MODULE OUTLINE` MIDLANDS STATE UNIVERSITY

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Gweru Fax: 260442
Zimbabwe

FACULTY OF COMMERCE
DEPARTMENT OF ACCOUNTING

MODULE TITLE & CODE: SPECIFIC & GROUP FINANCIAL REPORTING:

ACC 411

1. PREAMBLE

This module is based on the assumption that the student has

acquired the prerequisite skills at level 1 and 2 Financial Accounting.

2. PREREQUISITE MODULES

Acc 107, Acc 108, Acc 217 ,Acc 219 and Acc 409.

3. PURPOSE OF THE MODULE

The module is intended to enable students to gain knowledge of and

insight into the financial accounting and taxation implication aspects
of Specific Financial Reporting and Group Financial Reporting.
By the end of the module students should be able to prepare an entity’s
group financial statements in accordance with the Companies Act:
Chapter 24:03 and International Financial Reporting Standards (IFRSs)

4. ASSESSMENT

Coursework accounts for 30% of overall assessment while the

sessional examination accounts for 70% of the overall assessment.
NB: Coursework will be by way of two in-class tests. NOT
assignments.

5. MODULE CONTENT
 5.1 Specific Financial Reporting

 Related parties – 1AS 24

 Leases (IFRS 16)
 Borrowing Costs (IAS 23)
 Operating Segments (IFRS 8)
 Employee benefits (IAS 19)
 Financial instruments ( IAS 32, IFRS 9 & IFRS 7)
 Government assistance (IAS20)
 Earnings per share(IAS 33)

5.2 Group Financial Reporting

 Separate Financial Statements (IAS 27)
 Business Combinations (IFRS 3)
 Consolidated Financial Statements (IFRS 10)
 Joint Arrangements (IFRS 11)
 Associate and Joint Ventures (IAS 28)
 Disclosure of Interests in Other Entities (IFRS 12)

6. RECOMMENDED READING

 IASB International Financial Reporting Standards (currently

effective)
 Accounting Standards: Opperman et al.
 Descriptive Accounting: Vorster et al.
 Group statements vol 2 (latest edition)-Binneckade et al.
 A Guide through IFRS Part A: IFRS Foundation
 A Guide through IFRS Part B: IFRS Foundation

NB: Because of the rapid changes taking place on the international

financial accounting scene, it is strongly recommended that students
consult the latest publications of the above recommended reading. The
acc 411 module is revised at the end of each semester to assess its
continued appropriateness
GROUP FINANCIAL REPORTING
UNIT 1
1.0 IAS 27: SEPARATE FINANCIAL STATEMENTS
OVERVIEW

In May 2011 IASB reissued IAS27 as IAS27 Separate Financial Statements.

Consolidation requirements previously forming part of IAS 27 (2008) have
been revised and are now contained in IFRS10 Consolidated Financial
Statements. This also includes the related interpretation SIC12 Consolidated
– Special Purpose Entities. The effective date of the re-issue IAS27 is 1
January 2013
1.1 OBJECTIVE:
To prescribe the accounting and disclosure requirements for investments in
subsidiaries, joint ventures and associates when an entity prepare and
present separate financial statements.
1.2 SCOPE:
Applies to investments in subsidiaries, joint ventures and associates when an
entity elects, or is required by local regulation to present separate financial
statements. IAS 27 does not mandate which entities produces separate
financial statements.
1.3 DEFINITIONS:
1.3.1 Separate financial statements: Financial statements presented by a
parent (i.e. an investor with control of a subsidiary), an investor with joint
control of or significant influence over an investee, in which the investments
are accounted for; @ cost, in accordance with IFRS 9: Financial instruments
or IAS 28 Investments in an associate and joint venture.
1.3.2 Consolidated financial statements: the financial statements of a
group in which the assets, liabilities, equity, expenses, incomes and cash
flows, of the parent and its subsidiaries are presented as those of a single
entity. (IFRS 10)
1.3.3 Associate: an entity in which an investor has significant influence but
not control or joint control. (IAS 28)
1.3 4 Control of an investee: 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. (IFRS 10)
1.3.5 Joint control: the contractually agreed sharing of control of an
arrangement, which exists only when decisions about the relevant activities
require unanimous consent of the parties sharing control. (IFRS 11)

1.4.0 Choice of accounting method

When an entity prepares separate financial statements, investments in
subsidiaries, associates, and jointly controlled entities are accounted
for either:

 at cost; or
 in accordance with IFRS9 Financial Instruments, or
 in accordance with equity accounting - IAS 28, Investments in
Associates and Joint Ventures
The entity applies the same accounting method for each category of
investments. For example, if an entity has elected that one subsidiary
should be carried at cost in its separate financial statements, all
subsidiaries will be carried at cost.

This election is an accounting policy choice and would therefore be

disclosed as part of the accounting policies to the separate financial
statements.

Investments that are accounted for at cost and classified as held for
sale in accordance with IFRS5 Non-current Assets Held for Sale and
Discontinued Operations should be measured at the lower of their
carrying amount and fair value less costs to sell. The measurement of
investments accounted for in accordance with IFRS9 is not changed in
such circumstances as they should continue to be carried at fair value.

NB: In situations where an entity elects to carry investments in

subsidiaries in terms of IFRS9 and these investments are carried
at fair value in the separate financial statements as a result, any
fair value adjustments recognized on these investments need to
be reversed, before consolidation can commence. This would be
the case irrespective of whether these fair value adjustments have
been recognized in profit or loss or in other comprehensive
income.

If an entity elects, in accordance with IAS28 (as amended in

2011), to measure its investments in associates or joint ventures
at fair value through profit or loss in accordance with IFRS9, it
should also account for those investments in the same way in its
separate financial statements.
1.4.1 ACCOUNTING FOR SUBSIDIARY, JOINT VENTURES AND
ASSOCIATES
In the parent\investor’s individual fin stats, investments in subsidiaries,
associates and joint ventures should be accounted for:
At cost
In accordance with IFRS 9
OR using the equity method refer to IAS 28.
1.4.2 Recording purchase of shares in separate financial statements:
@ COST
On purchase of shares in the acquiree, the acquirer will record the
investments in subsidiary at cost as follows:
Initial measurement
Dr Investment in B Ltd
Cr Bank
Dr Investment (transaction costs)
Cr Bank
I.e. capitalise transaction costs.

Subsequent measurement
no entry required since investment is carried at cost.

1.4.3 recording purchase of shares in separate financial statements in

accordance with IFRS 9:
1.4.3.1 Parent designates investments as FVTPL (Fair value through profit or
loss)
Initial measurement:
Dr Investment in B ltd (SFP)
Dr Transaction costs (P/L)
Cr Bank (investment +transaction costs) (SFP)
Expense transaction costs
Subsequent Measurement
Dr investment in B Ltd (SFP)
Cr fair value adjustment (P/L)

1.4.3.2 Parent designates investment as fair value through Other

comprehensive income.
Initial measurement
Dr Investment in B ltd (SFP)
Cr Bank (cost +transaction costs) (SFP)
Capitalise transaction costs
Subsequent measurement
Dr investment
Cr Mark to market reserve

N/B: Dividends: an entity shall recognise a dividend from a subsidiary, jointly

controlled entity or an associate in Profit or loss in its separate financial
statements when its right to receive the dividend is established.

EXAMPLE 1: B ltd acquired 20 000 shares in A Ltd on 1 January 2017 for a

cash consideration of $300 000. The fair value of B Ltd.’s share on 31 Dec
2017 was $350 000. Transaction costs incurred on 1 Jan 2017 amounted to
$2 000.
Rqd: Prepare the journal entries required to account for the purchase of A
ltd’s shares by B ltd for the year ended 31/12/17 assuming that:
a) B ltd designated its investments at cost
b) B Ltd designated its investments as FVTPL
c) B Ltd designated its investment as FVTOCI
SOLUTION
Initial measurement 01/01/17
a) Investment 300 000
Bank 300 000
Investment 2 000
Bank 2 000
Subsequent measurement 31/12/17
No entry since investment is at cost i.e. no fair value adjustments since
company elects to value at cost.

b) Designated as FVTPL
Initial measurement
Dr Investment 300 000
Dr transaction costs 2 000
Cr Bank 302 000
Do not capitalise transaction cost they are written off through the
profit or loss.
Subsequent measurement
Dr Investment 50 000
Cr Fair value adjustment 50 000

c) Parent designated investment as FVTOCI

Initial measurement
Dr Investment 302 000
Cr Bank 302 000
Capitalise transaction costs

Subsequent measurement
Dr Investment 48 000
Cr Mark to market reserve 48 000
TAX IMPLICATIONS
EXAMPLE 2: Charlie Ltd acquired an 80% interest in Sub Ltd on 1 January
2017 for $100 000 when the share capital 0f $100 000 and retained earnings
of $10 000 were Sub Ltd.’s only items of equity. The fair value of the
investment amounted to $150 000 on 31 December 2017. The group’s
reporting date is 31 December. The rate of tax is 28% and 66,6% of capital
gains are included in the taxable income of a company.
Required:
 a) Record the investment in Charlie Ltd ‘s separate financial statements
when recording :
I. @ Cost
II. FVTPL
III. FVTOCI
b) Show the consolidation journal entries for the group
solution
a)
Initial measurement Subsequent measurement
@ Cost
Dr Investment 100 000 NO ENTRY
Cr Bank 100 000
FVTPL
Dr Investment 100 000 Dr Investment 50 000
Cr Bank 100 000 CrFair value adjustment 40 676
CrDeferred tax liability 9324
FVTOCI
Dr Investments 100 000 Dr Investment 50 000
Cr Bank 100 000 Cr Mark to market reserve 40 676
Cr Deferred tax liability 9 324

Part b. consolidation journals when valued at cost

Ordinary share capital 100 000
Retained earnings 10 000
Goodwill 12 000
Investment 100 000
Non-Controlling Interest 22 000

Mark to market reserve 40 676

Deferred tax 9 324
Investment 50 000

Ordinary share capital 100 000

Retained earnings 10 000
Goodwill 12 000
Investment 100 000
NCI 22 000

1.5 PRACTICE QUESTIONS (WITH ANSWERS)

Question 1.5.1 Investment at fair value

Changu Ltd acquired a 90% interest in the ordinary shares of Hama Ltd
on 1 January 20x1 at a cost of $225 000. At 31 December 20x1 the fair
value of the investment amounted to $250 000, while the value
increased to $285 000 on 31 December 20x2. Changu Ltd carries
investments in subsidiaries in terms of IFRS9, in its separate financial
statements. Upon initial recognition, Changu Ltd designated its
investment in Hama Ltd as at fair value through other comprehensive
income. Assume a tax rate of 30% and an effective capital gains tax rate
of 15%.

Required:
What is the accounting treatment of the change in fair value.
(Adapted GAAP 2012)

Solution 1.5.1

Before commencing consolidation, the fair value adjustments on the

investment in Hama Ltd should be reversed through a consolidation
journal entry. This is required as the investment must be reflected at
cost in order to calculate goodwill. The applicable consolidation journal
entry in the 20x1 financial year would be the following:
Dr Cr
$ $
Mark-to-market reserve (OCI) 25 000
Deferred tax (SFP) 3 750
Investment in Hama Ltd 25 000
Income tax expense : mark-to-market reserve(OCI) 3 750
(25 000 x 15%)
(Eliminate current year fair value adjustments)
The applicable consolidation journal entries in the 20x2 financial year
would be the following:
Dr Cr
$ $
Mark-to-market reserve (opening) (SCE)
25 000 x 85%) or (25 000 – 3750) 21 250
Deferred tax (SFP) 3 750
Investment in Hama Ltd 25 000
(Eliminate prior year fair value adjustments)

Mark-to-market reserve (OCI) 35 000

Deferred tax 5 250
Investment in Hama Ltd 35 000
Income tax expenses: mark –to-market reserve (OCI) 5 250
(35 000 x 15%)
(Eliminate current year fair value adjustments

Should the investment be carried at fair value through profit or loss,

the journal entries would be similar, with the exception that fair value
adjustment (i.e. the other comprehensive income mark-to-market
entries) and income tax expense entries would affect profit or loss that
 retained earnings would replace the mark-to-market reserve in the
above consolidation journal entries.

In certain instances, an entity is permitted by IAS28 and IFRS11 to

account for investments in associates and joint ventures at fair value
through profit or loss in terms of IFRS9 in the consolidated financial
statements (normally these investments would have been accounted for
using the equity method). Should an entity account for an investment
in an associate or joint venture at fair value through profit or loss in the
consolidated financial statements, IAS27 requires it to account for these
investments at fair value through profit or loss in its separate financial
statement.

If investment is subsidiaries, associates and joint ventures are

classified as held for sale in terms of IFRS5, the accounting treatment
in the separate financial statements is as follows:

 Investments carried at cost are measured at the lower of their

carrying amount and fair value less costs to sell in accordance
with the requirements of IFRS5; or

 Investments accounted for in accordance with IFRS9 continue to

be measured in terms of IFRS9, as the measurement
requirements of IFRS5 do not apply to financial assets within the
scope of IFRS 9.

UNIT 2

INVESTMENT IN ASSOCIATES AND JOINT VENTURES

IAS28 (EFFECTIVE DATE: 1 JANUARY 2013)

2.1. INTRODUCTION

Depending on the degree of influence, an entity exercises over another

three possible scenarios can arise with regard to the investment:

- an entity having little or no influence over the other party, in which

case the investment is accounted in terms of IFRS9 – Financial
Instruments.

- an entity assesses that it controls the other entity in terms of IFRS10,

in which case the investment is accounted for as a subsidiary.

- an entity has more than little influence but does not control, an
investee, in which case treatment of the investment is considered
 under IFRS11 Joint arrangements, and IAS 28, Investment in
associates and joint ventures.
This chapter covers IAS 28, Investment in Associates and Joint Ventures. IAS
28 defines and prescribes accounting for associates and sets out the
requirements for the equity method, which is applied to both associates and
joint ventures.

2.2 KEY TERMINOLOGY

 Associate : An entity over which an investor has significant influence

and that is neither a subsidiary nor an interest in a joint venture.

 Significant influence: The power to participate in the financial and

operating policy decisions of the investee but is not control or joint
control over those policies.

 Control : Control is power to govern the financial and operating policies

of an entity in order to obtain benefits from its activities.

 Joint control: is the contractually agreed sharing of power of an

arrangement, which exists only when decisions about relevant activities
require unanimous consent of the parties sharing control.

2.3. BASIC CONCEPTS

2.3.1 Significant influence

- If an investor holds, directly or indirectly (e.g. through

subsidiaries), 20 per cent or more of the voting power of the
investee, it is presumed that the investor has significant
influence, unless it can be clearly demonstrated that this is not
the case. Conversely, if the investor holds, directly or indirectly
(e.g. through subsidiaries), less than 20 per cent of the voting
power of the investee, it is presumed that the investor does not
have significant influence, unless such influence can be clearly
demonstrated. A substantial or majority ownership by another
investor does not necessarily preclude an investor from having
significant influence.

The existence of significant influence by an investor is usually

evidenced in one or more of the following ways:-
  representation on the board of directors or equivalent
governing body of the investee;
 participation in policy-making processes, including
participation in decisions about dividends or other
distributions;
 material transactions between the investor and the
investee;
 interchange of managerial personnel; or
 provision of essential technical information
2.3.2 Potential Voting Rights

An entity may own share warrants, share call options, debt or equity
instruments that are convertible into ordinary shares, or other similar
instruments that have the potential, if exercised or converted, to give
the entity additional voting power or reduce another party’s voting
power over the financial and operating policies of another entity (i.e.
potential voting rights). The existence and effect of potential voting
rights that are currently exercisable or convertible, including potential
voting rights held by subsidiaries are considered when assessing
whether an entity has significant influence. However, interests in joint
ventures and associates in the group hold are not taken into account.
Potential voting rights are not currently exercisable or convertible when,
for example, they cannot be exercised or converted until a future date
or until the occurrence of a future event.

IAS28 stipulates that all facts and circumstances should be examined

when considering potential voting rights, except the intention of
management and the financial ability to exercise or convert.

NB: The consideration surrounding potential voting rights in IAS28

differ from those in IFRS10. For example, IFRS10 effectively
allows an investor to consider the financial ability of the other
party (or itself) to exercise the option. As a result, when assessing
whether or not other parties’ potential voting rights preclude an
investor from having control, IFRS10 is applied. Should an
investor lack control and considers whether or not it has
significant influence over the investee, IAS 28 would apply when
considering other parties’ voting rights. This may have the effect
that potential voting rights are ignored when assessing control
from one investor’s perspective, but included when assessing
significant influence from another investor’s perspective.

2.3.3 Loss of significant influence

 An investor ceases to have significant influence over an associate from
the date that the investor loses the power to participate in the financial
and operating policy decisions of the investee. The loss of significant
influence can occur with or without a change in ownership, for example
by disposing of the interest, or if the associate becomes subject to the
control of government. If an associate is operated under severe long-
term restrictions that significantly impair its ability to transfer funds to
the investor, it may be an indication that significant influence is lost,
but the restrictions in themselves do not preclude the existence of
significant influence.

2.3.4 Equity method

The equity method applies to associates as well as joint ventures.

However, note that the equity method does not apply to joint operations,
for which the accounting requirements are set out in IFRS11. In respect
of an investment in an associate or joint venture, IAS 28 notes that the
recognition of profit on the basis of distributions received only, may not
be an adequate measure of the profit earned by the investor on its
investment in the investee, because the distributions received may bear
little relationship to the performance of the investee and the value of
the investment in the investee. The investor has significant influence or
joint control over the investee and therefore has a measure of
responsibility for the investee’s performance. The investor therefore
extends the scope of the cost method of accounting to incorporate its
share of the profits or losses of the associate or joint venture. This
information provides more informative reporting of the net assets and
profit or loss of the investor. The method is defined and its specific
requirements are set out in IAS 28.

2.4. APPLICATION OF THE EQUITY METHOD

According to IAS 28 an entity with joint control of a joint venture or

significant influence over an associate account for its investment using
the equity method, except when:-

 the investment is held by (or indirectly through) a venture capital

organisation, mutual fund, unit trust or similar entity (hereafter
referred to as “investment entities”).
The exemption has been allowed as the objective of investment entities
is usually to realize fair value gains and accordingly their users have a
particular interest in the fair value of investments. In other words, fair
value measurement provides more relevant information in such a
context than measurement using the equity method. Therefore where
an entity is an investment entity itself or holds an associate or joint
venture through an investment entity that it controls, the entity may
elect (but it not required) to measure the investment at fair value
through profit or loss, rather than applying the equity method.

A situation may arise where an entity has significant influence over an

associate through a combination of its own rights and investments
together with the rights and investments of an investment entity that it
controls. In this case, the entity may elect (but is not required) to
account for the portion of the associate held through the investment
entity at fair value through profit or loss in accordance with IFRS 9. An
entity is allowed to make this election regardless of whether or not the
investment entity has significant influence over the investee by itself.
However, in this case, the entity is required to account for any
remaining portion of the associate (i.e. the portion not held through an
investment entity) by using the equity method.

Note The first election above is available for investments in both

associates and joint ventures, while the second election is only
available for investments in associates.

 the investment is classified as held for sale in accordance with IFRS

5.
IAS 28 requires that IFRS 5 should be applied to an investment in an
associate or joint venture or, alternatively, a portion thereof, if it
meets the criteria to be classified as held for sale in terms of IFRS 5.

o Any retained portion of the associate of joint venture that has not
been classified as held for sale is accounted for using the equity
method until the disposal of the portion classified as held for sale
takes place.

o After the disposal of the portion classified as held for sale, the
retained interest should be accounted for in accordance with
IFRS 9, unless the retained interest itself is an associate or joint
venture (in which case the equity method is applied in the
measurement thereof).

o Should it happen that an investment previously classified as held

for sale no longer meets the criteria to be so classified the equity
method should be applied retrospectively from the date of initial
classification as held for sale. In other words, the resulting
financial statements should reflect the investment as if it had
 never been classified as held for sale. Therefore the amendment
of prior period financial statements may be necessary.
NB: An investment in an associate of joint venture may only be
presented as a current asset if it is classified as held for
sale in terms of IFRS 5. All other investments in associates
or joint ventures (including a portion of the investee that is
expected to be retained as discussed above) should be
presented as non-current assets on the statement of
financial position.

 The investor in the associate or joint venture is a parent who, in

terms of IAS 27, is exempt from preparing consolidated financial
statements.

o Such a parent may present separate financial statements as its

only financial statements, resulting in the investment in the
associate of joint venture being accounted for at cost or fair value
(refer to the chapter on separate financial statements).

 Alternatively, the investor is exempted from applying the equity

method if all of the following conditions are met:-

o The investor is a wholly owned subsidiary or, if partially owned,

the non-controlling shareholders (including those not otherwise
entitled to vote) have been informed about and do not object to
the investor not applying the equity method.

o The investor’s debt or equity instruments are not publicly traded.

o The investor is not in the process of issuing any class of

instruments in public markets.

o The ultimate or any intermediate parent of the investor produces

consolidated financial statements, which comply with IFRS and
these are available for public use.

Such an investor may present separate financial statements as

its only financial statements, resulting in the investment in the
associate of joint venture being accounted for at cost or fair value
(refer to the chapter on separate financial statements).

2.5. BASIC PRINCIPLES OF THE EQUITY METHOD

2.5.1 Profit or loss, other comprehensive income and distributions of the
investee

The equity method is a method of accounting whereby the investment

is initially recognized at cost and adjusted thereafter for the post-
acquisition change in the investor’s share of the net assets of the
investee. For example, if an investor has a 25% interest in an associate
or joint venture, and the investee’s net assets increase with $100 000
during a specified period, the investor has to increase its investment in
that associate or joint venture with $25 000 (100 000 x 25%). Net assets
are equal to equity, which means that an increase of $100 000 in the
net assets of the investee implies that the investee’s equity also
increased with $100 000. This increase in the equity of the associate or
joint venture consists of the profit or loss for the period, gains and
losses recognized in other comprehensive income and other items
affecting the equity of the investee since acquisition (e.g. dividends
paid). To account for the increase in the investment, the investor has to
recognize in profit or loss its share of the investee’s profit or loss, and
should furthermore recognize in other comprehensive income its share
of any other comprehensive income recognized by the investee. Other
comprehensive income will include, for example, gains and losses
arising from the revaluation of property, plant and equipment and fair
value adjustments on financial assets at fair value through other
comprehensive income accounted for since the date of acquisition of the
investee.

As the carrying amount of the investment in the associate or joint

venture includes the investor’s share of the investee’s total profit for the
period (before distributions), any dividends received from the associate
or joint venture should be accounted for as a reduction in the carrying
amount of the investment.

2.5.2 Transfer to reserves

If an associate or joint venture makes a transfer to a reserve, the

transfer is treated in the same manner as transfers made by
subsidiaries. Therefore, the investor’s equity accounted financial
statements will reflect its share of the investee’s transfer to the reserve.
This treatment reflects the fact that the investor influences the policy
and operating decisions of the associate.

2.5.3 Fair value adjustments at acquisition

 Goodwill/gain on bargain purchase

 In accounting for the acquisition of an associate or joint venture, the
assets and liabilities of the associate or joint venture are measured
at their fair values on the date of acquisition. Any differences
between the cost of the acquisition and the investor’s share of the
net fair value of the investee’s identifiable assets and liabilities is
accounted for as follows:-

o Goodwill arising on the acquisition is included in the carrying

amount of the investment and is not amortised.

o The excess of the investor’s share in the fair value of the net
assets of the associate over the cost of the investment on the
acquisition date is recognized as a gain from a bargain purchase.
This is done by taking this gain from a bargain purchase into
account in calculating the share of profit of associate in the period
in which the investment is acquired.
NB: Unrealised profits or losses on inter-group transactions are
eliminated.

2.5.4 Contribution of non-monetary assets

When an investor contributes a non-monetary asset to an associate in

exchange of an equity interest in that entity, the profit or loss from this
contribution is recognized in the investor’s financial statements only to
the extent of other investor’s interest in the associate. However, if the
contribution lacks commercial substance and no other assets have
been received, no profit or loss is received.

The criteria to determine commercial substance follow the same criteria

in IAS16, Property, plant and equipment, whereby a contribution
transaction has commercial substance if:-

 the configuration (risk, timing and amount) of the cash flows of the
asset received differs from the configuration of the cash flows of the
asset transferred; or

 the entity-specific value of the portion of the entity’s operations

affected by the transaction changes as a result of the contribution
transaction (the entity-specific value is the present value of the post-
tax cash flows an entity expects to arise from the continuing use of
an asset and from its disposal at the end of its useful life); and
  the difference in the above is significant relative to the fair value of
the assets effectively exchanged through the contribution
transaction.
Note that the cash flows used to determine commercial substance
are after tax cash flows. Furthermore, even if the configuration of the
cash flows of two assets is identical, their entity-specific values may
still differ due to different discount rates being used and/or
differences in tax cash flows. Therefore it is necessary to consider
both the configuration of the cash flows of the assets and their
entity-specific values when evaluating commercial substance.

NB: The contribution transaction in the separate financial

statements will always have commercial substance as the
risks, timing and configuration of cash flows associated
with a financial instrument (i.e. the investment) will most
certainly differ from those of individual, non-monetary
assets.

When an investor receives, in exchange for its own non-monetary

asset, a monetary or dissimilar non-monetary asset over and above
the equity interest in the associate, the entity will recognize in full in
profit or loss the portion of the gain/loss on the non-monetary
contribution relating to the asset.
2.5.5 Reporting dates

The investor should use the most recent available financial statements
of the associate in applying the equity method. A problem that arises is
that the financial year-end of the associate or joint venture may be
different from that of the investor (non-coterminous year ends).

When financial statements with different reporting dates are used for
equity accounting, adjustments should be made for the effect of
significant events or transactions that occurred between the date of the
investees financial statements. The difference may not be more than
three months. When the difference is more than three months, the
associate should prepare for use by the investor, statements as at the
same date as the financial statement of the investor.

2.5.5 Different accounting policies

The investor’s financial statements are usually prepared using uniform

accounting policies for like transactions and events in similar
circumstances. In cases where an associate uses accounting policies
other than those adapted by the investor for like transactions and
 events in similar circumstances, appropriate adjustments have to be
made to the associate’s financial statements when they are used by the
investor in equity accounting.

2.5.6 Other equity methods issues

2.5.6.1 Cumulative Preference Shares

When applying the equity method, only the income attributable

to equity or ordinary shares is included. Preference shares can be
classified either as equity or as a financial liability. If an associate
has issued preference shares which are classified as equity, the
current dividend payable in these shares should be deducted
when determining the equity income or loss, irrespective of
whether such dividends have been declared. If the preference
shares are classified as a financial liability, the dividends are
regarded as interest and would therefore have already been
recognized as an expense in the calculation of the associate’s
profit. Should the investor itself hold a portion of the preference
shares issued by the associate or joint venture, this investment
should be accounted for, separately.

2.5.6.2 Transactions between an investor and its associate/joint

venture

Gains and losses resulting from “upstream” and “downstream”

transaction between an investor (including its consolidated
subsidiaries) and its associate or joint venture are recognized in
the investors’ financial statements only to the extent of unrelated
investors’ interests in the associate or joint venture. “Upstream”
transactions are, for example, sales of assets from an associate
or joint venture to the investor. “Downstream” transactions are,
for example, sales or contributions of assets from the investor to
its associate or joint venture. The investor’s share in the
associates’ or joint ventures gains or losses resulting from these
transactions is eliminated.

When downstream transactions provide evidence of a reduction

in the realizable value of the assets to be sold or contributed, or
of an impairment loss, these losses should be recognized in full
by the investor. When upstream transactions provide evidence of
a reduction in the net realizable value of the assets to be
 purchased or of an impairment loss of these assets, the investor
should recognized its share in these losses.

2.5.6.3 Loses of an associate of joint venture

If an investor’s share of losses of an associate or a joint venture,

equals or exceeds its interest in the associate or joint venture, the
investor discontinues recognizing its share of further losses. This
means that the write-off should be limited to the investor’s net
investment in the associate or joint venture. The investor’s net
investment in the associate or joint venture includes the carrying
amount of the investment in equity and other long-term interests
of the associate or joint venture, such as loans to the investee.
Excluded from the investor’s net investment are, for example,
trade receivables, trade payables or any long-term receivables for
which adequate collateral exists (e.g. secured loans).

If an associate or joint venture subsequently reports profits, the

investor would resume recognition of its share of profit only after
the investor’s attributable portion of the profits exceeds the losses
that were previously not recognized.

2.5.7 Impairment

After application of the equity method (including recognizing the

investee’s losses), the requirements of IAS 39 should be applied to
determine if there are any indications that the net investment in the
associate or joint venture may be impaired (indicators include, for
example, severe financial difficulties of the investee). Because the
goodwill included in the carrying amount of an investment in an
associate or joint venture is not recognized as a separate asset, it cannot
be tested separately for impairment. Instead the entire carrying amount
of the investment is tested for impairment in accordance with IAS 36.
Similarly, if an impairment loss is recognized, it is not allocated to the
individual assets that form part of the carrying amount of the
investment in the associate or the joint venture but rather allocated to
the investment as a whole. As the impairment loss is not specifically
allocated to the goodwill element of the investment, reversals of
impairment losses may be recognized to the extent that the recoverable
amount of the investment subsequently increases. Each associate or
joint venture should be assessed individually, unless its forms part of
a cash-generating unit. In determining the value in use of the
investment, an entity estimates:-
 o its share of the present value of the estimated future cash flows
expected to be generated by the investee, including the cash flows
from the operations of the investee and the proceeds on the
ultimate disposal of the investment, or

o the present value of the estimated future cash flows expected to

arise from dividends to be received from the investment and from
its ultimate disposal.

Note that, as the appropriate discount rate would differ between the
alternative methodologies allowed by IAS 28, both methods give the
same result if appropriate assumptions are used.

In respect of interests that do not form part of the investor’s net

investment in the associate (e.g. trade receivables). IAS39 should be
applied to determine whether impairment losses should be recognized
and what the amount of those impairment losses should be.

The recoverable amount of an investment in an associate or joint

venture should be assessed for each associate or joint venture unless
the individual associate or joint venture does not generate cash inflows
from continuing use that are largely independent of those from other
assets of the reporting entity.

2.5.8 Separate financial statements

An investment in an associate or a joint venture should be accounted

for in the investor’s separate financial statements either:-

o at cost, or
o in accordance with IFRS9

2.6. PRACTICE QUESTIONS (With answers)

Question 7.6.1 : Potential voting rights

Mtapa Ltd holds 15% of the issued share capital of Ascot Ltd, but also
has an option to acquire a further 10% of Ascot Ltd’s ordinary share
capital.

Required:
 Does Mtapa Ltd have significant influence over Ascot Ltd. Motivate your
answer. (Adapted Group Statements).

Solution 2.6.1

As Mtapa Ltd potentially owns 25% of the voting rights in Ascot Ltd, it
is assumed that Mtapa Ltd has significant influence over Ascot Ltd
provided the option is presently exercisable, resulting in Ascot Ltd being
an associate of Mtapa Ltd. However when Ascot results, assets and
liabilities are equity accounted for, only the 15% existing interest will
be taken into account or not the potential interest of 25%.

Question 2.6.2 : Equity accounting – profit for the period

Z Ltd holds an interest in K Ltd. The following represents the equity (i.e.
net asset value) of K Ltd on various dates.

1/1/20x6 1/1/20x8
31/12/20x8
Carrying Carrying Carrying
amount and amount amount
fair value
$ $ $
Share capital 200 000 200 000 200 000
Retained earnings 400 000 1 000 000 2 000 000
Revaluation surplus
(land) 300 000 300 000 300 000

900 000 1 500 000 2 500 000

The movement in retained earnings for the year ended 31 December

20x8 consisted of the following:-
$
Revenue 4 800 000
Cost of sales (2 400 000)
Gross profit 2 400 000
Other expenses ( 733 334)
Income tax expense ( 466 666)
Profit after tax 1 200 000
Dividends declared ( 200 000)
Retained earnings for the period 1 000 000

The following information is applicable:

 On 1 January 20x6, Z Ltd acquired a 30% interest in K Ltd for $300

000. From this date Z Ltd exercised significant influence over K Ltd.
 It is the policy of Z Ltd to measure investments in associates at cost in
its separate financial statements.
  All the assets and liabilities of K Ltd were fairly valued on 1 January
20x6.

 The group follows a policy to revalue land every five years.

Required:

Show how Z Ltd would equity account for its investment in K Ltd.
(Adapted GAAP 2012).

Solution 2.6.2

Using the above information, the investment in K Ltd can be analysed

as follows:-
Total At (30%) Since
(30%)
$ $ $
At acquisition
Share capital 200 000

Retained earnings 400 000

Revaluation reserve 300 000

Net asset value 900 000 270 000

Cost of investment 300 000

Goodwill 30 000

Since acquisition
Retained earnings(1 000 000-400 000) 600 000 180 000

Current period
Profit 1 200 000 360 000

Dividends (200 000) (60 000)

2 500 000 480 000

NB: Unlike consolidated financial statements where the sum of the parent’s
and subsidiary’s total balances is assumed, equity accounting
commences with the separate financial statements of the investor (i.e.
Z Ltd) only. As equity accounting commences with the separate
financial statements of Z Ltd, the pro forma journal entries will focus
on including the desired items of K Ltd in the equity accounted financial
statements on Z Ltd.

As K Ltd is a 30% associate of Z Ltd, Z Ltd is entitled to 30% of the since

acquisition equity that K Ltd earned up to the start of the current
financial period. In this question the since acquisition equity earned up
to the start of the current financial period consists only of retained
earnings of $600 000 (1 000 000 – 400 000).

Journal 1
Dr Cr
$ $
Investment in K Ltd 180 000

Retained earnings (60 000 x 30%) 180 000

(Z Ltd’s share of opening retained earnings)

For the year ended 31 December 20x8 the associate earned a profit after
tax of $1 200 000. This means that K Ltd’s net assets increased with
$1 200 000 during the year (before taking dividends into account). As
the
“investment in associate” account reflects Z Ltd’s interest in K Ltd’s net
assets, Z Ltd should recognize in profit or loss its interest in K Ltd’s
profit
after tax, with a corresponding increase in the investment account:

Journal 2
Dr Cr
$ $
Investment in K Ltd 360 000

Share of profit of associate (1 2000x30%) 360 000

(Z Ltd’s share of the profit for the year)

In its separate financial statements, Z Ltd recognized dividends received

from K Ltd of $60 000 (200 000 x 30%) as income. The profit or loss in
the equity accounted financial statements, as well as the carrying
amount in the investment in K Ltd, already includes Z Ltd’s share of K
Ltd’s total profit for the period (before any dividends). To avoid double
counting, the dividends received from K Ltd should thus be accounted
for
as a reduction in the carrying amount of the investment. Consequently,
when equity accounting, the following pro forma journal entry should
be
processed to account for the dividends:-

Journal 3
Dr Cr
$ $
Dividend income (Soci) 60 000

Investment in K Ltd 60 000

(Reallocation of dividends received)
 After processing all the above pro forma journal entries the carrying
amount of the investment in the associate is $780 000 (300 000 cost +
180 000 (J1) + 360 000 (J2) – 60 000 (J3) on 31 December 20x8. This
amount can also be calculated as the cost of the investment of $300
000
plus the total of the “since” column in the analysis of $480 000. This
investment is reflected as a separate line item in the statement of
financial position under non-current assets. Alternatively the carrying
amount of the investment can be determined as follows:-

$
Share of net asset value at the end of the year 750 000
(2 500 000 x 30%)

Goodwill (300 000 – (900 00 x 30%) 30 000

Carrying amount 780 000

The equity accounted statement of profit or loss and other

comprehensive income of the Z Ltd Group for 20x8 will be prepared
as follows (assume that the first column represents Z Ltd’s separate
financial statements).

UNIT 3: BUSINESS COMBINATION: IFRS 3

3.0 OVERVIEW: IFRS 3 provides rules for recognition and measurement of
business combinations when an acquirer acquires assets and liabilities of
another entity (acquiree) and those constitute a business (parent & subsidiary
situation)
3.1 Objective: to improve the relevance, reliability and comparability of the
information that a reporting entity provides its finstats about a business
combination and its effects.
3.2 Scope: IFRS 3 applies to business combinations but does not apply to:

 Formation of a joint venture

 Acquisition of an asset or group of assets that is not a business,
although general guidance is provided on how such transactions should
be accounted for
 Combination of entities or businesses under common control (the IASB
has a separate agenda project on common transactions)
 Acquisition by an investment entity of a subsidiary that is required to
be measured at fair value through profit or loss under IFRS 10
consolidated finstats.
3.3 Definitions
Business combination: A transaction or event in which the acquirer obtains
control of one or more businesses.
Business: an integrated set of activities and assets that is capable of being
conducted and managed for the purpose of providing a return in the form of
dividends, lower costs or other economic benefits directly to investors or other
owners, members or participants.
Acquisition date: The date on which the acquirer obtains control of the
acquiree.
Acquirer: The entity that obtains control of the acquiree.
Acquiree: The business or businesses that the acquirer obtains control of in
a business combination
Fair value: the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants @ the
measurement date
Control of an investee: 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.
3.4 Method of accounting for business combinations
The acquisition method is the method used for all business combinations it
is also known as purchase method.

3.4.0 Steps in application of the acquisition (IFRS 3.5)

1) Identification of the acquirer
2) Determination of date of acquisition
3) Measurement and recognition of consideration transferred
4) Recognition and measurement of identifiable assets acquired and
liabilities assumed
5) Recognition and measurement of Non-Controlling Interest.
6) Recognition and measurement of goodwill.

3.4.1 STEP 1: Identification of acquirer:

IFRS 10 guidance is used to identify an acquirer in a business combination
i.e. the entity that obtains control of an acquiree. If IFRS 10 does not clearly
indicate the acquirer IFRS 3 provides the following additional guidance:
 The acquirer is usually the entity that transfers cash or other assets
where a business combination is effected in this manner.
  Usually but not always the entity issuing equity interests where the
transaction is effected this way
 The acquirer is usually the entity with the largest relative size , assets
,revenue or profit.
3.4.2 Step 2: Acquisition date
The date on which the entity obtains control of the acquiree. The
acquisition date may be a date earlier or later than the closing date
(IFRS 3.8-9) This is normally the date on which the acquirer legally
transfers the consideration and in return acquires the assets and
assumes the liabilities of the acquiree (i.e. the closing date). However,
control may be obtained on a date before or after the closing date, in
which case the acquisition date will not coincide with the closing date.
For example, a written agreement may provide control to the acquirer
even before the transfer of the related purchase consideration. On the
other hand, if the acquisition of an entity has to be approved by the
Competition Board and this approval is not merely a formality, the
acquisition date will be the date when the transaction is approved by
the Board, which may be after the transfer of the related purchase
consideration. Control may even be obtained without the transfer of any
consideration at the acquisition date. This situation may be brought
about by the investee entering into share buy-back arrangements with
some of its investors and, as a result, control now vests in one of the
investors who did not participate in the buy-back. Although this
investor originally acquired its interest some time ago, the date of
obtaining control (acquisition date) will only be at a later stage when
the share buy-back occurs.
The importance of the acquisition date is that this represents the date on
which the assets, liabilities, non-controlling interest and goodwill are
measured. It is also only from this date onwards that the results of the
acquiree are included in the consolidated financial statements of the acquirer.
EXAMPLES 1: Calso Ltd acquired a 10% interest in Kadash Ltd on 1 January
2x09. On 30 September 2x11 a further 45% interest is acquired.
Required:

What is the acquisition date in the above scenario. Motivate your answer.
The acquisition date is 30 September 2x11, as it is only from this date
onwards that Calso Ltd gained control over Kadash Ltd. Consolidation
will therefore commence on 30 September 2x11. From 1 January 2x09
to September 2x11, Calso should account for the 10% interest in
Kadash Ltd as a normal investment in terms of IFRS9.

EXAMPLE 2
3.4.3 STEP 3: Consideration of a Business Combination
 The fourth and final step in the application of the acquisition method is
to recognize and measure goodwill or a gain from a bargain purchase.
In order for this to be done, the consideration transferred in the
business combination should be determined first.

 In contrast to the previous standard which required equity instruments

transferred be measured at fair value on the date of exchange, all
items transferred to effect the business combination should be
measured at fair value at the acquisition date.

 The fair value of the consideration is the sum of the following as at the
acquisition date.

- the fair value of the assets transferred by the acquirer.

- the fair value of the liabilities incurred by the acquirer to former
owners of the acquiree.
- the fair value of equity instruments issued by the acquirer.

 Consideration transferred can be cash or other assets paid, contingents

considerations, ordinary or preference shares issued, options issued or
any share-based payment awards granted to former owners of the
acquiree. In addition to other considerations transferred in a business
combination, the acquirer may perhaps replace the acquiree’s share-
based payment awards with that the acquirer. Those share-based
payment awards are not measured at fair value but in accordance with
IFRS 2.

 The carrying amounts of assets and liabilities transferred as part of the

consideration may differ from their fair values as at date of acquisition,
used in the measurement of the consideration for the business
combination. In such situations, the acquirer should remeasure these
assets and liabilities to their fair values and recognize any gain or loss
in profit or loss.
2.5.5.1 Acquisition-related costs

According to revised IFRS 3, acquisition related costs are costs

that the acquirer incurs to effect a business combination, e.g.
finder’s fee, legal, accounting and valuation fees, general
administrative costs, cost of registering and issuing debt and
equity instruments. These costs do not form part of what the
acquirer and acquiree exchanged in the business combination
 and are not part of the consideration transferred to the former
owners of the acquiree.

The cost to issue debt or equity instruments should be recognized

in accordance with IAS 39 and form part of the initial
measurement of the liability or equity as required by the previous
version of IFRS 3. All other acquisition-related costs are
EXPENSED in the period in which the costs are incurred.

Contingents Consideration

According to the revised IFRS3, a contingent’s consideration is an

obligation of the acquirer to transfer additional assets or equity
instruments to the former owners of the acquiree as part of the
exchange for control of an acquiree if specified future events occur or
conditions are met e.g. an additional payment if a specified earning
level is achieved at an agreed date after the business consideration. A
contingent consideration may also give the acquirer the right to the
return of a previously transferred consideration if specified conditions
are met. The revised IFRS3 requires, the acquirer to recognize
contingent considerations as part of the consideration transferred in
exchange of the acquiree at acquisition date fair values.

After the business combination the fair value of the contingent

consideration may change due to the fact that e.g. a certain milestone
has been achieved. Such subsequent changes in value are generally
directly related to post-combination events and changes in
circumstances related to the combined entity and do not affect the
acquisition-date fair value of the consideration transferred. Except
where the changes in fair value related to measurement period
adjustments, the acquirer should account for changes in fair value of
contingent considerations as follows:

a) Contingent considerations classified as equity should not be

remeasured and its subsequent settlement should be accounted for
within equity.

b) Contingent assets or liabilities classified as financial instruments

and that is, are within the scope of IFRS9 or IAS39, should be
measured at fair value, with any resulting gains or losses recognized
in profit or loss or in other comprehensive income.

c) Contingent assets or liabilities not within the scope of IFRS9 or

IAS39 should be accounted for in accordance with IAS37 or other
standards as appropriate.
 EXAMPLE : (Measurement of Consideration transferred)

On 1 January 2x11 Zihombe Ltd acquired a 55% interest in Kadiki Ltd

from Vamwe Ltd. The purchase price was settled as follows:-

 A cash payment of $750 000 on 1 January 2x11.

 The transfer of land with a carrying amount of $225 000. The fair value
of the land amounted to $300 000 on 1 January 2x11, but increased to
$337 500 on 1 January 2 x11, when the transfer of the land was
formally registered.

 The issue of 10 000 ordinary shares to Vamwe Ltd on 15 January 2x11.

The fair value of these shares amounted to $15 each on 1 January 2x11
and $16,5 each on 15 January 2x11.

 As Zihombe Ltd did not have sufficient cash reserves, it was agreed that
the outstanding amount of $525 000 will be paid to Vamwe Ltd on 31
December 2x12. Taking into account the time value of money, the fair
value of this liability amounted to $450 000 on 1 January 2x11.
Required:

Calculate the fair value of the consideration transferred.

(Adapted GAAP 2012).

Solution

Cash payment $ 750 000

Land transferred $ 300 000
Shares issued (10 000 x $15) $ 150 000
Liability to be settled 31/12/2x12 $ 450 000
Fair value of consideration transferred $1 650 000

Question (Goodwill)

On 1 January 2x11 Zihombe Ltd acquired 70% interest (i.e. 70 000

ordinary shares) in Kadiki Ltd at a cost of $1 500 00. On this date, the
issued share capital of Kadiki Ltd consisted of 100 000 ordinary shares
with a market value of $18 each. The fair value of the net assets of
Kadiki Ltd amounted to $1 650 000. Kadiki Ltd does not have any other
equity instruments in issue.

Required:

i) Assuming that the non-controlling interest is measured at a

proportionate share of net assets, pass proforma journal entry to
account for goodwill.
 ii) Assuming that the non-controlling interest is measured at fair
value, pass proforma journal entry to account for goodwill.

(Adapted GAAP 2012)

Solution

a) Dr Cr
Equity of Kadiki Ltd 1 650 000
Goodwill 345 000
Investment in Kadiki Ltd 1 500
000
Non-controlling interest (equity) 495
000
(Elimination of investment and recognition of goodwill)

NB: Non-controlling interest is measured at $495 000 being 30% of

the fair value of the identifiable net assets of $1 650 000.

b) Dr Cr
Equity of Kadiki Ltd 1 650 000
Goodwill 390 000
Investment in Kadiki Ltd 1 500
000
Non-controlling interest (equity) 540
000
(Elimination of investment and recognition of goodwill)

NB: Non –controlling interest is measured at fair value which

amounts to $540 000 (100 000 shares x 30% x $18). The goodwill
will then amount to $390 000 (1 500 000+ $540 000 - $1 650
000)

*Tutorial Note

If the non-controlling interest is measured at the proportionate share of

only the identifiable net assets, goodwill relates to the controlling
interest, whereas, if the non-controlling interest is measured at fair
value, goodwill includes a portion attributable to the non-controlling
interest. The “non-controlling interest at proportionate” method is often
referred to as the partial-goodwill method”, whereas the non-controlling
interest at fair value method, is often referred to as the full goodwill
method”.

The measurement of non-controlling interest at the proportionate share

of the identifiable net assets results in a lower goodwill figure. If goodwill
 is subsequently impaired, the recognition of a lower goodwill figure will
result in a smaller impairment loss recognized in profit or loss.

3.4.4 STEP 4: Recognizing and measuring the identifiable assets

acquired and liabilities assumed

At acquisition date, the acquirer should recognize, separately from

goodwill, the identifiable assets acquired and liabilities assumed
relating to the acquiree. These assets and liabilities should generally be
measured at their fair value as at acquisition date.

These fair values should not be affected by the acquirer’s intentions for
the future use of the assets and liabilities e.g. for some reason, the
acquirer may intend not to use a specified acquired asset or may intend
to use the asset in a way that is different from the way other markets
participants would use it. In such cases, the fair value should be
determined in accordance with the assets use by other market
participants.

Exception to the recognition and/or measurement principles

IFRS 3 identifies the following as exceptions to both the general

recognition and measurement principles of the standard, and these
items should be recognized and measured as described below:

 Income taxes: the acquirer should recognize and measure deferred tax
assets or liabilities arising from the assets acquired and liabilities
assumed in a business combination in accordance with IAS12. The
potential tax effects of temporary differences and carry forwards of an
acquiree that existed at the acquisition date or arose as a result of the
acquisition shall be recognized and measured in accordance with
IAS12. It is important to note that temporary differences arising in a
business combination are not exempt and deferred tax should be
recognized.

 Employee benefits: The acquirer should apply IAS19 to recognize and

measure an asset or liability related to the acquiree’s employee benefit
arrangements.

 Indemnification assets: A business combination sometimes includes

an indemnification agreement under which the former owners of the
acquiree are required to reimburse the acquirer for any payments the
acquirer eventually makes upon settlement of a particular liability after
the business combination. The acquirer then recognizes the right to the
 indemnification or reimbursement, as an indemnification asset. The
acquirer recognizes the asset when it recognizes the related liability and
measures it on the same basis that it measured the indemnified item
(at fair value or on another basis due to the exceptions in the standard),
subject to the need for a valuation allowance for uncollectability. The
subsequent measurement of the indemnification asset should also be
based on the assumptions consistent with those used to measure the
related indemnified liability, subject to management’s assessment of
the collectability of the asset. This asset should be derecognized when
the right expires.
In addition to the above mentioned exceptions to both the recognition
and measurement principles, the standard also identifies the following
exceptions to the measurement principle. The items should be
measured as described below:

 Reacquired rights: The acquirer should measure the value of these

assets on the basis of the remaining contractual term of the related
contract, regardless of whether market participants would consider
potential contractual renewals in determining their fair value. It should
be noted that a reacquired right is not transferred to a third part and
the departure from assumptions that market participants would use in
measuring the value, is appropriate. The application guidance to the
standard also states that if the contract includes terms that are
favourable or unfavourable when compared with current market
transaction for similar items, the acquirer should recognize, separately
from the business combination, a gain or loss for the effective
settlement of the contract.

 Share-based payments: Liabilities or equity instruments related the

replacement of an acquiree’s share-based payment awards with share-
based payment awards of the acquirer should be measured in
accordance with IFRS2.

 Non-current assets held for sale: Non-current assets and disposal

groups of assets and liabilities acquired that are classified as held for
sale at the acquisition date, are to be measured at fair value less costs
to sell in terms of IFRS5.

3.4.5 STEP 5: Recognizing and measuring any non-controlling interest

in the acquiree
Non-controlling interest is defined as the equity in subsidiary not
attributable, directly or indirectly, to a parent. Non-controlling interests
 were previously referred to as “minority interests”. As a situation may
arise where a minority shareholder controls an entity or, alternatively,
where a majority shareholder has no control at all, it was decided that
“non-controlling interests” would be a more accurate description that
“minority interests”.

When measuring non-controlling interest, a distinction should be made

between instruments that are present ownership interests and entitle
their holders to a proportionate share of the entity’s net assets in the
event of liquidation (for example ordinary shares) and instruments that
are not present ownership interests and do not entitle their holders to a
proportionate share of the entity’s net assets in the event of liquidation
(for example options or preference shares). The reason for this
distinction is that different measurement bases apply – these
measurement bases are addressed in the following sections.

Present ownership interests

In respect of each business combination, those components of non-

controlling interest that are present ownership interests and entitle their
holders to a proportionate share of the entity’s net assets in the event of
liquidation should be measured, at acquisition date, based on one of
the following measurement bases:

 fair value; or

 the present ownership instruments’ proportionate share in recognized

amounts of the acquiree’s identifiable net assets.

If these interests are measured at fair value, goodwill will include a

portion attributable to the non-controlling interest, whereas, if these
interests are measured at the instruments’ proportionate share of the
identifiable net assets, goodwill relates only to the controlling interest.
There are likely to be three main differences in outcome that occur when
these components of non-controlling interest are measured at the
proportionate share of the acquiree’s identifiable net assets rather than
at fair value namely:

o The amounts recognized for non-controlling interest and goodwill

are likely to be lower.

o If a cash-generating unit is subsequently impaired, the total

impairment loss in respect of goodwill recognized in profit or loss
 is likely to be lower (although the impairment loss attributable to
the controlling interest will remain unchanged.

o If the acquirer subsequently purchases shares held by the non-

controlling interests, the reduction in the reported equity
attributable to the acquirer (i.e. the difference between the
amount paid to the non-controlling interest and the reduction in
the carrying amount of the non-controlling interest) is likely to be
higher.
Note that the selection of the measurement basis for these components
of non-controlling interest is not an accounting policy choice, as it is
made on a transaction by transaction basis. The option to measure these
components of non-controlling interest at fair value exists only at the
acquisition date. Subsequent changes in the non-controlling interest
are measured at their proportionate share of the subsequent changes
in the acquiree’s equity.

The acquisition date fair value of these components of non-controlling

interest may be based on, for example, quoted prices in an active market for
those shares that are not held by the acquirer. If quoted prices in an active
market are not available because the shares are not publicly traded,
alternative valuation techniques may be used. It should be noted that the par-
share fair value of the non-controlling interest may differ from the par-share
fair value of the acquirer’s interest. This is due to the fact that the acquirer’s
interest will normally include a premium paid for control, or alternatively the
non-controlling interest will include a discount due to lack of control, provided
such a premium or discount will be taken into account by market
participants.
(Measurement of Non-Controlling Interest)
On 1 January 2x11 the issued share capital of Kadash Ltd consisted of 100
000 ordinary shares with a market value of $18 each. On this date, Calso Ltd
acquired a 70% interest in Kadash Ltd (i.e. 70 000 ordinary shares), at a cost
of $1 500 000. The fair value of the net assets of Kadash Ltd amounted to $1
650 000. Kadash Ltd does not have any other equity instruments in issue.

Required:

Calculate the value of the non-controlling interest in the above scenario

(Adapted GAAP 2012).

Solution 2.8.2

The non-controlling interest may be measured at $495 000, being 30%

of the fair value of the identifiable net assets of $1 650 000. Alternatively
 it may be measured at fair value (based on the quoted prices in an active
market), which will amount to $540 000 (100 000 shares x 30% $18).
These two alternatives will result in different amounts of goodwill being
recognized.

3.4.6 STEP 6: Goodwill or gain from a bargain purchase.

The final step in applying the acquisition method is to recognize and
measure goodwill or a gain from a bargain purchase. Goodwill or a gain
from a bargain purchase at acquisition is always calculated as a
residual and the measurement of the amount of goodwill is dependent
on the following:

 the recognition and measurement of all the identifiable assets, liabilities

and contingent liabilities.

 the recognition and measurement of any con-controlling interest, either

at their proportionate share of the net assets acquired or at fair value.

 the recognition and measurement of the consideration transferred

including the fair value at the acquisition date of the acquirer’s equity
interest previously held in the acquiree if the business combination was
achieved in stages.
The acquirer should measure goodwill and a gain from bargain purchase
as at the acquisition date on the following basis:

o Consideration transferred
Add
The amount of any non-controlling interest.
Add
The acquisition date fair value of the acquirer’s interest
previously held in the acquiree in a business combination
achieved in stages.
Less
Net assets acquired
= Goodwill or gain from bargain purchase.

A positive residue requires goodwill to be recognized and a negative

residue indicates that a gain from bargain purchase should be recognized.

(Bargain Purchase)

On 1 January 2x11,Steele Ltd acquired 80% of the equity interests in

Cast Ltd in exchange for cash of $225 000. Because they needed to
dispose of their investments in Cast Ltd by a specific date, the former
owner of Cast Ltd did not have sufficient time to market Cast Ltd to
multiple potential buyers. The management of Steele Ltd initially
measured the separately recognizable identifiable assets acquired, and
liabilities assumed and determined that the identifiable assets are
measured at $375 000 and the liabilities measured at $75 000. Steele
Ltd engaged an independent consultant who determined that the fair
value of the 20% non-controlling interest in Cast Ltd was $63 000.

Assume that the fair value and consists only of present ownership
interests.

Required:

Prepare a proforma journal entry to record gain on bargain purchase in

the above scenario.
(Adapted GAAP 2012).

Solution 2.8.5

Proforma Journal Entry

Dr Cr
Equity at acquisition 300 000
Gain on the bargain purchase 12 000
Non-controlling interest (equity) 63 000
Investment in Cast Ltd 225 000
(Elimination of acquisition equity)

*Tutorial Note

The fair value of Cast Ltd’s identifiable net assets of $300 000
($375 000 - $75 000) exceeds the fair value of the consideration
transferred ($225 000) plus the fair value of non-controlling interest in
Cast Ltd ($63 000). This results in a gain on the bargain purchase of
$12 000 ($300 000 - $288 000).

According to IFRS 3, before recognizing a bargain purchase, Steele Ltd

should first assess whether:-

- All assets and liabilities were correctly identified.

- All assets and liabilities were measured correctly.
- The non-controlling interest in CastLtd was correctly measured.
- The consideration transferred was measured correctly.

After the review, the gain on bargain purchase is recognized if Steele

Ltd decides that the procedures and the resulting measures were
appropriate.

NB: In the above scenario, if Steele Ltd had chosen to measure the
non-controlling interest in Cast Ltd on the basis of the
proportionate interest in the identifiable net assets of Cast Ltd,
 the amount recognized in respect of non-controlling interest
would be $60 000 ($300 000 x 20%). The gain on the bargain
purchase would then be $15 000 ($300 000 - $225 000+$60 000).

3.5 APPLICATION OF THE ACQUISITION METHOD TO PARTICULAR

TYPES OF BUSINESS COMBINATIONS

- A business combination achieved in stages.

- A combination achieved without the transfer of consideration.

3.5.1 Business combination achieved in stages

In many instances control over another entity is achieved after a series

of transactions rather than after one transaction e.g. an entity may
acquire an initial 15% on a specific date and then later buy another
15%, and some time later a further 22%.

The first acquisition will be an investment in equity shares which will

probably be classified as a financial asset in terms of IFRS9. The second
acquisition may result in the acquiree being accounted for as an
associate. The third acquisition gives the acquirer control (i.e.
acquisition date) and the acquiree will thereafter be consolidated.

IFRS 3 requires that the consideration transferred in a business

combination should be measured at the fair value as at the acquisition
date. Consequently in business combinations achieved in stages, the
acquirer should remeasure its previously held equity interests in the
acquiree at its acquisition date fair value and recognize the resulting
gain or loss in profit or loss (in) the separate financial statements of the
acquirer. If the previous investment (before obtaining control) was
classified as a financial asset in terms of IFRS9, the acquirer would
have recognized any gains or losses on subsequent remeasurement to
fair value, in other comprehensive income. The amounts so recognized
should at the acquisition date, be reclassified to profit or loss (in the
separate financial statements of the acquirer), as if the acquirer had
disposed of the investment.

3.5.2 Business combination achieved without transfer of consideration

All forms of business combinations should be accounted for using the

acquisition method, even if the acquirer obtains control without the
 transfer of consideration. Obtaining control without transfer of
consideration would occur, for example in the following circumstances:

- A share buy-back by the acquiree resulting in an existing investor

(acquirer) obtaining control;
- Lapsing of veto rights held by minority that kept the acquirer from
controlling the acquiree;

- The business combination is achieved by contract alone that

resulted in the acquirer obtaining control.
In a business combination that is achieved by contract alone, the
acquirer transfers no consideration and may hold no equity interests in
the acquiree. The acquirer should still allocate the amount of the
acquiree’s net assets at fair value to the non-controlling interest, even
if the non-controlling have a 100% interest in the acquiree.

In the determining of goodwill in a business combination in which no

consideration is transferred, the acquirer should substitute the
“acquisition-date fair value of consideration transferred” with,
“acquisition-date fair value of the acquirer’s interest in the acquiree
determined using a valuation technique”.

3.5.3 Reverse takeover

A reverse takeover occurs when the acquirer (usually the larger entity)
is the entity whose equity interest has been acquired and the issuing
entity (usually the smaller entity is the acquiree). The entity that issues
securities (legal acquirer is identified as the acquiree for accounting
purposes). For these reasons, such a business combination is referred
to as a reverse takeover. This will happen for instance, when a large
private company has itself “acquired” by a smaller listed company in
order to obtain a stock exchange listing.

From a legal perspective the smaller entity is the parent and the larger
entity is the subsidiary. The economic reality of the transaction is
however, that the shareholders of the subsidiary (larger entity), have in
effect taken control of the parent (smaller entity) and the combined
entity. This happens as the majority of the shares in the parent are held
by shareholders of the subsidiary after the share issue to effect the
acquisition – consequently these shareholders now control both the new
parent and the combined entity. In a reverse takeover, the accounting
acquirer should base the acquisition-date fair value of the consideration
transferred for its interest in the accounting acquiree on the number of
equity interests the legal subsidiary would have issued to give the
owners of the legal parent the same percentage equity interests in the
combined entity that results from the reverse acquisition.

Reverse acquisitions impacts only on the consolidated financial

statements. After a reverse takeover, the consolidated financial
statements are issued under the name of the legal parent (acquiree)
with an explanation in the notes that it represents a continuation of the
business of the subsidiary (acquirer) with one adjustment, which is to
adjust retroactively the accounting acquirer’s legal capital to reflect the
legal capital of the accounting acquiree. The comparative information
in the consolidated financial statements is also retroactively adjusted
to reflect the legal capital of the legal parents (acquiree).

The acquisition method is applied as from the perspective of the

acquirer (the subsidiary). This means that the consolidated financial
statements reflect:-

- Assets and liabilities of the acquirer (subsidiary) at pre-combinations

carrying amounts.

- The assets and liabilities and contingent liabilities of the acquiree

(parent) revalued to their fair values at the date of acquisition in
terms of IFRS3.

- The retained earnings and other equity balances of the acquirer

(subsidiary) before the business combination.

- The issued equity interest in the consolidated financial statements

on the value of the equity of the acquirer before the combination plus
the fair value of the acquiree determined in terms of this standard.
However, the equity structure reflect the equity structure of the
acquiree (parents), including the equity interests the parent issued
to effect the combination.

- The non-controlling interest’s proportionate share of the acquirer’s

(subsidiary’s) carrying amounts of retained earnings and other
equity interest as before the business combination.
The owners of the subsidiary, who did not exchange their shares in the
subsidiary for shares in the parent, have only a legal interest in the
result and net assets of the subsidiary. They are therefore treated as
the non-controlling interest in the consolidated financial statements.
Shareholders (old and new) of the parent after the reverse takeover have
an interest in the results, assets and liabilities of the combined entity.
3.6 DISCLOSURES

 The acquirer should disclose information that enables users of its

financial statements to evaluate the nature and financial effect of a
business combination that occurs either:

During the current reporting period; or

a) After the end of the reporting period but before the financial
statements are authorized for issue.

UNIT 4: JOINT ARRANGEMENTS: IFRS 11

IFRS11 (EFFECTIVE DATE: 1 JANUARY 2013)

4.1. INTRODUCTION

IFRS11 supersedes IAS31 INTERESTS IN JOINT VENTURES and SIC 13

JOINTLY CONTROLLED ENTITIES – NON MONETARY CONTRIBUTIONS BY
VENTURES.

The objective of IFRS11 is to establish principles for financial reporting

by entities that have an interest in arrangements that are controlled
jointly.

To meet this objective IFRS11 defines joint control and requires an

entity that is a party to a joint arrangement to determine the type of
joint arrangement in which it is involved by assessing its rights and
obligations and to account for these rights and obligations in
accordance with that type of joint arrangement.

4.2. SCOPE

IFRS11 should be applied by all entities that are party to a joint

arrangement.

4.3. CORE PRINCIPLE

The core principle of IFRS11 is that a party to a joint arrangement

determines the type of joint arrangement in which it is involved by
assessing its rights and obligations and accounts for those rights and
obligations in accordance with that type of joint arrangement. (IFRS11:
1-2).

4.4. TERMINOLOGY
 Joint arrangement An arrangement of which two or more parties
have joint control.

Joint control The contractually agreed sharing of control of

an arrangement, which exists only when
decisions about the relevant activities
require the unanimous consent of the parties
sharing control.
Joint operation A joint arrangement whereby the parties that
have joint control of the arrangement have
rights to the assets, and obligations for the
liabilities, relating to the arrangement.

Joint venture A joint arrangement whereby the parties that

have joint control of the arrangement have
rights to the net assets of the arrangement.

Joint venturer A party to a joint venture that has joint control

of that joint venture.

Party to a joint An entity that participates in a joint

Arrangement arrangement, regardless of whether that entity
has joint control of the arrangement.

Separate vehicle A separately identifiable financial structure,

including separate legal entities recognized by
statute, regardless of whether those entities
have a legal personality.

4.5. JOINT ARRANGEMENTS

A joint arrangement is an arrangement of which two or more parties

have joint control.

A joint arrangement has the following characteristics:

 The parties are bound by a contractual arrangement, and

 The contractual arrangement gives two or more of those
parties joint control of the arrangement.

A joint arrangement is either a joint operation or a joint venture.

4.5.1 Contractual arrangement

For a joint arrangement to fall within the scope of IFRS11, firstly a

contractual arrangement must exist between the parties involved. A
contractual arrangement normally takes the form of a written contract
between the parties involved. Alternatively, if the joint arrangement
involves a separate entity, aspects of the contractual arrangements
could be incorporated in the founding documents of the separate entity.
Other contractual arrangements can also be a result of a statutory
mechanism which sets out conditions for any decision to be passed.
Thus the contractual arrangement sets out the terms upon which the
parties participate in the activity that is the subject of the arrangement.

4.5.2 Joint control

Joint control is the contractually agreed sharing of control of an

arrangement, which exists only when decisions about the relevant
activities require the unanimous consent of the parties sharing control.

Before assessing whether an entity has joint control over an

arrangement, an entity first assesses whether the parties, or a group of
the parties, control the arrangement (in accordance with the definition
of control in IFRS10 Consolidated Financial Statements). Accordingly an
entity considers whether the parties have all of the following:-

 Power over the arrangement

 Exposure (or rights) to variable returns through their involvement
with the arrangement.
 The ability to use their power over the arrangement to affect the
amount of the returns to which they are exposed.

After concluding that all the parties, or a group of the parties, control
the arrangement collectively, an entity should assess whether it has
joint control of the arrangement. Joint control exists only when
decisions about the relevant activities require the unanimous consent
of the parties that collectively control the arrangement.
 The requirement for unanimous consent means that any part with joint
control of the arrangement can prevent any of the other parties, or a
group of the parties, from making unilateral decisions (about the
relevant activities) without its consent.

4.5.3 Continuous Assessment

It is possible that facts and circumstances surrounding joint control

can change. Should that be the case, it is required by IFRS11 to
reassess whether or not it has joint control over the arrangement after
the change that took place. Joint control may be lost due to an action
of the investor (e.g. existing the contract that grants joint control),
through the actions of other parties (e.g. another party obtaining control
through the acquisition of potential voting rights) or through other
events and circumstances (e.g. the investee being placed under control
of a liquidator by order of the court). Conversely, an investor may obtain
sole control of the investee. Therefore it is important to consider any
change in facts and circumstances to determine whether joint control
still exists after a change in question.

4.6 TYPES OF JOINT ARRANGEMENTS

Joint arrangements are either joint operations or joint ventures,

depending on the right and obligations of the parties to the joint
arrangements:

 A joint operation is a joint arrangement whereby the parties that

have joint control of the arrangement have rights to the assets,
and obligations for the liabilities, relating to the arrangement.
Those parties are called joint operators.

 A joint venture is a joint arrangement whereby the parties that

have joint control of the arrangement have rights to the net assets
(equity) of the arrangement. Those parties are called joint
venturers.

4.7 CLASSIFYING JOINT ARRANGEMENTS

 According to IFRS11, the classification of joint arrangements requires
the parties to assess their rights and obligations arising from the
arrangement. When making that assessment, an entity should consider
the following:-

- the structure of the joint arrangement.

- when the joint arrangement is structured through a separate
vehicle.

i) the legal form of the separate vehicle.

ii) the terms of the contractual arrangement.
iii) when relevant, other facts and circumstances.

4.7.1 Structure of the joint arrangement

4.7.1.1 Joint arrangements not structured through a separate

vehicle

A joint arrangement that is not structured through a separate

vehicle is a joint operation. In such cases, the contractual
arrangement establishes the parties’ rights to the assets, and
obligations for the liabilities, relating to the arrangement, and the
parties rights to the corresponding revenues and obligations for
the corresponding expenses.

The contractual arrangement often describes the nature of the

activities that are the subject of the arrangement and how the
parties intend to undertake those activities together. For
example, the parties to a joint arrangement could agree to
manufacture a product together, with each party being
responsible for a specific task and each using its own assets and
incurring its own liabilities. The contractual arrangement could
also specify how the revenues and expenses that are common to
the parties are to be shared among them. In such a case, each
joint operator recognizes in its financial statements the assets
and liabilities used for the specific task, and recognizes its share
of the revenues and expenses in accordance with the contractual
arrangement.

In other cases, the parties to a joint arrangement might agree, for

example, to share and operate an asset together. In such a
case, the contractual arrangement establishes the parties’ rights
to the asset that is operated joint, and how output or revenue
 from the asset and operating costs are shared among the parties.
Each joint operator accounts for its share of the joint asset and
its agreed share of any liabilities, and recognizes its share of the
output, revenues and expenses in accordance with the
contractual arrangement.

4.7.1.2 Joint arrangements structured through a separate vehicle

(IFRS11: B 19-21)

A joint arrangement in which the assets and liabilities relating to

the arrangement are held in a separate vehicle can be either a
joint venture or a joint operation.

Whether a party is a joint operator or a joint venturer depends on

the party’s rights to the assets, and obligations for the liabilities,
relating to the arrangements that are held in the separate vehicle.

When the parties have structured a joint arrangement in a

separate vehicle, the parties need to assess whether the legal form
of the separate vehicle, the terms of the contractual arrangement
and, when relevant, any other facts and circumstances give
them:-

 rights to the assets, and obligations for the liabilities, relating

to the arrangement (i.e. the arrangement is a joint operation);
or

 rights to the nets assets of the arrangement (i.e. the

arrangement is a joint venture).

i) The legal form of the separate vehicle (IFRS11: B-22-24)

The legal form of the separate vehicle is relevant when assessing

the type of joint arrangement. The legal form assists in the initial
assessment of the parties’ rights to the assets and obligations for
the liabilities held in the separate vehicle, such as whether the
parties have interests in the assets held in the separate vehicle
and whether they are liable for the liabilities held in the separate
vehicle.

For example, the parties might conduct the joint arrangement

through a separate vehicle to be considered in its own right (i.e.
the assets and liabilities held in the separate vehicle are the
 assets and liabilities of the separate vehicle and not the assets
and liabilities of the parties). In such a case, the assessment of
the rights and obligations conferred upon the parties by the legal
form of the separate vehicle indicates that the arrangement is a
joint venture. However, the terms agreed by the parties in their
contractual arrangement and, when relevant, other facts and
circumstances can override the assessment of the rights and
obligations conferred upon the parties by the legal form of the
separate vehicle (Subsistence over legal form).

The assessment of the rights and obligations conferred upon the

parties by the legal form of the separate vehicle is sufficient to
conclude that the arrangement is a joint operation only if the
parties conduct the joint arrangement in a separate vehicle whose
legal form does not confer separation between the parties and the
separate vehicle (i.e. the assets and liabilities held in the separate
vehicle are the parties’ assets and liabilities.

ii) Assessing the terms of the contractual arrangement (IFRS

11:B25 &26)

In many cases, the rights and obligations agreed to by the parties

in their contractual arrangements are consistent, or do not
conflict, with the rights and obligations conferred on the parties
by the legal form of the separate vehicle in which the arrangement
has been structured.

In other cases, the parties use the contractual arrangement to

reverse or modify the rights and obligations conferred by the legal
form of the separate vehicle in which the arrangement has been
structured. The following example illustrates this:-

Assume that two parties structure a joint arrangement in an

incorporated entity. Each party has a 50 per cent ownership
interest in the incorporated entity. The incorporation enables the
separation of the entity from its owners and as a consequence the
assets and liabilities held in the entity are the assets and
liabilities of the incorporated entity. In such a case, the
assessment of the rights and obligations conferred upon the
parties by the legal form of the separate vehicle indicates that the
parties have rights to the net assets (equity) of the arrangement.
 However, the parties modify the features of the corporation
through their contractual arrangement so that each has an
interest in the assets of the incorporated entity and each is liable
for the liabilities of the incorporated entity in a specified
proportion. Such contractual modifications to the features of a
corporation can cause an arrangement to be a joint operation.

The following table adapted from IFRS11:B27 compares common terms

in contractual arrangements of parties to a joint operation and common
terms in contractual arrangements of parties to a joint venture. The
examples of the contractual terms provided in the following table are
not exhaustive

Assessing the terms of the contractual arrangement

Joint operation Joint venture

The terms of The contractual The contractual arrangement

the arrangement provides the provides the parties to the
contractual parties to the joint joint arrangement with rights
arrangement arrangement with rights to to the net assets of the
the assets, and obligations arrangement (i.e. it is the
for the liabilities, relating separate vehicle, not the
to the arrangement. parties, that has rights to the
assets, and obligations for the
liabilities, relating to the
arrangement).
Rights to The contractual The contractual arrangement
assets arrangement establishes establishes that the assets
that the parties to the joint brought into the arrangement
arrangement share all or subsequently acquired by
interests (e.g. rights, title the joint arrangements are
or ownership) in the assets the joint arrangement’s
relating to the assets. The parties have no
arrangement in a specified interests (i.e. no rights, title or
proportion (e.g. in ownership) in the assets of
proportion to the parties’ the arrangement.
ownership interest in the
arrangement or in
proportion to the activity
carried out through the
arrangement that is
directly attributable to
them.
Obligations The contractual The contractual arrangement
for liabilities arrangement establishes establishes the joint
that the parties to the joint arrangement is liable for the
 arrangement share all debts and obligations of the
liabilities, obligations, arrangement.
costs and expenses in a
specified proportion (e.g. The contractual arrangement
in proportion to the states that creditors of the
parties’ ownership interest joint arrangement do not
in the arrangement or in have rights of recourse
proportion to the activity against any party with
carried out through the respect to debts or obligations
arrangement that is of the arrangement.
directly attributable to
them).

The contractual
arrangement establishes
that the parties to the joint
arrangement are liable for
claims raised by third
parties.

Revenues, The contractual The contractual arrangement

expenses, arrangement establishes establishes each party’s share
profit or loss the allocation of revenues in the profit or loss relating to
and expenses on the basis the activities of the
of the relative performance arrangement.
of each party to the joint
arrangement. For
example, the contractual
arrangement might
establish that revenues
and expenses are allocated
on the basis of the
capacity that each party
uses in a plant operated
jointly, which could differ
from their ownership
interest in the joint
arrangement. In other
instances, the parties
might have agreed to share
the profit or loss relating to
the arrangement on the
basis of a specified
proportion such as the
parties’ ownership interest
in the arrangement. This
would not prevent the
arrangement from being a
 joint operation if the
parties have rights to the
assets, and obligations for
the liabilities, relating to
the arrangement.
Guarantees The parties to joint
arrangements are often
required to provide
guarantees to third
parties, that for example,
receive a service from, or
provide financing to, the
joint arrangement. The
provision of such
guarantees, or the
commitment by the parties
to provide them, does not,
but itself, determine that
the joint arrangement is a
joint operation. The
feature that determines
whether the joint
arrangement is a joint
operation or a joint
venture is whether the
parties have obligations
for the liabilities relating to
the arrangement (for some
of which the parties might
or might not have provided
guarantee).

NB: When the contractual arrangement specifies that the parties have
rights to the assets, and obligations for the liabilities, relating to
the arrangement, they are parties to a joint operation and do not
need to consider other facts and circumstances for the purposes
of classifying the joint arrangement.

iii) Assessing other facts and circumstances (IFRS11: B29-32)

When the terms of the contractual arrangement do not specify

that the parties have rights to the assets, and obligations for the
liabilities, relating to the arrangement, the parties should
consider other facts and circumstances to assess whether the
arrangement is a joint operation or a joint venture.
A joint arrangement might be structured in a separate vehicle
whose legal form confers separation between the parties and the
separate vehicle.

The contractual terms agreed among the parties might not specify
the parties’ rights to the assets and obligations for the liabilities,
yet consideration of other facts and circumstances can lead to
such an arrangement being classified as a joint operation. This
will be the case when other facts and circumstances give the
parties rights to the assets, and obligations for the liabilities,
relating to the arrangement.

When the activities of an arrangement are primarily designed for

the provision of output to the parties, this indicates that the
parties have rights to substantially all the economic benefits of
the assets of the arrangement. The parties to such arrangements
often ensure their access to the outputs provided by the
arrangement by preventing the arrangement from selling output
to third parties.
The effect of an arrangement with such a design and purpose is
that the liabilities incurred by the arrangement are, in substance,
satisfied by the cash flows received from the parties through their
purchases of the output. When the parties are substantially the
only source of cash flows contributing to the continuity of the
operations of the arrangement, this indicates that the parties
have an obligation for the liabilities relating to the arrangement.
The following example illustrates this:-

Assume that two parties structure a joint arrangement in an

incorporated entity (entity C) in which each party has a 50 per
cent ownership interest. The purpose of the arrangement is to
manufacture materials required by the parties for their own,
individual manufacturing processes. The arrangement ensures
that the parties operate the facility that produces the materials
to the quantity and quality specifications of the parties.

The legal form of entity C (an incorporated entity) through which

the activities are conducted initially indicates that the assets and
liabilities held in entity C are the assets and liabilities of entity C.
The contractual arrangement between the parties does not
specify that the parties have rights to the assets or obligations for
the liabilities of entity C. Accordingly, the legal form of entity C
 and the terms of the contractual arrangement indicate that the
arrangement is a joint venture.

However, the parties also consider the following aspects of the

arrangement.

 The parties agreed to purchase all the output produced by

entity C in a ration of 50:50. Entity C cannot sell any of the
output to third parties, unless this is approved by the two
parties to the arrangement. Because the purpose of the
arrangement is to provide the parties with output they require,
such sales to third parties are expected to be uncommon and
not material.

 The price of the output sold to the parties is set by both parties
at a level that is designed to cover the costs of production and
administrative expenses incurred by entity C. On the basis of
this operating model, the arrangement is intended to operate
at a break-even-level.

From the fact pattern above, the following facts and circumstances are
relevant:

 The obligation of the parties to purchase all the output produced by

entity C reflects the exclusive dependence of entity C upon the
parties for the generation of cash flows and, thus, the parties have
an obligation to fund the settlement of the liabilities of entity C.

 The fact that the parties have rights to all the output produced by
entity C means that the parties are consuming, and therefore have
rights to, all the economic benefits of the assets of entity C.

 These facts and circumstances indicate that the arrangement is a

joint operation. The conclusion about the classification of the joint
arrangement in these circumstances would not change, if, instead of
the parties using their share of the output themselves in a
subsequent manufacturing process, the parties sold their share of
the output to third parties.

If the parties changed the terms of the contractual arrangement so that

the arrangement was able to sell output to third parties, this would
result in entity C assuming demand, inventory and credit risks. In that
 scenario, such a change in the facts and circumstances would require
reassessment of the classification of the joint arrangement. Such facts
and circumstances would indicate that the arrangement is a joint
venture.

4.8 FINANCIAL STATEMENTS OF PARTIES TO A JOINT ARRANGEMENT

4.8.1 Joint operations

A joint operator recognizes in relation to its interest in a joint

operation:

 its assets, including its share of any assets held jointly;

 its liabilities, including its share of any liabilities incurred jointly;
 its revenue from the sale of its share of the output of joint operation;
 its share of the revenue from the sale of the output by the joint
operation; and
 its expenses, including its share of any expenses incurred jointly.

A joint operator accounts for the assets, liabilities, revenues and

expenses relating to its involvement in a joint operation in accordance
with the relevant IFRSs.
When an entity enters into a transaction with its joint operation it
conducts the transaction with other parties to the joint operation.
Accordingly it recognizes gains and losses resulting from such
transactions only to the extent of the other parties’ interest in the joint
operation.

A party that participates in, but does not have joint control of, a joint
operation shall also account for its interest in the arrangement in
accordance with the above if that party has rights to the assets, and
obligations for the liabilities, relating to the joint operation.

4.8.2 Joint ventures

A joint venturer recognizes its interest in a joint venture as an

investment and should account for that investment using the equity
method in accordance with IAS28 Investment in Associates and Joint
Ventures unless the entity is exempted from applying the equity method
as specified in IAS 28.
 A party that participates in, but does not have joint control of, a joint
venture accounts for its interest in the arrangement in accordance with
IFRS9 Financial Instruments unless it has significant influence over the
joint venture, in which case it accounts for it in accordance with IAS28
(as amended in 2011).

4.9 SEPARATE FINANCIAL STATEMENTS

The accounting for joint arrangements in an entity’s separate financial

statements depends on the involvement of the entity in that joint
arrangement and the type of the joint arrangement:
 If the entity is a joint operation or joint venture it should account
for its interest in :-
o a joint operation in accordance with 6.8.1. above
o a joint venture in accordance with paragraph 10 of IAS27
Separate Financial Statements.

 If the entity is a party that participates in, but does not have joint
control of, a joint arrangement should account for its interest in:

o a joint operation in accordance with 6.8.1. above

o a joint venture in accordance with IFRS9, unless the entity
has significant influence over the joint venture, in which
case it should apply paragraph 10 of IAS27 (as amended in
2011. (IFRS11:27)

4.10 DISCLOSURE

There are no disclosures specified in IFRS11. Instead IFRS12,

DISCLOSURES OF INTERESTS IN OTHER ENTITIES outlines the
disclosures required.

4.11 PRACTICE QUESTIONS (With answers)

All of the following scenario questions have been adapted from the
illustrative examples of IFRS11 JOINT ARRANGEMENTS.

Question 4.11.1 Constructive services

A and B (the parties) are two companies whose businesses are the
provision of many types of public and private construction services.
They set up a contractual arrangement to work together for the purpose
 of fulfilling a contract with a government for the design and
construction of a road between two cities. The contractual arrangement
determines the participation shares of A and B and establishes joint
control of the arrangement, the subject matter of which is the delivery
of the road.

The parties set up a separate vehicle (entity Z) through which to conduct

the arrangement. Entity Z, on behalf of A and B, enters into the contract
with government. In addition, the assets and liabilities relating to the
arrangement are held in entity Z. The main feature of entity Z’s legal
form is that the parties, not entity Z, have rights to the assets, and
obligations for the liabilities, of the entity.

The contractual arrangement between A and B additionally establishes

that:-

a) the rights to all the assets needed to undertake the activities of the
arrangement are shared by the parties on the basis of their
participation shares in the arrangement;

b) the parties have several and joint responsibility for all operating and
financial obligations relating to the activities of the arrangement on
the basis of their participation shares in the arrangement; and

c) the profit or loss resulting from the activities of the arrangement is

shared by A and B on the basis of their participation shares in the
arrangement.
For the purposes of co-coordinating and overseeing the activities, A and
B appoint an operator, who will be an employee of one of the parties.
After a specified time, the role of the operator will rotate to an employee
of the other party. A and B agree that the activities will be executed by
the operator’s employees on a ‘no gain or loss’ basis.

In accordance with the terms specified in the contract with the

government, entity Z invoices the construction services to the
government on behalf of the parties.

Required:

Explain and briefly motivate the accounting treatment of the of this

construction services joint arrangement in terms of IFRS11 joint
arrangements.

Solution 4.11.1
The joint arrangement is carried out through a separate vehicle whose
legal form does not confer separation between the parties and the
separate vehicle (i.e. the assets and liabilities held in entity Z are the
parties’ assets and liabilities). This is reinforced by the terms agreed by
the parties in their contractual arrangement, which state that A and B
have rights to the assets, and obligations for the liabilities, relating to
the arrangement that is conducted through entity Z. The joint
arrangement is a joint operation.

A and B each recognize in their financial statements their share of the

assets (e.g. property, plant and equipment, accounts receivable) and
their share of any liabilities resulting from the arrangement (e.g.
accounts payable to third parties) on the basis of their agreed
participation share. Each also recognizes its share of the revenue and
expenses resulting from the construction services provided to the
government through entity Z.

Question 6.11.2 : Shopping centre operated jointly

Two real estate companies (the parties) set up a separate vehicle (entity
X) for the purpose of acquiring and operating a shopping centre. The
contractual arrangement between the parties establishes joint control
of the activities that are conducted in entity X. The main feature of
entity X’s legal form is that the entity, not the parties, has rights to the
assets, and obligations for the liabilities, relating to the arrangement.
These activities include the rental of the retail units, managing the car
park, maintaining the centre and its equipment, such as lifts, and
building the reputation and customer base for the centre as a whole.

The terms of the contractual arrangement are such that:-

a) entity X owns the shopping centre. The contractual arrangement

does not specify that the parties have rights to the shopping centre.

b) the parties are not liable in respect of the debts, liabilities or

obligations of entity X. If entity X is unable to pay any of its debts or
other liabilities or to discharge its obligations to third parties, the
liability of each party to any third party will be limited to the unpaid
amount of that party’s capital contribution.

c) the parties have the right to sell or pledge their interests in entity X.

d) each party receives a share of the income from operating the

shopping centre (which is the rental income net of the operating
costs) in accordance with its interest in entity X.
Required:

Explain and motivate the accounting treatment of the shopping centre

joint arrangement in terms of IFRS11: Joint arrangements.

Solution 4.11.2

The joint arrangement is carried out through separate vehicle whose

legal forms, causes the separate vehicle to be considered in its own right
(i.e. the assets and liabilities held in the separate vehicle are the assets
and liabilities of the separate vehicle and not the assets and liabilities
of the parties). In addition, the terms of the contractual arrangement do
not specify that the parties have rights to the assets, or obligations for
the liabilities, relating to the arrangement. Instead, the terms of the
contractual arrangement establish that the parties have rights to the
net assets of entity X.

On the basis of the description above, there are not other facts and
circumstances that indicate that the parties have rights to substantially
all the economic benefits of the assets relating to the arrangement, and
that the parties have an obligation for the liabilities relating to the
arrangement. The joint arrangement is a joint venture.

The parties recognize their rights to the nets assets of entity X as

investments and accounts for them using the equity method.

Question 4.11.3 : Joint manufacturing and distribution of a

product

Companies A and B (the parties) have set up a strategic and operating

agreement (the framework agreement) in which they have agreed the
terms according to which they will conduct the manufacturing and
distribution of a product (product P) in different markets.

The parties have agreed to conduct manufacturing and distribution

activities by establishing joint arrangements, as described below:-

a) Manufacturing activity: the parties have agreed to undertake the

manufacturing activity through a joint arrangement (the
manufacturing arrangement). The manufacturing arrangement is
structured in a separate vehicle (entity M) whose legal form causes
it to be considered in its own right (i.e. the assets and liabilities held
in entity M are the assets and liabilities of entity M and not the assets
and liabilities of the parties). In accordance with the framework
agreement, the parties have committed themselves to purchasing
the whole production of product P manufactured by the
 manufacturing arrangement in accordance with their own
ownership interests in entity M. The parties subsequently sell
product P to another arrangement, jointly controlled by the two
parties themselves, that has been established exclusively for the
distribution of product P as described below. Neither the framework
agreement nor the contractual arrangement between A and B
dealing with the manufacturing activity specifies that the parties
have rights to the assets, and obligations for the liabilities, relating
to the manufacturing activity.

b) Distribution activity: the parties have agreed to undertake the

distribution activity through a joint arrangement (the distribution
arrangement). The parties have structured the distribution
arrangement in a separate vehicle (entity D) whose legal form causes
it to be considered in its own right (i.e. the assets and liabilities held
in entity D are the assets and liabilities of Entity D and not the assets
and liabilities of the parties). In accordance with the framework
agreement, the distribution arrangement orders its requirements for
product P from the parties according to the needs of the different
markets where the distribution arrangement sells the product.
Neither the framework agreement nor the contractual arrangement
between A and B dealing with the distribution activity specifies that
the parties have rights to the assets, and obligations for the
liabilities, relating to the distribution activity.

In addition, the framework agreement establishes:-

a) that the manufacturing arrangement will produce product P to meet

the requirements for product P that the distribution arrangement
places on the parties;

b) the commercial terms relating to the sale of product P by the

manufacturing arrangement to the parties. The manufacturing
arrangement will sell product P to the parties at a price agreed by A
and B that covers all production costs incurred. Subsequently, the
parties sell the product to the distribution arrangement at a price
agreed by A and B.

c) that any cash shortages that the manufacturing arrangement may

incur will be financed by the parties in accordance with their
ownership interests in entity M.
Required:
What is the accounting treatment of the above joint arrangement in
terms of IFRS11. Motivate your answer.

Solution 4.11.3

The framework agreement sets up the terms under which parties A and
B conducts the manufacturing and distribution of product P. These
activities are undertaken through joint arrangements whose purpose is
either the manufacturing or the distribution of product P.

The parties carry out the manufacturing arrangement through entity M

whose legal form confers separation between the parties and the entity.
In addition, neither the framework agreement nor the contractual
arrangement dealing with the manufacturing activity specifies that the
parties have rights to the assets, and obligations for the liabilities,
relating to the manufacturing activity. However, when considering the
following facts and circumstances the parties have concluded that the
manufacturing arrangement is a joint operation:

a) The parties have committed themselves to purchasing the whole

production of product P manufactured by the manufacturing
arrangement. Consequently, A and B have rights to substantially all
the economic benefits of the assets of the manufacturing
arrangement.

b) The manufacturing arrangement manufactures product P to meet

the quantity and quality needs of the parties so that they can fulfill
the demand for product P of the distribution arrangement. The
exclusive dependence of the manufacturing arrangement upon the
parties for the generation of cash flows and the parties’ commitments
to provide funds when the manufacturing arrangement incurs any
cash shortages indicate that the parties have an obligation for the
liabilities of the manufacturing arrangement, because those
liabilities will be settled through the parties’ purchase of product P
or by the parties’ direct provision of funds.
The parties carry out the distribution activities through entity D, whose
legal form confers separation between the parties and the entity. In
addition, neither the framework agreement nor the contractual
arrangement dealing with the distribution activity specifies that the
parties have rights to the assets, and obligations for the liabilities,
relating to the distribution activity.

There are no other facts and circumstances that indicate that the
parties have rights to substantially all the economic benefits of the
assets relating to the distribution arrangement or that the parties have
an obligation for the liabilities relating to the arrangement. The
distribution arrangement is a joint venture.

A and B each recognize in their financial statements their share of the

assets (e.g. property, plant and equipment, cash) and their share of any
liabilities resulting from the manufacturing arrangement (e.g. accounts
payable to third parties on the basis of their ownership interest in entity
M. Each party also recognizes its share of the expenses resulting from
the manufacture of product P incurred by the manufacturing
arrangement and its share of the revenues relating to the sales of
product P to the distribution arrangement.

The parties recognize their rights to the net assets of the distribution
arrangement as investments and account for them using the equity
method.

Question 4.11.4 : Variation

Assume that the parties in 6.11.3 above agree that the manufacturing
arrangement described above is responsible not only for manufacturing
product P, but also for its distribution to third-party customers.

The parties also agree to set up a distribution arrangement like the one
described in 6.11.3 above to distribute product P exclusively to assist
in widening the distribution of product P in additional specific markets.

The manufacturing arrangement also sells product P directly to the

distribution arrangement. No fixed proportion of the production of the
manufacturing arrangement is committed to be purchased by, or to be
reserved to, the distribution arrangement.

Required:

What is the effect of the variation on the accounting treatment of the

joint arrangement in terms of IFRS11.

Solution 4.11.4

The variation has affected neither the legal form of the separate vehicle
in which the manufacturing activity is conducted nor the contractual
terms relating to the parties’ rights to the assets, and obligations for the
liabilities, relating to the manufacturing activity. However, it causes the
manufacturing arrangement to be a self-financed arrangement because
it is able to undertake trade on its own behalf, distributing product P to
third-party customers and, consequently, assuming demand, inventory
 and credit risks. Even though the manufacturing arrangement might
also sell product P to the distribution arrangement, in this scenario the
manufacturing arrangement is not dependent on the parties to be able
to carry out its activities on a continuous basis. In this case, the
manufacturing arrangement is a joint venture.

The variation has no effect on the classification of the distribution

arrangement as a joint venture.

The parties recognize their rights to the net assets of the manufacturing
arrangement and their rights to the net assets of the distribution
arrangement as investments and account for them using the equity
method.

CONSOLIDATED FINANCIAL STATEMENTS

IFRS10 (EFFECTIVE DATE: 1 JANUARY 2013)

5.1. INTRODUCTION

The objective of IFRS10 is to establish principles for the presentation

and preparation of consolidated financial statements when an entity
controls one or more other entities. IFRS10 determines when an entity
should present consolidated financial statements and sets out the
accounting principles to be applied in the preparation thereof.

5.2 SCOPE

An entity that is a parent is required to present consolidated financial

statements that satisfy the requirements of IFRS10 with the exception
of:-
5.2.1 A parent that meets all of the following conditions:-

 The parent itself is a wholly owned subsidiary or if a partially

owned subsidiary, the other owners of the parent (including those
not otherwise entitled to vote) have been informed about and do
not object to the parent not presenting consolidated financial
statements;

 The parent’s debt or equity instruments are not publicly traded;

 The parent is not in the process of issuing any class of

instruments in public markets; and
  The ultimate or intermediate parent of parent produces
consolidated financial statements available for public use that
comply with IFRSs.

5.2.2 Post-employment benefit plans or other long-term benefit plans to

which

IAS19 Employee Benefits apply, are not required to apply the requirement of
IFRS10.

5.3. KEY TERMINOLOGY

 Consolidated Financial statements

The financial statements of a group in which the assets, liabilities,
equity, income, expenses and cash flows of the parent and its
subsidiaries are presented as those of a single economic entity.

 Control of Investee
An investor controls an investee when the investor is exposed, or has
rights to variable returns from its involvement with the investee and
has the ability to affect those returns through its power over the
investee.

 Parent
An entity that controls one or more entities.

 Power
Existing rights that give the current ability to direct the relevant
activities.

 Protective rights
Rights designed to protect the interest of the party holding those rights
without giving that party power over the entity to which those rights
relate.

 Decision maker
An entity with decision-making rights that is either a principal or an
agent of other parties.

 Group
A parent and its subsidiaries.

 Non-controlling interest
Equity of a subsidiary not attributable directly or indirectly to a parent.
  Relevant activities
Activities of the investee that significantly affect the investee’s returns.

5.4. CONCEPT OF CONTROL

An investor determines whether it is a parent by assessing whether it

controls one or more investees. An investor considers all relevant facts
and circumstances when assessing whether it controls an investee.

An investor controls an investee when it has all of the following:-

 Power over investee.

 Exposure (or rights) to variable returns through its relationship

with the investee.

 The ability to use its power over the investee to affect the amount
of the returns to which it is exposed.
Should facts and circumstances indicate that any of the above-
mentioned three elements of control have changed the investor should
reassess whether it controls the investee.

NB: Power arises from rights. Such rights can be straight forward (i.e.
through voting rights) or be complex (e.g. embedded in
contractual arrangements). An investor that holds only protective
rights cannot have power over an investee and so cannot control
and investee.

5.4.1 Assessing control

The broad categories of factors to be considered when assessing control

per IFRS10 are as follows:-

- Relationship with other parties.

- The purpose and design of the investee.
- Power of investee.
- Exposure (or rights) to variable returns.
- The link between power and returns.
- Continuous assessment.
5.4.2 Relationships with other parties
 In order for an investor to control the investee, it should be able to
exercise control unilaterally. If the consent of one or more other
investors is required in order to exercise control so that no investor
individually controls the investee, IFRS10 is NOT applied to the
investment. Instead the investor considers if it is a party to a joint
arrangement in terms of IFRS11 or it has significant influence in
terms of IAS28.

 An investor with decision making rights determines whether it acts

as principal or as an agent of other parties. An agent is a party
primarily engaged to act on behalf and for the benefit of another
party and therefore does not control the investee when it exercises
its decision-making authority. An essential characteristic of an agent
is that it receives market-related remuneration for exercising its
decision-making power.

Besides the remuneration to which the decision-maker is entitled

the investor should also consider all of the following factors when
determining whether the decision-maker is its agent.

- The scope of the decision-maker’s authority

This is evaluated by considering:-

i) The activities that are permitted in terms of the decision-

making
agreement and specified by law and;
ii) The discretion that the decision-maker has when making
decisions
about these activities.
By carrying out this evaluation, it can be established whether the
decision-maker has the ability to direct the relevant activities.

- The rights held by the investor and other parties

Substantive rights held by the investor and other parties may affect
the decision maker’s ability to direct the relevant activities of the
investee.

If the investor holds substantive removal rights and can remove the
decision-maker without cause, this in isolation, is sufficient to
determine that the decision-maker is an agent of the investor and no
further evaluation is required.
 - Exposure to variability of returns from other interests

If the decision-maker holds other interests (e.g. investments,

guarantees) in an investee and these, are over and above the
remuneration it receives, the decision-maker is likely to be a
principal and not an agent of the investor or another party. This
exposure of the decision-maker should be evaluated relative to the
total variability of returns of the investee.

NB: A decision-maker that is a principal in its own right, while

not an agent of the investor may still be a de facto agent of
another. A de facto agent can control an investee and be
required to present consolidated financial statements even
though the ultimate control over the investee rests
elsewhere e.g. an interim parent may be a de facto agent of
the ultimate parent.
5.4.3 The purpose and design of the investee

By considering the purpose and design of the investee it may be clear

that, an investee is controlled through proportionate voting rights
attached to equity instruments i.e. voting rights would be dominant
factor in determining control of the investee.

In some situations, holding the majority of voting rights does not

necessarily provide the investor with control over the investee. The
design of the investee may be such that a contractual agreement
provides the ability to direct the relevant activities of the investee to a
party that hold little (or even no) voting power, while the voting rights
of other parties relate only to insignificant activities outside the scope
of the contractual agreement.

5.4.4 Power over investee

An investor has power over an investee when:-

- it has existing rights;

- that gives it the current ability
- to direct the activities that significantly affects the investees returns
(relevant activities).

 According to IFRS10, the following examples of rights can

individually or in combination, give an investor power over an
investee.
 i) voting rights.

ii) rights to appoint, reassign or remove members of the

investee’s key personnel who have the ability to direct the
relevant activities.

iii) rights to appoint or remove another entity (e.g. service

provider) that directs the relevant activities.

iv) rights to direct the investee to enter (or veto any changes to)
transactions for the benefit of the investor.

v) other rights (e.g. contractual rights) that give the investor the
current ability to direct the relevant activities.

 IFRS10 requires that when assessing whether it has power over

another entity, an investor considers its existing substantive rights.
Substantive rights are those rights that the holder has the practical
ability to exercise. Substantive rights include ordinary shares that
currently carry voting power as well as potential ordinary shares (e.g.
options to purchase ordinary shares) that are practically exercisable
at the date that power is assessed.
NB: It is only the investor’s substantive rights that are taken into
account when assessing power.

5.4.4.1 Protective rights

As protective rights by definition do not provide a holder with power

over investee, an investor that hold only protective rights cannot have
power nor prevent another party from having power over an investee.
The following are examples of protective rights :-

 Rights of a lender under a loan covenant – a loan agreement may

place restrictions, on new borrowings of the payment of dividends.

 The right of a party holding non-controlling interest to approve for

example:-
 capital expenditure greater than required in the ordinary
course of business.
 issue of equity or debt instruments.
 the liquidation of investee.
 changes in the founding documents of investee.
  The right of lender to seize assets of investee in the case of default.
NB: Thus the holder of protective rights cannot interfere with
significant day-to-day decisions related to relevant activities of
the investee.

5.4.4.2 Voting rights

Voting rights are the most common way in which the activities of an
investee are directed. The following issues should be considered
where this is the case.

i) Power with a majority of voting rights

Generally speaking, an investor holding more than half of the
voting rights of an investee has power when the holder of the
majority voting rights can:

 direct the relevant activities; or

 appoint a majority of members of the governing board that
directs the relevant activities.

ii) A majority of voting rights, but no power

Such a situation arises if:-

 the investor’s voting rights are not substantive;

 the voting rights do not provide the investor with the current
ability to direct the relevant activities; or

 another entity, that is not an agent of the investor, holds

existing rights that provide it with the current ability to direct
the relevant activities.

iii) Power without a majority of voting rights

An investor may hold power without a majority of voting rights
even though the investee’s relevant activities are normally
directed through voting rights, for example:-
 Contractual arrangements between the investor and
other vote holders.
 Rights arising from other types of contractual
agreements e.g. a management contract.
 The existence of potential voting rights. These are,
considered only, when they are substantive. Voting
 rights are substantive if the holder has the practical
ability to exercise these rights.

iv)The nature and the circumstances around the investor’s voting

rights, e.g. the size of the investors holding relative to the size
(and dispersion) of the holdings of other vote holders.
5.4.5 Exposure (or Rights) to variable returns

IFRS10 requires an investor to assess whether its returns from

involvement with the investee are variable as well as how variable those
returns are on the basis of the substance of the arrangement (substance
over legal form).

NB: An investor is exposed (or has rights) to variable returns from its
involvements with the investee, when the investor’s returns from the
investee have the potential to vary as a result of the investee’s
performance. Variable returns may affect both the degree of potential
returns (e.g. magnitude of returns) and/the direction of the returns (i.e.
whether the returns are positive or negative).

5.4.6 The link between power and returns

An investor controls an investee if the investor not only has power over
the investee and exposure (or rights) to variable returns from its
involvement with the investee, but also has the ability to use its power
to affect the returns it receives.

5.4.7 Continuous assessment

An investor should reassess whether or not it controls an investee

whenever facts or circumstances indicate that there have been changes
to one or more of the elements of control, for example:-

 There may be a change in how power over an investee may be

exercised.

- for example, a change to decision-making rights can mean

that relevant activities are no longer directed by means of
voting rights, but by way of a contract. This could cause other
 parties to hold power over the investee, previously held by the
investor.

- an entity does not need to be involved in the event in question.

For example, the contractual decision-making rights of
another party may lapse and as a result, an investor gain
power over the investee.

 An investor’s exposure (or rights) to variable returns may change.

- an entity loses control over an investee if it ceases to be

entitled to returns or to be exposed to obligations e.g. if a
performance- related fees contract is terminated.

 The link between power and returns may have changed.

- in this respect the investor’s status as a principal or agent in

its relationship with the investee may change e.g. if voting
rights of various parties involved are renegotiated.

5.5. CONSOLIDATION PROCEDURES

5.5.1 General principles

Consolidated financial statements

 combine like items of assets, liabilities, equity, income, expenses and

cash flows of the parent with those of its subsidiaries.

 offset (eliminate) the carrying amount of the parent’s investment in

each subsidiary and the parent’s portion of equity of each subsidiary
(IFRS3 Business Combinations explains how to account for any
related goodwill).
 eliminate in full intragroup assets and liabilities, equity, income,
expenses and cash flows relating to transactions between entities of
the group (profits or losses resulting from intragroup transactions
that are recognized in assets, such as inventory and non-current
assets, are eliminated in full).
A reporting entity includes the income and expenses of a subsidiary in
the consolidated financial statements from the date it gains control
until the date when the reporting entity ceases to control the subsidiary.
Income and expenses of the subsidiary are based on the amounts of the
 assets and liabilities recognized in the consolidated financial
statements at the acquisition date.

5.5.2 Reporting date

The parent and subsidiaries are required to have the same reporting
dates, or consolidation based on additional financial information
prepared by subsidiary, unless impracticable. Where impracticable, the
most recent financial statements of the subsidiary are used, adjusted
for the effects of significant transactions or events between the reporting
dates of the subsidiary and consolidated financial statements. The
difference between the date of the subsidiary’s financial statements and
that of the consolidated financial statements shall be no more than
three months.

5.5.3 Uniform Accounting Policies

Consolidated financial statements should be prepared using uniform

accounting policies for like transactions and other events in similar
circumstances. If a subsidiary uses accounting policies that differ from
those of the group, appropriate adjustments need to be made before
commencing the consolidation process.

5.5.4 Non-controlling interests (NCIs)

A parent presents non-controlling interests in its consolidated

statements of financial position within equity, separately from the
equity of the owners of the parent.

A reporting entity attributes the profit or loss and each component of

other comprehensive income to the owners of the parent and to the non-
controlling interests. The proportion allocated to the parent and non-
controlling interests are determined on the basis of present ownership
interests.

5.5.5 Changes in ownership interests

Changes in a parent’s ownership interest in a subsidiary that do not

result in the parent losing control of the subsidiary are equity
transactions (i.e. transactions with owners in their capacity as owners).
When the proportion of the equity held by non-controlling interest
 changes, the carrying amounts of the controlling and non-controlling
interests are adjusted to reflect the changes in their relative interests in
the subsidiary. Any difference between the amount by which the non-
controlling interests are adjusted and the fair value of the consideration
paid or received is recognized directly in equity and attributable to the
owners of the parent.

If a parent loses control of a subsidiary, the parent (IFRS10:25):

 derecognizes the assets and liabilities of the former subsidiary

from the consolidated statement of financial position.

 recognizes any investment retained in the former subsidiary

at is fair value when control is lost and subsequently accounts
for it and for any amounts owed by or to the former subsidiary
in accordance with relevant IFRSs. That fair value is regarded
as the fair value on initial recognition of a financial asset in
accordance with IFRS9 Financial Instruments or, when
appropriate, the cost on initial recognition of an investment is
an associate or joint venture.

 recognizes the gain or loss associated with the loss of control

attributable to the former controlling interest.
Disclosures

There are no disclosures specified in IFRS10. Instead, IFRS12

Disclosure of Interests in Other Entities outlines the disclosures
required.

EXAMPLE 1:

Pascal ltd acquired 80% of the share capital of Peppermint Ltd two years ago,
when the reserves of Peppermint stood at $125,000.

Pascal Ltd paid an initial cash consideration of $1 million. Additionally,

Pascal Ltd issued 200,000 shares with a nominal value of $1 and a current
market value of $1.80. It was also agreed that Pascal Ltd would pay a further
$500 000 in 3 years’ time. Current interest rates are 10% per annum. The
appropriate discount factor for $1 receivable three years from now is 0.751

Statements of financial position as at 31/12/16

Pascal Ltd Peppermint

‘000’ ‘000’
 Investment in Peppermint @ cost 1000

PPE 5500 1500

Current assets 1100 350

Inventories 550 100

Trade receivables 400 200

Cash and cash equivalence 200 50

Total assets 7 650 1 850

Equity and liabilities

Total equity 3 400 800

Share capital 2 000 500

Profit or loss 1 400 300

Total liabilities 4 250 1 050

Non-current liabilities 3000 400

Current liabilities 1250 650

Total equity and liabilities 7650 1850

Additional information

1) On acquisition date the fair values of Peppermint’s PPE exceeded their

book values/carrying amount by $200 000. They had a remaining
useful life of five years at this date. One fifth of goodwill has been
written off.

2) For many years Peppermint has been selling some of its products under
the brand name Mint fresh. At date of acquisition the Directors of
Peppermint valued the brand at $250 000 with a remaining life of 10
years. The brand is not included in the SFP of Peppermint

3) The consolidated goodwill has been impaired by $258 000.

4) The Pascal Ltd group values the NCI using fair value method. At date of
Acquisition the fair value of the 20% Non-Controlling Interest was
valued at $380 000
 Required:

a) Prepare the consolidated statement of financial position as at 31

December 2016. (25 Marks). Please indicate the IFRS/IAS employed to
arrive at all the figures in your solution (5 Marks)

nsolidation practice question

EXAMPLE 2: Consolidation Question

Bazuka Ltd holds a leading position as a supplier of
telecommunication services. To improve its distribution network
Bazuka Ltd acquired 108 million shares in Bascom Ltd on 1 October
2016 for $292.5 million in cash with the followi ng condition:
Bazuka Ltd agreed to pay a further consideration, the fair value of
which on the acquisition date was $73.5 million, payable on 30
September 2017 if the post-acquisition profits of Bascom Ltd
exceeded an agreed figure at that date. Bascom Lt d also accepted 8%
loan notes of $75 million at an 8% interest rate from Bazuka Ltd
which is included on the date of acquisition in the cost of
investments. The acquisition of shares in Bazuka Ltd satisfies the
criteria of control specified in IFRS 10.

BAZUKA BAZUKA BASCOM BASCOM CHOCO CHOCO

‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’
Non-Current
Assets
Property plant
and Equipment 537 000 360 000 405 000
Investment in
Bascom 367 500
Other 67 500 972000 360 000 405 000
Current Assets
Inventories 195 000 120 000 165 000
Trade receivables 213 000 145 500 105 000
Cash and cash
equivalence - 408 000 6000 271 500 30 000 300 000
Total Assets 1380 000 631 500 705 000
Equity and
liabilities
Equity
Ordinary share 600 000 180 000 150 000
capital $1
Share premium 60 000 75 000 -
Revaluation 22 500
reserve
Retained 360 000 1042 500 90 000 345 000 450 000 600 000
earnings
Non-Current
liabilities
8% loan note 75 000
Deferred tax 67 500 67 500 75 000
Current
Liabilities
Trade payables 177 000 211 500 60 000
Bank overdraft 18 000
Current tax 75 000 270 000 - 211 500 45 000 105 000
payable
Total equity and
liabilities 1380 000 631 500 705 000
On 1st April 2017, 60 million shares in Choco Ltd were acquired by
way of exchange of two shares in Bazuka Ltd for each share acquired
in Choco Ltd (market value of one share of Bazuka Ltd was $2.50).
Bazuka Ltd has not recorded the acquisition of t he investment in
Choco.
The summarised statements of financial position of the three
companies as at 30 September 2017 are as follows:
Additional information:
(i) Retained earnings as on 1 Oct 2016 - Bascom Ltd -$ 30 million
Retained earnings as on 1 April 2017 - Choco Ltd -$ 300 million All
the profits deemed to accrue evenly throughout the year.
(ii) Goodwill should be written down by $30 million as shown by th e
impairment test on 30 September 2017.
(iii) The fair value of plant in Bascom Ltd is $30 million in excess of
the carrying value; with 4 years’ life remaining (the straight -line
depreciation method is used).
(iv) Bazuka Ltd carries land and building at fair value. The fair value
of the land of Bazuka Ltd at 30 September 2017 was 18 million in
excess of carrying value in the statement of financial position.
(v) Bascom’s land was 30 million in excess of the carrying value on
the acquisition date. On 30 September 2017 this excess amount
further increased by $ 7.5 million. (Bascom Ltd does not require fair
value adjustments for buildings).
(vi) At the acquisition date, Bascom Ltd had unrelieved tax losses of
$60 million from previous years. Bascom Ltd did not account for
related deferred tax assets. As the directors of Bazuka Ltd believe
that Bascom Ltd would be sufficiently profitable and that these losses
would be utilised, they decided to recognise this as a deferred tax
asset. The income tax rate is 25 %. (The Group has not utilized any
losses until 30 September 2017.)
(vii) The fair value of non-controlling interest at the acquisition date
is $200 million.
Required:
Prepare a consolidated statement of financial position for
Bazuka Ltd as at 30 September 2017 using the above
information. Please indicate the IFRS/IAS employed to arrive
at each answer in the statement of financial position.
Find other questions especially with intra group
transactions and try them out.

PRACTICE QUESTIONS (With answers)

Question 5.6.1: Removal rights held by investor

Notai Ltd has invested in an investment fund managed by Chimusoro,

the fund manager. Chimusoro has decision-making rights that provides
him with the current ability to direct all the relevant activities of the
fund, within the parameters of the founding document. Chimusoro
receives market related compensation for his services of 1% of the net
asset value of the fund.

Notai Ltd holds a 5% interest in the investment fund. In addition, Notai

Ltd holds a right with which it can terminate the services of Chimusoro
at any time and without consulting other parties by giving Chimusoro
30 days notice. Notai Ltd does not have to show just cause for the
decision to remove Chimusoro.

Required:

Does Notai Ltd control the investment fund? Motivate your answer.
(Adapted GAAP 2012)

Solution 5.6.1

As Notai Ltd holds a removal right that it can exercise on its own,
Chimusoro (the decision-maker) directs all the relevant activities of the
 fund, and according to IFRS10, no further consideration is necessary
in determining who controls the investment fund. Chimusoro is an
agent of Notai Ltd. Notai Ltd would take into consideration Chimusoro’s
decision-making rights together with its own when determining whether
or not it controls the investment fund.

Question 5.6.2 : (Remuneration)

Notai Ltd hold an investment in an investment fund managed by

Chimusoro, a fund manager. The fund manager has decision-making
rights that provide him with the current ability to direct all the relevant
activities of the fund, within the parameters of the founding document.

Chimusoro receives compensation for his services of 1% of the net asset

value of the fund. Market-related compensation for services of this
nature amounts to 3% of assets under management plus a
performance-based component.

Required:

Explain whether Notai Ltd has control over the investment fund or not.
(Adapted GAAP 2012).

Solution 5.6.2

The remuneration received by the fund manager is not market related.

Accordingly, Chimusoro cannot be an agent of Notai Ltd. On this basis,
Notai Ltd does not control the investment fund. Notai Ltd would
consider whether Chimusoro may still be a de facto agent. In addition,
Chimusoro would determine whether he is a principal in respect of the
investment fund and consider whether he control the investee.

Question 5.6.3 : Substantive Rights

Taguta Ltd holds 20% of the voting rights of Shinga Ltd. In addition,
Taguta enters into a forward contract that obligates it to acquire
ordinary shares with an additional 35% of the voting rights in Shinga
Ltd. The forward contract will be settled in 22 days time. In the
relationship of Taguta Ltd and Shinga Ltd, voting rights are the only
relevant factor in determining power and all significant decisions
regarding the relevant activities are required to be taken on a
shareholders’ meeting. 30 days notice is required by law to call a
shareholders’ meeting.

Required:
Does Taguta Ltd have power over Shinga Ltd? Motivate your answer.
(Adapted GAAP 2012).

Solution 5.6.3

Taguta Ltd has power over Shinga Ltd as it has substantive voting rights
of 55% (20% + 35%). The voting rights under the contract are
substantive from the date that Taguta Ltd enters into the contract, as
they will be exercisable on the first date that significant decisions
relating to relevant activities may be taken.

Tutorial Note

In the above scenario, if a shareholders’ meeting had been scheduled

for 2 days after Taguta Ltd entered into the forward contract, Taguta
Ltd would only acquire substantive rights under the forward contract
immediately after the close of the meeting in question. This is because
the voting rights will only be exercisable at subsequent meetings.

The same situation would apply if Taguta Ltd had entered into an option
instead of a forward contract, exercisable 22 days from the date of
issuance, provided that there are not other barriers to the exercise of
the option (e.g. the option is deeply in the money and Taguta Ltd has
the financial resources to exercise the option).

Question 5.6.4 : Potential voting rights held by Investor

Zihombe Ltd holds 30% of the voting rights in Kadiki Ltd, whose
relevant activities are directed through voting rights. Zihombe Ltd holds
an option to acquire an additional 25% of the voting rights in Kadiki Ltd
that is deeply in the money. The option is currently exercisable and
there are no other barriers to prevent Zihombe Ltd from exercising its
option.

Required:

Does Zihombe Ltd have powers over Kadiki Ltd? Motivate your answer.

Solution 5.6.4

Zihombe Ltd has power over Kadiki Ltd. As the option is deeply in the
money the exercise of the option is to the benefit of Zihombe. As the
option is currently exercisable and there are no other barriers
preventing Zihombe Ltd from exercising its option, the potential voting
 rights in Kadiki Ltd are substantive. Zihombe would consider its
current voting rights of 30% together with the potential of the option
(25%) to determine that it controls a majority of the voting rights (55%).

UNIT 6: DISCLOSURE OF INTERESTS IN OTHR ENTITIES:

IFRS 12 (EFFECTIVE DATE: 1 JANUARY 2013)

6.1 OBJECTIVE

The objective of IFRS 12 is to require the disclosure of information that

enables users of financial statements to evaluate: -

 The nature of, and risks associated with, its interests in other
entities;
 The effects of those interests on its financial position, financial
performance and cash flows.

Where the disclosures required by IFRS 12, together with the

disclosures required by other IFRSs, do not meet the above objective,
an entity is required to disclose whatever additional information is
necessary to meet the objective.

6.2 SCOPE

The disclosure requirements of IFRS 12 apply when an entity has an

interest in any of the following:-

 Subsidiaries - investees controlled by the entity as detailed in

IFRS 10

 Joint arrangements - joint control, where the entity has rights

to the assets and obligations for the liabilities of the joint
arrangement as laid down in IFRS 11/has rights to net assets.
 Associates- where the entity has significant influence over
another entity without control.

6.3 KEY TERMINOLOGY

IFRS 12 : Appendix A gives the following key terminology:

6.3.1 Interest in Refers to contractual and non-contractual

involvement that exposes an entity to variability of returns from the
performance of the other entity.
An interest in another entity can be evidenced by, but is not limited to, the
holding of equity or debt instruments as well as other forms of
 involvement such as the provision of funding, liquidity support, credit
enhancement and guarantees. It includes the means by which an entity
has control of, or significant influence over, another entity. An entity
does not necessarily have an interest in another entity solely because
of a typical customer supplier relationship.

NB: The variability of returns should be

determined in accordance with IFRS 10.

6.3.2 Structured An entity that has been designed so that voting or

entity similar rights are not the dominant factor in deciding
who controls the entity, such as when any voting
rights relate to administrative tasks only and the
relevant activities are directed by means of
contractual arrangements.

6.3.3 Income from

a structured
entity For the purpose of this IFRS, income from a structured
entity includes, but is not limited to recurring and non-
recurring fees, interest, dividends, gain or loss on the
remeasurement or derecognition of interests in
structured entities and gains or losses from the trans-
fer of assets and liabilities to the structured entity.

6.4 DISCLOSURES

6.4.1 Significant judgments and assumptions

An entity should disclose information about significant judgments and

assumptions (including changes taken) that it has made relating to its
interest in other entities in determining, for example:-

 That it controls another entity

 That it has joint control of an arrangement or significant
influence over another entity
 The type of joint arrangement i.e. (whether it is a joint operation,
or joint venture) when the arrangement has been structured
through a separate vehicle.

6.5 SPECIFIC DISCLOSURES REQUIREMENTS

6.5.1 Interests in subsidiaries

 The composition of the group

 Users of consolidated financial statements should be able to
understand the following, from the disclosures about interests in
subsidiaries:-

- The composition of the group e.g. whether or not the parent is solely
a holding company or has operations of its own as well as the
industries within which it operates.

 The interests that non-controlling interests have in the group’s

activities and cash flows

For each subsidiary that has non-controlling interest that are material
to the reporting entity, the following information must be disclosed:

- The name of the subsidiary.

- The principal place of business (and country of incorporation if

different) of the subsidiary.

- The proportion of ownership interests and, if different, the

proportion of voting rights, held by non-controlling interests.

- The profit or loss allocated to non-controlling interests of the

subsidiary during the reporting period.

- Dividends paid to non-controlling interests.

- Accumulated non-controlling interests of the subsidiary at the end

of the reporting period.

- Summarized financial information about the subsidiary: -

i) The summarized financial information should enable users to

understand the interest that non-controlling interests have in
the group’s activities and cash flows.

ii) IFRS12 requires that the information presented should be

before intra-group eliminations. Accordingly all adjustments
made as a result of transactions between the subsidiary and
its parent during the reporting period should be ignored when
disclosing this information.

iii) Note that intra-group eliminations do not include adjustments

made to reflect consistent accounting policies, nor do they
include fair value adjustments (or consequential adjustments
in later years) made at the acquisition of the subsidiary in
terms of IFRS3. Accordingly, the summarized financial
information should be presented after these have been taken
into account.
 iv) The summarized financial information could be limited to
subtotals such as current assets, current liabilities, non-
current assets, non-current liabilities, revenue, profit or loss
and total comprehensive income. However, an entity would
need to apply judgment in determining whether further
information is required to meet the disclosure objectives of the
standard.

The above disclosure is per material non-controlling interest.

Accordingly, it would not be appropriate to aggregate amounts from
two subsidiaries, if either has a non-controlling interest that is
material to the group as a whole.

NB: It is not required to disclose the dividends paid to non-

controlling interests nor the summarized financial
information required by IFRS12 if a subsidiary has been
classified as held for sale in terms of IFRS5.

 Nature and extent of significant restrictions

An entity should disclose:

- Significant restrictions on its ability to access or use the assets and

settle the liabilities of the group. These significant restrictions may
be statutory, contractual or regulatory in nature.

The following are examples of restrictions:-

i) Restrictions (e.g. loan covenants or solvency rules) that prevent

the payment of dividends or other capital distributions.

ii) Restrictions that prevent the transfer of cash or assets between

entities in the group, either as part of a sale or a loan transaction.

The nature and extent to which protective rights of non-controlling

interests can significantly restrict the reporting entity’s ability to access
or use the assets and settle the liabilities of the group.

NB: Protective rights are those rights that are designed to protect the
interest of the party holding the rights, without giving the party
power over the entity to which the rights relate.

The following are examples of restrictive protective rights of non-

controlling interests:
 i) Where approval of the non-controlling interests is required for
certain transactions.

ii) Where the parent is obliged to settle the liabilities of the

subsidiary before settling its own.

- The carrying amounts in the consolidated financial statements of the

assets and liabilities to which the restrictions apply.

NB: Carrying amounts in the consolidated financial statements are

after appropriate consolidated adjustments have been made (e.g.
the elimination of unrealized intra-group gains).

 Nature of the risks associated with interests in structured entities

that are consolidated

An entity should disclose any contractual terms that could require the
parent or its subsidiaries to provide financial support to a consolidated
and structured entity (i.e. to a structured entity that it controls).
Specifically, events or circumstances that could expose the reporting
entity (i.e. the parent) to a loss should be disclosed.

Events or circumstances that could expose the reporting entity to a loss,

are best considered from the point of view of an investor that holds
ordinary equity in the parent. For example, if a parent guarantees the
bank overdraft of a wholly owned structured entity, the ordinary equity
holders of the parent will have an equal share in the equity of the group
regardless of whether or not the parent settled the bank overdraft of the
structured entity. In contrast, should the structured entity be partially
owned, a settlement of its bank overdraft by the parent effectively
represents a partial transfer of the cash paid from the ordinary equity
holders of the parent to the non-controlling interests in the structured
entity, who benefit from this transfer.

The following are examples of contractual terms that could require the
parent or its subsidiaries to provide financial support include:-

i) Contractual triggers (e.g. a specified debt to equity ratio) that

require the reporting entity to purchase assets of the structured
entity or provide financial support.

ii) Contractual agreements to act as market-maker for the

structured entity (i.e. to stand ready to buy or sell the securities
issued by the entity at any time.

Over and above the above-mentioned disclosures, IFRS12 also

requires an entity to disclose:
 iii) Financial (e.g. a loan) or other support (e.g. purchasing assets of
the structured entity) provided to a consolidated structured entity
during the reporting period by a parent or any of its subsidiaries
when there was no contractual obligation to do so.

This requires the disclosure of the type and amount of support

provided, including situations where the support provided was to
assist the structured entity in obtaining financial support and the
reasons for providing the support.

iv) Financial or other support provided to a previously

unconsolidated structured entity during the reporting period by
a parent or any of its subsidiaries with the result that the entity
subsequently controls the structured entity.

To fulfill this disclosure requirement, the entity also discloses an

explanation of the relevant factors that led to the decision to
provide financial or other support to the structured entity.

v) Any current intentions to provide financial or other support to a

consolidated structured entity. This includes intentions to assist
the structured entity in obtaining financial support.

 Consequences of changes in ownership interests that do not result

in a loss of control

If a parent’s ownership interest in a subsidiary changes, without a loss

of control, it accounts for the transaction directly in equity. The
transaction is considered to be a transfer of equity from (to) the parent
to (from) the non-controlling interest.

IFRS12 requires a reporting entity to disclose a schedule showing the

effects on the equity attributable to the owners of the parent of any
changes in its ownership interest in a subsidiary that do not result in a
loss of control.

 Consequences of losing control of a subsidiary

If an entity loses control of a subsidiary, a gain or loss will be recognized

in profit or loss. IFRS12 requires the following disclosure when control
of a subsidiary has been lost during the reporting period:

i) The amount of the gain or loss.

ii) The portion of the gain or loss attributable to re-measuring any

investment retained in the former subsidiary to fair value upon
the loss of control.
 iii) The line item in profit or loss in which the gain or loss has been
included.

 Differences in reporting dates

When the reporting date (or period) of the financial statements of a

subsidiary used to compile the consolidated financial statements differs
from the reporting date of the consolidated financial statements, an
entity should disclose:

i) The reporting date of the subsidiary’s financial statements used.

ii) The reason for using a different date or period.

6.5.2 Joint arrangements and associates

IFRS12 only applies to the financial statements in which equity

accounting has been applied. As the standard does not apply to
separate financial statements prepared in terms of IAS27, an entity
should disclose information that enables users of financial statements
to evaluate:

 The nature, extent and financial effects of an entity’s interests in joint

arrangements and associates including the nature and effects of its
contractual relationship with other investors with joint control of, or
significant influence over joint arrangements and associates.

 The nature of, and changes in, the risks associated with its interests in
joint ventures and associates.

6.5.2.1Joint ventures and associates

An entity discloses the following for each interest that is material to the
reporting entity:

i) Whether the investment is measured using the equity method or

at fair value.

ii) If there are quoted market prices for an investment that is

measured using the equity method, the fair value of the
investment.

iii) The amount of dividends received from the investee.

iv) Summarized financial information about the investee.

- The summarized financial information should reflect the total
amounts included in the financial statements of the joint venture or
associate. Accordingly they reflect 100% of the amount and not only
the entity’s share therein.

- The summarized financial information is, however, adjusted to

reflect adjustments made by the entity when applying the equity
method. These include adjustments made to the fair value of assets
and liabilities upon acquisition of the investee (including
consequential adjustments) and adjustments made to reflect
consistent accounting policies. However, adjustments for intra-
group transactions since acquisition (e.g. sales of inventory or
property, plant and equipment) are excluded.

- An important implication of the requirement to disclose 100% of the

investee’s amounts is that the pro-forma journals passed by the
entity cannot be directly applied to the financial information of the
investee as these reflect adjustments made based on the entity’s
share of the items affected. Therefore each journal would need to be
“grossed up” in order to reflect the correct adjustment. Furthermore,
equity accounting generally makes use of net journals (e.g. net of
tax) while different assets or liabilities are affected, so that the
amounts in the pro-forma journals cannot be utilized directly for
disclosure purposes.

- Should the associate or joint venture prepare its financial

statements on a basis other than IFRS, an entity may, under certain
circumstances, disclose the required summarized financial
information on the basis of the joint venture’s or associate’s financial
statements (i.e. without adjusting for equity accounting
requirements). Such disclosure may be provided if it would cause
undue cost or be impracticable to prepare financial statements on
the basis of IFRS and the entity measures its interest in the joint
venture or associate at fair value through profit or loss. In such a
case, the entity should also disclose the basis on which the
summarized financial information has been prepared.

NB: The specific summarized financial information includes, at a

minimum, the following for each material joint venture or
associate:-

-Current assets, non-current assets, current liabilities and non-

current

-Revenue.

-Profit or loss from continuing operations.

- Post-tax profit or loss from discontinued operations.

 - Other comprehensive income and total comprehensive income.

If the investee is a joint venture, the summarized financial information,

must, at a minimum also include the following:-

- Cash and cash equivalents.

- Current financial liabilities that are not trade and other payables or
provisions.

- Non-current financial liabilities that are not trade and other

payables or provisions.

- Depreciation, amortization, interest income and interest expense.

- Income tax expense.

 The minimum disclosure of summarized financial information may not

be sufficient to meet the disclosure objective, in which case the entity
discloses additional information.

 Finally an entity should provide a reconciliation of the summarized

financial information disclosed to the carrying amount of its interest in
the joint venture or associate.

6.5.2.2 Risks associated with an entity’s interests in joint ventures and

associates

According to IFRS12, an entity should disclose the following

information
in respect of risks associated with its interests in joint ventures and
associates:

i) Commitments it has relating to its joint ventures (separately

from the amount of other commitments).

o Commitments are decisions that may lead to a future outflow

of cash or other resources, but do not result in recognized
elements in the financial statements.

o The entity discloses commitments made by itself as well as its

share of commitments made collectively with other investors
in its joint ventures.

NB : Examples of commitments to be disclosed include commitments

to contribute funding or resources to an investee (e.g. additional
loans, equity contributions or obligations to utilize the investee
as a supplier), which may be conditional upon certain future
 events (e.g. product milestones being achieved or management of
the joint venture requesting the funding).

Commitments to be disclosed also include commitments to acquire

another party’s ownership interest (or portion thereof) if a particular
future event occurs (or does not occur).

ii) Contingent liabilities in respect of its interests in joint ventures

or associates, including its share of contingent liabilities
incurred collectively with other investors in joint ventures or
associates (separately from the amount of other contingent
liabilities). As with all other contingent liabilities, this
disclosure is not required if the probability of loss is remote.

NB: Many of the disclosures required above may also be required in

terms of IAS24, Related party disclosures, and need not be
repeated if already addressed in the IAS 24 disclosure to the
financial statements.

6.5.3 Interests in unconsolidated structured entities

In addition to disclosures for interests in subsidiaries, joint

arrangements and associates, IFRS12 specifies required disclosures for
an entity’s interests in unconsolidated structured entities.
Unconsolidated in this context should be interpreted narrowly, i.e. as
any structured entity that is not controlled by the reporting entity.
Therefore, equity accounted structured entities (i.e. joint ventures or
associates) would also be subject to the disclosure requirements
discussed in this section.

The disclosures made by an entity in respect of its interests in

unconsolidated structured entities should enable users of its financial
statements to understand the nature and extent of these interests and
to evaluate the nature of (and changes in) risks associated with the
entity’s interests.

6.5.3.1 Nature of interests in unconsolidated structured entities

An entity is required to disclose qualitative and quantitative information

about its interests in unconsolidated structured entities. These
disclosures should provide information about:-

- The nature of the structured entity;

- The purpose of the structured entity;
- The size and activities of the structured entity; and
- How the structured entity is financed.

6.5.3.2 Risks associated with an entity’s interests in unconsolidated

structured entities
Structured entities may expose an entity to a great deal of risk,
sometimes not accurately reflected in accounting requirements when
an entity does not have control. Accordingly, IFRS 12 requires an entity
to disclose in respect of its interests in unconsolidated structured
entities:

i) The carrying amount of the assets and liabilities recognized in its

financial statements relating to its interests.

ii) The line items in the statement of financial position in which

these assets and liabilities have been included.

iii) The amount that best represents the entity’s maximum exposure
to loss from its interests.

- An entity should also disclose how it has determined its maximum

exposure.

- If an entity cannot quantify its maximum exposure, it should

disclose that fact together with the reasons why.

iv) The disclosure should reflect a comparison of the carrying

amounts of the assets and liabilities recognized with the entity’s
maximum exposure to loss.

The above disclosures should be in a tabular format, unless

another format is more appropriate.

If an entity currently has or previously had an interest in an

unconsolidated structured entity, it may provide financial (e.g.
loan) or other support (e.g. purchasing assets of the structured
entity) to the structured entity. Should the entity have provided
such support during the current reporting period, without having
a contractual obligation to do so, it should disclose.

v) The type and amount of support provided, including situations

where the support provided was to assist the structured entity in
obtaining financial support; and

vi) The reasons for providing the support.

An entity should also disclose any current intentions to provide

financial or other support to an unconsolidated structured entity.
This includes intentions to assist the structured entity in
obtaining financial support.
 In addition to the disclosures discussed above, the standard
requires an entity to provide further information that may be
necessary for a user of the financial statements to evaluate the
nature of (and changes in) the risks associated with its interests
in unconsolidated structured entities. Some examples of
information to be provided as a result of this requirement include:
vii) The terms of an arrangement that could require the entity to
provide financial support to an unconsolidated structured entity,
for example:

- a description of events or circumstances that could expose an entity

to loss;

- whether there are any terms that would limit the obligation; and

- whether there are other parties that provide financial support to the
structured entity and how the entity’s obligation ranks compared to
those of other parties.

viii) Whether an entity is required to absorb losses of the structured

entity before other parties.

- The maximum amount of the losses that the entity could be required
to absorb should be disclosed.

- The exposure of other parties to absorb potential losses and the

ranking of these obligations, if these other parties rank lower than
the entity.

ix) Losses incurred by the entity during the reporting period related
to its interests in structured entities.

x) The types of income received by the entity during the reporting

period from its interests in unconsolidated structured entities.

- The income received from structured entities may include fees,

interest, dividends and realized or unrealized gains or losses on
interests the entity holds.
xi) Information about arrangements (e.g. liquidity arrangements,
guarantees or commitments) with third parties that may affect
the fair value or risk of the entity’s interests in unconsolidated
structured entities.

xii) Any difficulties that an unconsolidated structured entity has

experienced in financing its activities during the reporting period.

xiii) The forms of funding of an unconsolidated structured entity and

their weighted average life.
 If the unconsolidated structured entity funds longer-term assets
by way of shorter-term funding, maturity analyses of its assets
and funding are also required.

Note that the disclosures discussed in this section also apply to

structured entities with which the entity had contractual
involvement in previous periods, even though it no longer has
such involvement at the end of the current reporting period. This
may be the case, for example, if the reporting entity sponsored
the structured entity in a previous period but no longer holds any
interests in the structured entity. This requirement would
therefore imply that the entity provides the disclosures discussed
above for the comparative amounts where applicable (e.g. the
requirements relating to carrying amounts and line items). The
standard does not specify the period for which an entity should
continue to provide disclosures relating to previous involvement.
However, generally, such disclosure should continue for as long
as the period of involvement is included in comparatives to the
financial statements.

6.5.3.3 Structured entities for which risk disclosures are not

applicable

In certain instances, an entity would not provide the required

disclosures discussed in 6.5.3.2 above. This would be the case,
for example, where the entity sponsors a structured entity during
the current period, but does not hold an interest in the structured
entity at reporting date, or never held an interest in the
structured entity. In such instances, an entity should disclose:-

i) How it has determined which unconsolidated structured

entities it has sponsored.

ii) The amount of income received from unconsolidated

structured entities that it has sponsored, including a
description of the type of income received.

iii) The carrying amount (at the time of transfer) of all assets
transferred to unconsolidated structured entities that it
has sponsored during the reporting period.

The above disclosures should be in a tabular format, unless

another format is more appropriate. Sponsoring activities may be
aggregated if appropriate.
SPECIFIC FINANCIAL REPORTING

IAS 23: BORROWING COSTS

IAS 33: EARNINGS PER SHARE
IAS 24: RELATED PARTIES
IAS 20: GOVERNMENT GRANTS
IFRS 8: OPERATING SEGMENTS
IFRS 16: LEASES

UNIT 1: BORROWING COSTS IAS 23

1.0 OVERVIEW OF IAS 23

 Borrowing costs
Definitions  Qualifying asset

 Capitalise borrowing costs directly

attributable to production;
construction or acquisition of a
Recognition qualifying asset
 Commence when 1) expenditure for
the asset and 2) borrowing costs are
being incurred and 3) activities
necessary to prepare asset are
undertaken.
 Suspend when active development
of qualifying asset is interrupted for
extended periods.
 Cease when substantially all the
activities necessary to prepare
qualifying asset for intended use or
sale are complete.
 Borrowing Costs  Specific funds: actual borrowing
eligible for costs incurred on that borrowing,
capitalisation less any investment income from
surplus funds invested.
 General funds: Weighted average
rate of borrowing costs. limited to
actual borrowing costs incurred.

1.1 Definitions:
1.1.1 Borrowing costs: are interest and other costs incurred by an entity in
connection with the borrowing of funds.
Borrowing costs may include; interest on bank overdraft, short term and long-
term borrowings, (including intercompany borrowings) amortisation of
discounts or premium relating to borrowings, finance charges in respect of
finance leases, exchange differences from foreign currency borrowings to the
extent that they are regarded as an adjustment to interest costs.
1.1 2 Qualifying asset: is an asset that necessarily takes a substantial period
of time to get ready for its intended use or sale. E.g. inventories (not) produced
over short periods of time), manufacturing plants, power generation facilities,
intangible assets and investment properties.
1.2 Borrowing costs capitalisation
Borrowing costs are essentially interests incurred on any type of borrowing.
When using borrowed funds for constructing, manufacturing or producing an
asset that takes necessarily long to get to its intended use or sale the interests
on borrowed funds are capitalised to Non-current assets. Its however not
prudent to capitalise costs to an asset so there is a strict criterion that should
be followed before one can capitalise interests to an asset. IAS 23 stipulates
when to capitalise, how much to capitalise and when to stop
capitalisation. It stipulates that borrowing costs net of income from
investments of the borrowed money on a qualifying asset must be capitalised
over the production, construction or manufacturing period.
Capitalisation starts when:
 Expenditure on the asset commences
 Borrowing costs are incurred
 Activities necessary to prepare asset to its intended use are incurred
and in progress
Capitalisation stops when; the asset is ready for its intended use(whether or
not it is being used)or sale.
Capitalisation ceases when: when there is no active construction or when
there are interruptions to construction.
1.3 type of borrowed funds and capitalisation thereon:
If borrowing is specifically for the construction, manufacturing or production
of a qualifying asset it is known as specific borrowing. If a company borrows
and has a pool of funds or one loan used for different items then decide to use
some of the funds to construct a qualifying asset the borrowed funds are then
known as general borrowings.
1.3.1 Specific borrowing : when you use one specific loan to produce a
qualifying asset the interest rate used in calculating borrowing costs is the
effective rate of interest.
Example 1:
MSU commenced the construction of an item of PPE on 1 March 2017 and
funded it with a $10m loan. The rate of interest on the borrowing was 5%.
Due to a strike no construction took place between 1 October and 1 November.
Required: Calculate the amount of borrowing costs to be capitalised as part
of Non- current assets on 31 Dec 2017. (adapted from ACCA)
Solution:
Interest rate:5%
Commencement: 1 March
Stop: 1 October -1 November
Annual Interest =0.05 *$10m= $500 000
Capitalisation period= March to December =10 months-1 month (strike)= 9
months
Capitalisation/NCA(SFP) = $500 000*9/12=$375 000
Uncapitalized (SCI) = $500 000*1/12= $41 667
When using specific funds determine the expenditure incurred on the
qualifying asset not funded out of specific funding or surplus cash funds that
may be available since interest will not be incurred. There is need to determine
when the expenditure was incurred i.e. was it at the beginning of the period,
the end of period or evenly throughout the year.
Weighted average expenditure
Consider when the expenditure on the qualifying asset was incurred. If the
expenditure was incurred evenly throughout the period there is need to
calculate the weighted average expenditure for the period.
Example 2:
The following information is presented:
Budgeted cost of project to construct plant 4 000 000
Expenses incurred evenly during the year ended 30/06/17 2 400 000
A loan of $4m was obtained to finance the project on 01/07/16 @ an interest
rate of 20% p.a. This loan was negotiated specifically for this project. Interest
on any surplus funds invested is earned at 16% p.a. interest is paid and
received annually on 30/06. The year end of the company is 30 June. The
loan capital is repayable after 10years.
Required: calculate the borrowing costs to be capitalised to the plant for the
year ended 30.06.17. (Adapted from Descriptive Accounting)
Solution

Borrowing costs incurred for the year (4000 000*.2) 800 000
Interest received on surplus funds invested
4000000-2 400 000=1 600 000(1600 000 +2400 000/2)0.16 448 000
Borrowing costs capitalised 352 000

Or
Investment @ beginning of the year 4 000 000
Investment @ year end (4 000 000-2 400 000) 1 600 000
Average investment for the year (4m+1.6m) 2 800 000
 2
Interest income (2 800 000*.16) 448 000
Borrowing costs incurred (4m*.2) (800 000)
Borrowing costs capitalised 352 000

Example 3
Nyasha has arranged a loan with his bank to enable him to construct a new
football stadium in Harare Zimbabwe. He will be allowed to borrow up to
$300m to be used in such amounts and @ the rate of 7% per annum and
Nyasha is able to invest any surplus funds at the rate of 5% per annum.
He borrowed $100m on 1January 2017 and immediately invested $50m. On
28 February he withdrew $30m. On 1 April he borrowed a further $120m of
which he invested $70m.On 31May he spent $60m. On 31 August he
borrowed a further $80m and spent $60m immediately. On 1 November work
was stopped because of a strike by the workforce. The work commenced on 1
Jan 2018 and Nyasha spent the rest of the loan in completing the project
which was ready for final inspection by 28 February. The local authority
finally gave their approval of the stadium on 1 April and paid Nyasha the full
contract price of $350m.
Required: calculate the carrying amount in Nyasha’s financial statements
immediately before the sale transaction. (Adapted from ACCA)

Solution

Date borrowed time Interest investment Time Interest

01/01/17 100m 3/12 1.7m 50m 2/12 0.41667m
01/03 20m 1/12 0.88333
01/04 220m 5/12 6.14667m 90m 2/12 0.750m
01/06 30m 3/12 0.375m
01/09 300m 2/12 3.5m 90m 2/12 0.750m
01/01/18 2/12 3.5m
Total (15 166 2 375 000
167)

Loan 300 000 000

Borrowing costs 15 166 667
Investment income (2 375 000)
Carrying amount 312 791 000

1.4 General funds

This is when several loans are used to finance the construction of a qualifying
asset. When general loans are used there is need to determine the Weighted
average capitalisation rate of general loans.
Example 1:
Vienna had the following bank loans in issue during 2017
4% bank loan $25m
3% bank loan $ 40m
Vienna commenced the construction of an item of PPE on I January 2017 for
which it used its borrowings.
$10m of expenditure was used on 1Jan and $15m was used on 1 July.
Required: calculate the amount of interest to be capitalised as part of the
Non-current Assets? (adapted from ACCA)
SOLUTION
Calculation of the weighted average capitalisation rate.
4/100*25m 1m 25m
3/100*40 1.2m 40m
2.2m 65m

Capitalisation rate = 2.2m*100%= 3.38%

65m

Capitalised amounts = $10m*0.338*12/12= 0.338m

= $15m*0.338*6/12= 0.253m
0.591m
Example 2
Datvest is a wholly owned subsidiary of CBZ Bank. Datvest incurred capex
at the beginning of March 2017 amounting to $60 000. The finance for the
capex was obtained from a loan of $30 000 from the parent (CBZ bank) @ 16%
per annum in arrears and a loan 0f $50 000 from ZB bank @ 17% p.a. in
arrears. CBZ obtained the finance for the loan made to its subsidiary from a
loan of $70 000 from Stanbic bank @ 14% p.a. in arrears. Assume the
following scenarios in calculating the capitalisation of borrowing costs for
March 2017
a) Both loans in Datvest are general loans
b) The loan from ZB bank is a specific loan and the loan from CBZ is a
general loan.
c) The loan from CBZ bank is a specific loan and the loan from ZB bank
is a general loan.
Required: show how the borrowing costs will be recorded in these
scenarios for both the separate financial statements and the
consolidated financial statements. (adapted from Descriptive
accounting)

Solution
a) Both loans are general loans.
Cbz bank 30 000 16% 4 800
ZB bank 50 000 17% 8 500
80 000 13 300
Capitalisation rate = 13 300 *100=16.625%
80 000
Borrowing costs capitalised = 60 000*0.16625*1/12=$831
Individual finstats
Journal entries: separate finstats
Capital
expenditure(SFP) 831
Interest paid 831

Journal entries: Consolidated finstats

Stanbic bank 70 000 14% 9 800
ZB bank 50 000 17% 8 500
120 000 18 300
Capitalisation rate = 18300 * 100% 15.25%
120 000
Borrowing costs capitalised = 60 000*0.01525*1/12= 762.5=$763.

Interest paid 68
capital 68

b. External loan from ZB bank is a specific loan and the intra-group loan is
a general loan
individual finstats
ZB bank 50 000 17% 708.33
CBZ bank 10 000 16% 133,33
60 000 841.66

Journal entry
Capex 841
Interest paid 841

Consolidated finstats
ZB bank 50 000 17% 708
Stanbic 10 000 14% 117
60 000 825
Journal entry
Interest paid 16
Capital expenditure 16

c. Intragroup loan is specific and ZB general

Individual fin stats
CBZ 30 000 16% 400
ZB bank 30 000 17% 425
80 000 825
Journal entry
Capex 825
Interest paid 825

Consolidated financial statements

ZB Bank 30 000 15.67% 350
Stanbic 30 000 14% 392

Rate calculation
Stanbic 40 000 14% 5 600
ZB bank 50 000 17% 8500
90 000 14 100

Capitalisation rate = 14 100 * 100%=16.67%

90 000
Journal entry
Interest paid 83
capex 83

Tax implications
The income tax that the deduction of interest is deferred until asset is brought
to its intended use, in which year all pre-production interest is allowed as a
deduction against income. In the pre-production period the period the
accounting treatment largely corresponds. If, however the particular asset
particular asset will be written-off against income from the date the used asset
is ready for its intended use. For income tax purpose the borrowing costs will
be allowed as a deduction in full when the asset is first brought into use.
Temporary differences will therefore arise and deferred taxation must be
provided for in the normal manner.
Pre-production interest incurred in the financing of land is not deductible for
tax purposes and gives rise to an exempt temporary difference on which
deferred tax is not provided (IAS 12.15(b)
Temporary differences may also arise as capitalisation of borrowing costs for
accounting purposes continues only to the date of substantial completion, i.e.
when the asset is ready for its intended use. For tax purposes pre-production
interest is only allowed as a deduction against income once the asset is
brought to use. Temporary differences may also arise when applying the
capitalisation limit on borrowing costs in accounting.
Example:
Alpha Ltd has a qualifying asset of which the following borrowing costs are
capitalised. The following expenses were incurred @ the beginning of each
year on the qualifying asset
Year amount
1 $ 80000
2 $150 000
3 $200 000
4 $120 000
$550 000
The asset was available for use and was put into use @ the beginning of year
5 and it is depreciated at 15% p.a. on a straight line basis. Wear and tear is
allowed @ 20% on cost, and the tax rate is 28%. The following borrowing costs
were capitalised on the asst
Year amount
1 $12 000
2 $24 000
3 $30 000
4 $16 800
$82 800
Required: Show deferred tax implications

Solution
Calculation of carrying amount
Cost 550 000
Capitalised interest 82 800
632 800
Depreciation (632800*0.15) (94 920)
537 880
Tax base
Cost (excluding borrowing costs capitalised) 550 000
Wear and tear (550 000*0.2) 110 000
440 000
Temporary differences= carrying amount -tax base
=$537 880-440 000=$97 880
Deferred tax liability= temporary difference *tax rate= 97 880*0.28=$27 406
Temporary difference arose as follows:
Depreciation 94 920
Wear and tear (110 000)
Pre-production interest (borrowing costs k ) (82 800)
Temporary differences (97 880)

UNIT 2: IAS 33: EARNINGS PER SHARE

Objective: to prescribe principles for the determination and presentation of

EPS so as to improve performance.
Scope of IAS 33: applies to:

 separate or individual financial statements of an entity that has shares

/potential shares that are traded in a plc mkt or is in the process of
seeking a listing.
 Consolidated fin stats of such a group
EPS is a measure of performance for a company which allows for comparisons
between entities and across different reporting periods.
Main focus of IAS 33: focuses on the appropriate determination of the
denominator (number of shares) in the determination of EPS. Many
companies determine and present additional entity or jurisdiction specific
performance measures in addition to EPS which the standard permits.
These additional measures may not be presented with more prominence than
EPS.ONLY EPS i.e. BEPS (basic earnings per share) and DEPS (diluted
earnings per share) may be presented on the face of the statement of
comprehensive income with additional performance measures disclosed
in the notes to the fin stats e.g. headline earnings.
The method of determining these additional measures of performance shall
be disclosed.
Eps is further disclosed for:
Continuing operations and
Discontinued operations.
EARNINGS
An entity is required to determine BEPS based on profits /(losses) attributable
to ordinary equity holders of the parent entity. BEPS is determined by
dividing P/L attributable to ordinary equity holders of the parent entity by the
Weighted average number of ordinary shares outstanding during the period.
The standard requires entities to determine profit for the period (after tax) and
present the attribution of the parent and NCI.
The profit attributable to equity holders of the parent is further adjusted for
the after-tax effects of:
 Any other instruments classified as equity which are not ordinary
shares (e.g. preference shares ) which may have been classified as
equity in terms of IFRS 9 &IAS 32.
 Non-cumulative preference shares should be adjusted for the after tax
effect of the dividend declared in respect of the period (declared).
 Cumulative preference shares: adjust for the after tax effect of any
preference dividends required for the period whether declared or not
but excluding the preference dividend declared or paid in respect of the
previous period ( to avoid double accounting)
Further adjustments
 Increasing rate preference shares (accretion of issues premium or
discounts)
 Premium /discounts on the redemption of preference shares
 Early conversion premiums on convertible preference shares,
DENOMINATOR
An ordinary share is an equity instrument that is subordinate to all other
classes of equity instruments. Ordinary shares participate in the profits only
after all other types of shares (e.g. Preference shares) have participated. An
entity may have more than one class of ordinary shares. Ordinary shares of
the same class have the same rights to receive dividends so calculate EPS for
them as a class. Ordinary shares are usually included in BEPS from the date
consideration is receivable( this is often the issue date but not necessarily so).
When consideration is due:
 Cash issue: (when cash is receivable) not necessarily received
 Reinvestment of dividends: (when reinvested)
 Conversion of instrument: (when interest accrual on prior instrument
ceases.
  In settlement of interest or principal of financial liability (when
interest accrual ceases)
 Issued as consideration for purchase or acquisition of an asset
other than cash (when asset is recognised in PPE)
 Issued as consideration of services rendered (as services are
rendered). issued shares may not necessarily coincide with the weighted
average number of shares due to the triggers above.
 Ordinary shares issued as part of a business combination are
included in WANS from acquisition date which is dependent on
control IFRS 10.
 Mandatorily convertible instruments: are included from date of
contract not date of concersion
 Contingently issuable shares: included in BEPS from date when all
necessary conditions are classified (i.e. the events have occured).
 Issued shares that are contingently returnable are excluded from
BEPS until they are no longer subject to recall
WEIGHTED AVERAGE NUMBER OF SHARES (WANS)

The WANS of ordinary shares outstanding during the period and for all
periods presented are adjusted for events that have changed the number
of ordinary shares outstanding without a corresponding change in
resources e.g. 1) bonus shares
2) capitalisation shares
3) share splits
4) share consolidations
In such circumstances the number of shares applied in the determination
of BEPS is adjusted as if such events had occurred @ the beginning of the
earliest period presented.
Example: company A has a reporting date of 31 Dec. it had 100 ordinary
shares in issue on 1 January 2017 when it concluded a share
consolidation on a basis of 2.1 thereby reducing its ordinary shares in
issue to 50. On 1 january 2016 it had 80 shares in issue a further 20
shares were issued in July 2016.
Required: Calculate WANS to be used in calculating BEPS.
SOLUTION
2016
80 shares @ 1 January 2016 adjusted for 2.1 consolidation =40
20 shares issued at 1 july adjusted for 2.1 consolidation= 10*6/12=5
 WANS = 40+5 =45
2017
100 shares @ 1Jan adjusted 2.1 =50

As an exception to IAS 10 events after Reporting date such transactions

(bonus issues, capitalisation issue, share splits and consolidations) shall
be treated as ‘ADJUSTING’ post balance sheet events even when they occur
after the reporting date but before the fin stats are approved/ authorised.
Calculation of BEPS
EXAMPLE:
Profit after tax 2 500 000
Preference dividend 200 000
Extract SFP
Shares outstanding (01/01/17) 1 000 000
Shares outstanding (01/10/17) 1 400 000
Required: calculate BEPS
SOLUTION
BEPS = profit attributable to Owners of the parent
Weighted average number of shares (WANS)
= 2 500 000-200 000
(1300 000*9/12) +(1 400 000*3/12)
= $2 300 000 = $2.09*100c= 209c
1 100 000
Example 2
In the year ended 31 Dec 2016 there were 12m ordinary shares in issue and
the EPS was calculated as 33.3c per share. In the year ended 31/12/17 the
earnings available for ordinary shareholders amounted to $5m. on 30.09.17
the company made a 1for 4 bonus issue
Required: what is the EPS for the year ended 31/12/17
And the restated EPS FOR the year ended 31/12/16
Solution:
WANS for 2017
12+(1/4*12m/1)
12m+3m=15m
EPS= $5m 0.3333*100c= 33.3c
15m
2016 EPS
No earnings for 2016 hence adjust the previous BEPS by conversion
12m shares =33.3c
15 m shares=? Less
12/15*33.3c
=26.7c

Rights issue and EPS.

The rights issue combine the characteristics of issues @ full market price and
bonus issue, hence when determining WANS 4 steps are involved.
STEP 1: calculation of Theoretical ex-rights price (TERP)
Start with the number previously held by an individual at their market price.
Bing in the number of new shares purchased @the rights price. Find TERP
E.g. if there was a 1 for 3 rights issue for $3 and the market price before was
$5
TERP=
3 shares @$5 = $15
1 share @$3 =$03
=$18
TERP= 18/4= $4.5
STEP 2: Show the bonus fraction
Bonus fraction = market price before issue
TERP
= $5/$4.5
STEP 3: Calculate WANS
Draw up a table to calculate the WANS. The bonus fraction would be applied
from the start of the year up to the date of rights issue but not afterwards.
STEP 4: Calculating EPS
Use the usual formula for current year EPS but when calculating comparative
EPS Simply take prior year EPS and multiply by the inverse of the bonus
fraction.
Example
In the year ended 31/12/16 there were 12m shares in issue and the earnings
per share was calculated as 33.3c. In the year ended 31/12/17 the earnings
available for ordinary shareholders amounted to $5m. The company made a
1 for 5 rights issues on 30 June 2017 @ a price of $1.50 and the cum rights
price on the last day before the rights was $2.00.
Required: Calculate BEPS
Solution
STEP 1: TERP
5 shares @ $2 =$10
1 share @ $1.50=$1.50
TERP= $10+$1.50=$11.50
6shares
= $1.92
STEP 2: Bonus fraction= market price before issue = $2/$1.92
TERP
STEP 3: Determination of WANS
Date number Bonus time wans
fraction
1 January 12m 2/1.92 6/12 6.25m
1 July 14.4 6/12 7.2m
13.45m

STEP 4: BEPS 2017= $5m = 37.2c

13.45m shares

BEPS 2016= 33.3C*$1.92/$2= 32c

DILUTED EARNINGS PER SHARE
To determine DEPS, it is necessary to adjust P/L attributable to ordinary
shareholders of the parent entity and the weighted average number of shares
to account for the effects of dilutive potential ordinary shares.
A potential ordinary share is a financial instrument or other contract that may
entitle its holder to ordinary shares.
Dilution is a reduction in BEPS or an increase in Basic loss per share resulting
from the assumption that:
 Convertible instruments are converted
 That options or warrants are exercised
 That ordinary shares are issued upon satisfaction of specified
conditions.
Formulae for DEPS
Adjust basic earnings for the after tax effects of any of the following items
deducted in arriving @ basic earnings (related to dilutive potential
ordinary shares)
 Any dividends
 Any interest recognised in the period
 Any other changes in income or expense that would result from
conversion
Diluted earnings
An entity uses P/L from continuing operations as the control number
to establish whether potential ordinary shares are dilutive /anti-
dilutive
Anti-dilutive potential ordinary shares are excluded from the
determination of DEPS.
Potential ordinary shares are considered for each issue class starting
with the most dilutive to continuing BEPS.
Generally, options and warrants are considered as they do not add to
the numerator.
Once no further dilution of continuing BEPS is achievable from
potential ordinary shares the determination of dilutive potential
ordinary shares is complete.
WANS
The number of shares applied in determining DEPS is the number of
shares applied in determining BEPS plus
  The number of shares that would be issued on the conversion of
all dilutive potential ordinary shares into ordinary shares.
 Dilutive potential ordinary shares shall be deemed to have been
converted into ordinary shares @ the beginning of the period ( if
such instruments already existed at that date) or the date of
issue of the potential ordinary shares ( not the issue of actual
ordinary shares ) if later.
 Dilutive potential ordinary shares are determined independently
for each period presented (including each interim period e.g. an
instrument which may have been considered dilutive in an
earlier quarter or period may not necessarily be dilutive relative
to current period BEPS.
Example: dilutive earnings per share
Net income $2 500 000
Deferred dividends` $200 000
Shares outstanding (01/01/17) 1 000 000
Shares outstanding (01/10/17) 1 400 000
Options outstanding (number) 30 000
Average option exercise price $35
Average stock price $55
Options proceeds if exercised $1 050 000

Required: Calculate DEPS

Solution:
Formulae= Earnings + notional income
BEPS + Notional number of shares
WANS calculation
BEPS shares 1 100 000
Options shares
Average income =30000*$35= $1 050 000
Purchased shares= $1 050 000
$55
=19 091
Unpurchased shares /free shares/bonus shares= 30 000-19 909=10 909
DEPS = $2 300 000
1 100 000+10 909
=$2,07 = 207c

UNIT: LEASES IFRS 16

OBJECTIVE: to ensure that lessees and lessors provide relevant information
in a manner that faithfully represents those transactions.
SCOPE: Applies to all leases including subleases save for: leases of biological
assets held by a lessee (apply IAS 41).
 Rights held by a lessee under licensing agreements within the scope of
IAS 38 Intangible Assets.
 Lease to exposure for or use minerals, oil, natural gas and similar non-
ex regenerate resources.
 Services concession arrangements (see IFRIC12 service concession
arrangement
DEFINITIONS
Interest rate implicit in the lease: the interest rate that yields a present
value of a) the lease payments
b) The unguaranteed residual value equal to the Sum of:
Fair value of the underlying asset
Any initial direct costs of the lessor.
Lease term: the non-cancellable period for which a lessee has a right to use
an underlying asset, plus
a) Periods covered by an extension option if exercise of that option by the
lessee is reasonably certain
b) Periods covered by a termination option if the lessee is reasonably
certain not to exercise the option.
Finance lease: is a lease that transfers substantially all the risks and rewards
incidental to ownership of an underlying asset
An operating lease: is a lease that does not transfer substantially all the risks
and rewards incidental to ownership of an underlying asset.
Inception date: is the earlier date of the lease agreement and the date of
commitment by the parties to the principal terms and conditions of the lease.
At inception of a contract, an entity shall assess whether the contract is ,or
contains a lease.
Commencement date: the date on which a lessor makes an underlying asset
available for use by the lessee @ this date:
  A lessee recognises a right of use asset and a lease liability
 A lessor shall recognise assets held under a finance lease in its
statement of financial position and present them as receivables.
A right- of- use asset: is an asset that represents a lessee’s right to use an
underlying asset for the duration of the lease term.
Initial direct costs: are the incremental costs of obtaining a lease that would
not have been incurred if the lease had not been obtained, excluding said
costs incurred by a manufacturer or dealer lessor in connection with a finance
lease.
Lease incentives: are payments made by a lessor to a lessee associated with
a lease or the reimbursement or assumption by a lessor of costs of a lessee.
Economic life: is either the period over which an asset is expected to be
economically usable by one or more users or the number of production or
similar units expected to be obtained from an asset by one or more users
Useful life: refers to the period over which an asset is expected to be available
for use by an entity or the number of production or similar units.
Identifying a lease
A contract is or contains a lease if it conveys the right to control the use of an
identifiable asset for a period in exchange for consideration (IFRS 16:9).
Control is conveyed where the customer has both the right to direct the
identifiable asset’s use and to obtain substantially all the economic benefits
from that use (IFRS 16: B9).an asset is typically identified by being explicitly
specified in a contract, but an asset can also be identified by being implicitly
specified at the time it is made available for use by the customer.
However, if the supplier has a substantive right to substitute (i.e. substitution
rights) the asset during the period of use then the customer does not have the
right of use of the asset and hence there is no lease.
Substitution rights by the supplier NO Lease…
No substitution rights by supplier -Lease (IFRS16)
Example: for each of the 2 following scenarios explain if the contract is a lease
or if it contains a lease.
1) Rachel Ltd needs to transport its goods to customers in Europe using
rail freight. The companies enter into a contract with rail freight carriers
for the use of 10 rail cars of a particular type for 5 years.

2) Rachel Ltd needs to transport its goods to customers in Europe using

rail freight. The company enters into a contract with a rail freight carrier
that requires the carrier to transport a specified quantity of goods by
 using a specific type of rail car in accordance with a specified timetable
for 5 years

Solutions:
Scenario 1
There is a lease in scenario 1. there is an identified asset i.e. 10 rail cars, of a
particular type for 5 years. the 10 rail cars are hired exclusively there won’t
be any substitution rights hence YES there is a lease.
Scenario 2
No lease because the specified rail car can be any car which means no right
of use asset. The rail cars are using a specific timetable so it can be any car
like that hence no identified asset and no control over the assets. Substitution
can be done since its just a special type which could be any of that specific
type.

Lease and non-lease components:

A combined contract where part of the payment is for the lease of the asset
and part of it is for the provision of additional services by the lessor
(maintenance) then the lessee needs to split the rental into a lease component
and a non-lease component. The payment by the lessee is to be allocated
based on the stand-alone prices of the components.

Example: Patrick enters into a contract for the use of an item of machinery
and its maintenance for a combined total of $100 000 per annum, payable at
the end of the lease period. The rental of the machinery without any
maintenance is $95 000 p.a. whilst a stand-alone maintenance contract is
$10 000 per annum.
Required:
Explain how the annual rental should be split between the lease and non-
lease component.
Solution:
Total contractual amount = $95 000+$10 000
= $105 000
Lease amount = lease without maintenance * amount paid
Total contractual amount
= 95 000 * $100 000
 105 000
=$90 476
Non-lease amount =non lease amount without lease * amount paid
Total contractual amount
= $10 000 *$100 000= $9 524
$105 000
OVERVIEW of leases:
Company Z legally owns land and buildings which it wishes to rent out to
company B (which wishes to use the asset). Company B pays rentals then
Company Z receives rentals.
From the above Company Z is the lessor (legal owner of asset) and company
B is the lessee (legal user of asset). There is need to know the accounting
transactions made the two companies i.e. the lessor and the lessee. The new
standard prescribes the right of use asset model as the way of accounting for
leases. This removes the classification of finance lease and operating
lease for the lessee, hence for lessee the accounting treatment is thru
the right of use asset model.
For the lessor classification still applies as in the previous standard (IAS
17).

Lessee accounting
One model accounting for lessees i.e. through the right of use asset model. No
classification is needed between finance lease and operating lease as the right
of use asset model applies. All leases are brought into the SFP in exception of
low value and short-term leases
Exemptions from model.
Leases with a lease term if 12 months or less and containing no purchase
options are short term leases which may be classified as short-term leases.
Leases where the underlying asset has a low value when new (such as
personal computers) or small items of office furniture and fittings can also be
exempted from the right of use asset model. This election can be made on a
lease by lease basis.
The accounting for short term/low value leases is done through expensing the
rental through P/L on a straight-line basis.
Example low value asset
Chingwa leases out a machine to Mango under a 4-year lease and Mango
elects to apply the low value exemption. The terms of the lease are that the
annual lease rentals are $2 000 payable in arrears. As an incentive Chingwa
grants Mango a rent-free period in the first year.
Required: explain how Mango would account for the lease in the fin stats.
Solution:
Mango is the lessee and Chingwa is the lessor.
Rental expense = 3* $2000 = $ $1 500
4years
Journal entries Year 1-4
Year 1
Interest expense 1 500
Accrued interest 1 500
Year 2
Interest expense 1 500
Accrued expense 500
Bank 2000
Year 3
Interest expense 1 500
Accrued interest 500
Bank 2 000
Year 4
Interest expense 1 500
Accrued interest 500
Bank 2 000

Statement of comprehensive income

Finance costs Year 1 Year 2 Year 3 Year 4
Lease interest expense 1 500 1 500 1 500 1 500

The SPL is debited by the interest expense throughout the period

Statement of financial position
Current liabilities Year 1 Year 2 Year 3 Year 4
Accrued interest 1 500 1000 500 -

Right of use asset model

Initial recognition
At the start of the lease the lessee initially recognises a right -of -use -asset
and a lease liability (IFRS 16:22)
Right of use asset Dr Lease liability Cr
Measured @ the amount of the lease Measured @ the PV of the lease
liability plus any initial direct costs payments payable over the lease
incurred by the lessee. term, discounted @ the rate implicit
in the lease.