P2 Exp Notes

Notes
ACCA Paper P2 (INT)

Corporate Reporting
For exams in 2012
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ExPress Notes

ACCA P2 Corporate Reporting
Contents
About ExPress Notes
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Group Accounting Foreign currency: IAS 21 Statements of cash flow: IAS 7 Provisions and contingencies: IAS 37 Taxation: IAS 12 Employment costs: IAS 19 Financial instruments: Share based payment: IFRS 2 Tangible non-current assets Intangible non-current assets: IAS 38 Impairment of assets: IAS 36 Revenue: IAS 18 Estimates, errors and accounting policies: IAS 8 Equity reconstructions (insolvency)
3
7 15 21 26 28 32 36 42 49 52 56 59 61 63
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ExPress Notes
Chapter 1
Group Accounting
START The Big Picture

Group accounting will form the backbone of the compulsory question 1 in the exam, and will be worth approximately a third of the marks in the exam. Most people do rather better in the groups part of the exam. Without doubt, groups are important, but be careful not to over-estimate the importance of groups in your preparation. Paper P2 is mostly not about group accounting! Although question 1 will be a groups question at its core, there will be lots of other adjustments in the individual accounts that require correction before the consolidation. These notes focus on the areas of groups that are new to paper P2 from paper F7, though we start with some core definitions and workings that should be familiar from paper F7. Consolidation is the process of replacing the single figure for investment in subsidiary in the individual financial statements of the parent with more useful information about what assets, liabilities, income and expenditure the parent company controls via its investment, ie:
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ExPress Notes
Net assets in the subsidiarys financial statements (ie equity or capital plus reserves) at the acquisition date. Consideration transferred to buy subsidiary (as shown in the parent companys individual accounts) Non-controlling interests share of the net assets of the subsidiary.
Goodwill arising on acquisition (premium paid to acquire the subsidiary). Consolidation is basically a double entry to derecognise the carrying value of the investment (Cr Investment in subsidiary) and recognise the individual assets (Dr PP&E, etc), the liabilities (Cr Payables, etc), the non-controlling interest (CR NCI) and recognise goodwill as a balancing, residual, item (normally DR Goodwill).
Key definitions
Subsidiary
What group accounting is trying to do
Any entity that is controlled by another entity, normally by having more than 50% of the voting power, though there is no minimum shareholding. An entity that controls one or more entities. A company in which the parent has significant influence, but not control nor joint control (as with a joint venture). An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.
Parent Associate Control
Significant influence Equity
The power to control the financial and operating policies of another entity, so as to obtain benefit from its activities. Equity is defined in the Framework document as assets less liabilities. By definition, this is the same as capital and reserves of any company at any date in time. In group accounting, we very frequently use the capital + reserves = net assets. For example,
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ExPress Notes
this is used to work out the net assets on the date of acquiring control of a company (as part of the goodwill working) and to work out post-acquisition growth in a subsidiarys assets (ie postacquisition profit). Group reserves The cumulative gains made under the control of the parent. The parent companys reserves, plus the post-acquisition retained gains of all subsidiaries, joint ventures and associates. Formerly called minority interest. The share of the net assets and gains of a subsidiary that is not owned by the parent. The premium paid by the parent to acquire its interest in a subsidiary or associate.
Non-controlling interest Goodwill
Key workings Hopefully familiar from paper F7, but revise thoroughly
Group retained earnings This working is a core means of earning good marks in the exam. Produce one column for each company under the parent companys influence. Then work down the rows methodically, perhaps using the mnemonic TOP TIP PET to make sure you havent forgotten anything. If the question has different types of reserves (eg revaluation reserve as well as retained earnings) you will need to do a separate working like the one below for each reserve to be shown in the group SOFP. Parent $000 Today Omissions/ errors to correct in the individual financial statements of each company Provision (eg for unrealised profit) Time passage effects (eg write-off of fair value adjustments) Impairments of goodwill (cumulative) Sub-total Pre-acquisition reserves Post-acquisition 10,350 (30) 10,350 4,110 (2,000) 2,110 2,970 (1,800) 1,170 4,500 (4,200) 300 10,000 400 (20) Sub 1 $000 4,000 200 (50) (40) 20 Sub 2 $000 3,000 (50) Assoc $000 4,500
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ExPress Notes
x Effective ownership x 100% 10,350 TOTAL 12,204 x 60 % 1,266 x 40% ** 468 x 40% 120
** This is not a typo! A subsidiary may still be a subsidiary if an effective ownership of less than 50% still gives the parent control. See multiple groups below.
Non-controlling interests These show the net assets controlled by the parent and so part of the group, but not actually owned by the parent. There is no need to consider pre- and post-acquisition profits when calculating non-controlling interests in the SOFP. Sub 1 $000 Capital and share premium at SOFP date Reserves, as consolidated (see eg above) Fair value adjustments at acquisition Less: Any items in the individual companys SOFP not recognised in the group SOFP (see below) Net assets (ie equity) as consolidated in the group SOFP x NCI % Non-controlling interest Total non-controlling interest Goodwill on a business combination Fair value of consideration transferred Less: Fair value of identifiable net assets acquired, calculated as: Capital and share premium of target Reserves of target at acquisition date Net assets (equity) of target at targets book value Fair value adjustments to targets net assets 800 2,000 2,800 250 2,240 800 4,110 250 (50) Sub 2 $000 400 2,970 (80) -
5,110 40% 2,044 4,018
3,290 60% 1,974
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ExPress Notes
Net assets (equity) of target at fair value X % acquired (60%) Goodwill arising in books of parent for consolidation Goodwill: gross (total) or net (partial)? The standard double entry working above produces a goodwill figures as it relates to the parents share. Imagine that the fair value paid for the subsidiary was the fair value for a 60% stake. Then we deduct 60% of the net assets. This logically gives 60% or thereabouts of the total implied goodwill (eg reputation, client list, motivated staff) of the subsidiary. IFRS 3 allows groups a choice with each acquisition whether to leave goodwill net as above, or gross it up to show the implied total value of goodwill. In order to do the gross up, it is necessary to be given the fair value of the non-controlling interests stake in the business at the acquisition date. This would be given in the exam. 3,050 (1,830) 410
EXAMPLE
1,350 2,240 3,590 (3,050) 540 410 130
Non-controlling interest at fair value at acquisition date Fair value of consideration transferred for 60% stake Implied total value of company Less: Fair value of identifiable net assets Implied total goodwill Partial goodwill automatically recognised (see above) Gross-up required for total goodwill recognition
This gross up, if chosen as the accounting policy, would be recognised as: Dr Goodwill Cr Non-controlling interests Fair values When buying a company, its previous owner will only accept the fair value of the company as consideration, or they will not sell! 130 130
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ExPress Notes
In order to give a true and fair picture of the actual goodwill purchased, it is therefore necessary to record all the assets and liabilities acquired in the subsidiary at their fair value. Fair value is defined in IFRS 13 as the price that would be received to sell an asset or paid to transfer liability in an orderly transaction between market participants at measurement date; i.e. it is an exit price or estimated using a valuation technique.A few notable fair value adjustments are: Consideration paid includes the market value of any shares paid. Any contingent consideration is valued assuming that it will be paid, even if this is not certain. Acquisition costs are written off immediately. Contingent liabilities of the subsidiary will be shown in the individual accounts at zero value (see notes on IAS 37), but their existence would reduce the amount the acquirer is willing to pay. They are therefore revalued as if they were provisions in the fair value exercise.
Changes in group structure Disposals The gain or loss on disposal of anything is the increase or decrease in net assets recognised as a result of the transaction. Proceeds (what is coming into the SOFP in the transaction) Less: Carrying value derecognised (what leaves the SOFP) Profit or loss on disposal (the increase or decrease in net assets) X (X) X
The carrying value of a subsidiary in a group SOFP comprises: Individual assets and liabilities of the subsidiary at the SOFP date Goodwill remaining from the purchase by the parent Non-controlling interests at the SOFP date.
Therefore, the gain or loss on derecognition of a subsidiary is: Proceeds (what is coming into the SOFP in the transaction) Less: Individual assets and liabilities of the subsidiary at the SOFP date (X) X
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ExPress Notes
Goodwill remaining from the purchase by the parent Non-controlling interests at the SOFP date Group gain or loss on disposal (X) (X) XX
The same working can be used to calculate gain or loss on partial disposal, where noncontrolling interest increases (eg where ownership goes from 80% to 60%). Where a holding goes from 80% to 40%, the calculation is amended slightly, as in addition to sales proceeds for the partial stake, there will also be a new associate recognised. Proceeds (what is coming into the SOFP in the transaction) Value of new associate recognised Less: Individual assets and liabilities of the subsidiary at the SOFP date Goodwill remaining from the purchase by the parent Non-controlling interests at the SOFP date Group gain or loss on disposal Step acquisitions Where an acquisition happens in stages (as it often does in reality), the treatment is to treat the acquisition as a purchase on the date when control happens. Also derecognise any previous holding, which might have been an available-for-sale financial asset or an associate. This results in an acquisition of a subsidiary and a gain or loss on disposal as part of the same transaction. In effect, step acquisitions use much the same logic as disposals, but in reverse. (X) (X) (X) XX X X
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ExPress Notes
Multiple group structures You should expect the structure of the group in question 1 in the exam to be a multiple group structure, such as: Parent Subsidiary 1 60% Subsidiary 2 The main additional maters to consider here are: What is the nature of the relationship between parent and subsidiary 2? Even if the effective ownership is less than 50% (as it is here), it may still be a subsidiary, as there is effectively a chain of command by which the parent can control subsidiary 2. Parent has control of subsidiary 1, which has control of subsidiary 2. In this example, the parent has an effective ownership of 36%, but has control. Subsidiary 2 is therefore consolidated as part of the Parent group, with noncontrolling interests of 64%. The dates of acquisition determine whether there is one goodwill calculation, or more. If Parent acquired Subsidiary 1 on 1.1.x1 and Subsidiary 1 acquired Subsidiary 2 on 1.1.x2, then there would be two transactions under Parents control, using resources controlled by Parent. This would require two goodwill calculations. However, if Subsidiary 1 had acquired Subsidiary 2 on 1.1.x1 and Parent acquired Subsidiary 1 on 1.1.x2, there would only be one transaction under Parents control, using Parents resources. This would give one goodwill calculation In the group SOFP, any historical costs of investments in subsidiaries are not included in the group SOFP, as the subsidiarys individual assets and liabilities are consolidated instead. This means that any cost of investment in Subsidiary 2 in the SOFP in Subsidiary 1 are excluded from the group SOFP and therefore NCI calculation. 60%
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ExPress Notes
Chapter 2
IAS 21

An entity cannot mix currencies when producing financial statements! Eg USD + EUR = Nothing useful. There are two sets of rules to know, depending upon where in the flow of transactions something is happening.
Foreign currency Translation rules Functional currency
Functional currency Presentation rules
Presentation currency
Generally, the currency that the entitys trial balance is produced in. The currency of the primary economic environment in which the company operates. Effectively the currency that the company thinks in.
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ExPress Notes
May not be the currency of the country in which the company operates, especially if the company is more like a branch of a foreign parent and depends upon the foreign parent for day-to-day support. All other currencies other than the functional currency are a foreign currency.
Key workings/ methods Translation rules
1 2 3A
Record all transactions in the functional currency. Record all purchases, sales, etc at the spot rate ruling on the date of the translation. At the period end: Translate monetary assets and liabilities at the closing rate. Dont retranslate non-monetary items. Exchange difference arising in the year on retranslation of foreign currency loans is reported in profit in finance income/ finance cost.
3 B
Exchange difference arising in the year on retranslation of foreign currency trade payables and receivables is reported in profit in other operating income/ other operating expenses.
Key workings/ methods Presentation rules
This is normally examined in the context of group accounting, but it could be examined as a single company only. An entity may choose any currency it likes for the presentation of its financial statements. Eg a company with a dual listing in the USA and in the European Union is likely to choose the US dollar as its presentation currency and also the euro as its presentation currency. The basic rules are simple: translate the financial statements using these rules: All items in the SOFP: translate at the closing rate. All items in the SOCI: translate at the average rate for the period, or spot rate for any large one-off items.
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ExPress Notes
Exchange differences will arise, eg imagine the position of Lear Co for the year ended 31 Dec 20x1: Date Net assets (equity) at 1 Jan 20x1 Profit for the year to 31 Dec 20x1 Other comprehensive income for the year to 31 Dec 20x1 Dividend declared for the year Net assets (equity) at 31 Dec 20x1 Assume these exchange rates USD/ EUR 1 Jan 20x1 Average for 20x1 31 Dec 20x1 Date Net assets (equity) at 1 Jan 20x1 Profit for the year to 31 Dec 20x1 Other comprehensive income for the year to 31 Dec 20x1 Dividend declared for the year Net assets (equity) at 31 Dec 20x1 Euro 10,000 2,000 1,000 (1,500) 11,500 Exchange rate 1.2 1.25 1.25 1.15 1.15 USD 12,000 2,500 1,250 (1,725) 13,225 1.2 1.25 1.15 Euro 10,000 2,000 1,000 (1,500) 11,500
This does not add up!
The error is an exchange difference arising in the year. This is not considered to be a realised gain or loss, so is reported directly in equity in the statement of changes in equity. It is not reported as part of other comprehensive income.
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ExPress Notes
So Lear Cos statement of changes in equity for the year ended 31 Dec 20x1 will show: Date Net assets (equity) at 1 Jan 20x1 Profit for the year to 31 Dec 20x1 Other comprehensive income for the year to 31 Dec 20x1 Dividend declared for the year Exchange gain on translation arising in the year (balancing item) Net assets (equity) at 31 Dec 20x1 USD 12,000 2,500 1,250 (1,725) 800 13,225 This exchange gain or loss arising on translation in the year is a gain in the reserves of the subsidiary for consolidation. It is therefore split between parent and non-controlling interests.
Groups and foreign currency

It is common to have to translate the financial statements of a subsidiary into the reporting currency of the parent prior to consolidation. This is simply an additional stage to complete prior to the process of consolidation.
Approach to questions with foreign subsidiaries:
1 2 3
Correct the individual accounts of each company for errors/ omissions in the individual accounts. Translate the subsidiarys financial statements into the presentation currency of the parent using the presentation rules. Consolidate as normal.
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ExPress Notes

Further aspects of foreign currency groups

Goodwill Goodwill on consolidation always arises in the books of the acquirer (ie parent) since it is the property of the parent company. The cost of buying the subsidiary from its previous owners can be broken down into: Net assets in the subsidiarys financial statements (ie equity or capital plus reserves) at the acquisition date. Non-controlling interests share of the net assets of the subsidiary.
Consideration transferred to buy subsidiary (as shown in the parent companys individual accounts)
Goodwill arising on acquisition (premium paid to acquire the subsidiary).
The goodwills value will vary with the exchange rate as the value of the subsidiarys future earnings in the parents currency will vary with the exchange rate. This means that goodwill must be revalued each year with a consequent revaluation gain or loss. This means that each year, goodwill must be calculated similarly to how the exchange gain or loss is calculated for the translation of the net assets of the subsidiary: Date Goodwill at 1 Jan 20x1 Impairment loss in the year to 31 Dec 20x1 Exchange difference in the year Goodwill at 31 Dec 20x1 Thisgainof50isagain madebytheparent,so partoftheparents reserves Euro 1,000 (200) 800 Exchange rate 1.2 1.25 balance 1.25 USD 1,200 (250) 50 1,000
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ExPress Notes

Key workings/ methods

Translation of subsidiarys financial statements for consolidation
Foreign currency () X X X X X X Exchange rate Year end rate Rate at acquisition Rate at acquisition balance Year-end rate Presentation currency ($) $X $X $X $X $X $X
Statement of financial position of subsidiary at the year-end Assets (top half of SOFP) Capital of subsidiary Reserves of subsidiary @ acquisition Post acquisition gains (balancing item) Liabilities Total equity and liabilities
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ExPress Notes
Chapter 3
IAS 7

These notes focus on group statements of cash flow. If you are unsure of single company statements of cash flow, you should revise the notes for paper F7 before studying these. Statements of cash flow for a group show cash and cash equivalents leaving the group of companies and coming into the group of companies. Intra-group cash flows are not reported. Group statements of cash flow are generally somewhat more straightforward than group statements of comprehensive income in the exam, since most of the adjustments required to group financial statements (eg intra-group balances, allowances for unrealised profit, fair value adjustments) are non-cash adjustments. Group statements of cash flow generally appear in question 1 of the exam, probably about one sitting in every five. They may alternatively appear in section B of the exam, but this is less common. They are one of the more popular subjects with students and the level of performance in the exam itself is likely to be strong if a cash flow question comes up, so you need to be well prepared for this topic.
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ExPress Notes
You should study group statements of cash flow after revising single company statements of cash flow from paper F7 and studying groups for paper P2. If you are reasonably comfortable with these two topics, group statements of cash flow are likely to give you few difficulties. These are the main techniques that you need to be familiar with when preparing a group statement of cash flow over a single company statement of cash flow: Reconciliation of profit to operating cash flow: impact of purchase/ sale of a subsidiary Impact of purchase/ sale of subsidiary on T account workings (eg property, plant and equipment) Cash paid to non-controlling interests Cash received from associates Disclosures on acquisition and disposal of a subsidiary (these are simple).
Key workings/ methods Reconciliation of profit before tax to cash from operations
A reconciliation is a statement explaining why two numbers do not agree. IAS 7 (indirect method) starts with profit before tax and reconciles this to cash flow from operations. The easiest way to do this is to reconcile EBIT (ie operating profit) to operating cash flow. An item will appear in the reconciliation if it does affect EBIT but does not affect operating cash flow, or vice versa. Affects Affects In EBIT? operating reconciliation? cash flow? Depreciation Impairment of goodwill in the year Credit sale made but not paid in cash (ie increase in receivables) Write-down of inventory to recoverable value Increase in tax payable Goods purchased on credit (ie increase in payables) Increase in provision for warranty costs Yes Yes Yes Yes No Yes Yes No No No No No No No Yes Yes Yes Yes No Yes Yes
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ExPress Notes
The only addition so far compared with statements of cash flow in paper F7 is the mention of goodwill impairment above. Normally, an increase in receivables is deducted, since this is a credit sale (which has been credited to revenue) but no cash received. When a subsidiary is purchased, it is likely that the subsidiary will have receivables in its SOFP at purchase. These will cause an increase in group receivables, but they will not have affected group EBIT. Think about it if the receivable existed when the subsidiary was purchased, that receivable must have been created by a pre-acquisition sale. Preacquisition revenue and expenses are not consolidated. Affects EBIT? No (preacquisition) No (preacquisition) No (preacquisition) Affects operating cash flow? No No No In reconciliation? No No No
Increase in receivables due to purchase of subsidiary Increase in payables/ accruals/ provisions due to purchase of subsidiary Increase in receivables/ prepayments due to purchase of subsidiary
This means that the usual working capital adjustments when you prepare the reconciliation of profit to operating cash flow needs to be amended. Since the year-end figure will include any receivables (etc) arising on a purchase of subsidiary, but these should be excluded from the reconciliation, they must be deducted in the calculation.
EXAMPLE
Edgar Co purchased a subsidiary Edmund Co on 30 September 20x1. On that date, Edmund Co had receivables in its SOFP of $1,200. Edgar Co and its subsidiaries at the start of 20x1 had receivables of $9,800 and on 31 December 20x1 had receivables of $11,450.
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ExPress Notes
The figure in the reconciliation of profit to operating cash flow in the year to 31 December 20x1 will be: Increase in receivables (11,450 1,200 9,800) (450)
Key workings/ methods Associates, non-controlling interests
In a group statement of cash flows, cash can come into the group from an associate (an associate is not part of the group, since its not controlled by the parent) and cash paid to non-controlling interests. The cash paid to non-controlling interest will be their share of dividend paid by the subsidiary. Both of these can be calculated using a T-account (or similar presentation), using the figures from the group SOFP.
1.1.x1 31.12.x1
b/d
EXAMPLE
Associate (SOFP) 10,000 31.12.x1 31.12.x1 2,000 12,000
Share of profit after tax
Cash received (balancing item) c/d
1,500 10,500 12,000
Non-controlling interests (SOFP) 1.1.x1 b/d Cash paid 700 31.12.x1 Share of profit of (balancing item) subsidiaries 16,800 31.12.x1 Share of other comprehensive income of subsidiaries 17,500 15,000 2,000 500
31.12.x1 31.12.x1
17,500
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ExPress Notes
Effect of acquisition or disposal of subsidiary The acquisition of a subsidiary in the year will increase the size of each item in the SOFP, as a result of the parent having control of a greater number of (eg) non-current assets. This increase will not represent a payment in cash directly for those non-current assets (any payment of cash to acquire control of a subsidiary was a payment to acquire shares!) This will need to be adjusted for in each item in the SOFP, eg:
Property, plant and equipment (SOFP) 1.1.x1 31.12.x1 31.12.x1 b/d Finance leases incepting in year Acquired via control of new subsidiary in year Cash paid to acquire new P,P&E in the year (balancing item) Revaluation surplus in the year X X X 31.12.x1 Disposals @ NBV X 31.12.x1 31.12.x1 Depreciation expense Impairment losses X X
31.12.x1
31.12.x1
X XX
31.12.x1
c/d
X XX
The actual acquisition itself will be shown as a single cash flow in the investing activities section of the statement of cash flows. This will be the cash paid (if any) by the parent to the previous owners of the subsidiary, less any cash balances of the subsidiary acquired.
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ExPress Notes
Chapter 4
IAS 37

Provisions are a form of liability, simply one of uncertain timing or amount. If requires an obligation (something that is legally or constructively impossible to avoid by any means). An intention is never an obligation, so an intention to incur an expense can never generate a provision. Initial valuation (provisions) For a series of events (eg multiple goods sold under guarantee), use the expected value of the outflow and discount if the time value of money is material. For a one-off event (eg a single litigation), use the single most probable outcome and discount if the time value of money is material.
Change in valuation: Update each period to the latest estimate. This is a change in accounting estimates, so an increase of $10,000 would be recorded in profit in the year when the estimate is changed, not as a prior period adjustment:
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ExPress Notes
Dr Expense Cr Provision $10,000 $10,000
Initial valuation (contingent liabilities) Given a value of zero, unless on a fair value adjustment on acquisition by another company. See groups notes. Summary diagram Provisions and contingent liabilities for individual companies
Probable: Possible: Remote: Reliable: Provide:
Greater than 50% estimated probability Greater than 5% and up to 50% estimated probability 5% of lower probability Any estimate which is more reliable than making no estimate Provide expected value and discount at an appropriate rate.
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Chapter 5
IAS 12

Current tax: The amount demanded by the tax authority in respect of taxable gains/ losses subject to tax in the current period. Generally an estimate at the year-end. Deferred tax: Future tax due on gains recognised in the current period but not assessed for tax until some future period. Generally a net liability, but can very occasionally be a net asset.
Deferred tax is pervasive in financial statements, though it is generally examined as either a part of a question or as a stand alone question on its own. Normally, questions instruct you to ignore deferred tax. In practice, you will need to consider the deferred tax position of every transaction where the accounting policy and the tax base (tax accounting policy see below) are not the same.
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Key definitions
Tax base
These are ExPs definitions, which are simplified for exam preparation purposes
The carrying value of the asset as it would be in the statement of financial position if the tax policy were used as the accounting policy, eg using taxable capital allowances instead of depreciation. The difference between the IFRS carrying value of an asset/ liability and its tax base. Both tax base and IFRS value start with purchase price and both will become zero when the asset is scrapped. This is not a phrase used in IAS 12, but its helpful in forming an understanding. This is where the tax base and the IFRS value of an asset or liability are always different, as a matter of principle. Eg government grant income received may never be taxable, though its income in profit. Goodwill gives a permanent difference since impairment losses on goodwill are never a tax deductible expense. The tax base of an investment in a subsidiary is historical cost of purchase, so goodwill never appears at all in the tax computation. The fact that it never appears makes it a permanent difference.
Temporary difference
Permanent difference
Exchange differences will arise, eg imagine the position of Lear Co for the year ended 31 Dec 20x1: Eg IFRS value in SOFP Less: Tax base Temporary difference Tax rate expected when the difference reverses Deferred tax Net deferred tax liability = 1,200 CR Property 10,000 DR 8,000 DR 2,000 DR 30% 600 CR Software 4,000 DR 500 DR 4,500DR 30% 1,350 CR Provisions 3,000 CR 0 CR 3,000 CR 25% 750 DR
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Exam approach
Calculation of deferred tax liability and SOCI effect

1 2
Go through the accounting policies of the entity and identify each one where the accounting policy (IFRS) is not the same as the tax base.
Identify which of these differences are permanent differences, eg: Business entertaining expenditure Government grants receivable Goodwill arising on consolidation.
State in your exam answer that this is a permanent difference, so has no future tax effects.
3 4
For each difference (other than permanent difference) calculate the temporary difference at the period end using the working above.
Multiply the temporary difference by the tax rate expected to be in force when the item becomes taxable (when it reverses). Note: Cr temporary differences produce Dr deferred tax assets Dr temporary differences produce Cr deferred tax liabilities
5 6
Look at all the deferred tax assets for evidence of impairment. Offset deferred tax liabilities against deferred tax assets with the same tax authority.
Calculate the movement on the deferred tax liability. This will be the total charge to the statement of comprehensive income for deferred tax.
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Split the movement on deferred tax liability in the year into the element reported in other comprehensive income and the rest that will be reported as part of the profit and loss charge for taxation in the period. This is done by matching the movement on deferred tax (eg caused by a property upward revaluation) with where the gain or loss causing that movement in deferred tax was reported.
7A
Work out the movement in deferred tax due to items reported in equity, eg: Property revaluation gains Movements in value on available-for-sale financial assets
7 B
Show the movement in deferred tax that isnt shown as gains taken to equity (step 7A) and show this as the deferred tax movement in profit.
Take the proportion of deferred tax movement on equity gains to equity.
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Chapter 6
IAS 19

Promises of pensions payable to staff are an expense of the sponsoring company. The act of making a promise to pay pensions creates an obligation (ie liability). This may be a liability to pay pension funds into a private pension plan, or a liability to pay a pension between retirement and death, depending on the pension type. There are two types of pension plan: defined contribution and defined benefit. Pension costs are fairly frequently examined. Although they seem difficult at first, they are surprisingly easy to deal with after working a few examples. To master the subject, you need to have: A good working understanding of double entry bookkeeping To understand the transaction itself (ie how a promise is made and assets set aside to cover the cost of honouring that promise) A methodical step-by-step approach to dealing with the numbers in a logical, chronological, sequence.
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Defined contribution
These are easy. The employer makes contributions into a savings scheme for the employee. All risks of the fund being inadequate to support the employee between retirement and death rest with the employee, not with the employer. They are therefore much more risky for the employee than for the employer. The accounting is simple: Impact on SOFP: None. Impact on SOCI: Contributions payable into the pension plan are an expense.
Defined benefit plans

These are considerably more complicated for the accountant and considerably more risky for the employer. Here, the employer promises to make future pension payments (an obligation, therefore a liability). Impact on SOFP: Pension plan assets (ringfenced assets from which future pensions will be paid). Pension plan liability (NPV of pensions promised by the year-end) Deferred costs and income (see below) Impact on SOCI: Service component: the cost of pensions promised in the year (current service cost and past service cost) that is charged to P/L. Net interest component: computed by applying the discount rate to measure the plan obligation to the net defined benefit liability or asset. This is charged/credited to P/L. Remeasurement component: includes actuarial gains and losses during the reporting period, including the returns on plan assets less any amount taken to P/L as part of net interest component. This is charged to OCI and will never be recycled to P/L in future periods. Actuarial gains/ losses If a pension plan is perfectly in balance, then the assets will precisely equal the liabilities. This is unlikely ever to happen, as the valuation of investments will be volatile. Also,
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assumptions about the actuarial liability (ie expected cost of paying an uncertain amount to pensioners until they die) will vary year by year. It is normal for a pension plan therefore to be slightly out of balance. Assets Liabilities Deficit
These unexpected movements give an actuarial gain or loss each period and are always a balancing item in the calculations, since (by definition) they are unexpected!
Key definitions
These are ExPs definitions, which are simplified for exam preparation purposes
The NPV of the extra pensions promised to staff in return for work they did this period. Defined benefit plans are characterised by offering greater pensions to people who have worked for the company longer, so one extra period of service increases pensions liability.(part of the service cost component). The NPV of the extra pensions promised to staff in return for work they did in the past. This is much less common than current service cost and might happen only if a company needs to eliminate an actuarial surplus on the pension plan (part of service cost component)..
Current service cost
Past service cost
Net interest component Relates to change in measurement in both the plan obligation and the plan assets arising from passage of time ans is reported as a separate component to P/L.
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EXAMPLE CordeliaCo
Below are given the fictional numbers of Cordelia Co, relating to Cordelia Cos defined benefit pension plan in the year to 31 December 20x1. Plan assets Pensions liability 9,500 CR 500 CR 200 CR 450 CR 210 DR 10,440 CR 10,200 CR 240 DR 1,920 CR 1,680 CR See below See below See below Profit and loss effect 500 DR 200DR 450 DR 600 CR
B/f @ start of period Current service costs Past service costs Interest charge Contributions paid into the plan (Dr Plan assets, Cr company cash) Pensions paid to pensioners Interest return Expected figure c/f Actual figure c/f => Remeasurement component (gain) => Remeasurement component (loss) Net actuarial loss in year
10,000 DR 180 DR 210 CR 600 DR 10,570 DR 8,650 DR
Recognition of actuarial gains and losses Actuarial gains and losses arise each year. Often they are self-correcting over time (eg a short-term stock market crash is likely to recover by it comes time to pay out the pensions promised).
Actuarial gains and losses arising during the accounting period (comprised in the remeasurement component) are recognised in OCI for the year and will not be recycled to P/L in future periods.
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Chapter 7
IAS 39

Although financial instruments appear frequently in the P2 exam, they are only at level 2 knowledge within the syllabus. This means that the scenarios in which they are tested are likely to be relatively straightforward. Its easy to spend too much time preparing for these accounting standards, since they cover a huge array of different possible transactions, from regular trade receivables to exotic currency and interest rate swaps. The best way to approach study is to know: The classifications of all financial instruments The difference in fair value and amortised cost accounting The possible ways in which any gain or loss (whether on a financial instrument or not) may be reported in financial statements.
If you are keen to take this as far as you can, then move on to study hedging, though this has generally only been worth a couple of marks in the exam.
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Financial liabilities When used... Example.... Trade payables, debenture loans, redeemable preference shares Fair value Fair value (derivatives and liabilities held for trading) or amortised cost.. Profit or loss Financial assets Trade receivables, options, investments in equity shares Fair value and will exclude transactions costs for all assets kept at FVPL Fair value (either to P/L or OCI) or amortised cost less impairements. Profit or loss/OCI ACCA P2 Corporate Reporting
Initial recognition Subsequent measurement
Gains or losses reported in...
When used... Example.... Example that cant be categorised this way Initial recognised value Year-end valuation method Gains or losses reported in...
Recognition and derecognition The recognition criteria for financial instruments are slightly different to the recognition criteria in many other IASs/ IFRSs. The intention is to ensure that as many as recognised as possible, for as long as possible. They are recognised when the entity becomes party to the contract rather than when control is obtained. They are derecognised only when its virtually certain that all the risks of a financial instrument have expired or have been transferred to another party.
Fair value accounting Fair value essentially means market value. So if the market is acting irrationally, then fair value may lead to dysfunctional financial reporting. This is a recent criticism of fair value accounting techniques.
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Fair values are determined as: Best achievable market value (but not deducting expected transaction costs), or Valuation using discounted cash flows that consider all matters relevant (eg expected cash flows, timing of cash flows, credit risk, market interest rates, or Exceptionally if no reliable DCF valuation is possible, historical cost.
Amortised cost Can apply to debt instruments only if the following two tests are passed: the business model test, and the contractual cash flow characteristics test. The business model test establishes whether the entity holds the financial asset to collect the contractual cash flows or whether the objective is to sell the financial asset prior to maturity to realise changes in fair value. If it is the former, it implies that there will be no or few sales of such financial assets from a portfolio prior to their maturity date. If this is the case, the test is passed. Where this is not the case, it would suggest that the assets are not being held with the objective to collect contractual cashflows, but perhaps may be disposed of to respond to changes in fair value. In this situation, the test is failed and the financial asset cannot be measured at amortised cost. The contractual cash flow characteristics test determines whether the contractual terms of the financial asset give rise to cash flows on specified dates that are solely of principal and interest based upon the principal amount outstanding. If this is not the case, the test is failed and the financial asset cannot be measured at amortised cost. For example, convertible bonds contain rights in addition to the repayment of interest and principal (the right to convert the bond to equity) and therefore would fail the test and must be accounted for as fair value through profit or loss. In summary, for a debt instrument to be measured at amortised cost, it will therefore require that: the asset is held within a business model whose objective is to hold the assets to collect the contractual cashflows, and the contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal outstanding.
EXAMPLE
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On 1 January 20x1, Cordelia Co issued a bond with a nominal value of $200,000, a coupon rate (ie cash paid) of 4% of nominal value. The bond is due for redemption on 31 December 20x5 for $200,000 (plus the coupon payable on that date). In reality, its likely that the effective rate would be worked out using a spreadsheet and the IRR function, which is illustrated below.
This means that by the end of the five year life of the bond, it has been transformed (amortised) from its initially recognised value to its redemption value of $200,000. So the charge or credit to profit for finance costs/ finance income is determined using the effective rate. The difference between interest calculated using the effective rate and the coupon paid/ received is the rolled up interest, which is added to the value of the bond each year. Reclassication Where an entity changes its business model, it may be required to reclassify its financial assets as a consequence, but this is expected to be infrequent occurrence. If reclassification does occur, it is accounted for from the first day of the accounting period in which reclassification takes place. Impairments
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All financial assets held at fair value are automatically revalued for impairments. If a financial asset measured at amortised cost appears to be impaired (eg if the credit risk increases a great deal), then the new impaired value must be calculated using: The revised expected cash flows and expected timing At the original discount rate.
Note that discounting the revised cash flows at the new rate (which would be higher, as the risk has increased) would double count the risk factor and result in undervaluation of the asset.
Hedging
The Big Picture

Hedging has only occasionally been tested in paper P2 and then normally as a relatively minor adjustment in question 1. It is common in practice and useful knowledge. Becoming expert in hedging should not be a top priority for most students studying for paper P2, since it can take a lot of time to master for a relatively low profile in the exam itself.
Hedged item: The thing the enterprise is worried about changing in value, eg: Foreign currency investment Foreign currency payable Variable interest rate loan resulting in higher than expected cash outflows Forecast future major purchase in a foreign currency becoming unaffordable due to changes in the exchange rate.
To remove or reduce this risk, the entity may buy something that is expected to move in value in the opposite direction to the hedged item. This counterweight is the hedging instrument and may be an almost infinite number of different financial instruments, though derivatives are common. Understanding the intricacies of how hedging relationships may be set up is not important for paper P2. Its useful to know how to account for movements in the hedged item and the hedging instrument.
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Though three types of hedge are mentioned in IAS 39, there are only two accounting treatments for hedges, so there are basically two types of hedge:
Fair value hedge. The hedging instrument was taken out in order to protect against value changes of an item recognised in the SOFP. Eg a foreign currency loan to protect against a foreign exchange chage in value ofa foreign currency receivable that is being shown in the SOFP.
Cash flow hedge. A hedge that is not a fair value hedge, broadly! This might be to protect against adverse movements in an item not in the SOFP yet. Eg an entity may structure its business plan around buying a ship from a foreign ship builder, but it has not yet placed a binding order. As there is no binding order, there is no obligation, so there is no liability. The forecast/ intended transaction is not yet a liability, though the company will want to ensure that they can afford the expected future cash outflow. To protect against adverse exchange movements making the ship unaffordable, the entity may hedge the foreign currency exposure, eg buy buying a foreign currency forward contract.
Accounting for hedges A fair value hedge is simple. Both the hedged item and hedging instrument will be in the SOFP and will record a gain and a loss. The accounting rules simply offset the gain on the hedged item with the loss on the hedging instrument, or vice versa. A cash flow hedge is a bigger challenge for the writers of the IAS! The hedging instrument will be a contract, so will be in the SOFP, but the hedged item will be an intention, so is not in the SOFP. Since the hedging instrument exists only because of the expected existence of the hedged item, the gain or loss on the hedging instrument is hidden in equity until the hedged transaction takes place.
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Chapter 8
IFRS 2

Prior to IFRS 2, listed companies often paid senior staff in shares that were issued below market value. These shares were then sold at a profit by the holders, with two effects: The holder made a profit on sale, which in substance was part of their total remuneration, and The other shareholders lost wealth (ie suffered an expense) as the share price fell by new shares being issued below market price.
Prior to IFRS 2, this was simply recorded as: Dr Cash (with actual cash received, below market value) Cr Capital/ share premium account. IFRS 2 remedies this by making an estimate of the loss to other shareholders by granting cheap shares and spreading that cost over the period the company gains benefit from the share scheme. IFRS 2 is an unpopular accounting standard with many preparers of accounts, who say that it generates artificial expenses, brings in highly subjective valuations as expenses and repeats the same information as IAS 33 diluted earnings per share.
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KEY KNOWLEDGE Suggested approach to questions
1A
2 3

Decide whether the scheme is entirely payment in shares, is a payment in cash that is linked to the share price or some mix of the two. This decides how the share based payment is valued, as the rules are different for pure equity schemes and schemes in cash. Equity settled: The holder is paid only in shares. He/ she has no right to a cash alternative. For a cash based payment, estimate For an equity settled transaction, the total liability that the plan estimate the total benefit of the generates. As this is a liability, it share plan to the holders by must be revalued at the end of multiplying the total number of each period to its latest value. cheap shares to be issued by the option of the share at its grant date. This option value will be given in the exam. It is then frozen at the value per share at the grant date it is never updated. Work out the vesting period. That is the period that staff must stay in the companys employment to be able to exercise their options over cheap shares. This is the period over which the cost/ benefit of the share option plan will be spread.
1B
Work out the cost of the share based payment each period, as: Latest estimate of total cost of the plan Divided by years between grant and vesting date Less: Costs cumulatively already recognised (X) Current period expense X X X (Expected total cost) (Total cost to date)
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REVIEW AND TEST 1 The Crossmen
On 1 January 20x1, Crossmen Coropration granted 5,000 options on shares to each of its 200 most senior staff. Each option is conditional upon each member of staff staying in the companys employment until 31 December 20x3. On 31 December 20x3, participating staff can continue to hold the share options and may choose to exercise them on 31 December 20x4 or 31 December 20x5. Each option allows the holder to buy Crossmen Co shares at a price of $1 each. You are given this data and are required to calculate the expense for each of the years in question.
Date
Fair value of option ($)
Number of participants expected to stay until 31 Dec 20x3 180 175 180 165 165 165
Share price ($)
1 Jan 20x1 31 Dec 20x1 31 Dec 20x2 31 Dec 20x3 31 Dec 20x4 31 Dec 20x5
3.30 3.40 3.45 2.95 3.10 3.30
4.00 4.20 4.25 3.80 3.95 4.30
Step 1: This is a pure equity settled transaction. Its value per share option is therefore frozen at the grant date. Total expected cost to the companys other shareholders: 5,000 x 180 x 3.30 = $2.97 million. Step 2: The vesting period is three years. Although people may stay longer than that, the company cannot presume that they will voluntarily stay longer than the minimum required. Step 3: The cumulative cost in each year is now worked out.
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Date Cumulative expense ($) 20x1 20x2 20x3 20x4 20x5 (5,000 (5,000 (5,000 (5,000 (5,000 x x x x x $3.30 $3.30 $3.30 $3.30 $3.30 x x x x x 175 180 165 165 165 x x x x x 1/3) 2/3) 3/3) 3/3) 3/3) 962,500 1,980,000 2,722,500 2,722,500 2,722,500 Expense Expense previously recognised recognised in year 0 962,500 1,017,500 2,722,500 2,722,500 962,500 1,017,500 742,500 0 0
31 31 31 31 31
Dec Dec Dec Dec Dec
The expense each year is recognised as: Dr Expense Cr Equity.
REVIEW AND TEST 2 Wright
On 1 January 20x1, Wright Co granted 15,000 cash appreciation rights to 150 of its staff. These rights gave a bonus in cash based on the price of Wright Cos shares. The cash appreciation rights offered a cash payment equal to the companys share price at the exercise date, less the share price at the grant date. Participants have to stay in Wright Cos employment until 31 December 20x3 in order for the rights to vest, though they may exercise on either 31 December 20x3, 31 December 20x4 or 31 December 20x5.
Date
Number of options exercised in the period (000s) 0 0 0 1,100 800 260
Number of participants expected to stay until 31 Dec 20x3 140 140 142 144 144 144
Share price ($)
1.20 1.45 1.50 1.52 1.60 1.48
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Step 1: This is a cash settled transaction, which therefore gives rise to a liability. As a liability, the expected value must be revalued each year. Step 2: The vesting period is three years. Although people may stay longer than that, the company cannot presume that they will voluntarily stay longer than the minimum required. Step 3: The cumulative cost in each year is now worked out, including updates of cost in the last two years after the first vesting period but before the latest possible exercise date.
Date
Liability recognised ($000) 0 175,000 426,000 691,200
Increase in liability ($000) 0 175,000 251,000 262,200
1 Jan 20x1 (15,000 x 140 x (1.20 1.20) x 0/3 31 Dec 20x1 (15,000 x 140 x (1.45 1.20) x 1/3 31 Dec 20x2 (15,000 x 142 x (1.50 1.20) x 2/3 31 Dec 20x3 (15,000 x 144 x (1.52 1.20) x 3/3
31.12.x3 31.12.x3 31.12.x3 31.12.x4 31.12.x4 31.12.x5 31.12.x5
Liability for Cash Appreciation Rights 1.1.x1 b/c 31.12.x1 Expense 31.12.x2 Expense c/d 691,200 31.12.x3 Expense 691,200 Cash (1.1m x ($1.52- 352,000 31.12.x3 b/d $1.20)) c/d 339,200 691,200 1.1.x4 b/d Cash (800 x (1.60 320,000 1.20) c/d (260 x (1.60 104,000 31.12.x4 Profit/ loss 1.20) 424,000 Cash (260 x (1.48 1.20) 72,800 1.1.x5 b/d c/d (all expired) 0 Profit/ loss 31,200 104,000
0 175,000 251,000 262,000 691,200 691,200 691,200 339,200 84,800 424,000 104,000
104,000
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STAR PERFORMERS POINT Deferred tax and share based payment
Tax authorities may allow a future tax deduction for the expense created by share based payment, or they may allow nothing. If there is an allowable deduction from taxable profits for share based payment, then the future tax recovery (ie deferred tax asset) should be recognised systematically alongside the expense. In exams to date, the examiner for paper P2 has always said to assume that the future tax deduction will be based on the intrinsic value of the share based payment. IFRS 2 defines intrinsic value as the difference between the spot price of a share and the exercise price. To return to the example of Crossmen (RAT 1) Date Fair value of option ($) Number of participants expected to stay until 31 Dec 20x3 180 175 180 165 165 165 Share price ($) Intrinsic value ($)
3.30 3.40 3.45 2.95 3.10 3.30
4.00 4.20 4.25 3.80 3.95 4.30
3.00 3.20 3.25 2.80 2.95 3.30
The maximum tax recoveries are therefore: Date Number of options expected to vest (000s) 900 875 900 825 Intrinsic value per option 3.00 3.20 3.25 2.80 Expected future tax saving $ (1) 0 933,333 1,950,000 2,310,000 Deferred tax asset in SOFP @ 30% (2) 0 280,000 585,000 693,000
1 Jan 20x1 31 Dec 20x1 31 Dec 20x2 31 Dec 20x3
(1) This is calculated as number of options expected to vest x intrinsic value per option x 1/3, 2/3, 3/3 for each year. (2) This is calculated as the expected future tax saving multiplied by the expected future tax rate.
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Wrapping up this topic

PAUSE Do something else for a while. Reflect on how you might be able to apply this knowledge to something in your own life or work. REWIND Reread and rework the examples in this chapter once or twice until you are comfortable with it. EJECT Move on to something else!
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Chapter 9
IAS 16

Property, plant and equipment comprises tangible non-current assets that a business uses in the course of its own business. It excludes investment property.
Issues in accounting for all assets and liabilities Initial recognition/ classification Initial valuation Write-off period Amortisation/ depreciation/ impairments Revaluation upwards Additions/ enhancements Profit/ loss on disposal calculation.
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Initial recognition/ classication Recognise when an entity has control over the asset, not necessarily ownership. This complies with the Framework definition of an asset and also enables assets held under finance leases to be shown as property, plant and equipment.
Initial valuation All costs directly attributable. This includes site preparation, irrecoverable import taxes, inwards delivery charges, professional fees, attributable borrowing costs (IAS 23, below). It excludes training costs, any abnormal costs in installation. Write-off period Depreciate the asset so that the pattern of depreciation charges match the income stream generated. Review useful life periodically. Depreciation is not aimed at showing market value of assets in the SOFP.
Impairments Recognise any losses in profit, unless to reverse any previous upwards revaluation shown in equity. See notes on IAS 36 impairments.
Revaluation Default accounting policy is simple historical costs. If choose to revalue a non-current asset: Must revalue all property, plant and equipment in the same class Must keep up to date, generally annually Must disclose details of valuation, which may be done by the directors Cannot return to historical costs later Will charge depreciation on the higher revalued figure Common to make an annual transfer from revaluation reserve to retained earnings of the difference between deprecation on revalued amount and depreciation on historical costs. Eventual gain on disposal likely to be lower, as carrying value on derecognition will be higher (see below).
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Additions Further costs must be added to the assets value if the cost enhances the earningsgenerating potential of the asset above its original specification, eg upgrade of a servers memory capacity. Other cost (eg repair of hardware) must be expensed immediately.
Borrowing costs: IAS 23

Finance costs msut be added to the initial value of the asset if directly attributable to the acquisition of the asset. This can include a fair weighted average of general company finance costs. Must write off finance costs incurred during periods of extended stoppage when no construction work takes place. Must write off once the asset is ready for use, even if not brought into use on that date. Other borrowing costs must be written off as an expense.
Profit or loss on disposal Proceeds (what is coming into the SOFP in the transaction) Less: Carrying value derecognised (what leaves the SOFP) Profit or loss on disposal (the increase or decrease in net assets) X (X) X
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Chapter 10
IAS 38

Property, plant and equipment comprises tangible non-current assets that a business uses in the course of its own business. It excludes investment property.
Issues in accounting for all assets and liabilities Initial recognition/ classification Initial valuation Write-off period Amortisation/ depreciation/ impairments Revaluation upwards Additions/ enhancements Profit/ loss on disposal calculation.
Initial recognition/ classication An identifiable non-monetary asset without physical substance. This can include the right to use a tangible asset. So premiums paid to acquire services of a person (eg transfer price of a sports player) are intangible assets. Goodwill is an example of an intangible asset.
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Identifiable means that the asset can be seen as separate from the business as a whole, in contrast to goodwill (though goodwill is also accounted for under IAS 38). An intangible is recognised once it meets the definition of an asset, which means that its controlled by the entity and its reasonably expected to generate a positive inflow of benefit. So intellectual property (knowledge generally known) is not controlled by an entity and is not an intangible. Intellectual property rights are controlled by the entity (eg patent) and so may be recognised. It includes development costs, brands, licenses, patents, etc. Research costs are written off as incurred as they either are not controlled by the entity or are not sufficiently certain to generate future benefits. Paragraph 57 of IAS 38 gives the test for deciding if an expenditure is research (write off) or development (treat as an asset). Expenditure is development cost if (mnemonic RAT PIE): Resources are adequate to complete the project Ability to complete Technically feasible Probable economic benefit (ie expected to be profitable) Intend to complete the project Expenditure on the project can be separately recorded.
An intangible asset may be acquired by an entity individually, or may arise as a result of a business combination (ie goodwill in group accounting).
Initial valuation All costs directly attributable. Similar rules to IAS 16, Property, Plant and Equipment. If negative goodwill arises on a business combination, first check all the figures in the calculation. If all the figures appear to be correct, recognise immediately in profit as income.
Write-off period For intangible assets with a definite (ie known) life, such as patents: similar rules to IAS 16, Property, Plant and Equipment. For intangible assets with an indefinite (ie unknown) life, such as goodwill, do not amortise, but test annually for impairment. All intangible assets have a finite (ie limited) useful life.
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Impairments Recognise any losses in profit, unless to reverse any previous upwards revaluation shown in equity. See notes on IAS 36 impairments.
Revaluation Default accounting policy is simple historical costs. If choose to revalue a non-current asset, there are similar consequences as for IAS 16 Property, Plant and Equipment. Intangible assets can be revalued upwards only by reference to a market value in an active market. Paragraph 8 of IAS 38 defines an active market as: the items traded in the market are homogeneous willing buyers and sellers can normally be found at any time; and prices are available to the public.
It is common for intangible assets to be unique or at least very distinctive (ie not homogenous) or for the market in them to be shallow. Active markets in intangibles are therefore rare so it is rare for intangibles to be revalued upwards. Goodwill relating to a business is unique, so can never be revalued upwards.
Additions Further costs must be added to the assets value if the cost enhances the earningsgenerating potential of the asset above its original specification, eg upgrade of a servers memory capacity. Other cost (eg repair of hardware) must be expensed immediately.
Profit or loss on disposal Proceeds (what is coming into the SOFP in the transaction) Less: Carrying value derecognised (what leaves the SOFP) Profit or loss on disposal (the increase or decrease in net assets) X (X) X
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ExPress Notes
Goodwill on a business combination Fair value of consideration transferred Less: Fair value of identifiable net assets acquired, calculated as: Capital and share premium of target Reserves of target at acquisition date Net assets (equity) of target at targets book value Fair value adjustments to targets net assets Net assets (equity) of target at fair value X % acquired Goodwill arising in books of parent for consolidation X X X X/(X) X (X) X X
This figure may then be grossed up to full goodwill. See notes on business combinations.
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ExPress Notes
Chapter 11
IAS 36

An asset cannot be shown in the SOFP at a valuation greater than the economic benefits its expected to generate, since this would violate the Framework definition of an asset.
Cash generating unit A cash generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. In practical terms, its the smallest group of assets which together could be a going concern. CGUs exist since individual assets often do not generate cash inflows on their own.
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Any asset which appears to have been impaired must be reviewed for an impairment, with any loss recognised as given below. Assets with a finite but indefinite life (eg purchased goodwill) must be reviewed for impairment each period, even if there is no indicator of impairment. Determining impaired value The value in use is calculated using the NPV of expected future net cash flows (profit before interest and tax) from the asset: In its current condition (ie not allowing for expected enhancements), although there is no prohibition on considering the most profitable potential use of the asset in its current condition (eg switching from making product X to product Y). Over a period of five years, unless a longer period can be justified by reference to past accuracy in budgeting income streams longer than five years. Using the latest general market risk-free interest rate. Expected revenue less costs necessarily incurred to generate that revenue. Mutually compatible, eg if future cash flows are money flows including expected inflation, they must be discounted at an appropriate money discount rate, not real rate. Foreign currency cash flows must be translated at the spot rate on the date of the impairment review.
Impairment indicators: external to the business include: Decline in market value Adverse technological or environmental changes Long-term increase in interest rates Obsolescence.
Impairment indicators: internal to the business include: Change in intended use Poor performance Physical damage.
Reporting impairment losses: individual assets Reverse any prior revaluation gain in equity (other comprehensive income), then charge to profit.
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Reporting impairment losses: cash generating unit Any assets physically damaged or otherwise specifically impaired, then Goodwill attributable to the CGU, to a minimum value of zero, ie do not recognise internally generated negative goodwill, then Other assets pro rata to value but never impair an asset below its potential net sales value, as the rational thing would be to sell an asset if it appears to have a higher value to somebody else than it does to the current owner.
Reversal of impairments This is possible if the circumstances creating the impairment no longer exist. The reversal would be reported wherever the initial impairment had been recorded, which is normally as a credit to profit. BUT impaired goodwill can never be reversed.
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ExPress Notes
Chapter 12
IAS 18

Adjustments for revenue recognition often appear in the exam, most frequently as adjustments in question 1, but can come up as longer parts of Section B questions. The key issue is commercial substance over legal form. The rules are different depending upon whether a sale is for goods or for services.
Goods Recognise revenue when most of the more important inherent risks and rewards of the goods have passed from the seller to the buyer. This might well be earlier or later than when legal title passes or when payment occurs.
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Services Recognise revenue as the costs of providing the service are incurred. Where a service is paid for up front, revenue often must be deferred as a liability in the SOFP until the revenue is earned.
Valuation of revenue If sales are made with long-term payment terms, recognise the sale and the receivable at its net present value using an appropriate discount rate. This then shows finance income over time.
Bundled sales Where goods are sold with serviced bundled (eg after-sales servicing for two years), then unbundle into separate components.
EXAMPLE
If a car is sold for $30,000 with three years of free servicing, recognise this as: $ Total sales value Less: Market value of three year servicing agreement (to be recognised over 3 years) Value of goods sold (recognise immediately) (3,000) 27,000 30,000
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ExPress Notes
Chapter 13
IAS 8

Preparation of financial statements involves inclusion of many accounting estimates, such as: Depreciation method (estimate of how assets generate a revenue stream) Provisions Tax payable for the year.
It is normal for estimates to be wrong. They are normally simply corrected the following year with the following year taking the profit and loss effect of the correction.
Accounting estimates Normal Expected Affects profit of the year discovered
Accounting errors
Not normal Possibly careless Adjust prior year Normally no effect on profit in the year the error is discovered
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Accounting estimates and treatment of changes Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors. Changes in accounting estimates are simply absorbed the following period as an expense (or income) in that following period. No adjustment is made to the previously published financial statements of the previous period.
Accounting errors (prior period errors) These are errors and omissions the entitys financial statements for prior period(s) arising from a failure to use reliable information that: was available when financial statements for those periods were authorised for issue and could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements.
To make an error in an accounting estimate is to be human. To make a general accounting error is to be careless! Accounting errors are corrected by amending the previously issued financial statements of the previous year, meaning that there is not normally a profit effect in the current year when the error is discovered.
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ExPress Notes
Chapter 14
Equity reconstructions


Where an entity has become technically insolvent, such as having large retained losses, there may be serious difficulties including: Going concern being in doubt due to unsustainable cash outflow Inability to pay dividends before retained losses are made up Inability to raise new finance.
The syllabus for paper P2 requires that you be able to identify when an entity may no longer be a going concern. There is a heavy overlap here with papers F8 and P7. ISA 570 assesses going concern indicators under the headings: Financial Operating Other (eg legal and regulatory).
Where an entitys going concern status is threatened due to uncertainty in its financing structure, but the underlying business appears to have potential to become stable, there are two possible outcomes that commercially would happen: 1. The business goes bankrupt and a new entity takes over its viable assets in a liquidation, or 2. The business obtains approval of the law courts and providers of finance to restructure its operations. Its generally better for investors and all other stakeholders to allow a business to restructure and be given an opportunity for a fresh start, rather than to go bankrupt.
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Mechanics of a reconstruction The exact mechanism of a financing reconstruction vary greatly between legal systems. The following is based on Part 26 of the UK Companies Act 2006. A meeting of all the shareholders and creditors is convened. A scheme of arrangement is provided to the providers of finance. Agreement of at least 75% of each class of provider of finance must be obtained. In practice, each group needs to be convinced that they will be at least as well off under the proposed scheme than if the company were to be liquidated (see below). If this vote is passed, all providers of finance are bound by the reconstruction scheme. The scheme then has to be approved by a court of law. This approval is likely to be given if the court is satisfied that the scheme is a viable alternative to liquidation. The assets and liabilities are all revalued and the old company transferred to a new company, with novation of all contracts, assumption of old company liabilities and continuity of employment contracts. All existing finance is extinguished and replaced with the new finance.
Legally, the old entity is destroyed and a new entity created that takes on all the assets and liabilities (including trade name, etc) of the old business. For accounting purposes, the easiest way to do this is to retain the existing general ledger but record the replacement of the old companys financing with the new companys financing. This is normally done by a reconstruction account. This means that although a new company is taking on assets and liabilities from a legally separate old company, the general ledger recording continues as if it were always the same company.
Reconstruction account Impairment of assets Retained earnings (losses) X X Oldco ordinary capital Oldco preference capital Oldco debentures Oldco payables Net worth c/d X Revaluation reserve (including any new revaluations) X X X X X
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XX
Net worth b/d Newco ordinary capital Newco preference capital Newco debentures Newco payables X X X X
XX
X
XX
Selling the plan!
XX
In order to obtain the 75% or more approval of each class of provider of finance, it will be necessary to ensure that each finance provider is at least as well off under the transfer of the old companys assets to the new company. To get this, its necessary to understand the order in which insolvency law typically pays out assets on liquidation of a business. The order is typically: 1. Fees of the lawyer/ liquidator (often described by the misleading euphemism of costs) 2. Preferred creditors (eg staff holiday pay, VAT, taxes) 3. Debentures secured with a fixed charges, in date order of creation of fixed charges 4. Debentures secured with floating charges, in date order of creation of floating charges 5. Other creditors ranked pari passu 6. Unpaid preference dividends 7. Preference capital 8. Ordinary capital. The fees of a liquidator are often substantial and the assets will be sold in a hurry, so for knock down prices. It is therefore unlikely that much money will be left over to pay much more than the preferred creditors. Providers of equity finance are probably the easiest to please with the reconstruction, as they have little to lose. If you are required to assess whether a proposed reconstruction is likely to succeed, it is generally best to list all the providers of finance and assess how much they are likely to receive from a liquidation and how much they are likely to receive from the reconstruction. Remember that each provider effectively has a right to veto a reconstruction, so everybody will need to be better off.
(end of ExPress Notes)
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Notes

ACCA Paper P2 (INT)

START About ExPress Notes

ACCA P2 Corporate Reporting

At the start of the learning phase

The night before the real exam

At the door of the exam room before you go in.

START About The ExP Group

START The Big Picture

What group accounting is trying to do

Parent Associate Control

Significant influence Equity

Non-controlling interest Goodwill

5,110 40% 2,044 4,018

3,290 60% 1,974

ACCA P2 Corporate Reporting

START The Big Picture

Foreign currency Translation rules Functional currency

Functional currency Presentation rules

Key workings/ methods Translation rules

Key workings/ methods Presentation rules

ACCA P2 Corporate Reporting

This does not add up!

ACCA P2 Corporate Reporting

Groups and foreign currency

Approach to questions with foreign subsidiaries:

Further aspects of foreign currency groups

Goodwill arising on acquisition (premium paid to acquire the subsidiary).

Key workings/ methods

START The Big Picture

ACCA P2 Corporate Reporting

ACCA P2 Corporate Reporting

ACCA P2 Corporate Reporting

Key workings/ methods Associates, non-controlling interests

Share of profit after tax

Cash received (balancing item) c/d

1,500 10,500 12,000

START The Big Picture

Probable: Possible: Remote: Reliable: Provide:

START The Big Picture

Key workings/ methods

Take the proportion of deferred tax movement on equity gains to equity.

START The Big Picture

Defined benefit plans

ACCA P2 Corporate Reporting

Current service cost

Past service cost

10,000 DR 180 DR 210 CR 600 DR 10,570 DR 8,650 DR

START The Big Picture

Initial recognition Subsequent measurement

Gains or losses reported in...

Key workings/ methods

ACCA P2 Corporate Reporting

ACCA P2 Corporate Reporting

The Big Picture

Key workings/ methods

ACCA P2 Corporate Reporting

START The Big Picture

KEY KNOWLEDGE Suggested approach to questions

REVIEW AND TEST 1 The Crossmen

Fair value of option ($)

Share price ($)

3.30 3.40 3.45 2.95 3.10 3.30