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IAS 1 Presentation of Financial Statements
XYZ plcStatement of Comprehensive Income for the year ended 31 December !X"
• IAS 1 allows Comprehensive Income to be presented in two ways: [IAS 1: 81]
i. A single Statement of Comprehensive Incomeii. wo separate statements as shown above
• I!"S do not specify whether reven#e can be presented only as a single line item in the statement of comprehensive income$ or whether an entity also may incl#de the individ#al components ofreven#e %for e&le: vario#s s#b'totals for ban(s).
• *&penses can be classi+ed by: [IAS 1: ,,]' !#nction: more common in practice %as the above statement)' -at#re %e.g. p#rchase of materials$ depreciation$ wages and salaries$ transport costs)
• !inance income cannot be netted against +nance costs it is incl#ded in /0ther income or show
separately in the income statement.' 2here +nance income is an incidental income$ it is acceptable to present +nance income
immediately before +nance costs and incl#de a s#b'total of /-et +nance costs in the incomestatement.' 2here earning interest income is one of the entitys main line of b#siness$ it is presented as
/reven#e.
• #ntities m$st prominently display% [IAS 1: 31]
' name of the reporting entity' whether the statements are for a single entity or a gro#p of entities' date of the end of the reporting period$ or the period covered' presentation c#rrency
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' the level of ro#nding #sed in the preparation of the statements
XYZ plc &Statement of Chan'es in #($ity for the year ended 31 December !X"
• IAS 14 %55*) permits and it is best practice to ma(e a transfer between reserves of the e&cessdepreciation arising as a res#lt of reval#ation. [IAS 1: 61]
• 2hen an asset carrying #sing reval#ation model is disposed$ any remaining reval#ation reserverelating to that asset is transferred directly to retained earnings. [IAS 1: 61]
• An entity can present components of changes in e7#ity either in the /Statement of Changes in*7#ity or in the notes to the +nancial statements. [IAS 1: 14]
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XYZ plc & Statement of Financial Position as at 31 December !X"
• "eserves other than share capital and retained earnings may be gro#ped as /other componentsof e7#ity.
• *ntities m#st present a set of previo#s years statements for comparison p#rposes.
• An entity shall classify an asset as c$rrent )hen% [IAS 1: 44]
a) It e&pects to realise the asset$ or intends to sell or cons#me it$ in its normal operatingcycle
b) It holds the asset primarily for the p#rpose of trading
c) It e&pects to realise the asset within twelve months after the reporting period or
d) he asset is cash or cash e7#ivalents #nless the asset is restricted from being e&changedor #sed to settle a liability for at least twelve months after the reporting period.
• An entity shall classify a liability as c$rrent )hen% [IAS 1: 4,]
a) It e&pects to settle the liability in its normal operating cycle
b) It holds the liability primarily for the p#rpose of trading
c) he liability is d#e to be settled within twelve months after the reporting period or
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d) It does not have #nconditional right to defer settlement of the liability for at least twelvemonths after the reporting period.
IAS 1* Property+ plant and e($ipment
• An asset is a reso#rce controlled by the entity as a res#lt of past events and from which f#t#re
economic bene+ts are e&pected 9ow to the entity.
• 5roperty$ plant and e7#ipment are tangible assets that:
' are held for #se in the prod#ction or s#pply of goods or services$ for rental to others$ or foradministrative p#rposes and
' are e&pected to be #sed d#ring more than one period.
• Initial reco'nition%
' 55* sho#ld initially be recognised in an entitys statement of +nancial position at cost.
Cost is the amo#nt of cash and cash e7#ivalents paid to ac7#ire the asset at the time of its
ac7#isition or constr#ction 5;<S the fair val#e of any other consideration given.
• #lements of Cost% Cost can incl#de:
' 5#rchase price less any trade disco#nt %not prompt payment disco#nt) or rebate' Import d#ties and non'ref#ndable p#rchase ta&es
' =irectly attrib#table costs of bringing the asset to wor(ing condition for its intended #se.
#,amples%' Costs of site preparation
' Initial delivery and handling costs
' Installation and assembly costs
' 5rofessional fees s#ch as legal fees$ architects fees
' Initial costs of testing that asset is f#nctioning correctly%after ded#cting the net proceeds from selling any items prod#ced)
' he initial estimate of dismantlin' and removing the item and restoring the site where it islocated if the entity is obliged to do so %to the e&tent it is recognised as a provision per IAS >?).@ains from the e&pected disposal of assets sho#ld not be ta(en into acco#nt in meas#ring aprovision.
' In case of a land$ if initial estimation of restoration cost is capitalised then this capitalisedrestoration cost shall be depreciated.
' orrowing costs inc#rred in the constr#ction of 7#alifying assets if in accordance with IAS 23Borrowing costs.
Any abnormal costs inc#rred by the entity$ for e&le those arising from design errors$
wastage or ind#strial disp#tes$ sho#ld be e&pensed as they are inc#rred and do not formpart of the capitalised cost of the 55* asset.
#stimated economic life and resid$al val$e of asset sho#ld be reviewed at the end of
each reporting period. If either changes signi+cantly$ the change sho#ld be acco#nted forover the #sef#l economic life remaining.
he resid$al val$e of an asset is the estimated amo#nt that an entity wo#ld c#rrently
obtain from disposal of the asset$ after ded#cting the estimated costs of disposal$ if theasset were already of the age and in the condition e&pected at the end of its #sef#l life. [IAS14: 4]
2here these costs are inc#rred over aperiod of time$ the period for which thecosts can be incl#ded in the cost of 55*ends )hen the asset is ready for $se$even if not bro#ght into #se.
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S#bse7#ent e&pendit#re only to be capitalised if enhances the life of the asset$ or improves
7#ality or 7#antity of o#tp#t$ or red#ces the cost. If not capitalised then recognise ase&pense in IBS.
*&les of s#bse7#ent e&pendit#re to be capitalised can incl#de:' odi+cation of an item of plant to e&tend its #sef#l life' <pgrade of machine parts to improve the 7#ality of o#tp#t
' Adoption of a new prod#ction process$ leading to large red#ctions in operating costs 2here an asset is made #p of many distinct %i.e. signi+cant) parts %e&les: aircraft$ ship)$
these sho#ld be separately identi+ed and depreciated.
aDor inspections or overha#ls sho#ld be recognised as part of %i.e. increase) carrying amo#nt
of the item of 55*$ ass#ming that this meets the recognition criteria.' An e&le is where an aircraft is re7#ired to #ndergo a maDor inspection after so many
9ying ho#rs. 2itho#t the inspection the aircraft wo#ld not be permitted to contin#e 9ying.' As a separate component of 55*$ the capitalised overha#l cost shall be depreciated over
the period to ne&t overha#l.
• -eas$rement after initial reco'nition% After initially recognising an item of property$ plant ande7#ipment in its statement of +nancial position at cost$ an entity has two choices abo#t how itacco#nts for that item going forwards.
• .eval$ation model%' An entity can$ if it chooses$ reval#e assets to their fair val#e %only if the fair val#e of the item
can be meas#red reliably)' !or land and b#ildings this is normally determined based on their mar(et val#es as determinedby an appraisal #nderta(en by professionally 7#ali+ed val#ers.
' If this model is applied to one asset$ it m#st also be applied to all other assets in the sameclass.
' -ote that when the reval#ation model is #sed 55* m#st still be depreciated. he reval#edamo#nt is depreciated over the assets remaining #sef#l life.
' !or a reval#ed asset$ IAS 14 allows %and enco#rage) a reserve transfer in the statement ofchanges in e7#ity %from /reval#ation reserve to /retained earnings) of the /e,cess/depreciation beca#se of an #pward reval#ation.
.eval$ation model%Carrying asset at reval#ed amo#nt less
s#bse7#ent acc#m#lated depreciation and
Cost model%Carrying asset at cost less acc#m#lated
depreciation and impairment losses
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• -ethods of depreciation%' Straight line method' "ed#cing balance method' achine ho#r method' S#m'of'the'digits method
• Dereco'nition% 5roperty$ plant and e7#ipment shall be derecognised %i.e. removed from thestatement of +nancial position) either:' 0n disposal or' 2hen no f#t#re economic bene+ts are e&pected from its #se or disposal.
he gain or loss arising from de'recognition is incl#ded in pro+t or loss.
' his gain or loss is calc#lated by comparing the sale proceeds to the assets carrying amo#nt.' he gain or loss is calc#lated in the same way$ regardless of whether the asset is reval#ed or
not.' Any gain sho#ld not be classi+ed as part of the entitys reven#e.
If on disposal of a reval#ed asset there remains a balance on the reval#ation s#rpl#s relating to the
asset$ this balance sho#ld be transferred to retained earnings.
S#m of the years of assets e&pected life E - F %-G1)BH where - is theassets e&pected life
Cost of a lorry was 13$ and e&pected to last for +ve years. -o scrapval#e.
S#m of the years of assets e&pected life E - F %-G1)BH E 3 F %3G1)BH E 13
=epreciation in Jear1 13$ F 3 B13 E 3$H 13$ F 6 B13 E6$> 13$ F > B13 E >$
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IAS 3 0orro)in' costs
• An entity shall capitalise %i.e. as part of the asset) borrowing costs that are directly attrib#table tothe ac7#isition$ constr#ction or prod#ction of a 7#alifying asset as part of the costs of that asset.[IAS H>: 8]
• An entity shall cease capitalisation borrowing costs when s#bstantially all the activities necessaryto prepare the 7#alifying asset for its intended #se or sale are complete. [IAS H>: HH]
• he commencement date for capitalisation% [IAS H>: 1?]2hen the following 3 conditions are 2rst met:
' *&pendit#res for the asset are being inc#rred
' orrowing costs are being inc#rred$ and
' Activities that are necessary to prepare the asset for its intended #se are being #nderta(en.
• Capitalisation is s$spended if active development is interr#pted for e&tended periods.
%emporary delays or technicalBadministrative wor( will not ca#se s#spension).
' Interest income from deposit d#ring this period is not ded#ctible from capitalised borrowingcost since cost from this s#spended period is not capitalised. [IAS H>: H1]
orrowing costs eligible forcapitalisation are those that wo#ld havebeen avoided otherwise. [IAS H>: 1]
orrowing costs are interest and othercosts that an entity inc#rs in connectionwith the borrowing of f#nds. [IAS H>: 3]
A 7#alifying asset is an asset that necessarily ta(es as#bstantial period of time to get ready for its intended #se
orrowing cost %i.e. interest e&pense)of > months %i.e. H3$) to be
recognised in Income Statement
orrowing cost of1H months %i.e.
1$) to berecognised in IBS
orrowing cost of ,months %i.e. ?3$) to
be capitalised as part ofasset in Statement of
>1.1H.1> ' ;oanis mat#red and
>1.1H.1H ' Asset isdelivered K read
>1.>.1H '5ayment made to
H8.H.1H '5#rchase order
made to b# the
1.1.1H ' 1mloan L1M for
All three conditions are met at this
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• Amo#nt of borrowing costs available for capitalisation is act#al borrowing costs inc#rred less any
investment income from temporary investment of those borrowings. [IAS H>: 1>]
• !or borrowings obtained generally$ apply the capitalisation rate to the e&pendit#re on the asset%weighted average borrowing cost). [IAS H>: 16]
0n 1 Nan#ary HF4 Stremans Co borrowed 1.3m to +nance the prod#ction of two assets$ both ofwhich were e&pected to ta(e a year to b#ild. 2or( started d#ring HF4. he loan facility was drawndown and inc#rred on 1 Nan#ary HF4$ and was #tilised as follows$ with the remaining f#ndsinvested temporarily. Asset A Asset 1 Nan#ary HF4 H3 3 1 N#ly HF4 H3 3 he loan rate was ,M and Stremans Co can invest s#rpl#s f#nds at ?M.
.e($ired% Ignoring compo#nd interest$ calc#late the borrowing costs which may be capitalised for
Asset A Asset
orrowing costs: o >1 =ecember HF4 %3$B1$$ O ,M)63$ ,$;ess investment income: o > N#ne HF4 %H3$B3$ O ?M O 4B1H)%8$?3) %1?$3)
Acr#ni Co had the following loans in place at the beginning and end of HF4.
1 Nan#ary >1=ecember
HF4 HF4m m
1M an( loan repayable HF8 1H 1H,.3M an( loan repayable HF, 8 88.,M debent#re repayable HF? P 13
he 8.,M debent#re was iss#ed to f#nd the constr#ction of a 7#alifying asset %a piece of mininge7#ipment)$ constr#ction of which began on 1 N#ly HF4.
0n 1 Nan#ary HF4$ Acr#ni Co began constr#ction of a 7#alifying asset$ a piece of machinery for a
hydroelectric plant$ #sing e&isting borrowings. *&pendit#re drawn down for the constr#ction was: Q>m on 1 Nan#ary HF4$ Hm on 1 0ctober HF4.
.e($ired% Calc#late the borrowing costs that can be capitalised for the hydro'electric plant
Capitalisation rate E weighted average rate E %1M O %1HB %8 G 1H))) G %,.3M O %8 B %1H G8))) E ,.8M
orrowing costs E %>m O ,.8M) G %Hm O ,.8M O >B1H) E >.6>m
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IAS ! Investment property
• Investment property is a property %land or a b#ilding P or part of a b#ilding P or both) held %bythe owner or by the lessee #nder a +nance lease) to earn rentals or for capital appreciation orboth$ rather than for:
' <se in the prod#ction or s#pply of goods or services or for administrative p#rposes or
' Sale in the ordinary co#rse of b#siness. [IAS 6: 3]
• IAS 6 lists the following as e,amples of investment property% [IAS 6: 8]
' ;and held for long'term capital appreciation rather than short'term sale in the ordinary co#rseof b#siness
' ;and held for a c#rrently #ndetermined f#t#re #se
' A b#ilding owned by the entity %or held #nder a +nance lease) and leased to a third party #nderoperating lease
' A b#ilding which is vacant b#t is held to be leased o#t #nder an operating lease
' 5roperty being constr#cted or developed for f#t#re #se as an investment property %propertyconstr#cted for sale is not investment property)
• !ollowings are o$tside the scope of IAS !: [IAS 6: ,]
' 5roperty intended for sale in the ordinary co#rse of b#siness: IAS H Inventories
' 5roperty being constr#cted or developed on behalf of third parties: IAS 11 ConstructionContracts
' 0wner'occ#pied property$ incl#ding property held for f#t#re #se as owner'occ#pied: IAS 14Property, Plant and Equipment
' 5roperty occ#pied by employees whether or not the employees pay rent at mar(et rates: IAS16 PPE
' 5roperty leased to another entity #nder a +nance lease: IAS 1? Leases
• Points to note%
' If a portion of an asset meets investment property criteria and other portion is not$ then anentity acco#nts for the portions separately %e.g. one portion #nder IAS 6 and another #nderIAS 14) if those portions co#ld be sold separately or leased o#t separately #nder +nance lease.[IAS 6: 1]
' 2here an entity owns property that is leased to+ and occ$pied by+ its parent or anothers$bsidiary$ the property is treated as an investment property in the entitys own acco#nts.Rowever$ the property does not 7#alify as investment property in the consolidated +nancialstatements as it is owner'occ#pied from the gro#p perspective. [IAS 6: 13]
• Initial reco'nition and meas$rement%
' An investment property sho#ld be initially meas#red at cost %IAS 14s initial recognition r#les
applies). [IAS 6: H]
• -eas$rement after reco'nition% After initial meas#rement at cost$ an entity can choosebetween two models: [IAS 6: >]
' he IAS 1* cost model
4 he fair val$e model
If the fair val#e model is adopted$ the acco#nting treatment of investment properties will be asfollows:
' All investment properties sho#ld be meas#red at fair val#e at the end of each reportingperiod provided fair val#e can be meas#red reliably.
' Chan'es in fair val$e+ )hether 'ains or losses+ sho$ld be reco'nised in pro2t orloss for the period in )hich they arise5 [IAS 6: >3]
6 7
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he policy chosen sho#ld be applied consistently to all of the entitys investment property
IAS 6 enco#rages the assessment of fair val#e by independent$ appropriately 7#ali+ed ande&perienced professionals b#t does not re7#ire it.
IAS ! 8overnment 'rants
• An entity sho#ld not recognise government grants #ntil it has reasonable ass#rance that: [IAS H:?]
' he entity will comply with any conditions attached to the grant
' he entity will act#ally receive the grant
"eceiving the grant not necessarily prove that the conditions attached to it have been or willbe f#l+lled.
he treatment will be same whether the grant is received in cash or given as a red#ction in a
liability to government. [IAS H: 1]
• 8rants relatin' to assets% IAS ! allo)s t)o alternatives%
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• 8overnment 'rant reco'nised as 6Deferred income7 9:ption 1; needs to be amortised9i5e5 recycled in I<S as Income; over the $sef$l life of the asset5
• 8rants relatin' to income% S#ch grants sho#ld be recognised in pro+t or loss as other income or
ded#cted from the related e&pense. [IAS H: H,]
' As with grants related to assets$ the bene+t of the grant sho#ld be recognised in pro+t or lossover the periods in which the entity recognises as e&penses the related costs for which thegrants are intended to compensate.
• A non'monetary asset %e&le: land$ b#ilding$ etc.) may be transferred by government to anentity as a grant.
' he fair val#e of s#ch an asset is #s#ally assessed and this is #sed to acco#nt for both theasset and the grant.
' Alternatively$ both may be val#ed at a nominal %i.e. insigni+cant) amo#nt. [IAS H: H>]
• @overnment grants that cannot reasonably have a val#e placed on them %for e&le theprovision of free services by a government department) are e&cl#ded from the de+nition of
government grants.
• "epayment of government grant: If a grant m#st be repaid it sho#ld be acco#nted for as a revisionof an acco#nting estimate %IAS 8). [IAS H: >6]
' "epayment of grant related to income: apply +rst against any #namortised deferred incomeset #p in respect of the grant$ any e&cess sho#ld be recognised immediately as an e&pense.[IAS H: >H]
' "epayment of a grant related to an asset: increase the carrying amo#nt of the asset or red#cethe deferred income balance by the amo#nt repayable. he c#m#lative additional depreciationthat wo#ld have been recognised to date in the absence of the grant sho#ld be immediatelyrecognised as an e&pense. [IAS H: >H]
It is possible that the circ#mstances s#rro#nding repayment may re7#ire a review of the asset
val#e and an impairment of the new carrying amo#nt of the asset.
• IAS H does not cover: [IAS H: H]
' Acco#nting for government grants in +nancial statements re9ecting the eects of changingprices
' @overnment assistance given in the form of /ta& brea(s
' @overnment acting as part'owner of the entity
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IAS 3= Intan'ible assets
• An intan'ible asset is an identi+able non'monetary asset witho#t physical s#bstance. [IAS >8: 8]
• IAS >8 states that an intangible asset is to be reco'nised if+ and only if+ the following criteriaare met: [IAS >8: H1]' it is probable that f#t#re economic bene+ts from the asset will 9ow to the entity' the cost of the asset can be reliably meas#red.
5 # r c h a s e d
• At reco'nition the intangible sho#ld be recognised at cost. [IAS >8: H6]
• *&les of e,pendit$res that are not part of the cost of an intan'ible asset
are: [IAS >8: H,]' Costs of advertising and promotional activities) [IAS >8: 4,%c)]
An asset is a reso#rce controlled by theentity as a res#lt of past event%s) and fromwhich f#t#re economic bene+ts aree&pected to 9ow to the entity. [IAS >8: 8]
An asset is identi+able if it either: [IAS >8: 1H]%a) is separable$ i.e. is capable of being
separated or divided from the entityand sold$ transferred$ licensed$ rentedor e&changed$ either individ#ally ortogether with a related contract$identi+able asset or liability$ regardlessof whether the entity intends to do soor
%b) arises from contract#al or other legalrights$ regardless of whether those
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I n t e r n a
l l y ' e n e r a t e d
. e s e a r c h
e
• "esearch is original and planned investigation$ #nderta(en with the prospect ofgaining new scienti+c or technical (nowledge and #nderstanding. [IAS >8: 8]
• he res#lt of research is #n(nown and$ so$ no probable f$t$re economic bene2t
D e v e l o p m
e n t
e
• An intangible asset arising from development m#st be capitalised if an entity candemonstrate all of the follo)in' criteria: [IAS >8: 3?]' the technical feasibility of completing the intangible asset %so that it will be
available for #se or sale)' intention to complete and #se or sell the asset' abilit to #se or sell the asset
• Internally generated goodwill sho#ld not be recognised as an asset. [IAS >8: 68]
• Internally generated brands$ mastheads$ p#blishing titles$ c#stomer lists and items similar ins#bstance shall not be recognised as intangible assets. [IAS >8: 4>]
• An intangible asset with a 2nite $sef$l life sho#ld be amortised over its e&pected #sef#l life [IAS >8:8,]
• An intangible asset with an inde2nite life sho#ld not be amortised [IAS >8: 8,]$ b#t sho#ld bereviewed for impairment on an ann#al basis [IAS >8: 18]' here m#st be an ann#al review of whether the inde+nite life assessment is still appropriate. [IAS
>8: 1,]
• .esid$al val$es sho#ld be ass#med to be nil$ e&cept if an active mar(et e&ists or there is acommitment by a third party to p#rchase the asset at the end of its #sef#l life [IAS >8: 1]
IAS 3* Impairment of assets
• An asset is impaired when its /carrying amo#nt is higher than its /recoverable amo#nt. [IAS >4: 4]
• Impairment loss > Carryin' val$e & .ecoverable amo$nt [IAS >4: 3,]
An active mar(et is a mar(et in which all the followingconditions e&ist:
%a) he items traded in the mar(et are homogeneo#s %i.e.similar)
Righer of
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• .eco'nition of impairment losses in +nancial statements: [IAS >4: 4$ 41]' Asset carried o#t at historical cost: in pro+t or loss.' "eval#ed assets: +rst against any reval#ation s#rpl#s relating to the asset and then %if amo#nt
left) in pro+t or loss.
If no impairment loss then do nothingT
After impairment revie)% the depreciationBamortisation sho#ld be adD#sted for f#t#re
periods. [IAS >4: 4>] If 'ood)ill is val$ed at fair val$e %in f#ll) the non'controlling share of impairment will be
allocated to non'controlling goodwill %i.e. will red#ce -CI).
• 2here it is not possible to estimate the recoverable amo#nt of an individ#al asset$ the entityestimates the recoverable amo#nt of the cash4'eneratin' $nit to which it belongs. [IAS >4: 44]- A cash'generating #nit is the smallest identi+able gro#p of assets that generates cash in9ows
that are largely independent of the cash in9ows from other assets or gro#ps of assets. [IAS >4:48]- If an active mar(et e&ists for the o#tp#t prod#ced by an asset or a gro#p of assets$ this gro#p
of assets sho#ld be identi+ed as a C@< even if some or all of the o#tp#t is #sed internally. [IAS>4: ?]
- If the cash in9ows are aected by internal transfer pricing$ managements best estimate off#t#re price that co#ld be achieved in arms length transactions are #sed in estimating theC@<s val#e in #se. [IAS >4: ?]
• Impairment loss is allocated amon' the asset<C8? in the follo)in' order% [IAS >4: 16]1. any individ#al asset that is speci+cally impairedH. goodwill allocated to the C@<>. other assets pro rata to their carrying amo#nt in the C@< %s#bDect of the carrying amo#nt of an
asset not being red#ced below its individ#al recoverable amo#nt. [IAS >4: 13]
• .eversal of past impairment%
• I<S% ' An impairment loss reversal on property$ plant and e7#ipment +rst reverses the loss recorded in
pro+t or loss %and any remainder is credited to the reval#ation s#rpl#s$ s#bDect to IAS 14
re7#irements) [IAS >4: 11,]
• SFP%' A reversal for a C@< is allocated to the assets of the C@<$ e&cept for goodwill$ pro rata with the
carrying amo#nts of those assets [IAS >4: 1HH]
@al$e in $se%
4 ased on cash4o) proBections4 Cash 9ows sho#ld incl#de e&pected disposal proceed.
[IAS >4: >1%a)]4 !#t#re cash 9ows shall be estimated for the asset in its
c$rrent condition. *stimates of f#t#re cash 9ows shallnot incl#de estimated f#t#re cash in9ows or o#t9owsthat are e&pected to arise from improving or enhancingthe assets performance. [IAS >4: 66]
4 Cash o#t9ows to maintain the level of economic bene+tsfrom the asset in its c#rrent condition sho#ld beincl#ded %e.g. repair and replacement of parts). [IAS >4:61]
Fair val$e less costs to sell%- Ual#e in a binding sale agreement less
incremental costs directly attrib#table tothe assets disposal. [IAS >4: H3]
- 0therwise$ the assets maret price%where there is an active mar(et)$ oramo#nt obtainable in an arms lengthtransaction %i.e. fair val#e)$ less costs of
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0nce recognised$ impairment losses on goodwill are not reversed [IAS >4: 1H6]
In case of a reversal$ the carrying amo#nt of an asset m#st not increase above the lower of:
- Its recoverable amo#nt and- Its depreciated carrying amo#nt had no impairment loss originally been recognised. [IAS
>4: 1H>]
• Impairment indicators% he entity sho#ld loo( for evidence at the end of each period and cond#ct an impairment review
on any asset where there is evidence of impairment. [IAS >4: ,]
' Intangible assets with an inde+nite #sef#l life or not yet available for #se$ and goodwill ac7#ired in
b#siness combination are s#bDect to ann#al impairment test irrespective of whether there are
indications of impairment. [IAS >4: 1]
IAS = Acco$ntin' policies+ chan'es in acco$ntin'
estimates and errors
Internal indicators: [IAS >4: 1H]
' *vidence of obsolescence or
physical damage' Signi+cant changes with an
adverse eect on the entity
' *vidence available that asset
performance will be worse than
e&pected.
#,ternal indicators: [IAS >4: 1H]
' Signi+cant decline in mar(et
val#e of asset' Signi+cant change in
technological$ economic or legal
environment' Increased mar(et interest rate
th#s red#cing val#e in #se
' Carrying amo#nt of net assets
of the entity e&ceeds mar(et
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• Chan'es in acco$ntin' policies
he same acco#nting policies are #s#ally adopted from period to period$ to allow #sers to
analyse trends over time in pro+t$ cash 9ows and +nancial position.
*&les of acco#nting policies:' Alternative presentation of government grant %IAS H)' !I!0 or 2eighted average method of inventory val#ation
4 !air val#e model of cost model for investment properties %IAS 6: >1)
→ A change in acco#nting policy m#st be applied retrospectively.' "etrospective application means that the new acco#nting policy is applied to transactions
and events as if it had always been in #se. In other words$ at the earliest date s#ch
transactions or events occ#rred$ the policy is applied from that date.' his involves restating opening balances of c#rrent year and comparative previo#s year.
→ wo types of event which do not constit#te changes in acco#nting policy:
%i) Adopting an acco#nting policy for a new type of transaction or event not dealt with
previo#sly by the entity.%ii) Adopting a new acco#nting policy for a transaction or event which has not occ#rred in
the past or which was not material.
→ Changes in acco#nting policy will be very rare and sho#ld be made only if:' he change is re7#ired by an I!"S$ or' he change will res#lt in a more appropriate presentation of events or transactions in the
+nancial statements of the entity$ providing more reliable and relevant information.
"eval#ation of non'c#rrent assets sho#ld not be treated as changes in acco#nting policy %i.e.
no retrospective eect for reval#ation).
• Chan'es in acco$ntin' estimates
→ anagement applies D#dgement based on information available at the time
→ *&les of acco#nting estimates:' <sef#l life or resid#al val#e of a non'c#rrent asset %IAS 14)' 5rovision made for f#t#re loss or e&penses %IAS >?)
→ A change in acco#nting estimate m#st be applied prospectively.
• #rrors%
→ *rrors discovered d#ring a c#rrent period which relate to a prior period may arise thro#gh:
' athematical mista(es' ista(es in the application of acco#nting policies' isinterpretation of facts' 0missions' !ra#d
→ 5rior period errors correct retrospectively.' *ither restating the comparative amo#nts for the prior period%s) in which the error
occ#rred$ or
!rom earliest date of same
transaction
%i.e. retrospective eect)
0n f#t#re
5olicy change
Changes in acco#nting
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' when the error occ#rred before the earliest prior period presented$ restating the opening
balances of assets$ liabilities and e7#ity for that period
IAS 1 Eeases
• :peratin' lease% Any lease other than a +nance lease.' reat this as normal rental agreement.
*rrorB fra#d
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• Finance lease% A lease that transfers s#bstantially all the ris(s and rewards incidental to
ownership of an asset to the lessee %who too( the lease). itle may or may not event#ally be
transferred.
• IAS 1 identi2es 2ve sit$ations )hich )o$ld normally lead to a lease bein' classi2ed as
a 2nance lease%
i. ransfer of ownership of the asset to the lessee at the end of the lease termii. he lessee has the option to p#rchase the asset at a price s#Vciently below fair val#e at
the option e&ercise date$ that it is reasonably certain the option will be e&ercisediii. he lease term is for a maDor part of the assets economic life even if title is not transferred
at end of lease termiv. 5resent val#e of minim#m lease payment amo#nts to s#bstantially all of the assets fair
val#e at inception
v. he leased asset is so specialised that it co#ld only be #sed by the lessee witho#t maDor
modi+cations being made
• At commencement of a +nance lease$ leasee %i.e. #ser of the asset) recognises a -on'c#rrent asset
and a ;iability in Statement of +nancial position.
• #,ample% Eeasee acco$ntin'% Payment ($arterly in advance
5resent val#e of minim#m lease payments is the payments over the lease term that the lessee is re7#ired to
ma(e disco#nted applying implicit interest rate.
he amo#nt of non'c#rrent asset to be capitaliWed is lower
of: [IAS 1?: H]
' 5resent val#e of minim#m lease payment$ and' !air val#e of the leased asset
In !? #sing cash price %fair val#e) given in the
;iability component comprises a c#rrent
portion and a non'c#rrent portion and
amortised over the lease term.
on4c$rrent asset is s$bse($ently depreciated over shorter of%
' Assets #sef#l life$ and
' ;ease term incl#ding any secondary period
#se #sef#l life if reasonable certainty e&ists that the lessee will obtain
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0n 1 0ctober HF> *vans entered into a non'cancellable agreement whereby *vans wo#ld lease a new
roc(et booster. he terms of the agreement were that *vans wo#ld pay H4 rentals of >$ 7#arterly
in advance commencing on 1 0ctober HF>$ and that after this initial period *vans co#ld contin#e$ at
its option$ to #se the roc(et booster for a nominal rental which is not material. he cash price of this
asset wo#ld have been 41$3? and the asset has a #sef#l life of 1 years. *vans has a policy to
charge f#ll years depreciation in the year of p#rchase of a non'c#rrent asset. he rate of interest
implicit in the lease is HM per 7#arter.
.e($ired:
Identify whether this is a +nance lease and show how these transactions wo#ld be re9ected in the
+nancial statements for the year ended >1 =ecember HF>.
Ans)er%
ho#gh the lease term is only 4.3 years %%H4 7#arter F >)B 1H months)$ the lease ass#med to be a
+nance lease beca#se the present val#e of the minim#m lease payment is similar to the fair val#e of
the leased asset.
5resent val#e of the minim#m lease payment:
1st instalment %in advance$ so already at present val#e)
>$5resent val#e Hnd P H4th installment %>$ F 1,.3H>6) %H3 years ann#ity at HM) 38$3?
41$3?
And$ fair val#e of the lease asset at commencement of the lease %Cash price) 41$3?
Eeaseee acco$ntin'%
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• #,ample% Eeasee acco$ntin'% Payment ann$ally in arrears
ranch ac7#ired an item of plant and e7#ipment on a +nance lease on 1 Nan#ary HF1. he terms ofthe agreement were as follows:
=eposit : 1$13 %non'ref#ndable)Instalments : 6$ per ann#m for seven years payable in arrearsCash price : H$ %!air val#e of the lease asset at commencement of the
lease)
he asset has #sef#l life of fo#r years and the interest rate implicit in the lease is 11M.
.e($ired% 5repare e&tracts from the income statement and statement of the +nancial position of
ranch for the year ending >1 =ecember HF1.
Ans)er%
It is ass#med that fair val#e of the leased asset and present val#e of minim#m lease payments aresame at the commencement of the lease.
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• #,ample% Eeasee acco$ntin'% Comple,
owtoc( has leased an item of plant. Commencement of the lease was 1 Nan#ary HFH and term of the
lease is 3 years. 5ayments of 1H$ to be made ann#ally in advance. Cash price and fair val#e of the
asset ' 3H$ at 1 Nan#ary HFH P e7#ivalent to the present val#e of the minim#m lease payments.
Implicit interest rate within the lease 8M per ann#m. he companys depreciation policy for this type of
plant is HM per ann#m on cost %apportioned on a time basis where relevant).
.e($ired% 5repare e&tracts of the income statement and statement of +nancial position for owtoc(for the year to > September HF> for the above lease.
Ans)er%
Eeaseee acco$ntin'%
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IAS 1= .even$e
Income is increases in economic bene+ts d#ring the acco#nting period in theform of in9ows or enhancements of assets or decreases of liabilities that
res#lt in increases in e7#ity$ other than those relating to contrib#tions from
Income
"even#e is income that arises in the co#rse of ordinary activities of an entity."even#e
From sale of 'oods sho#ld only be recognised
when all of the +ve criteria are met: [IAS 18: 16]
' It is probable that f#t#re economic bene+ts will
9ow to the entity.' he amo#nt of reven#e can be meas#red
reliably.' he costs inc#rred in relation to the transaction
can be reliably meas#red.' he seller no longer has management
involvement or eective control of the goods.' he seller m#st have transferred to the b#yer all
of the signi+cant ris(s and rewards of
From renderin' of services sho#ld only be
recognised when all of the fo#r criteria are met: [IAS
18: H]
' It is probable that f#t#re economic bene+ts will
9ow to the entity.' he amo#nt of reven#e can be meas#red
reliably.' he costs inc#rred and the costs to complete in
relation to the transaction can be reliably
meas#red.
' he stage of completion can be meas#red
reliabl .
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• Amo#nts collected on behalf of third parties s#ch as sales ta&es$ goods and services ta&es andval#e added ta&es are not part of reven#e. [IAS 18: 8]
• In an agency relationship$ for an agent$ reven#e is only the amo#nt of his commission. [IAS 18: 8]
• In certain circ#mstances$ it is necessary to apply the reven#e recognition criteria to theseparately identi+able components of a single transaction in order to re9ect the s#bstanceof the transaction. !or e&le$ when the selling price of a prod#ct incl#des anidenti+able amo#nt for s#bse7#ent servicing$ that amo#nt is deferred and recognised as reven#eover the period d#ring which the service is performed. [IAS 18: 1>]
• In some cases two or more transactions are considered together. !or e&le$ an entity may sellgoods and$ at the same time$ enter into a separate agreement to rep#rchase the goods at a laterdate. his sale and rep#rchase agreement may constit#te a sec#red loan and recognised as loanliability instead of sales reven#e. [IAS 18: 1>]
IAS Inventories
•
Inventories are assets:' held for sale in the ordinary co#rse of b#siness' in the process of prod#ction for s#ch sale or' in the form of materials or s#pplies to be cons#med in the prod#ction process or in the
rendering of services.
• Inventories needs to be val#ed lower of:
G G
Seller transfer signi+cant ris(s and
rewards:
' In most cases the transfer of
signi+cant ris(s and rewards ofownership coincides with the
2here consideration %e.g. money) from sales is received b#t above
reven#e recognition criteria are not met:
=" Asset: Cash
C" ;iability: =eferred income
2hen reven#e recognition criteria are met:
=" ;iability: =eferred income
C" IBS: "even#eBIncome
S#ppliers gross price
for raw materials
G
Import d#ties$ etc
G
Costs of transporting
materials to b#siness
premises
'
rade disco#nts
*stimated selling price in the ordinary
co#rse of b#siness$ when completed
'
*stimated costs to completion and the
estimated costs necessary to ma(e the sale.
Cost of conversionCost of p#rchase
Cost -et "ealisable Ual#e %-"U)
Costs directly relatedto the #nits of
prod#ction %e.g. direct
materials$ direct
labo#rs)
G
!i&ed and variable
prod#ction overheads
inc#rred in converting
materials to +nished
goods$ allocated on a
systematic basis
G
orrowing costs %if met
IAS H> criteria)
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• Costs sho#ld not incl#de:' Abnormal waste$ +nished goods storage$ #nrelated administrative overheads
• 2rite'down to -"U:' If inventories are write'down to their -"U$ this will res#lt closing inventory with lower carrying
val#e$ which will have a#tomatic eect on cost of sales %i.e. cost of sales will be increased).
• IAS H does not apply to inventories covered by other standards$ s#ch as:
' 2or( in progress #nder constr#ction contracts %IAS 11 Constr#ction contracts)
IAS 3 Provisions+ contin'ent liabilities and contin'ent
assets
• 5rovision: is a liability where there is #ncertainty over its timing or the amo#nt at which it will be
settled. A provision sho#ld be recognised where:
' An entity has a present obligation %legal or constr#ctive) as a res#lt of a past event' It is probable %i.e. more li(ely than not) that there will be an o#t9ow of reso#rces in the form of
cash or other assets' A reliable estimate can be made of the amo#nt [IAS >?: 1]
• A provision sho#ld not be recognised in respect of f#t#re operating losses since there is no present
obligation arising from a past event. [IAS >?: 4>]
• An entity can be re7#ired to recognise a provision and capitalise %=" -on'c#rrent asset: 5roperty$
plant K e7#ipment C" ;iability: 5rovision) initial estimation of f#t#re dismantling and restoration
cost if above provision recognition criteria and IAS 14 capitalisation criteria are met. [IAS 14: 14$ 18]' @ains from the e&pected disposal of assets shall not be ta(en into acco#nt in meas#ring a
provision. [IAS >?: 31]
• If an entity sells goods with a warranty$ a provision recognition %=" IBS: *&pense C" ;iability:
5rovision) can be re7#ired based on the best estimate of the e&pendit#re re7#ired to settle the
present obligation at the end of the reporting period. [IAS >?: >4]
' 2hen the selling price incl#des an identi+able %i.e. disting#ishable) amo#nt for s#bse7#ent
servicing$ that amo#nt is deferred %=" Asset: CashB "eceivable C" ;iability: =eferred income)
and recognised as reven#e over the period d#ring which the service is performed %=" ;iability:
=eferred income C" IBS: "even#e). [IAS 18: 1>]
i.e. established ast
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2here the provision being meas#red involves a large pop#lation of items$ the obligation is
estimated by /e&pected val#e calc#lation. [IAS >?: >,]
• .estr$ct$rin' costs% A constr#ctive obligation$ re7#iring a provision$ only arises in respect of
restr#ct#ring costs where the following criteria are met:
' A detailed formal plan has been made$ identifying the areas of the b#siness and n#mber of
employees aected with an estimate of li(ely costs an timescales and' An anno#ncement has been made to those who will e aected by the restr#ct#ring.
A restr#ct#ring provision does not incl#de costs of retraining or relocating contin#ing sta$
mar(eting$ or investment in new systems [IAS >?: 81]
• Disco$ntin' to present val$e: 2hen there is a signi+cant period of time between the end of
reporting period and settlement of the obligation$ the amo#nt of provision sho#ld be disco#nted to
present val#e. [IAS >?: 63]
' =isco#nt factor: %1Gr)XY' he disco#nt rate shall be a pre'ta& rate that re9ects c#rrent mar(et assessment of the time val#e
of money and the ris(s speci+c to the liability.
*&le: If a provision of 1$ is re7#ired to settle a liability after H years at 1M disco#nt rate
the provision will be recognised at Jear' is 8H? %1$ F .8H?).
• ?n)indin' of disco$nt: 2hen a provision is incl#ded in the statement of +nancial position at a
disco#nt val#e %i.e. at present val#e) the amo#nt of the provision will increase over time$ to re9ect the
passage of time.
' <nwinding of disco#nt will be incl#ded in the +nance cost.' <nwinding of disco#nt %i.e. the amo#nt to be charged in +nance cost and by the amo#nt the
provision needs to be increased) can be fo#nd by applying /disco#nt rate on opening balance of
the provision.
At end of Jear'1: 8> %8H?F1M) =" IBS: !inance cost C" ;iability: 5rovision %that ma(es closing
provision liability E ,1 %8H?G8>)) At end of Jear'H: ,1 %,1F1M) =" IBS: !inance cost C" ;iabilit : 5rovision %that ma(es closin
• "eimb#rsement: An entity may be entitled to reimb#rsement from a third party for all or part of the
e&pendit#re re7#ired to settle a provision. S#ch a reimb#rsement:
' Sho#ld only be recognised %=" Assets: "eceivable C" IBS: 0ther income) where receipt is /virt#ally
certain$ and' Sho#ld be treated as a separate asset in the statement of +nancial position %i.e. not netted o
against the provision) at an amo#nt no greater than that provision.'
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• Contingent liability: is a possible obligation that arises from past events and whose e&istence will
be con+rmed only by occ#rrence or non'occ#rrence of one or more #ncertain f#t#re events not
wholly within the control of the entity.
' Contingent liability is not recognised in the +nancial statements beca#se either it is notprobable$ or the amo#nt cannot be meas#red with s#Vcient reliability.
' Contingent liability is only disclosed in the notes of +nancial statements. [IAS >?: 1$ 1>]
• Contingent asset: is a possible asset that arises from past events and whose e&istence will be
con+rmed only by occ#rrence or non'occ#rrence of one or more #ncertain f#t#re events not wholly
within the control of the entity.
' A contingent asset sho#ld not be recognised in the +nancial statements' Contingent assets sho#ld only be disclosed in the notes of +nancial statements when the
e&pected in9ow of economic bene+ts is probable. [IAS >?: >1$ >6]
• 2hen the realisation of income is virt#ally certain$ then the related receivable is recognised in the
+nancial statements %=" Asset: "eceivable C" IBS: 0ther income) [IAS >?: >>]
Disclos$re let o$t: IAS >? permits reporting entities to avoid disclos#re re7#irements relating to
provisions$ contingent liabilities and contingent assets if they wo#ld be e&pected to be serio#sly preD#dicial
%i.e. will ca#se serio#s disadvantage) to the position of the entity in disp#te with other parties.
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IF.S G on4c$rrent assets held for sale and discontin$ed
operations
Held for sale%
• An entity shall classify a non'c#rrent asset %or disposal gro#p) as held for sale if its carrying
amo#nt will be recovered principally thro#gh a sale transaction rather than thro#gh contin#ing #se.[I!"S 3: 4]
• o be classi+ed as held for sale$ the following conditions m#st be met:
' Available for immediate sale in present condition [I!"S 3: ?].' Sale is highly probable [I!"S 3: 8].
' he sale sho#ld be e&pected to ta(e place within one year from the date of classi+cation [I!"S
3: 8].
• 0nce an asset or gro#p of assets and related liabilities is classi+ed as held for sale$ the following
r#les sho#ld be followed:
A gro#p of assets and liabilities that will be
disposed of in a single transaction are referred to
he assets c#rrent condition
sho#ld be ade7#ate to be
!or a sale to be highly probable$ the following m#st apply:
' anagement m#st be committed to a plan to sell the
asset' here m#st be an active programme to locate a b#yer
' he asset m#st be mar(eted for sale at a price that is
!air val#e less cost to sell is e7#ivalent to net
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' Carry at lower of its carrying amo#nt and fair val#e less cost to sell$ which may give rise to an
impairment loss [I!"S 3: 13].
' =o not depreciate even if still being #sed by the entity. [I!"S 3: 1]' 5resent separately in the statement of +nancial position. [I!"S 3: 1]' -on'c#rrent asset held for sale recognise #nder c#rrent asset. [I!"S 3: >]
• Presentation of a non4c$rrent asset or a disposal 'ro$p classi2ed as held for sale: [I!"S
3: >8]-on'c#rrent assets and disposal gro#ps classi+ed as held for sale sho#ld be presented separately
from other assets in the statements of +nancial position. he liabilities of a disposal gro#p sho#ld
be presented separately from other liabilities in the statement of +nancial position.' Assets and liabilities held for sale sho#ld not be oset.' he maDor classes of assets and liabilities held for sale sho#ld be separately disclosed either
on the face of the statement of +nancial position or in the notes.
• :n $ltimate disposal of an asset classi+ed as held for sale$ any dierence between its carrying
amo#nt and the disposal proceeds is treated as a loss or gain recognised in income statement.
• A non4c$rrent asset or disposal 'ro$p that is no lon'er classi2ed as held for sale %for
e&le$ beca#se the sale has not ta(en place within one year) is meas#red at the lo)er of% [I!"S
3: H?]
' Its carryin' amo$nt before it was classi+ed as held for sale$ adD#sted for any depreciation
that wo#ld have been charged had the asset not been held for sale.' Its recoverable amo$nt at the date of the decision not to sell.
An asset that is to be abandoned sho#ld not be classi+ed as held for sale. [I!"S 3: 1>]
Disco$nted operation%
• =iscontin#ed operation is a component of an entity that has either been disposed of$ or is
classi+ed as /held for sale$ and:' represents a separate maDor line of b#siness or geographical area of operations' is part of a single co'ordinated plan to dispose of a separate maDor line of b#siness or
geographical area of operations$ or' is a s#bsidiary ac7#ired e&cl#sively with a view to resale. [I!"S 3: >H]
• !or discontin$ed operations$ an entity sho#ld disclose a sin'le amo$nt in the statement ofcomprehensive income comprising the total of: [I!"S 3: >>]
' he post'ta& pro+t or loss from discontin#ed operations and' he post'ta& gain or loss on the re'meas#rement to /fair val#e less costs to sell or on the
disposal of the discontin#ed operation.
An entity sho#ld also disclose an analysis of the above single amo#nt either on the face of the
statement of comprehensive income or in the notes.
his is an e&ception to the normal IAS >4 r#le.
IAS >4 impairment of assets re7#ires an entity
to recognise an impairment loss only when an
assets recoverable amo#nt is lower than its
. . . can incl#de transport costs and costs to
advertise that the asset is available for sale
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An entity shall disclose the amo#nt of income from contin#ing operations and from
discontin#ing operations attrib#table to owners of the parent. An entity sho#ld also disclose the net cash 9ows attrib#table to the operating$ investing and
+nancing activities of discontin#ed operations. hese disclos#res may be presented either onthe face of the statement of cash 9ows or in the notes.
• @ains and losses on the re'meas#rement of a non4c$rrent asset or disposal 'ro$p that is not a
discontin#ed operation b#t is held for sale sho#ld be incl#ded in pro+t or loss from contin#ingoperations. [I!"S 3: >?]
IAS 11 Constr$ction contracts
• .even$e and cost% sho#ld be recognised according to the stage of completion of the contract at
the end of the reporting period$ b#t only when the o#tcome of the activity can be estimated
reliably.
• hen o$tcome of the contract cannot be reliably estimated%' .even$e% 0nly recognise reven#e to the e&tent of contract costs inc#rred which are e&pected
to be recoverable' Cost% "ecognise contract costs as an e&pense in the period they are inc#rred
• Contract costs which cannot be recovered sho#ld be recognised as an e&pense straight away.
• If a loss is predicted %i.e. the contract val#e Z total contract cost) on a contract then it sho#ld berecognised immediately in IBS.
• Costs that sho$ld be #XCE?D#D from constr$ction contract costs%' @eneral administration costs %#nless reimb#rsement is speci+ed to the contract)' Selling costs' "esearch and development %#nless reimb#rsement is speci+ed to the contract)' =epreciation of idle plant and e7#ipment not #sed on in the contract
FJ plc ' Consolidated statement of comprehensive income for the year ended >1 =ecember
HF,
"even#e
F
Cost of sales
%F)
@ross pro+tF
0ther income
F
=istrib#tion costs
%F)
Administrative e&penses
%F)
0ther e&penses
' 5robable that economic bene+t of the
contract will 9ow to the entity.
' Costs and reven#e can be identi+ed
clearl and be reliabl meas#red.
' *ither$ proportion of total contract costs
inc#rred for wor( carried o#t to date
' 0r$ physical proportion of the contract wor(
Costs inc#rred to date G costs will
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5enalty charged by client %may be for delay) will red#ce the reven#e will not increase the cost.
!inance costs sho#ld be incl#ded in contract costs #nder IAS H> orrowing Costs.
• Acco$ntin' treatments%Income Statement%"even#e
F %%otal contract val#e F M completed) P "even#e recognised in previo#s periods )Cost of sales
%F)%%otal contract costs F M completed) P Costs and losses charged in previo#s periods)
Foreseeable loss not previo$sly reco'nised 9AEAYS test for foreseeable loss; %F)
%%%otal contract val#e P otal contract cost) F M yet to complete)P Any of this loss previo#sly recognised)
Pro2t<9loss; %before non'reimb#rsable abnormal cost)
FB%F)
Abnormal cost %e.g. recti+cation cost which is not reimb#rsed by client)
%F)
et pro2t<9loss;
FB%F)
%Any recti+cation cost which will be reimb#rsed by client will increase
both /total contract val#e and /total contract costs)
Statement of 2nancial position%
Contract costs inc#rred to date
F
5ro+tsB%losses) recognised to date %before ded#cting non'reimb#rsable abnormal cost)
FB%F)
F5rogress billing to date
%F)
.eceivables < 9payables; %c#rrent assetBliability)
FB%F)
IAS 1 Income ta,es
AF
Income ta& =eferred ta&Sales ta&
• Also (nown as c#rrent ta&.
• his is the ta& on /ta&able pro+t %-0 on
/acco#nting pro+t).
• Companies prepare pro+t or loss acco#nt
based on acco#nting standards b#t ta&able
pro+t is calc#lated based on ta& r#les.
• If ta&able pro+t for the year is 1
%acco#nting pro+t can be dierent) and
applicable ta& rate is >M then the
acco#nting treatment will be:
=" IBS: *&pense: Income ta&
>
C" S!5: C#rrent liability: a& payable >
%If ta& is paid as inc#rred then C" S!5: Cash)
• If there is a ta& loss for the year is 1 then
the acco#nting treatment will be:
=" S!5: C#rrent asset: a& recoverable >
%or$ =" S!5: C#rrent liability: a& payable$
if there is already a ta& payable balance)
C" IBS: Income ta& %will red#ce e&penses) >
• <nder'provision or over'provision of ta&: he
act#al ta& liability for the year and the ta&charge in the income statement are not
necessarily the same amo#nt. he act#al ta&
liability for the year is agreed with ta&
a#thorities$ may be$ in a later year.
' If ta& charge in Jear'1 on Jear'1 ta&able pro+t
is 1 and in Jear'H the act#al ta& charge for
Jear'1 determined 1H then the ta& charge
for Jear'H will be increased by H %this is the
/#nder'provision made in Jear'1). I.e. if ta&
charge in Jear'H on Jear'H ta&able pro+t is
13$ the ta& e&pense amo#nt in Jear'H IBS will
be 13GHE1?.
→ An over'provision of ta& from year 1 is
• Also (nown as UA %val#e added ta&).
• Seller collect /sales ta& at the point of saleand the p#rchaser pays /sales ta& at the point
of p#rchase.
• If 13M sales ta& applicable on sales made by
Company / the acco#nting for 1 sales
will be:
=" S!5: Cash
113
C" IBS: "even#e
1
C" S!5: C#rrent liability: Sales ta& payable 13
%eca#se as per IAS 18$ reven#e cannot be
recognised for the amo#nt %13) collected on
behalf of others %i.e. sales ta& collected on behalf
of government).
• If 13M sales ta& applicable on p#rchases made
by Company / and if the sales ta&es paid by
Company / is recoverable the acco#nting for
8 p#rchase will be:
=" 5#rchase
8
=" S!5: C#rrent asset: Sales ta& recoverable
1H%or$ =" S!5: C#rrent liability: Sales ta& payable$
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• Deferred ta,: his is an acco#nting meas#re rather than a ta& levied by government it
represents ta& payable or recoverable in f#t#re acco#nting periods in relation to transactions which
have already ta(en place.
• emporary diJerences are dierences between the carrying amo#nt of an asset or liability in the
statement of +nancial position and its ta& base. emporary dierences may be either ta,able or
ded$ctible.
' a,able temporary diJerences will res#lt in ta&able amo#nts in determining ta&able pro+t
%loss) of f#t#re periods when the carrying amo#nt of the asset or liability is recovered orsettled.
Deferred ta, liabilities: are the amo#nts of income ta&es payable in f#t#re periods in
respect of ta&able temporary dierences.
=" a& charge
C" S!5: -on'c#rrent liabilities: =eferred ta& liability
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' Ded$ctible temporary diJerences will res#lt in amo#nts that are ded#ctible in determining
ta&able pro+t %ta& loss) of f#t#re periods when the carrying amo#nt of the asset is recovered or
settled.
Deferred ta, assets: are the amo#nts of income ta&es recoverable in f#t#re periods in
respect of ded#ctible temporary dierences %and in respect of the carry forward of #n#sed
ta& losses or ta& credits).
=" S!5: -on'c#rrent assets: =eferred ta& asset
C" a& charge
• "ecognise deferred ta& %that is the dierence between the opening and closing deferred ta&
balances in the S!5) normally in pro+t or loss. #t$ e&ceptions are:
' =eferred ta& relating to items dealt with as other comprehensive income %s#ch as reval#ation)
sho#ld be recognised as ta& relating to other comprehensive income within the statement of
comprehensive income
' =eferred ta& relating to items dealt with directly in e7#ity %s#ch as the correction of an error
or retrospective application of a change in acco#nting policy) sho#ld also be recognised
directly in e7#ity
• Steps to follow in determining deferred ta& balances:
→ Step 1: =etermine the items carrying amo#nt %i.e. boo( val#e i.e. S!5 val#e) and ta& base
val#e as at year beginning and year end.
→ Step % Calc#late the temporary dierence %i.e. dierence between carrying val#e and ta&
base val#e) at year beginning and at year end.' emporary dierence will be either /ta&able temporary dierence or /ded#ctible temporary
dierence. Chec( the decision tree below.' In the 7#estion sometime the temporary dierences are given. In that case yo# dont need
to apply Step 1.
→ Step 3: Apply ta& rate on temporary dierences to identify deferred ta& asset or liability at
year beginning and at year end.' he deferred ta& asset or liability identi+ed from year end balances is the amo#nt to be
shown in Statement of !inancial 5osition.' he movement from year beginning deferred ta& asset or liability to year end deferred ta&
asset or liability to be shown in IBS %in other comprehensive income if the portion related to
reval#ation).
' he ta& rate to be #sed in the calc#lation for determining a deferred ta& asset or liability is
the rate that is e&pected to apply when the asset is realised$ or the liability is settled.
Income:
Asset
*&pense:
Asset
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\#estion:Company b#ys e7#ipment for 3$ and depreciates it on a straight line basis over its e&pected
#sef#l life of +ve years %i.e. LHM). !or ta& p#rposes$ the e7#ipment is depreciated at H3M per ann#m
on a straight line basis %i.e. will be f#lly depreciated at end of Jear'6). Acco#nting pro+t before ta& is
3$ for each of Jear 1 to 3. he ta& rate is 6M. Show c#rrent and deferred ta& impacts from Jear 1
to 3.
Answer:
he most important temporary dierence is that between depreciation charged in the
+nancial statements and capital allowances in the ta& comp#tation. In practice capital
allowances tend to be higher than depreciation charges$ res#lting in acco#nting pro+ts being
higher than ta&able pro+ts. his means that the act#al ta& charge %c#rrent ta&) is too low in
comparison with acco#nting pro+ts. Rowever$ these dierences even o#t over the life of an
asset$ and so at some point in the f#t#re the acco#nting pro+ts will be lower than the ta&ablepro+ts$ res#lting in a relatively high c#rrent ta& charge.
hese dierences are misleading for investors who val#e companies on the basis of their
post'ta& pro+ts %by #sing *5S for e&le). =eferred ta& adD#sts the reported ta& e&pense for
these dierences. As a res#lt the reported ta& e&pense %the c#rrent ta& pl#s the deferred ta&)
will be comparable to the reported pro+ts$ and in the statement of +nancial position a
provision is b#ilt #p for the e&pected increase in the ta& charge in the f#t#re.
here are dierent ways that deferred ta& co#ld be calc#lated. IAS 1H states that the balance
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• =etermining ta& base of assets:
→ he ta& base of an asset is the amo#nt that will be ded#ctible for ta& p#rposes against any
ta&able economic bene+ts that will 9ow to an entity when it recovers the carrying amo#nt of
the asset. If those economic bene+ts are not ta&able$ the ta& base of the asset is e7#al to its
carrying amo#nt. [IAS 1H: ?]
→ 5#tting above into a form#la: a& base E Carrying amo#nt P !#t#re ta&able amo#nts G !#t#re ded#ctible amo#nts
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-ote:
1.
' !#t#re ta&able amo#nt considered as e7#ivalent to the Carrying amo#nt since the economic
bene+t %e.g. operations of the b#siness which will generate income) from #sing the 5K* yet to be
ta&able.' !#t#re ded#ctible amo#nt is >$3 since 4$3 already claimed as ta& depreciation in ta&able
pro+t calc#lation. >$3 will be ded#ctible in the f#t#re periods ta&able pro+t calc#lation.
H.
' he amo#nt will be ta&able on cash basis i.e. when the cash will be received in the f#t#re. So$
the whole 1$ amo#nt is !#t#re ta&able amo#nt.' he amo#nt will never be ded#ctible in ta&able pro+t calc#lation. So$ /-il !#t#re ded#ctible
amo#nt.
>.
' he amo#nt already been ta&ed so will not be ta&ed f#rther. hat is why !#t#re ta&able amo#nt
is /-il. ' he amo#nt will never be ded#ctible in ta&able pro+t calc#lation. So$ /-il !#t#re
ded#ctible amo#nt.
6.
' he amo#nt not ta&able and not ded#ctible in the f#t#re. So$ !#t#re ta&able amo#nt and !#t#re
ded#ctible amo#nt both are -il.
3.
' he amo#nt will not be ta&ed or ded#ctible in the f#t#re. So$ both of the val#es are /-il.
• =etermining ta& base of liabilities:
→ he ta& base of a liability is its carrying amo#nt$ less any amo#nt that will be ded#ctible for ta&
p#rposes in respect of that liability in f#t#re periods. In the case of reven#e which is received
in advance$ the ta& base of the res#lting liability is its carrying amo#nt$ less any amo#nt of the
reven#e that will not be ta&able in f#t#re periods. [IAS 1H: 8]
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→ 5#tting this into a form#la: a& base E Carrying amo#nt G !#t#re ta&able amo#nt P !#t#re
ded#ctible amo#nt
*&ception applies for #nearned reven#e %i.e. reven#e received in advance) %see following -ote'H)
-ote:
1.
' he related e&pense will be ded#cted for ta& p#rposes on a cash basis. Since the amo#nt yet to
be paid$ the 1$ will be !#t#re ded#ctible amo#nt.' he amo#nt is an e&pense$ so will not the ta&able in the f#t#re.
H.
' he amo#nt is charged for ta& on cash basis. Since the cash is already received$ the amo#nt is
already ta&ed and will not be ta&ed again. hat is why !#t#re ta&able amo#nt is ta(en as a
negative +g#re$ instead of positive %as given in the form#la). his is e&ception to the general
form#la$ b#t in compliance with IAS 1H re7#irements.
' Alternative way of calc#lating a& base of <nearned reven#e is: Carryin' amo$nt & Amo$ntthat )ill not be ta,able in the f$t$re. h#s the calc#lation will be: 1$ ' 1$ E -il
>. he amo#nt will not be ded#ctible$ or chargeable for ta& p#rposes.
6. he amo#nt will not be ded#ctible$ or chargeable for ta& p#rposes.
Financial instr$ments
• !o#r standards on +nancial instr#ments:
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→ IAS >H !inancial instr#ments: 5resentation' IAS >H deals with classi+cation of +nancial instr#ments between liabilities and e7#ity$ and
presentation of certain compo#nd instr#ments
→ I!"S ? !inancial instr#ments: =isclos#res' I!"S ? revised$ simpli+ed and incorporated disclos#re re7#irements previo#sly in IAS >H
→ IAS >, !inancial instr#ments: "ecognition and meas#rement' IAS >, deals with recognition$ derecognition and meas#rement of +nancial instr#ments
and hedge acco#nting
→ I!"S , !inancial instr#ments' I!"S , is a wor( in progress and will replace IAS >,. It will come into force for acco#nting
periods ending in H1>.
• Compo$nd 2nancial instr$ments%
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A compo#nd or /hybrid +nancial instr#ment is one that contains both a liability component and an
e7#ity component. As an e&le$ an iss#er of a convertible bond has:
' he obligation to pay ann#al interest and event#ally repay the capital P the liability component' he possibility of iss#ing e7#ity$ sho#ld bondholders choose the conversion option P the e7#ity
component.
In s#bstance the iss#e of s#ch a bond is the same as iss#ing separately a non'convertible bond and anoption to p#rchase shares. At the date of iss#e the components of s#ch instr#ments sho#ld be
classi+ed separately according to their s#bstance. his is often called /split acco#nting.
he amo#nt received on the iss#e %net of any iss#e e&pense) sho#ld be allocated between the
separate components as follows:
' he fair val#e of the liability component sho#ld be meas#red at the present val#e of the
periodic interest payments and the event#al capital repayment ass#ming the bond is
redeemed.
' he fair val#e of the e7#ity component sho#ld be meas#red as the remainder of the net
proceeds.
-ote that the rate of interest on the convertible will be lower than the rate of interest on the
comparable instr#ment witho#t the convertibility option$ beca#se of the val#e of the option to
ac7#ire e7#ity.
he present val#e sho#ld be disco#nted at the mar(et rate for an instr#ment of comparable credit
stat#s and the same cash 9ows b#t witho#t the conversion option.
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Consolidated statement of 2nancial position
• =ierent types of investment and re7#ired acco#nting:
I@#S-# C.I#.IA .#K?I.#D .#A-# I
8.:?P ACC:?SS#bsidiary Control %^ 3M r#le) !#ll consolidation$ i.e. single
entity IAS H? Consolidated and
Separate !inancial Statements
I!"S > #siness Combinations
I!"S 1 Consolidated !inancial
StatementsAssociate Signi+cant in9#ence %3M ^
HM r#le)
*7#ity acco#nting
IAS H8 Investment in Associates
and Noint Uent#res
Noint vent#re %Dointly controlled
entity)
Contract#al agreement 5roportionate consolidation or
e7#ity acco#nting IAS H8
Investment in Associates and
Noint Uent#res I!"S 11 Noint
ArrangementsInvestments which is none of
the above
Asset held for accretion %i.e.
increase) of wealth
As for single company acco#nts
%I!"S ,: !inancial instr#ments)
Investments /held for sale
%I!"S 3: -on'C#rrent Asset Reld
for Sale and =iscontin#ed
0perations)
Sale is highly probable G r#le 5resent assets or gro#p of
assets separately in Statement
of !inancial 5osition and res#lts
of discontin#ed operations to
be presented separately in the
Statement of Comprehensive
Income.
• Investments in S#bsidiary:
' Control achieved by owning more than 3M voting power. #t$ control can still e&ist with lessthan 3M voting power.
' Control may be lost even witho#t changing the ownership levels when s#bsidiary becomess#bDect to control of a government$ co#rt administration or reg#lator.
• #,emptions from preparin' 'ro$p acco$nts% A parent need not present consolidated +nancial
statements if A;; of the following conditions are satis+ed:' It is a wholly'owned s#bsidiary or a partially'owned s#bsidiary of another entity and its other
owners have not obDected to the parent not presenting consolidated +nancial statements' Its sec#rities are not p#blicly traded' It is not in the process of iss#ing sec#rities in p#blic sec#rities mar(ets
2hen parent has:
' 5ower over more than 3M of the voting rights by virt#e of agreement with other
investors.
' he power to govern the +nancial and operating policies of the entity by stat#e or
#nder an agreement.
' he power to appoint or remove a maDority of members of the board of directors.
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' he #ltimate or intermediate parent p#blishes consolidated +nancial statements that comply
with I!"S
• DiJerent reportin' dates: If a s#bsidiarys reporting date is dierent then parent and b#l( of
other s#bsidiaries in the gro#p:' the s#bsidiary may prepare another set of +nancial statements' 0"$ if it is not possible$ the s#bsidiarys acco#nts may still be #sed provided that the gap is
not more than three months and adD#stments are made to re9ect signi+cant transactions orother events.
• DiJerin' acco$ntin' policies: <niform acco#nting policies sho#ld be #sed. AdD#stments sho#ld
be made where acco#nting policies of s#bsidiary dier from parent.
1. @"0<5 S"<C<"*:
5arent
3M G %control) HM G %signi+cant in9#ence)
S#bsidiary Associate
H. -* ASS*S A !AI" UA;<* A R* =A* 0!:
>. C0S 0! I-U*S*-:
' =o not incl#de costs li(e professional fees$ legal fees in the cost of investment these m#st berecognised in the 5ro+t or ;oss acco#nt as e&pense as inc#rred. Also$ in cost of investment do not
incl#de loan iss#ed to s#bsidiary.
' Any contingent consideration payable m#st be incl#ded even at the date of ac7#isition if it is not
deemed probable that it will be paid
' It is possible that the !U of the contingent consideration may change after the ac7#isition date. If
it is d#e to additional information obtained that aects the position at ac7#isition date$ goodwill
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sho#ld be remeas#red %one year 7#alifying period applies). If the change is d#e to events after the
ac7#isition date %s#ch as earnings target met) then the goodwill will not be remeas#red %gainBloss
from remeas#rement will be recognised in IBS)
6. @00=2I;;:
i. e) method: 2hen e&aminer will re7#ire to #se the new method$ he will mention /f#ll$
/gross$ /new$ or /calc#late -CI at fair val#e. In this case !U of -CI %val#e of shares notac7#ired) at ac7#isition date will be given.
ii. :ld method: 2here an e&am 7#estion re7#ires #se of the old method$ it will state that /it is
gro#p policy to val#e the non'controlling interest at its proportionate share of the fair val#e of
the s#bsidiarys identi+able net assets.
3. -0-'C0-"0;;I-@ I-*"*S %-CI) I- S<SI=IA"J:
' -CI is not applicable for associates.
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4. C0-S0;I=A*= "*S*"U*:
?. I-U*S*- I- ASS0CIA*:
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Consolidated statement of comprehensive income
If s#bsidiary is ac7#ired part way thro#gh the year then all income and e&penses of s#bsidiary shall
be time apportioned
F1: ransaction val#e of inter'company trading %i.e. the total selling price in inter'company trading)
FH: 2ho is the seller_ %only ded#ct the #nrealised pro+t)
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F>: Interest on inter'company loan
IAS Statement of cash o)s
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he formats are not comprehensive. All information in the formats may not be re7#ired in every
sit#ation. It is very important to #nderstand the #nderlying concept than mere memorising the format.
.atio analysis
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Ei($idity .atios: ;i7#idity ratio meas#res a companys ability to pay short'term obligations
1. C#rrent ratio E C#rrent Asset
C#rrent ;iabilities E F : 1
→ C#rrent ratio is mainly #sed to give an idea of the companys ability to pay bac( its short'term
liabilities %debt and payables) with its short'term assets %cash$ inventory$ receivables).
→ he higher the c#rrent ratio$ the more capable the company is of paying its obligations.
→ A c#rrent ratio of 1.3:1 to H:1 can mean s#Vcient c#rrent asset to cover its c#rrent liabilities.
→ A c#rrent ratio of above H:1 may mean over investment in wor(ing capital %i.e. in c#rrent
assets). S#rpl#s assets can be #sed to
' to e&pand the b#siness operation or to increase capacity which will earn additional pro+t$' to repay debt which will save interest e&penses$
' distrib#te to shareholders as dividend.
→ A c#rrent ratio below 1 s#ggests that the company wo#ld be #nable to pay o all of its c#rrent
liabilities if they came d#e at that point.
→ C#rrent ratio can be improved by
' selling of #n#sed non'c#rrent assets$' ta(ing long'term loan$' speeding #p the receivables collection$' slowing payables payment
→ A wea( c#rrent ratio shows that the company is not in good +nancial health$ b#t it does not
necessarily mean that it will go ban(r#pt as there are many ways to access +nancing b#t it is
de+nitely not a good sign.
→ Companies that have tro#ble getting paid by its receivables or have long inventory t#rnovercan r#n into li7#idity problems
H. \#ic( or \#ic( asset or Acid test ratio E C#rrent Asset ' Closing Inventory
C#rrent ;iabilities E F : 1
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→ he 7#ic( ratio meas#res a companys ability to meet its short'term obligations with its most
li7#id assets %as it e&cl#des inventory).
→ Inventory is e&cl#ded beca#se some companies %specially man#fact#ring companies with high
inventory holding period) have diVc#lty t#rning their inventory into cash.
→ he higher the 7#ic( ratio$ the better the position of the company.
→ A 7#ic( ratio of 1:1 is normally most appropriate. !or companies with a high inventory t#rnover
ratio %i.e. short inventory holding period) can have a less than 1 7#ic( ratio witho#t s#ggesting
that the company co#ld be cash 9ow tro#ble.
→ If 7#ic( ratio is too low than the c#rrent ratio this co#ld mean that high amo#nt of wor(ing
capital is tied #p in inventory. Righ amo#nt of inventory means high inventory holding costs.
Pro2tibality .atios%
1. .et$rn on capital employed 9.:C#; > 5ro+t efore Interest and a&
Capital *mployed F 1M E FM
→ Capital employed > otal asset & C$rrent liabilities
> Share capital L .eserves L Eon'4term liabilities
→ =eferred a& ;iability or Asset normally e&cl#ded from Capital *mployed.In that case$ Capital employed E otal asset P C#rrent liabilities P =eferred ta& liability or asset
E Share capital G "eserves G ;ong'term liabilities P
=eferred ta& liability or asset
→ C#rrent ;iability portion of ;ong'term liabilities and a constant amo#nt of 0verdraft normally
also considered as -on'c#rrent liability for Capital employed calc#lation
→ etter to #se average Capital *mployed %0pening G Closing B H ) where possible.
' If yo# are re7#ired to compare ratios between two dierent years and cannot calc#late
average for both of the years$ then ta(e only the S!5 val#e of the year %i.e. do not
average). his is for comparability p#rpose.
→ If mar(et val#e of e7#ity is ta(en then do not incl#de /"eserves.
here is a lot other conte&ts to de+ne capital employed. his is basically the capital re7#ired
for a b#siness to f#nction.
→ "0C* is the prime meas#re of operating performance. his ratio indicates how eVciently a
b#siness %i.e. managers) is #sing the f#nds invested %e7#ity and long'term debt).
→ It is the ratio over which operations management has most control.
→ "0C* increase from previo#s year or above ind#stry average means a good sign and re9ects
the fact that the company %by managers) has managed to increase the sales witho#t a
proportionate increase in costs.
→ "0C* decrease from previo#s year or below ind#stry average shows problem with controlling
of costs. ;evel of dividend may also fall as a conse7#ence.
→ he val#e of capital employed is lower where company mainly #ses rented assets %i.e.
thoro#gh operating lease) rather owning or +nance lease. his is also possible where assets
carrying val#e is lot less than the cost %remember in that case assets will need replacement).
hese may res#lt a higher "0C*.
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→ Asset reval#ation %especially land) will res#lt a higher amo#nt of Capital employed$ which will
give a lower "0C* witho#t indicating company performance became poorer.
→ "0C* sho#ld always be higher than the rate at which the company borrows otherwise any
increase in borrowing will red#ce shareholders earnings.
H. .et$rn on e($ity 9.:#;+ or .et$rn on Shareholders7 Capital 9.:SC; >
5ro+t After a& and 5reference =ividend
0rdinary Share Capital and "eserve F 1M E FM
→ 5ro+t after ta& and preference dividend is the /5ro+t attrib#table to ordinary shareholders
→ It is common to #se boo( val#es rather mar(et val#e of shares %if mar(et val#e #sed then
remember to e&cl#de "eserves)
→ etter to #se average of Shareholders Capital %0pening G Closing 0rdinary Share Capital and
"eserves B H ) where possible specially$ when closing balance signi+cantly diers from
opening balance.
' If yo# are re7#ired to compare ratios between two dierent years and cannot calc#late
average for both of the years$ then ta(e only the S!5 val#e of the year %i.e. do not average).
his is for comparability p#rpose.
→ "et#rn on e7#ity %"0*) indicates to ordinary shareholders how well their investments have
performed meas#ring how m#ch pro+t the company has generated for them with their money.
→ A good +g#re res#lts in a high share price and ma(es it easy to attract new f#nds.
→ 2ith a similar level of "0C*$ a fall in "0* may mean increased +nance cost beca#se of new
loans.
→ An improved "0* with a similar "0C* may mean some of the loans are repaid which res#lted alower +nance cost and$ so$ improved pro+t attrib#table to ordinary shareholders.
→ If new share iss#ed sometime at period end$ this may res#lt a declined "0* witho#t indicating
poor performance of the company beca#se company really did not get time to #tilise the new
capital.
35 8ross pro2t mar'in > @ross 5ro+t
Sales F 1M E FM
→ Righ gross pro+t margin may indicate eective p#rchasing strategy which res#lts a lower
material KB prod#ction cost %i.e. lower cost of sales). A high gross pro+t margin may also
indicate concentration on low vol#me'high margin sales.
→ ;ow gross pro+t margin may be an indication of selling prod#cts cheaply %i.e. at disco#nt) in
order to generate high vol#me of sales. his may also indicate increased prod#ction cost
%incl#ding material and labo#r cost) witho#t a proportionate increase in selling price.
5 :peratin' pro2t mar'in > 5ro+t before Interest and a&
Sales F 1M E FM
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→ 0perating pro+t margin gives analysts an idea of how m#ch pro+t %before interest and ta&) the
company is ma(ing from each dollar of sales.
→ ypically operational management has f#ll control over operating costs %the amo#nt of loan
capital and$ so$ interest e&pense normally depends on more higher level of management and
the amo#nt of ta& payable depends on government policy). So$ operating pro+t margin
eectively meas#res performance of operational management.
→ A poor or declining 0perating pro+t margin may indicate b#siness is str#ggling in controlling
the costs. his may also happen beca#se of decrease in selling price.
→ A healthy operating pro+t margin is re7#ired for a company to be able to pay interest on loans.
G5 et pro2t mar'in > 5ro+t After a&
Sales F 1M E FM
→ -et pro+t margin sometimes calc#lated based on /5ro+t before ta& %after interest). Chec(
7#estion for indication.
→ A higher percentage than last year or ind#stry average indicates costs are being controlled
better. his may also indicate prod#cts are sold at higher price.
→ A wea(en -et pro+t margin may indicate management is str#ggling in controlling the costs.
→ Company can sell at a disco#nt to retain mar(et share d#ring economic downt#rn %andBor
beca#se of intense competition). If costs remain at similar level this will res#lt a lower -et
5ro+t argin. Companies trading cheaper prod#cts can gain d#ring economic downt#rn when
c#stomers generally stop b#ying l#&#ry prod#cts and t#rn to cheaper ones.
→ In large companies$ where higher level of economies of scale can be achieved %i.e. lower level
of per #nit cost) the net pro+t margin can be higher as a res#lt.
→
#ltinational companies can gain or loss from favo#rable or adverse e&change ratemovements.
*5 Asset t$rnover or Asset $tilisation ratio > Sales
Capital *mployed E F:1
→ <se of /-on'c#rrent assets instead of /Capital employed is also correct. Chec( 7#estion for
indication. If 7#estion says nothing$ then #se /Capital employed.
→ his shows the sales that is generated from each 1 worth of Capital %or asset) employed. he
higher the sales per 1 invested the more eVcient #se of the capital was.
→ If b#siness is selling l#&#ry prod#cts or prod#cts with higher pro+t margin that may res#lt alower Asset t#rnover ratio witho#t a wea(en "0C* or -et pro+t margin ratio.
#Mciency .atios%
1. Avera'e receivables collection period > Average rade "eceivables
Credit Sales F >43 E F days
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→ <se only C"*=I SA;*S. If 7#estion gives #s only a Sales +g#re %i.e. does not split between
credit and cash sales) then #se the given Sales +g#re.
→ 2e need only "A=* "*C*IUA;*S %i.e. receivables derived from credit sales). -ontrade
receivables %e.g. advance$ damage claim$ receivables of government grant) shall not be
incl#ded. If 7#estion gives #s only a "eceivables +g#re$ and does not give any other indication
abo#t its components then ass#me that is the rade receivables +g#re.
→ etter to #se average trade receivables %0pening G Closing BH ) where possible specially$
when closing balance signi+cantly diers from opening balance.
→ An alternative of #sing Average "eceivables is #sing year'end receivables +g#re where amo#nt
of receivables did not change signi+cantly from year'beginning to year'end.
' If yo# are re7#ired to compare ratios between two dierent years and cannot calc#late
average for both of the years$ then ta(e only the S!5 val#e of the year %i.e. do not average).
his is for comparability p#rpose.
→ "eceivables collection period is an appro&imate meas#re of the length of time c#stomers ta(e
to pay what they owe.
→ A "eceivables Collection 5eriod similar to 5ayables 5ayment 5eriod may be an indication of
good credit control policy.
→ Collection 5eriod of less than > days may seem normal. Signi+cantly in e&cess of > days
might be representative of poor management of f#nds of the b#siness. Rowever$ some
b#sinesses s#ch as e&port oriented b#sinesses normally needs to allow genero#s credit terms
%may be 4 days) to win c#stomers whereas retailer may sell only or mainly on cash %may be
collection period of not more than 1 days).
→ A high or increasing collection period may mean poorly managed credit control f#nction$ and
increased ris( of bad debts. his also may mean over investment in receivables.
→ Rowever$ increase in collection period might be a deliberate policy to increase sales byoering better credit terms than competitors.
→ =ecreasing or low collection period may mean tighten credit control policy which may ca#se
declining c#stomer n#mbers %i.e. red#ction of sales).
→ "eceivables collection days can be improved by oering disco#nt to c#stomers for early
payment.
5 Avera'e payables payment period > Average rade 5ayables
Credit 5#rchase F >43 E F days
→ If Credit p#rchase or p#rchase amo#nt cannot be identi+ed from the 7#estion$ #se Cost of sales
as it serves as an appro&imation.
→ <se only rade payables i.e. payables generated from credit p#rchase.
→ Increasing or long payment period may indicate li7#idity problem and also may indicate
loosing opport#nity of prompt payment disco#nts.
→ A longer payment period may also mean company has s#cceeded in obtaining very favo#rable
credit terms from its s#ppliers contradictorily$ this may also mean #nethical b#siness practice.
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→ ;ong credit term from s#ppliers is a so#rce of interest free +nancing. #t$ some s#ppliers may
charge interest if payment period e&ceeds a certain d#ration.
→ =eclining or short payment period may indicate b#siness has s#Vcient cash to meet payables.
A short payment period may p#t companys credit ratings in higher position.
→ If receivables collection period is longer than the payables payment period then it can ca#se
cash 9ow diVc#lties.
>. Inventory t$rnover< holdin' period E Average Inventory
Cost of Sales F >43 days E F days
or$
Cost of Sales
Average Inventory E F imes
→ etter to #se Average Inventory +g#re to ta(e into acco#nt the variation between 0pening
inventory and Closing inventory. #t$ instead of Average Inventory the closing inventory +g#re
can be #sed where opening inventory level cannot be determined in that case comparable
+g#re has to derive from same approach.
→ his ratio is an estimate of the average time that inventory is held before it is #sed or sold. If
average inventory holding period is > days$ this means that the inventory is /t#rned over %i.e.
sold) on average 1H.14 times %E >43B>) in a year
→ A low t#rnover %i.e. high holding period) implies slow sales and$ therefore$ e&cess inventory
andB or high level of inventory holding costs.
→ Righ inventory levels are #nhealthy beca#se they represent an investment with a Wero rate of
ret#rn. It may also p#t company at a great loss if prices start to decline %thin( abo#t
technological prod#cts).
In !,:
1. !inished goods inventory t#rnover period E Average !@ InventoryCost of Sales F >43 days E F days
H. "aw materials inventory t#rnover period E Average " Inventory
Ann#l 5#rchases F >43 days E F days
>. Average prod#ction %2I5) period E Average 2I5
Cost of Sales F >43 days E F days
6. 2or(ing capital cycle$ or$ Cash operating cycle %in days) E
Inventory holding period %days) G "eceivables collection period P 5ayables payment period
In !,:
=ays
!inished goods inventory t#rnover period F"aw materials inventory t#rnover period F
Average prod#ction %2I5) period F
Average receivables collection period F
Average payables payment period %F)
0perating cycle FB%F)
→ his cycle is the length of time between cash payment to s#ppliers and cash received form
c#stomers. his meas#red how long a +rm will be deprived of cash.
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→ A company co#ld even achieve a negative cycle by collecting from c#stomers before paying
s#ppliers. his policy of strict collections and delay payments is not always s#stainable or
appreciable by c#stomers %beca#se they have to pay early) and s#ppliers %beca#se they are
being paid late).
Investment .atios%
1. #arnin's per share 9#PS; E *arnings %i.e. 5ro+t) Attrib#table le to 0rdinary Shareholders
2eighted Avg. -#mber of 0rdinary Shares
E F
or$
ar(et 5rice per Share
5rice *arnings "atio E F
→ *5S is generally considered to be the single most important variable in determining a shares
price. his is a (ey meas#re of company performance from ordinary shareholders point of
view.
→ *5S shows the amo#nt of pro+t attrib#table to each ordinary share. #t$ it does not represent
act#al income of the ordinary shareholders.
→ Increase in *5S generally indicates s#ccess whereas a decrease is not welcomed by
shareholders.
→ A constant growth in *5S may res#lt in favo#rable movements %i.e. increase) in share price.
→ oth right iss#e and bon#s iss#e of shares res#lt in a fall of *5S. So$ care m#st be ta(en while
interpreting.
→ *5S often ignores the amo#nt of capital employed to generate the earnings. wo companies
co#ld generate the same *5S$ b#t one co#ld do so with less investment this co#ld mean that
this company was more eVcient at #sing its capital.
H. Dividend per share 9DPS; > 0rdinary =ividend =eclared and 5aid for he Jear
2eighted Avg. -#mber of 0rdinary Shares E F
→ =5S is the act#al portion of income received by the ordinary shareholders from *5S.
→ =5S is important for shareholders who are see(ing income from shares rather capital gain.
→ @rowth in dividend per share #sed in share price val#ation. So$ companies may have a policy
of achieving steady growth in dividend pay'o#t per share. A steady growth normally creates
positive mar(et reaction %i.e. increase in share price).
35 Dividend pay4o$t ratio > =ividend 5er Share
*arnings 5er Share F 1M E FM
or$
0rdinary =ividend =eclared and 5aid for he Jear
*arnings %i e 5ro+t) Attrib#table to 0rdinary Shareholders F 1M E
FM
→ =ividend pay'o#t ratio is the percentage of earnings paid to shareholders as dividends. his
shows how well earnings s#pport the dividend payments.
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→ Righ dividend pay'o#t ratio may mean company con+dence on f#t#re earnings. #t$ where
maDority of shares are held by a small n#mber of shareholders$ it may also mean that
shareholders are ta(ing o#t as m#ch pro+t as they can and this does not necessarily serve
companys long'term interest.
→ ;ow dividend pay'o#t ratio may mean company is e&pecting diVc#lties in the f#t#re so now
interested in retaining earnings. #t$ it can also mean e&pansion %by reinvesting the retained
earnings) of b#siness in the f#t#re.
→ at#re companies tend to have a higher pay'o#t ratio.
6. Dividend cover > *arnings 5er Share
=ividend 5er Share E F imes
or$
*arnings %i.e. 5ro+t) Attrib#table to 0rdinary Shareholders
0rdinary =ividend for the Jear E F imes
→ =ividend cover represents how many times dividend co#ld have paid from the pro+t
attrib#table to ordinary shareholders.
→ =ividend cover is a meas#re of the ability of a company to maintain the level of dividend paid
o#t. he higher the cover$ the better the ability to maintain dividend pay'o#t if pro+ts drop.
→ ypically$ a ratio of H or higher is considered safe in the sense that the company can well aord
the dividend b#t dividend cover below 1.3 may seem ris(y.
→ If the dividend cover is below 1 then the company is #sing its retained earnings from previo#s
years to pay c#rrent years dividend
→ A low level of dividend cover might be acceptable in a company with very stable pro+ts$ b#t
the same level of cover for a company with volatile pro+ts wo#ld indicate that company may
not able to maintain the c#rrent level of dividend pay'o#t.
G5 Price<#arnin' 9P<#; ratio > ar(et 5rice 5er Share*arnings 5er Share E F imes
or$
Companys ar(et Capitalisation
*arnings %i.e.5ro+t) Attrib#table to 0rdinary Shareholders E F imes
→ ar(et capitalisation is the total mar(et val#e of all the iss#ed ordinary shares of the company.
→ 5B* ratio also (nows as /5rice #ltiple or /*arnings #ltiple ratio
→ 5B* ratio is a meas#re of company performance from the mar(ets point of view.
→ 5B* ratio shows how m#ch money investors are c#rrently willing to pay for each dollar of
earnings. It gives an indication of the con+dence that the investors have in the f#t#re s#ccess
%i.e. earnings) of the b#siness.
→ In a very basic term$ a 5B* ratio of H means investors are paying e7#ivalent of H years
earnings %at c#rrent *5S level) to own a share in the company.
→ A 5B* ratio of 1 means mar(et is c#rrently willing to pay 1 for each dollar of earnings c#rrently
made by the company this shows very little con+dence on the companys f#t#re prosperity.
2hereas$ a 5B* ratio of H e&presses a great deal of optimism abo#t the f#t#re of the company
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since investors are c#rrently willing to pay H for each dollar of companys earnings. Investors
paying H times of c#rrent earnings believe that company will do signi+cantly better in coming
years$ and this will not ta(e long to get the H earnings.
→ ar(et can over'val#e or #nder'val#e company shares depending of information available.
*5 Dividend yield > =ividend 5er Share
ar(et 5rice 5er Share F 1M E FM
→ =ividend Jield is a +nancial ratio that shows how m#ch a company pays o#t in dividends
relative to its share price.
→ In the absence of any capital gains$ the =ividend Jield is the ret#rn on investment for a share.
→ Investors can sec#re a minim#m stream of cash 9ow from their investment portfolio by
investing in shares which is paying relatively high and stable dividend yields.
→ at#re and well'established companies tend to have higher dividend yields while yo#ng and
growth oriented companies tend to have lower yield. any fast growing companies do not
have a dividend yield at all beca#se they do not pay'o#t any dividend.
Eon'4erm Solvency .atios%
1. =ebt ratio E otal =ebt
otal Assets F 1M E FM
→ otal assets consist of non'c#rrent and c#rrent assets.
→ =ebts consist of all c#rrent and non'c#rrent liabilities %=eferred ta& liabilities can be ignored).
→ his ratio represents how m#ch money company owes compared to its otal assets.
→ If =ebt ratio is greater than 3M$ the b#siness can be considered as a ris(y company. #t$ a
high =ebt ratio may also mean companys ability to raise debt +nance which shows con+dence
of debt holders on the company.
H. @earing ratios:
a. =ebt to *7#ity ratio E
=ebt Capital "edeemable 5reference Share Capital G ;ong'term
;iabilities
*7#ity Capital F 1M E 0rdinary Share Capital Irredeemable 5reference Share
Capital G "eserves F 1M E FM
b. =ebt to otal capital ratio E
=ebt Capital =ebt Capital
otal Capital F 1M E *7#ity Capital G =ebt Capital F 1M E FM
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>. ;everage ratio :
*7#ity Capital*7#ity Capital G =ebt Capital F 1M
→ a(e c#rrent liability portion as well of long'term liabilities in =ebt capital calc#lation.
→ -ormally do not incl#de =eferred ta& liability within =ebt capital.
→ In !, 5reference share considered as =ebt capital not *7#ity capital.
→ Also in !,$ val#es for @earing ratio can be either boo( val#es or mar(et val#es. If #sing mar(et
val#es remember mar(et val#e of ordinary shares ta(e acco#nt of reserves %i.e. do not add
reserve amo#nt with total mar(et val#e of ordinary shares)
→ A gearing level of more than 3M %where =ebt Capital to otal Capital #sed) or more than
1M %where =ebt Capital to *7#ity Capital #sed) or ;everage ratio of less than 3M means
company is highly geared %i.e. ris(y).
→ "is( is high for investors in a high geared company beca#se of obligation to pay the interest
and repaying capital on time.
→ he standard level of gearing depends on ind#stry sector.
→ A relatively higher gearing may mean company adopted an aggressive strategy to e&pand its
operation. his has to be D#sti+ed with sales and pro+t growth. A higher gearing may also
mean company is having +nancial diVc#lties so may be a going concern iss#e.
→ A low or declining gearing may mean company is getting stronger +nancially and con+dent on
f#t#re earnings.
→ 2here gearing is high$ shareholders re7#ired rate of ret#rn will increase beca#se of high level
of ris( involve in the investment.
→ o lend money in a highly geared company$ lenders may impose some covenants on thecompany %e&le: a ma&im#m limit of gearing$ a minim#m level of interest cover$ pledge on
some assets)
6. Interest cover > 5ro+t before Interest and a&
Interest Charge E F imes
→ Interest cover is a meas#re of the ade7#acy of a companys pro+t relative to interest payment
on its debt.
→ A high interest cover ratio means that the b#siness is easily able to meet its interest
obligations from pro+ts. Similarly$ a low level of interest cover ratio means that the b#siness is
potentially in danger of not being able to meet its interest obligations.
→ Interest cover of more than H is normally considered reasonably safe. #t$ companies with very
volatile earnings may re7#ire an even higher level of Interest cover.
→ Interest cover of less than 1 means the company did not earn s#Vcient earning %i.e. pro+t) to
meet its interest charge. his means company will have to pay some of its interest from
retained pro+t from previo#s years. his may also raise 7#estion abo#t companys going
concern.
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IAS 33 #arnin's per share
• An entity is re7#ired to calc#late and present a basic *5S and a dil#ted *5S amo#nt based on
the pro+tB %loss) attrib#table to the ordinary shareholders %of the parent entity).
• asic and dil#ted *5S +g#res sho#ld be presented on the face of the statement of
comprehensive income with e7#al prominence.
• asic *5S E -et pro+t or %loss) attrib#table to ordinary shareholdersweighted average n#mber of ordinary shares
→ 2eighted average n#mber of shares can be calc#lated as:
→ 0asic #PS )ith bon$s iss$e 9scrip iss$e+ capitalisation iss$e; and share split% increases n#mber of shares witho#t any consideration. As a res#lt$ this distorts the comparison
of *5S in the c#rrent year with the *5S in the previo#s year. So$ to ens#re that the distortion
does not occ#r:' he *5S of the c#rrent year is calc#lated as if the bon#s iss#e was in e&istence of the
beginning too( place at the start of the year and$' he corresponding previo#s years *5S also restated as that bon#s iss#e was in e&istence
thro#gho#t that previo#s year.
Simple e,ample% 0on$s iss$e
At year beginning %1.1.H11)$ company A has a share capital of 6$ ordinary shares$ when it
decides to ma(e a bon#s iss#e of 1 for 6 on 1 April H11. Its pro+t for the year to >1 =ecember H1
and H11 was 4$ and 43$ respectively. Calc#late the *5S for the year ending H11 and for
corresponding previo#s year.
Shares are #s#ally incl#ded in the
weighted average n#mber of
shares from the date consideration
is receivable.
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Comple, e,ample% 0on$s iss$e after a f$ll maret price iss$e
At year beginning %1.1.H11)$ company A has a share capital of 6$ ordinary shares. It made a
f#ll mar(et price iss#e on 1 arch H11 of 1$ shares and a bon#s iss#e of 1 for 6 on 1 April
H11. Its pro+t for the year to >1 =ecember H1 and H11 was 4$ and 43$ respectively.
Calc#late the *5S for the year ending H11 and for corresponding previo#s year.
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→ asic #PS )ith ri'ht iss$e%' A rights iss#e oers e&isting shareholders the right to b#y new shares in proportion of their
e&isting holding at a price slightly below the mar(et price.' o calc#late *5S when right iss#e is made we need to (now:
he c$m ri'ht price: his is the mar(et price of a share D#st before the right iss#e
he e,4ri'ht price% his is the price of a share after the right iss#e. In theory the e&'right
price sho#ld be the weighted average of the c#m right price of the shares and iss#e price of
corresponding n#mber of share. his price is called the /theoretical e,4ri'ht price7.
' In a right iss#e$ shares are sold at a red#ced price so$ we need to divide the total n#mber
of shares iss#ed into /bon#s shares and /f#lly paid shares and treat as s#ch.
' Steps to follo) in a ri'ht iss$e%
Step 1: Calc#late the theoretical e&'rights price
Step H: Split the n#mber of shares in the rights iss#e into bon#s shares and f#ll price
shares.
:ri'inal shares pl$s bon$s shares > :ri'inal n$mber of shares X C$m ri'ht
price
heoretical e, ri'ht price
=ed#ct original n#mber of shares from the res#lt of the above form#la to get the /bon#s
shares
he res#lted /0riginal shares pl#s bon#s shares will be a higher
n#mber of shares as we are m#ltiplying by a bigger +g#re and
!rom above heoretical e&'right price e&le:
i. -#mber of rights share iss#ed: 1$$B6 E H$3$ii. Amo#nt received from rights iss#e: H$3$ F > E ?$3$ iii. ?$3$ can be
raised by iss#ing %?$3$B >.3) E H$16H$83? shares at f#ll mar(et price iv. So$ we cansay$ H$16H$83? shares were iss#ed at f#ll mar(et price and %H$3$ P H$16H$83?) E
>3?$16> shares were bon#s iss#e
o verify the form#la in Step H: %0riginal shares G on#s shares) F *"5 E 0riginal shares F C#m right
price %1$$ G >3?$16>) F >.6 E 1$$ F >.3 >3$H16$H84 E >3$$
So$ there is a mismatch of %>3$H16$H84 ' >3$$) E H16$H84 %.4M) if we #se above form#laT
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Step >: Calc#late c#rrent years *5S
Step 6: Calc#late corresponding previo#s years *5S ta(ing the bon#s share eect. 2e can#se following form#la:
"e'stated *5S of the previo#s year E
0riginal *5S of the previo#s year F
Rolding ratio to have the bon#s share%s) heoretical e& right price
Share ratio with bon#s shares F C#m right price
0asic #PS )ith ri'ht and bon$s iss$e%
!enton had 3$$ ordinary shares in iss#e on 1 Nan#ary HF1. 0n >1 Nan#ary HF1$ the company
made a rights iss#e of 1 for 6 at 1.?3. he c#m rights price was H per share. 0n > N#ne HF1$ the
company made an iss#e at f#ll mar(et price of 1H3$ shares. !inally$ on > -ovember HF1$ the
company made a 1 for 1 bon#s iss#e. 5ro+t for the year was H$,$. he reported *5S for year
ended >1 =ecember HF was 64.6c.
.e($ired% hat )as the earnin's per share 2'$re for year ended 31 December !X1 andthe restated #PS for year ended 31 December !X!N
Ans)er% %a 7#ic(er$ smarter b#t comple& way)
5"0;*TT
' when there will be m#ltiple
iss#es
he res#lted /"e'stated *5S will be a
smaller +g#re as we are m#ltiplying by
a smaller +g#re and dividing by a
' <se this part of the form#la only
if there is a bon#s iss#e in the
c#rrent year.
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→ =il#ted *5S:' =il#ted *5S warns e&isting shareholders that the *5S may fall in f#t#re years beca#se of
potential new ordinary shares that have been iss#ed.
' he dil#ted *5S is calc#lated by revising the original earnings %e.g. cancelling interest and
its ta& eect in case of convertible bond) and weighted average n#mber of shares as
tho#gh the potential ordinary shares had already been iss#ed.
#,ample% Dil$ted #PS )ith convertible bond
In H1 !arrah Co had a basic *5S of 13c based on earnings of 13$ and 1$ ordinary 1
shares. It also had in iss#e 6$ 13M convertible bond which is convertible in two years time at the
rate of 6 ordinary shares for every 3 of bond. a& is >M of /pro+t before ta&. In H1 gross pro+t of
H$ and e&penses of 3$ were recorded$ incl#ding interest payable of 4$. Calc#late the
dil#ted *5S.
Sol$tion%
@ross pro+t
H$
*&penses
%3$)
Add'bac(: Interest %6$F13M)
4$
5ro+t before ta&
134$
a& e&pense %>M)
%64$8)
*arnings attrib#table to ordinary shareholders
1,$H
-#mber of shares iss#ed
1$Additional shares from conversation %6$F6B3)
>H$
1>H$
=il#ted *5S E %1,$B1>H$) E .8H.4$ i.e. 8H.4c
=il#tion %i.e. decrease) in earnings wo#ld be %13c P 8H.4c) E HH.6c per share
→ =il#tive or antidil#tive:
5otential ordinary shares may be iss#ed in the following forms:
' Convertible bonds %bonds and debent#res that can be converted into ordinary shares)' Convertible preference shares %5reference shares that can be converted into ordinary shares)' 0ptions and warrants %0ption holders has right$ b#t not obligation$ to b#y ordinary shares in a f#t#re
date at a predetermined price)
' Contingently iss#able shares %these are ordinary shares will be iss#ed if certain conditions are met)
2hen calc#lating the revised weighted average n#mber of shares$ the convertible instr#ment %e.g.
convertible bond) is deemed to have been converted into ordinary shares at the beginning of the period
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' 0nly dil#ted shares sho#ld be incl#ded in the dil#ted *5S calc#lation.' 5otential new ordinary shares are not dil#tive if *5S wo#ld have been higher if the potential
shares had been act#al shares in the period.
#,ample%
Ardent Co has 3$$ ordinary shares of H3 cents each in iss#e. he total earnings in H1 were
1$?3$. he rate of income ta& is >3M. =ecide which one of the following will dil#te the *5S and
will be incl#ded in dil#ted *5S calc#lation:
%a) 1$$ of 16M convertible loan stoc($ convertible in three years time at the rate of H shares
per 1of stoc(
%b) H$$ of 1M convertible loan stoc($ convertible in one years time at the rate of > shares per
3 of stoc(
Sol$tion%
asic *5S E 1$?3$B3$$ E >3 cents
%a) *arnings increased %i.e. interest e&pense saves): i F%1 P t) E 1$$ F .16 %1 P .>3) E
,1$5otential ordinary shares: %1$$ F H)B 1 E H$ sharesSo$ incremental *5S E ,1$BH$ E 63.3c
Incremental *5S is higher than basic *5S so -0 dil#ted and do not incl#de in the dil#ted *5S
calc#lation.
%b) *arnings increased %i.e. interest e&pense saves): i F%1 P t) E H$$ F .1 %1 P .>3) E
1>$
5otential ordinary shares: %H$$ F >)B 3 E 1$H$ sharesSo$ incremental *5S E 1>$B1$H$ E 1.8c
Incremental *5S is lower than basic *5S so dil#ted %i.e. wea(ened) and need to incl#de in the
dil#ted *5S calc#lation.
Dil$ted #PS )ith option%' 0ptions and warrants are dil#tive when they wo#ld res#lt in the iss#e of ordinary shares for
less than the average mar(et price of ordinary shares d#ring the period %i.e. when they
are /in the money).' he shares that wo#ld be iss#ed if the options or warrants are e&ercised are divided into
f#ll priced shares and free shares. he free fraction is the dil#tive.
#,ample% rand Co had net pro+t of 1$H$ for the year ending >1 =ecember H1. 2eighted
average n#mber of ordinary shares o#tstanding d#ring the year was 3$. Average fair
' Ade7#ate to #se a simple average of wee(ly or
monthly prices or$' Average of closing mar(et prices or$' Average of high and low prices when prices 9#ct#ate
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val#e of one ordinary share d#ring the year was H. rand Co iss#ed share option of 1$
shares with e&ercise price applicable of 13. Calc#late both basic and dil#ted *5S.
Sol$tion% If the options are e&ercised$ the company will raise cash of %1$ shares F 13) E
1$3$. hat is %1$3$ B H) E ?3$ shares if iss#ed f#ll price. So$ the company is
giving away %1$ P ?3$) E H3$ shares for free. hese H3$ shares will dil#te the
basic *5S.
-#mber of shares 5ro+t after ta&asic 3$ 1$H$=il#tive eect H3$ -o eect
3H3$ 1$H$
asic *5S in H1 E 1$H$ B 3$ E H.6=il#ted *5S in H1 E 1$H$ B 3H3$ E H.H,
→ Contingently iss#able shares:' hese are ordinary shares iss#ed for little or no cash when another party satis+es
performance related conditions %e.g. pro+t target is met) rather mere passing of time.' hese shares can be a part of consideration for ac7#isitions or iss#ed to senior stas.' S#ch shares need to be incl#ded in the dil#ted *5S calc#lation if and only if the conditions
are met' If m#ltiple performance related criteria e&ists then dil#ted eect e&ists when all
performance related criteria are met.' his sho#ld be incl#ded from the beginning of the period$ or$ if later$ from the date of the
contingent agreement.
*mployee share option
Uesting conditions: Stay with the company 5erformance related
=il#tive eect e&ists from: @rant date 2hen performance criteria are
met
→ If shares are partly paid %i.e. less than shares mar(et val#e is paid):' he e7#ivalent n#mber of f#lly paid shares m#st be established to the e&tent that partly
paid shares are entitled to participate in dividends d#ring the period and the e7#ivalent
f#ll n#mber is incl#ded in the basic *5S calc#lation.' o the e&tent that partly paid shares are not entitled to participate in dividends d#ring the
period they are treated as the e7#ivalent of warrants or options in the calc#lation of dil#ted
*5S.
→ Dil$ted losses% when loss per share wo#ld be higher if potential shares were in iss#e.
→ Post reportin' date iss$es% ' on#s iss#e$ share splits and share consolidations after the year end b#t before the
+nancial statements are a#thorised for iss#e$ the n#mber of shares in the *5S calc#lation
is adD#sted for the period D#st ended and prior periods presented.
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.eceivables factorin'
%"elevant acco#nting standard: I!"S , !inancial instr#ments$ para >.H.>'>.H.,)
• .eceivables factorin'% Companies sometimes need cash before c#stomers pay their acco#nt
balances. In s#ch sit#ations$ the company may choose to sell acco#nts receivable to another
company that specialiWes in collections. his process is called factoring$ and the company thatp#rchases acco#nts receivable is often called a /factor.
• Factorin' )ith reco$rse%
' he seller retains the ris( of any #nder'collection of receivables by the /factor. If the /factor
fails to collect any amo#nt of receivables then the seller reimb#rses that #ncollected amo#nt
to the factor.
' Acco#nting:i. 2hen the seller receives money from factor$ the do#ble entry is: =" S!5: an($ C" S!5:
;iabilityii. Interest charged by /factor to the seller: =" IBS: !inance cost$ C" S!5: an(iii. Amo#nt received by /factor from /"eceivables: =" S!5: ;iability$ C": S!5: "eceivablesiv. Any remaining receivables amo#nt reimb#rsed by the seller: =" S!5: ;iability$ C": S!5:
an(
• Factorin' )itho$t reco$rse%
' he seller transfers ris( associated with collection of receivables to the /factor. If the /factor
fails to collect any amo#nt of receivables$ the seller does -0 reimb#rse that amo#nt.
' Acco#nting:i. Amo#nt received by the seller from /factor: =" S!5: an($ C": "eceivablesii. Any cash commission charged by the /factor: =" IBS: !inance cost$ C" S!5: an(iii. If /factor charge commission by paying a lower amo#nt of "eceivables the seller: ="
S!5: an($ =" IBS: !inance cost: amo#nt #nder'received by seller$ C" S!5: "eceivables
• *&ercise 7#estion:
0n 1 0ctober HF$ Nedders signed a receivables factoring agreement with a company !ab !actors.
Nedders trade receivables are to be split into three gro#ps$ as follows.
@ro#p A receivables will not be factored or administered by !ab !actors #nder the agreement$ b#t
instead will be collected as #s#al by Nedders.
@ro#p receivables are to be factored and collected by !ab !actors on a /with reco#rse basis.
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!ab !actors will charge a 1M per month +nance charge on the balance o#tstanding at the beginning of
the month. Nedders will reimb#rse in f#ll any individ#al balance o#tstanding after three months.
@ro#p C receivables will be factored and collected by !ab !actors /witho#t reco#rse !ab !actors will
pay Nedders ,3M of the boo( val#e of the debtors.
Nedders has a policy of ma(ing a receivables allowance of HM of a trade receivables balance when it
becomes three months old.
he receivables gro#ps have been analysed as follows:
.e($ired%
!or the acco#nts of Nedders$ calc#late the +nance costs and receivables allowance for each gro#p of
trade receivables for the period 1 0ctober P >1 =ecember HF and show the +nancial position val#es
for those trade receivables as at >1 =ecember HF.
Sol$tion%
@ro#p A: -o factoring
y >1 =ecember HF$ 8M %>MG>MGHM) of the receivables collected by Nedders. So$ "eceivables
allowance of HM to be recognised on remaining HM receivables balance.
L >1 0ctober HF:
=" S!5: an( %1$H3$ F >M) >?3$
C" S!5: "eceivables >?3$
%>M of receivables collected by Nedders. So$ decrease in receivables)
L > -ovember HF:
=" S!5: an( %1$H3$ F >M) >?3$
C" S!5: "eceivables >?3$
%!#rther >M of receivables collected by Nedders. So$ decrease in receivables)
L >1 =ecember HF:
=" S!5: an( %1$H3$ F HM) H3$
C" S!5: "eceivables H3$
%!#rther HM of receivables collected by Nedders. So$ decrease in receivables)
=" IBS: *&pense: Increase in receivables allowance
%%1$H3$ F HM) F HM) 3$
C" S!5: "eceivables: Allowance for receivables 3$
%"eceivables allowance of HM recognised on remaining HM receivables balance.
his is provision for do#btf#l debts and presented as decrease in receivables in S!5.)
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So$ @ro#p A receivables balance to be presented in S!5 as at >1 =ecember HF: %%1$H3$ '
>?3$ ' >?3$ ' H3$) ' 3$) E H$.
@ro#p : !actoring with reco#rse"is( associated with any #nder'collection of receivables is retained with Nedders. So$ the amo#nt
received by Nedders from !ab !actors in advance shall be treated as a loan in Nedders acco#nt.
L 1 0ctober HF:=" S!5: an(
1$3$
C" S!5: ;iability1$3$%1$3$ received from !ab !actors by Nedders so$ increase in liability)
L >1 0ctober HF:=" IBS: !inance cost %1$3$ F 1M)
13$C" S!5: an(
13$%Interest charged by !ab !actors on o#tstanding balance at month beginning)
=" S!5: ;iability %1$3$ F 6M)
4$C" S!5: "eceivables
4$%6M of receivables collected by !ab !actors. So$ decrease in receivables and liability)
L > -ovember HF:=" IBS: !inance cost %1$3$'4$) F 1M)
,$C" S!5: an(
,$%Interest charged by !ab !actors on o#tstanding balance at month beginning)
=" S!5: ;iability %1$3$ F >M)
63$C" S!5: "eceivables
63$
%!#rther >M of receivables collected by !ab !actors. So$ decrease in receivables and liability)
L >1 =ecember HF:
=" IBS: !inance cost %1$3$'4$'63$) F 1M)
6$3
C" S!5: an(
6$3
%Interest charged by !ab !actors on o#tstanding balance at month beginning)
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=" S!5: ;iability %1$3$ F HM)
>$C" S!5: "eceivables
>$%!#rther HM of receivables collected by !ab !actors. So$ decrease in receivables and liability)
=" S!5: ;iability %1$3$'4$'63$'>$)
13$=" S!5: an(
13$
%"eceivables balance #ncollected by !ab !actors reimb#rsed by Nedders to !ab !actors.So$ decrease in liability. -ow$ Nedders is responsible in collecting the remaining receivables
balance$ not !ab !actors.)
=" IBS: *&pense: Increase in receivables allowance%%13$ F HM)
>$C" S!5: "eceivables: Allowance for receivables
>$%"eceivables allowance of HM recognised on remaining 13$ receivables balance.
his is provision for do#btf#l debts and presented as decrease in receivables in S!5.)
So$ @ro#p receivables balance to be presented in S!5 as at >1 =ecember HF: %%1$3$ '
4$ ' 63$ ' >$) ' >$) E 1H$. And$ +nance cost charged in IBS: %13$ G
,$ G 6$3 E H8$3.
@ro#p : !actoring witho#t reco#rse"is( associated with any #nder'collection of receivables is transferred to !ab !actors. So$ receivables
balance shall be derecognised %i.e. removed from S!5) at the point of cash received from !ab !actors.
Any commission charged by !ab !actors %may be by #nder'payment of receivables balance to Nedders
or cash) shall be recognised as !inance cost.
L 1 0ctober HF:=" S!5: an( %H$$ F ,3M) 1$,$=" IBS: !inance cost: !actors commission %H$$ F 3M) 1$C" S!5: "eceivables %decrease in receivables) H$$
here is no need for recognising any allowance for receivables on >1 =ecember HF$ since all the
receivables balance derecognised on 1 0ctober HF. Nedders transferred the ris( of any #nder'
collection to !ab !actors that is$ Nedders has no more right on receivables balance.
%Shortc#t answer is in the boo(T Chec( \'33'Nedders of 55 7#estion ban(.)
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IAS 1! #vents after reportin' period
• *vents after the reporting period are split into:
• he c$t4oJ date for the consideration of events after the reporting period is the date on which the
+nancial statements are a#thorised for iss#e.
' -ormally the +nancial statements are a#thorised by the directors before being iss#ed to the
shareholders for approval.
' 2here a s#pervisory board is made #p wholly of non'e&ec#tive directors$ the +nancial
statements will +rst be a#thorised by the e&ec#tive directors for iss#e to that s#pervisory
AdB$stin' events: are events that provide
evidence of conditions that e&isted at the
reporting date$ and the +nancial statements
sho#ld be adD#sted to re9ect them. *&les
incl#de:
' Settlement of a co#rt case that con+rmsthat the entity had an obligation at the
reporting date.' *vidence that an asset was impaired at the
reporting date %e.g. ban(r#ptcy of a
c#stomer).' !inalisations of prices for assets sold or
p#rchased before year end.' he discovery of fra#d or errors that show
that the +nancial statements are misstated
' An adD#stment to the disclosed *5S %as par
IAS >>) for transactions where the n#mber
of shares altered witho#t an increase in
reso#rces %e.g. bon#s iss#e$ share split or
on4adB$stin' events: are events that are
indicative of conditions that arose after the
reporting date. =isclos#re sho#ld be made in
the +nancial statements where the o#tcome of
a nonadD#sting event wo#ld in9#ence the
economic decisions made by #sers of the
+nancial statements.
' A maDor b#siness combination after the
reporting date %I!"S > or the disposing of a
maDor s#bsidiary).' Anno#ncement of plan to discontin#e an
operation' aDor p#rchases and disposals of assets' Classi+cation of assets as held for sale' =estr#ction of assets$ for e&le by +re or
9ood' aDor ordinary share transactions %#nless
capitalisation or bon#s iss#e)
' =ecline in mar(et val#e of investments
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board for its approval. he relevant c#t'o date is the date on which the +nancial statements
are a#thorised for iss#e to the s#pervisory board.
' he date on which the +nancial statements were a#thorised for iss#e sho#ld be disclosed.
• If a si'ni2cant event occ$rs after the a$thorisation of the +nancial statements b#t before the
ann#al report is p#blished$ then the entity is not re7#ired to apply the re7#irements of IAS 1.
' Rowever$ if the event was so material that it aects the entitys b#siness and operations inthe f#t#re$ the entity may wish to disc#ss the event in the narrative section at the front of the
Ann#al "eview b#t o#tside of the +nancial statements themselves.
• #($ity dividend %i.e. dividend to ordinary and irredeemable non'c#m#lative preference shares)
sho#ld only be recognised as a liability where they have been declared before the reporting date$
as this is the date on which the entity has an obligation.' 2here e7#ity dividends are declared after the reporting date$ this fact sho#ld be disclosed b#t
no liability recognised at the reporting date.
• here the 'oin'4concern basis is clearly not appropriate$ /brea('#p basis sho#ld be
adopted.' he /brea('#p meas#res the assets at their recoverable amo#nt in a non trading environment$
and a provision is recognised for f#t#re costs that will be inc#rred to /brea('#p the b#siness.
Important de2nitions
• Asset%A reso#rce controlled by an entity as a res#lt of past events and from which f#t#re economic
bene+ts are e&pected to 9ow to the entity. [Concept#al !ramewor(: 6.6a]
• Eiability%A present obligation of the entity arising from past events$ the settlement of which is e&pected to
res#lt in an o#t9ow from the entity of reso#rces embodying economic bene+ts. [Concept#al
!ramewor(: 6.6b]
• #($ity% he resid#al interest in the assets of the entity after ded#cting all its liabilities. [Concept#al
!ramewor(: 6.6c]
• Income%Increases in economic bene+ts d#ring the acco#nting period in the form of in9ows or
enhancements of assets or decrease of liabilities that res#lt in increases in e7#ity$ other than those
relating to contrib#tions from e7#ity participants. [Concept#al !ramewor(: 6.H3a]
• #,penses%=ecrease in economic bene+ts d#ring the acco#nting period in the form of o#t9ow or depletions of
assets or inc#rrences of liabilities that res#lt in decrease in e7#ity$ other than those relating to
distrib#tions to e7#ity participants. [Concept#al !ramewor(: 6.H3b]
•
Ei($idity% he availability of s#Vcient f#nds to meet deposit withdrawals and other short'term +nancial
commitments as they fall d#e.
• Solvency% he availability of cash over the longer term to meet +nancial commitments as they fall d#e.
• ?nderlyin' ass$mptions in preparin' 2nancial statements%' Accr$als basis% he eects of transactions and other events are recognised when they occ#r
%and not as cash or its e7#ivalent is received or paid) and they are recorded in the acco#nting
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records and reported in the +nancial statements of the periods to which they relate.
[Concept#al !ramewor(: 01?]
' 8oin' concern: he entity is normally viewed as a going concern$ that is$ as contin#ing in
operation for the foreseeable f#t#re. It is ass#med that the entity has neither the intention nor
the necessity of li7#idation or of c#rtailing materially the scale of its operations. [Concept#al
!ramewor(: 6.1]
• -ateriality%Information is material if its omissions or misstatements co#ld in9#ence the economic decisions of
#sers ta(en on the basis of the +nancial statements. [Concept#al !ramewor(: \C11]
• S$bstance over form% he principle that transactions and other events are acco#nted for and presented in accordance
with their s#bstance and economic reality and not merely their legal form.
• K$alitative characteristics% he attrib#tes which ma(e the information provided in +nancial statements #sef#l to the #sers.
[Concept#al !ramewor(: \C1,]' Comparability ' imeliness %"elevance)
' Ueri+ability %"eliability) ' <nderstandability