Fin119 Activities PDF

Chartered Accountants Program
Financial Accounting & Reporting
ACT
Unit 1: Financial reporting AU
Activity 1.1 (Australia)

Applying the regulatory framework
Introduction
It is important to understand the complexities of the financial reporting regulatory framework
to fulfil your professional and ethical duties as a Chartered Accountant. The interaction between
local and international Accounting Standards, and the effect of local legislation on financial
reporting are important parts of financial reporting in practice. The following short scenarios
aim to help Candidates understand key aspects from this unit.
This activity links to learning outcomes:
1. Describe the purpose of financial reporting.
2. Analyse the reporting requirements of an entity based on the national regulatory
framework.
3. Explain the interaction between national and international financial reporting regulatory
frameworks including the relationship with their respective accounting standards.
4. Explain a Chartered Accountant’s ethical requirements relating to financial reporting.
It will take you approximately 60 minutes to complete.
This activity exceeds 45 minutes, which is the designated set time for an exam question (exams
have four questions to be completed over three hours). It has been developed to bring together
a number of important examinable concepts and will assist you with your understanding of
the topic areas covered, each of which could be examined individually or together in a smaller
question. Alternatively, only part of the required may be used in an exam.
The estimated time for completion of the activity includes time to review the stepped-through
recommended approach provided. This level of detail is provided to aid your understanding of the
concepts covered, and similar preparation would not be required in answering individual exam
questions. The activity is designed to assist you in achieving the specified learning outcome(s),
and the exam is designed to test whether or not you have achieved the learning outcomes.
fin11901_activities_03
Unit 1 – Activities Page 1-1

Financial Accounting & Reporting Chartered Accountants Program
ACT
AU Scenario A
You are the financial controller of Alpha Limited (Alpha). Two separate issues have arisen
during the year ending 30 June 20X5 on which Alpha’s directors require your advice:
1. Alpha had surplus cash reserves in May 20X5 and decided to prepay its marketing costs
for the next reporting period. The draft profit for the year ended 30 June 20X5 exceeded
market expectations and the directors decided to expense the $800,000, which represents
the prepayment of marketing costs, in the statement of profit and loss for the year ended
30 June 20X5.
2. In February 20X5, Alpha entered into a lease contract for an office building. The lease
contract includes a clause that requires Alpha to return the site to its original condition
upon vacating the premises when the lease expires on 31 January 20X9. Alpha has installed
fixtures and fittings to make the premises suitable for its business. Alpha will incur
significant expenditure to remove these items and to repaint the office to return it to its
original condition.
The directors of Alpha do not want to record a liability in relation to these expected future
restoration costs as the calculations would require significant estimation.
Task A
For this activity you are required to discuss whether each of the items should be recognised in
the statement of financial position of Alpha, considering only the definitions of an asset and a
liability and the recognition criteria from the Conceptual Framework (2018).
Note: You should ignore any requirements of specific Accounting Standards relating to these items.
Scenario B
Jack Bridges, a Chartered Accountant, is the chief financial officer (CFO) of Beta Limited (Beta),
he holds 30% of the ordinary shares in Beta.
On 1 February 20X5 Jack borrowed $1 million from Beta to purchase a new house. Jack sold his
old house on 1 May 20X5 and repaid the full $1 million plus interest on 15 May 20X5. Details
of the nature of the relationship between Jack and Beta, together with details of the transaction
should be disclosed in the financial statements for the year ending 30 June 20X5 in accordance
with IAS 24 Related Party Disclosures (IAS 24); however, there is no mention of either in the
financial statements.
Jack believes that the loan does not require disclosure as it was not outstanding at the year-end;
however, he is not familiar with the detail of IAS 24. Jack is also keen to keep the details of the
loan from the other shareholders as authorisation for the loan was denied when it was raised
with them.
Task B
For this activity you are required to identify and explain the key fundamental ethical principle
at risk as a result of not making the required disclosures.
Note: You are not required to comment on the required accounting treatment under IAS 24.
Page 1-2 Activities – Unit 1

Chartered Accountants Program Financial Accounting & Reporting
ACT
Scenario C AU
Rosie Adams works for a small accounting practice. She has asked you to assist her in
establishing the annual reporting requirements for two new clients, Gamma Pty Limited
(Gamma) and Kappa Pty Limited (Kappa).
The following details are relevant:
•• Gamma is a large proprietary company that produces springs for use in the automotive
industry. It does not publicly trade any debt or equity instruments. There are a significant
number of investors in Gamma, many of whom are not involved in the day-to-day running
of the company.
•• Kappa is a large proprietary company that provides an online tuition service for primary
school children to improve their skills in spelling and basic maths. It is a wholly owned
subsidiary of Lambda Pty Limited (Lambda), a large proprietary company that is required
to prepare and lodge an annual financial report with the Australian Securities Investments
Commission (ASIC). Kappa is a non-reporting entity.
Task C
For this activity you are required to determine the annual reporting requirements of both
Gamma and Kappa. You should justify your determination.
Scenario D
Rosie Adams works for a small accounting practice. She has been approached by three different
proprietary limited companies to assist with their annual reporting requirements. Details of the
companies are set out in the following table:
Company details for reporting requirements
Delta Pty Limited (Delta) Eta Pty Limited Theta Pty Limited
(ETA) (Theta)
Consolidated revenue $19.8 million $26.2 million $83.5 million
Consolidated gross assets $11.1 million $12.8 million $10.3 million

at 30 June 20X5
Consolidated net assets $5.2 million $8.7 million $7.2 million

at 30 June 20X5
Number of full time 51 37 47

equivalent employees
at 30 June 20X5
Average number of full 47 36 51

time equivalent employees
during the year to 30 June
20X5
Other relevant information Bob Black holds 207,600 of Controlled by Lota N/A
the 4,325,000 equity shares. inc. (Lota), a foreign
Following a dispute between company. Lota
Bob and one of the directors, prepares consolidated
Bob has notified the company financial statements
in writing that he requires a but they are not
financial report to be prepared lodged with ASIC
Task D
For this activity you are required to determine whether each of the above companies is required
to lodge a financial report with ASIC. Justify your determination.

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AU Scenario E
Eta Pty Limited (Eta) is a large proprietary company that prepares a general purpose financial
report (GPFR) under Tier 2 of the reduced disclosure regime (RDR).
Polly Kibble is the finance manager at Eta. She recently joined Eta, having emigrated from the
United Kingdom. Polly’s previous role in the United Kingdom was as a financial controller
for an entity that prepares financial statements under International Financial Reporting
Standards (IFRS).
You are one of the advisors to Eta and Polly has asked you the following questions:
1. What is AASB 1053 Application of Tiers of Australian Accounting Standards? I thought that all
Australian Standards had a corresponding International Standard but I am not familiar with
this one.
2. Where can I find the RDR? Under IFRS there is IFRS for SMEs, which is a single
pronouncement, I assume the RDR is set up in the same way.
3. I have reviewed the financial report for the last financial year. I am a little confused as it
doesn’t say that the financial statements comply with IFRS.
Task E
Prepare a response to each of Polly’s three (3) questions.

ACT
Activity 1.1 (Australia ) Solution – Task A AU

The treatment of each item in the statement of financial position at 30 June 20X5, based on the
definitions of an asset and a liability and the recognition criteria in the Conceptual Framework
(2018), is summarised in the following table:
Item: Prepaid marketing expenses
1. Does it meet the definition of ‘asset’ or ‘liability’ in the Conceptual Framework (2018)?
Definition Application
An asset is a present economic resource controlled by
the entity as a result of past events (para. 4.3).
Para. 4.5 requires three conditions to be met to satisfy
the asset definition:
•• There is a right The prepayment provides the right to future marketing
services (para. 4.6)
•• There is the potential to produce economic The marketing services are expected to produce
benefits economic benefits for Alpha (para. 4.14)
•• Alpha has control over the economic resource Alpha has the present ability to direct the use of the
marketing services and obtain economic benefits that
may flow from them (para. 4.20)
Conclusion: the prepaid marketing expenses meet the definition of an asset
2. Does it satisfy the requirements for recognition in the financial statements?
(a) The item must meet the definition before the asset or liability to be recognised in the statement of
financial position
Conclusion: The prepaid marketing expenses meet the asset definition (refer step 1)
(b) An asset or liability is recognised only if recognition of that asset or liability and of any resulting income,
expenses or changes in equity provides users of financial statements with information that is useful
What is useful information concerning the asset?
(i) Information about the asset is relevant to the (ii) Information that provides a faithful
users of the financial statements representation of the asset
However, information may not be relevant if:
•• It is uncertain that the Alpha’s asset exists. There Faithful representation There is no measurement
asset exists were no facts to suggest to may be affected by the uncertainty concerning
the contrary level of measurement the asset as its value can
•• The asset exists, but There were no facts to uncertainty associated be readily quantified by
the probability of an suggest the probability of with the asset the $800,000 that has been
inflow of economic inflow of benefits to Alpha prepaid
benefits is low is low
Conclusion: Information about the asset is relevant to Conclusion: A faithful representation of the asset can
users of Alpha’s financial statements be made
Conclusion: an asset should be recognised on Alpha’s statement of financial position for the prepaid marketing
expenses

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AU Item: Expected future restoration costs

A liability is a present obligation of the
entity to transfer an economic resource as a
result of past events (para. 4.26)
Para. 4.27 requires three conditions to be
met to satisfy the liability definition:
•• The entity has an obligation The lease contract creates the obligation to restore the site (para.
4.31)
•• The obligation is to transfer an The obligation to restore the site requires Alpha to either pay a third
economic resource party to restore the site, or perform the restoration themselves. Either
option results in a transfer of economic resources as described in
para. 4.39 (i.e. cash or provision of a service)
•• The obligation is a present obligation By signing the lease contract and changing the original condition of
that exists as a result of past events the office, Alpha has obligated itself to transfer resources to restore
the site in the future (para. 4.43)
Conclusion: the expected future restoration costs meet the definition of a liability
Does it satisfy the requirements for recognition in the financial statements?

(a) The item must meet the definition before the asset or liability can be recognised in the statement of
financial position
Conclusion: The expected future restoration costs meet the liability definition (refer step 1)
What is useful information concerning the liability?
(i) Information about the liability is relevant to (ii) Information that provides a faithful
the users of the financial statements representation of the liability
•• It is uncertain that the The lease contract requires Faithful representation There is measurement
liability exists Alpha to restore the site may be affected by the uncertainty concerning
therefore the liability exists level of measurement the liability as the expected
•• The liability exists, but There were no facts to uncertainty associated costs to restore the office
the probability of an suggest the probability with the liability to its original condition
outflow of economic of outflow of benefits to will require estimation.
benefits is low Alpha is low as the lease However, para 5.19 states
contract requires the that even a high level of
restoration to occur and measurement uncertainty
the costs are expected to be does not necessarily
significant prevent the estimate
from providing useful
information
[Note: as covered in Unit
11, these estimated future
costs would be discounted
in measuring the liability,
which also involves
measurement uncertainty
concerning the choice of a
discount rate]
Conclusion: Information about the liability is relevant Conclusion: A faithful representation of the liability
to users of Alpha’s financial statements can be made
Conclusion: a liability should be recognised on Alpha’s statement of financial position for the expected future
restoration costs
Note: The accounting treatment for these items has been established by applying the principles
from the Conceptual Framework (2018). Specific Accounting Standards relating to these items
will be covered in later units of the module. However, you will see that the Standards themselves

ACT
also apply the principles from the Conceptual Framework (2018) and applying the Accounting
Standards would reach the same conclusion.
AU
Recommended approach – Task A

The steps outline a recommended approach for successfully completing this task.
Step 1 – Review the conceptual framework (2018)

Review the following paragraphs from the Conceptual Framework (2018):
•• 4.3 for the definition of an asset.
•• 5.7 for the recognition criteria of an asset.
•• 4.26 for the definition of a liability.
•• 5.7 for the recognition criteria of a liability.
Paragraphs 4.5. 4.6, 4.14, 4.20, 4.26, 4.27, 4.31, 4.39,4.43, 5.12, 5.18 and 5.19 assist in applying the
framework in this scenario.
Step 2 – Apply the definitions of asset and liability from the

Conceptual Framework (2018)
The definitions of ‘asset’ and ‘liability’ need to be applied before recognition on the statement of
financial position can be considered for each item. The definitions should be considered in light
of the facts provided. This is presented in the solution.
Step 3 – Apply the recognition criteria from the Conceptual

Framework (2018)
To establish whether an asset or liability should be recognised in respect of each of the items,
each of the recognition criteria should be considered in light of the facts provided. This is
presented in the solution.
Step 4 – Form a conclusion as to whether the items should be

recognised as an asset/liability in the financial statements
The conclusion is shown in the solution.
Activity 1.1 (Australia ) Solution – Task B

The key fundamental ethical principle at risk is integrity as the other shareholders did not
authorise the loan and Jack is being dishonest by not disclosing it and trying to hide it from
them.

ACT
AU Activity 1.1 (Australia ) Recommended approach – Task B

Step 1 – Review the IESBA Code

Review the fundamental ethical principles from s. 110.1 A1 of the IESBA Code.
Step 2 – Consider each of the fundamental ethical principles and

determine whether they are at risk
Consider each of the fundamental ethical principles in turn and determine whether Jack’s
actions are putting the principle at risk
Fundamental ethical Explanation At risk?

principle
Yes/No
Integrity Jack wants to hide the details of the loan from the other Yes
shareholders, as authorisation for the loan was not
granted. This behaviour is dishonest and is therefore in
breach of the fundamental principle of integrity
Objectivity Jack has a conflict of interest as the loan was made to Yes
him even though it was not authorised to be made,
and now he does not want to disclose the detail. Jack
is protecting his position which may be overriding his
professional judgement
Professional competence and Jack has not made the required disclosures in the Yes
due care financial statements as he is not aware of the detail of
IAS 24; therefore, he has not acted in accordance with
applicable technical standards. It also indicates that
he has not maintained his knowledge and skill at the
appropriate level to perform his role as a CFO
Confidentiality The issue does not relate to the disclosure of information No

acquired as a result of professional or business
relationships
Professional behaviour Jack’s actions are not in accordance with the Yes
Corporations Act 2001 as he is not following the
Accounting Standards. In addition, as a Chartered
Accountant, his actions of taking out the loan without
authorisation and trying to hide the loan by not
disclosing it could discredit the profession
Step 3 – Form a conclusion on the key fundamental ethical principle

at risk providing an explanation for the principle identified
Four of the five fundamental ethical principles are at risk, demonstrating the interlinked
relationship between the principles.
As the task specifically asks for the key fundamental ethical principle at risk, a conclusion must
be made as to which one is the key principle.
Jack’s dishonest actions of taking out the loan when it had not been authorised by the other
shareholders and not disclosing the loan in order to avoid his actions being found out is key;
therefore, integrity would be the key fundamental principle at risk.

ACT
Activity 1.1 (Australia ) Solution – Task C AU

The annual reporting requirements for Gamma and Kappa are summarised in the following
table:
Annual reporting requirements
Company Requirement Justification
Gamma GPFR – Gamma would apply Tier 2 Gamma is a reporting entity and must
reporting requirements under the produce a GPFR. However, as it is not
RDR unless it elects to apply full IFRS publically accountable, it would apply
via Tier 1 Tier 2 reporting requirements under
the RDR
Kappa Special purpose financial report Kappa is a non-reporting entity

(SPFR). Alternatively, Kappa can and can therefore produce a SPFR.
choose to prepare a GPFR Alternatively, it can choose to prepare
a GPFR
Activity 1.1 (Australia ) Recommended approach – Task C

Step 1 – Review the relevant guidance for establishing the reporting

requirements of an entity
Review Corporations Act s. 292 for entities operating under the Corporations Act.
Review SAC 1 Definition of the Reporting Entity (SAC 1) para. 40 for the definition of a
reporting entity.
Step 2 – Establish whether the entities are within the scope of the
Corporations Act and whether they are required to file an annual
report
Proprietary companies are within the scope of the Corporations Act. As both Gamma and
Kappa are proprietary companies, they are within the scope of the Corporations Act.
Gamma and Kappa are large proprietary companies and therefore must prepare and lodge an
audited financial report.
Step 3 – Establish whether the entity is a reporting entity

Referring to the definition from SAC 1, factors to consider when establishing whether an entity
is a reporting entity include:
•• The degree to which management and ownership interest is separated.
•• Political or economic interest.
•• Financial characteristics.
Professional judgement is exercised in determining whether an entity is a reporting entity – the

users and users’ needs should be considered.
Gamma is a large proprietary company with a significant number of investors, many of whom
are not involved in the day-to-day running of the company. Investors cannot command specific
reports, but would require the reports to help them make decisions about where to allocate their

ACT
AU capital. Gamma would therefore be a reporting entity and, accordingly, would be required to
prepare a GPFR.
The facts state that Kappa is a non-reporting entity and this is because it is a wholly owned
subsidiary of Lambda, a large proprietary company that is required to prepare and lodge an
annual financial report with ASIC.
As a non-reporting entity, Kappa would prepare an SPFR. Alternatively, Kappa could choose
to prepare a GPFR.
Step 4 – Establish whether entities required to prepare a GPFR have

public accountability
Gamma is required to prepare a GPFR. It would have public accountability if its debt or equity
instruments are traded in a public market, or it is in the process of issuing such instruments,
or it holds assets in a fiduciary capacity for a broad group of outsiders.
Gamma does not meet any of these criteria and therefore does not have public accountability.
It would therefore apply the Tier 2 reporting requirements under the RDR.
Step 5 – Form a conclusion as to the annual reporting requirements


ACT
Activity 1.1 (Australia ) Solution – Task D AU

The requirement for each company to lodge a financial report is summarised in the following
table:
Requirement to lodge a financial report
Delta Not required to prepare and lodge a Small proprietary company and
financial report additional requirements from
s. 292(2) are not met
Eta Lodge a financial report Large proprietary company and no

relief from ASIC Class orders
Theta Not required to prepare and lodge a Small proprietary company and no
financial report additional relevant information from
which to gain relief
Activity 1.1 (Australia ) Recommended approach –

Task D
Step 1 – Review the criteria for preparing and lodging financial

reports for small and large proprietary companies
Review Corporations Act s. 45(A) for the criteria applying to small and large proprietary
companies.
Section 292(2) of the Corporations Act details when a small proprietary company is required to
prepare a financial report.
Consider the ASIC Class orders where relief is provided from certain financial reporting
requirements, specifically CO 2017/204, ASIC Corporations (Audit Relief) Instrument 2016/784,
ASIC Corporations (Wholly Owned Companies) Instrument 2016/785 and CO 10/654.
Step 2 – Compare the details for each company to the Section 45(A)
criteria
Where two out of three of the thresholds are exceeded, the company is classed as a large
proprietary company and is required to lodge a financial report with ASIC.
Note that the thresholds are based on:
•• consolidated revenue
•• consolidated gross assets, and
•• number of full time equivalent employees at year end.

ACT
AU Therefore, the information Rosie received on consolidated net assets and average number of full
time equivalent employees is not relevant in establishing whether each company is classified
as small or large.
Company Threshold Delta Exceed Eta Exceed Theta Exceed

threshold? threshold? threshold?
Consolidated $25 million $19.8 N $26.2 Y $83.5 Y

revenue million million million
Consolidated $12.5 $11.1 N $12.8 Y $10.3 N

gross assets at million million million million
30 June 20X5
Number of full 50 51 Y 37 N 47 N
time equivalent
employees at
30 June 20X5
Classification Exceed at Small Large Small

based on least 2
thresholds
Step 3 – Consider other relevant information in accordance with

s. 292(2) to establish whether the small proprietary companies are
required to prepare a financial report
Both Delta and Theta are classified as small proprietary companies based on the s. 45(A) criteria.
Other relevant information to be considered is analysed in the following table:
Other relevant information
Company Detail Required to prepare?
Delta Bob Black holds 207,600 of the Bob holds 4.8% of the equity shares
4,325,000 equity shares. Following in Delta. Shareholders holding at
a dispute between Bob and one of least 5% of the votes can direct
the directors, Bob has notified the the company to prepare a financial
company in writing that he requires report. Bob does not have a sufficient
a financial report to be prepared holding to do this therefore Delta is
not required to prepare a financial
report
Theta N/A As there is no other relevant

information to consider, Theta is not
required to prepare a financial report

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Step 4 – Consider other relevant information in accordance with AU

the ASIC Class orders to establish whether the large proprietary
companies can obtain relief from preparing and lodging a financial
report
Eta is classified as a large proprietary company based on the s. 45(A) criteria.
Other relevant information to be considered is analysed in the following table:
Other relevant information
Company Detail Required to prepare?
Eta Controlled by Lota, a foreign Eta is controlled by a foreign company.

company. Lota prepares consolidated CO 2017/204 only provides relief from
financial statements but they are not preparing and lodging an audited financial
lodged with ASIC report to small proprietary companies
that are controlled by a foreign company
but which are not part of a large group.
Therefore, ETA cannot obtain relief under this
class order and will be required to prepare a
financial report
Step 5 – Form a conclusion as to whether a financial report needs to

be lodged with ASIC

ACT
AU Activity 1.1 (Australia ) Solution – Task E

Responses to each of Polly’s questions:
1. There are some AASB Standards that do not have an international equivalent and
AASB 1053 is one example. AASB 1053 sets out the application of tiers of Australian
Accounting Standards to different categories of entities.
2. The RDR is not a single document like IFRS for SMEs. In each AASB Standard, any
disclosure paragraphs that are not required for entities following the RDR are shaded
in grey.
3. Entities following the RDR must comply with the recognition and measurement paragraphs
in each Standard; however, the disclosures are reduced. In order to comply with IFRS, the
full Standards need to be complied with (including full disclosure requirements), so there
is no explicit compliance with IFRS.
Activity 1.1 (Australia ) Recommended approach – Task E

Step 1 – Review the relevant guidance

Review AASB 1053.
Step 2 – Apply the guidance to the scenario

Application of the guidance to Polly’s questions is shown in the solution.

ACT
Activity 1.1 (New Zealand) NZ

Applying the regulatory framework
Introduction
It is important to understand the complexities of the financial reporting regulatory framework
to fulfil your professional and ethical duties as a Chartered Accountant. The interaction between
local and international Accounting Standards, and the effect of local legislation on financial
reporting are important parts of financial reporting in practice. The following short scenarios
aim to help Candidates understand key aspects from this unit.
1. Describe the purpose of financial reporting.
2. Analyse the reporting requirements of an entity based on the national regulatory
framework.
3. Explain the interaction between national and international financial reporting regulatory
frameworks including the relationship with their respective accounting standards.
4. Explain a Chartered Accountant’s ethical requirements relating to financial reporting.

ACT
NZ Scenario A
You are the financial controller of Alpha Limited (Alpha). Two separate issues have arisen
during the year ending 30 June 20X5 on which Alpha’s directors require your advice:
1. Alpha had surplus cash reserves in May 20X5 and decided to prepay its marketing costs
for the next reporting period. The draft profit for the year ended 30 June 20X5 exceeded
market expectations and the directors decided to expense the $800,000, which represents
the prepayment of marketing costs, in the statement of profit and loss for the year ended
30 June 20X5.
2. In February 20X5, Alpha entered into a lease contract for an office building. The lease
contract includes a clause that requires Alpha to return the site to its original condition
upon vacating the premises when the lease expires on 31 January 20X9. Alpha has installed
fixtures and fittings to make the premises suitable for its business. Alpha will incur
significant expenditure to remove these items and to repaint the office to return it to its
original condition.
The directors of Alpha do not want to record a liability in relation to these expected future
restoration costs as the calculations would require significant estimation.
Task A
For this activity you are required to discuss whether each of the items should be recognised in
the statement of financial position of Alpha, considering only the definitions of an asset and a
liability and the recognition criteria from the Conceptual Framework (2018).
Note: You should ignore any requirements of specific Accounting Standards relating to these
items.
Scenario B
Jack Bridges, a Chartered Accountant, is the chief financial officer (CFO) of Beta Limited (Beta),
he holds 30% of the ordinary shares in Beta.
On 1 February 20X5 Jack borrowed $1 million from Beta to purchase a new house. Jack sold his
old house on 1 May 20X5 and repaid the full $1 million plus interest on 15 May 20X5. Details
of the nature of the relationship between Jack and Beta, together with details of the transaction
should be disclosed in the financial statements for the year ending 30 June 20X5 in accordance
with IAS 24 Related Party Disclosures (IAS 24); however, there is no mention of either in the
Jack believes that the loan does not require disclosure as it was not outstanding at the year-end;
however, he is not familiar with the detail of IAS 24. Jack is also keen to keep the details of the
loan from the other shareholders as authorisation for the loan was denied when it was raised
with them.
Task B
For this activity you are required to identify and explain the key fundamental ethical principle
at risk as a result of not making the required disclosures.
Note: You are not required to comment on the required accounting treatment under IAS 24.

ACT
Scenario C NZ
Rosie Adams works for a small accounting practice. She has asked you to assist her in
establishing the annual reporting requirements for two new clients, Gamma Limited (Gamma)
and Kappa Limited (Kappa).
The following details are relevant:
•• Gamma is a New Zealand registered for-profit private company that produces springs
for use in the automotive industry. While Gamma has not previously issued any publicly
listed debt or equity instruments, Gamma did issue shares under a regulated offer under
the Securities Act 1978 several years ago. Gamma has approximately 2,000 investors, who
are not involved in the day-to-day running of the company. It has average revenue of
$35 million per annum and assets of $80 million for the last two years.
•• Kappa is a New Zealand registered for-profit private company that provides an online
tuition service for primary school children to improve their skills in spelling and basic
maths. Kappa is owned by husband and wife team John and Kushla Jones who are the sole
shareholders. Kappa earns average revenue of $10 million per annum year-on-year and
assets have totalled approximately $15 million for the last two years.
Task C
For this activity you are required to determine the annual reporting requirements of both
Gamma and Kappa under the Financial Reporting Act 2013 (FRA 2013) and/or the Financial
Markets Conduct Act 2013 (FMCA 2013). Justify your determination.
Scenario D
Rosie Adams works for a small accounting practice. She has been approached by three different
New Zealand registered companies to assist with their annual reporting requirements. Details
of the companies are set out in the following table:
Company Delta Limited (Delta) Pi Limited (Pi) Theta Limited (Theta)
Consolidated revenue $19.8 million $26.2 million $29.5 million
Consolidated expenses $16.4 million $19.8 million $20.8 million
Consolidated total assets $11.1 million $22.8 million $10.3 million
Consolidated net assets $5.2 million $18.7 million $7.2 million
Number of shareholders 8 2 – Lota and one other 8

entity
Other relevant Bob Black holds 300,600 Pi is a for-profit entity. It Theta is a for-profit
information of the 4,325,000 equity is controlled by Lota Inc. entity and is not an FMC
shares. Following a (Lota), a foreign company reporting entity. Theta is
dispute between Bob and defined as large under the not a registered charity
one of the Directors, Bob FRA 2013. Lota prepares
has notified the company consolidated financial
in writing that he requires statements which are
a financial report to audited in its home
be prepared and to be jurisdiction
audited
Note that for each company, the levels of revenue, expenses, total assets and net assets have been the same for the past
two accounting periods.
Task D
For this activity you are required to determine whether each of the above companies is required
to prepare, audit or file financial statements with the Registrar of Companies. Justify your
determination.

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NZ Scenario E
Nickel Limited (Nickel) is company defined as large under the FRA 2013 and that prepares a
general purpose financial report (GPFR) under Tier 2 of the financial reporting framework.
Polly Kibble is the finance manager at Nickel. She recently joined Nickel having emigrated from
the United Kingdom. Polly’s previous role in the United Kingdom was as a financial controller
for an entity that prepares financial statements under International Financial Reporting
Standards (IFRS).
You are one of the advisors to Nickel and Polly has asked you the following questions:
1. What is FRS-44 New Zealand Additional Disclosures (FRS-44)? I thought that all New Zealand
Standards had a corresponding International Standard but I am not familiar with this one.
2. Where can I find the RDR? Under IFRS there is IFRS for SMEs, which is a single
pronouncement, I assume the RDR is set up in the same way.
3. I have reviewed the financial report for last financial year, I am a little confused as it doesn’t
say that the financial statements comply with IFRS.
Task E
Prepare a response to each of Polly’s three (3) questions.

ACT
Activity 1.1 (New Zealand) Solution – Task A NZ

The treatment of each item in the statement of financial position at 30 June 20X5, based on the
definitions of an asset and a liability and the recognition criteria in the Conceptual Framework
(2018), is summarised in the following table:
Item: Prepaid marketing expenses
An asset is a present economic resource controlled by
the entity as a result of past events (para. 4.3).
Para. 4.5 requires three conditions to be met to satisfy
the asset definition:
•• There is a right The prepayment provides the right to future marketing
services (para. 4.6)
•• There is the potential to produce economic The marketing services are expected to produce
benefits economic benefits for Alpha (para. 4.14)
•• Alpha has control over the economic resource Alpha has the present ability to direct the use of the
marketing services and obtain economic benefits that
may flow from them (para. 4.20)
Conclusion: the prepaid marketing expenses meet the definition of an asset
2. Does it satisfy the requirements for recognition in the financial statements?
financial position
Conclusion: The prepaid marketing expenses meet the asset definition (refer step 1)
What is useful information concerning the asset?
(i) Information about the asset is relevant to the (ii) Information that provides a faithful
users of the financial statements representation of the asset
•• It is uncertain that the Alpha’s asset exists. There Faithful representation There is no measurement
asset exists were no facts to suggest to may be affected by the uncertainty concerning
the contrary level of measurement the asset as its value can
•• The asset exists, but There were no facts to uncertainty associated be readily quantified by
the probability of an suggest the probability of with the asset the $800,000 that has been
inflow of economic inflow of benefits to Alpha prepaid
benefits is low is low
Conclusion: Information about the asset is relevant to Conclusion: A faithful representation of the asset can
users of Alpha’s financial statements be made
Conclusion: an asset should be recognised on Alpha’s statement of financial position for the prepaid marketing
expenses

ACT
NZ Item: Expected future restoration costs

A liability is a present obligation of the
entity to transfer an economic resource as a
result of past events (para. 4.26)
Para. 4.27 requires three conditions to be
met to satisfy the liability definition:
•• The entity has an obligation The lease contract creates the obligation to restore the site (para.
4.31)
•• The obligation is to transfer an The obligation to restore the site requires Alpha to either pay a third
economic resource party to restore the site, or perform the restoration themselves. Either
option results in a transfer of economic resources as described in
para. 4.39 (i.e. cash or provision of a service)
•• The obligation is a present obligation By signing the lease contract and changing the original condition of
that exists as a result of past events the office, Alpha has obligated itself to transfer resources to restore
the site in the future (para. 4.43)
Conclusion: the expected future restoration costs meet the definition of a liability
Does it satisfy the requirements for recognition in the financial statements?

financial position
Conclusion: The expected future restoration costs meet the liability definition (refer step 1)
What is useful information concerning the liability?
(i) Information about the liability is relevant to (ii) Information that provides a faithful
the users of the financial statements representation of the liability
•• It is uncertain that the The lease contract requires Faithful representation There is measurement
liability exists Alpha to restore the site may be affected by the uncertainty concerning
therefore the liability exists level of measurement the liability as the expected
•• The liability exists, but There were no facts to uncertainty associated costs to restore the office
the probability of an suggest the probability with the liability to its original condition
outflow of economic of outflow of benefits to will require estimation.
benefits is low Alpha is low as the lease However, para 5.19 states
contract requires the that even a high level of
restoration to occur and measurement uncertainty
the costs are expected to be does not necessarily
significant prevent the estimate
from providing useful
information
[Note: as covered in Unit
11, these estimated future
costs would be discounted
in measuring the liability,
which also involves
measurement uncertainty
concerning the choice of a
discount rate]
Conclusion: Information about the liability is relevant Conclusion: A faithful representation of the liability
to users of Alpha’s financial statements can be made
Conclusion: a liability should be recognised on Alpha’s statement of financial position for the expected future
restoration costs
Note: The accounting treatment for these items has been established by applying the principles
from the Conceptual Framework (2018). Specific Accounting Standards relating to these items
will be covered in later units of the module. However, you will see that the Standards themselves
also apply the principles from the Conceptual Framework (2018) and applying the Accounting
Standards would reach the same conclusion.

ACT
Activity 1.1 (New Zealand) Recommended approach – NZ

Task A
Step 1 – Review the conceptual framework (2018)

Review the following paragraphs from the Conceptual Framework (2018):
•• 4.3 for the definition of an asset.
•• 5.7 for the recognition criteria of an asset.
•• 4.26 for the definition of a liability.
•• 5.7 for the recognition criteria of a liability.
Paragraphs 4.5. 4.6, 4.14, 4.20, 4.26, 4.27, 4.31, 4.39,4.43, 5.12, 5.18 and 5.19 assist in applying the
framework in this scenario.
Step 2 – Apply the definitions of asset and liability from the

Conceptual Framework (2018)
The definitions of ‘asset’ and ‘liability’ need to be applied before recognition on the statement of
financial position can be considered for each item. The definitions should be considered in light
of the facts provided. This is presented in the solution.
Step 3 – Apply the recognition criteria from the Conceptual

Framework (2018)
To establish whether an asset or liability should be recognised in respect of each of the items,
each of the recognition criteria should be considered in light of the facts provided. This is
Step 4 – Form a conclusion as to whether the items should be

recognised as an asset/liability in the financial statements
Activity 1.1 (New Zealand) Solution – Task B

The key fundamental ethical principle at risk is integrity as the other shareholders did
not authorise the loan and Jack is being dishonest by not disclosing it and trying to hide it
from them.

ACT
NZ Activity 1.1 (New Zealand) Recommended approach –

Task B
Step 1 – Review the IESBA Code

Review the fundamental ethical principles from s. 110.1 A1 of the IESBA Code.
Step 2 – Consider each of the fundamental ethical principles and

determine whether they are at risk
Consider each of the fundamental ethical principles in turn and determine whether Jack’s
actions are putting the principle at risk
Fundamental ethical Explanation At risk?

principle
Yes/No
Integrity Jack wants to hide the details of the loan from the other Yes
shareholders, as authorisation for the loan was not
granted. This behaviour is dishonest and is therefore in
breach of the fundamental principle of integrity
Objectivity Jack has a conflict of interest as the loan was made to Yes
him even though it was not authorised to be made,
and now he does not want to disclose the detail. Jack
is protecting his position which may be overriding his
professional judgement
Professional competence and Jack has not made the required disclosures in the Yes
due care financial statements as he is not aware of the detail of
IAS 24; therefore, he has not acted in accordance with
applicable technical standards. It also indicates that
he has not maintained his knowledge and skill at the
appropriate level to perform his role as a CFO
Confidentiality The issue does not relate to the disclosure of information No

acquired as a result of professional or business
relationships
Professional behaviour Jack’s actions are not in accordance with the Companies Yes
Act 1993 as he is not following the Accounting
Standards. In addition, as a Chartered Accountant, his
actions of taking out the loan without authorisation
and trying to hide the loan by not disclosing it could
discredit the profession
Step 3 – Form a conclusion on the key fundamental ethical principle

at risk providing an explanation for the principle identified
Four of the five fundamental ethical principles are at risk, demonstrating the interlinked
relationship between the principles.
As the task specifically asks for the key fundamental ethical principle at risk, a conclusion must
be made as to which one is the key principle.
Jack’s dishonest actions of taking out the loan when it had not been authorised by the other
shareholders and not disclosing the loan in order to avoid his actions being found out is key;
therefore, integrity would be the key fundamental principle at risk.

ACT
Activity 1.1 (New Zealand) Solution – Task C NZ

The annual reporting requirements for Gamma and Kappa are summarised in the following
table:
Annual reporting requirements
Gamma General purpose financial report Gamma is a large private company

(GPFR) – Gamma must apply Tier 1 and must produce a GPFR. This is
financial reporting, which is full IFRS because it has public accountability
financial statements due to the previous issue of shares
(a regulated product under the
Financial Markets Conduct Act 2013
(FMCA 2013)). It also has more than
50 shareholders; therefore, it is an
FMC reporting entity (less than 50
shareholders would be exempt).
Gamma is not able to apply Tier 2 but
must report under Tier 1 (per Part 7 of
FMCA 2013)
Kappa Special purpose financial report Kappa is not an FMC reporting entity,
(SPFR). Alternatively, Kappa can elect and does not meet the size criteria in
to prepare a GPFR the FRA 2013 requiring it to prepare a
GPFR, Kappa can produce an SPFR, or
elect to prepare a GPFR
Activity 1.1 (New Zealand) Recommended approach –

Task C
Step 1 – Review the relevant guidance for establishing the reporting

requirements of an entity
Review s. 451–452 FMCA 2013 to determine what is an FMC reporting entity.
Review s. 45 FRA 2013 for provisions relating to companies that are large and have a reporting
requirement.
Review XRB standards A1 Accounting Standards Framework (XRB A1) and A2 Meaning of Specified
Statutory Size Thresholds (XRB A2) to assess which tiers of reporting an entity fits into and the
related size criteria.
Step 2 – Establish whether the entities are within the scope of the
Financial Reporting Act 2013 and the Financial Markets Conduct Act
2013 and whether they are required to prepare an annual report
Gamma is an FMC reporting entity, as they the original issue of shares meets s. 451(a) FMCA
2013 (as they have more than 50 shareholders). Kappa is not an FMC reporting entity, as none of
the requirements are met.
Under s. 208 CA 2013, Gamma will be required to prepare an annual report as it is large. Kappa
does not meet any of the requirements of s. 208, so will not have to prepare an annual report.

ACT
NZ Step 3 – Establish whether the entities are required to prepare

financial statements
Any entity that is an FMC reporting entity is directed to the FMCA 2013 where there are specific
financial reporting provisions in Part 7 (s. 56 FRA 2013). An entity that is not an FMC reporting
entity will prepare financial statements under FRA 2013 only if it meets the size criteria in s. 45.
As Gamma is an FMC reporting entity under s. 451 of the FMCA 2013, it therefore is required to
prepare a GPFR.
Kappa is not large under the FRA 2013; therefore, it does not have to prepare a GPFR and can
prepare an SPFR instead.
Step 4 – Establish whether entities required to prepare a GPFR have

public accountability
Gamma, as an FMC reporting entity, has public accountability and therefore must prepare
financial statements under Tier 1 following the provisions of Part 7 FMCA 2013, as it is not
eligible to elect to report under Tier 2.
Step 5 – Form a conclusion as to the annual reporting requirements

Activity 1.1 (New Zealand) Solution – Task D

The requirement for each company to prepare, audit and file its financial statements is
summarised in the following table:
Requirement to lodge a financial report
Delta Required to prepare and audit Delta is not a large company and
financial statements. The financial does not have a wide shareholding.
statements are not required to be However, a shareholder owning more
filed with the Registrar than 5% of the company’s shares
can request in writing that financial
statements are prepared and audited
Pi Prepare, audit and file financial Large overseas company that

statements prepares audited financial statements
in its home jurisdiction
Theta Not required to prepare a financial Small company; therefore, not

report required to prepare, audit or file

ACT
Activity 1.1 (New Zealand) Recommended approach – NZ

Task D
Step 1 – Review the criteria for preparing, auditing and filing

financial statements for small and large companies
Review FMCA 2013 ss 451– 452 to determine who is an FMC reporting entity, ss 460–461 for
requirement to prepare financial statements, and s. 461D for audit requirements.
Review FRA 2013 ss 45 and 46 for size criteria relating to companies that are large, have a
reporting requirement, and are for-profit entities.
Review the XRB website for which standards will apply using the ‘Find your standard’ tool
(available on www.xrb.govt.nz  Find your standard).
Review XRB A1 for the criteria to be a public benefit entity (Appendix A).
Review ss 207H – 207K CA 1993 for any specific ‘opt–in’ provisions for companies, ss 200–204
for provisions relating to overseas companies, and s. 207E for registration requirements for
overseas companies.
Step 2 – Establish what type of entity is being dealt with and the
relevant legislation. Compare the details for each company to the
legislative criteria
Delta Limited
Delta is a small company as it does not meet the size criteria in s. 45 FRA 2013 (which
would require it to prepare financial statements). However, a company with fewer than 10
shareholders may opt in to comply with one or more of the financial statement preparation,
audit and annual report preparation requirements for an accounting period if shareholders
holding at least 5% of the voting shares require the company to comply (s. 207K CA 1993). In
Delta’s case Bob Black has written to require the company to prepare it financial statements and
have them audited. Delta will need to comply with this request as Bob holds more than 5% of
the shares; however, the financial statements do not need to be filed with the Registrar.
Pi Limited
Pi is an overseas owned company, which means that the size criteria (for whether it is
required to prepare financial statements) is smaller than for New Zealand resident companies.
Section. 45(2) FRA 2013 provides the size criteria which is: that as at the balance date of each
of the two preceding accounting periods, the total assets of the entity exceed $20 million or the
total revenue of the entity exceeds $10 million. If this criteria is met then s. 201 CA 1993 requires
the company to prepare financial statements. These financial statements must be audited and
filed with the Registrar of Companies (s. 207E CA 1993), unless the exemption under s. 206(3)
CA 1993 is met.
An overseas company qualifies as ‘large’ if they meet either of these two thresholds. In Pi’s
case, both revenue and assets are above the size criteria, so Pi is considered as a large overseas
company and therefore must prepare, file and have its financial statements audited. Note that Pi
does not meet the exemption under s. 206(3) CA 1993 as it prepares audited financial statements
in its home jurisdiction.
Theta Limited
Theta is not an FMC reporting entity and is not large. In the absence of any other factors, there
is no requirement for Theta to prepare, file or have audited financial statements.

ACT
NZ Step 3 – Form a conclusion as to whether each of the companies are

required to prepare, audit or file their financial statements with the
Registrar of Companies
Activity 1.1 (New Zealand) Solution – Task E

Responses to each of Polly’s questions:
1. There are some New Zealand Accounting Standards that do not have an international
equivalent and FRS 44 New Zealand Additional Disclosures is an example. FRS 44 sets
out the specific disclosure requirements for entities preparing financial statements under
New Zealand GAAP (NZ IFRS and RDR).
2. The RDR is not a single document like IFRS for SMEs. In each New Zealand IFRS and
NZ IAS Standards any disclosures that are not required for entities following the RDR
are marked with an asterisk (*). Specific paragraphs relating to entities following RDR are
marked as RDR, for example ’RDR 8.1’.
3. Entities following the RDR must comply with the recognition and measurement paragraphs
in each Standard; however, the disclosures are reduced. In order to comply with IFRS, the
full Standards need to be complied with (including full disclosure requirements), so there is
no explicit compliance with IFRS.
Activity 1.1 (New Zealand) Recommended approach –

Task E
Step 1 – Review the relevant guidance

Review FRS 44.
Step 2 – Apply the guidance to the scenario

Application of the guidance to Polly’s questions is shown in the solution.

ACT
Unit 2: Presentation of financial

statements
Introduction to preparing a Statement of Cash Flows
This video and activity are designed to refresh your basic understanding on how to prepare a
statement of cash flows using the:
•• reconstruction (T-accounts) method
•• addition (formula) method
•• spreadsheet method
It is recommended you watch the video and work through the activity prior to attempting
Activity 2.1.
The video and activity are on myLearning in the Unit 2 folder.
Activity 2.1
Preparing a statement of cash flows
Introduction
The statement of cash flows provides important information to readers about an entity’s sources
and use of cash during a given period. Preparing the statement of cash flows is often a more
complicated exercise than preparing other statements because the cash flows presented must
be derived from the accrual-based accounting records. It also requires an understanding of the
nature of the accounts in the accounting records and the entity’s non-cash activities.
This activity links to learning outcome:
•• Advise on the requirement for financial statements.
At the end of this activity you will be able to prepare a statement of cash flows in accordance
with IAS 7 Statement of Cash Flows (IAS 7).

ACT
Scenario
Stanhope Services Limited (Stanhope Services) provides consultancy services. The following is
an extract from Stanhope Services’ financial statements:
Account 30 June 20X6 30 June 20X5

$ $
Cash 2,590,000 380,000
Trade receivables 750,000 1,000,000
Allowance for impairment loss – trade receivables (50,000) (60,000)
Equipment at cost 2,500,000 2,000,000
Accumulated depreciation of equipment (1,250,000) (800,000)
Bank overdraft 0 (140,000)
Trade payables (590,000) (680,000)
Dividend payable (150,000) (120,000)
Current tax liability (426,000) (300,000)
Share capital (2,500,000) (1,200,000)
Revenue 5,500,000
Impairment loss – trade receivables (70,000)
Bad debts expense (10,000)
Other expenses (including depreciation and interest (4,000,000)

expense)
Income tax expense (426,000)
Dividends declared (200,000)
Additional information
•• All revenue is made on credit.
•• Included in other expenses is $10,000 in interest paid.
•• There has been no disposal of equipment during the year.
•• Equipment was acquired for cash during the year.
•• The company undertook a share issue during the year.
•• An interim dividend of $50,000 was paid in November 20X5.
•• There are no temporary differences for tax purposes.
Ignore the impact for GST.
Tasks
A. Prepare the statement of cash flows, using the direct method, for the year ended 30 June
20X6.
B. Prepare the reconciliation of cash flows from operating activities to profit for the year,
in accordance with AASB 1054 or FRS-44, for the year ended 30 June 20X6.
Note: Sufficient information has been provided in the extract from the Financial Statements for
the profit to be calculated.

ACT
Activity 2.1 Solutions
Task A
Stanhope Services Limited
Statement of cash flows for the year ended 30 June 20X6
Cash flows from operating activities
Cash receipts from customers 5,660,000
Cash payments to suppliers, employees and others (3,630,000)
Interest paid (10,000)
Income tax paid (300,000)
Net cash provided by operating activities 1,720,000
Cash flows from investing activities
Payment for equipment (500,000)
Net cash used in investing activities (500,000)
Cash flows from financing activities
Proceeds from share issue 1,300,000
Dividends paid (170,000)
Net cash from financing activities 1,130,000
Net increase in cash held 2,350,000
Cash at beginning of the year 240,000
Cash at end of the year 2,590,000

ACT
Task B
Reconciliation of cash flows from operating activities to profit
Net profit for the year 994,000
Adjustments for items not related to operating activities
Depreciation expense 450,000
Changes in operating assets and liabilities
Trade receivables 250,000
Allowance for impairment loss – trade receivables (10,000)
Trade payables (90,000)
Current tax liability 126,000
Net cash provided by operating activities 1,720,000
Recommended steps
Task A
Step 1 – Determine the movement in the cash balances for the year
•• Scan through the extract from the financial statements to identify the cash and cash
equivalent balances:
–– The 20X5 comparatives show cash of $380,000 and a bank overdraft of $140,000.
Therefore, the opening cash balance for the statement of cash flows is $240,000 ($380,000
– $140,000).
–– At 30 June 20X6 there is a cash balance of $2,590,000.
–– The net increase in cash held is therefore $2,350,000 ($2,590,000 – $240,000).
•• The statement of cash flows will explain how Stanhope Services’ operating, investing and
financing activities created this $2,350,000 net cash inflow for the year ended 30 June 20X6.
Step 2 – Classify the items in the extract from the financial statements
Scan through the items in the extract from the financial statements and classify each according
to one of the following categories to determine which line item in the statement of cash flows
each item impacts:
•• Cash and cash equivalents.
•• Operating activity.
•• Investing activity.
•• Financing activity.
•• Non-cash item.
This classification will enable related accounts to be reconstructed/analysed when calculating

the specific cash flow. Comments are added to identify the interrelationship between accounts
and to take note of any specific facts.

ACT
Classification of items from extract from financial statements
Account 30 June 20X6 30 June 20X5 Classification Comments

within cash
$ $ flow statement
Cash 2,590,000 380,000 Cash and cash Opening and closing balances
equivalents contribute to the cash movement
for the year
Trade receivables 750,000 1,000,000 Operating Receipts from customers are

activities credited to this account. Other
items (e.g. bad debts expense)
impact this account, therefore the
account must be reconstructed
Allowance for (50,000) (60,000) Operating Not a cash flow but used in the
impairment loss – activities calculation of receipts from
trade receivables customers. Impacts the trade
receivables account
Equipment at cost 2,500,000 2,000,000 Investing There have been no disposals

activities during the year, therefore the
debit movement represents asset
acquisitions
Accumulated (1,250,000) (800,000) Investing Not a cash flow, and given there
depreciation of activities are no asset disposals for the year,
equipment the movement will not impact
the calculation of equipment
acquisitions
Bank overdraft 0 (140,000) Cash and cash Opening and closing balances
equivalents contribute to the cash movement
for the year
Trade payables (590,000) (680,000) Operating Payment of creditors is debited

activities to this account. Other items
(e.g. other expenses) impact this
account, therefore the account
must be reconstructed
Dividend payable (150,000) (120,000) Financing Dividend payments are debited

activities to this account. Related to the
dividends declared account to
determine dividends paid
Current tax liability (426,000) (300,000) Operating Income taxes paid are debited
activities to this account. Related to the
income tax expense account to
determine income taxes paid
Share capital (2,500,000) (1,200,000) Financing The share issue during the year
activities was credited to this account
Revenue 5,500,000 Operating Not a cash flow but related to

activities the trade receivables account
to determine receipts from
customers
Impairment loss – (70,000) Operating Not a cash flow but related to

trade receivables activities the trade receivables account
customers
Bad debts expense (10,000) Operating Not a cash flow but related to
activities the trade receivables account
customers

ACT
Classification of items from extract from financial statements
Account 30 June 20X6 30 June 20X5 Classification Comments

within cash
$ $ flow statement
Other expenses (4,000,000) Operating May be a mix of cash and non-

(including activities cash flows. Other expenses are
depreciation and related to the trade payables
interest expense) account to determine payments to
suppliers, employees and others
Other expenses includes
depreciation and interest paid,
neither of which relates to
payments to suppliers, employees
and others. Depreciation and
interest paid must be excluded
from the $4 million in other
expenses so that the correct cash
flow will be calculated in the trade
payables account
Income tax expense (426,000) Operating Not a cash flow but related to the
activities current tax liability account to
determine income taxes paid
Dividends declared (200,000) Financing Not a cash flow but related to the
activities dividends payable account to
determine dividends paid
Step 3 – Reconstruct the related accounts to calculate the specific cash flow
Remember this is only an extract from the company’s financial statements and thus there are no
balancing totals. However, sufficient information has been provided to prepare the statement of
cash flows.
The reconstruction method can be used to calculate the specific cash flows. T-accounts can be
created and reconstructed for each cash flow line item identified in Step 2. Other approaches
can be used to arrive at the same values.
T-accounts to calculate cash receipts from customers

Trade receivables
Dr Cr
$ $
Opening balance 1,000,000 Allowance for impairment loss – trade 80,000
receivables
Sales revenue 5,500,000 Bad debts expense 10,000
Closing balance 750,000
Cash – receipts from customers 5,660,000
6,500,000 6,500,000
Allowance for impairment loss – trade receivables

Dr Cr
$ $
Trade receivables 80,000 Opening balance 60,000
Closing balance 50,000 Impairment loss expense – trade 70,000
receivables
130,000 130,000

ACT
T-account to calculate payments to suppliers, employees and others

Trade payables
Dr Cr
$ $
Cash – payments to suppliers, 3,630,000 Opening balance 680,000

employees and others
Closing balance 590,000 Other expenses1 3,540,000
4,220,000 4,220,000
Note
1 Depreciation, as a non-cash item, does not belong in the trade payables reconstruction. The depreciation expense
must be calculated and then excluded from the other expenses value. Here, the movement in accumulated
depreciation provides the $450,000 depreciation expense, given that there were no disposals during the period.
Interest paid must be separately disclosed (as per IAS 7 para. 31) and therefore the cash outflow cannot be included
with payments to suppliers, employees and others. The $10,000 in interest paid must be subtracted from other
expenses so that the correct payments to suppliers, employees and others can be calculated.
Other expenses excluding depreciation and interest is therefore $3,540,000 ($4,000,000 in total for other expenses
– $450,000 depreciation expense – $10,000 interest paid)
T-account to calculate income tax paid

Current tax liability
Dr Cr
$ $
Cash – income tax paid 300,000 Opening balance 300,000
Closing balance 426,000 Income tax expense 426,000
726,000 726,000
Income tax paid must be separately disclosed (as per IAS 7 para. 35) and therefore the cash
outflow cannot be included with payments to suppliers, employees and others.
T-account to calculate payment for equipment

Equipment at cost*
Dr Cr
$ $
Opening balance 2,000,000
Cash – payment for equipment 500,000 Closing balance 2,500,000
2,500,000 2,500,000
* The scenario stated that there were no disposals during the year, hence the movement for the year represents
equipment acquisitions.

ACT
T-account to calculate dividends paid

Dividend payable
Dr Cr
$ $
Cash – dividends paid2 170,000 Opening balance 120,000
Closing balance 150,000 Dividends declared 1

200,000
320,000 320,000
Notes
1 Includes the $50,000 interim dividend paid in November 20X5.
2 The dividends paid represents the payment of the $120,000 dividend in the opening balance of the liability account
plus the $50,000 interim dividend.
T-account to calculate proceeds from share issue

Share capital
Dr Cr
$ $
Opening balance 1,200,000
Closing balance 2,500,000 Cash – proceeds from share issue 1,300,000
2,500,000 2,500,000
Step 4 – Prepare the statement of cash flows

Prepare the statement of cash flows by entering the cash flows calculated in Step 3 into a format
that complies with the disclosure requirements of IAS 7.
Check that the sum of the cash flows from operating, investing and financing activities agrees to
the movement in cash balances for the year in Step 1.
The statement of cash flows is shown in the solution.

ACT
Task B
Step 1 – Calculate the profit for the year
The reconciliation starts with the net profit for the year; therefore, this value must be calculated
from the relevant amounts in the extract from the financial statements.
Net profit for the year is calculated as:
Revenue 5,500,000
Impairment loss – trade receivables 70,000
Bad debts expense 10,000
Other expenses 4,000,000
Income tax expense 426,000
Net profit for the year 994,000
Step 2 – Determine an approach to performing the reconciliation

AASB 1054 and FRS-44 do not specify how the reconciliation should be performed; however,
the approach discussed below is one common method used in practice.
Approach to performing the reconciliation
Disclosure Explanation for inclusion
Profit for the year While the requirements in AASB 1054 and FRS-44 refer to a reconciliation
of net cash flow from operating activities to profit (loss), in practice the
reconciliations are usually performed by using profit or loss as the starting
point, similar to the indirect method discussed in IAS 7 para. 20
Adjustments for non-cash As described in IAS 7 paras 20(b) and (c), profit or loss is adjusted for items
items or items for which the (i.e. items of income or expense) that are non-cash, such as depreciation, and
cash flows are investing or for items that relate to investing or financing cash flows
financing cash flows Some items that are non-cash but relate to operating assets and liabilities are
not adjusted here, but in the next section of the reconciliation. For example,
impairment losses on trade receivables are non-cash items, but they are not
adjusted here, rather they are accounted for in the movement in the trade
receivables balance
Changes in operating assets Profit or loss is adjusted for the movement in operating assets and liabilities
and liabilities in the statement of financial position. It does not matter if these account
movements do not contain any cash flows. Non-cash flow entries cancel
themselves out when added to, or subtracted from, related items.
A useful rule to follow is to:
•• Subtract debit movements (i.e. an increase in assets or decrease in
liabilities) from profit, and
•• Add credit movements (i.e. a decrease in assets or increase in liabilities)
to profit
Net cash flow from operating The total profit for the period and all the adjustments and changes in
activities operating assets and liabilities should equal the net cash flow from operating
activities in the statement of cash flows
Step 3 – Prepare the reconciliation

The bottom line of the reconciliation agrees with the $1,720,000 net cash provided by operating
activities value in the statement of cash flows in Task A.
The reconciliation is shown in the solution.

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ACT
Activity 2.2
Preparing key financial statements (SPLOCI
and SOCE)
Introduction
The statement of profit or loss and other comprehensive income (SPLOCI) is possibly the most
read document within the financial statements, as readers are interested in how the entity
performed over the financial period. The statement of changes in equity might be of less interest
to readers than the SPLOCI; however, it helps to tie SPLOCI into the equity section of the
statement of financial position.
•• Advise on the requirement for financial statements.
•• Prepare, analyse and explain a complete set of financial statements.
At the end of this activity you will be able to prepare a statement of profit or loss and other
comprehensive income and a statement of changes in equity in accordance with IAS 1
Presentation of Financial Statements (IAS 1).

ACT
Scenario
Fur-Mates Limited (Fur-Mates) is a distributor of pet food. The following is an extract from its
trial balance as at 30 June 20X6:
Fur-Mates Limited
Extract from trial balance as at 30 June 20X6
Item Note $ $
Income
Sales revenue relating to:
Dog food 5,000,000
Cat food 2,000,000
Total sales revenue 7,000,000
Other revenue 1 510,000
Revaluation of land 2 300,000
Adjustment relating to dividend income 3 800,000
Expenses
Cost of sales relating to:
Dog food (3,000,000)
Cat food (700,000)
Total cost of sales (3,700,000)
Distribution expenses relating to:
Dog food (200,000)
Cat food (80,000)
Total distribution expenses (280,000)
Marketing expenses relating to:
Storefront sales (400,000)
Online distribution (100,000)
New product launches (140,000)
Total marketing expenses (640,000)
Occupancy expenses 4 (800,000)
Administrative expenses (400,000)
Other expenses 5 (140,000)
Income tax relating to:
Items recognised in profit or loss 6 (735,000)
Revaluation of land 2 (90,000)
(825,000)
Equity
Share capital 7 10,000,000
Opening retained earnings – 1 July 20X5 2,000,000
Dividend declared 8 (600,000)

ACT
Notes
1. Other revenue includes:
•• $500,000 in damages awarded to Fur-Mates arising from a legal suit with a competitor
•• $10,000 in interest revenue on cash balance.
2. The revaluation of land to fair value was recognised on 1 March 20X6. The land had previously been
recognised at cost. A net credit of $210,000 was recognised in the revaluation surplus account within equity
($300,000 revaluation – $90,000 tax effect). This is the first revaluation the company has recognised since
adopting the revaluation basis for this class of assets. No other company assets are measured at fair value.
3. In August 20X5, a material error relating to the year ended 30 June 20X5 was discovered; that is, dividend
income relating to shares that were sold on 1 June 20X5 was understated by $800,000. The related income
tax expense was $240,000.
4. On 19 June 20X6 the company prepaid $100,000 in insurance costs for the period July–September 20X6. This
amount has been included within occupancy expenses.
5. Included within other expenses is $50,000 in interest expense.
6. The $735,000 includes:
•• $240,000 in income tax expense relating to the dividend income outlined in Note 3.
•• $495,000 in income tax expense relating to other items recognised in profit or loss.
7. A share issue in December 20X5 raised $3 million in additional capital to enable Fur-Mates to expand into
exporting products.
8. The dividend was declared and paid in November 20X5.
1. Fur-Mates chooses the one statement approach under IAS 1 Presentation of Financial
Statements para. 10A to prepare its statement of profit or loss and other comprehensive
income.
2. Fur-Mates classifies items by function when presenting its financial statements.
3. The company presents its financial statements to meet the minimum disclosure
requirements specified in the Accounting Standards, as it believes disclosing further
information may provide information that could benefit its competitors.
Please note
•• Some information within the extract from the trial balance may not be in the correct part of
the financial statements; however, sufficient information has been provided for the profit to
be calculated.
•• No adjustments for income tax is required for the information presented. (The unit on
income taxes will refresh and extend your knowledge of the accounting for income taxes).
•• Reporting of segment information under IFRS 8 Operating Segments is presented in
Fur‑Mates’ notes to the financial statements.
Tasks
A. Prepare the statement of profit or loss and other comprehensive income for the year ended
30 June 20X6.
B. Prepare the statement of changes in equity for the year ended 30 June 20X6.

ACT
Activity 2.2 Solutions
Task A
Fur-Mates Limited
Statement of profit or loss and other comprehensive income for the year ended 30 June 20X6
Profit
Revenue 7,000,000
Cost of sales (3,700,000)
Gross profit 3,300,000
Settlement of legal suit 500,000
Other income 10,000
Distribution expenses (280,000)
Marketing expenses (640,000)
Occupancy expenses (700,000)
Administrative expenses (400,000)
Other expenses (90,000)
Finance costs (50,000)
Profit before tax 1,650,000
Profit for the year 1,155,000
Other comprehensive income
Items that will not be reclassified to profit or loss
Revaluation of land 300,000
Income tax effect (90,000)
Items that are or may be reclassified to profit or loss*
Item (on a before tax basis) _
Income tax effect on the item _
Other comprehensive income, net of tax 210,000
Total comprehensive income for the period 1,365,000
* This section in italics is presented here for illustration only.

ACT
Task B
Fur-Mates Limited
Statement of changes in equity for the year ended 30 June 20X6
Share Revaluation Retained Total

capital surplus earnings equity
$ $ $ $
Balance at 1 July 20X5 as previously 7,000,000 0 2,000,000 9,000,000

reported
Adjustment for impact of error – – 560,000 560,000
Restated balance at 1 July 20X5 7,000,000 0 2,560,000 9,560,000
Profit – – 1,155,000 1,155,000
Other comprehensive income – 210,000 – 210,000
Total comprehensive income – 210,000 1,155,000 1,365,000
Transactions with owners
Shares issued 3,000,000 3,000,000
Dividend (600,000) (600,000)
Balance at 30 June 20X6 10,000,000 210,000 3,115,000 13,325,000

ACT
Recommended steps
Task A
Step 1 – Identify the types of issues and read the relevant paragraphs in the
Accounting Standards
Type of issue Relevant Accounting Standard paragraphs
Revenue and expense items for the year are included IAS 1 paras 81A–82 and 97–105
in the statement of profit or loss section
Prior period error IAS 8 para. 42
Prepaid insurance Conceptual Framework, definitions of expense

(para. 70(b)) and asset (para. 49(a))
Other comprehensive income disclosure for a current IAS 1 paras 82A and 90–91
year movement in a reserve
Step 2 – Prepare the SPLOCI

•• Work through each line in the extract from the trial balance to prepare the SPLOCI.
•• Tick off each piece of information that you use to ensure you capture all the items.
•• If you are unsure of the accounting treatment for the prepayments or other items in
the extract from the trial balance, you should revise your bookkeeping notes from your
university study, or other resources.
•• Consider the additional information as this has implications for the categorisation within
the SPLOCI.
•• The table below can be used to prepare the SPLOCI. It contains a summary of the relevant
information to help you apply the requirements from the relevant Accounting Standards.

ACT
Fur-Mates Limited Not part of the statement but provided to support the values and explain the treatment*
Page 2-18
Statement of profit or loss and other Workings Explanation of treatment Reference to the relevant
comprehensive income for the year ended 30 June Accounting Standard to
20X6 support treatment
Profit IAS 1 para. 81A

Revenue 7,000,000 $5,000,000 dog food Fur-Mates wants to comply with the minimum disclosure requirements IAS 1 para. 82(a)
+ $2,000,000 cat of the Accounting Standards, therefore information from the trial balance
food should be summarised
Cost of sales (3,700,000) $3,000,000 dog food The company classifies expenses by function IAS 1 paras 99 and 103
+ $700,000 cat food
Gross profit 3,300,000 IAS 1 para. 103
Settlement of legal suit 500,000 Separate disclosure as this item of income is material IAS 1 paras 97 and 98(f )
Other income 10,000 Interest income IAS 1 paras 85 and 103
Distribution expenses (280,000) $200,000 dog food + Not required to be itemised IAS 1 para. 103
$80,000 cat food
Marketing expenses (640,000) Not required to be itemised IAS 1 para. 103
Occupancy expenses (700,000) $800,000 – $100,000 Rather than expensing the $100,000 in insurance costs, the amount should IAS 1 para. 103 (in relation to
in prepaid insurance have been recognised as a prepayment. It should have been recognised the $700,000)
in the statement of financial position as an asset and the following journal
entry should have been recorded:
Dr Prepayment $100,000 Conceptual Framework
Cr Cash $100,000 definitions of expense
(para. 70(b)) and asset
(Being prepayment of insurance for July–September 20X6) (para. 49(a))
A correcting journal entry will need to be recorded to transfer the amount
from occupancy expenses to the prepayments account
Administrative expenses (400,000) IAS 1 para. 103
Other expenses (90,000) $140,000 –$50,000 The interest expense must be separately disclosed so it cannot be included IAS 1 para. 103
Activities – Unit 2
interest expense within other expenses
Fur-Mates Limited Not part of the statement but provided to support the values and explain the treatment*
Statement of profit or loss and other Workings Explanation of treatment Reference to the relevant
comprehensive income for the year ended 30 June Accounting Standard to
20X6 support treatment
Unit 2 – Activities
$
Finance costs (50,000) $50,000 interest Must be separately disclosed and is called ‘finance costs’ rather than IAS 1 para. 82(b)
expense interest expense
Profit before tax 1,650,000 IAS 1 does not specify this line
although para. 103 shows this

line in an example IAS 1 para. 85
Income tax expense (495,000) Must be separately disclosed IAS 1 para. 82(d)
Profit for the year 1,155,000 IAS 1 para. 81A(a)
Other comprehensive income IAS 1 para. 82A
Items that will not be reclassified

to profit or loss
Revaluation of land 300,000 Movement in revaluation surplus reserve for the year. This is the first time IAS 1 para. 82A(a)
there is an increment
Income tax effect (90,000) The tax relating to the reserve movement must also be disclosed IAS 1 para. 91
(alternatively the revaluation could be shown net of tax)
Items that are or may be There are no items in OCI that may be reclassified through profit or loss;
reclassified to profit or loss however, it has been shown here in the workings for completeness
Item (on a before tax basis) _ IAS 1 para. 82A(b)
Income tax effect on the item _ IAS 1 para. 91
Other comprehensive income, 210,000 IAS 1 para. 81A(b)

net of tax
Total comprehensive income for 1,365,000 $1,155,000 profit for IAS 1 para. 81A(c)
the period the year + $210,000
OCI
Page 2-19
* Note that these workings, explanation of treatment and reference to the Accounting Standards are provided to explain the values and descriptions in the SPLOCI.
ACT
ACT
Exclusion
The $800,000 dividend income understatement should be accounted for as a prior period
error (along with the related $240,000 in income tax expense). The error should be recognised
retrospectively (IAS 8 para. 42) by adjusting the comparative financial statements for the year
ended 30 June 20X5, and therefore should not be included in this year’s profit. This $560,000
adjustment after tax ($800,000 – $240,000) will increase the opening retained earnings balance
from $2,000,000 to $2,560,000.
Task B
Step 1 – Review the Standard
Review IAS 1 paras 106–110.
Step 2 – Identify the equity items that will be shown in the statement
Review the extract from Fur-Mates’ trial balance to identify that the statement of changes in
equity will need to reconcile three equity items for their movements during the year:
•• Share capital.
•• Revaluation surplus.
•• Retained earnings.
Step 3 – Identify the movements that will be shown in the statement

The movement during the year for each equity item should capture the following:
Equity item Movements to be shown in the statement
Share capital Share issue
Revaluation surplus Movement in the revaluation surplus
Retained earnings •• Adjustment to opening retained earnings for the prior year error
•• Profit for the year
•• Dividend paid
Step 4 – Prepare the statement of changes in equity

•• Prepare the statement of changes in equity using the wording from IAS 1 to create
appropriate descriptions within the statement.
•• Bring forward the relevant totals from SPLOCI along with the appropriate information from
the extract from Fur-Mates’ trial balance.
•• Ensure that the statement adds across and adds down to the same total.
•• The statement of changes in equity is shown in the solution.

ACT
Activity 2.3
Accounting for changes in accounting
policies and estimates
Introduction
Identifying whether a change relates to an accounting policy, an accounting estimate or a prior
period error will drive whether that change is accounted for retrospectively or prospectively,
in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (IAS 8).
As a Chartered Accountant you may need to apply IAS 8 to establish the nature of a change and
the resulting accounting treatment.
•• Explain and account for changes in accounting policies, revision of accounting estimates
and errors.
At the end of this activity you will be able to explain and account for changes in accounting
policies and revisions of accounting estimates, in accordance with IAS 8.
Scenario
You are a Chartered Accountant employed by Heavy Industries Limited (Heavy Industries),
and are currently involved with the preparation of the 30 June 20X6 financial statements.
The following three issues have been identified during the process of preparing the financial
statements:
1. Heavy Industries owns heavy machinery that it uses in its road construction business. On
1 January 20X6 the useful life of its asphalt laying machines was reassessed. Originally the
useful life was estimated to be 10 years but was revised to 13 years, based on how these
assets are being used in the business. The differential in the residual value of a machine at
the end of 10 and 13 years is insignificant. Heavy Industries owns eight of these machines,
the oldest of which is seven years old and the newest one was purchased 12 months ago.
2. The company has been presenting its statement of cash flows using the indirect method.
However, at the previous annual general meeting, the finance team received a number of
complaints from shareholders claiming they found the statement difficult to understand
compared to other companies’ statement of cash flows (which they said were far easier to
read and interpret). As such, Heavy Industries will present its statement of cash flows this
year using the direct method under IAS 7 Statement of Cash Flows (IAS 7).
3. Heavy Industries signed a new industrial agreement with its employees on 30 June 20X6.
This resulted in an improved workers’ entitlements, which entitle the employees to long
service leave after only seven years of employment, instead of ten years.

ACT
Task
You have been asked by your manager to prepare a summary explaining the impact of IAS 8 on
each issue and the related impact on the financial statements for the year ending 30 June 20X6.
Ignore the impact of tax.

ACT
Activity 2.3 Solution

The impact of IAS 8 on each issue and the related impact on the financial statements are
summarised in the following table:
Summary of IAS 8 impact on financial statements
Item 20X6 20X5 comparative financial

statements
Reassessing the useful life of the No change to the depreciation No impact as the change in
machinery expense up to 31 December 20X5 accounting estimate is applied
Lower depreciation expense from prospectively from 1 January 20X6
1 January 20X6 when the useful
life is increased to apply the
change in the accounting estimate
prospectively
Presentation of statement of cash The statement of cash flows will be The 20X5 statement of cash flows
flows presented using the direct method will be presented using the direct
for the change in account policy method to give retrospective effect
to this change in accounting policy
Long service leave entitlement in IAS 8 has no impact as it is neither IAS 8 has no impact as it is neither
new industrial agreement a change in accounting policy or a change in accounting policy or
change in accounting estimate change in accounting estimate
The explanation for the accounting treatment is summarised in Step 3 of the recommended
approach.
Recommended approach

Review IAS 8 for guidance to determine the nature of each issue. IAS 8 para. 5 contains the
definitions of ‘accounting policies’ and ‘change in accounting estimate’. More detail is provided
in IAS 8 in the following paragraphs:
Changes in accounting policies – paras 14–19.
Changes in accounting estimates – paras 32–38.

ACT
Step 2 – Identify the nature of the issues

Apply the relevant guidance from IAS 8 in order to identify the nature of each issue.
Heavy Industries Limited – Nature of issues
Issue Explanation Nature
Reassessing the useful life Changing the calculation of the depreciation Change in accounting estimate
of the machinery meets the definition of a change in accounting
estimate in IAS 8 para. 5 (i.e. the original estimate
of the useful life was changed to reflect new
information, notwithstanding that it was correct
at the time of purchase)
Presentation of statement The change from the indirect to the direct Change in accounting policy
of cash flows method of presenting a statement of cash flows
is a voluntary change in accounting policy
The change to the direct method should result in
the financial statements providing reliable and
more relevant information about the cash flows
of Heavy Industries, in accordance with IAS 8
para. 14(b)
Long service leave The improved entitlement under the agreement Not a change in accounting
entitlement in new represents a change in a condition that differs policy
industrial agreement substantially from the previous agreement.
Therefore, it is not a change in accounting policy
in accordance with IAS 8 para. 16(a)
Neither is it an estimate as the entitlement is Not a change in accounting
specified rather than estimated (IAS 8 para. 32) estimate
Step 3 – Determine the accounting treatment for the issues

Determine the accounting treatment for each of the issues, in accordance with IAS 8.
Heavy Industries Limited – IAS 8 accounting treatment for each issue
Issue Accounting treatment
Reassessing the useful A change in accounting estimate should be applied prospectively (IAS 8 paras 36–
life of the machinery 38)
Depreciation from 1 January 20X6 for the machinery should be calculated based on
the revised estimate of the useful life. This will decrease the depreciation expense
due to the increased estimate of the useful life
As a change in an accounting estimate is applied prospectively:
•• Depreciation on the machinery for the six months to 31 December 20X5 should
be recognised on the basis of the original estimate of the useful life
•• Depreciation recognised to date that is captured within opening retained
earnings for prior reporting periods is not changed
Presentation of A voluntary change in accounting policy must be accounted for retrospectively

statement of cash flows (IAS 8 para. 19(b))
Accordingly, the 30 June 20X5 comparative statement of cash flows should be
presented using the direct method to apply this change retrospectively
Long service leave IAS 8 does not apply to this change

entitlement in new The improved entitlement arising under the agreement reached on 30 June 20X6
industrial agreement will be accounted for in accordance with the relevant Accounting Standard (IAS 19
Employee Benefits)
A summary of the impact of each issue on the financial statements is shown in the solution.

ACT
Activity 2.4
Identifying related parties
Introduction
To ensure that users of financial statements can assess the financial performance and position
of the entity, it is important that any related party transactions are disclosed in accordance
with IAS 24 Related Party Disclosures (IAS 24). As a Chartered Accountant you may be required
to identify related parties in order to establish whether there have been any transactions with
these parties that require disclosure.
•• Identify and analyse related parties.
At the end of this activity you will be able to identify related parties in accordance with IAS 24.
Scenario
You are a Chartered Accountant working for Renovation Limited (Renovation), a company
involved in the construction industry. Renovation has a number of investments in companies
that provide complementary services within the construction industry as follows:
•• 80% of the equity capital of Building Limited (Building), resulting in control.
•• 20% of the equity capital of Plumbing Limited (Plumbing), resulting in significant influence.
•• 1% of the equity capital of Plasterer Limited (Plasterer).
In addition, Building and Plumbing jointly own and jointly control Electrician Limited
(Electrician), with each owning 50% of the equity capital, and they are classified as a joint
venture under IFRS 11 Joint Arrangements.

ACT
Renovation’s investments
RENOVATION
80% 20% 1%
BUILDING PLUMBING PLASTERER
50% 50%
ELECTRICIAN
Key management personnel (in addition to directors)
Company Personnel details
Renovation Chief executive officer (CEO) – Mike Hammer

Mike is married to Sue Hammer and they have a two-year-old daughter, Eloise
Plasterer Chief engineer – Mandy Saw

Mandy is the daughter of Tran Saw. Mandy is 32 years old
Plumbing CEO – John Pipe
Electrician CEO – John Pipe

Chief Operating Officer – Tran Saw
Building CEO – Tran Saw
Task
You are required to identify whether or not each entity and individual are related parties of
Renovation, with reference to IAS 24. Justify your answer.

ACT

Identifying related parties of Renovation
Party Related Justification IAS 24

party? para. 9
Yes/No reference
Plasterer No Plasterer does not meet the definition of a related party as none of n/a
the conditions in IAS 24 para. 9(b) apply
Plumbing Yes Plumbing is an associate of Renovation (b)(ii)
Electrician Yes Electrician is a joint venture of a member of the group (b)(ii)
Building Yes Building and Renovation are members of the same group (b)(i)
Mike Hammer Yes Mike is a member of the key management personnel (KMP) of (a)(iii)
Renovation
Sue Hammer Yes Sue is the spouse of Mike and therefore is a close family member of (a)(iii)
a member of the KMP of Renovation
Eloise Hammer Yes* Eloise is the child of Mike and therefore is a close family member of (a)(iii)
the KMP of Renovation
Mandy Saw No Mandy is a member of the KMP of an investment of Renovation – n/a

this entity is not classified as a related party of Renovation – she is
not classified as a related party as IAS 24 para. 9(a)(iii) is limited to
KMPs of the reporting entity or a parent of the reporting entity
Tran Saw No Tran is a member of the KMP of a subsidiary of Renovation – he is n/a

John Pipe No John is a member of the key management personnel of an n/a

associate of Renovation and of the associate’s joint venture – he is
*A
pplying the strict definition of a related party and close members of the family of a person from IAS 24 para. 9, Eloise
could be a related party of Renovation. However, as Eloise is only two years old, it could be argued that in substance
she is not a related party (IAS 24 para. 10) as she would not have influence over Renovation.

ACT

Review IAS 24 para. 9 for definitions that are relevant to identifying the related parties of
Renovation, specifically:
•• Related party.
•• Close members of the family of a person.
•• Key management personnel.
Step 2 – Prepare to apply the Standard

Identify all parties that have a connection with Renovation and create a table to apply the
definitions from IAS 24 para. 9 in order to establish whether or not they are related parties of
Renovation.
Identifying related parties of Renovation
Party Related Justification IAS 24

party? para. 9
Yes/No reference
Plasterer
Plumbing
Electrician
Building
Mike Hammer
Sue Hammer
Eloise Hammer
Mandy Saw
Tran Saw
John Pipe
Step 3 – Identify the related parties of Renovation

Consider the relationship of the parties identified in Step 2 to Renovation, with reference to the
definition of a related party in IAS 24 para. 9.
Complete the table, justifying why a party is or is not a related party.
The table is shown in the solution.

ACT
Activity 2.5
Accounting for events after the reporting
period
Introduction
Identifying the nature of events after the reporting period, and determining whether an
entity should adjust its existing financial statements or provide new disclosures regarding
those events, requires an understanding of IAS 10 Events after the Reporting Period (IAS 10).
As a Chartered Accountant, you may have to decide if a particular event is an adjusting or
non‑adjusting event, and the appropriate treatment in the financial statements of an entity.
•• Explain and account for events after the reporting period.
At the end of this activity you will be able to identify the nature of, and account for, events after
the reporting period, in accordance with IAS 10.
Scenario
You are a Chartered Accountant employed by ABC Limited (ABC) and are involved with the
preparation of the 30 June 20X6 financial statements.
ABC manufactures brakes for motor vehicles, which it sells with a one-year warranty. In its
financial statements, ABC does not recognise a provision for warranties, as warranty claims in
the past 10 years have been immaterial. For the financial year ending 30 June 20X6, ABC showed
a profit of $4 million before any final amendments to the financial statements were made.
Prior to the financial statements being finalised, two events were identified:
1. In August 20X6, a warranty claim was made regarding a wholesale order of faulty brakes,
which were sold in January 20X6. An investigation revealed that the fault could not be
repaired, and the cost of replacing all the brakes totalled $250,000. ABC suspected the fault
related to a number of batches sold in January and February 20X6, and consequently all
the suspected affected batches were recalled on 16 August 20X6. The cost of the recall is
estimated to be $1,000,000. This information was disclosed in a note to the draft financial
statements. The inventory on hand at 30 June 20X6, relating to brakes from the suspected
batches identified as faulty, was included in the draft financial statements at $450,000.
2. In September 20X6, a lawsuit for negligence was brought against ABC for damages
sustained in a car crash that injured one of its sales managers (the driver of the car) on
31 July 20X6. The resulting investigation into the crash claims that the driver may have
fallen asleep while driving.
Since May 20X6, ABC’s sales team has been under intense pressure to lift revenue. The
lawsuit alleges that pressure from ABC’s senior management contributed to, or caused, the
crash. The damages claim is estimated to be $2 million. This amount has not been recognised
in ABC’s financial statements because ABC does not expect the claim to be successful.
For the purpose of this activity, assume that all amounts are material.

ACT
Task
You are required to explain the impact of the two events on ABC’s financial statements for the
year ended 30 June 20X6.

ACT

The table summarises the impact of the two events on ABC’s financial statements for the year
ended 30 June 20X6.
Accounting treatment of the events
Event Accounting treatment
Warranty claim The warranty claim occurred after the reporting period and is therefore
an adjusting event. It provides evidence that the entity had a present
obligation for warranty costs at 30 June 20X6
Recognise a provision
As the total cost of replacement ($250,000 + $1,000,000) is material, it will
be recorded as a warranty provision at 30 June 20X6 in ABC’s financial
statements (i.e. IAS 10 paras 8–9 require adjusting events to be recognised
in the financial statements). ABC’s current treatment of disclosing this
event in the notes to the financial statements is not correct, as such
treatment applies only to to non-adjusting events
Write down the inventory
The inventory from the affected batches must be written down to the
lower of cost and net realisable value as at 30 June 20X6
Car crash The car crash occurred after the end of the reporting period. Consequently,
the lawsuit against ABC provides evidence of a condition that arose after
the reporting date. It is therefore a non-adjusting event
Although ABC does not expect the claim to be successful, the event itself
is material, and must therefore be disclosed as a non-adjusting event
under IAS 10 para. 21 in the notes to ABC’s financial statements. This note
disclosure should also include an estimate of the financial effect of the
claim

ACT

Review IAS 10 paras 3, 8–11, 19 and 21.
Step 2 – Plot the events on a timeline

Read the scenario and plot each event on a timeline.
A timeline could be presented as follows:
End of
reporting Issue of financial
Did condition of
period statements
the faulty breaks
exist at 30 June
20X6? 20X6
JUNE
30
Did the condition
that triggered the
lawsuit exist at
30 June 20X6?
EVENT
EVENT car crash
warranty
claim for
Brakes sold faulty brakes
Step 3 – Identify any evidence of the condition existing at the end of

the reporting period
Apply the relevant guidance from IAS 10 to identify whether there is evidence that the
condition existed at the end of the reporting period.
Identification of the nature of events
Event Nature of the event Conclusion – did the

condition exist at the end
of the reporting period?
Warranty The brakes and the associated warranty were sold in January and Yes, the condition existed
claim February 20X6. The recall confirms that the entity had a present at 30 June 20X6
obligation at the end of the reporting period
Car crash The lawsuit for negligence commenced after the reporting No, the condition did not
period, and indicates a condition that arose after 30 June 20X6; exist at 30 June 20X6
that is, the date of the crash itself
The lawsuit provides evidence of the car crash itself, despite the
alleged work pressure occurring since May 20X6

ACT
Step 4 – Determine the treatment of the events in ABC’s 20X6

Apply the relevant guidance from IAS 10 to determine the accounting treatment of the events,
as shown in the table in the solution and mapped in the timeline below:
Yes, an adjusting
event therefore
adjust 30 June 20X6 End of
financial statements reporting Issue of financial
period statements
Did condition of
the faulty breaks
exist at 30 June 20X6
20X6? JUNE
Did the condition

that triggered the
lawsuit exist at
30 EVENT
30 June 20X6?
EVENT car crash
No, a non-adjusting warranty
event therefore claim for
note disclosure only
Brakes sold faulty brakes

ACT
Unit 3: Revenue
Activity 3.1
Measuring revenue for the sale of goods
Introduction
Determining when to recognise revenue from contracts with customers, and how much revenue
to recognise, is a core skill for all Chartered Accountants. All entities must record revenue.
IFRS 15 Revenue from Contracts with Customers (IFRS 15) is mandatory for annual reporting
periods commencing on or after 1 January 2018. The five-step model under IFRS 15 can seem
simple at first glance, but contains a number of principles which can be tricky to apply in
practice. Many aspects of this Standard require the use of professional judgement.
•• Identify, measure and recognise revenue from contracts with customers
Scenario
You are a financial accountant at Build-and-Drive Limited. Build-and-Drive manufactures and
sells heavy haulage trucks, as well as medium and small delivery vehicles. Build-and-Drive
only sells its vehicles to customers who have passed a thorough credit worthiness process.
During the week 12–17 December 20X6, Build-and-Drive enters into the following three sales
contracts with All-Your-Delivery Needs and its two subsidiaries, Deliver-a-Lot and Deliver-a-
Bit:
•• Contract to sell 20 heavy haulage trucks to Deliver-a-Lot. The contract price is $100,000 per
truck (normal selling price is only $95,000 per truck), and the delivery date is 1 January
20X7.

Deliver-a-Lot will pay the total contract price of $2,000,000 on 15 January 20X7, two weeks
after the delivery of the trucks.
•• Contract to sell 10 small delivery vehicles to Deliver-a-Bit. The contract price is $15,000
per delivery vehicle, which is well below the normal selling price of $40,000 per vehicle.
Build-and-Drive agreed to this low selling price due to the large contract entered into with
Deliver-a-Lot.

These vehicles will be delivered on 1 January 20X7. Deliver-a-Bit will pay the total contract
price of $150,000 on 15 January 20X7, two weeks after the delivery of the vehicles.
•• A $100,000 contract to perform services on all vehicles purchased and provide ongoing
maintenance for the first 12 months after delivery.

This contract was entered into with All-Your-Delivery-Needs, the parent entity of Deliver-a-
Lot and Deliver-a-Bit. The $100,000 contract fee will be paid to Build-and-Drive on 30 June
20X7. The normal price of a first-year service agreement for a heavy haulage truck is $2,000,
and $800 for a small delivery vehicle.

ACT
Build-and-Drive’s reporting date is 31 March 20X7. Revenue recognised over time is taken up
on a quarterly basis.
Ignore tax.
Required
Applying the requirements of IFRS 15, analyse the three contracts above against each step in the
five-step revenue model.
Prepare the journal entries for the life of the three sales contracts in the records of Build-and-Drive.

ACT
Activity 3.1 Suggested Solution
Step 1 – Identify the contract(s) with a customer

Identifying the contract
The three contracts should be accounted for in terms of IFRS 15, for the following reasons:
•• There was no information to suggest that the parties to the contract have not approved the
contract and that they are not committed to perform their respective obligations.
•• Build-and-Drive can identify each party’s rights regarding the goods and services to be
delivered.
•• Build-and-Drive can identify the payment terms outlined in the three contracts.
•• The contracts have commercial substance.
•• It is probable that Build-and-Drive will collect the consideration, because it has a credit
worthiness process in place to check the credit worthiness of all its customers, and these
three entities have all passed that process/check.
Considering the potential combination of contracts

The three sales contracts are entered into with the following three entities:
•• All-Your-Delivery-Needs (parent entity of Deliver-a-Lot and Deliver-a-Bit).
•• Deliver-a-Lot (subsidiary of All-Your-Delivery-Needs).
•• Deliver-a-Bit (subsidiary of All-Your-Delivery-Needs).
These three entities are therefore related parties as defined in IAS 24 Related Party Disclosures
para. 9(b)(i).
The three sales contracts are entered into at or near the same time (within the same week)
and the contracts are entered into with the same customer (or related parties of the same
customer). In addition, the contracts have been negotiated with a single commercial objective –
the purchase and maintenance of a fleet of vehicles. The amount of consideration to be paid
for the purchase of delivery vehicles by Deliver-a-Bit is lower than market price due to the
large quantity of vehicles also purchased by Deliver-a-Lot. Therefore, Build-and-Drive should
combine these three contracts for the purposes of IFRS 15 para. 17.

ACT
Step 2 – Identify the separate performance obligations

According to the three signed sales contracts, Build-and-Drive has agreed to the following three
performance obligations:
•• Sale of 20 heavy haulage trucks.
•• Sale of 10 small delivery vehicles.
•• Maintenance and service of the trucks and delivery vehicles for one year.
Step 3 – Determine the transaction price

The transaction price can be calculated as follows:
Contract with Deliver-a-Lot – heavy haulage trucks (20 × $100,000) 2,000,000
Contract with Deliver-a-Bit – delivery vehicles (10 × $15,000) 150,000
Contract with All-Your-Delivery-Needs – service and maintenance (per contract) 100,000
Transaction price 2,250,000
There is no financing component in the transaction price, because there is not more than
12 months difference between the date of cash received and the date of revenue recognition.
The transaction price also does not include a variable consideration.
Step 4 – Allocate the transaction price

The transaction price of $2,250,000 is allocated to the three performance obligations based on
their stand-alone selling prices as follows:
Performance obligation Stand-alone Transaction price

selling price allocated
$ $
Sale of 20 heavy haulage trucks (20 × $95,000) 1,900,000 1,820,6981
Sale of the 10 small delivery vehicles (10 × $40,000) 400,000 383,305
Maintenance and service of the 20 heavy haulage trucks (20 × $2,000) 48,000 45,997
and the 10 small delivery vehicles (10 × $800)
Total 2,348,000 2,250,000
1. Calculated as 1,900,000 ÷ 2,348,000 × 2,250,000 transaction price from Step 3

ACT
Step 5 – Recognise revenue when a performance obligation is

satisfied
Build-and-Drive will recognise revenue when the performance obligations are satisfied
as follows:
•• Sale of 20 heavy haulage trucks – at a point in time 1 January 20X7
•• Sale of the 10 small delivery vehicles – at a point in time 1 January 20X7
•• Maintenance and service of the heavy haulage trucks and delivery 1 January 20X7 to 31 December 20X7
vehicles – over time
It is important to note that the dates of receipt of the cash amounts have no impact on the
timing of the revenue recognition. None of the steps in the five-step revenue model refers to
cash received. Therefore, the date of recognition of revenue does not necessarily coincide with
the date of receipt of the related cash.
The following journal entries illustrate the recognition of revenue in terms of the five-step
revenue model, as well as the receipt of the related cash amounts. The revenue being recognised
on the sale of the trucks differs to the trade receivable, because the contracts were combined and
the transaction price allocated between performance obligations based on relative stand-alone
selling prices.
Date Account description Dr Cr

$ $
01.01.20X7 Trade receivable 2,204,003
Revenue from contracts with customers 2,204,003
Recognition of trade receivable on the heavy haulage and delivery trucks, and revenue earned but not yet
invoiced due to contract terms and combining the contracts ($1,820,698 + $383,305)

$ $
15.01.20X7 Bank 2,150,000
Trade receivables 2,150,000
Receipt of cash payment for delivery of large haulage and small delivery vehicles as per contract

$ $
31.03.20X7 Trade receivables 11,499
Revenue from contracts with customers (service) 11,499
Accrue revenue at year end for 3 months of service and maintenance, recognised over time
(($45,997 ÷ 12 months) × 3 months)

$ $
30.06.20X7 Cash 100,000
Revenue from contracts with customers 11,499
Trade Receivables 65,502
Revenue received in advance (servicing) 22,999
Recognise cash receipt for service and maintenance contract, take up 3 months service revenue, and record
6 months service revenue received in advance

ACT

$ $
30.09.20X7 Revenue received in advance 11,499
Recognise revenue for 3 months of service and maintenance, recognised over time

$ $
Recognise revenue for 3 months of service and maintenance, recognised over time

ACT
Activity 3.2
Identify, measure and recognise revenue
Introduction
Contracts with multiple performance obligations are now a common feature of many entities’
product offerings. IFRS 15 Revenue from Contracts with Customers (IFRS 15) requires that a
transaction price is allocated to each performance obligation based on the relative stand-alone
selling price. In addition, many contracts will involve some revenue being recognised at a point-
in-time, and other revenue being recognised over time. This distinction is important and has the
potential for material effects on the entity’s bottom line.
These skills of identifying performance obligations and allocating the transaction price, as well
as understanding when revenue can be recognised, are vital for all Chartered Accountants.
Scenario
You are a financial accountant at Buildicoat Limited (Buildicoat). Buildicoat offers powder
coating of metal in any colour or design. It creates decorative paint finishes for the outside
of modern buildings. Buildicoat is considered the leader in its field and has been operating
profitably for the past 20 years.
Buildicoat does the powder coating in its factory in Sydney’s west, then delivers the coated
metal to the customer’s building site as the work progresses.
On 1 June 20X7, Buildicoat signed a large new contract for the development at Garamboo,
Sydney. Under the contract, Buildicoat will powder coat pieces of metal fit out to pre-approved
specifications. Under the terms of the contract, Buildicoat has an enforceable right to payment
for work completed to date. If building work were to be discontinued, the coated metal is
tailored to the customer specifications, so it cannot be onsold to other customers and has no
alternative use to Buildicoat.
The contract price is $120,000.
The contract includes:
•• Powder coat external metal fittings as specified in the contract.
•• Subsequent cleaning – a free, specialised cleaning service for eight months after Buildicoat’s
powder coating service is completed, to protect the powder-coated metal from corrosion
due to sea spray. This service is expected to commence on 1 November 20X7.
The payment terms outlined in the contract are as follows:

•• 1 June 20X7 – signing of the contract and payment of a $20,000 deposit.
•• Two instalments of $50,000 each due on 30 June 20X7 and 31 October 20X7.
The powder coating is expected to commence on 1 June 20X7 and finish on 31 October 20X7.
The after-sales cleaning service will commence on 1 November 20X7 and continue for eight
months until 30 June 20X8.
The stand-alone selling price for a similar amount of powder coating is $90,000. Buildicoat has
never provided a specialised cleaning service as a stand-alone product before and Buildicoat’s
engineers cannot provide an expected cost estimate for the future cleaning costs.

ACT
Based on surveys of work done, Buildicoat estimates the stage of completion for the coating
services at 25% at 30 June 20X7. No work has commenced on the cleaning service.
Buildicoat’s reporting date is 30 June.
Ignore tax.
Required
Discuss the accounting treatment of the contract in the records of Buildicoat under the IFRS 15,
and prepare the journal entries in the records of Buildicoat.

ACT
Activity 3.2 Suggested Solution
Step 1 – Identify the contract(s) with a customer

Identifying the contract
The contract should be accounted for in terms of IFRS 15, for the following reasons:
•• There was no information to suggest that the parties to the contract have not approved the
contract and that they are not committed to perform their respective obligations.
•• Buildicoat can identify each party’s rights regarding the goods and services to be delivered.
•• Buildicoat can identify the payment terms outlined in the contract.
•• The contract has commercial substance.
•• It is probable that the entity will collect the consideration (or nothing in the information that
suggests otherwise).
Considering the potential combination of contracts

Not applicable, because only one contract.
Step 2 – Identify the separate performance obligations

According to the signed sales contract, Buildicoat has agreed to the following two performance
obligations:
•• A coating service.
•• An after-sales cleaning service.
Step 3 – Determine the transaction price

The transaction price is $120,000.
There is no financing component in the transaction price, because there is not more than 12
months difference between the date of cash received and the date of revenue recognition. The
transaction price also does not include a variable consideration.
Step 4 – Allocate the transaction price

The stand-alone selling price of the coating service is $90,000 and the stand-alone selling price
of the after-sales cleaning cannot be determined. Also, Buildicoat’s engineers cannot provide
an expected cost estimate for the future cleaning costs. Therefore, the residual approach is used
to allocate the transaction price to the two performance obligations. The transaction price of
$120,000 is allocated as follows:
Contract price 120,000
A coating service 90,000
An after-sales cleaning service (residual) 30,000

ACT
Step 5 – Recognise revenue when a performance obligation is

satisfied
Buildicoat will recognise revenue for both services over time, for the following reasons:
•• Coating service – Buildicoat has an enforceable right to payment for work completed to
date, and Buildicoat’s performance creates an asset with no alternative use to the entity.
•• After-sales cleaning service – the customer simultaneously receives and consumes the
benefits provided by Buildicoat’s performance as Buildicoat performs. Buildicoat would
recognise this revenue on a straight line basis during the period of this service.
Buildicoat will recognise revenue when the two performance obligations are satisfied as
follows:
A coating service 1 June 20X7 to 31 October 20X7, recognised in line with % completion
An after-sales cleaning service 1 November 20X7 to 30 June 20X8, recognised on a straight line basis
It is important to note that the dates of receipt of the cash amounts have no impact on the
timing of the revenue recognition. None of the steps in the five-step revenue model refers to
cash received. Therefore, the date of recognition of revenue does not necessarily coincide with
the date of receipt of the related cash.
It should also be noted that the exact sequence of journal entries will differ in different entities.
Most entities would recognise revenue earned over time via a monthly journal.
The following journal entries illustrate the recognition of revenue in terms of the five-step
revenue model, as well as the receipt of the related cash amounts:

$ $
01.06.20X7 Cash 20,000
Revenue received in advance 20,000
Receipt of deposit

$ $
30.06.20X7 Cash 50,000
Receipt of instalment 1

$ $
Recognition of revenue on delivery of coating service using estimates of % completion ($90,000 × 25%)

$ $
31.10.20X7 Cash 50,000
Receipt of instalment 2

ACT

$ $
31.10.20X7 Revenue received in advance** 67,500
Recognition of revenue on delivery of coating service ($90,000 – $22,500)

$ $
30.11.20X7# Revenue received in advance 30,000
30.11.20X7 Revenue from contracts with customers 30,000
Recognition of revenue on delivery of cleaning service for the month of November

($30,000 ÷ 8 months × 1 month)
Notes
# The last journal for after sales cleaning revenue recognition would generally be done on a monthly basis, at $30,000 ÷
8 = $3,750 each month, from 30 November 20X7 to 30 June 20X8.
** the revenue from the coating work would normally recognised each month, in line with the percentage completion
at each month end. Exam questions will either direct candidates on the timing of revenue recognition, or markers
would accept a variety of responses.

ACT
Unit 4: Income taxes
Activity 4.1
Accounting for income taxes
Introduction
At the end of each reporting period, the income tax position of an entity needs to be determined
so that the financial statements accurately reflect the entity’s tax liability resulting from past
transactions and events, and records the potential future impact shown as deferred tax balances.
This activity links to learning outcomes
•• Calculate and account for current tax.
•• Calculate and account for deferred tax.
At the end of this activity you will be able to:

•• Calculate the current tax liability for an entity.
•• Calculate the tax base of assets and liabilities.
•• Calculate and record deferred tax assets and liabilities arising from temporary differences.
•• Account for the utilisation of a of a tax loss from a prior period.
•• Prepare the journal entries in accordance with IAS 12 Income Taxes to reflect transactions
and events.
It will take you approximately 60 minutes to complete this activity.

ACT
Scenario
You are a Chartered Accountant working for Kunapipi Limited (Kunapipi) and are responsible
for preparing tax effect accounting journal entries in accordance with IAS 12.
An extract from Kunapipi’s financial statements for the year ended 30 June 20X3, together with
additional information, is shown below.
Kunapipi Limited
Internal statement of profit or loss for the year ended 30 June 20X3
Year ended 30 June 20X3 Note 20X3

$
Revenue 617,000
Profit on sale of investment 1 8,000
Total revenue and other income 625,000
Expenses
Depreciation – buildings 2 100,000
Development amortisation 3 20,000
Annual leave expense 4,000
Allowance for impairment loss – trade receivables expense 25,000
Entertainment expenses 12,000
Other expenses 349,000
Total expenses 510,000
Accounting profit before tax 115,000
Statement of financial position as at 30 June 20X3 20X3 20X2

$ $
Current assets
Cash 367,000 32,000
Trade receivables 185,000 130,000
Allowance for impairment loss – trade receivables (40,000) (20,000)
Total current assets 512,000 142,000
Non-current assets
Buildings – cost 1,000,000 1,000,000
Buildings – accumulated depreciation 2 (300,000) (200,000)
Capitalised development costs 3 140,000 90,000
Capitalised development costs – accumulated amortisation 3 (60,000) (40,000)

ACT
Kunapipi Limited
Internal statement of financial position as at 30 June 20X3
Note 20X3 20X2

$ $
Investments at cost 430,000 130,000
Deferred tax asset 4 72,000 72,000
Total non-current assets 1,282,000 1,052,000
Total assets 1,794,000 1,194,000
Liabilities
Trade payables 61,200 48,200
Annual leave liability 22,000 30,000
Total current liabilities 83,200 78,200
Non-current liabilities
Borrowing 350,000 350,000
Deferred tax liability 15,000 15,000
Total non-current liabilities 365,000 365,000
Total liabilities 448,200 443,200
Net assets 1,345,800 750,800
Equity
Share capital 5 580,000 100,000
Retained earnings 765,800 650,800
Total equity 1,345,800 750,800
Notes
1. The profit on sale of the investment is not assessable for tax purposes.
2. Accumulated depreciation on buildings at 30 June 20X2, for tax purposes, was $100,000. Tax depreciation for the year
ended 30 June 20X3 is $50,000. There have been no disposals or additions during the year.
3. All development expenditure incurred is capitalised by Kunapipi, in accordance with IAS 38 Intangible Assets. All
development expenditure incurred is deducted in full for tax purposes in the year in which it is incurred, giving rise
to a tax deduction equal to the costs incurred.
4. The $72,000 deferred tax asset (DTA) balance at 30 June 20X2 comprises:
•• DTAs relating to temporary differences: $45,000.
•• DTAs relating to carried forward tax losses: $27,000. This relates to $90,000 in tax losses that may be utilised in the
year ended 30 June 20X3. The tax losses utilised are treated under the tax law as a tax deduction, thus reducing
the taxable income.
5. An additional $500,000 in share capital was issued on 1 July 20X2. Share issue costs of $20,000 were incurred and
have been correctly debited against the share capital account. These costs are deductible for tax purposes, with
$4,000 being deductible in the year ended 30 June 20X3, and the $16,000 costs being tax deductible in future years.
•• Employee entitlements are deductible for tax purposes when paid.
•• The entertainment expenses are not deductible for tax purposes.
•• A bad debt deduction is only allowed when previously brought to account as income and specifically written
off as bad.
•• The accounting treatment of accounts or transactions is assumed to be the same as the taxation treatment,
unless otherwise indicated.
•• Kunapipi’s tax rate is 30%.

ACT
Task
You are required to prepare the tax effect journal entries that should be included in Kunapipi’s
financial statements for the year ended 30 June 20X3.

ACT

The two tax journal entries which will be included in Kunapipi’s financial statements for the
year ended 30 June 20X3 are as follows:
Journal entry to account for the current tax liability at 30 June 20X3

$ $
30.06.X3 Income tax expense 45,300
Share capital 1,200
Deferred tax asset (DTA) 27,000
To record the current tax liability and recognise the utilisation of carryforward tax losses
Journal entry to account for the deferred tax movement at 30 June 20X3

$ $
30.06.X3 DTA 23,400
Income tax expense 9,600
Deferred tax liability (DTL) 9,000
Share capital 4,800
To record the movement in the deferred tax balances at 30 June 20X3

ACT
The followings steps outline the recommended approach to successfully complete this task:
Preliminary step – Identify the journal entries required

Journal entries will need to be prepared, to account for Kunapipi’s current tax liability at
30 June 20X3 and for the movement in deferred tax balances for the year ended 30 June 20X3.
Preliminary step – Review the Standard

Review IAS 12 Income Taxes for the relevant guidance.
The following paragraphs are applicable in relation to current tax and deferred tax:
IAS 12 paragraphs that offer relevant guidance
Item Definition Recognition Measurement
Current tax Para. 5 Para. 12 Para. 46
Deferred tax liability (DTL) Para. 5 Para. 15 Paras 47, 51, 53
Deferred tax asset (DTA) Para. 5 Para. 24 Paras 47, 51, 53, 56
Unused tax losses and unused tax credits – Paras 34–36 Paras 47, 51, 53, 56
The following paragraphs provide further guidance relating to the tax base, taxable temporary
differences (TTDs) and deductible temporary differences (DTDs) for calculating deferred tax:
IAS 12 paragraphs relevant to calculating deferred tax
Item Definition Guidance
Tax base Para. 5 Paras 7–11
TTDs Para. 5 Paras 15 and 16
DTDs Para. 5 Paras 24 and 25

Step 1 – Set up a worksheet to calculate the current tax liability
Set up a worksheet to calculate the current tax liability. Start with the accounting profit for
the period and note the categories of adjustments that may be identified from the financial
information for the period. These categories are:
•• Items where the tax and accounting treatments are never the same (non-temporary
difference adjustments).
•• Items where tax and accounting treatments are the same but in different periods (temporary
difference adjustments). This information will be useful later when performing the deferred
tax journal entries.
•• Equity or other comprehensive income (OCI) differences affecting taxable income.

ACT
Worksheet to calculate the current tax liability at 30 June 20X3
Item $ $
1. Non-temporary difference adjustments
2. Temporary difference adjustments
3. Equity or OCI adjustments affecting taxable income
Taxable income
Step 2 – Identify the items that require adjustment in the calculation

of taxable income
Review the statement of profit or loss and the statement of financial position to identify items
where the accounting treatment is different from the treatment for tax purposes. Categorise the
items and provide a summary of where adjustments are required:
Nature of adjustment Items requiring adjustment
1. Items where the tax and accounting treatments •• Profit on sale of investment
are never the same (non-temporary difference •• Entertainment expenses
adjustments)
2. Items where tax and accounting treatments are •• Depreciation – buildings

the same but in different periods (temporary •• Development costs incurred and amortisation
difference adjustments) thereon
•• Annual leave
•• Allowance for impairment loss – trade receivables
expense
3. Equity or OCI differences Share issue costs

ACT
Step 3 – Calculate the adjustments required to complete the calculation

of taxable income and current tax liability
Deal with each item in turn and total the worksheet to calculate the taxable income and the
current tax liability.
Please note that an explanation of the treatment has been provided to aid understanding but
it is not required to complete the worksheet.
Worksheet to calculate current tax liability at 30 June 20X3
Item Explanation of treatment $ $
1. Non-temporary difference
adjustments
Profit on sale of investment The profit on sale is income for accounting (8,000)
purposes. It will never be assessable for tax
and needs to be subtracted to undo the
income recognised in the accounting profit
Entertainment expenses The costs are an accounting expense 12,000

but are not allowable as a tax deduction
and need to be added back to undo
the expense recognised in the
accounting profit
4,000
2. Temporary difference
adjustments
Accounting depreciation – The item is an expense for accounting 100,000

buildings purposes but is not allowable as a tax
deduction and needs to be added back
Tax depreciation – buildings The deduction for tax depreciation needs (50,000)
to be subtracted
Development amortisation The item is an expense for accounting 20,000

purposes but is not allowable as a tax
Development costs incurred1 The deduction for development costs (50,000)

incurred during the year needs to be
subtracted
Annual leave expense The item is an expense for accounting 4,000

purposes but is not allowable as a tax
Annual leave paid2 The deduction for annual leave paid needs (12,000)
to be subtracted
Allowance for impairment loss – The item is an expense for accounting 25,000
trade receivables expense purposes but is not allowable as a tax
Bad debts written off3 The deduction for the bad debts written off (5,000)
needs to be subtracted
32,000
Taxable income prior to equity 151,000

or OCI adjustments and utilising
carryforward tax losses

ACT
Worksheet to calculate current tax liability at 30 June 20X3
Item Explanation of treatment $ $
3. Equity or OCI adjustments

affecting taxable income
Tax deduction for share issue costs The $20,000 in share issue costs were (4,000)
correctly debited against the share
capital account and, of this total, $4,000
are deductible this year. The $4,000 tax
deduction has not been included in
the accounting profit and needs to be
subtracted when calculating taxable
income
Taxable income prior to utilising 147,000

carryforward tax losses
Less: Utilisation of carryforward tax The tax losses may be utilised in the year (90,000)
losses ended 30 June 20X3. They are treated
under the tax law as a tax deduction and
need to be subtracted as they are not
included in the accounting profit
Taxable income 57,000
Current tax liability at 30% 17,100
Notes
1. $140,000 capitalised development cost balance at 30 June 20X3 – $90,000 capitalised development cost balance
at 30 June 20X3 = $50,000.
2. $30,000 annual leave liability balance at 30 June 20X2 + $4,000 annual leave expense – $22,000 annual leave liability
balance at 30 June 20X3 = $12,000 annual leave paid.
3. $20,000 allowance for impairment loss – trade receivables balance at 30 June 20X2 + $25,000 allowance for
impairment loss – trade receivables expense – $40,000 allowance for impairment loss – trade receivables balance
at 30 June 20X2 = $5,000 bad debts written off.
Step 4 – Prepare the journal entry to record the current tax liability
Using the figure calculated in the worksheet, prepare the journal entry for the current tax
liability at 30 June 20X3. The journal entry is shown in the solution.
To aid your understanding, the lines in the journal entry can be explained as follows:
•• The debit of $45,300 in the journal entry against the income tax expense equates to 30% of
the $151,000 taxable income prior to deducting the $4,000 in share issue costs and utilising
the $90,000 in carryforward losses. This is because the underlying transactions were all
recognised in profit (and not in other comprehensive income or equity).
•• The credit of $1,200 in the journal entry against share capital equates to 30% of the $4,000
share issue costs that give rise to a tax deduction this year. IAS 12 para. 61A(b) requires the
tax relating to an underlying transaction recognised directly in equity to be recorded against
that transaction.
•• The credit of $27,000 in the journal entry against the DTA equates to 30% of the $90,000 tax
losses that have been utilised in the current year as a tax deduction to reduce taxable income
that had been recognised as an asset under IAS 12.
•• The credit of $17,100 in the journal entry to the current tax liability equates to 30% of the
$57,000 taxable income.

ACT
Deferred tax movements

Step 1 – Calculate temporary differences at the end of the reporting period
To identify a temporary difference, examine those assets and liabilities at 30 June 20X3 where
the tax base and the accounting carrying amount differ. This can be done by examining the
following:
•• The assets and liabilities included in the extract of the internal statement of financial
position at 30 June 20X3.
•• The worksheet will allow you to calculate the current tax liability at 30 June 20X3 as item 2
in the worksheet showed temporary difference adjustments.
A temporary difference also arises in relation to some of the $20,000 in share issue costs that
have been recognised directly in equity. Of these total costs, $16,000 will be tax deductible in
future years, thus giving rise to a temporary difference at 30 June 20X3.
The treatment of items such as cash, trade payables and borrowings is the same for tax and
accounting purposes for Kunapipi, and these items therefore do not give rise to a temporary
difference.
The items where there is a temporary difference are:
•• Trade receivables.
•• Buildings.
•• Capitalised development costs.
•• Annual leave liability.
•• Share issue costs (recognised within the share capital account).
Calculate the temporary differences at 30 June 20X3 by subtracting the tax base of the item from
its carrying amount as follows:
Calculation of temporary differences at 30 June 20X3
Item Carrying amount Tax base Temporary difference

$ $ $
Trade receivables 145,000 185,0001 40,000
Buildings 700,000 850,0002 150,000
Capitalised development costs 80,000 03 80,000
Annual leave liability 22,000 04 22,000
Share issue costs 06 16,0005 16,000

ACT
Notes Tax base calculation
Formula-based approach OR Notional tax balance sheet approach
1. Trade receivables $145,000 carrying amount – $0 If a tax balance sheet was prepared,
$185,000 tax base future taxable amounts (as the $185,000 would be recognised for
revenue has already been assessed the trade receivables asset
for tax purposes) + $40,000 in future The $40,000 allowance for
deductible amounts impairment loss would not be
recognised because a tax deduction
only arises when the receivables are
actually written off
2. Buildings $700,000 carrying amount – If a tax balance sheet was prepared,

$850,000 tax base $700,000 future taxable amounts the building’s $850,000 tax written
(capped at the asset’s carrying down value would be recognised
amount) + $850,000 in future
deductible amounts
3. Capitalised $80,000 carrying amount – $80,000 If a tax balance sheet was prepared,
development costs future taxable amounts (capped at $0 would be recognised for
$0 tax base the asset’s carrying amount) + $0 in capitalised development costs as
future deductible amounts the costs were tax deductible when
incurred
4. Annual leave liability $22,000 carrying amount – $22,000 If a tax balance sheet was prepared,
$0 tax base in future deductible amounts (the there would not be an employee
accounting balance sheet tells us we benefits liability for annual leave.
are going to pay $22,000 in annual Annual leave is a deduction on a cash
leave in the future. When paid, this basis, not carried forward. Therefore,
will become a tax deduction. So the the tax base is zero
future deductible amount is $22,000)
+ $0 future taxable amounts (as a
liability will not be taxable)
5. Share issue costs IAS 12 does not suggest a formula for If a tax balance sheet was prepared,
$16,000 tax base a temporary difference within equity. $16,000 would be recognised for the
However, para. 10 provides guidance future tax deductions
that the tax base can be determined
by considering whether future tax
payments will be smaller or larger.
Accordingly, the tax base of the share
issue costs is $16,000 representing
the future deductible amounts as
these will result in smaller future tax
payments
6. The carrying amount of the share issue costs is $0 as this amount is offset against equity, and not included
as an asset or liability.

ACT
Step 2 – Allocate temporary differences

Once the temporary difference for each item has been calculated, determine whether each item
resulted in a taxable temporary difference or a deductible temporary difference.
Allocation of temporary differences
Item Carrying Tax base Temporary Applicable rule TTD or DTD

amount difference
$ $ $
Trade receivables 145,000 185,000 40,000 Asset rule: $40,000 DTD

Carrying amount < tax base
Buildings 700,000 850,000 150,000 Asset rule: $150,000 DTD

Carrying amount < tax base
Capitalised 80,000 0 80,000 Asset rule: $80,000 TTD

development costs Carrying amount > tax base
Annual leave 22,000 0 22,000 Liability rule: $22,000 DTD

liability Carrying amount > tax base
Share issue costs 0 16,000 16,000 No applicable rule $16,0001 DTD

Note
1. The $16,000 in future tax deductions for share issue costs will make future tax payments smaller. Accordingly,
the $16,000 is a DTD.
Step 3 – Calculate deferred tax balances at the end of the reporting period
Create a table to input the relevant information from the previous steps. Complete the table
to calculate the deferred tax balances at the end of the reporting period. A separate column
is added for the share issue cost DTD as the deferred tax movement will be recognised in
equity rather than in income tax expense (IAS 12 para. 61A requires the related tax effect
to be recognised outside profit or loss where the tax relates to an item recognised outside
profit or loss).
Calculation of deferred tax balances as at 30 June 20X3
Item Carrying Tax base TTD DTD DTD

amount (equity)
$ $ $ $ $
Buildings 700,000 850,000 150,000
Capitalised 80,000 0 80,000

development costs
Share issue costs 0 16,000 16,000
Total temporary 80,000 212,000 16,000

differences
DTL/DTA at 30% 24,000 63,600 4,800

ACT
Step 4 – Apply recognition criteria

Examine the criteria for recognising a DTA and DTL. Assume that, in these circumstances,
Kunapipi continues to satisfy the IAS 12 requirements at 30 June 20X3.
Step 5 – Calculate movement in deferred tax balances

The opening balances in the deferred tax asset and liability accounts carry forward from the
previous year. Therefore, it is necessary to determine the movement in the deferred tax balances
from 30 June 20X2 to 30 June 20X3 as the movement will be recorded in a journal entry. The
movement is calculated by subtracting the opening balance in the deferred tax asset and
liability accounts.
The DTA relating to the carryforward tax loss that was fully utilised when calculating the
current tax liability is excluded, as the journal entry has already been recorded to derecognise
the related $27,000 DTA balance.
Calculation of deferred tax balances as at 30 June 20X3
Item Carrying Tax base TTD DTD DTD

amount (equity)
$ $ $ $ $
Buildings 700,000 850,000 150,000
Capitalised development 80,000 0 80,000

costs
Share issue costs 0 16,000 0 0 16,000
Total temporary 80,000 212,000 16,000

differences
DTL/DTA at 30% 24,000 63,600 4,800
Less: opening balances (15,000) (45,000) 0
Movement 9,000 18,600 4,800
Step 6 – Prepare journal entry

Record the journal entries based on the movement calculated in Step 5.

$ $
30.06.X3 DTA 18,600
Income tax expense1 9,600
DTL 9,000
To record the movement in the deferred tax balances at 30 June 20X3

Note
1. The credit is made to income tax expense. This is because the underlying transactions were all recognised in profit
(and not in other comprehensive income or equity).

ACT

$ $
30.06.X3 DTA 4,800
Share capital 1
4,800
To record the movement in the deferred tax balance at 30 June 20X3

Note
1. The $4,800 DTA relating to the future deductions for the share issues costs is recognised as a credit to share capital
(IAS 12 para. 61A).
The above entries may be summarised into a single entry, as shown in the solution.
Although the share capital account is not required to complete the activity, it has a closing
credit balance of $586,000 after recording the tax effect journal entries. As the underlying
transaction ($20,000 in share issue costs) was recognised in equity, the related tax effect is
also recognised in equity, as shown below in the share capital T-account.
Share capital
$ $
Cash (share issue costs) 20,000 Opening balance 100,000
Cash (share issue proceeds) 500,000
Closing balance 586,000 DTA 4,800
606,000 606,000

ACT
Unit 5: Foreign exchange
Activity 5.1
Determining the functional currency
of a foreign operation
Introduction
As companies grow there is an increasing tendency to develop overseas operations to expand
markets, to achieve cost savings and/or to access additional skills and resources often not
available in the country in which the business was originally established. As the business
environment becomes more global, there is an increasing need for Chartered Accountants to
determine the functional currency of these foreign operations.
•• Determine the functional currency.
At the end of this activity you will be able to apply the indicative factors from IAS 21 to
determine the functional currency of foreign branches of a New Zealand company and be able
to explain your determination.
Scenario
You are the financial controller for a New Zealand company, Climbing Limited (Climbing New
Zealand) and report to the chief financial officer (CFO).
Climbing New Zealand has two overseas branches, as shown in the table.
Overseas branch information
Branch Details
Swiss branch – This branch sells and distributes Climbing New Zealand’s patented climbing equipment
Climbing Switzerland in Europe
All products are sourced from Climbing New Zealand, with the cost to the branch for
their purchases denominated in New Zealand dollars
Sales prices charged to customers are determined based on a margin over the
acquisition costs
As the equipment is quite specialised, its pricing is not subject to competition in the
local market
All European sales are handled by the Swiss branch and pricing is standard throughout
the European distribution network
All profits generated by the Swiss branch are retained to fund the European operations

ACT
Overseas branch information
Branch Details
Japanese branch – This branch was established to research future improvements in Climbing New
Climbing Japan Zealand’s equipment
The Japanese branch distributes Climbing New Zealand’s current lines, but is principally
focused on future products
All pricing is based on margin over acquisition costs
All funds generated by the branch are retained in Japan, and regular funding is provided
to it by Climbing New Zealand to continue its operations
There is a possibility that Climbing Japan could become the major manufacturing plant
for all of Climbing New Zealand’s products in the future; in which case, it would then
supply to the New Zealand, European and Japanese markets
Task
For this activity you are required to:
•• Determine the functional currency for each of the overseas branches, documenting your
reasoning in a table that shows the relevant IAS 21 reference, the indicative factors and their
application to each branch.
•• Outline the circumstances that may lead to a change in the functional currency of Climbing
Switzerland.

ACT

The functional currency of Climbing Switzerland and Climbing Japan is the New Zealand
dollar after applying indicative factors, as follows.
Application of indicative factors to determine functional currency
IAS 21 Indicative factor Application to Climbing Application to Climbing

reference Switzerland Japan
Paragraph 9(a)(i) The currency that mainly Sales prices are determined Sales prices are determined
influences sales prices principally by the New principally by the New
Zealand dollar, given the Zealand dollar, given the
selling price is determined selling price is determined
based on a margin over based on a margin over
the New Zealand dollar the New Zealand dollar
denominated purchase price denominated purchase price
of the product of the product
Paragraph 9(a)(ii) The currency of the country The pricing is not impacted No information
whose competitive forces by Swiss or European
and regulations mainly competitive forces
determine the sales price
Paragraph 9(b) The currency that mainly All products are supplied The prime focus of the
influences labour, materials from New Zealand, so the branch is research and
and other costs New Zealand dollar mainly these costs are incurred in
influences input costs Japanese yen
All products are supplied
from New Zealand, so the
New Zealand dollar mainly
influences these input costs
Paragraph 10(a) The currency in which funds No information Operations are funded from
from financing activities Japanese funds and New
(debt and equity) are Zealand investment
generated
Paragraph 10(b) The currency in which Profits are retained All profits are retained in
receipts from operating to support European Japan
activities are usually retained operations
Paragraph 11(a) Whether the activities of The activities of Climbing The principal activities of
the foreign operation are Switzerland are carried Climbing Japan are to carry
carried out as an extension out as an extension of out research for Climbing
of the reporting entity or Climbing New Zealand New Zealand
autonomously to the extent that it is,
in effect, a distributor of
products manufactured in
New Zealand
Paragraph 11(b) Whether inter-entity All products are sourced Distributes products sourced
transactions are a significant from Climbing New Zealand, from Climbing New Zealand
proportion of the foreign so one would expect it and conducts research for
operation’s activities would be a significant the group, but is primarily
proportion of Climbing focused on future products.
Switzerland’s activities Climbing Japan could supply
products for sale in New
Zealand and Europe in the
future

ACT
Application of indicative factors to determine functional currency
IAS 21 Indicative factor Application to Climbing Application to Climbing

reference Switzerland Japan
Paragraph 11(c) Whether cash flows of the Profits are not remitted Profits are not remitted to
foreign operation directly to New Zealand, so there New Zealand and regular
affect the cash flows of is no direct impact on funding is provided by
the reporting entity and Climbing New Zealand’s Climbing New Zealand for
are readily available for cash flows. However, there operational purposes, so one
remittance is no information to suggest would anticipate an impact
that any retained profits on Climbing New Zealand’s
are not readily available for cash flows
remittance to Climbing New
Zealand
Paragraph 11(d) Whether cash flows of No information Regular funding provided by

the foreign operation are Climbing New Zealand
sufficient to service existing
and normally expected debt
obligations
The functional currency of Climbing Switzerland would probably change if:

•• the pricing of its goods became subject to European competitive forces and regulations,
•• goods were not sourced from Climbing New Zealand, or
•• the cost to the branch for their purchases were made in a currency other than New Zealand
dollars.

First review the definitions of functional currency and presentation currency that are set out
in IAS 21 para. 8. Then identify the indicative factors to be considered when determining
the functional currency of each of the branches. These indicative factors are set out in IAS 21
paras 9–11. Paragraph 9 sets out the primary indicators and paras 10 and 11 provide additional
supporting evidence.
If the indicators are mixed, then para. 12 states that judgement should be used to determine
the functional currency that most faithfully represents the economic effects of the underlying
transactions, events and conditions. Priority should be given to the primary factors before
considering the additional supporting evidence.
Step 2 – Apply the indicative factors

Prepare the table requested by the CFO showing the Standard reference, the indicative factor
and the application of the Standard to Climbing Switzerland and Climbing Japan. The table is
Step 3 – Determine the functional currencies

Based on the application of the facts to the indicative factors, the functional currency of each
branch can be determined.

ACT
Functional currency based on indicative factors
Branch Implications Details Functional currency

of application
of indicative
factors
Climbing The indicative IAS 21 para. 12 requires management to use On this basis, it is concluded
Switzerland factors are its judgement to determine the functional that the functional currency
mixed currency that most faithfully represents of Climbing Switzerland is
the economic effects of the underlying the New Zealand dollar
transactions, events and conditions
Priority must be given to the factors in
para. 9 before considering the factors in
paras 10 and 11
Climbing Japan The indicative Para. 12 should be applied to determine the As Climbing Japan appears
factors are functional currency to be an extension of
mixed Climbing New Zealand,
it is concluded that the
functional currency is the
New Zealand dollar
Step 4 – Identify circumstances that may lead to a change in the functional

currency
To identify the circumstances that may lead to a change in the functional currency of
Climbing Switzerland, review the table detailed in the solution, showing the application of
the indicative factors.
The factors that indicate that the functional currency is the New Zealand dollar are the ones that
would need to change in order for the functional currency to change. These factors are detailed
in the solution.

ACT
Activity 5.2
Translating from the functional currency
to the presentation currency
Introduction
Many entities operate overseas via foreign branches and/or subsidiaries. Alternatively, they
may operate as branches or subsidiaries of a foreign entity. It is common that these foreign
operations will have a different functional currency to the parent, and therefore the financial
statements of the foreign operation will need to be translated into the presentation currency.
As a Chartered Accountant, you will be involved in translating financial statements from the
functional currency to the presentation currency.
•• Explain and account for the translation of financial statements of an entity from its
functional currency to its presentation currency.
At the end of this activity you will be able to translate financial statements from the functional
currency to the presentation currency.
Scenario
Shafiq Limited (Shafiq) is an Australian company. It uses the Australian dollar as its functional
and presentation currency.
Shafiq has established a branch in central Auckland, New Zeland, which opened on 1 July
20X3. Its initial investment of NZ$1,000,000, was contributed on 1 March 20X3. The branch is
operationally independent from Shafiq.
You are the financial accountant in Shafiq’s New Zealand branch, and Jane Jones is the
operations manager.
Jane emails you with additional information:
To: You
From: Jane Jones
Subject: Translating functional currency to presentation currency
Attachment: New Zealand branch financial statement working papers
Please find attached the New Zealand branch financial statement working
papers in Excel.
As we discussed on the phone, it has already been determined that the
functional currency of the New Zealand branch is NZ dollars.
The following points might also be relevant:
• The branch remitted NZ$400,000 to Shafiq on 1 June 20X4. No other
amounts were paid to Shafiq during the year.

ACT
• The branch acquired a property asset on 1 June 20X4 for NZ$1,500,000.
Depreciation expense of $25,000 was recognised for the month of June
20X4.
• All other revenues/expenses have been earned/incurred evenly
throughout the year.
Please email me the two completed statements as soon as possible.
Note: The email attachment (an Excel spreadsheet [Activity 5.2.xlsx]) contains additional
information required to complete the task. Please access myLearning to view the spreadsheet.
Task
For this activity you are required to prepare the following financial statements in the
presentation currency of Shafiq as at 30 June 20X4:
•• Statement of profit or loss.
•• Statement of financial position.

ACT

The outcome of this translation is that the financial statements are now presented in Australian
dollars rather than New Zealand dollars. In addition, due to exchange rate movements and the
specific translation rules contained in IAS 21, there is now an additional item reflected in the
statement of financial position (i.e. a ‘foreign currency translation reserve’).
This email to Jane Jones, the New Zealand branch operations manager, shows the translated
To: Jane Jones

Dear Jane,
The following are the New Zealand branch financial statements translated
into Shafiq’s presentation currency as requested.
Shafiq’s New Zealand branch’s statement of profit or loss for the

year ended 30 June 20X4
A$
Revenue 1,577,287
Expenses (excluding depreciation and finance costs) (394,322)
Depreciation (19,826)
Finance costs (19,716)
Profit before income tax expense 1,143,423
Profit for the period 946,262

ACT
Shafiq’s New Zealand branch’s statement of financial position as at

30 June 20X4
A$
Current assets
Cash 121,971
Trade receivables 243,942
Inventories 630,184
Total current assets 996,097
Non-current assets
Property, plant and equipment 1,199,382
Total non-current assets 1,199,382
Total assets 2,195,479
Current liabilities
Trade and other payables 121,971
Provisions 162,628
Total current liabilities 487,884
Provisions 121,971
Other payables 121,971
Total non-current liabilities 243,942
Total liabilities 731,826
Net assets 1,463,653
Net investment
Investment from head office (Shafiq) 796,495
Retained earnings 621,323
Foreign currency translation reserve 45,835
Total investment 1,463,653

ACT
Step 1 – Review the Standards

First, review IAS 21 to establish the guidance for translating financial statements of a foreign
branch into the presentation currency of its reporting entity. Paragraphs 39 and 40 provide
the relevant information for translating the statement of profit or loss and the statement of
financial position from the functional currency. In addition, the principles contained elsewhere
in IAS 21 can be applied to translate equity balances. Relevant guidance for translation into the
presentation currency is as follows:
Translation to presentation currency – statement of profit or loss and statement of financial position
Item Exchange rate
Assets and liabilities Closing rate (spot exchange rate at reporting date)
Income and expenses Exchange rate at date of transaction

If items occur regularly throughout the period, an average rate is used unless the
exchange rate fluctuates significantly
Equity/net investment Spot exchange rate in force at the date of the investment
Spot exchange rate on the date of payment of the distribution
Step 2 – Determine the exchange rate to use

The next step is to establish which rate is relevant for translating each balance. The guidance
from the Standards and the information provided by Jane is relevant.
Translation to presentation currency – NZ branch
Item Relevant rate/date Exchange rate
Income and expenses Average rate for the year to 30 June 20X4 A$1 = NZ$1.2680
(excluding depreciation
expense)
Depreciation expense Average rate for the month of June 20X4 A$1 = NZ$1.2610
Remittance to Shafiq Rate at date of transaction (1 June 20X4) A$1 = NZ$1.2310
Assets and liabilities Closing rate (30 June 20X4) A$1 = NZ$1.2298
Initial investment/equity Rate at date of transaction (1 March 20X3) A$1 = NZ$1.2555

ACT
Step 3 – Translate the statement of profit or loss

Access the Excel spreadsheet [Activity 5.2.xlsx] sent by Jane and input the relevant exchange
rates from Step 2 for the statement of profit or loss. Check that the exchange rates are applied in
the correct way. You are converting New Zealand dollars into Australian dollars and therefore
need to divide the NZ$ amount by the NZ$ exchange rate.
Shafiq New Zealand branch’s statement of profit and loss for the year ended 30 June 20X4
Description NZ$ FX rate A$
Revenue 2,000,000 1.2680 1,577,287
Expenses (excluding depreciation and finance costs) (500,000) 1.2680 (394,322)
Depreciation expense (25,000) 1.2610 (19,826)
Finance costs (25,000) 1.2680 (19,716)
Profit before income tax expense 1,450,000 1,143,423
Income tax expense (250,000) 1.2680 (197,161)
Profit for the period 1,200,000 946,262
Step 4 – Translate the statement of financial position

Repeat Step 3 for the statement of financial position. The statement of financial position will
not balance. To make it balance, insert the ‘foreign currency translation reserve’ (FCTR) as a
balancing figure.
Shafiq New Zealand branch’s statement of financial position as at 30 June 20X4
Current assets
Cash 150,000 1.2298 121,971
Trade receivables 300,000 1.2298 243,942
Inventories 775,000 1.2298 630,184
Total current assets 1,225,000 996,097
Non-current assets
Property, plant and equipment 1,475,000 1.2298 1,199,382
Total non-current assets 1,475,000 1,199,382
Total assets 2,700,000 2,195,479
Current liabilities
Trade and other payables 150,000 1.2298 121,971
Current tax liability 250,000 1.2298 203,285
Provisions 200,000 1.2298 162,628
Total current liabilities 600,000 487,884
Provisions 150,000 1.2298 121,971
Other payables 150,000 1.2298 121,971
Total non-current liabilities 300,000 243,942
Total liabilities 900,000 731,826
Net assets 1,800,000 1,463,653

ACT
Shafiq New Zealand branch’s statement of financial position as at 30 June 20X4
Net investment
Investment from head office (Shafiq) 1,000,000 1.2555 796,495
Retained earnings1
Profit 1,200,000 From 946,262

statement of
profit or loss
Distribution to Shafiq (400,000) 1.2310 (324,939)
800,000 621,323
Foreign currency translation reserve2 0 Balance 45,835
Total investment 1,800,000 1,463,653
Notes
1. The retained earnings figure can be obtained from the statement of profit or loss. In future years this figure will
be obtained by adding together the retained earnings brought forward and the current year movement from the
statement of profit or loss and other comprehensive income (where relevant), adjusting for any distributions to Shafiq.
2. To ensure the balancing item recorded in the FCTR is correct, a verification of the balance can be performed and
is considered best practice (although not specifically required by this task). As net assets were all translated at the
closing rate, exchange differences will arise on the initial investment and retained earnings, as these have been
translated at historical, average or other rates. This verification may be performed as follows:
Verification of FCTR
Item FX rates Calculation

Closing rate –
NZ$ rate used A$ A$
Opening net investment 1,000,000 1.2298 – 1.2555 813,140 – 796,495 16,645

(initial investment)
Post-acquisition movements in net investment
Profit for the period 1,225,000 1.2298 – 1.2680 996,097 – 966,088 30,009
(excluding depreciation)
Depreciation (25,000 ) 1.2298 – 1.2610 (20,328) – (19,826) (502)
Amount remitted (400,000) 1.2298 – 1.2310 (325,256) – (324,939) (317)
Closing net investment 1,800,000
FCTR 45,835

ACT
Activity 5.3
Integrated activity 1
Integration of different topics into one scenario is an important skill for CA program
exams and professional practice. At this point in the activities, you are ready to attempt
Integrated Activity 1.
Please download this activity from MyLearning > Integrated Activities.

ACT
Unit 6: Fair value measurement
Activity 6.1
Measuring fair value of non-financial assets
Introduction
Fair value measurement is required by various Accounting Standards, either at each reporting
date or at particular points in time – all known as the measurement date.
•• Explain and identify the key principles of fair value measurement, along with the related
disclosure requirements.
At the end of this activity you will be able to determine the basis for measuring the fair value
of a non-financial asset, in accordance with IFRS 13 Fair Value Measurement (IFRS 13).
Scenario
You are a financial accountant at Multinational Enterprises Limited (MEL), a New Zealand
company that has businesses operating in a range of industries. MEL has a functional currency
of New Zealand dollars (NZ$) and an annual reporting date of 31 December.
MEL presents its financial statements in accordance with International Financial Reporting
Standards (IFRS).
MEL’s financial controller, Darius, provides you with the following information concerning two
assets required to be measured at fair value at the reporting date:
Assets to be measured at fair value
Item Details
Vacant land MEL is holding the land to allow for expansion of its manufacturing capability
(Task A) in future years. At this stage, construction of a factory is not likely to commence for at
least three years
The land is currently zoned for industrial use
Average prices per square metre of land can be obtained for recent sales of nearby
industrial-zoned vacant land
Due to significant population growth, the land could be rezoned for high density
residential use and would sell for a significantly higher price than as vacant industrial
land. MEL anticipates that the cost of performing this rezoning would be $50,000
based on a discussion with a representative from the local planning department
Average prices per square metre of land can be obtained for recent sales of nearby
residential-zoned land
MEL does not intend to sell the land in the coming two years, given the land’s
proximity to rail and shipping distribution points in the event of a factory being
constructed

ACT
Assets to be measured at fair value
Item Details
A specialised asset1 Identical assets are sold in two different active markets at different prices. MEL
(Task B) transacts in the New Zealand market but could access the Australian market
Details of the trading that occurs in each market and MEL’s estimated transport and
transaction costs are as follows:
New Zealand market Australian market
Annual sales volume 300 1,000
Average number of 15 45
transactions per month
Sales price per unit NZ$385,000 NZ$380,000
MEL’s quoted transport NZ$3,000 NZ$5,000

costs
MEL’s estimated NZ$500 NZ$1,000

transaction costs
Note
1. Adapted from: KPMG June 2011, First Impressions: Fair value measurement, p. 8, accessed 4 May 2016,
www.kpmg.com, search for ‘fair value measurement’.
Task
Task A
Determine the basis for measuring the fair value of the land by applying Steps 1–7 in the
process for measuring fair value. Note that there is insufficient information available to
complete Step 8.
Task B
Calculate the fair value of the specialised asset by applying Step 8 in the process for measuring
fair value. Justify your calculation with three (3) references to IFRS 13.

ACT
Task A
Step Application to the fair value measurement of the vacant land
Step 1. Determine the asset The vacant land is the asset and a market participant would factor in the zoning
or liability to be measured restrictions in measuring its fair value
Step 2. Measure fair value Look at the price from a market participant’s perspective rather than from MEL’s
using an exit price perspective
Step 3. In the principal (or No mention of other markets, therefore the local market is the principal market
most advantageous) market as this is where MEL would normally enter into a transaction to sell the asset
Step 4. Between market A fair value measurement should be based on the assumptions of market
participants participants. In particular, they are assumed to be knowledgeable about and
have a reasonable understanding of the parcel of land including:
•• How it could be used including zoning restrictions
•• Selling prices for industrial use versus high density residential use
Step 5. Based on the The land’s current use of being held as vacant land for future factory
highest and best use for construction and manufacturing operations cannot be presumed to be its
non‑financial assets highest and best
The land’s highest and best use will be as residential-zoned land as it would
attract a considerably higher selling price than MEL’s current use of the land
as vacant industrial land
The fair value is taken from the viewpoint of a market participant where the use
of the asset is:
•• physically possible – the land is physically suitable for residential housing
•• legally permissible – it is possible to rezone as indicated by the local planning
department
•• financially feasible – the selling price for residential use would be significantly
higher than as vacant industrial land
The fair value of the land is therefore measured on the basis of redevelopment
even though MEL is intending to hold the asset for the next two years
The $50,000 in rezoning costs are included in the fair value calculation. They
are not excluded from the calculation on the basis of being ‘transaction costs’
(as defined in IFRS 13 Appendix A). A decision to rezone could be made regardless
of whether the land were later to be sold, therefore the costs do not ‘result directly
from’ a transaction to dispose of the asset. [This treatment of the rezoning costs is
supported by the illustrative examples to IFRS 13, Example 2 ‘Land’]
Step 6. Using an appropriate A market approach (for each of the alternate uses) is appropriate because real
valuation technique estate selling prices are available from the market for recent sales for both
industrial and residential use
Step 7. Based on inputs from Level 2: Sales price per square metre from comparable vacant land sales in
the fair value hierarchy similar locations that are zoned for residential use
Level 3: A factor (e.g. a probability factor) to reflect the risk that rezoning may
not be approved
Level 3: Estimates of costs to be incurred to rezone the land
Step 8. To arrive at a fair Not required by the activity
value measurement

ACT
Task B
Step 8. To arrive at a fair value measurement
NZ$375,000 fair value (NZ$380,000 selling price – NZ$5,000 transport costs).
Justification (only three paragraph references are required)
The NZ$380,000 selling price is used as it is the price in the principal market for the asset
(IFRS 13 para. 16).
The principal market is defined as the market with the greatest volume and level of activity for
the asset or liability (IFRS 13 Appendix A). For the specialised asset, Australia is the principal
market for this asset because its annual sales volume and average monthly transactions exceed
those in the New Zealand market. As MEL can access the Australian market, it must use the
Australian market prices (IFRS 13 para. 18) even though it transacts in the New Zealand market.
The fair value is an exit price (IFRS 13 para. 24), which therefore factors in transport costs
(IFRS 13 para. 26).
When performing the fair value measurement, the NZ$1,000 in transaction costs are excluded
as they are characteristics of the transaction rather than of the asset (IFRS 13 para. 25).
Task A
The steps outline the recommended approach for successfully completing this task.
Step 1 – Review the Standard and identify the relevant paragraphs
The relevant paragraphs of IFRS 13 for the task are:
Step Issue Relevant IFRS 13

paragraphs
Step 1 – Determine the asset or Identify the asset and its unit of account 11
liability to be measured Restrictions on the asset’s use
Step 2 – Measure fair value using Pricing from a market participant’s perspective 15
an exit price
Step 3 – In the principal (or most Identify the principal market (the most 16–17
advantageous) market advantageous market is only considered if there
is no principal market)
Step 4 – Between market Based on assumptions of market participants 22

participants
Step 5 – Based on the highest and Determine the highest and best use 27
best use for non-financial assets Transaction costs incurred Appendix A, definition
of ‘transaction costs’
Step 6 – Using an appropriate Market approach, income approach and cost 61–63
valuation technique approach
Step 7 – Based on inputs from the The fair value hierarchy categorises the inputs 72
fair value hierarchy used in a valuation technique into three levels

ACT
Step 2 – Determine the basis of measuring the fair value of the vacant land
Based on the steps within the table above and considering the requirements of the Standard
in the paragraphs identified, the fair value measurement process for the vacant land can be
applied as summarised in the table shown in the solution.
Task B
The steps outline the recommended approach for successfully completing this task.
Step 1 – Review the Standard and identify the relevant paragraphs
The relevant paragraphs of IFRS 13 for the task are:
Issue Relevant paragraphs
Identify the principal (or most advantageous) market for the 16

asset
Analyse the definition of ‘principal market’ Appendix A, definition of ‘principal

market’
Use of the price in the principal market 18
The fair value is an exit price 24
Treatment of transaction costs 25
Treatment of transport costs 26
Step 2 – Perform the calculation

The fair value calculation for the specialised asset is shown in the solution.
Step 3 – Justify the fair value calculation with reference to IFRS 13
The fair value calculation for the specialised asset is justified with reference to the paragraphs
mentioned in the table above as shown in the solution. Only three references are required to
justify the calculation for this task.

ACT
Unit 7: Property, plant and equipment
Activity 7.1
Accounting for property, plant and
equipment
Introduction
As a Chartered Accountant you may be required to account for fixed assets that are utilised
over a number of years under changing circumstances.
•• Describe the nature of property, plant and equipment.
•• Explain and account for property, plant and equipment during its useful life.
•• Explain and account for borrowing costs in relation to a qualifying asset.
At the end of this activity you will be able to account for a fixed asset using the criteria set out in
IAS 16 and IAS 23.
This activity exceeds 45 minutes, which is the designated set time for an exam question
(exams have four questions to be completed over three hours). It has been developed to
bring together a number of important examinable concepts and will assist you with your
understanding of the topic areas covered, each of which could be examined individually
or together in a smaller question. Alternatively, only part of the required may be used in
an exam.
The estimated time for completion of the activity includes time to review the stepped-
through recommended approach provided. This level of detail is provided to aid your
understanding of the concepts covered, and similar preparation would not be required in
answering individual exam questions. The activity is designed to assist you in achieving the
specified learning outcome(s), and the exam is designed to test whether or not you have
achieved the learning outcomes.

ACT
Scenario
You are a Chartered Accountant working for Avenga Limited (Avenga). Avenga manufactures
corrugated metal for roofing and fences. Its current manufacturing plant is nearing the end
of its useful life and needs to be replaced. After much consideration Avenga signed a contract
on 1 November 20X2 to purchase a new machine that will fold metal sheeting into the
desired profiles.
The value of the contract is $12,000,000, payable in instalments:
•• 10% on signing of the contract.
•• 40% in six months.
•• 40% on delivery (31 January 20X4).
•• 10% two months after delivery.
The liability for an instalment arises when the particular instalment is payable under the
contract.
As the machine is crucial to the ongoing success of Avenga, management decided to fund the
purchase of the new machine through a bank loan. The contract for the bank loan was also
signed on 1 November 20X2.
The terms of the bank loan are:
•• Amount borrowed $12,000,000.
•• Term five years.
•• Fixed interest rate at 7.5% per annum and paid annually.
As the funds from the bank loan are not all required immediately, Avenga established an
investment account with the same bank for the surplus funds. This investment account pays
interest at 5% per annum.
•• Avenga has a 30 June year end.
•• Avenga uses the revaluation method to account for all of its property, plant and equipment,
and depreciates using the straight-line method.
•• The useful life of the machine is 10 years and it is expected to have a residual value of
$500,000.
•• Formal revaluations are undertaken every three years, with the next one due for the year
ended 30 June 20X5. In addition, a review is undertaken each year to ensure carrying value
is not materially different to fair value.
•• When assets are revalued, the accumulated depreciation is offset against the value of
the asset.
•• The procurement manager’s time to successfully negotiate both contracts was costed at
$30,000.
•• An additional $125,000 was expended to ready the site for installation of the new machine.
•• Five employees had to undergo training so that they could operate the machine safely and
correctly. The training course cost $55,000 in total.
•• The machine was delivered in accordance with the contract, and was operational on
1 February 20X4.
•• There was a delivery charge of $250,000.

ACT
Tasks
There are three tasks: A, B and C.
It is recommended that you complete Task A and check your answer against the solution before
moving on to Tasks B and C.
Task A
You are required to determine the carrying value of the machine as at 30 June 20X4.
Task B
It is now 30 June 20X5, and the machine has been operating successfully since it was first
operational on 1 February 20X4. Annual reviews have determined there has been no change
to the residual value or the useful life of the machine, and it has been revalued as part of the
revaluation of all property, plant and equipment that occurs as part of Avenga’s policy of
regular revaluations.
At 30 June 20X5 the valuer determined the fair value of the machine at $11,500,000; its remaining
useful life at eight years and seven months, and that there was no change to the residual value.
Tax treatment often depends on the specific factors in particular transactions. For the purposes
of this transaction assume:
•• The tax base of the machine at 1 February 20X4 is the same as the accounting cost.
•• The asset has a zero residual for tax purposes.
•• For tax purposes the machine is being depreciated over 10 years using the straight-line
method.
•• The tax rate is 30%.
You are required to prepare the journal entries in relation to the machine for the year ended
30 June 20X5.
Task C
You are required to determine the depreciation expense for the machine for the year ended
30 June 20X6.

ACT
Activity 7.1 Solution – Task A

The carrying value of the machine as at 30 June 20X4 is $12,483,958.
Recommended approach – Task A

The steps outline a recommended approach for successfully completing Task A.

Two Standards are applicable to Task A: IAS 16 and IAS 23.
Access IAS 16 and review the relevant paragraphs for the task:
Relevant IAS 16 paragraphs
Paragraphs Relevance to task
6 Provides definitions for:

•• Property, plant and equipment, which enables you to determine when the new machine
becomes plant and equipment for Avenga
•• The carrying amount, which tells you that as well as determining the cost to correctly
respond to the task, you will also need to calculate the accumulated depreciation
•• The depreciable amount, which tells you that you need to take into consideration the
residual value when calculating the depreciation expense
•• Depreciation, which tells you that you need to allocate the depreciable amount of the asset
over the asset’s useful life
15–23 Provides an understanding of which costs can be capitalised as part of the value of the
machine, and which need to be expensed. Paragraph 23 provides that the cost of the asset is
the cash price equivalent at acquisition date. It also reminds you to refer to IAS 23 regarding the
capitalisation of interest
50 Requires the systematic allocation of the depreciable amount over the asset’s useful life. The
general additional information states that the machine has a residual value of $500,000, which
must be taken into account when calculating the depreciable amount, and Avenga uses the
straight-line method over the useful life of 10 years
55 Determines the commencement of depreciation for an asset. Based on the additional

information for this machine, depreciation will commence on 1 February 20X4, as this is when
the machine was available for use

ACT
Now access IAS 23 and review the relevant paragraphs for the task:
5 Provides definitions for:

•• Borrowing costs: the interest on the bank loan meets the definition
•• Qualifying assets: as the time from the signing of the contract to the delivery of the machine
is a substantial period of time, the machine would meet the definition of a qualifying asset
8 and 10 Provides that any borrowing costs directly attributable to the acquisition of a qualifying asset
shall be capitalised and explains what is meant by directly attributable. The interest on the
Avenga bank loan would qualify as being directly attributable, as the loan was specifically taken
out to fund the purchase of the machine
12 Explains that the borrowing costs that can be capitalised are the actual borrowing costs
incurred less any investment income on the temporary investment of those borrowings. While
the borrowing costs from the bank loan are capitalised, the interest income on the investment
account will reduce the value of the borrowing costs capitalised
17 Specifies when the capitalisation of borrowing costs commences. For the machine it is 1
November 20X2, as this is when the conditions of para. 17 are all met
22 Specifies when capitalisation of borrowing costs will cease. For the machine it is 1 February
20X4, as this will be when the machine is substantially ready for its intended use
Step 2 – Determine the cost of the machine

Applying the relevant guidance from IAS 16 paras 15–23 and IAS 23 paras 17 and 22, calculate
the cost of the machine.
Cost of the machine
Description Amount
$
Value of the contract 12,000,000
Additional site costs 125,000
Delivery costs 250,000
Capitalised interest on bank loan1 1,125,000
Interest income on investment account2 (495,000)
Cost of the machine 13,005,000
Notes
1. The first payment on the contract was made on 1 November 20X2 and capital WIP was recognised at this date.
The asset was not completed until 1 February 20X4. It therefore took a substantial period of time to be ready for its
intended use and is a qualifying asset under IAS 23. On this basis, interest on the loan is capitalised into the cost of
the machine.
$12,000,000 × 0.075 × (15 ÷ 12) = $1,125,000
1 November 20X2 – 31 January 20X4 = 15 months
2. $270,000 + $225,000 = $495,000
($12,000,000 – $1,200,000) × 0.05 × (6 ÷ 12) = $270,000
1 November 20X2 – 1 May 20X3 = 6 months
(($12,000,000 – $1,200,000) – $4,800,000) × 0.05 × (9 ÷ 12) = $225,000
1 May 20X3 – 31 January 20X4 = 9 months
The cost of staff training has not been included in the cost of the machine, as it is an example of
the cost of conducting business and is excluded under IAS 16 para. 19(c).

ACT
The cost of the procurement manager’s time has not been included in the cost of the machine as
it is an example of an administration and other general overheads cost, and is excluded under
IAS 16 para. 19(d).
Step 3 – Calculate the depreciation expense for the year ended 30 June 20X4
Applying the relevant guidance from IAS 16 paras 6, 50 and 55, calculate the depreciation of the
new machine.
Depreciation expense for the year ended 30 June 20X4
Description Amount
$
Cost of the machine (Step 2) 13,005,000
Less residual value (500,000)
Depreciable amount 12,505,000
Useful life 10 years
Depreciation expense per year 1,250,500
Depreciation expense for the year ended 30 June 20X4 (asset was ready for use from 521,042
1 February 20X4, i.e. five months)
As this is the first year, the depreciation expense is the same as the accumulated depreciation.
Step 4 – Calculate the carrying amount of the machine

Applying the definition of carrying amount from IAS 16 para. 5, calculate the carrying amount
of the machine as at 30 June 20X4.
Carrying amount of the machine as at 30 June 20X4
Description Amount
$
Cost of the machine (Step 2) 13,005,000
Less: accumulated depreciation (Step 3) (521,042)
Carrying amount of machine 12,483,958

ACT
Activity 7.1 Solution – Task B
Journal entries for Avenga for the year ended 30 June 20X5
There are four journal entries in relation to the machine for the year ended 30 June 20X5.
Journal entry for depreciation of the machine

$ $
30.06.X5 Depreciation expense 1,250,500
30.06.X5 Accumulated depreciation 1,250,500
Depreciation of the machine for the year ended 30 June 20X5 (as calculated in Task A, Step 3)
Journal entry for reversal of accumulated depreciation on revaluation

$ $
30.06.X5 Accumulated depreciation 1,771,542
30.06.X5 Machine 1,771,542
Reversal of accumulated depreciation on revaluation, in accordance with Avenga’s policy (IAS 16 para. 35(b))
Journal entry for revaluation of machine

$ $
30.06.X5 Machine 266,542
30.06.X5 Revaluation surplus (equity account) 186,580
30.06.X5 Deferred tax liability (DTL) 79,962
Revaluation of machine to fair value of $11,500,000 from a carrying amount of $11,233,458, including tax
impact
Journal entry for the tax impact of differing depreciation rates for accounting and tax
$ $
30.06.X5 DTL 15,000
Tax impact of the difference in the depreciation rates between accounting and tax

ACT
Recommended approach – Task B


There are two Standards that are applicable to Task B: IAS 16 and IAS 12.
Access IAS 16 and review the following paragraphs that are relevant to this task:
29 and 35 Gives the preparer of the financial statements a choice between the cost model and the
revaluation model. Paragraph 35 deals with how to treat the accumulated depreciation on
revaluation. As per the general additional information, Avenga has a policy of reversing all
the accumulated depreciation against the value of the asset. That is, they use the method
described in para. 35(b)
39 and 40 Specifies how the revaluation increments and decrements need to be treated. In this
instance, the revaluation is an increase and there have been no previous decreases in value;
therefore, para. 39 will apply
42 Reminds you to go to IAS 12 to determine if there are any effects of tax that may arise as a
result of the revaluation
IAS 12 applies as the accounting carrying amount of the machine and the tax base will be
different due to two factors:
1. There will be a difference in the amount of depreciation that is charged in the statement
of profit or loss and other comprehensive income, and the amount that is claimed as a
deduction in Avenga’s tax return, as the machine has a residual value for accounting
purposes.
2. The revaluation increases the carrying value for accounting purposes, but has no impact on
the tax base (IAS 12 para. 20).
These concepts are covered in the unit on income taxes.
Step 2 – Prepare the journal entry for the depreciation expense for the year
ended 30 June 20X5
The annual depreciation expense was calculated as $1,250,500 in Task A, Step 3. As nothing has
changed during the year regarding the use or value of the machine, the depreciation expense
calculated in 20X4 is correct for the year ended 30 June 20X5.
The journal entry is shown in the solution.
Step 3 – Prepare the journal entry to reverse the accumulated depreciation as at

30 June 20X5
Avenga has elected to treat the accumulated depreciation in accordance with IAS 16 para. 35(b)
and eliminate the accumulated depreciation at the date of revaluation against the gross carrying
amount of the asset. The accumulated depreciation at 30 June 20X5 is $1,771,542 ($521,042 +
$1,250,500).
Step 4 – Prepare the journal entry to account for the revaluation as at 30 June
20X5
The carrying value of the asset has increased from $11,233,500 ($13,005,000 − $521,042 −
$1,250,500) to $11,500,000 based on the valuation. The revaluation changes the accounting
carrying value but not the tax base; therefore, there is a tax consequence to the revaluation.
As the revaluation is taken directly into equity, the deferred tax liability is credited directly into
equity in accordance with IAS 12 para. 61A.

ACT
Step 5 – Calculate the deferred tax consequences for the year ended 30 June
20X5 and prepare the journal entry
Calculate the carrying amount and the tax base at 30 June 20X5.
Calculation of impairment loss
Date Description Carrying Tax base

amount $
$
01.02.X4 Cost1 13,005,000 13,005,000
30.06.X4 Depreciation 521,042 1 541,875 2
30.06.X4 Closing value 12,483,958 3 12,463,125
30.06.X5 Depreciation 1,250,500 1 1,300,500
30.06.X5 Closing value 11,233,458 4

11,162,625
Notes
1. From Task A, Step 3.
2. Tax depreciation is 10 years straight-line ($13,005,000 ÷ 10 × 5 ÷ 12).
3. Answer to Task A.
4. There is no need to take into account the revaluation at this time as the deferred tax impact of the revaluation is
accounted for separately, going directly into equity (refer to Task B, Step 4).
As the carrying amount is greater than the tax base, a taxable temporary difference (TTD) has
arisen. When the TTD is multiplied by the tax rate a DTL is created.
Deferred tax consequences
Date Description Carrying Tax base TTD DTL

amount $ $ $
$ (b) (a) – (b) = (c) × 30%
(a)
01.02.X4 Cost 13,005,000 13,005,000
30.06.X4 Depreciation 521,042 541,875
30.06.X4 Closing value 12,483,958 12,463,125 20,833 6,250
30.06.X5 Depreciation 1,250,500 1,300,500
30.06.X5 Closing value 11,233,458 11,162,625 70,833 21,250
As 30 June 20X5 is the second year of operation of the machine, the DTL as at 30 June 20X4
has already been recorded. The tax effect entry for 30 June 20X5 needs to only account for the
movement of $15,000 ($21,250 – $6,250) in the DTL account.
To double-check your tax entries compare the revalued amount to the tax base as at
30 June 20X5.
Deferred tax consequences
Date Revalued carrying Tax base TTD DTL

amount $ $ $
$ (b) (a) – (b) = (c) × 30%
(a)
30.06.X5 11,500,000 11,162,625 337,375 101,212

ACT
The DTL comprises:
Composition of DTL
Item Amount Source

$
DTL on revaluation 79,962 Step 4, Task B
DTL on depreciation 21,250 Earlier in Step 5, Task B
Total DTL 101,212
Activity 7.1 Solution – Task C

The depreciation expense for the machine for the year ended 30 June 20X6 is $1,281,553.
Recommended approach – Task C

Calculate the depreciation expense for the year ended 30 June 20X6
Use the same logic from Task A, Step 3 and update the depreciation calculation for the new
information received as a result of the revaluation.
Depreciation expense calculation for the year ended 30 June 20X6
Description Amount
$
Value of the machine 11,500,000
Less: residual value (500,000)
Depreciable amount 11,000,000
Useful life 8 years 7 months
Depreciation expense for the year ended 30 June 20X6 1,281,553

(($11,000,000 ÷ 103 months) × 12 months))

ACT
Unit 8: Intangible assets
Activity 8.1
Accounting for intangible assets
Introduction
As a Chartered Accountant, you may be called upon to identify and explain the key
characteristics of, and account for, intangible assets in financial statements in accordance with
IAS 38 Intangible Assets (IAS 38).
•• Identify and explain the key characteristics of an intangible asset, including whether it can
be recognised for financial reporting purposes.
•• Explain and account for an intangible asset.
At the end of this activity you will be able to identify and explain the key characteristics of, and
account for, intangible assets in financial statements.
Scenario
You are a Chartered Accountant working for Alpha Limited (Alpha). Alpha’s principal business
activities include the distribution of imported electrical components to the local building
industry.
The chief financial officer has advised you of expenditure on intangible assets for the year
ended 30 June 20X3.
Expenditure on intangible assets during the year ended

30 June 20X3
Account description $
Distribution licence costs 6,000,000
Computer software costs 3,000,000
Additional information about each of these intangible assets follows:
Distribution licence costs

A distribution licence agreement was entered into and commenced from 1 July 20X2. It entitles
Alpha to the non-transferable, sole distribution rights in Australia for specific product lines of
Beta Limited (Beta). It is for a non-renewable period of three years.

ACT
On 1 December 20X3 Beta went into liquidation and their product lines were withdrawn from
the Australian market. Alpha is not entitled to, nor is it expecting to receive, any compensation
for this event.
Computer software costs

Computer software costs were incurred on 1 July 20X2 when Alpha acquired new application
software specifically designed for its operations from an external supplier. The IT steering
committee advised that the expected useful life of the software is five years.
In June 20X4 Alpha commenced discussions with MBI, an external computer software
developer, to design and install new application software with an anticipated installation date
of 1 July 20X6. The proposed software would replace the existing software. On 1 July 20X4 the
remaining useful life of the existing computer software was reviewed and revised to two years.
Task
For this activity, which is in two parts, you are required to:
A. Explain whether Alpha’s classification of the distribution licence and computer software
as intangible assets is appropriate at 1 July 20X2.
B. Assuming the distribution licence and computer software assets are correctly classified
as intangible assets, and are accounted for using the cost model after initial recognition,
prepare relevant journal entries for the different stages of the intangible asset life cycle
(i.e. for the years ended 30 June 20X3–20X6). Ignore tax entries and ensure your journal
entries cover acquisition, amortisation and derecognition.

ACT

A. Alpha’s classification of the distribution licence and computer software as intangible assets
is appropriate at 1 July 20X2. They both meet the three conditions in the definition of an
intangible asset from IAS 38 para. 10 and they each meet the two recognition criteria from
IAS 38 para. 21.
B.
Acquisition of intangible assets

$ $
01.07.X2 Distribution licence 6,000,000
01.07.X2 Computer software 3,000,000
01.07.X2 Cash/payables 9,000,000
To record the acquisition of the distribution licence and computer software
Amortisation of distribution licence – 30 June 20X3

$ $
30.06.X3 Amortisation expense – distribution licence 2,000,000
30.06.X3 Accumulated amortisation – distribution licence 2,000,000
To record amortisation expense for the distribution licence intangible asset for the year ended 30 June
20X3 [$6,000,000 ÷ 3 years]
Amortisation of computer software – 30 June 20X3

$ $
30.06.X3 Amortisation expense – computer software 600,000
30.06.X3 Accumulated amortisation – computer software 600,000
To record amortisation expense for the computer software intangible asset for the year ended 30 June
20X3 [$3,000,000 ÷ 5 years]
Amortisation of distribution licence – 30 November 20X3

$ $
30.11.X3 Amortisation expense – distribution licence 833,333
30.11.X3 Accumulated amortisation – distribution licence 833,333
To record amortisation expense for the distribution licence intangible asset for a period of five months
ended 30 November 20X3 [($6,000,000 ÷ 3 years) × (5 months ÷ 12 months)]

ACT
Derecognition of distribution licence – 1 December 20X3

$ $
01.12.X3 Loss on retirement of distribution licence 3,166,667
01.12.X3 Accumulated amortisation – distribution licence 2,833,333
01.12.X3 Distribution licence 6,000,000
To record loss on derecognition (retirement) of the distribution licence as no future economic benefits
are expected from its use [$6,000,000 original cost less accumulated amortisation – distribution licence
$2,833,333]

$ $
To record amortisation expense for computer software costs for the year ended 30 June 20X4 [$3,000,000 ÷
5 years]

$ $
To record amortisation expense for the computer software for the year ended 30 June 20X5 [($3,000,000
original cost – $1,200,000 accumulated amortisation = $1,800,000 net carrying amount) ÷ 2 years revised
remaining useful life]

$ $
To record amortisation expense for the computer software for the year ended 30 June 20X6 ($1,800,000 ÷
2 years)

ACT
The steps outline a recommended approach for successfully completing the task.
Part A
Review IAS 38 para. 10, which specifies that an intangible asset must satisfy the conditions of
identifiability, control and future economic benefits. These are further explained in paras 11–17.
In addition, review IAS 38 para. 21, which specifies the two recognition criteria for an intangible
asset.
Step 2 – Apply the Standard

Applying the requirements of IAS 38 to recognise an intangible asset, Alpha must satisfy the
three conditions in the definition of an intangible asset (IAS 38 para. 10), and also meet the
two recognition criteria (IAS 38 para. 21).
A table helps to identify whether the distribution licence costs and computer software costs
meet the definition (three conditions) and recognition criteria (two conditions) of an intangible
asset.
Distribution licence costs – 1 July 20X2
Criterion Met? Yes/No Explanation
Definition of intangible asset (IAS 38 paras 10–17)
Identifiable Yes The distribution licence is identifiable as it arises from

contractual or other legal rights from the legal agreement
with Beta
Control Yes Alpha has control as it can deny other parties access to
specific product lines of Beta due to its sole distribution
rights
Future economic benefits Yes Future economic benefits will occur to Alpha through sales
of specific product lines of Beta
Recognition of intangible asset (IAS 38 para. 21)
Probable future economic Yes The distribution licence is likely to provide future economic
benefits benefits to Alpha through sales of Beta’s product lines
Cost measured reliably Yes The cost of a separately acquired intangible asset can
usually be measured reliably. As the distribution licence
has been acquired by way of an agreement, the cost can
be measured reliably

ACT
Computer software costs – 1 July 20X2
Criterion Met? Yes/No Explanation
Definition of intangible asset (IAS 38 paras 10–17)
Identifiable Yes The computer software is identifiable as it can be

separated from Alpha and has arisen from a contractual
agreement with the external supplier
Control Yes The specific nature of the software will deny other parties
the opportunity to use it; therefore, Alpha has control over
the computer software
Future economic benefits Yes Future economic benefits will occur to Alpha by capturing
information about Alpha’s operations in current and
subsequent accounting periods
Recognition of intangible asset (IAS 38 para. 21)
Probable future economic Yes The computer software is likely to provide future economic
benefits benefits to Alpha by capturing information about Alpha’s
operations in current and subsequent accounting periods
Cost measured reliably Yes The cost of a separately acquired intangible asset can
usually be measured reliably. As the computer software
has been acquired by way of an agreement, the cost can
be measured reliably
Part B
Review IAS 38 paras 24–27, 72, 74, 88–90, 94, 97, 99, 100 and 104, which provide guidance
and requirements regarding the measurement of an intangible asset on initial recognition,
measurement after recognition, the cost model, useful life, amortisation period and amortisation
method, and a review of amortisation periods and methods for intangible assets with a finite
useful life.
Step 2 – Prepare the journal entry for the acquisition of intangible assets
Applying the requirements of IAS 38 para. 24, both of the intangible assets are measured initially
at cost. The cost of a separately acquired intangible asset comprises its purchase price and any
directly attributable cost of preparing the asset for its intended use (IAS 38 para. 27). Costs
recorded for both of the intangible assets in the management accounts are assumed to include
the purchase price and any directly attributable costs. The journal entry is shown in the solution.
Step 3 – Assess the useful life of intangible assets on acquisition

Applying the requirements and guidance in IAS 38 paras 88–90 and 94, the distribution licence
is assessed to have a useful life of three years because the intangible asset arises from a legal
agreement with Beta, which gives Alpha the sole distribution rights for a period of three years.
The computer software is initially assessed to have a useful life of five years because the
intangible asset, which is specifically designed for Alpha’s operations, arises from a contractual
agreement with an external supplier and is expected to be used for five years.
Step 4 – Prepare the journal entries for intangible assets for the year ended 30 June 20X3
IAS 38 para. 97 requires the depreciable amount of an intangible asset with a finite useful life
to be allocated on a systematic basis over its useful life, which should begin when the asset is
available for use.
As both of the intangible assets were purchased on 1 July 20X2 and are in the form of
distribution rights and computer software, it can be concluded that these assets were available
for use on that date.

ACT
The amortisation method should reflect the pattern in which the asset’s future economic benefits
are expected to be consumed by the entity. However, based on the available information, the
pattern cannot be determined reliably. Hence, the straight-line method of amortisation is used, as
required by IAS 38 para. 97. The journal entries are shown in the solution.
Step 5 – Prepare the journal entries for intangible assets for the year ended 30 June 20X4
As Beta went into liquidation on 1 December 20X3 and no future economic benefits are expected
from the intangible assets’ use or disposal, the distribution licence asset is derecognised at that
date, in accordance with IAS 38 para. 112.
A journal entry is required to record the amortisation expense for the distribution licence for the
period from 1 July 20X3 and ending on the date before derecognition (i.e. 30 November 20X3).
Alpha needs to derecognise the distribution licence asset, at 1 December 20X3 as required by
IAS 38 para. 112(b).
The loss arising from derecognition of the distribution licence asset is recognised in profit or
loss on the date of derecognition (IAS 38 para. 113). The journal entry is shown in the solution.
The computer software is amortised for the year ended 30 June 20X4 in accordance with IAS 38
para. 97. The journal entry is shown in the solution.
Step 6 – Prepare the journal entry for intangible assets for the year ended 30 June 20X5
On 1 July 20X4 the remaining useful life of the computer software was reviewed and revised
to two years. The amortisation period is therefore changed to two years, as required by IAS 38
para. 104.
The net carrying amount at the date the useful life was revised is amortised over the revised
remaining useful life of two years. Such a change is accounted for as a change in accounting
estimate in accordance with IAS 8 para. 36. The journal entry is shown in the solution.
Step 7 – Prepare the journal entry for intangible assets for the year ended 30 June 20X6
The computer software is amortised for the year ended 30 June 20X6 in accordance with IAS 38
para. 97. The journal entry is shown in the solution.

ACT
Unit 9: Financial instruments
Adaptive Learning Lesson: Financial Instrument Basics

Attempt the adaptive learning lesson online now. Access via MyLearning in the Unit 9 landing page.
Activity 9.1
Classification of financial instruments
Introduction
An entity may have a variety of different financial instruments that are not all necessarily
accounted for in the same manner. While some types of financial instruments are generally
classified in the same category by most entities, the classification of others will vary between
entities based on the nature of the entity’s operations and the purpose of entering into
the instrument.
•• Explain and identify financial instruments and the principles for classifying them as
financial assets, financial liabilities or equity instruments of the issuer.
At the end of this activity, you will be able to appropriately classify financial instruments in
accordance with IAS 32 Financial Instruments: Presentation (IAS 32), and further classify financial
assets and financial liabilities in accordance with IFRS 9 Financial Instruments (IFRS 9).
Scenario
You have recently joined Sorrenti Limited (Sorrenti) as its new financial accountant. Sorrenti is
an importer and wholesaler of authentic Italian produce and fine food. It supplies to most large
supermarkets and delicatessens in Melbourne, Victoria.
You are currently working on the financial statements for the year ended 30 June 20X7. Sorrenti
is planning on early adopting IFRS 9, although the previous financial accountant left rather
abruptly and the company’s financial instruments are yet to be incorporated into the financial
statements in accordance with IFRS 9.

ACT
You have found a document the previous financial accountant had prepared, which contains
details of various financial instruments that are yet to be accounted for in the year ended
30 June 20X7. These instruments are listed in the following table:
Financial instruments yet to be accounted for in the year ended 30 June 20X7
Financial instrument Details
Cash at bank Working bank account held with Primary Bank, Sorrenti’s primary banker, on
which no interest is payable. Primary Bank is an Australian bank rated AA– by
Standard & Poor’s, a credit rating agency
Trade receivables This represents amounts due from Sorrenti’s customers. Payment on trade
receivables is due within 30 days of invoice date. Sorrenti has no intention of
factoring its trade receivables
Trade payables This represents amounts due to suppliers of goods to Sorrenti. Invoices are
usually payable within 45 days of receipt of the goods
Foreign exchange (FX) Sorrenti hedges its euro-denominated purchases from Italy by entering into
forward contracts foreign exchange (FX) forward contracts
Secured bank loan Sorrenti has a 7-year bank loan secured over its warehouse in Melbourne. The
loan carries interest at a floating rate of bank bill swap rate (BBSW) plus 2%
Equity investment in Sorrenti holds shares in a number of suppliers in order to establish more
unlisted companies strategic alliances with them. The shareholdings are less than 10% of the
relevant company’s shares
Portfolio of short-term Sorrenti invests surplus cash in short-term debt securities – primarily bank
debt securities bills and corporate bonds. It holds this portfolio to receive interest and
principal repayments on the securities to fund the cash flow needs of the
business. Sorrenti may sell some of the securities in the portfolio to meet
larger cash flow needs (e.g. acquisitions). Historically, this has occurred quite
regularly and may be a significant percentage of the portfolio
Investment in convertible notes Sorrenti has made a long-term investment in some convertible notes issued
by a number of banks. The notes pay interest coupons every six months.
On maturity, Sorrenti has the option to receive the principal as cash or as
shares in the relevant banks. The number of shares it receives is fixed, and so
whether Sorrenti exercises this option will depend on the share price of the
relevant bank at the maturity date of the notes
Interest rate swaps Sorrenti has hedged a portion of the secured bank loan using an interest rate
swap with a term of 7 years
Ordinary shares Sorrenti has issued 2 million ordinary shares at $1 each to its shareholders
Convertible preference shares Sorrenti has issued 100,000 preference shares at $5 each, which will convert
to $500,000 worth of ordinary shares in 10 years’ time (i.e. a variable number
of shares with a value of $500,000 depending on the market price on the day
of conversion). Sorrenti has a contractual obligation to pay a 5% dividend
each year. If a dividend is missed due to insufficient profit, the payment must
be added to future dividends
Task
In order to ensure these financial instruments are correctly recognised in the 30 June 20X7
financial statements, you are required to determine and document how each of the instruments
should be classified under IAS 32 and IFRS 9, giving reasons for your choice of category.

ACT

The IFRS 9 classification of the financial assets and liabilities held by Sorrenti at 30 June 20X7
are as follows:
Financial instrument Classification Explanation
IAS 32 IFRS 9
Cash at bank Financial asset Amortised cost Cash is included in the definition of a
financial asset under IAS 32
SPPI – this instrument meets the SPPI test as
the principal amount is the balance of the
account (which may be repaid on demand)
and interest is zero
Business model – this account is held to
collect contractual cash flows
Trade receivables Financial asset Amortised cost Trade receivables are a contractual right to
receive cash from another entity
SPPI – the principal amount is the amount
resulting from each transaction. Payment
terms are 30 days so there is no financing
element present and, accordingly, the
interest rate is deemed to be zero
Business model – Sorrenti’s intention
is to hold the receivables to collect the
contractual cash flows. It has no intention
of selling the trade receivables
Trade payables Financial liability Amortised cost Trade payables are a contractual obligation
to deliver cash to another entity
Financial liabilities are measured at
amortised cost unless they are held for
trading or initially designated as measured
at fair value through profit or less (FVTPL)
FX forward contracts Financial asset/ FVTPL These are contracts that contain a
liability contractual obligation to exchange cash
with another entity on settlement
FX forward contracts are derivatives that
fail the SPPI test as cash flow variability
is dependent on FX rates and do not
represent principal and interest on principal
outstanding. In addition, they contain
considerable leverage
Secured bank loan Financial liability Amortised cost Bank loans involve a contractual obligation
to deliver cash to the bank
at FVTPL

ACT
IAS 32 IFRS 9
Equity investment in Financial asset FVTPL or FVTOCI Equity investments are assets that are equity
unlisted companies if election made instruments of another entity and therefore
are included in the definition of a financial
asset under IAS 32
Investments in equity instruments fail the
SPPI test as the cash flows do not represent
payments of principal and interest on
the principal outstanding. Accordingly,
they should be classified as FVTPL.
However, Sorrenti can make an irrevocable
election to present subsequent changes
in the fair value of these shares in other
comprehensive income (OCI) if the shares
are not held for trading. These shares are
held for long-term strategic purposes –
accordingly, Sorrenti is permitted to make
the election
Portfolio of short-term Financial asset FVTOCI This asset is a contractual right to receive
debt securities cash from another entity
SPPI – the debt securities will give rise
to cash flows that represent payments
of principal and interest on the principal
outstanding
Business model – Sorrenti holds the portfolio
to collect contractual cash flows and to sell
the securities to fund business needs
Investment in Financial asset FVTPL This investment involves a contractual right

convertible notes to receive cash or another financial asset
(shares) from the relevant banks
SPPI – the convertible notes will give rise
to regular coupon receipts, but the value
received at maturity is dependent on the
share price of the issuer. Accordingly, the
contractual cash flows are not payments
of principal and interest on the principal
outstanding
Interest rate swaps Financial asset/ FVTPL These are contracts that contain a
liability contractual obligation to exchange cash
with another entity on settlement
Even though interest rate swaps involve
interest payments and receipts on notional
principal amounts, they are derivatives
with no physical principal cash flows and,
accordingly, fail the SPPI test
Ordinary shares Equity N/A Ordinary shares issued by a company reflect

a residual interest in the net assets of the
company and, accordingly, are equity

ACT
IAS 32 IFRS 9
Convertible preference Financial liability Amortised cost The shares contain a contractual obligation
shares to make dividend payments and, in 10 years’
time, deliver a variable number of Sorrenti’s
ordinary shares (equalling $500,000 in value)
to the holders. This means the convertible
preference shares meet the definition of a
financial liability under IAS 32
at FVTPL

The relevant paragraphs of IAS 32 and IFRS 9 are as follows:
Standard Paragraphs Relevance
IAS 32 11 Definitions of financial asset, financial liability and equity
28 Compound financial instruments
IFRS 9 4.1.1–4.1.5 Classification of financial assets
4.2.1 Classification of financial liabilities
5.7.5 Provisions relating to investments in equity instruments
Appendix A Definition of ‘financial liability at fair value through profit or loss’
Step 2 – Identify the categories available

From your reading of IAS 32 and IFRS 9, you identify the following categories available to you:
•• Financial assets (defined in IAS 32 para. 11).
•• Amortised cost – instruments with cash flows that are solely principal and interest on the
principal outstanding, and held under a business model to collect contractual cash flows
(IFRS 9 para. 4.1.2).
•• Fair value through other comprehensive income (FVTOCI) – instruments with cash
flows that are solely principal and interest on the principal outstanding, and held
under a business model to both collect contractual cash flows and sell the assets (IFRS 9
para. 4.1.2A).
•• Fair value through profit or loss (FVTPL) – instruments with cash flows that are not solely
principal and interest on the principal outstanding, are held under a business model to sell
the assets, or are initially designated as FVTPL (IFRS 9 paras 4.1.4 and 4.1.5).
•• Investments in equity instruments – entities may make an irrevocable election on initial
designation to present changes in fair value in OCI as long as the investment is not held for
trading (IFRS 9 para. 5.7.5).
•• Financial liabilities (defined in IAS 32 para. 11).
•• Amortised cost – default classification for financial liabilities (IFRS 9 para. 4.2.1).
•• Fair value through profit or loss – only available if the liability is held for trading, or it is
designated upon initial recognition (IFRS 9 Appendix A).

ACT
•• Equity (defined in IAS 32 para. 11).
•• Compound financial instruments (defined in IAS 32 para. 28).
Step 3 – Identify the relevant factors for each financial instrument

Financial instrument Relevant factors
Financial assets (assets that are cash, equity instruments of another entity, or contractual rights to
receive cash or another financial asset from another entity)
Cash at bank Funds in the account are held on demand and there is no interest payable on the
account. As the account is on demand, the principal is the balance of the account. The
fact that the interest rate is zero does not mean the asset fails the SPPI test. Sorrenti
is holding the asset in order to collect the balance of the account (the contractual
amount due to it)
Trade receivables The principal on trade receivables is the amount resulting from the sales transactions.
As terms are 30 days, the receivables do not contain a financing component and the
interest rate is deemed to be zero. Again, this does not mean the asset fails the SPPI
test. The information provided also indicates Sorrenti does not have any intention
of selling the trade receivables (through factoring). Accordingly, the business model
is to hold the asset to collect contractual cash flows (i.e. the invoiced amounts
outstanding)
Equity investment in In order to meet the SPPI test, cash flows need to arise on specified dates. Equity
unlisted companies investments fail this test as they do not contractually deliver payments on specified
dates. In addition, dividends do not have characteristics of interest. Therefore, this
instrument should be classified as FVTPL, which means changes in the fair value of
the investment will be recognised in profit or loss. However, under IFRS 9 para. 5.7.5,
Sorrenti may elect to present these changes in OCI, which will remove any volatility
in the profit or loss that may result from this long-term strategic investment
Portfolio of short-term The instruments within this portfolio (bank bills and corporate bonds) are ‘vanilla’
debt securities debt instruments (debt instruments that result in payments of principal and interest
on the principal outstanding). The business model under which Sorrenti holds these
instruments is a combination of collecting contractual cash flows (the interest and
principal payments) as well as selling the securities in order to fund the liquidity
needs of the business. Since this sales activity is relatively frequent, it is part of the
objective of the business model
Investment in From Sorrenti’s perspective, this investment is a financial asset as it involves a

convertible notes contractual right to receive cash or another financial asset from the banks that have
issued the notes. The principal that Sorrenti will be repaid at maturity will depend on
the share price of the relevant bank at the time, since Sorrenti may receive either cash
or a fixed number of shares. The choice Sorrenti makes will depend on the share price
at maturity. If the share price has risen so the value of the shares received on maturity
is higher than the cash amount, Sorrenti will likely exercise the option, receive the
shares and then sell them – resulting in a higher principal amount received. If the
share price has fallen so the value is below the cash amount, Sorrenti will not exercise
the option and will instead receive the cash principal amount. When applying the
SPPI test, the amount repaid on maturity does not meet the definition of principal in
para. 4.1.3(a) of IFRS 9 because it changes depending on the prevailing share price.
The return received on these notes is linked to the value of the equity of the issuer.
This is inconsistent with a basic lending arrangement and, therefore, does not meet
the SPPI test. Accordingly, the notes are classified as FVTPL
Financial liabilities (a liability that is a contractual obligation to deliver cash or another financial asset
to another entity, or a non-derivative for which Sorrenti may be obliged to deliver a variable number of
their own equity instruments)
Trade payables These liabilities are not held for trading and there is no reason for Sorrenti to
designate them at FVTPL upon initial recognition. Accordingly, they fit the default
classification for financial liabilities
Secured bank loan Refer above

ACT
Financial instrument Relevant factors
Convertible preference While these are shares issued by Sorrenti (and, accordingly, may be equity), they have
shares contractual characteristics that meet the definition of a financial liability. They include
a contractual obligation to make fixed dividend payments annually, and repay a fixed
value of ordinary shares in 10 years’ time (i.e. a variable number based on the share
price at the time). There is no reason for Sorrenti to designate these shares at FVTPL
upon initial recognition – accordingly they should be measured at amortised cost.
These shares are not a compound financial instrument as they do not contain any
characteristics of equity
Equity (a contract that evidences a residual interest in the net assets of an entity)
Ordinary shares From Sorrenti’s perspective, these shares do not meet the definition of either a
financial asset or a financial liability, but reflect a residual interest in the net assets of
Sorrenti
Other
FX forward contracts These are derivatives and so do not meet the SPPI test, as they contain significant
leverage and do not represent payments of principal and interest on the principal
outstanding
Interest rate swaps Refer above
Step 4 – Identify and explain the choice of category for each

financial instrument
Based on the category options available and the relevant factors for each instrument, you are
now able to classify them appropriately and explain the reasons for your choice of classification.

ACT
Activity 9.2
Basic accounting comparing FVTPL and
FVTOCI
Introduction
How an entity classifies a financial instrument will impact on how that instrument is accounted
for. Once the classification has been determined, accounting for the instrument follows the
requirements for that particular category.
•• Account for financial assets, financial liabilities and equity instruments of the issuer
(including derivatives)
At the end of this activity, you will be able to account for an investment in an equity instrument
under different categories of financial instruments in accordance with IFRS 9 Financial
Instruments (IFRS 9).
Scenario
You are the financial accountant for Giant Limited (Giant), a company based in Adelaide, South
Australia. Giant manufactures wind turbines for use in local wind farms. A significant supplier
to Giant is Tiny Blades Limited (Tiny Blades), a company that is a leader in the manufacture
of rotor blades and regularly invests in new technology to improve the quality of its product.
Recently, as part of a strategic initiative to create closer relationships with its suppliers, Giant
made a fixed rate $3 million loan to Tiny Blades, to assist in funding their future technological
developments. Giant used a bank to assist with arranging the loan, and incurred $30,000 in
transaction costs.
The group treasurer of Giant, Lyn Towers, realises that the loan should probably be classified
as measured at amortised cost, but is uncertain as to what circumstances would permit its
classification as measured at fair value through other comprehensive income (FVTOCI) or
fair value through profit or loss (FVTPL) and the difference this would make in the financial
statements. She seeks your advice about accounting for the loan in the year ended 31 December
20X7. She provides the following details of the loan transaction:
•• The $3 million loan was made on 1 January 20X7and is repayable on 31 December 20X9.
•• Transaction costs incurred were $30,000.
•• Interest rate on the loan is 5.5% per annum, payable on 30 June and 31 December each year.
•• Fair value of the loan at 30 June 20X7 is $3,017,000, and at 31 December 20X7 is $3,005,000.
•• Effective interest rate of the loan is 5.1361%.
Lyn is concerned about the impact of changes in the fair value of the loan on the profit or loss
for the year, and wants to reduce this impact if possible; particularly since Giant has recently
issued a $5 million fixed rate medium term note (MTN), which is classified as measured at
FVTPL.

ACT
Task
Lyn has asked you to:
•• advise her on the circumstances that would permit classification of the loan to Tiny Blades
as FVTOCI or FVTPL
•• prepare the journal entries required under each option for the year ended 31 December
20X7, and
•• recommend which option would minimise volatility in the profit or loss for the year.

ACT

Options available for classification:
•• Fair value through other comprehensive income (FVTOCI) – since the loan meets the SPPI
test, this option will only be available if it can be demonstrated that the business model
under which the loan is managed is to collect contractual cash flows as well as sell the loan
(IFRS 9 para. 4.1.2A). There is no information to suggest that the loan is being managed in
order to earn a return from selling it – accordingly, it is unlikely this classification could be
justified.
•• Fair value through profit or loss (FVTPL) – this option is only available to Giant under
para. 4.1.5 of IFRS 9 as an election that can be made to irrevocably designate the loan as
FVTPL if doing so eliminates an accounting mismatch. Giant already has $5 million of fixed
rate liabilities that are classified as measured at FVTPL – accordingly, electing to measure
the loan at FVTPL will offset the impact on the profit or loss (P&L) of the liabilities and
significantly reduce the measurement inconsistency.
In order to prepare the journal entries for the loan receivable using the FVTOCI classification,
interest needs to be calculated using the effective interest method (EIM):
Date Opening Principal Interest Interest accrued Closing

balance repayments receipts using EIM balance
$ $ $ $ $
01.01.X7 3,030,000
30.06.X7 3,030,000 (82,500)1 77,8122 3,025,312
31.12.X7 3,025,312 (82,500) 77,6913 3,020,503
1. Calculated as 3,000,000 × 5.5% x 6 months/12 months (for half a year)

2. Calculated as 3,030,000 × 5.1361% (EIR) × 6 months/12 months (for half a year)
3. Calculated as 3,025,312 (opening balance) × 5.1361% (EIR) × 6 months/12 months (for half a year)
Journal entries for the two classification options are as follows.
Fair value through other comprehensive income (FVTOCI)

Date Description Dr Cr
$ $
01.01.X7 Loan – Tiny Blades (transaction costs) [statement of financial 30,000

position]
Loan – Tiny Blades 3,000,000
Cash at bank 3,030,000
Recognition of the loan to Tiny Blades at 1 January 20X7 including capitalisation of transaction costs
$ $
30.06.X7 Cash at bank 82,500
Loan – Tiny Blades 4,688
Interest revenue 77,812
Recognition of interest revenue and coupon received for the 6 months to 30 June 20X7

ACT
$ $
30.06.X7 FVTOCI reserve [Equity]* 8,312
Revaluation of loan to fair value at 30 June 20X7 [$3,030,000 – $4,688 (interest) – $3,017,000 (fair value at
30.6.X7)]
*Disclosed in OCI
$ $
31.12.X7 Cash at bank 82,500
Recognition of interest revenue and coupon received for the 6 months to 31 December 20X7
$ $
31.12.X7 FVTOCI reserve 7,191
Revaluation of loan to fair value at 31 December 20X7 [$3,017,000 (opening value at beginning of period) –
$4,809 (interest) – $3,005,000 (fair value at 31.12.X7)]
Fair value through profit or loss (FVTPL)

$ $
01.01.X7 Transaction costs [P&L] 30,000
Loan – Tiny Blades 3,000,000
Recognition of the loan to Tiny Blades at 1 January 20X7 and the expensing of transaction costs
$ $
30.06.X7 Cash at bank 82,500
Gain/loss on FVTPL assets 82,500
Recognition of the coupon receipt of $82,500, in profit or loss as part of the change in fair value
$ $
30.6.X7 Loan – Tiny Blades 17,000
Gain/Loss on FVTPL assets 17,000
Recognition of the change in fair value of the loan at 30 June 20X7 of $17,000 [$3,000,000 carrying amount –
$3,017,000 fair value]

ACT
$ $
31.12.X7 Cash at bank 82,500
Gain/loss on FVTPL assets 82,500
Recognition of the coupon receipt of $82,500, in profit or loss as part of the change in fair value
$ $
31.12.X7 Gain/loss on FVTPL assets 12,000
Recognition of the change in fair value of the loan at 31 December 20X7 of $12,000 [$3,017,000 carrying
amount – $3,005,000 fair value]
Recommendation
While the FVTOCI classification cannot be justified from the background information, if the
FVTOCI and FVTPL classifications are compared, the FVTOCI will result in lower volatility in
P&L for the year. This is because, under FVTOCI, transaction costs are included in the value of
the loan, rather than being recognised directly in P&L, and changes in the fair value that do not
relate to interest accruals are recognised in the FVTOCI reserve and do not impact on P&L.
However, the election to classify as measured at FVTPL is made in order to reduce an
accounting mismatch. Currently, the medium term note (MTN) is being accounted for under
the FVTPL classification, and measuring the loan at FVTPL will offset P&L volatility created by
the MTN.
Accordingly, it is recommended that the loan be classified as measured at FVTPL in order to
reduce the accounting mismatch of the MTN.

The relevant paragraphs of IFRS 9 are as follows:
5.1.1 Initial measurement of financial instruments
5.2.1 Subsequent measurement of financial assets
5.7.1 Recognition of gains and losses
5.7.10–5.7.11 Assets measured at fair value through other comprehensive income

ACT
Step 2 – Assess the classification requirements for financial assets

•• The cash flows of the loan asset are solely payments of principal and interest on the
principal outstanding. However, there is no information to indicate that the loan has been
entered into for any other reason than to be held until maturity, and the return earned
relates solely to collecting the contractual cash flows. This does not fit into the business
model required to measure an asset at FVTOCI, which requires that the business model
objective needs to include selling the loan as well as collecting contractual cash flows.

•• Given the assessment for FVTOCI classification, the loan would not comply with the normal
requirements for being classified as measured at FVTPL. However, under para. 4.1.5 of
IFRS 9, an election can be made to irrevocably designate the loan as measured at FVTPL if it
significantly reduces or eliminates an accounting mismatch. Because of the measurement of
the MTN issued at FVTPL, an accounting mismatch would exist unless Giant classified the
loan as FVTPL as well.
Step 3 – Calculate the amounts to be recorded

•• The loan will be recorded at its fair value ($3 million) plus transaction costs of $30,000
(IFRS 9 para. 5.1.1).
•• Interest will be measured using the effective interest method (IFRS 9 para. 5.7.11).
•• At 30 June 20X7 and 31 December 20X7, the loan will be restated to its fair value with the
difference being recognised in other comprehensive income (IFRS 9 para. 5.7.10).

•• The loan will be recorded at its fair value ($3 million), with transaction costs recognised in
profit or loss (IFRS 9 para. 5.1.1).
•• Changes in fair value at 30 June 20X7 and 31 December 20X7 are recognised in the profit or
loss (IFRS 9 para. 5.7.1).
Step 4 – Prepare the journal entries required

Under both the FVTOCI and FVTPL classifications, the journal entries can be prepared for:
•• initial recognition of the loan
•• initial recognition of transaction costs
•• interest received on 30 June 20X7 and 31 December 20X7
•• changes in fair value at 30 June 20X7 and 31 December 20X7.

ACT
Activity 9.3
Basic accounting under amortised cost
Introduction
How an entity classifies a financial instrument will impact on how that instrument is accounted
for. Once the classification has been determined, accounting for it follows the requirements for
that particular category.
(including derivatives).
At the end of this activity, you will be able to account for a debt security issued by an entity (i.e.
a financial liability) in accordance with IFRS 9 Financial Instruments (IFRS 9).
Scenario – Part A
You are a trainee accountant for Giant Limited (Giant), a company based in Adelaide, South
Australia. Giant manufactures wind turbines for use in local wind farms. You have recently
been engaged by Giant’s financial accountant, Cindy Song, who is coaching you in how to
account for financial instruments.
Giant issued a three-year corporate bond on 1 January 20X6 for $4,010,000. The bond has a face
value of $4 million and fixed annual interest payments of 5.5%, which are paid on 31 December
of each year. The bond was issued at a price higher than the face value because the coupon rate
was above the prevailing market interest rates. Transaction costs on arranging the issue of the
bond were $75,000. Based on these terms, the effective interest rate on the bond is 6.1092%.
Giant has not elected to initially designate the bond at fair value through profit or loss (FVTPL)
and accordingly will classify the bond as amortised cost. Giant has a 31 December year end.
Task – Part A
While the bond has already been recorded by Giant, as a learning exercise Cindy asks you to
prepare the journal entries (excluding any tax effect entries) necessary to account for the bond
from inception until the next balance date of 31 December 20X6.

ACT
Scenario – Part B
An alternative proposal Giant received at the time was to borrow $4,000,000 from the bank
at the same coupon interest rate of 5.5% and an upfront fee of $65,000. The loan would have
commenced on 1 January 20X6, and would have been repaid with three even payments of
$1,482,616 made on 31 December in each year of the loan. The final repayment would have been
on 1 January 20X9. The payments include both principal and interest. This is a typical mortgage-
style loan repayment profile from a bank. The effective interest rate of this loan is 6.3849%.
Again, Giant would have not elected to initially designate the loan at fair value through profit
or loss (FVTPL) and therefore will classify the borrowing as amortised cost.
Task – Part B
As a learning exercise, Cindy asks you to prepare the journal entries (excluding any tax
effect entries) necessary to account for the loan from inception until the next balance date of
31 December 20X6.

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Activity 9.3 Suggested solution – Part A

The amortised cost and interest accrued each year based on the effective interest method
(EIM) needs to be calculated first, as follows (the entire table has been shown, but only up to
31 December 20X6 is required for the journal entries):

balance repayments payments using EIM balance
$ $ $ $ $
01.01.X6 3,935,000
31.12.X6 3,935,000 (220,000) 240,397 3,955,397
31.12.X7 3,955,397 (220,000) 241,643 3,977,040
31.12.X8 3,977,040 (4,000,000) (220,000) 242,960 –
Journal entries to account for the bond until 31 December 20X6 are as follows.
Initial recognition
$ $
01.01.X6 Cash at bank 3,935,000
Corporate bond issued (transaction costs) 75,000
Corporate bond issued (fair value) 4,010,000
Recognition of corporate bond issued on 1 January 20X6, including transaction costs
31 December 20X6 year-end accounting entries

$ $
31.12.X6 Interest expense 240,397
Corporate bond issued 20,397
Cash at bank 220,000
Recognition of the corporate bond coupon paid on 31 December 20X6

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Activity 9.3 Suggested solution – Part B

The amortised cost and interest accrued each year based on the effective interest method (EIM)
needs to be calculated first, as follows (the entire table has been shown, but only up to
31 December 20X6 is required for the journal entries):

balance repayments payments using EIM balance
$ $ $ $ $
01.01.X6 3,935,000
31.12.X6 3,935,000 (1,262,616) 2

(220,000) 1
251,2453
2,703,629
31.12.X7 2,703,629 (1,332,060)5 (150,556)4 172,624 1,393,637
31.12.X8 1,393,637 (1,405,324) (77,293) 88,979 0
1. The interest payment is calculated as 5.5% of the balance outstanding ($4 million).
2. The principal repayment is calculated as the total repayment required ($1,482,616) less the interest component
of $220,000.
3. Interest accrued is calculated as 6.3849% of the opening balance of $3,935,000.
4. The interest payment is calculated as 5.5% of the balance outstanding ($4,000,000 – the $1,262,616 repayment made
on 1 Jan X7).
5. The principal repayment is calculated as the total repayment required ($1,482,616) less the interest component
of $150,556.
Journal entries to account for the loan until 30 June 20X7 are as follows:
Initial recognition
$ $
01.01.X6 Cash at bank 3,935,000
Bank loan (transaction costs) 65,000
Bank loan 4,000,000
Recognition of funds borrowed under the bank loan on 1 January 20X6, including transaction costs
31 December 20X6 year-end accounting entries

$ $
Bank loan 1,231,371
Recognition of principal and interest payment on 31 December 20X6

ACT
Activity 9.3 Recommended approach – Part A

Paragraphs Relevance
4.2.1–4.2.2 Classification of financial liabilities
5.1.1 Initial measurement of financial instruments
5.3.1 Subsequent measurement of financial liabilities
Appendix A Definition of amortised cost
Step 2 – Calculate the amounts to be recorded for the corporate bond

You calculate the interest expense and amortised cost of the bond using the effective interest
method (EIM). You know from IFRS 9 that the amortised cost is the initial balance less principal
repayments less coupon payments plus interest accrued using the EIM. The interest expense is
calculated by applying the effective interest rate to the opening balance of the bond each year.

The journal entries can be prepared for initial recognition, as well as for the year ended
31 December 20X6.
You need to be careful with accounting for the transaction costs, as these costs reduce the value
of the bond recognised.
Activity 9.3 Recommended approach – Part B
Step 4 – Calculate the amounts to be recorded for the loan

You calculate the interest expense and amortised cost of the loan using the effective interest
method (EIM). You know from IFRS 9 that the amortised cost is the initial balance less principal
repayments less coupon payments plus interest accrued using the EIM. The interest expense is
calculated by applying the effective interest rate to the opening balance of the loan each year.
You know from the information provided that the total cash payment (being principal plus
coupon payment) made each year is $1,482,616. There is no need to calculate the split into
principal and interest as it makes no difference to the amortisation schedule if you do –
however, this has been shown for your information.

The journal entries can be prepared for initial recognition, as well as for the year ended
31 December 20X6.
You need to be careful with accounting for the transaction costs, as these costs reduce the value
of the loan recognised.

ACT
Activity 9.4
Integrated financial instruments activity
Introduction
This integrated activity is designed to allow candidates to practise their technical skills across a
number of concepts within the financial instruments unit. Being able to apply this knowledge to
a comprehensive practical scenario is central to professional practice and the FIN module exam.
This activity links to the following learning outcomes:
•• Explain and identify financial instruments and the principles for classifying them as
financial assets, financial liabilities or equity instruments of the issuer.
(including derivatives).
•• Explain and account for basic cash flow and fair value hedges.
•• Explain and account for impairment of financial assets.
This activity is longer than candidates would normally expect an exam question to be. Some
parts of the activity follow on from each other. It is recommended that candidates check their
answers to each part before moving on to the next part.
Background
You are a financial accountant working in the treasury team at Generous Bank (Generous).
Generous provides the full suite of banking products to its predominantly retail customers, and
prides itself on its quick approval processes and friendly customer service.
The treasury team is responsible for managing the bank’s asset and liability portfolio. Generous
has decided to early adopt IFRS 9 Financial Instruments (IFRS 9) and you are currently preparing
for the 30 June 20X7 year end.
Scenario – Part A
You start by reviewing the asset portfolio to determine how it should be classified and
accounted for at year end. You collect the following information about the portfolio:
•• The portfolio consists of a range of debt securities with varying maturities. Historically,
the portfolio has been split into two parts based on the average maturity of the securities.
•• The longer term part of the portfolio contains predominantly high-grade corporate and
government bonds. Generous’ credit department has assessed these securities as having
low credit risk. Generous manages this portfolio with the objective of earning in excess of
a benchmark return within a predefined risk and maturity profile. Accordingly, Generous
will hold the securities to receive the coupons and principal repayments, but will also
buy and sell these securities as opportunities arise to improve the return of the portfolio.

ACT
The return earned on the portfolio incorporates the interest earned, gains and losses on sale
and changes in fair value of the securities.
•• The shorter term part of the portfolio is managed in order to provide liquidity for the bank.
Accordingly, it contains short-term ‘vanilla’ debt securities, as well as bank bill futures that
will be bought and sold as the bank’s day-to-day liquidity needs fluctuate. This portfolio’s
performance is managed in the same way as the longer term part of the portfolio.
Task – Part A
To ensure the asset portfolio is correctly recognised in the 30 June 20X7 financial statements,
you are required to determine and document how the portfolio should be classified under
IFRS 9, giving reasons for your choice of category.
Scenario – Part B
You then investigate one particular debt security within Generous’ longer term portfolio to
ensure you understand how the accounting for this security works. The debt security is a
$10 million government bond that was acquired on 1 July 20X6 for $10.15 million and matures
on 30 June 20X8. The interest rate is 3.5% per annum and interest is paid on 30 June and
31 December each year. You have calculated its effective interest rate as 2.7243%. The debt
security had a fair value of $10.119 million on 31 December 20X6 and $10.070 million on 30 June
20X7. Both fair values include interest accruals and coupon payments up to those dates.
Task – Part B
Prepare the journal entries to account for the debt security for the year ended 30 June 20X7.
Scenario – Part C
Generous’ treasurer, Jonny Fudge, knows you are working on the implementation of IFRS 9 and
reminds you that the longer term part of the portfolio includes some Australian government
bonds that have been hedged with swaps that convert the fixed coupon receipts into variable
receipts. Johnny would like to understand how these should be accounted for under IFRS 9 and
how effectiveness will be assessed.
You use the government bond you investigated in Part B to explain the accounting treatment to
Jonny. Details of the bond and the relevant hedge are as follows:
Date Fair value Change in fair value Change in fair

of government of the bond value of the swap
bond since inception since inception
$ $ $
31.12.X6 10,119,000 (31,000) (7,000)
30.06.X7 10,070,000 (80,000) 5,000

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Task – Part C
Prepare a memorandum to Johnny Fudge advising him on how the hedge will be classified, and
showing the journal entries required to account for the bond and the hedge for the six months
ended 30 June 20X7. In the memorandum, include details of how effectiveness will be assessed
during the life of the hedge.
Scenario – Part D
Johnny is concerned about how impairment of the portfolio will be accounted for under IFRS 9.
Previously, impairment would not have been recognised unless there was a default on a
security. Johnny is worried about how its recognition will impact on the reported performance
of the portfolio. Given the high credit quality of the portfolio, he thinks the risk of default
within 12 months is 2% and lifetime is 5%.
Task – Part D
Advise Johnny on the impact that recognising impairment of the portfolio under IFRS 9 will
have on the financial statements and the portfolio’s performance.

ACT
Activity 9.4 Solution – Part A

The basis for determining the asset portfolio’s classification rests on two primary tests contained
within IFRS 9 para. 4.1: these tests relate to the business model for managing financial assets,
and the characteristics of the contractual cash flows.
Generous Bank has historically split the portfolio into two parts. Given the two parts have
different characteristics, they should be assessed separately, as follows:
1. Longer term part – the portfolio consists of high-grade corporate and government bonds.
These are ‘vanilla’ securities that comprise payments of principal (on maturity) and interest
on the principal outstanding. Accordingly, they meet the solely payments of principal
and interest (SPPI) test. The business model that Generous uses to manage these assets
involves collecting contractual cash flows as well as selling securities in order to maximise
the portfolio return. This is further supported by the fact that the portfolio performance is
assessed based on changes in fair value as well as interest earned. Therefore, the business
model and SPPI characteristics would lead this part of the portfolio to be categorised as fair
value through other comprehensive income (FVTOCI).
2. Shorter term part – this part of the portfolio consists of short-term debt securities as well as
futures contracts. While the debt securities are ‘vanilla’ securities that will meet the SPPI
test, the futures contracts do not have cash flows that are solely payments of principal and
interest. Accordingly, the portfolio as a whole does not meet the SPPI test. This means that
this part of the portfolio should be categorised as fair value through profit or loss (FVTPL).
The objective of the business model that Generous uses to manage this part of the portfolio
does not impact on this classification, although it appears to be managed to buy and sell
financial assets rather than to collect contractual cash flows.
Activity 9.4 Solution – Part B

Based on the categorisation of the asset portfolio in Part A, the debt security will be measured at
FVTOCI. Interest on the security should be measured using the effective interest method (EIM).
This means that in order to prepare the journal entries to account for the debt security, the
amortisation profile needs to be prepared. This is shown below.
(Note: The entire profile is shown, but in an exam candidates would only need to calculate as
much as is required to prepare the journal entries.)
Date Opening Principal Interest Interest Closing balance

balance repayments receipts accrued
using EIM $
$ $ $ $
30.06.X6 10,150,000
31.12.X6 10,150,000 (175,000) 138,258 10,113,258
30.06.X7 10,113,258 (175,000) 137,757 10,076,015
31.12.X7 10,076,015 (175,000) 137,249 10,038,264
30.06.X8 10,038,264 (10,000,000) (175,000) 136,736 –

ACT
Journals are as follows:
$ $
01.07.X6 Long term portfolio asset 10,150,000
Recognition of the government bond on 1 July 20X6
$ $
31.12.X6 Cash at bank 175,000
Long term portfolio asset 36,742
Recognition of interest coupon received 31 December 20X6
$ $
31.12.X6 Long term portfolio asset 5,742
FVTOCI reserve [Equity]* 5,742
Recognition of the change in fair value of the security at 31 December 20X6 [$10,150,000 – $36,742 –
$10,119,000]
*Disclosed in OCI
$ $
30.06.X7 Cash at bank 175,000
Recognition of interest coupon received 30 June 20X7
$ $
30.06.X7 FVTOCI reserve 11,757
Recognition of the change in fair value of the security at 30 June 20X7 [$10,119,000 – $37,243 – $10,070,000]

ACT
Activity 9.4 Solution – Part C
Memorandum
To: Johnny Fudge
From: C Accountant
Generous has a number of Australian government bonds in the longer term part of its asset
portfolio that have been hedged with interest rate swaps. Using one bond as an example, this
memo outlines how the hedges will be classified and accounted for under IFRS 9 and how their
effectiveness will be assessed.
How the hedge will be classified

The risk that is being hedged on these bonds is the interest rate risk and its impact on the fair
value of the bond. The cash flows received on the investment are fixed, and therefore Generous
is not subject to cash flow risk. This means the hedge will be classified as a fair value hedge, and
gains and losses on both the bond and the swap will be recognised in profit or loss (P&L). To the
extent the hedge is effective, gains and losses will offset and only the ineffective portion will
remain in P&L.
Hedge journal entries

If we ignore hedging of the government bond, the revaluation of the bond would be recognised
entirely in a reserve account in Equity. At 30 June 20X7, the journal entry would be as follows:
$ $
30.06.X7 FVTOCI reserve [Equity]* 11,757
Recognition of the change in fair value of the debt security at 30 June 20X7 [$10,119,000 – $37,243 –
$10,070,000]
*Disclosed in OCI
If we assume a fair value hedge is in place, the journal entries for the six months to 30 June 20X7
will change to the following:
$ $
30.06.X7 Loss on revaluation of long term portfolio asset 11,757
Recognition of the change in fair value of the security at 30 June 20X7 [$10,119,000 – $37,243 – $10,070,000]
$ $
30.06.X7 Interest rate swap [statement of financial position] 12,000
Gain on interest rate swap [P&L] 12,000
Recognition of the fair value of the interest rate swap at 30 June 20X7 [$5,000 – ($7,000)]
It is evident from the journal entries that there is a very small amount of hedge ineffectiveness
($243) in the six months to 30 June 20X7, which is recognised in P&L.

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Effectiveness testing
In order for the hedge between the bond and the swap to be effective, it needs to meet the
following requirements:
•• There is an economic relationship between the government bond and the interest rate swap.
It would be expected that the fair values of the bond and the swap will move in opposite
directions on an ongoing basis, as they are based on the same underlying interest rates.
•• The effect of credit risk does not dominate the value changes. As the bond is issued by the
Australian Government, it is unlikely changes in credit risk will have a material impact on
the value of the bond. However, the value of the interest rate swap will change based on the
credit standing of the counterparty bank, and this will need to be monitored over the life of
the hedge to ensure it does not move materially.
•• The accounting hedge ratio remains the same as the economic hedge ratio. The only reason
the economic hedge ratio would need to change over the life of the hedge is if there was
basis risk that was resulting in significant hedge ineffectiveness. If this was the case, the
hedge ratio for accounting purposes would also need to change to reflect this.

ACT
Activity 9.4 Solution – Part D

IFRS 9 requires credit losses to be recognised on financial assets regardless of whether a default
has actually occurred. The impact on the portfolio’s performance should be considered for each
part of the portfolio separately:
•• Longer term part – this part of the portfolio contains predominantly high-grade securities
that are accounted for at FVTOCI. Generous’ credit department has rated these securities
as having low credit risk, which means that low credit risk operational simplification can
be adopted. The implications are that no ongoing assessment of credit risk is required and
Generous can just recognise 12-month expected credit losses (ECLs) on these assets, which
will be calculated at 2% of the long-term portfolio value. This loss allowance will effectively
transfer a portion of the fair value revaluation from OCI to P&L and will not impact on the
fair value of the asset recognised. Since the level of ECL recognised will remain at 12-month
ECL, there will be minimal ongoing impact on the portfolio’s performance after initial
recognition of ECLs.
•• Shorter term part – this part of the portfolio contains short-term debt securities and futures
contracts that are measured at FVTPL. Since changes in credit risk are already incorporated
into the fair value of these assets and recognised in P&L, there is no need to recognise
additional expected credit losses. Accordingly, there will be no impact on the financial
statements or portfolio’s performance as compared to IAS 39.
Activity 9.4 Recommended approaches

5.2.1 Subsequent measurement of financial assets
5.4.1 Recognition of interest on financial assets using effective interest

method
5.5.1–5.5.5 Recognition of expected credit losses
5.5.10 Low credit risk operational simplification
5.7.10–5.7.11 Recognition of interest on FVTOCI assets
6.4.1 Hedge effectiveness criteria
6.5.2 Fair value and cash flow hedges
6.5.8 Fair value hedge accounting
Appendix A Definitions

ACT
Part A
Step 2 – Identify the categories available
From your reading of IFRS 9, you identify the following categories available to you:
•• Amortised cost – instruments with cash flows that are solely principal and interest on the
principal outstanding, and held under a business model to collect contractual cash flows
(IFRS 9 para. 4.1.2).
•• Fair value through other comprehensive income – instruments with cash flows that are
solely principal and interest on the principal outstanding, and held under a business model
to both collect contractual cash flows and sell the assets (IFRS 9 para. 4.1.2A).
•• Fair value through profit or loss – instruments with cash flows that are not solely principal
and interest on the principal outstanding, are held under a business model to sell the assets,
or are initially designated as FVTPL (IFRS 9 paras 4.1.4 and 4.1.5).
Step 3 – Identify the relevant factors for each part of the portfolio
You know that the portfolio has historically been split into two parts and that each part has
different characteristics. Accordingly, you should evaluate each part separately.
Portfolio part Relevant factors
Longer term This part of the portfolio consists of corporate and government bonds. In the absence of
any information to the contrary, the securities within this part are considered to be ‘vanilla’
securities. Accordingly, cash flows would be expected to consist solely of interest coupons
on the face value of the security and repayments of principal
The background information also clearly sets out the business model that Generous adopts
for managing these securities – receiving contractual cash flows and selling securities
in order to maximise portfolio returns. In addition, the performance of the portfolio is
measured based on these two activities
Shorter term The background information indicates this part of the portfolio contains a combination of
‘vanilla’ debt securities as well as futures. Futures are derivatives that will not have interest
and principal cash flows. Even though the short-term debt securities will have interest and
principal cash flows, the portfolio as a whole does not have cash flows that consist solely of
interest and principal payments
Step 4 – Identify and explain the choice of category for each financial
instrument
Based on the options available and the relevant factors for each instrument, you can classify
them appropriately and explain the reasons for your choice of classification.
Part B
Step 5 – Calculate the amounts to be recorded for the corporate bond
Calculate the interest expense and amortised cost of the bond using the effective interest method
(EIM). Paragraphs 5.7.10 and 5.7.11 of IFRS 9 indicate that interest on FVTOCI instruments
should be measured using the EIM, in the same way that you would if the instrument was
measured at amortised cost. You know from IFRS 9 that the amortised cost is the initial balance
less principal repayments less coupon payments plus interest accrued using the EIM. The
interest expense is calculated by applying the effective interest rate to the opening balance of the
bond each year. In this case, this calculation is quite straightforward as the effective interest rate
and coupon are the same.

ACT

The journal entries can be prepared for the year 30 June 20X7. Initial recognition of the
investment occurred on 30 June 20X6, so this journal is not required. Effectively, simply account
for it as if it was measured at amortised cost and then revalue it each period to fair value.
Changes in fair value are recognised in other comprehensive income (OCI).
Part C
Step 7 – Apply the requirements of IFRS 9 to the hedging relationship
Review para. 6.5.2 of IFRS 9, which defines the different types of hedging relationships.
The instrument being hedged in this case is a fixed rate government bond. There are no risks
relating to cash flow as these are fixed over the life of the bond. However, the fair value of the
bond will change as interest rates move. Accordingly, the interest rate swap is hedging against
interest rate risk as it impacts on the fair value of the bond, and is a fair value hedge.
Also review para. 6.5.8 of IFRS 9, which outlines how fair value hedges should be accounted
for. The gain or loss on the hedging instrument (the interest rate swap) is recognised in profit
or loss. The hedging gain or loss of the hedged item (the bond) is also recognised in profit or
loss. In this situation, where the bond is measured at FVTOCI and the interest rate risk is being
hedged, the hedging gains or losses are the portion of the change in fair value that has been
recognised in OCI.
From a practical perspective, Generous would prefer the fair value of the bond acquired to
follow its amortised cost profile and not be impacted by changes in interest rates (particularly
increasing interest rates that will reduce the value of the bond). Hedging this exposure with
an interest rate swap enables the movement in fair value to be offset against the change in fair
value of the swap.
Step 8 – Prepare the journal entries for the hedging relationship at 30 June
20X7 under fair value hedging
Interest rate swap – At 30 June 20X7, this has a fair value of $5,000. However, at 31 December
20X6, the swap had a fair value of ($7,000), and accordingly its value has increased by $12,000
during the six months. This gain on the swap will be recognised in profit or loss against the
change in value of the swap on the statement of financial position.
Government bond – At 30 June 20X7, this has a fair value of $10,070,000. This is a decrease of
$80,000 since inception, and $49,000 since 31 December 20X6. Of the $49,000 change in fair
value, $37,243 was recognised as part of the interest recognition process using the EIM, and
$11,757 was recognised in OCI as a revaluation of the bond to fair value. It is the $11,757 that
represents the hedging loss on the bond for the six months.
Because the government bond is now a hedged item, the loss for the six months of $11,757
will now need to be recorded in profit and loss in order to offset against the gain made on the
interest rate swap (the hedging instrument).
Step 9 – Effectiveness testing

Paragraph 6.4.1 of IFRS 9 outlines the criteria for an effective hedging relationship.

ACT
Part D
Step 10 – Apply the requirements of IFRS 9 to the asset portfolio
Paragraph 5.5.1 of IFRS 9 indicates that ECLs are only required to be recognised for financial
assets measured at amortised cost or FVTOCI. Accordingly, only the longer term part of the
portfolio needs to have the impairment provisions of IFRS 9 applied to it.
Paragraph 5.5.5 of IFRS 9 indicates that entities should recognise 12-month ECL (which is ECL
resulting from default events likely to occur in the next 12 months), unless a significant increase
in credit risk has occurred since initial recognition. To avoid assessing credit risk at each
reporting period, a simplification is available in para. 5.5.10 of IFRS 9 for financial instruments
that an entity has determined have a low credit risk. The background information indicates that
this is the case for the longer term part of the asset portfolio – accordingly, ECL can remain at
12-month ECL.

ACT
Unit 10: Impairment of assets
Activity 10.1
Accounting for impairment and subsequent
reversal for a CGU
Introduction
As a Chartered Accountant, you may be called on to identify, explain and account for an
impairment loss for a cash-generating unit (CGU), including the impairment of goodwill.
Over the years, circumstances may change and you may be required to account for the reversal
of an impairment loss for the CGU that was recognised in previous years. This requires you to
understand the application of IAS 36 Impairment of Assets (IAS 36).
For this activity, you are required to explain and account for an impairment loss for a CGU, and
to account for the reversal of an impairment loss, in accordance with the requirements of IAS 36.
•• Identify, explain and account for an impairment loss for a cash-generating unit (CGU)
including impairment of goodwill.
•• Explain and account for reversals of impairment losses.
At the end of this activity, you will be able to explain and account for an impairment loss for a
CGU, including the impairment of goodwill. You should also be able to explain and account for
reversals of impairment losses.
Scenario
You are a financial accountant working for Taurus Limited (Taurus) and report to James Smart,
the company’s chief financial officer. You are in charge of the accounting for the Dorado
division (Dorado), a CGU of Taurus. Your accounting responsibilities include the annual
impairment testing of Dorado, as the CGU contains goodwill.
Information for the year ended 30 June 20X2

At 30 June 20X2, the carrying amount of the Dorado CGU’s assets was as follows:
Carrying amount of the Dorado CGU assets $
Land 500,000
Plant 2,500,000
Accumulated depreciation (500,000)
Goodwill* 200,000
Total 2,700,000
*This asset arose from the acquisition of a business.

ACT
All assets are measured using the cost model. Plant is depreciated at 10% per annum on a
straight-line basis, resulting in a depreciation expense of $250,000 per annum. At 30 June 20X2,
the remaining useful life of the plant was eight years. The fair value less costs of disposal
(FVLCOD) of Dorado’s land was $480,000. The recoverable amount of the plant was not able to
be determined.
At 30 June 20X2, the recoverable amount of the CGU was $2,350,000 based on a value in
use (VIU) measurement.
Information for the year ended 30 June 20X3

Since 30 June 20X2, there have been significant improvements in Dorado’s business operations.
As part of your investigations you specifically considered IAS 36 para. 110:
An entity shall assess at the end of each reporting period whether there is any indication that an
impairment loss recognised in prior periods for an asset other than goodwill may no longer exist or
may have decreased. If any such indication exists, the entity shall estimate the recoverable amount of
that asset.
In performing this assessment, you considered both external and internal sources of information
in accordance with IAS 36 para. 111. You are now satisfied that the requirements to reverse the
30 June 20X2 impairment loss under IAS 36 have been satisfied.
At 30 June 20X3, the carrying amount of the Dorado CGU’s assets was as follows:
Carrying amount of the Dorado CGU assets $
Land 480,000
Plant (net of accumulated depreciation) 1,636,250
Total 2,116,250
No acquisition or disposal of land or plant has occurred since 30 June 20X2.

At 30 June 20X3, the recoverable amount of the Dorado CGU was measured at $2,400,000 based
on VIU. The FVLCOD of Dorado’s land is $490,000. The recoverable amount for the plant was
not able to be determined.
Task
For this activity, you are required to:
A. Calculate the impairment loss for the Dorado CGU at 30 June 20X2 and allocate it to the
relevant assets.
B. Calculate the maximum impairment loss reversal that can be recognised at 30 June 20X3,
and explain how it is allocated to the Dorado CGU’s assets.

ACT

1. The impairment loss for the Dorado CGU at 30 June 20X2 is $350,000, which is allocated to
goodwill ($200,000), land ($20,000) and plant ($130,000).
2. Although the maximum impairment loss reversal is $283,750, the rules in IAS 36 permit
only a $10,000 reversal for land and $113,750 for plant to be recognised.
Preliminary step – Review the Standard

IAS 36 paras 2, 63, 104–105, 114, 119, 122 and 123 are relevant to your task.
Task A: Calculate and allocate the impairment loss of the Dorado CGU
at 30 June 20X2
Step 1 – Identify indications of impairment/perform annual

impairment testing as CGU contains goodwill
The Dorado CGU must be tested annually for impairment as it contains goodwill.
Step 2 – Determine the CGU’s recoverable amount

The Dorado CGU’s recoverable amount was calculated to be $2,350,000 based on its value in
use (VIU).
Step 3 – Determine the carrying amount of the CGU

The Dorado CGU’s carrying amount at 30 June 20X2 was $2,700,000.
Step 4 – Determine if the CGU is impaired

Compare the CGU’s carrying amount to its recoverable amount. If the carrying amount of a
CGU exceeds its recoverable amount, the excess is an impairment loss.
The Dorado CGU is impaired as its carrying amount exceeds its recoverable amount.
Step 5 – Calculate the impairment loss as at 30 June 20X2

The impairment loss for the Dorado CGU is $350,000, calculated as follows:
Dorado CGU impairment loss
Carrying amount of Recoverable amount Impairment loss

CGU assets of CGU (VIU)
$ $ $
Dorado 2,700,000 2,350,000 350,000

ACT
Step 6 – Determine the allocation of the impairment loss across

individual assets
The $350,000 impairment loss for the Dorado CGU is allocated across the individual assets
as follows:
•• First, it is allocated to goodwill (in accordance with IAS 36 para. 104).
• • The remaining impairment loss then is allocated pro rata to the remaining assets of the CGU
in proportion to their carrying amounts subject to the floor limit in IAS 36 para. 105.
As the land has a fair value less costs of disposal (FVLCOD) of $480,000 compared to the
carrying amount of $500,000, only $20,000 of the impairment loss can be allocated to this asset.
This is because of the requirements of IAS 36 para. 105, which establish $480,000 as the floor in
this situation. Therefore, the land cannot be reduced below its FVLCOD of $480,000.
The calculation of the impairment loss allocation is performed as follows:
Dorado CGU – allocation of impairment loss
Carrying Allocation Allocation of Revised

amount impairment carrying
loss amount
$ $ $
Goodwill 200,000 Allocated first to goodwill 200,000 –
Land 500,000 Allocated to satisfy the $480,000 20,000 480,000

floor limit
Plant (net of 2,000,000 Remaining impairment loss 130,000 1,870,000

accumulated allocated
depreciation)
Total impairment loss 2,700,000 350,000 2,350,000

ACT
Task B: Calculate and allocate the maximum impairment loss reversal

at 30 June 20X3
Step 1 – Calculate the maximum impairment loss reversal at

30 June 20X3
The carrying amount of the Dorado CGU’s assets at 30 June 20X3 is as follows:
Asset $
Land 480,000
Plant (net of depreciation)* 1,636,250
Total 2,116,250
* The revised carrying amount at 30 June 20X2 after recognising the impairment loss was $1,870,000. As the plant had a
remaining useful life of eight years, the depreciation expense for the year ended 30 June 20X3 was $233,750 ($1,870,000
÷ 8 years). Accordingly, the carrying amount at 30 June 20X3 is $1,636,250 ($1,870,000 – $233,750).
The Dorado CGU’s recoverable amount at 30 June 20X3 is $2,400,000.

Therefore, the excess of the recoverable amount of the Dorado CGU over the carrying amount
of the total assets of the Dorado CGU is $283,750, calculated as follows:
Carrying amount of total

Excess of recoverable
Recoverable amount of assets of Dorado CGU
– = amount over carrying
Dorado CGU (net of accumulated
amount of total assets
depreciation)
$2,400,000 – $2,116,250 = $283,750
The $283,750 represents the maximum impairment loss reversal.
Step 2 – Allocate the maximum impairment loss reversal

IAS 36 para. 122 prohibits a reversal of an impairment loss for goodwill, so it is not possible
to reverse any write-down of goodwill. Accordingly, the $283,750 maximum impairment loss
reversal can only be allocated to the land and plant subject to the limits specified in IAS 36
paras 122–123.
This process can be performed in four steps, as follows.
Step A: Calculate the carrying amount at 30 June 20X3 if no impairment loss had been
recognised at 30 June 20X2
Asset
Land Plant
$500,000 cost $2,500,000 cost

Depreciation: $2,500,000 ÷ 10 years = $250,000 p.a.
Depreciation to 30.06.X3 is 3 years × $250,000 = $750,000
Carrying amount if impairment Carrying amount if impairment never occurred:

never occurred: Cost $2,500,000 – Accumulated depreciation $750,000
$500,000 = $1,750,000

ACT
Step B: Allocate the maximum impairment loss reversal to the individual assets
The maximum impairment loss reversal is allocated to the land and plant in proportion to their
actual carrying amounts at 30 June 20X3.
Allocation of impairment loss reversal
Asset Carrying Proportion Allocation Revised

amount of maximum carrying
impairment amount
loss reversal
$ $ $
Land 480,000 ($480,000 ÷ $2,116,250) × $283,750 64,359 544,359
Plant (net of 1,636,250 ($1,636,250 ÷ $2,116,250) × $283,750 219,391 1,855,641

accumulated
depreciation)
2,116,250 283,750 2,400,000
Step C: Establish the ceiling for an impairment reversal under IAS 36 para. 123
The Standard imposes a ceiling on the reversal of the impairment loss after the revised carrying
amount in Step B has been calculated. Would the pro rata allocation of the reversal of the
impairment loss cause the new carrying amount of any individual asset to exceed the lower of
that asset’s:
•• recoverable amount, and
•• carrying amount (after depreciation)
had no impairment loss been initially recognised?

A recoverable amount was able to be determined for the land but not for the plant.
The values are considered to determine whether a ceiling applies to the land and/or plant.
Asset
Land Plant
Carrying Recoverable Revised carrying Carrying Recoverable Revised carrying

amount if amount: amount after pro amount if amount: Not amount after pro
impairment $490,000 rata allocation: impairment determinable rata allocation:
never occurred: $544,359 never occurred: $1,855,641
$500,000 $1,750,000
(from Step A) (from Step B) (from Step A) (from Step B)
The revised carrying amount of $544,359, after the The revised carrying amount of $1,855,641, after the
allocated reversal, would cause the land’s value to allocated reversal, would cause the plant’s value to
exceed its $490,000 recoverable amount (as this exceed its $1,750,000 carrying amount if impairment
value is lower than its $500,000 carrying amount if never occurred
impairment never occurred)
The ceiling applies so that the land can only be written The ceiling applies so that the plant can only be
up to a value of $490,000 written up to a value of $1,750,000

ACT
Step D: Impairment loss reversal calculation
The impairment loss reversal is calculated as follows:
Asset
Land Plant
Ceiling value: Actual carrying amount at Ceiling value: Actual carrying amount at
$490,000 30 June 20X3: $1,750,000 30 June 20X3:
(from Step C) $480,000 (from Step C) $1,636,250
Impairment loss reversal: $10,000 Impairment loss reversal: $113,750

($490,000 – $480,00) ($1,750,000 – $1,636,250)
Although the maximum impairment loss reversal calculated in Step 1 was $283,750, only
$123,750 ($10,000 for land + $113,750 for plant) is permitted to be recognised.
The $123,750 impairment loss reversal is recognised in profit or loss in accordance with IAS 36
para. 119.

ACT
Activity 10.2
Impairment and ethics
Introduction
This Activity draws on real world events surrounding the Rio Tinto Group, one of the world’s
largest companies. All comments and statements below are based on or have been extracted
from newspaper articles, court filings and regulator reports, and do not represent CA ANZ’s
views on the merits of any legal case. Candidates should review the references detailed below
and form their own conclusions.
This is intended for teaching and learning purposes only.
Scenario
Group structure
Rio Tinto is a dual-listed company. Rio Tinto Limited is a public company listed on the
Australian Securities Exchange (ASX), and Rio Tinto plc is a public company listed on the
London Stock Exchange (LSE). Together these entities share a common board of directors,
and the dual-listed structure forms the Rio Tinto group. One set of consolidated accounts are
prepared for the group, with a 31 December year end.
Riversdale mining / Rio Tinto Coal Mozambique

In 2010–2011, Rio Tinto undertook a takeover of the ASX-listed Riversdale Mining Limited
(Riversdale). Riversdale was subsequently delisted and renamed as Rio Tinto Coal Mozambique
(RTCM). The takeover was completed in August 2011, at a cost of over US$3.7 billion.
Prior to the acquisition of Riversdale, Rio Tinto had recognised two major impairment write-
downs on its subsidiary, Alcan.
Rio Tinto defined RTCM as a cash generating unit (CGU), which included $1.8 billion in
intangible assets related to exploration and evaluation of mining assets. (These are accounted
for under IFRS 6 Exploration for and Evaluation of Mineral Resources and are beyond the scope
of the CA Programme at this time.)
The plan for RTCM was to mine coal and use barges to transport between 30 and 45 metric
tons of coal annually for 540 kilometres via the Zambezi River in Mozambique. These transport
plans, along with the quality of the coal at the site, were central to establishing the recoverable
amount of the CGU. US Securities and Exchange Commission (SEC) alleged Rio Tinto assumed
that Riversdale’s mining sites in Mozambique could produce over 25 million tons of hard
coking coal per year by 2020 (relatively rare and demands a higher market price compared to
thermal coal). Before Rio Tinto’s acquisition, Riversdale estimated that there were 13 billion
tonnes of coal resources at the site. Rio Tinto’s own due diligence assessment of Riversdale
estimated the coal resources to be approximately 7 billion tonnes.1
In its court complaint, SEC stated that Rio Tinto had determined in October 2011 that the river
barges could not be used to transport coal at the capacity expected and the transport capacity
United States Securities and Exchange Commission v. Rio Tinto plc, Rio Tinto Limited,
1
Thomas Albanese and Guy Robert Elliott (SEC v Rio Tinto) 1:17-cv07994 (2017).

ACT
was revised to 10 million tonnes of coal per year. In addition, RTCM’s attempts to negotiate
transport arrangements with the government of Mozambique were not successful.2, 3
On 6 February 2012, the Rio Tinto Audit Committee was told that the reported reserves and
resources (the amount and quality of coal in the mine sites) would be significantly lower than
anticipated at acquisition, but were also informed that these would still be ’substantial and able
to underpin the significant growth planned by RTCM’ 4.
On 18 April 2012, the Government of Mozambique rejected RTCM’s proposed integrated
transportation system, which includes barging coal up the Zambezi River in addition to rail and
port. An RTCM manager described the meeting as follows5:
’the government again rejected the notion of barging coal on the Zambezi River, and made it
absolutely clear to me that they did not wish to have the barging matter raised again with government.
So effectively that meeting killed dead the bid model that had been developed for the acquisition
of Riversdale’
During May 2012, modelling was done within Rio Tinto, indicating that the estimated net
present value estimated by RTCM, which did not include barging as a method for transporting
coal, was actually negative US$(680 million). However this information was not included in
reports to the Audit Committee. Instead, an impairment paper was drafted by controllers to
brief the Audit Committee. The paper documented that the issues affecting RTCM did not
constitute an impairment trigger6.
A decision was made not to undertake an impairment review for this CGU for the June 2012
Interim Financial Report
On 17 January 2013, Rio Tinto announced it expected to recognise a non-cash impairment
charge of approximately US$14 billion (post tax) in its 2012 full year results (i.e. 31 December
2012). This included approximately US$3 billion relating to RTCM. It was also announced that
Mr Albanese had stepped down from his role as Rio Tinto’s CEO. The CFO, Guy Elliott, also
resigned from the Rio Tinto group in April 2013.
In 2014, the RTCM assets were sold for US$50 million, less than 2% of its original acquisition price.
Legal action against Rio Tinto

On 17 October 2017, the Financial Conduct Authority (FCA) in the United Kingdom (UK) fined
Rio Tinto plc £27,385,400 for breaching the UK disclosure and transparency rules. In its report
the FCA concludes that Rio Tinto’s failure to treat the information as an indicator of impairment
under IAS 36 Impairment of Assets demonstrated a serious lack of judgement.
Subsequently, the US Securities and Exchange Commission (SEC) charged both Rio Tinto’s
former CEO and former CFO with fraud, launching a court action in October 2017, which is
still ongoing.
The Australian regulator, the Australian Securities and Investments Commission (ASIC)
launched action on 2 March 2018, which it expanded in May 2018, for breaches of Corporations
Act and failure to apply the Accounting Standards. Again, this action is ongoing.
Guy Elliott, the former CFO, was not an accountant, but had risen through internal ranks at
Rio Tinto. In his profile in Accountancy Age, Mr Elliot was quoted as saying:
‘I don’t want to beat a drum on the subject, but there are several types of CFO,’ he says.
‘I don’t pretend to be a great expert on the minutiae of accounting standards, but I don’t feel
at a disadvantage not being an accountant, either. I would even say that my background in
2 Ibid.
3 Financial Conduct Authority (FCA), ‘Final Notice 2017: Rio Tinto plc’, 17 October 2017,
at 4.23–4.37.
4 Financial Conduct Authority (FCA), ‘Final Notice 2017: Rio Tinto plc’, 17 October 2017,
at 4.27.
5 Ibid. at 4.29.
6 Ibid. at 4.49–4.51.

ACT
marketing, in operations management, in strategy, helps me in the job. An accountant has a
particular way of looking at things and I’ve picked up some of that – but my perspective is
probably somewhat different.’ 7
Task
For this activity, you are required to read the summaries in references below and:
1. Discuss how the requirements of IAS 36 Impairment of Assets should be applied to
the valuation of RTCM for Rio Tinto plc. Ensure your response refers to IAS 34 Interim
Financial Reporting.
2. Assume you are a Chartered Accountant. You have been asked to draft an impairment
paper for the board of directors stating there are no impairment indicators at 30 June 2012.
What are the ethical issues in this scenario? Support your response with specific references
from the current IESBA International Code of Ethics for Professional Accountants. (This can
be accessed after a free registration at www.ethicsboard.org).
References
•• Hall, Matthew 2018, ‘Financial Reporting lessons from Rio Tinto’, The Institute of Chartered
Accountants of Scotland, student blog, December, www.icas.com/education-and-
qualifications/fr-lessons-from-rio-tinto-student-blog, accessed 19 December 2018.
•• Financial Conduct Authority (FCA) 2017, ‘Final Notice 2017: Rio Tinto plc’ (Summary of
Reasons), December, www.fca.org.uk/publication/final-notices/rio-tinto-plc-2017.pdf,
accessed 19 December 2019.
Additional reading
•• Australian Securities and Investment Commission 2018, ‘18-061MR ASIC takes action
against Rio Tinto and its former CEO and CFO for misleading and deceptive conduct’,
media release, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2018-
releases/18-061mr-asic-takes-action-against-rio-tinto-and-its-former-ceo-and-cfo-for-
misleading-and-deceptive-conduct/, accessed 19 December 2018.
•• Ker, Peter 2018, ‘Firm Coal prices slowed Rio’s Riversdale write-down’, Australian Financial
Review, March, www.afr.com/business/mining/firm-coal-prices-slowed-rios-riversdale-
writedown-20180306-h0x34d, accessed 19 December 2018.
•• Lynch, David J and Hume, Neill 2017, ‘Rio Tinto charged with fraud in US and fined in
UK’, Financial Times, October, https://www.ft.com/content/163f2e3c-b38a-11e7-a398-
73d59db9e399, accessed 19 December 2018.
•• Rio Tinto 2013, ‘Rio Tinto impairments and management changes’, media release,
January, http://www.riotinto.com/media/media-releases-237_rio-tinto-impairments-and-
management-changes.aspx, accessed 19 December 2018.
•• Rio Tinto media release on SEC filing, October 2017
•• Stern Melanie 2010, ‘Profile: Guy Elliott, Rio Tinto CFO’, AccountancyAge, April, www.
accountancyage.com/aa/interview/1809501/profile-guy-elliott-rio-tinto-cfo, accessed
19 December 2018.
7 Stern Melanie 2010, ‘Profile: Guy Elliott, Rio Tinto CFO’, AccountancyAge, April, www.
accountancyage.com/aa/interview/1809501/profile-guy-elliott-rio-tinto-cfo, accessed
19 December 2018.

ACT
Activity 10.2 Suggested solution

1. Under IAS 34 Interim Financial Reporting, the interim financial report needs to explain
events and transactions that are ‘significant to an understanding of the changes in financial
position and performance of the entity’ (IAS 34 para. 15). This includes the recognition of
impairment losses under para. 15B (b).
This is detailed in the IAS 34 para B36:
This Standard requires that an entity apply the same impairment testing, recognition, and reversal
criteria at an interim date as it would at the end of its financial year. That does not mean, however,
that an entity must necessarily make a detailed impairment calculation at the end of each interim
period. Rather, an entity will review for indications of significant impairment since the end of the
most recent financial year to determine whether such a calculation is needed.
IAS 36 Impairment of Assets

Under IAS 36 para. 12(b), indicators of impairment include ’significant changes that
adversely affect the entity in the technological, market, economic or legal environment
in which it operates’. The falling estimates of coal transporting capacity towards the end
of 2011, and the Government of Mozambique’s refusal to consider further discussions
around the transport via barge (in April 2012), could certainly be judged as indicators of
impairment. This was exacerbated by the documented decline in quality and volume of coal
reserves at some sites versus estimates.
In addition, IAS 36 para. 12(g) states that internal sources of information indicating
impairment include internal reporting that indicates that the economic performance of an
asset is worse than expected. This includes where cash needs for operating or maintaining
an asset are significantly higher than those originally budgeted (IAS 36 para. 14(a)). Both the
rising estimates of transport costs and the internal financial modelling assessing a value of
US$(680 million) (which would have reflected adjusted expectations as to transport) should
have been considered as relevant sources of internal information for IAS 36 purposes.
While issues around impairment involve extensive professional judgement, it is possible
that these indicators should have triggered an impairment review of the RTCM CGU at
30 June 2012. If the impairment review was undertaken, and found that the recoverable
amount of RTCM exceeded its carrying amount at that time, an impairment loss should
have been recognised in the 30 June 2012 interim financial report.
2. Guy Elliott, the former CFO of Rio Tinto, was not an accountant or a Chartered Accountant.
He was therefore not bound by the IESBA Code of Ethics. However, a Chartered
Accountant placed in this position would have a number of ethical considerations.
Section 210.1 of the IESBA Code of Ethics states:
‘Professional accountants are required to comply with the fundamental principles and apply the
conceptual framework set out in Section 120 to identify, evaluate and address threats.’
The fine imposed by the FCA (UK) demonstrates the financial impact of unethical activity.
Further action could be taken by professional accounting bodies against any Chartered
Accountants governed by the IESBA Code of Ethics.
Assessment of threats
If any Rio Tinto employees were involved in the due diligence around the RTCM
acquisition, and were also involved in the impairment calculations, this may pose a self-
review threat (s. 120.6 A3) to the principles of objectivity and integrity.
An advocacy threat is created when a Chartered Accountant promotes the employer’s (or
client’s) interests to the extent that it compromises the Chartered Accountant’s objectivity
(s. 120.6 A3).

ACT
An intimidation threat could arise when actual or perceived pressures may cause a
Chartered Accountant to act unethically, in this instance, threatening compliance with the
fundamental principles of integrity and objectivity.
The assessment of threats needs to look at both the potential compromise of ethical
principles as well as any perception that ethical principles may be compromised. A
Chartered Accountant in this situation should document the threat and the actions taken.
The management of threats involves:
•• assessing whether these threats are at an acceptable level
•• assessing safeguards and putting in place additional safeguards that protect against the
threats, and may lower threats to an acceptable level
•• communicating to those charged with governance or recusing self from offering the
services or performing the work where the threats remain at an unacceptable level.
The safeguards may be within the entity (e.g. policies and procedures within Rio Tinto)
or may come from a professional body such as CA ANZ in the form of a risk of ethical
misconduct proceedings.
Section R200.9 states:
‘When communicating with those charged with governance in accordance with the Code, a
professional accountant shall determine the appropriate individual(s) within the employing
organization’s governance structure with whom to communicate. If the accountant
communicates with a subgroup of those charged with governance, the accountant shall
determine whether communication with all of those charged with governance is also
necessary so that they are adequately informed’
The ethical principles that may be at risk in drafting the requested impairment paper are:
•• Integrity – to be straightforward and honest in all professional and business
relationships. In the FCA UK final notice, the authority concluded that communications
with the audit committee of Rio Tinto excluded or minimised some key matters around
transport options and other issues that may have affected the professional judgements
made.
•• Objectivity – to not allow bias, conflict of interest or undue influence of others to
override professional or business judgments. In the FCA UK final notice, the previous
impairment losses recognised by Rio Tinto on Alcan, and the perceived pressure from
stakeholders to avoid any similar issues, contributed to the decisions by Guy Elliott and
Tom Albanese to avoid recognition of further impairment losses in the 30 June 2012
financial report.
•• Professional competence and due care – accountants have a duty to act with
professional competence and due care, diligently applying the requirements of the
Accounting Standards. Although it is an area requiring significant professional
judgement, the requirements of IAS 36 indicated an impairment review should have
been performed at 30 June 2012.
•• Professional behaviour – professional accountants have a duty to comply with relevant
laws and regulations. Under s. 260 of the IESBA Code of Ethics, a Chartered Accountant
working at Rio Tinto plc had an obligation to act in the public interest if they became
aware of breaches of financial reporting laws in the UK. Actions may have involved
alerting management to deter non-compliance with UK laws. Non-compliance with
laws and regulations (NOCLAR) creates a self-interest or intimidation threat to the
principles of integrity and professional behaviour. Non-compliance includes acts of
omission (i.e., omitting information from reports to the audit committee).

ACT
Unit 11: Provisions (including employee

benefit entitlements), contingent liabilities
and contingent assets
Activity 11.1
Calculating employee benefit liabilities
Introduction
Deciding when to account for an employee benefit liability requires a sound knowledge of
IAS 19. As a Chartered Accountant you may be required to demonstrate that knowledge in
order to account for employee entitlements in accordance with IAS 19.
•• Explain and account for a provision.
At the end of the activity you will be able to distinguish and account for short-term and other
long-term benefits, in accordance with IAS 19.
Scenario
You are a Chartered Accountant working for Bruxus Limited (Bruxus) and you report to Jack
Brown, the finance manager.
You have gathered the following information to allow you to calculate the employee benefit
liabilities as at 30 June 20X3:
Staff details for employee benefit liabilities at 30 June 20X3
Department
Description CEO Marketing Finance
Number of staff 1 4 3
Average annual salary $230,000 $63,000 $54,000
Average annual leave accrued at 30 June 20X3 6.5 days 10.5 days 20 days
Probability of actually taking LSL 30% 55% 95%
Average years of service 3 5 8
Anticipated salary increase per year 15% 8% 3%


ACT
All employees are expected to take their annual leave accrued in the next financial year and
their LSL as soon as they are entitled. All employees have an LSL employee benefit of eight
weeks for every 10 years of service.
Interest rate as at 30 June 20X3
Years to maturity %
10 5.10
9 5.04
8 4.97
7 4.90
6 4.79
5 4.69
4 4.61
3 4.44
2 4.44
1 4.45
On-costs of 10% will be incurred on any leave entitlements incurred.

The 30 June 20X2 statement of financial position included the following employee benefit
liabilities:
Balances in statement of financial position at 30 June 20X2
Leave type $
Annual 30,298
Long service 31,474
Annual leave taken during the year for these departments was $58,000 and was debited to the
liability account.
Assume that there are 260 working days per year when calculating the short‑term employee
benefit liability. Annual leave and LSL are allowable deductions for tax purposes when the
leave is taken (paid). Bruxus only calculates leave provisions at year end.
The tax rate is 30%.
Task
For this activity, which is in two parts, you are required to:
A. Calculate Bruxus’ employee benefit liabilities at 30 June 20X3.
B. Prepare the journal entries to record the short‑term and long-term employee benefit
liabilities at 30 June 20X3 and restate the related deferred tax balance at the reporting date.

ACT
Activity 11.1 Solution – Task A

Bruxus’ employee benefit liabilities at 30 June 20X3:
Employee benefit liabilities at 30 June 20X3
Leave type $
Annual 33,483
Long service 40,675
Step 1 – Identify the employee benefit liabilities to be calculated

A liability must be calculated for annual leave, which is a short-term benefit, and for LSL, which
is another long-term benefit.

Review the recognition and measurement requirements of IAS 19 in relation to short-term
benefits for the calculation of the liability for annual leave (IAS 19 paras 11–18) and other
long‑term benefits for the calculation of the LSL (IAS 19 paras 155–156).
Step 3 – Apply the Standard to calculate the annual leave liability

Annual leave is an accumulating absence and recognition occurs when the employee renders
the service that increases their entitlement to future compensated absences. Therefore, any
annual leave accrued at 30 June 20X3 must be recognised as a liability.
The liability is measured at the expected cost of the leave entitlement. As all employees are
expected to take their accrued annual leave in the next financial year, the cost to Bruxus will be
the current salary cost plus salary increase plus on-costs.
Calculation of annual leave liability

Department Average Salary Salary On-costs1 Annual Number Average Liability2
annual increase after cost of staff annual
salary increase leave
$ % $ $ $ days $
CEO 230,000 15 264,500 26,450 290,950 1 6.5 7,274
Marketing 63,000 8 68,040 6,804 74,844 4 10.5 12,090
Finance 54,000 3 55,620 5,562 61,182 3 20 14,119
33,483
Notes
1. On-costs are 10% of salary costs.
2. Calculated as: Annual cost ÷ 260 days × number of staff × average annual leave days.

ACT
Step 4 – Apply the Standard to calculate the LSL liability

To calculate the LSL liability, first, calculate the ‘service value’. This is the employee’s salary
at reporting date plus any employee-related costs (e.g. taxes paid by employers based on
employee wages), multiplied by the proportion of LSL entitlement they have accrued through
service provided to the reporting date.
Calculation of service value
Department Average On-costs Average Average Entitlement Service

annual annual years of rate1 value
salary salary plus service
on-costs
$ % $ $
CEO 230,000 10 253,000 3 0.0154 11,689
Marketing 63,000 10 69,300 5 0.0154 5,336
Finance 54,000 10 59,400 8 0.0154 7,318

Note
1. Amount of LSL accumulated for each year of service, calculated as 1 ÷ 10 × 8 ÷ 52 (1 ÷ number of years of service
required for LSL × number of weeks of LSL ÷ number of weeks in the year).
Second, inflate the service value to the anticipated future cash flow when the LSL is taken. This
is based on the date when it is expected the LSL will be taken, not when the employee is entitled
to LSL. In this case, employees are expected to take LSL as soon as they are entitled.
Inflate the service value to the anticipated future cash flow when LSL is taken
Department Service value Salary increase per Growth in salary Anticipated future
year factor1 cash flow
$ % $
CEO 11,689 15 2.6600 31,093
Marketing 5,336 8 1.4693 7,840
Finance 7,318 3 1.0609 7,764

Note
1. (1 + growth rate)n, where n = years remaining.
CEO = (1 + 0.15)7
Marketing = (1 + 0.08)5
Finance = (1 + 0.03)2
Third, discount the anticipated future cash flow to present value (PV) using the appropriate rate.
Discounted future cash flow
Department Anticipated future Discount rate Discount factor1 PV of anticipated

cash flow future cash flow
$ % $
CEO 31,093 4.90 0.71544 22,245
Marketing 7,840 4.69 0.79520 6,234
Finance 7,764 4.44 0.91678 7,118

Note
1. 1 ÷ (1 + discount rate)n, where n = years remaining.
CEO = 1 ÷ (1 + 0.0490)7
Marketing = 1 ÷ (1 + 0.0469)5
Finance = 1 ÷ (1 + 0.0444)2

ACT
Finally, multiply the PV of the anticipated future cash flow by the probability that the employee
will receive their LSL benefit (i.e. will still be employed when the LSL becomes payable) and by
the number of employees in each department.
LSL liability
Department PV of anticipated Probability Number of staff LSL liability

future cash flow
$ % $
CEO 22,245 30 1 6,674
Marketing 6,234 55 4 13,715
Finance 7,118 95 3 20,286
Total 40,675
Activity 11.1 Solution – Task B

The journal entries required to record the employee benefit liabilities at 30 June 20X3 are as
follows:

$ $
30.06.X3 Employee benefits expense 61,185
30.06.X3 Short-term employee benefits liability 61,185
To record the annual leave liability at the reporting date

$ $
30.06.X3 Deferred tax asset (DTA) 956
30.06.X3 Income tax expense 956
To record the movement in the DTA relating to the annual leave liability

$ $
30.06.X3 Long-term employee benefits liability 9,201
To record the movement in the LSL liability

$ $
30.06.X3 DTA 2,760
To record the movement in the DTA relating to the LSL liability

ACT
Step 1 – Calculate the liability at year end and prepare the journal
entries
The journal entry restates the liability from 30 June 20X2 to 30 June 20X3 by recognising the
related expense. The movement in the short‑term employee benefits liability is impacted by the
$58,000 annual leave paid during the year as this was debited to the liability account.
A reconciliation of the movement in the short‑term employee benefits liability account during
the year ended 30 June 20X3 is as follows:
Movement in short-term employee benefits liability
Item $
Opening liability at 30.06.20X2 30,298
Less: Leave paid (58,000)
Add: Current year expense1 61,185
Closing liability at 30.06.20X3 33,483
1. The current year expense represents the balancing item to arrive at the closing liability balance of $33,483,
which was calculated in Step 3 of Task A.
Step 2 – Calculate the deferred tax impact and prepare the journal
entry
As the annual leave is an allowable deduction for tax purposes when the leave is paid, the
recording of a liability will give rise to a deferred tax balance as it represents future income tax
deductions.
The carrying amount of the liability is the amounts recorded in the statement of financial
position, being $33,483.
The tax base of the liability is the carrying amount less future deductible amounts, as the full
amount is deductible in the future and the tax base is nil.
This will give rise to a DTA as follows:
Deductible
Carrying amount > Tax base = temporary
difference (DTD)
DTD × Tax rate % = DTA
The DTA balance would have been recorded in the 30 June 20X2 financial statements and,
therefore, it is only the movement in the DTA that needs to be recorded at 30 June 20X3.

ACT
The calculation of the movement in the DTA is shown in the following table:
Movement in DTA
Movement in liability Tax rate Movement in DTA

during year ended during year ended
30.06.X3 30.06.X3
$ % $
Annual leave liability 3,185 30 956

Note
The annual leave paid would result in an income tax deduction of $58,000, which will reduce the current tax liability
by $17,400 ($58,000 × 30%). This would be accounted for as part of the current tax liability calculated at 30 June 20X3,
which has been covered in the unit on income taxes.

ACT
Activity 11.2
Provisions, contingent liabilities and
contingent assets
Introduction
Deciding whether to account for a provision or disclose a contingent liability or contingent
asset in a set of financial statements requires a sound knowledge of IAS 37 together with the
use of judgement in applying the Standard to the specific facts of the particular situation. As a
Chartered Accountant you may be required to demonstrate such knowledge and judgement in
order to explain the impact of provisions, contingent liabilities and contingent assets in financial
statements, in accordance with IAS 37.
•• Explain and account for a provision.
•• Identify and explain a contingent liability.
•• Identify and explain a contingent asset.
At the end of the activity you will be able to distinguish and account for provisions, contingent
liabilities and contingent assets, in accordance with IAS 37.
Scenario
You are a Chartered Accountant working for Pinpoint PLC (Pinpoint) and you report to Sue
Bryan, the finance manager.
Pinpoint is facing the following legal claims which may affect its financial statements:
1. A claim against Pinpoint for patent infringement.
2. A claim by Pinpoint for defamation.
Part A: Impact of legal claims on Pinpoint’s 30 June 20X3 financial

statements
Information available for 30 June 20X3 financial statements
1. Claim against Pinpoint for patent infringement
In May 20X3, Simpatico Limited (Simpatico) an international fashion label based in Milan, took
legal action against Pinpoint for patent infringement.
Simpatico is seeking damages equal to $2 million. It asserts that Pinpoint’s new handbag
collection contains a number of bags bearing logos that closely resemble its patented signature
monogram.
Pinpoint is defending the claim and the company’s lawyers have indicated there is a 40%
probability of Pinpoint successfully defending the claim.
Pinpoint’s insurer, Towers Insurance Limited (Towers), has confirmed the policy will cover this
claim, however there is an excess of $100,000 payable by Pinpoint for claims of this nature.

ACT
2. Claim by Pinpoint for defamation

In January 20X3, a top-rating national television current affairs program, the National Enquirer,
ran a story on Pinpoint claiming that it was a ‘dodgy’ fashion label that regularly ‘ripped off’
designs from top international designers.
Since the story aired, Pinpoint’s sales have declined sharply. On advice from its lawyers,
Pinpoint is now suing the producers of the National Enquirer for defamation in the amount of
$10 million. Pinpoint’s lawyers believe there is a 75% chance of the claim being successful.
Part B: Impact of legal claims on Pinpoint’s 30 June 20X4 financial

statements
Information available for 30 June 20X4 financial statements
As at 30 June 20X4, Simpatico’s case against Pinpoint for patent infringement continues.
Pinpoint’s lawyers have advised that they estimate there is now a 55% chance of Pinpoint
successfully defending the claim.

In May 20X4, Pinpoint won the case against the National Enquirer and was awarded damages
of $600,000. This amount was received during June 20X4.
Task
For this activity, which is in two parts, you are required to explain the impact of the legal claims
on Pinpoint’s financial statements, in accordance with IAS 37, for:
•• 30 June 20X3 (Part A)
•• 30 June 20X4 (Part B).
Assume all amounts are material. Ignore any tax impact.
Tip
In the ‘Guidance on implementing IAS 37 Provisions, Contingent Liabilities and Contingent Assets’,
Section B, there is a decision tree summarising the Standard’s main recognition requirements for
provisions and contingent liabilities. This may assist you with this activity.

ACT
Part A: Impact of legal claims on Pinpoint’s 30 June 20X3 financial

statements
Given the likelihood of success, a payment is probable (i.e. more likely than not), and IAS 37
para. 36 requires a provision to be recognised as the best estimate of the present obligation.
Accordingly, a provision for the full amount of the claim of $2 million should be made.
The $1,900,000 reimbursement from the insurance company is recognised as a receivable (i.e. net
of the excess) because it is virtually certain that, if a payment is made to the claimants, the
insurance company will reimburse $1,900,000.
For this legal claim, a net expense of $100,000 will be recorded in Pinpoint’s statement of profit
or loss and other comprehensive income for the year ended 30 June 20X3, as this represents the
excess on the insurance policy (IAS 37 para. 54).
Disclosures concerning this provision and the related insurance recovery receivable will be
required. If disclosure of this information is likely to prejudice the interests of Pinpoint in
defending the legal claim, then this information need not be disclosed; however, the notes to the
financial statements would still have to disclose the general nature of the dispute, together with
the fact that the information has not been disclosed and the reason why (IAS 37 para. 92).
2. Claim by Pinpoint against the National Enquirer

It is probable, but not virtually certain, that Pinpoint will receive an inflow. Therefore, a
contingent asset should be disclosed, in accordance with IAS 37 para. 34. In a note to the financial
statements, there is a requirement to provide a brief description of the nature of the contingent
asset and an estimate of its financial effect, being the $10 million claim for damages (IAS 37
para. 89).
The steps outline a recommended approach for successfully completing Part A of this task.

Review the definitions of a provision, contingent liability and contingent asset as defined in
IAS 37 para. 10. The criteria for recognising a provision are detailed in IAS 37 para. 14, the
required treatment of a contingent liability is in IAS 37 paras 27 and 28, and the required
treatment of a contingent asset is in IAS 37 paras 31 and 34.
As the claim against Pinpoint is covered by the insurers, IAS 37 paras 53 and 54 are also relevant
regarding the recognition of reimbursements of expenditure required to settle a provision and
the net expense to be presented. Disclosures relating to provisions, contingent liabilities and
contingent assets are specified in IAS 37 paras 84–92.

Apply the recognition criteria in IAS 37 para. 14 to the scenario in order to determine the correct
classification of the $2,000,000 legal claim. These recognition criteria are depicted in a decision
tree in Implementation guidance B, which is useful in determining the classification of the
legal claim.

ACT
Application of the recognition criteria
Recognition criteria Application to the scenario
Present obligation as a result of As it is more likely than not that Pinpoint will be required to settle the claim
an obligating event there is a present obligation
The alleged patent infringement is the obligating event
Probable outflow of economic The solicitors believe there is a 60% chance of Pinpoint not successfully
benefit defending the case; therefore, it is more likely than not that a settlement of
the claim will be required
Reliable estimate The claim is for $2,000,000, which is therefore the best estimate of the
amount required to settle the claim
As the claim is covered by insurance, the probability of the reimbursement is assessed and
recognised in accordance with IAS 37 para. 53. A net expense of $100,000 should be presented
(IAS 37 para. 54) after netting the expected reimbursement against the likely damages.
Disclosures in the notes to the financial statements will also be required:
•• Provisions – details concerning the provision must include the nature of the obligation,
the likely timing of any outflow of economic benefits, and the amount of the expected
reimbursement which has been recognised as an asset (IAS 37 paras 84–85).
•• Prejudicial information – if disclosure of this information in paras 84–85 in relation to the
legal claim is likely to prejudice the interests of the entity then this information need not be
disclosed. However, the company must disclose the general nature of the dispute, together
with the fact that the information has not been disclosed and reason why (IAS 37 para. 92).

The claim against the National Enquirer meets the definition of a contingent asset; there is a
possible asset arising from a past event, the outcome of which will only be confirmed when the
claim is settled.
To determine how the contingent asset is treated in the financial statements, its probability
is assessed. In this case, the lawyers have advised of a 75% chance of success. This means the
contingent asset is probable and is treated in accordance with IAS 37 para. 34, with disclosures
specified in para. 89.
Part B – Impact of legal claims on Pinpoint’s 30 June 20X4 financial

statements
As it is no longer probable that Pinpoint will have to make a payment, there is no longer a need
to include a provision in the financial statements at 30 June 20X4 and, similarly, no longer a
need to include a receivable for the reimbursement from the insurance company.
This has the result of a reversal of the $100,000 expense relating to the insurance excess through
the statement of profit or loss and other comprehensive income for the year ended 30 June 20X4.
A note to the financial statements must be included, under contingent liabilities (IAS 37 para. 86),
relating to the court case, as although the obligation is no longer probable, it is not remote.
In the note to the financial statements, there is a requirement to provide a brief description of
the nature of the contingent liability and, where practicable, an estimate of its financial effect
and an indication of the uncertainties relating to the amount or timing of any payment required
(IAS 37 paras 86(a) and 86(b)).
In this note, the reimbursement that would be received from the insurance company should
there be a requirement of a payout should also be disclosed under IAS 37 para. 86(c).

ACT
However, if disclosure of this information is likely to prejudice the interests of Pinpoint in
fighting the legal claim, then this information need not be disclosed. However, the notes to the
financial statements would still have to disclose the general nature of the dispute, together with
the fact that the information has not been disclosed and the reason why (IAS 37 para. 92).

In May 20X4, Pinpoint was successful in its claim against the producers of the National Enquirer.
Thus, there is no contingent asset disclosure to be made in the 30 June 20X4 financial statements.
The steps outline a recommended approach for successfully completing Part B of this task.

The references from Part A of the task are still relevant for Part B. Paragraph 59 is also relevant
for this reporting period.

The recognition criteria are assessed in the following table:
Application of the recognition criteria
Recognition criteria Relevance to the scenario
Present obligation as a result of an As it is only possible (no longer probable) that Pinpoint will be
obligating event required to settle the claim there is a possible obligation as a
result of a past event
Probable outflow of economic benefit The solicitors believe there is a 55% chance of Pinpoint winning
the case
Reliable estimate Not applicable, as there is no longer a probable outflow
As the claim against Pinpoint does not meet the three recognition criteria it should be classified
as a contingent liability and treated in accordance with IAS 37 para. 28, with disclosure
requirements specified in paras 86 and 92.
It is important to remember that as the claim against Pinpoint was provided for in 20X3, the
provision and related reimbursement should be reversed in the financial statements for the year
ended 30 June 20X4 (IAS 37 para. 59).

The claim against the National Enquirer is now settled and is therefore no longer contingent.

ACT
Unit 12: Leases
Activity 12.1
Accounting for a lease by a lessee and lessor
Introduction
In your working career as a Chartered Accountant you will most likely encounter leasing
transactions. It is important that you understand how these should be accounted for under the
new leasing standard, IFRS 16 Leases (IFRS 16) as they are a common way for businesses to gain
the use of an asset.
•• Explain and account for lease transactions (for lessees).
•• Explain and account for lease transactions (for lessors).
At the end of this activity you will be able to account for a lease from the perspective of both a
lessee and a lessor.
Scenario
You are a Chartered Accountant working for Brightwell Limited (Brightwell). You report to
Lauren McGee, the financial controller.
Brightwell has entered into a lease agreement for a piece of equipment from Lease-Right
Limited (Lease-Right). The lease contract gives Brightwell the right to use the equipment for
the period of the lease. The equipment is an identified asset and the contract is a lease for the
purposes of IFRS 16.
Lease-Right operates a finance business. It does not manufacture or trade in physical assets.
Terms of the lease

The lease commences on 30 June 20X3 and ends on 30 June 20X7. It includes the following key
terms:
Lease payments Four equal, upfront annual payments of $60,000 with the first payment to be made on
30 June 20X3
Purchase option Brightwell has the option to pay $40,000 on 30 June 20X7, which will result in the
transfer of legal ownership of the equipment. Brightwell is reasonably certain of paying
this amount as it intends to use the equipment for a further two years beyond the end of
the lease
Interest rate The interest rate implicit in the lease is 9%


ACT
Brightwell
•• Calculates the lease liability at the commencement date as follows:
Calculation of lease liability at the commencement date
Year Date Payment PV factor PV cash

flow
$ $
0 30 June 20X3 60,000 1.0000 60,000
1 30 June 20X4 60,000 0.9174 55,046
2 30 June 20X5 60,000 0.8417 50,501
3 30 June 20X6 60,000 0.7722 46,331
4 30 June 20X7 40,000 0.7084 28,337
Lease 240,215
liability
•• Estimates the useful life of the equipment to be six years for accounting purposes.
•• Uses the straight-line depreciation method.
•• Incurs $4,000 in legal costs for arranging the lease.
•• Is subject to the following tax treatment for the lease:
–– can claim income tax deductions for lease payments and legal costs paid.
–– interest expense calculated for accounting purposes and accounting depreciation do not
give rise to a tax deduction.
•• Is subject to a 30% tax rate.
Lease-Right
•• Pays the fair value of the equipment amount of $240,215 to the third party manufacturer on
30 June 20X3.
•• Lease-Right correctly classifies the lease as a finance lease.
Tasks
For this activity you are required to perform the following tasks in relation to the lease:
1. Prepare the journal entries for Brightwell for the years ending 30 June 20X3 and 30 June
20X4. Ignore any tax effect entries required by IAS 12 Income Taxes (IAS 12).
2. Calculate the deferred tax balance to be recognised by Brightwell under IAS 12 at 30 June
20X4.
3. Prepare the journal entries for Lease-Right at 30 June 20X3. Ignore any tax effect entries
required by IAS 12.

ACT
Solutions
1. Journal entries for Brightwell
30 June 20X3
$ $
30.06.X3 Right-of-use asset 240,215
Lease liability 240,215
To record the lease liability and the right-of-use asset for the underlying asset being leased

$ $
30.06.X3 Right-of-use asset 4,000
Cash 4,000
To record the initial direct costs under the lease contract capitalised as part of the right-of-use asset

$ $
30.06.X3 Lease liability 60,000
Cash 60,000
To record the lease payment made in advance on the commencement of the lease
30 June 20X4
$ $
Cash 60,000
To record the lease payment made on 30 June 20X4

$ $
30.06.X4 Depreciation expense 40,703
Accumulated depreciation 40,703
To record the annual depreciation of the right-of-use asset over the six-year useful life of the underlying
asset (equipment) given the purchase option to take ownership of the asset ($244,215 ÷ 6)

ACT
In order to prepare the journal entries for the two years, you will need to:
i. Determine the amount to be recognised for the right-of-use asset (IFRS 16 para. 24)
ii. Prepare the lease repayment schedule for Brightwell by performing the calculations up
to 30 June 20X4 (IFRS 16 para. 36).
iii. Determine the correct timeframe for depreciating the right-of-use asset (IFRS 16
para. 32).
The lease repayment schedule is determined as follows (note that the complete lease
payment schedule has been provided):
Lease repayment schedule – Brightwell
Date Opening Interest Liability Lease Closing

liability expense1 reduction payment liability
$ $ $ $ $
30.06.X3 240,215 – 60,000 60,000 180,215
30.06.X4 180,215 16,219 43,781 60,000 136,434
30.06.X5 136,434 12,279 47,721 60,000 88,713
30.06.X6 88,713 7,984 52,016 60,000 36,697
30.06.X7 36,697 3,303 36,697 40,000 –
Note 1: The interest expense has been calculated at 9% of the opening balance. No interest is allocated to the first
lease payment as the payments are in advance.
2. Deferred tax balance calculation at 30 June 20X4
Item $
Carrying amount of the right-of-use asset ($244,215 right-of-use asset – $40,703 203,512
accumulated depreciation)
Net lease asset 67,078
Tax base 0
Taxable temporary difference ($67,078 carrying amount of the net lease asset – $0 tax base) 67,078
Deferred tax liability ($67,078 TTD × 30%) 20,123

ACT
IAS 12 does not specify how to determine the deferred tax relating to a lease. However, the
principles of calculating a temporary difference are applied.
Based on a practical interpretation of IAS 12:
•• The carrying amount of the lease can be determined by calculating the net lease asset or
net lease liability.
The $203,512 carrying amount of the right-of-use asset is calculated net of the
accumulated depreciation (as shown in the solution).
The $136,434 lease liability is determined from the lease payment schedule, or by
combining the effects of the journal entries relating to the lease liability in Task 1.
Accordingly, there is a net lease asset of $67,078.
•• The tax base of the lease can be determined by preparing a notional tax balance sheet.
This is because the definition of tax base in IAS 12 para. 5 states
The tax base of an asset or liability is the amount attributed to that asset or liability for tax
purposes.
The tax base is $0 as the lease is not recognised for tax purposes. Only the lease
payments and the initial direct costs are tax deductible. Accordingly, if a notional tax
balance sheet was being prepared, there would be $0 attributed to the right-of-use asset
and the lease liability.
Given there is a net lease asset, apply the appropriate asset rule (covered in Unit 4 under
’Tax base’ on p. 4-12)). Use the values of the carrying amount of the net lease asset and the
tax base to determine whether it is a deductible temporary difference or a taxable temporary
difference. As the $67,078 carrying amount of the net lease asset is greater than the $0 tax
base, there is a $67,078 taxable temporary difference.
To determine the deferred tax liability, the taxable temporary difference is multiplied by
Brightwell’s 30% tax rate.
3. Journal entries for Lease-Right

30 June 20X3

$ $
30.06.X3 Finance lease receivable 240,215
Cash 240,215
To record the net investment in the lease on its commencement with Brightwell and payment to
manufacturer for the equipment (IFRS 16 paras 67–68)

$ $
30.06.X3 Cash 60,000
Finance lease receivable 60,000
To record the lease payment made in advance on the commencement of the lease (IFRS 16 para. 76)

ACT
Activity 12.2
Integration of different topics into one scenario is an important skill for CA program
exams and professional practice. At this point in the activities, you are ready to attempt
Integrated Activity 2.
Please download this activity from MyLearning > Integrated Activities.

ACT
Unit 13: Earnings per share (EPS)
Activity 13.1
Calculating basic EPS
Introduction
An entity whose ordinary shares or potential ordinary shares are traded in a public market, or
that files, or is in the process of filing, its financial statements with a securities commission or
other regulatory organisation for the purpose of issuing ordinary shares in a public market, will
calculate and disclose earnings per share (EPS) in accordance with IAS 33.
In your role as a Chartered Accountant, it is likely you will be required to calculate EPS
and present EPS information as part of preparing financial statements, and/or use your
understanding of EPS to analyse and interpret an entity’s performance.
•• Calculate basic and diluted EPS for continuing and discontinued operations.
At the end of this activity you will be able to calculate basic EPS, taking into account the impact
of preference shares on issue and of changes in the number of shares outstanding during the
period, including partly paid ordinary shares and share buy-backs, in accordance with IAS 33.
Scenario
You are a Chartered Accountant working for Wohtle Limited (Wohtle), a publicly listed
company. You report to the group chief financial officer (CFO), James Clean.
James has provided you with a summary of information from the draft financial statements for
the year ended 30 June 20X2.
Extract from the Statement of profit or loss for Wohtle for the year ended 30 June 20X2
Description $’000
Revenue 255,500
Expenses (237,400)
Profit before income tax expense 18,100
Profit after tax 12,400


ACT
At 30 June 20X1, Wohtle had the following share capital:
Share capital at 30 June 20X1
Class of shares on issue Number of shares Amount

’000 $’000
Ordinary 10,000 25,000
Preference 1,000 3,500
Total share capital 11,000 28,500
The following movements occurred in share capital during the year ended 30 June 20X2:
Movements in share capital during the year ended 30 June 20X2
Date Class Details
20.10.20X1 Ordinary Public issue of 750,000 partly paid ordinary shares for $6 each, which was the
current share price at the time of issue. An amount of $4 was paid on allotment,
with the balance due in one year’s time. The partly paid ordinary shares were
entitled to participate in dividends from 1 January 20X2. Holders of partly paid
ordinary shares received 2⁄3 of the dividends received by fully paid ordinary
shareholders
16.12.20X1 Ordinary Buy-back of 250,000 fully paid ordinary shares for $6.50, which was the current
share price at the time of buy-back
11.04.20X2 Ordinary Private placement of 500,000 fully paid ordinary shares for $6.75, which was the
current share price at the time of issue
Preference shares are classified as equity, and dividends are paid half-yearly on 31 December
and 30 June at a rate of 10% per annum.
Task
For this activity you are required to calculate the basic EPS for Wohtle for the year ended
30 June 20X2.

ACT

The basic EPS for Wohtle for the year ended 30 June 20X2 is $1.18 per share.

Access IAS 33 and review the following paragraphs relevant to this task.
Paragraph Relevance to task
10 Provides the formula for calculating basic EPS
12–14 Details adjustments to profit or loss for the impact of preference shares on issue
19–21 Specifies the calculation of the weighted average number of ordinary shares outstanding
using a time-weighting factor
26 Details the required adjustment to the weighted average number of ordinary shares for
changes in the number of ordinary shares during the period
Appendix A, A15 Specifies the treatment of partly paid ordinary shares as a fraction of a share to the extent
they are entitled to participate in dividends
Step 2 – Calculate profit or loss attributable to ordinary equity holders

Applying the relevant guidance from IAS 33 paras 12 and 14, adjust the profit after tax
attributable to ordinary equity holders of the parent entity for preference share dividends.
Calculation of profit or loss attributable to ordinary equity holders of the parent entity
Description Amount
$
Profit after tax attributable to ordinary equity holders of the parent entity 12,400,000
Less: Preference share dividends
– 31 December 20X1 ($3,500,000 × 10%) × 6 ÷ 12 (175,000)
– 30 June 20X2 ($3,500,000 × 10%) × 6 ÷ 12 (175,000)
Profit attributable to ordinary equity holders of the parent entity 12,050,000

ACT
Step 3 – Calculate the weighted average number of ordinary shares

Applying the relevant guidance from IAS 33 paras 19 and 20, prepare a table of all movements
in ordinary shares during the period to calculate the weighted average number of ordinary
shares using time-weighting factors.
Weighted average number of ordinary shares
Details Period Days in Number of Cumulative Weighted

period shares shares average
number of
ordinary
shares
Ordinary shares 01.07.20X1– 168 10,000,000 10,000,000 4,602,740

15.12.20X1
Share buy-back 16.12.20X1– 16 (250,000) 9,750,000 427,397

31.12.20X1
Partly paid ordinary 01.01.20X2– 100 500,000 10,250,000 2,808,219

share issue (2⁄3 dividend 10.04.20X2
participation)*
Share issue 11.04.20X2– 81 500,000 10,750,000 2,385,616

30.06.20X2
365 10,223,972
*P
artly paid shares were treated as a fraction of an ordinary share to the extent that they were entitled to participate in
dividends during the period relative to a fully paid ordinary share. The partly paid shares were issued on 20 October
20X1 but were entitled to a 2⁄3 dividend participation from 1 January 20X2. The partly paid shares were therefore
included at 750,000 × 2⁄3 from 1 January 20X2.
Step 4 – Calculate basic EPS

Basic EPS (calculated to two decimal places)
Weighted average number of ordinary
Basic earnings ÷ = Basic EPS
shares
$12,050,000 ÷ 10,223,972 = $1.18

ACT
Activity 13.2
Calculating diluted EPS
Introduction
An entity whose ordinary shares or potential ordinary shares are traded in a public market, or
that files, or is in the process of filing its financial statements with a securities commission or
other regulatory organisation for the purpose of issuing ordinary shares in a public market, will
calculate and disclose earnings per share (EPS), in accordance with IAS 33.
In your role as a Chartered Accountant, it is likely you will be required to calculate EPS
and present EPS information as part of preparing financial statements, and/or use your
understanding of EPS to analyse and interpret an entity’s performance.
•• Calculate basic and diluted EPS for continuing and discontinued operations.
At the end of this activity you will be able to calculate diluted EPS, taking into account the
impact of dilutive potential ordinary shares on earnings and the weighted average number of
shares, in accordance with IAS 33.
Scenario
You are a Chartered Accountant working for Best Limited (Best), a listed company. You report
to the financial controller, Raj Patel.
Raj has provided you with a summary of instruments (other than ordinary equity shares) that
Best has on issue at 30 June 20X2 (and were all on issue at 1 July 20X1):
Summary of other instruments on issue
Instrument* Number on issue Terms
Convertible notes 2,000,000 7% interest, $1 each, convertible to one ordinary share per
$1 of debt if not repaid in cash
Convertible preference shares 1,000,000 $1 each, 12% dividend per annum, 25 preference shares
convertible to one ordinary share at any time
Options 500,000 Convertible to one ordinary share per option, with an

exercise price of $5
*A
ssume that for the purposes of IAS 32, the convertible notes are classified as a financial liability while the convertible
preference shares and options are classified as equity.
Raj also advises you that interest on the convertible notes is deductible for income tax purposes;
however, dividends on the convertible preference shares are not deductible.
On 1 September 20X1 Best acquired the business of a smaller competitor, Mandle. Part of the
acquisition price comprised 200,000 ordinary shares to be issued on 31 August 20X2, contingent
on Mandle earning a profit before tax of $600,000 for the year to 31 August 20X2. For the
10 months to 30 June 20X2, Mandle earned a profit before tax of $650,000.

ACT
Raj has also provided you with the basic EPS calculation for the year ended 30 June 20X2.
Basic earnings ÷ Weighted average number of shares = Basic EPS
$14,364,000 ÷ 11,400,000 = $1.26
The average share price of Best shares for the year ended 30 June 20X2 was $6.60. Best’s tax rate
is 30%.
Task
For this activity you are required to calculate the diluted EPS for Best for the year ended
30 June 20X2.

ACT

The diluted EPS for Best for the year ended 30 June 20X2 is $1.06 per share.

Access IAS 33 and review the following paragraphs relevant to the task.
Paragraph/ Relevance to task

Illustrative
example
31 The adjustments to profit or loss and to the weighted average number of shares outstanding
for the impact of dilutive potential ordinary shares
33 The adjustments to profit or loss attributable to ordinary equity holders of the parent entity
for dividends, interest and other changes in income or expense that would arise if dilutive
potential ordinary shares were converted into ordinary shares
36–38 To calculate diluted EPS, the weighted average number of ordinary shares outstanding for
basic EPS is adjusted for the impact of dilutive potential ordinary shares
39 The conversion of dilutive potential ordinary shares is calculated on the basis most
advantageous to the holders
41 Potential ordinary shares are only treated as dilutive when their conversion to ordinary shares
would decrease basic EPS
44 In determining whether potential ordinary shares are dilutive, each issue is considered
separately, from the most dilutive to the least dilutive
45–47 Options are dilutive where the issue price is less than the average market price of shares. The
extent of dilution is limited to the difference between the number of shares on issue, less the
number of shares that would be issued at the average market price using the proceeds from
the conversion
52–53 Contingently issuable shares are included in the calculation of diluted EPS if the conditions
are met, or would be met if the period end were the end of the contingency period
Illustrative Provides an example of the calculation of the weighted average number of shares, including
example 9 the determination of the order in which to include dilutive instruments

ACT
Step 2 – Calculate the earnings per incremental share from potential ordinary
shares
Determine the impact on earnings and the number of ordinary shares that would be issued,
assuming that all potential ordinary shares are converted to ordinary shares. Calculate the
earnings per incremental share for each category of potential ordinary shares.
Potential ordinary shares – incremental earnings
Description Increase in Increase in Earnings per

earnings number of incremental
ordinary share
$ shares $
Convertible notes 98,000 1 2,000,000 0.05
Convertible preference shares 120,000 2 40,000 3.00
Options Nil 121,212 3

Nil
Contingently issuable shares Nil 166,027 4 Nil

Notes
1. $2,000,000 × 7% × (1 – 0.30).
2. $1,000,000 × 12%.
3. The assumed proceeds from the options ($2,500,000) are regarded as having been received from the issue of ordinary
shares at the average market price ($2,500,000 ÷ $6.60 = 378,788 shares at average market price). The difference
between the number of shares issued and the number of shares that would have been issued at the average market
price (500,000 – 378,788 = 121,212) are the shares that are deemed to have been issued for no consideration.
4. The contingently issuable shares are included in accordance with IAS 33 para. 52, because the contingency (profit
before tax of $600,000 for the year to 31 August 20X2) would have been satisfied if the period end (30 June 20X2)
were the end of the contingency period (as the profit before tax to 30 June 20X2 was $650,000).
The number of contingently issuable shares included in the diluted EPS calculation is the number that would be
issuable, included from 1 September 20X1 (and weighted for the period), which was the date of the contingent share
agreement (200,000 × 303 ÷ 365).
Step 3 – Rank potential ordinary shares

The order in which to include the dilutive instruments in the diluted EPS calculation is
determined by the earnings per incremental share calculation, from lowest to highest; the lowest
representing the most dilutive. Therefore the ranking is:
Instrument Earnings per incremental share
Contingently issuable shares Nil1
Options Nil
Convertible notes $0.05
Convertible preference shares $3.00

1. These rank before the options as they would result in 166,027 ordinary shares being issued versus 121,212 for the
options, and therefore have a greater dilutive effect.

ACT
Step 4 – Calculate diluted EPS

To calculate diluted EPS, each issue is considered separately, from the most dilutive to the least
dilutive.
Dilutive effect of potential ordinary shares
Earnings Ordinary EPS Dilutive

$ shares $ Yes/No
Basic EPS 14,364,000 11,400,000 1.2600
Contingently issuable shares Nil 166,027
14,364,000 11,566,027 1.2419 Yes
Options Nil 121,212
14,364,000 11,687,239 1.2290 Yes
Convertible notes 98,000 2,000,000
14,462,000 13,687,239 1.0566 Yes
Convertible preference shares 120,000 40,000
14,582,000 13,727,239 1.0623 No
As the convertible preference shares are anti-dilutive, since they cause the calculation to
increase, they are not included in diluted EPS.
Therefore, diluted EPS for Best for the year ended 30 June 20X2 is $1.06 per share (rounded from
$1.0566).

ACT
Unit 14: Share-based payments
Activity 14.1
Accounting for a cash-settled share-based
payment transaction
Introduction
In a cash-settled SBP transaction a liability arises based on the price of the entity’s equity
instruments. As a Chartered Accountant you may be required to account for a cash-settled SBP
transaction, in accordance with IFRS 2 Share-based Payment (IFRS 2).
•• Identify and account for share-based payments.
At the end of this activity you will be able to account for a cash-settled SBP transaction,
in accordance with IFRS 2.
Scenario
You are the financial controller at Heath Engineering Products Limited (HEP). HEP has
introduced a new SBP scheme to align management’s incentives to shareholder value.
On 1 July 20X3 HEP granted 200 cash-settled share appreciation rights (SARs) to each of its
50 managers on the condition that the managers remain in its employ until 30 June 20X6.
The SARs will automatically vest on 30 June 20X6 for all managers still employed by HEP.
The SARs can be exercised up to two years after they vest (i.e. to 30 June 20X8).
Details of the number of managers leaving the scheme and exercising their SARs are shown
in the following table.
Manager numbers relevant to SARs
Year ending Number of managers Number of managers expected Number of managers who
who departed to depart in future years exercised SARs
30.06.X4 4 6 n/a
30.06.X5 3 2 n/a
30.06.X6 2 n/a 15
30.06.X7 n/a n/a 14
30.06.X8 n/a n/a 12


ACT
The cash paid out equals the intrinsic value of the SARs at the date of exercise. The fair value
and the intrinsic value of the SARs for each year of the scheme are shown in the following table.
Value of SARs
Year ending Fair value Intrinsic value

$ $
30.06.X4 12.00 –
30.06.X5 16.10 –
30.06.X6 19.60 15.00
30.06.X7 22.75 20.00
30.06.X8 – 25.00
Task
For this activity you are required to prepare the journal entries to record the SARs over the
five‑year period from grant date, 1 July 20X3, to the end of the exercise period, 30 June 20X8.
Ignore the impact of tax and assume that all managers exercised their SARs on the last day
of the relevant reporting period.

ACT

Journal entries to record the SARs over the five-year period from grant date, 1 July 20X3, to the
end of the exercise period, 30 June 20X8, are as follows:
Year 1

$ $
30.06.X4 Employee benefits liability 32,000
Record cash-settled SBP transaction
Year 2

$ $
Year 3

$ $
30.06.X6 Bank 45,000
Year 4

$ $
30.06.X7 Bank 56,000
Year 5

$ $
30.06.X8 Bank 60,000

ACT

Review IFRS 2 for guidance on accounting for cash-settled SBP transactions, specifically
paras 30–33.
IFRS 2 Implementation guidance IG Example 12 provides an example of accounting for cash-
settled SBP transactions.
Step 2 – Calculate the expense and liability for the SARs for the first year
Calculate the expense and liability to be recognised at 30 June 20X4. The services provided
by the managers and the liability incurred are measured at the fair value of the liability (IFRS 2
para. 30). As the managers have to complete three years of service, the expense and liability are
recognised over the three-year period (IFRS 2 para. 32).
The expense to be recognised for year ending 30 June 20X4 is calculated as:
Number of
Number Expense
managers Fair value Proportion
of SARs Opening for SARs for
for whom it of shares at of vesting
× granted × × – liability for = year ending
is expected reporting period
to each SARs 30 June
that SARs date completed
manager 20X4
will vest
(50 – 4 – 6) × 200 × $12.00 × ⁄3

1
– $0 = $32,000
There is no opening liability; therefore, $32,000 is the liability for SARs balance at 30 June 20X4.
Step 3 – Prepare the journal entry

Step 4 – Calculate the expense and liability for the SARs for the second year
The liability is remeasured to fair value at each year end until the liability is settled.
Any changes in fair value are recorded in profit or loss for the period (IFRS 2 para. 30).
Number of Number Expense
Fair value Proportion
managers for of SARs Opening for SARs for
of shares at of vesting
whom it is × granted × × – liability for = year ending
reporting period
expected that to each SARs 30 June
date completed
SARs will vest manager 20X5
(50 – 4 – 3 – 2) × 200 × $16.10 × ⁄3

2
– $32,000 = $56,013
The current year expense is added to the prior year liability; therefore, $88,013 ($56,013 +
$32,000) is the liability for SARs balance at 30 June 20X5.

Step 6 – Calculate the expense and liability for the SARs for the third year
The liability at 30 June 20X6 must reflect the fair value of the outstanding liability. The SARs that
were exercised on 30 June 20X6 should not be included in the liability.

ACT
Number Expense
Number of of SARs Opening for SARs for
managers holding × granted × × – liability for = year ending
reporting period
unexercised SARs to each SARs 30 June
date complete
manager 20X6
(50 – 4 – 3 –2 – 15) × 200 × $19.60 × ⁄3

3
– $88,013 = $13,907
The current year expense is added to the prior year liability; therefore, $101,920 ($13,907 +
$88,013) is the liability for SARs balance at 30 June 20X6.
In addition, 15 managers exercised their SARs on 30 June 20X6 and cash paid out for each SAR
equals the intrinsic value. The cash payment is $45,000 (15 × 200 × $15.00) and this amount will
be expensed, as the liability of $101,920 reflects the outstanding liability at 30 June 20X6.

Step 8 – Calculate the expense and liability for the SARs for the fourth year
The liability at 30 June 20X7 must reflect the fair value of the outstanding liability. The SARs that
were exercised on 30 June 20X7 should not be included in the liability.
Number Expense
Number of managers of SARs Opening for SARs for
holding unexercised × granted × × – liability for = year ending
reporting period
SARs to each SARs 30 June
date complete
manager 20X7
(50 – 4 – 3 –2 – 15 – 14) × 200 × $22.75 × ⁄3

3
– $101,920 = ($47,320)
The current year expense is added to the prior year liability; therefore, $54,600 (($47,320)
+ $101,920) is the liability for SARs balance at 30 June 20X7.
In addition, 14 managers exercised their SARs on 30 June 20X7 and cash paid out for each SAR
equals the intrinsic value. The cash payment is $56,000 (14 × 200 × $20.00).

Step 10 – Calculate the expense and liability for the SARs for the final year
The remaining SARs were exercised on 30 June 20X8, and therefore no liability is outstanding
at 30 June 20X8. The liability is currently recorded at $54,600 and this can be derecognised.
Twelve managers exercised their SARs on 30 June 20X8 and cash paid out for each SAR equals
the intrinsic value. The cash payment is $60,000 (12 × 200 × $25.00).


ACT
Unit 15: Business combinations
Activity 15.1
Accounting for a business combination
Introduction
While some entities’ growth strategies may involve organic growth through expanding their
customer base and product offerings, other entities may pursue a growth strategy that focuses
on business acquisitions. Under IFRS, business acquisitions are termed ‘business combinations’.
Accounting for a business combination is prescribed by IFRS 3 Business Combinations (IFRS 3).
•• Identify a business combination.
•• Explain and account for a business combination in the books of the acquirer.
•• Account for subsequent adjustments to the initial accounting for a business combination.
At the end of this activity you will be able to account for a business combination in accordance
with IFRS 3.
Scenario
You are a recently qualified Chartered Accountant working at Starc Industries Limited (Starc).
Peter Cartus, the chief financial officer of Starc, has recently been heavily involved in
negotiations over the acquisition of an Australian-based company. In seeking to achieve cost
savings and improvements in its supply chain, Starc acquired a controlling interest in To Be
Sure Limited (TBS), a company that manufactures zips and buttons. TBS has a patented zip
design and it guarantees that its zips will never catch or run off the track. Starc acquired an
80% interest on 1 April 20X2, with the founding shareholders retaining a 20% interest and a seat
on the board.

ACT
Acquisition information
At the acquisition date:
•• the recorded net assets of TBS were represented as follows:
TBS net assets at 1 April 20X2
Description $
Share capital (1,000,000 shares) 1,000,000
Retained earnings 3,740,000
Total equity 4,740,000
•• the identifiable assets and liabilities of TBS were recorded at fair value except for:
–– Plant and equipment, which had a fair value of $1,200,000 while the carrying amount
was $920,000 (cost $1,000,000 and accumulated depreciation of $80,000). At 1 April 20X2,
it was estimated the remaining useful life was five years. TBS did not record an asset
revaluation.
•• TBS was a defendant in an ongoing lawsuit. The plaintiff is seeking $380,000 in damages.
This information was disclosed in the notes to TBS’s most recent financial report, but
no amount was recognised as a liability. At 1 April 20X2:
–– The legal counsel for TBS estimates that there is a 30% chance of the plaintiff being
successful.
–– TBS would have needed to pay $150,000 (which would be tax deductible to TBS) for
a third party to assume responsibility in respect of this claim.
Starc has chosen to measure any goodwill using the full goodwill method for this business
combination. The fair value of the NCI at acquisition was measured as $980,000.
Purchase consideration
The purchase consideration comprised cash and shares, as follows:
•• $1,100,000 cash payable at the acquisition date.
•• $400,000 cash due 12 months after the acquisition date.
•• The issue of one share in Starc in exchange for two shares acquired in TBS. At the date the
acquisition was announced to the market, Starc’s shares were trading at $6.90 and at the
acquisition date were trading at $7.10. Share issue costs of $20,000 were incurred.
•• Starc’s incremental borrowing rate is 12%.
•• Starc’s financial statements for the year ended 30 June 20X2 were approved on 16 September
20X2.
•• On 1 October 20X2 the law suit was settled out of court by TBS, paying the plaintiff
$140,000. Assume that the fair value of the NCI measured at 1 April 20X2 does not change
as a result of the settlement.
Assume
All amounts are material.
The tax rate of both TBS and Starc is 30%.

ACT
Tasks
For this activity you are required to perform a number of tasks in relation to the business
combination to assist Peter Cartus in preparing for a board presentation:
A. Prepare the journal entries to be recorded by Starc as a result of the acquisition of TBS
at 1 April 20X2.
B. Calculate the value of goodwill as at 30 June 20X2 and 30 June 20X3.
C. Prepare the journal entries to be recorded by Starc in the 12 months to 1 April 20X3,
ignoring any entries that may be required by IAS 12 Income Taxes.

ACT

A. Journal entries recorded by Starc as a result of the acquisition of TBS at 1 April 20X2:
Acquisition of the investment in TBS

$ $
01.04.X2 Investment in TBS 4,297,160
Cash 1,100,000
Deferred consideration payable 357,160
Share capital 2,840,000
To record the acquisition of the investment in TBS
Share issue costs

$ $
01.04.X2 Share capital 20,000
Cash 20,000
To record the share issue costs related to acquisition of the investment in TBS

ACT
B. The value of goodwill at 30 June 20X2 is $446,160 and at 30 June 20X3 is $439,160, calculated
as follows:
Goodwill calculation as at 30 June 20X2 and 30 June 20X3

30 June 20X2 30 June 20X3
Item $ $ $ $
Consideration transferred 4,297,160 4,297,160
Fair value of NCI 980,000 980,000
5,277,160 5,277,160
Assets acquired
Book value of net assets acquired 4,740,000 4,740,000
Fair value adjustments (all amounts are
net of tax, where applicable)
Plant and equipment (($1,200,000 – 196,000 196,000
$920,000) × (1 – 30%))
Recognition of contingent liability (105,000) (98,000)
20X2: ($150,000 × (1 – 30%)) = (105,000)
20X3: ($140,000 × (1 – 30%)) = (98,000)
FVINA 4,831,000 4,838,000
Goodwill acquired 446,160 439,160
C. Journal entries to be recorded by Starc in the 12 months to 1 April 20X3 (ignoring tax effect
entries):
Interest expense on deferred consideration
$ $
To record the interest expense on the deferred consideration to 30 June 20X2

$ $
To record the interest expense on the deferred consideration from 1 July 20X2 to 1 April 20X3
Payment of the deferred consideration

$ $
01.04.X3 Deferred consideration payable 400,000
Cash 400,000
To record the payment of the deferred consideration to the former shareholders of TBS

ACT
The steps outline a recommended approach for successfully completing the tasks.
Task A
Step 1 – Identify the journal entries required
Journal entries will be recorded in Starc’s general ledger for the investment in TBS and for the
share issue costs associated with the acquisition.
Step 2 – Apply the Standards

Consider each item of consideration to establish at what value it should be included in the cost
of investment in accordance with IAS 39 paras 43 and AG64.
Cost of investment in TBS – 1 April 20X2

Description $
Cash – payable at acquisition 1,100,000
Deferred consideration 1
357,160
Shares issued2 2,840,000
Investment in TBS at initial recognition 4,297,160
Notes
1. To measure the fair value of the deferred consideration, it is discounted using a discount rate reflecting the acquirer’s
incremental borrowing rate (in this case 12%). Therefore, the fair value of the deferred payment is calculated as:
$400,000 × present value of a single dollar at 12% for one year = $400,000 × 0.8929 (1 ÷ 1.12) = $357,160.
2. The shares are valued at their fair value, calculated as: 1 share in Starc × 800,000 ÷ 2 shares acquired in TBS × $7.10 fair
value = $2,840,000.
The $20,000 in share issue costs are accounted for as a deduction from equity under IAS 32
para. 35. As they are not part of the fair value of the consideration given, they are not netted
against the $2,840,000 in determining the amount initially recognised for the investment.
Step 3 – Prepare the journal entries

Prepare the journal entry to record the acquisition of TBS in Starc’s accounting records based on
the amounts calculated in Step 3 together with the journal entry for the share issue costs.
The journal entries are shown in the solution.
Task B
Calculating goodwill under IFRS 3 utilises the concept of consideration transferred.
Review IFRS 3 paras 37–40 to recap on what should be included in the consideration transferred
and paras 51–52 regarding what is part of the business combination.
Review the definition of ‘goodwill’ in IFRS 3 Appendix A.
Review IFRS 3 paras 45–50 detailing the measurement period when adjustments are made to
provisional amounts recognised at the acquisition date.

The consideration transferred is $4,297,160.
Goodwill acquired on the acquisition of TBS is calculated as ((fair value of consideration + fair
value of NCI at acquisition) – (FVINA)). The tax effect of any fair value adjustments should be
taken into account.

ACT
The goodwill calculation at 30 June 20X2 is calculated based on the exit price applicable to the
contingent liability at the acquisition date. The plaintiff has claimed $380,000 in damages but
the lawyers believe TBS will successfully defend the case. The 30% chance of losing the case
indicates that TBS would have only disclosed a contingent liability in its financial statements as
the probability of an outflow is 50% or lower (IAS 37 para. 10(b)(i)). Accordingly, the after tax
effect of the $150,000 exit price value is subtracted in calculating the FVINA.
The goodwill at 30 June 20X3 reflects the settlement of the contingent liability within the
measurement period. As the measurement period shall not exceed one year from the date of
acquisition (i.e. to 31 March 20X3), any new information obtained about facts and circumstances
that existed at 1 April 20X2 and would have changed the measurement of goodwill are
adjusted for in accordance with IFRS 3 para. 45. As a result, an adjustment needs to be made
to the FVINA for the contingent liability as the settlement of the lawsuit occurred within the
measurement period.
Step 3 – Perform the calculation

The goodwill calculation for the two years are shown in the solution.
[Note that in Unit 16 the consolidation journal entries will be covered including those relating to
the measurement period adjustment.]
Task C
Step 1 – Consider any transactions/accounting entries in the year to 1 April 20X3
Items that directly affect Starc need to be recorded in Starc’s records, as follows:
Interest expense on deferred consideration

This represents the unwinding of the discount of $42,840 on the deferred consideration payable
($400,000 – $357,160), which is recognised as interest expense. Three months of this interest
($10,710) would have been expensed in Starc’s 30 June 20X2 financial statements, with the
remaining nine months worth of interest ($32,130) expensed in the year ended 30 June 20X3.
Payment of the deferred consideration

The deferred consideration of $400,000 was paid on 1 April 20X3.
Step 2 – Prepare the journal entries

The journal entries are shown in the solution.

ACT
Unit 17: Equity accounting
Activity 17.1
Accounting for an investment in an associate
under the equity method of accounting
Introduction
An investor may have significant influence over an entity which could give it a strategic
advantage while generating strong returns and appreciation in the investment’s value.
Accounting for an investment in an associate is prescribed by IAS 28 Investments in Associates
and Joint Ventures (IAS 28) and involves the application of the equity method of accounting.
IAS 28 also specifies the recognition and measurement rules for investments in associates.
•• Explain and account for an investment using the equity method.
At the end of this activity you will be able to account for an investment in an associate in
accordance with IAS 28.
Scenario
You are a Chartered Accountant working for Benaud Limited (Benaud). You are currently
involved in preparing Benaud’s consolidated financial statements for the year ended 30 June
20X3.
On 1 July 20X1 Benaud acquired a 40% interest in the ordinary issued capital of Touch of Bling
Accessories (TOBA) for $2.5 million. In so doing, it achieved significant influence over TOBA.
Further information about TOBA is given below:

ACT
Acquisition of TOBA
Identifiable net assets of TOBA at the date of
acquisition – 1 July 20X1
Item $
Share capital 1,500,000
Revaluation surplus 1,800,000
General reserve 1,550,000
Retained earnings 950,000
Total 5,800,000
All assets and liabilities were stated at fair value except for an item of machinery which had a
fair value of $300,000 in excess of its book value. The depreciation rate on the machinery is 20%
on a straight‑line basis.
Profits earned and dividends paid by TOBA

Profits earned and dividends paid by TOBA for the years ending 30 June 20X2
and 20X3
Item 20X2 20X3

$ $
Profit before income tax 750,000 460,000
Income tax expense (190,000) (120,000)
Profit for the period 560,000 340,000
Dividends paid (400,000) (300,000)
Reserve balances
Reserve balances in the books of TOBA at 30 June
20X2 and 30 June 20X3
Reserve $
Revaluation surplus 2,000,000
General reserve 1,550,000
During the 20X2 financial year, TOBA sold inventory to Benaud on the basis of cost plus 25%.
The total value of sales for the year was $4 million. Of this total, $400,000 remained on hand
as at 30 June 20X2 and was sold to external parties in the 20X3 reporting period.
The tax rate for both Benaud and TOBA is 30%.
Task
For this activity you are required to prepare the journal entries as at 30 June 20X3 to apply the
equity method of accounting in the consolidated financial statements of Benaud, reflecting the
two years since the acquisition of TOBA occurred.

ACT

The journal entries as at 30 June 20X3 applying the equity method of accounting in the
consolidated financial statements of Benaud are as follows:
Journal 1
$ $
30.06.X3 Dividend revenue 120,000
30.06.X3 Investment in TOBA 120,000
To record the elimination of dividends received by Benaud during the 20X3 year
Journal 2
$ $
30.06.X3 Share of TOBA’s revaluation surplus 80,000
To record the share of TOBA’s post-acquisition revaluation surplus
Journal 3
$ $
30.06.X3 Retained earnings brought forward 24,800
30.06.X3 Share of TOBA’s profit after tax 141,600
To record the recognition of Benaud’s 40% share of TOBA’s post-acquisition retained earnings and profit after
tax for the 20X3 year

ACT

Review IAS 28 for guidance on accounting for an associate. The following paragraphs are
relevant:
•• Paragraph 3 defines the equity method.
•• Paragraphs 2, 4 and 44 explain whether the equity method is applied in the investor’s
general ledger or on the consolidation worksheet with consolidation journal entries.
•• Paragraph 10 explains how the equity method affects the carrying amount of the
investment.
•• Paragraphs 26–39 explain in detail the procedures involved in applying the equity method.
Step 2 – Identify the approach to apply the equity method of accounting for the
investment
Establish the approach to prepare the journal entries as at 30 June 20X3 to apply the equity
method of accounting:
•• Calculate goodwill or any negative goodwill included in the cost of the investment.
•• Prepare all necessary equity accounting journal entries and adjustments.
•• Calculate the equity carrying amount at 30 June 20X3.
Step 3 – Calculate goodwill or any negative goodwill in the cost of the

investment
Apply the requirements of IAS 28 to calculate goodwill or any negative goodwill in the cost of
the investment at the acquisition date. Goodwill arising is included in the carrying amount of
the investment; however, if there is any negative goodwill in the cost of the investment it will be
included as income in the period of acquisition via an equity accounting journal entry.
Perform the calculation by comparing the investment cost with Benaud’s share of the net fair
value of TOBA’s identifiable assets and liabilities.
Calculation of the value of goodwill included in Benaud’s investment cost for TOBA
Description $
Book value of net assets at acquisition 5,800,000
Add: fair value adjustment on machinery ($300,000 net of tax effect 30%) 210,000
Fair value of identifiable net assets 6,010,000
× 40% interest 2,404,000
Cost of investment in TOBA 2,500,000
Goodwill 96,000
Goodwill arising on the acquisition of TOBA is $96,000. IAS 28 paras 32(a) and 42 state that any
goodwill is included in the carrying amount of the investment; that is, it is not recognised as a
separate asset. As such, no equity journal entry will be required in regard to the $96,000.
Step 4 – Prepare all necessary equity accounting journal entries and

adjustments
A number of issues must be addressed through the equity accounting journal entries.
It is important to note that the equity accounting journal entries are notional entries
(i.e. recorded on the consolidation worksheet only), as Benaud prepares consolidated financial

ACT
statements (IAS 28 para 44). Note: The equity method is applied in an investor’s separate
financial statements if it is not a parent in a consolidated group.
The equity accounting journal entries need to reflect:
•• The 20X3 dividend received from TOBA.
•• The post-acquisition revaluation surplus.
•• The post-acquisition retained earnings, including current year profit as adjusted for intra-
group transactions, and depreciation based on fair value of the machinery at the acquisition
date.
Benaud’s share of the 20X3 dividend is $120,000 (40% × $300,000), which needs to be eliminated.
The journal entry is presented in the solution.
As the 20X2 dividend is reflected in the post‑acquisition opening retained earnings it does not
require adjustment.
Benaud’s share of the post-acquisition movement on the revaluation surplus is $80,000
(($2,000,000 – $1,800,000) × 40%). The journal entry is presented in the solution.
To calculate the post-acquisition opening retained earnings and current year profit, adjustment
needs to be made for:
•• The unrealised profit on inventory sold by TOBA to Benaud.
•• The depreciation based on the fair value of the machinery at the acquisition date.
A table can be used for these calculations:
Post-acquisition opening retained earnings and profit after tax
Description Post-acquisition Current year profit

opening retained after tax
earnings
$ $
Opening retained earnings1 1,110,000
Less: pre-acquisition retained earnings (950,000)
Post-acquisition opening retained earnings 160,000
Current year profit after tax 340,000
After-tax effect of fair value adjustments
Depreciation on machinery2 (42,000) (42,000)
After-tax effect of unrealised profits on inter-entity

transactions
Unrealised profit in inventory at 01.07.X2, realised in 20X33 (56,000) 56,000
Adjusted opening retained earnings 62,000
Adjusted current year profits 354,000
40% interest 24,800 141,600
Notes
1. $950,000 opening retained earnings at 1 July 20X1 + $560,000 profit for 20X2 – $400,000 dividend for 20X2 (IAS 28
para. 10).
2. $300,000 × 20% = $60,000 × (1 – 30%) = $42,000 (IAS 28 para. 32).
3. $400,000 – ($400,000 ÷ 1.25) = $80,000 × (1 – 30%) = $56,000 (IAS 28 para. 28).
Benaud’s 40% interest is used for the journal entry to record the post-acquisition movement
in retained earnings for TOBA. The journal entry is presented in the solution.


Fin119 Activities PDF

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Chartered Accountants Program

Financial Accounting & Reporting

Unit 1: Financial reporting AU

Activity 1.1 (Australia)

Unit 1 – Activities Page 1-1

Page 1-2 Activities – Unit 1

Company details for reporting requirements

Consolidated revenue $19.8 million $26.2 million $83.5 million

Consolidated gross assets $11.1 million $12.8 million $10.3 million

Consolidated net assets $5.2 million $8.7 million $7.2 million

Number of full time 51 37 47

Average number of full 47 36 51

Unit 1 – Activities Page 1-3

Page 1-4 Activities – Unit 1

Activity 1.1 (Australia ) Solution – Task A AU

Unit 1 – Activities Page 1-5

AU Item: Expected future restoration costs

Does it satisfy the requirements for recognition in the financial statements?

Page 1-6 Activities – Unit 1

Recommended approach – Task A

Step 1 – Review the conceptual framework (2018)

Step 2 – Apply the definitions of asset and liability from the

Step 3 – Apply the recognition criteria from the Conceptual

Step 4 – Form a conclusion as to whether the items should be

Activity 1.1 (Australia ) Solution – Task B

Unit 1 – Activities Page 1-7

AU Activity 1.1 (Australia ) Recommended approach – Task B

Step 1 – Review the IESBA Code

Step 2 – Consider each of the fundamental ethical principles and

Fundamental ethical Explanation At risk?

Confidentiality The issue does not relate to the disclosure of information No

Step 3 – Form a conclusion on the key fundamental ethical principle

Page 1-8 Activities – Unit 1

Activity 1.1 (Australia ) Solution – Task C AU

Annual reporting requirements

Company Requirement Justification

Kappa Special purpose financial report Kappa is a non-reporting entity

Activity 1.1 (Australia ) Recommended approach – Task C

Step 1 – Review the relevant guidance for establishing the reporting

Step 3 – Establish whether the entity is a reporting entity

Professional judgement is exercised in determining whether an entity is a reporting entity – the

Unit 1 – Activities Page 1-9

Step 4 – Establish whether entities required to prepare a GPFR have

Step 5 – Form a conclusion as to the annual reporting requirements

Page 1-10 Activities – Unit 1

Activity 1.1 (Australia ) Solution – Task D AU

Requirement to lodge a financial report

Company Requirement Justification

Eta Lodge a financial report Large proprietary company and no

Activity 1.1 (Australia ) Recommended approach –

Step 1 – Review the criteria for preparing and lodging financial

Unit 1 – Activities Page 1-11

Company details for reporting requirements

Company Threshold Delta Exceed Eta Exceed Theta Exceed

Consolidated $25 million $19.8 N $26.2 Y $83.5 Y

Consolidated $12.5 $11.1 N $12.8 Y $10.3 N

Classification Exceed at Small Large Small

Step 3 – Consider other relevant information in accordance with

Other relevant information

Company Detail Required to prepare?

Theta N/A As there is no other relevant

Page 1-12 Activities – Unit 1

Step 4 – Consider other relevant information in accordance with AU