Revised). It is an implicit assumption that a fair value should be obtainable for all identified assets and liabilities at the date of acquisition. NON-CONTROLLING INTERESTS (MINORITY INTERESTS) IFRS 3 (Revised) has option, available on a transaction-by-transaction basis, to measure any non-controlling interest (NCI) in the entity acquired either at fair value or at the non-controlling interests proportionate share of the net identifiable assets of the entity acquired. The latter treatment corresponds to the measurement basis in the current version of IFRS 3. For the purpose of measuring NCI at fair value, it may be possible to determine the acquisition-date fair value on the basis of market prices for the equity shares not held by the acquirer. When a market price for the equity shares is not available because the shares are not publicly-traded, the acquirer must measure the fair value of the NCI using other valuation techniques.

2.2.2. IAS 27 (REVISED) THE MAIN CHANGES ACQUISITIONS AND DISPOSALS THAT DO NOT RESULT IN A CHANGE OF CONTROL Changes in a parents ownership interest in a subsidiary that do not result in a loss of control are accounted for within shareholders equity as transactions with owners acting in their capacity as owners. No gain or loss is recognised on such transactions and goodwill is not re-measured.

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Any difference between the change in the non-controlling interests (NCI) and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent. LOSS OF CONTROL A parent can lose control of a subsidiary through a sale or distribution, or through some other transaction or event in which it takes no part (e.g. the subsidiary being placed in administration or bankruptcy). When control is lost, the parent derecognises all assets, liabilities and NCI at their carrying amount. Any retained interest in the former subsidiary is recognised at its fair value at the date control is lost. If the loss of control of the former subsidiary involves the distribution of equity interests to owners of the parent acting in their capacity as owners, that distribution is recognised at the date control is lost. A gain or loss on loss of control is recognised as the net of the proceeds, if any, and these transactions. Any such gain or loss is recognised in profit or loss. LOSS OF SIGNIFICANT INFLUENCE OR JOINT CONTROL Amendments to IAS 28 and IAS 31 extend the treatment required for loss of control to these Standards. Thus, when an investor loses significant influence over an associate, it derecognises that associate and recognises in profit or loss the difference between: the sum of the proceeds received and any retained interest, and the carrying amount of the investment in the associate at the date significant influence is lost. A similar treatment is required when an investor loses joint control over a jointly controlled entity.

2.2.3. Exam discussion points

At this time, the examiner has not written an article for students on the subject of the changes in accounting for business combinations. This makes it hard to gauge the type of question that could be asked, or the depth of knowledge that is would be required for numerical questions. The F7 examiner, Steve Scott, has produces an article which is relevant to P2 dealing with some of the accounting issues. It is essential that any student attempting P2 in December 2008 has worked through a number of consolidation questions which have been redrafted to incorporate the revisions to IFRS 3 and IAS 27. In particular, students should focus on disposals, step acquisitions, valuation of NCI, and the new goodwill calculation. Both the consolidated balance sheet and income statement are affected by these changes, though the impact on the consolidated cash flow statement is minimal. The Pilot Paper for P2 contains (in question 4) a short requirement dealing with the changes to accounting practice in relation to business combinations, so it is suggested that students work through this question, which also covers the broader issues in relation to international harmonisation.

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3. Discussion Papers and Exposure Drafts

The list of examinable documents for the December 2008 sitting of P2 INT contains the following Exposure Drafts and Discussion Papers. An indication is also provided of when the issue has been tested in previous examinations. ED ED DP DP DP DP IFRS for Small and Medium Sized Entities (NB now renamed as IFRS for Private Entities) Preliminary views on an improved conceptual framework for financial reporting. Management commentary Fair value measurements Reducing complexity in reporting financial instruments. Preliminary views on amendments to IAS 19, Employee Benefits 3.6. exam June 06 P2 exam December 07 3.6 exam December 06 3.6 exam June 07 DP not yet examined DP not yet examined

3.1 The IFRS for Private Entities

The IASB has been working on the IFRS for Private Entities for a number of years. The main issue is that international standards have always been developed with larger companies in mind, and in many jurisdictions, the standards are only followed by listed companies. This means that many people feel that the requirements of international standards are too onerous for small entities, which often have simpler transactions and less complex structures than larger companies. The cost of complying with international standards outweighs the benefits provided to the users of the accounts. It is argued that small and medium sized entities have a reduced level of accountability than larger entities, and so should be able to follow a simpler accounting and disclosure framework. This led to the development of an Exposure Draft of IFRS for Smaller Entities. This is a collection of standards which are aimed specifically at the needs of smaller entities. For example, it eliminates topics which are not relevant to smaller entities, such as hyperinflation, simplifies certain accounting treatments and disclosure requirements, and removes choice in some accounting treatments, for example, all development costs must be expensed. The ED arranges topics in an easy to follow order and contains cross references to the full accounting standard. It is much easier to use, containing approximately 85% less volume than the full standards. However, there are some problems with having a set of accounting standards aimed just at smaller entities. Many people argue that the simplification of accounting treatments will lead to financial statements that are less reliable and relevant to the users. And it can also be argued that introducing a set of standards for a particular type of entity creates a two tier financial reporting framework, which goes against the principles of harmonisation. Another problem is deciding which entities should be eligible to follow the simplified rules should the decision be based on a monetary size limit, such as a turnover or asset threshold? If so, how would the rules cope with different currencies and with inflation? Or should eligibility be based on legal status or the concept of public accountability? If so, the IASB will need to clarify exactly what is meant by public accountability. Students are advised to carefully review the model answer to the June 2006 3.6 question dealing with this topic.
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3.2 Improved Conceptual Framework 3.2.1. The technical issue

This ED, issued in May 2008, proposes some changes to the way that entities apply the fundamental accounting principles which are laid out in the Framework document (sometimes referred to as the conceptual framework). The IASB is looking to revise the whole Framework document, and this ED looks at the first two chapters of the Framework document the objective of financial reporting, and the qualitative characteristics and constraints of decision-useful financial reporting information. The ED is lengthy at 64 pages, and some of the main issues are summarised below: The financial statements should be prepared from the entitys point of view (rather than the owners point of view) and should identify present and potential capital providers as the main user group. However it is acknowledged that there is a wide range of users for most sets of financial statements. Relevance and faithful representation are identified as fundamental characteristics for financial information, and should be underpinned by the characteristics of comparability, verifiability, timeliness and understandability. Financial statements should also have a predictive value, and contain information that is complete, free from error, and neural. Materiality and cost are both constraints to useful financial reporting.

3.2.2 Exam discussion points

The Conceptual Framework was tested in the December 2007 P2 paper, in which it featured in Q4 as an essay question. The question firstly focuses on why there is a need for an agreed conceptual framework, and secondly on the key issues that should be addressed in determining the components of a framework. The main points to be aware of are: A common conceptual framework should help harmonisation as a globally accepted framework should reduce differences in accounting treatments followed worldwide. Using an agreed conceptual framework should mean that where countries are still developing local accounting rules, those rules should be consistent with those principles used internationally. The framework is particularly important to guide accounting treatment for areas where there is no specific accounting standard to follow. The framework will not always provide solutions to accounting dilemmas, but will provide a framework which can be used to make principle based decisions. A common conceptual framework should contain definitions of the main elements of financial statements and of key principles used in accounting, such as the definitions of assets and liabilities, and of issues like control and substance. It should also describe principles for the general recognition and derecognition of elements in the financial statements, and how elements should be measured. Students are advised to review the model answer to Q4 December 2007, to see the issues discussed in answering the specific requirements of that question.
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3.3 DP Management Commentary 3.3.1. The technical issue

The DP on Management Commentary was issued by the IASB in October 2005. The aim of the DP is to discuss the need for management commentary, and to outline how the IASB could provide guidance on the preparation of such commentary. It is expected that final guidance will be published in 2009, and that this will not be in the form of a mandatory accounting standard, but in a guide to best practice. The DP draws heavily on existing practice in many jurisdictions, where it is common for listed entities to produce management commentary as part of their listing requirements. For example in the UK, listed companies must produce a detailed business review, including financial and non-financial key performance indicators, following guidance from the UKs Reporting Statement Operating and Financial Review, and in order to comply with the Companies Act. The DP suggests that management commentary should present a balanced and comprehensive review of the entitys business activities, and of its financial performance and position. The review should be: Through the eyes of key management (a concept now embodied in IFRS 8) Consistent with information provided in the financial statements Compliant with general qualitative requirements (i.e. understandable, comparable, free from bias), and Balanced, so that good and bad elements are both discussed. The point of the DP is not to prescribe a series of mandatory disclosures, some of which could be irrelevant for some businesses, but to promote the concept that management should decide on the key areas of the business that should be described and analysed to lead to a better understanding of the financial results and position of the entity.

3.3.2. Exam discussion points

Management commentary is topical at the moment due to the increased pressure on entities to disclose information about risk exposure. In the current economic climate many companies will be suffering reduced profits and poor liquidity due to the economic downturn and credit crunch, and investors will be highly interested in the impact of this on companys past results and on future performance. In addition, the issue of corporate social responsibility is highly topical, with many stakeholders particularly interested in the environmental impact of corporate activities. Many companies voluntarily disclose such information, often making use of frameworks such as the Global Reporting Initiative. The DP proposes that such disclosures should be made if they help in the understanding of business activities. Students are advised to carefully review the model answer to the question on management commentary from the December 3.6 paper. In addition it is recommended that students read some of the many articles in the accountancy and business press that have recently been published on the issue of the credit crunch and its potential impact on financial statements.

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3.4 Discussion Papers: Fair value measurements and reducing complexity in reporting financial instruments 3.4.1. The technical issue
There are currently 2 DPs which deal with fair values one is a general paper, whereas the other focuses on financial instruments. The general paper on fair values was issued in November 2006, and discusses the general application of fair value measurements within financial reporting. The IASB recognises that fair value measurements are required for some assets and liabilities, but not for others, leading to inconsistencies in accounting practice. In addition, in some areas (e.g. under IAS 16 Property, plant and equipment) measurement at fair value is a choice, making comparisons between company accounts problematical. The DP proposes to introduce a single, concise definition of what is meant by fair value, which can then be consistently applied to assets and liabilities which are required to be measured at fair value. It is argued that this will simplify financial reporting, and improve the quality of fair value information included n accounts. The DP is not about extending the use of fair value measurements, but about standardising the approach used when dealing with fair values. The second DP is specifically about financial instruments. The issue is that current accounting rules for financial instruments are extremely complicated, and that the many amendments that have been made to IAS 32 and IAS 39 since they were originally issued make the situation even more complex. The DP focuses on the classification and measurement rules for financial instruments, and discusses the following proposals: Eliminate the held to maturity category This would eliminate the controversial tainting issue Eliminate the available for sale category This would eliminate recycling of gains and losses on the derecognition of the instrument Get rid of categories completely and require fair value measurement for all financial instruments (with some optional exceptions) But difficulties regarding exemptions envisaged Simplify the rules on hedge accounting, or eliminate the hedging rules completely Rules for cash flow hedges would be retained however

The IASBs ultimate argument is that the only way to reduce complexity is to move to a single measurement model i.e. fair value is the only measure appropriate for all types of financial instruments. Arguments FOR this revolve around fair value being usually the only RELEVANT measure at the reporting date, as users are only concerned about the market or fair value of a financial instrument. Arguments AGAINST this focus mainly on the problems inherent in any fair value measurement system, notably volatility in income, subjectivity of measurement, and whether taking unrealised gains/losses to income statement is misleading.

3.4.2 Exam discussion points

Financial instruments is a key area of the P2 syllabus, but has not yet been tested in much detail. This means that for the December 2008 sitting, it is likely that financial instruments will appear on the paper, possibly in conjunction with this current issue.
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In an essay question, students could be asked to discuss the problems in accounting for financial instruments, especially the difficulties created by the complex rules on categorisation of financial instruments, and the consequential measurement issues, and the presentation of fair value gains and losses. This could also be linked to IAS 1 (Revised) where, as discussed above, there are new presentation issues for gains and losses in the Statement of Comprehensive Income. Remember that students are not expected to have a detailed knowledge of DPs, but to be aware of the issues that are being discussed. So it is important to thoroughly revise the measurement rules of IAS 39, and be able to critically appraise current accounting practice in relation to financial instruments. Recommended question practice is firstly the question on fair value measurement from the June 2007 3.6 paper, and secondly the question Ambush, from the December 2005 3.6 paper.

3.5 Discussion Paper: Preliminary views on amendments to IAS 19, Employee Benefits 3.5.1 The technical issue
Current accounting practice under IAS 19 allows many choices, especially in the treatment of actuarial gains and losses. Analysts, investors and other users have long voiced concerns over IAS 19. Some of the main concerns are: the accounting model has too many conceptual compromises and promotes an accounting treatment inconsistent with recognition and measurement rules used in other accounting standards; the different options for recognising gains and losses lead to lack of comparability; and the measurement model is inappropriate for some types of benefit obligations.

In response, the IASB is addressing the critical flaws identified in this project with an aim to making a significant improvement in the standard within 4 years. There are no proposals to substantially change the reporting of defined contribution schemes, however, the reporting of defined benefit schemes could be changed in the future. The main discussion points are: Should actuarial gains and losses always be recognised immediately? Should actuarial gains and losses be recognised as part of net profit? Should other items of income and expense (e.g. current service cost and return on investment) be recognised as part of net profit? Should there be any changes to how plan assets and liabilities are recognised and measured?

3.5.2. Exam discussion points

It is important to fully understand the different ways that IAS 19 allows entities to account for pension plans, in particular defined benefit plans, and to be able to critically discuss the accounting treatment.
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4. Recent developments in international harmonisation

4.1 A short history of harmonisation
After their joint meeting in September 2002, the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their Norwalk Agreement. Each acknowledged their commitment to the development of high quality, compatible accounting standards that could be used for both domestic and cross-border financial reporting. At that meeting, the FASB and the IASB pledged to use their best efforts to make their existing financial reporting standards fully compatible as soon as is practicable and to co-ordinate their future work programmes to ensure that once achieved, compatibility is maintained.

At their meetings in April and October 2005, the FASB and the IASB reaffirmed their commitment to the convergence of US generally accepted accounting principles (US GAAP) and International Financial Reporting Standards (IFRSs). A common set of high quality global standards remains the long-term strategic priority of both the FASB and the IASB. The FASB and the IASB recognise the relevance of the roadmap for the removal of the need for the reconciliation requirement for non-US companies that use IFRSs and are registered in the United States. It has been noted that the removal of this reconciliation requirement would depend on, among other things, the effective implementation of IFRSs in financial statements across companies and jurisdictions, and measurable progress in addressing priority issues on the IASB-FASB convergence programme. Projects that are currently being worked on as part of convergence include business combinations, financial instruments, leases and revenue recognition, as well as the conceptual framework discussed above.

4.2 Exam discussion points

Harmonisation is one of the examiners favourite topics and has been tested often, usually in a discussion or essay question. It is important to be aware of the main reasons in favour of international harmonisation, including greater consistency in accounting treatments which will make comparisons of financial statements from across the world easier. It is also essential to be able to discuss the problem in harmonisation, including differing conceptual frameworks, different user groups and therefore different accountability of entities in different countries, and in some countries a reluctance to switch to international standards due to conflicts with local laws and regulations. Students may also be asked to discuss the impact on financial reporting of a move from national to international GAAP, and the practical matters that need to be considered when adopting a new financial reporting framework. Students should review the question Guide, from the December 2003 3.6 exam, and the essay question from the June 2008 P2 paper, both of which deal with international harmonisation.
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5. Current business issues and the impact on financial reporting

5.1 The credit crunch financial reporting implications
Students are expected to be aware of general issues being faced by global businesses, and to consider the possible impact of such issues on corporate reporting. Of course, for the last 12 months or so, many companies have been facing financial distress as a result of the credit crunch. It is therefore important that students make themselves aware of the specific financial reporting implications of this. Some of the issues are outlined below: Investments in shares are likely to have fallen in value, resulting in a revaluation loss or impairment (depending on the categorisation of the investment under IAS 39 or FRS 26 in the UK). For investments measured at fair value, it may be difficult to determine the fair value if the market is inactive. A different valuation method may be needed in this case. In a group situation, goodwill may be impaired if a subsidiary is facing financial distress. Impairment reviews will need to be conducted using modified assumptions about the future cash generating potential of the subsidiary. If customers are in financial difficulties, trade payables may be overstated. A careful review of outstanding receivables will be essential, and adequate allowances against bad debtors must be made. The going concern assumption may not be valid if an entity is facing severe financial distress. In particular, access to loans and other sources of finance are likely to be restricted in the current economic climate, which could jeopardise the long term future of a business. Disclosures may be needed in the notes to explain any uncertainty over the future operational existence of the entity, or the accounts may need to be prepared on the break up basis if the going concern assumption is not appropriate. In certain jurisdictions (such as the UK), company law and / or listing rules require a discussion by the directors of risks and uncertainties facing the entity. In this climate, new risks may have emerged which will need to be fully explored in order to provide a fair review of the position and performance for the year. Similar disclosures about financial risks are required by IFRS 7 (FRS 29 in the UK). At this year end companies may be facing heightened credit risk and liquidity risk (risks associated with cash inflows and outflows), so extra disclosure about how such risks are being monitored and measured may be needed. If an entity recognises a defined benefit pension plan on the balance sheet, then the pension obligation may have increased due to a fall in the fair value of assets held by the pension plan. If an entity recognises deferred tax assets, especially those arising to unutilised tax losses, the recoverability of those assets will become doubtful if the company is making losses. In such cases, the deferred tax asset should be derecognised.

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5.2 The credit crunch ethical considerations

The examiner has introduced requirements dealing with ethical considerations into the paper. For example, the June 2008 paper (Q1) included a requirement dealing with the ethical issues arising from a manipulation of the financial statements. The credit crunch and consequent financial distress means that preparers of the accounts will be under some pressure to present financial statements in as favorable a way as possible. This increases the risk of creative accounting, or of deliberate breaches of accounting rules, in order to create a false impression of profits or liquidity position. There is also an increased risk of inappropriate changes in accounting policy, again with the aim of using a new policy which creates. Students should be alert for instances of creative accounting, new accounting policies, or the incorrect application of standards when reading through question scenarios. The examiner may expect you to challenge accounting treatments which appear to be incorrect, and to explain the impact of the incorrect treatment or the subsequent adjustment to correct the error. There are no past exam questions which deal specifically with financial distress, but students should review Q1 (c) from June 2008, which deals with manipulation of financial statements.

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